Cash flow

Posted by admin on August 26th, 2011

The cash flow statement summaries the cash received and paid out

during a period of time which, as in the case of an income statement, is

usually a month or a year. As many of the items in an income statement

are paid for in cash, the cash flow statement could just repeat the same

information. To simplify the detail, the cash flow statement starts with

the operating income that has been earned and then adjusts for non-cash

items and movements in working capital. As a business grows more cash

is tied up in it (inventory levels rise and more customer balances are

tied up in receivables). Consequently, as a business shrinks it generates

considerable cash as the money tied up in the working capital is released.

Success is achieved when the new business starts to generate more cash

than is needed to fund the growth.

 

The income statement

Posted by admin on August 26th, 2011

The income or profit and loss statement provides a summary of the

revenue earned and the costs incurred over a period of time which is

usually a month or a year. The statement starts with the trading activities,

covering the revenue and direct costs incurred in earning that revenue.

These are followed by the indirect or overhead costs to derive the

operating income:

Revenue $100

Direct costs ($60) Costs incurred in providing products or services

such as raw materials and packaging

Gross profit $40 Also known as trading profit

Indirect costs ($25) Costs incurred in running the business such as

rent, IT and payroll

Operating income $15

Also known as ebit (earnings before interest and tax)

For example, most retailers earn revenue from selling bought-in

products. The direct costs are easily identified as the costs charged by

the manufacturer of those products. Subtracting the direct costs from the

revenue gives the gross profit or trading profit. Deducting the indirect

or non-trading costs such as rent and payroll costs gives the operating

income.

The split between what is classified as direct and indirect is up to

the business to decide and is not always obvious. For a retailer, are the

delivery costs direct (as they relate to moving the products) or indirect (as

they are a consequence of the main activity)? The answer is a commercial

judgment and there is inconsistent treatment in the retail sector. Therefore

comparison of gross profit levels between businesses is not as easy as you

might expect it to be because of the ways different businesses categories

their costs. Hence most comparisons are done at the operating income

level when all costs have been accounted for and the judgment element

removed.

The structure of an income statement is shown in Table 4.3. In the

past dividends used to be shown at the foot of an income statement as a

distribution of profit. These are now shown separately in financial statements

as a movement in shareholders’ equity. Furthermore, in published

accounts the income statement is extended to include a statement of recognized

income and costs. The purpose of this is to show the non-operating

items such as gains in property values or foreign-exchange movements.

 

The relationship of three statements

Posted by admin on August 9th, 2011

He would not include the bus tickets as they have been used and there is

no future benefi t to be derived from them.

To evaluate whether the day has been successful he needs to compare

the assets of the business with the amount originally invested.

Original capital $500

Profi t $130 Analysed in the income statement

Total equity $630

The increase in value is the profi t that has been earned. This can be

analysed in more detail in the income statement.

The income statement – day 1

The profi t has been earned by selling the dusters at more that they cost

to purchase. Money was also spent on an item that has no future benefi t

(the bus fares) and therefore this must be deducted in arriving at the profi t

earned.

Sales $250 50 dusters at $5 each

Less: cost of dusters sold ($100) 50 dusters at $2 each

Less: bus fares ($20)

Total profi t $130

Only the cost of the dusters that were sold is deducted in arriving at

the profi t. The cost of the other 150 dusters originally purchased is shown

as inventory on the balance sheet as it will provide the basis for future

trading.

In financial statements, the convention for showing negative numbers

is to put them in brackets. Hence in calculating the profi t, the cost of the

dusters and the bus fares are deducted from the revenue received.

The cash fl ow – day 1

The cash fl ow is like a bank statement, though in this example it is a

summary of the physical cash payments and receipts. It starts with the

original capital invested and shows all the cash received and paid out.

GUIDE TO FINANCIAL MANAGEMENT

32

Capital invested $500

Add: sales $250 50 dusters at $5 each

Less: dusters bought ($400) 200 dusters at $2 each

Less: holdall ($50)

Less: bus fares ($20)

Closing balance $280

Day 2

On day two the business becomes more successful, but also more complicated.

