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Financial Statements for Small Business Management. Dr. Alex White Ag & Applied Economics [email protected] 540-231-3132 http://faculty.agecon.vt.edu/alexwhite/. Outline. Why you need financial statements What financial statements you need Construction of statements

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Financial statements for small business management

Financial Statements for Small Business Management

Dr. Alex White

Ag & Applied Economics

[email protected]

540-231-3132

http://faculty.agecon.vt.edu/alexwhite/


Outline
Outline

  • Why you need financial statements

  • What financial statements you need

  • Construction of statements

    • Start-up capital exercise

    • Labor cost exercise

    • Balance sheet exercise

  • Breakeven analysis

  • Ratio Analysis


Why you need em
Why you need ‘em

  • Applying for loans

    • Start-up loans, operating loans/lines, etc.

    • Typical loan application (“loan app”)

      • 2-3 years of balance sheets, income statements

        • Historical, projected

    • Impress your lender with:

      • Cash flow statement and breakevens

      • Best/worst case scenarios


Why you need em1
Why you need ‘em

  • Powerful management tools

    • Compare the business to the industry averages

    • Identify strengths/weaknesses of the business

    • Identify trends within the business

    • Identify strategies to improve

    • Enterprise analysis!! (woo hoo!!)

  • Helps with tax preparation

    • Improved recordkeeping


The main statements
The Main Statements

  • Balance sheet

    • Listing of what you own and how you paid for it

      • Assets = Liabilities + Net Worth

      • Value of Assets = Debt financing + “Owner financing”

    • Tells lender

      • Liquidity and solvency position

      • Outstanding debts, creditors

      • Assets available for collateral

    • Not a useful day-to-day tool for managers


The main statements1
The Main Statements

  • Income Statement

    • Shows the economic profit for the period (year)

      • Revenues – COGS – Overhead = EBT

    • Cash vs accrual accounting

    • Lenders & managers use to assess:

      • Profitability, Repayment ability, and Financial efficiency

      • Breakevens, sensitivity analysis

    • Retail operations usually do a weekly income statements


The main statements2
The Main Statements

  • Cash Flow Statement (Budget)

    • Shows all cash coming in/going out and the timing

    • Helps the lender and manager:

      • Estimate cash surplus/deficits for each period

      • Shift the timing of cash flows

      • Determine when to schedule loan payments

      • Determine operating loan needs and terms

    • IMO – the most powerful statement for managers


Using financial statements
Using Financial Statements

  • Calculate ratios and measures

  • Compare to benchmarks (RMA, S&P, etc.)

    • Available at libraries

      • Usually at the reference desk

      • Robert Morris Associates – Annual Statement Studies

  • Look for trends over time

    • Compare years side-by-side


Building the statements
Building the Statements

  • Alex’s preferred method

    • Start-up capital worksheet

    • Labor cost budgets

    • Balance sheet (Day 1, Year 1)

    • Projected cash flow statement

    • Projected income statement

    • Projected balance sheet (Day 1, Year 2)

    • Yadda yadda yadda


Start up capital worksheet
Start-up Capital Worksheet

  • Makes you think about all the assets you will need before opening the doors

    • How you will pay for each item

      • Owner capital (cash or net worth)

      • Term loan

        • “Hard assets” - machinery, equipment, real estate, improvements

      • Operating loan/line

        • “Operating assets” – inventory, prepaids, etc.

  • Use a 10-25% fudge factor


Labor cost estimate
Labor Cost Estimate

  • For each “type” of employee

    • Manager, cashier, etc.

  • Estimates the payroll taxes

    • FICA, FUTA, Medicare, worker’s comp.

  • Estimates cost of non-cash benefits

    • Insurance, retirement, uniform, company car, etc.

  • Determines $cost/hour and $value/hour

    • Useful in budgeting and negotiation!


Balance sheet
Balance Sheet

  • Assets = Value of things used in the business

    • Only what you have that day!!

    • Current Assets = life of about 1 year or less

      • Cash, savings, inventory, A/Rec., prepaids, supplies, etc.

    • Non-current Assets = life greater than 1 year

      • Machinery, equipment, real estate, improvements

    • List each at its purchase cost

      • Lenders want market value instead!


Balance sheet1
Balance Sheet

  • Liabilities = what you owe as of that day

    • Current Liabilities = owed within 1 year

      • Operating loan, A/Pay., principal due, accrued interest

    • Non-current liabilities = owed AFTER 1 year

      • Remaining principal balances

    • List the actual dollar amount owed as of that day

  • Net Worth = owner’s investment as of that day

    • Original cash invested – withdrawals + additions

    • Retained Earnings ~ net income from previous years


Cash flow statement
Cash Flow Statement

  • Cash “Budget”

  • List cash inflows WHEN they occur

  • List cash outflows WHEN they occur

  • Bottom half deals with operating loan

    • Thank goodness for computers!

  • Helps you do your projected balance sheet & income statement


Income statement
Income Statement

  • List of revenues and expenses

  • “Cheater’s” method = use total column of cash flow statement

    • Except for principal payments, income taxes

    • Add depreciation

  • For “accrual” statements

    • Need to account for changes in inventories, payables, receivables, etc.


Projected balance sheet
Projected Balance Sheet

  • From cash flow stmt

    • Cash balance

    • Operating loan balance & accrued interest

  • Adjust other asset values as needed

    • Add another year of depreciation on hard assets

  • From income statement

    • Net income helps determined retained earnings

  • 4-step process for loans


Breakeven analysis
Breakeven Analysis

  • Measure of minimum performance needed

  • 1,000s of ways to calculate BEs

  • Key equation

    • (Price – COGS) x Qty sold – Overhead = $0

  • BE qty. = Overhead / (Price – COGS)

  • BE Price = Overhead / Qty Sold + COGS


Ratio analysis benchmarks
Ratio Analysis & Benchmarks

  • RMA Annual Statement Studies

    • Indexed by NAICS codes

      • By Sales, by Assets, by Year

    • Top, middle, bottom quartiles

  • Compare ratios to benchmarks

  • Look for trends over time

    • That’s why lenders want 2-3 years of statements


Ratio analysis
Ratio Analysis

  • Identify strengths and weaknesses

  • Develop strategies to improve the financial condition

    • Cost control

    • Pricing

    • Marketing

    • Debt structure

    • Labor efficiency, etc.


Financial ratios
Financial Ratios

  • Liquidity – ability to meet current obligations

    • Current Ratio current assets/current liabilities

    • Quick Ratio (current asset – inventory)/cur. liab.

  • Solvency – ability to meet all debts

    • Debt/Asset total liabilities/total assets

    • Debt/Worth total liabilities/net worth


Financial ratios1
Financial Ratios

  • Repayment ability

    • EBIT/Interest EBIT/Interest

    • Debt Coverage Ratio

      (EBT + other income + Depreciation + Interest Expense – Taxes & Family Living) / Annual P&I payments

  • Profitability

    • ROA EBT/Total Assets

    • ROE EBT/Net Worth


Financial ratios2
Financial Ratios

  • Financial Efficiency

    • Sales/Total Assets

    • COGS/Sales

    • Operating Exp/Sales

    • Operating Profit Margin EBT/Sales


Spreadsheet template
Spreadsheet Template

  • http://faculty.agecon.vt.edu/alexwhite/

    • Go to the Small Business tab

    • Built as a teaching tool for start-up businesses

      • Excel 2003

    • Can be used for existing businesses


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