Financial Management and Business Planning

Meassuring Firm Performance

• The Balance Sheet: is a snapshot of a firm’s financial position at a particular point in time (normally the last day of accounting period). It summarizes assets, liabilities and owners’ equity.
• The Income Statement: summarizes revenues and expenses over a period of time. (revenues, expenses, profits before taxes, taxes paid and profits after taxes)
• Financial Performance ratios (Key performance indicators)

The Balance Sheet

• Every organization has assets and liabilities Assets
• $\text{Assets}-\text{Liabilities}=\text{Owners’ Equity}$
• Assets are items to which the organization has legal title
• Current assets can be converted into cash within 1 year
• Fixed assets have a life greater than 1 year Liabillities
• Liabilities: debt owed (suppliers, employees, government)
• Current Liabilities debt normally paid within a year (accounts payable, taxes, wages, bank loan, …)
• Long-term liabilities debt normally paid beyond current year Owners Equity
• Owners’ Equity: The difference between assets and liabilities is a means of measuring what the organization is worth – it’s equity:
• Owners’ equity often appears as two components in a balance sheet:
• Stock: par value per share, also known as nominal or original value, is the face value of a bond or the value of a stock certificate, as stated in the corporate charter
• Retained earnings: the amount of net income left over for the business after it has paid out dividends to its shareholders

The Income Statement

• Income Statement summarizes revenues and expenses over a specified accounting period (Month, quarter, and year)
• Major components: Revenues, Expenses, Profits
• Revenues: from sales of goods/services
• Expenses: cost of goods sold, rent, insurance, wages, depreciation
• Income or profit before taxes: Revenues – Expenses
• Net income (profit): Income (profit) before taxes – taxes

Estimated Values in Financial Statements

• Financial statements are often estimated: they may not reflect market values
• Assets are valued on the basis of their cost (book value)
• Land is listed at the price paid - not its market value
• Plant and equipment is listed at the price paid less accumulated depreciation
• Depreciation on equipment computed using a depreciation model
• Stock or Shares are listed at par value (issue price)
• Finished goods inventory – manufacturing cost
• Most firms include their accounting methods/assumptions
• within periodic reports to aid interpretation of statements

Financial Performance Ratios

• Decision makers (inside and outside) need to know general performance of a firm
• Balance sheet/income statements are used for assessment
• Financial Ratio Analysis : key performance indicators
• These performance measures are financial ratios calculated from items on the income statement and balance sheet.
• In interpreting ratios, analysts should calculate the ratios over a number of periods to do a trend analysis
• Ratios should also be compared to industry standards
• Industry standards routinely published by commercial and government websites/publications (Statistics Canada)

Financial Ratios

• Liquidity ratios: firm’s ability to meet short term financial obligations
  • Company’s net reserve of cash and assets that easily can be converted to cash is called working capital.
  • Working capital = current assets − current liabilities
  • The adequacy of working capital is measured with two ratios:
    • Current ratio
    • Acid-test ratio (Quick ratio)
  • $\text{Current ratio}=\frac{\text{current assets}}{\text{current liabilities}}$
  • A current ratio of 2+ is adequate
  • $\text{Acid-test (quick) ratio}=\frac{\text{quick assets}}{\text{current liabilities}}$
    • Where quick assets are assets that are quickly convertible to cash
      • Cash, accounts receivable, notes receivable, temporary investments in the market
      • Inventory is not a quick asset
    • An acid-test > 1 is adequate
• Debt Management Ratios: the extend to which a firm relies on debt for its operations
  • $\text{Debt Ratio}=\frac{\text{total liabilities}}{\text{total assets}}$: this is a measure of financial strength
  • Debt ratio < 0.2 or less indicates sound financial condition
  • $\text{Equity Ratio}=\frac{\text{total owners’ equity}}{\text{total assets}}$
    • The smaller the ratio, the more dependent a firm on debt and the higher risk of not being able to manage debt
  • Comparison to industry norms/trend analysis necessary
• Efficiency Ratios: assess efficiency of use of its assets
  • $\text{Inventory Turnover Ratio}=\frac{\text{Sales}}{\text{Average inventory at selling price}}$
    • The total sale in a period divided by the value of average inventory level at the same period by the average selling price
    • A higher ratio points to Strong sales and a lower ratio to weak sales
• Profitability Ratios: How productively assets have been employed in producing a profit?
  • $\text{ROA}=\frac{\text{Net income}}{\text{total assets}}$
  • $\text{ROE}=\frac{\text{Net income}}{\text{total equity}}$

Business Plan

A 3-5 year road map of a business

• Outlines operating, marketing, financial and HR status and intensions
• Identifies the nature and feasibility of the business considering financing options and forecasts cash flows
• Drafting a good BP is an essential step in starting a business
• Balance sheets, income statements and financial ratios are used in a BP to analuze the financial status of the company

Aspects of a Business Plan

• Executive summary
  • Convinces investors to read further
  • Primarily convinces reader of future success
  • Features the mission statement, provided products and services, overall financial health, future plans
• Company Description
  • High level overview of company and operations
  • Products / services and market needs
  • Company HR capabilities
  • Competitive advantages of the company
• Market Analysis / Future Outlook
  • Description of industry and growth plans of company
  • Market demand: discussion of target market
  • Future trends: customer demand, technology and market share
  • Market share: present / future share compared to competitors
  • Weaknesses and strengths
  • IT and technology advances
  • Geographical location
  • Financial situation
  • Experience and human factors
  • Pricing, revenue and cash flow predictions
  • Regulatory environment
• Management and Organization
  • Explanation of structure of business in detail
    • sole proprietorship, partnership or corporation
    • Key corporate employee information provided
      • Experience, education, qualifications
  • Functional groups, corporate structure, job titles
    • How this structure suits corporate mission and future growth
• Funding Requirements
  • Discussion of where the funding will originate
    • Owners and investors
    • Banks and other financial institutions
    • How company will attract investors for new projects or expansion
• Sales and Marketing
  • Strategies to penetrate target markets
  • Creation / maintaining of customers
  • Recognition and fulfillment of needs
  • Communication mechanisms (surveys, advertisements) promotions