Travelling further on buses for $30, the salesman sold 60 dusters for

$5 each. He also sold 30 dusters to a part-time offi ce cleaner for $4 each,

but the offi ce cleaner promised to pay for them at the end of the week

when he received his next pay cheque. Running low on dusters for day

three, he went back to the wholesaler, opened an account and purchased

100 more dusters on credit. At the end of the month he will have to pay

the wholesaler.

The balance sheet – day 2

Again adding up the items in his possession at the end of the day that

have future benefi t for the next day and beyond, he would produce the

following:

Holdall $50

Inventory $320 160 dusters at $2 each

Money due from customer $120 30 dusters at $4

Cash $550 Analysed in the cash fl ow

Total assets $1,040

It is valid to include the money due in the balance sheet as the customer

has taken some of the stock on the basis that he will pay for it in the

future. Therefore there is a future benefi t of the cash receipt.

Although this accumulation of assets looks successful, the obligation

to the wholesaler also needs to be included as it is a future claim on the

business.

Money due to supplier $200

Original capital $500

Profi t $340 Analysed in the income statement

Total liabilities $1,040

 

The income statement – day 2

The income statement summarises a period of trade and in this example

covers day 2. The profi t for day 1 is added on at the end of the statement

to arrive at the total profi t earned by the business.

Sales: cash $300 60 dusters at $5 each

Sales: credit $120 30 dusters at $4 each

Total sales $420

Less: cost of dusters sold ($180) 90 dusters at $2 each

Less: bus fares ($30)

Profi t: day 2 $210

Profi t: day 1 $130

Total profi t $340

The sale on credit can be included in revenue at this stage as the goods

have been delivered and the business has performed all it needs to do to

fulfi l its part of the transaction. The only matter outstanding is to collect

the cash which, until it is received, puts the business at risk.

The cash fl ow – day 2

The cash fl ow continues where it fi nished the day before with the opening

balance for day two being the closing balance for day one. The new cash

received and that paid out during day two are the only items shown.

Opening balance $280

Add: sales $300 60 dusters at $5 each

Less: bus fares ($30)

Closing balance $550

Having introduced the core elements involved in the three statements,

the next stage is to look at the details of the complete statements.

The balance sheet

The balance sheet provides a snapshot of the business showing the

assets owned, liabilities owed and the money put in by investors at

a particular moment in time, typically the end of a month or year as

follows:

_ An asset is something that is owned by the business and has

a future value either through its conversion to cash (such as

inventory or receivables) or by its use in the business (such as a

piece of property, plant or equipment).

_ A liability is an obligation to pay a business or individual at a

future date. This can be either short term (such as payables due to

suppliers) or long term (such as debt).

Ironically, a business does not create wealth for itself. Any profi t that

is generated belongs to the investors who risked their capital in establishing

the business. Therefore any profi t earned becomes a liability of the

business as it belongs to the investors. Through this principle the assets

in a business will always equal the liabilities and a balance sheet will

indeed balance.

The balance sheet does not value a company as many assets are

recorded at their original cost (known as historic cost) when they were

fi rst acquired. Hence after many years, even allowing for depreciation

(see Chapter 5), items such as property, plant and equipment may on the

balance sheet have a much lower value than what they are worth to the

business or indeed their market value. The value of a company is its future

potential as an earning machine rather than the historic collection of assets

it has amassed.

 

 

Contact

Posted by admin on July 20th, 2011

Punto Rojo Marketing!
Av. Corrientes 818 Piso 4° Of 409
Phone: +54 11 4325-2790
Mail: info@puntorojomarketing.com

Editors

Posted by admin on July 20th, 2011

4m-bg is a business and finance blog that have thousands of visits thanks to users. The writters of 4m-bg that day to day works to publish a new article in this wonderful blog.

The 4m-bg staff is composed for three professional writers:

  • Mauro Quieto – mquieto@puntorojomarketing.com
  • Laura Militi – lmiliti@puntorojomarketing.com
  • Diego Rodriguez – drodriguez@puntorojomarketing.com

Financial statements and accounting systems

Posted by admin on July 19th, 2011

All businesses need a system of recording transactions and of presenting

them in a coherent way which is widely understandable. The fundamental

business model, introduced in Chapter 2 and reproduced here as

Figure 4.1, shows the fl ow of transactions round the business.

The underlying transactions can be grouped into four categories as set

out in Table 4.1. The two columns split transactions according to whether

they involve money coming into the business or money going out of the

business. The two rows are split according to whether the effect of the

transaction has either a future or a current impact.

These categories provide the basis for the three core statements that

make up a set of accounts:

_ Balance sheet. A snapshot of the business showing the assets

owned, the liabilities owed and the money put in by investors.

A balance sheet represents the items that will provide a future

benefi t or have a future claim on the business.

The fundamental business model

_ Income (or profi t and loss) statement. A trading statement that

summarises the revenue earned and the costs incurred for a

period. The costs comprise all the items that have been consumed

or have been spent in earning the revenue. For example, the cost of

telephone calls would be shown as a cost in the income statement

as the benefi t is derived at the time they are made and there is no

future benefi t to be derived. However, the purchase of telephone

equipment such as a handset is an asset that will appear on the

balance sheet as the business will be able to continue deriving

benefi t from this equipment in the future.

_ Cash fl ow. A summary of the cash received and paid for a period.

This is effectively a summarised bank statement showing money

in and money out.

As shown in Figure 4.2 on the next page, the balance sheet is a

statement at a point in time whereas the income statement and cash fl ow

summarise the activity over a period of time (typically a month or year).

The priorities of three crucial items on these statements can be summarised

by the adage that:

_ Revenue is vanity

_ Profi t is sanity

_ Cash is reality

Thus revenue that does not generate a profi t or provide a basis for

earning future profi t (a loss leader) may fl atter a business in terms of

growth but generates no shareholder value. Profi t that has been earned

but is tied up in receivables cannot be reinvested until it is turned into

cash. Without cash a business cannot survive in the longer term.

The statements in practice

To illustrate the construction of the three statements, take an example of

a door-to-door salesman who sets up a cleaning products business with

$500. He goes to a wholesaler and buys 200 dusters for $2 each and a

holdall for $50. After a hard day on the road, spending $20 on bus fares

and fi nding only a few customers, he has sold 50 of the dusters for $5

each. At the end of the fi rst day he has a lot of dusters left, some cash and

some used bus tickets. Has it been a successful day?

The balance sheet – day 1

Adding up the items in his possession at the end of the day that have

a future benefi t for the next day and beyond, he would produce the

following.

Holdall $50

Inventory $300 150 dusters at cost of $2 each

Cash $280 Analysed in the cash fl ow

Total assets $630

 

 

Presentation of management information

Posted by admin on June 30th, 2011

Financial results can be presented in a bare way that many may fi nd
diffi cult to interpret usefully. Alternatively, they can be presented with
an engaging analysis that is supported by pictorial or graphical charts to
convey important information. In his book A Primer in Data Reduction
(Wiley, 1982), A.S.C. Ehrenberg describes several methods for communicating
data through tables and charts that make it easier to read, assimilate
and act upon. Some of his techniques include:
Rounding
Most people cannot manipulate long numbers in their heads, so to enable
readers to analyse the data presented it can be helpful to round each
number to two digits. This may seem a reduction in detail, but it will
probably be suffi cient to support the decision-making it is intended to
instigate.
For example, if the margins for two products were 18.86% and 38.12%,
it can be diffi cult to compare them easily. However, with just two digits
these become 19% and 38%, making it quicker to see that one number is
half the other.

Designing management information

Posted by admin on June 28th, 2011

In many organisations the finance department is the fount of all financial
knowledge. Reports are regularly produced, often referred to anonymously
as, for example, the “Blue Book”. They are published on a set day, such as
six working days after the month end, and crafted by analysts who toil
with their spreadsheet “front ends” to drill down into the database. These
reports are often based on standard templates that have been used for
several years, are only ever added to and are rarely thinned out.
This is fi ne if managers have the skills to assess strengths and weaknesses
and identify appropriate actions that will improve performance.
Unfortunately, it often results in “so what?” being asked and does not help
drive future action or produce change. This is frequently characterised by
management reports presented with content and style that generate more
heat than light.
The defi ciency is often in the quality of the narrative that supports the
report. This can be because a finance department fi nds it easy to mechanise
the tables of data but may not have the business insight to interpret them
in a valuable way. Too often the narrative will suffer from “elevator
syndrome”, simply stating the numbers that are going up, going down or
not moving at all. This information can be obvious from the data, but what
is needed is to understand why the movements are taking place and what
is being done about the numbers that indicate there are problems.
As well as standard monthly reporting, online reporting is becoming
increasingly common as system access in organisations becomes more
widespread. Managers from all functions have access to the accounting
system and can view transactions, monitor budgets and raise purchase
orders. This can reduce, if not eliminate, the need for the printed reports
and instead move the business to providing more tailored information,
which is less cumbersome, more action oriented and allows a more
effi cient use of management time.
To create these reports requires intelligent design and communication.
The reports may be the responsibility of the financial analyst, but it is
also up to the managers who are going to read and use them to provide
feedback on how they can be improved.
The fi rst stage in designing any report is to identify its purpose and/or
the questions that it seeks to answer. Typical questions might be: “What
proportion of the budget has been spent?”; “Which transactions are over
a specifi c amount?”; “Which customer invoices are unpaid after 60 days?”
Once the purpose has been defi ned it is a simple matter to create an
appropriate report for distribution as frequently as required.
Where there are many questions to answer, a type of “dashboard” can
be created which summarises on one page the most important items of
data and performance metrics. The typical metrics are summarised in
Chapter 12 and may be in the form of a balanced business scorecard.
A helpful way to summarise signifi cant amounts of data is through
exception reporting. This is a technique of stripping out data that meets
specifi c acceptance criteria and therefore leaves the items that fail and
require action. An example might be a series of cost-centre account codes
that in month three have overspent their budget. A criterion might be
all areas that have spent more than a quarter of their budget. Even using
this criterion may generate too much information, particularly for areas
that have an uneven spend. Minor overspends can be eliminated by only
reporting areas that have spent more than four-twelfths of the annual
total or are more than, say, $1,000 overspent at the end of month three.
Working with finance
As managers build their financial acumen and experience, they should
see their finance colleagues as “business partners” who are there to help
complete the financial analysis and reports required to support decisions.
For this collaborative approach to work the operational managers need to
have a good relationship with and to communicate effectively with their
finance colleagues. This involves four things:
_ Briefi ng – describing the decision to be made and the analysis
support that is required.
_ Co-inventing – working together on the required analysis so that its
fi ndings can be interpreted and challenged.
_ Implementing – identifying the impact on such business resources
as cash and people, including how they will be sourced.
_ Communicating – presenting the proposed action plans (with
supporting analysis) to more senior management for approval.
This process assumes that the finance team has the capability and
staff numbers to provide the business partner with support. Finance
managers often have limited exposure to or experience in operational
areas. Therefore the co-invention stage really is a joint activity, with the
finance manager providing the finance skills and the operational manager
providing the operational experience.

The role of the finance department

Posted by admin on June 27th, 2011

The directors of a company have a legal responsibility for ensuring
that the company keeps appropriate accounting records which enable
them to report the fi nancial position of the business to investors, regulators
and tax authorities.
This responsibility is normally delegated to the fi nance director. Until
recently the fi nance director would be in charge of the “accounts department”,
often a large team of people whose primary role was bookkeeping.
They manually recorded every transaction in ledgers for purchases, sales,
cash and a host of other details.
Today the transaction recording is as much about computer systems
as it is about accounting. Large organisations choose highly integrated
systems that have direct data feeds with customers and suppliers, continually
reducing the need for paperwork and human intervention. The
accounts department has become the “fi nance department” where the
role is about adding value to the numbers by providing decision support
such as cost analysis, trends, investment appraisal and business plans.
The fi nance department is still responsible for record keeping and
fi nancial reporting, but has evolved into a service department that
supports the rest of the business, taking a lead in strategic planning and
putting together the business plan.
Some organisations fi nd they can split these responsibilities into
transactional work (routine record keeping) and transformational work
(the added value services). With so much of the transactional work
being electronically generated and transmitted the location of these
services is no longer required at the centre of decision-making (head
offi ce). Many organisations now outsource this work to locations such
as Bangalore where wages are lower. A robust data connection back
to head offi ce enables the transformational work to continue without
any time lag.
Financial and management reporting
In adding value to the transactional information that is recorded there are
two types of reporting:
_ Financial reporting. Summarising historic information to report externally on how the business performed (for example, the
annual report that is distributed to all investors).
_ Management reporting. Using analysis of historic information and
judgment to provide the basis of future decisions.
What managers need to know
In an organisation fi nancial acumen is a skill that will support any
manager in their career. The skill is not about knowing the intricacies
of transaction recording or the details of fi nancial reporting; it is about
having the ability to do six things:
_ Engage with the business strategy – know the organisation’s
mission, objectives, strategy and tactics at a macro level to make
sure that all actions that are taken align with these overarching
principles.
_ Understand performance indicators – know the portfolio of
metrics that are used to monitor business performance at a
company, department and project level. This includes knowing
how the indicators are calculated to make sure that actions taken
can be translated into how the indicators will be affected.
_ Read and interpret fi nancial reports – be able to read the fi nancial
reports that are generated within the business. This includes
company, department, budget area and projects. The skill is being
able to assess strengths and weaknesses and identify appropriate
actions that will improve performance.
_ Contribute to the budgetary process – participate in the budgetary
process, the setting of budgets and the monitoring of performance
through the budget year. At a detailed level this includes using
variance analysis to interpret the causes of deviation from budget
predictions and producing year-end forecasts that predict the likely
outturn for the year.
_ Know the fi nancial consequences of the decisions – identify
the fi nancial implication of decisions through the creation and
evaluation of a business case that takes into account the likely
fi nancial effects of the changes to the business that will take
place as a result of any decision. This involves venturing beyond
fi nance into judgment, but the judgment is made on the basis of
experience and sound evidence.
_ Seek ways to add value not cost – continually improve the
performance of the products and services by adding customer
value while eliminating cost and waste in their provision.
Although strength in these six abilities is by no means a fast-track
ticket up through an organisation, the opposite is almost certainly true.
Weakness in them will hold back even the most ambitious individual.
Other abilities are important, depending on the role of the manager
in the organisation; for example, sales people may fi nd it helpful to be
able to read published fi nancial statements to complete credit checks, and
those in manufacturing should know cost allocation techniques to be able
to build up a product cost. These other abilities build on the foundation
of the six abilities outlined above.

Business structures

Posted by admin on June 26th, 2011

For a business to be successful it needs to develop a revenue stream by
providing a product or service that customers will buy. The criteria for
this customer proposition are to:
_ have a product or service that meets a specifi c need for a customer
such that they will want to buy it;
_ provide the product or service better than a competitor so the
business will be chosen in preference to others;
_ charge a price that offers value to the customer yet enables the
business to earn a profi t.
These criteria are diffi cult to combine in practice. A product or service
that is better than a competitor’s is, because of its differentiating factors,
likely to cost more to provide. However, the additional cost may not be
able to be passed on to the customer in the price, and this will reduce
the profi t. Many fi rms in the same line of business seek to prosper by
exploiting the criteria in different ways; for example, a scheduled airline
providing a high-quality service at a relatively high price and a low-cost
carrier relying on low fares and no frills.
The business model
Building businesses that can generate a revenue stream requires investment
to pay for infrastructure, equipment and staff. Figure 2.1 illustrates
how a business is structured to provide a customer proposition.
The model is built on fi ve activities:
1 Starting on the left, the investors provide the capital for the business.
The cash received will be held in a bank account.
2 The cash in the business can be:
_ converted into another type of asset that will be used in the
business such as equipment or goods for sale (inventory); or
_ spent on running costs such as staff and utilities.
3 The combination of the business resources (assets and staff) provides
the basis for producing the products or services that are available for
customers to buy.
BUSINESS STRUCTURES
4 The sale of a product or service to a customer generates what is called
a receivable which, once collected, will produce more cash for the
business.
5 This new cash is used to provide any debt providers with interest on
their loans. The rest can be sent round the cycle again by being converted
into further assets or spent on running costs (back to stage 2).
Providing the whole process earns more money than it consumes, a
profi t will be generated on which tax will have to be paid. Any surplus
after tax can continue to be reinvested in the cycle or paid out to the
shareholders as a “return” on their investment.
The model illustrates the way money fl ows around a business and
provides the basis of accounting, which is the collecting, recording, analysing
and communicating of all the fi nancial activity in the business.
To manage a business effectively it is important to know how the
cash has been spent and how profi table the products or services have
been to the business. The availability of this historic information helps
management to make judgments on how to improve the performance
of business.
Crucial elements
To make a business successful requires three crucial elements:
_ Cash. The money that it is used in the cycle described above.
The fundamental business model 2.1
Without suffi cient cash it is diffi cult for any business to start the
cycle.
_ People. The means of creating the products, providing the service
and running the business. The quality of the skills of the people in
the business is crucial in achieving success.
_ Customers. A business cannot survive without customers.
Attracting customers is where the process begins, but retaining
customers by continuing to satisfy their needs is just as important.
Existing and satisfi ed customers not only provide revenue but may
also become advocates for the business.
Types of business
Although the fundamental business model does not vary, there are
infi nite ways of applying it to provide the range of products and services
that make up the business world. However, the range of products and
services can be summarised in seven broad categories.
All these activities are a combination of a product and a service
proposition to a customer. The raw material producer is primarily a
product-based business, but the service element emerges in the way
the materials are sold, the speed of response to orders and the manner
with which customer relationships are built. At the other end of the
spectrum is a service provider which is primarily a people business,
but the way this type of business can develop effi ciencies is by using
products such as, in the case of an accountant, a software package to
process tax returns.
The mix of product and service elements in the customer proposition
will defi ne the need for acquiring assets and hiring staff.
Structuring a business for fl exibility
The investment of cash in assets and staff will defi ne the fl exibility that
a business will have in responding to a changing business environment.
A rapid increase in the need for assets and staff can be diffi cult to meet,
particularly if they are specialist in nature. The assets may need to be
built by a manufacturer and the staff may need to be trained.
A business with substantial non-cash assets will fi nd it diffi cult to
adjust to a decrease in sales volume; for example, in the aftermath of
terrorist events airlines have found themselves owning assets they could
neither fi ll with passengers nor sell. A business with high staff costs may
be able to respond more quickly to a downturn by laying off people,
particularly if it has employed staff on short-term contracts (for example,
the software industry where programmers are often hired on short-term
contracts), but labour laws can make this costly.
In seeking greater fl exibility to cope with changing circumstances,
businesses may choose to outsource parts of their operations, particularly
non-core activities. This is the process of letting another business
acquire and operate the assets, and provide services or products on a
contractual basis. For example, businesses may fi nd that outsourcing their
cleaning and catering provides much greater fl exibility than recruiting and
managing their own staff. As there are many businesses supplying such
services the prices are likely to be competitive and service quality forced
upwards.
Management of any business needs to identify the optimum structure
that will enable long-term success to be achieved. This may be done by
combining owned resources with outsourced resources to provide the
products and services.
Because of constraints on how quickly a business can respond to
signifi cant changes, careful planning is essential. This involves making
projections about demand and making sure an appropriate business infrastructure
is in place. As events unfold, the judgments made need to be
refi ned in the light of new information and opportunities.
Causes of failure
The high proportion of businesses that fail never seems to deter entrepreneurs.
Failure is often a result of one of the following three events:
_ Insuffi cient revenue. Producing products or services that
customers do not buy in suffi cient quantities. This is often caused
by entrepreneurs not really understanding the needs of customers.
An example is what marketers call “a musical ash tray”, a product
that meets no specifi c need and relies wholly on customers
making whimsical purchases.
_ Excess fi xed cost. A high cost base in a business that does not
enable a profi t to be made; or a cost base that is not fl exible
enough to adapt to changing volumes if sales decline. Many
airlines struggle to survive because of the way that demand for air
travel can suddenly slump.
_ Poor quality and service. The inability of managers and staff
to plan, control and operate the business effectively. This affects
the quality and reliability of the business, ultimately leading to a
decline in its revenue. Many have experienced examples of this
in poorly run restaurants and have left saying “never again”. The
word spreads and that business continues its downward spiral.

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