Entrepreneurship: To go with Chapter 12 HDCS 4369 1 Accounting Method Cash - report income received, deduct expenses as you pay them Used by service and construction Accrual - report income when earned, deduct expenses when incurred Used by manufacturers and retail stores HDCS 4369 2 Good Records: Monitor your business’s progress Prepare your financial statements Identify whether receipts apply to taxable or nontaxable income Support the income, expenses, and credits you report in your tax returns HDCS 4369 3 Supporting Documents Gross Receipts Income Purchases Items you buy Expenses Costs you incur Employment taxes Immigration and nationalization I-9 Forms Assets Things you own Special expenses Travel, gifts, transportation, etc. HDCS 4369 4 Assets When and how acquired Purchase price Improvement costs Depreciation Deductions How used Selling price Sales expenses HDCS 4369 5 The Accounting Equation Assets = Liabilities + Owner’s Equity Assets - anything that is owned Liabilities - anything that is owed Owner’s Equity - financial rights to the assets of a business HDCS 4369 6 Accounting Forms Pro Forma Financial Statements The Income Statement The Balance Sheet The Cash Flow Statement Budgets and Projections HDCS 4369 7 Pro Forma Financial Statements Projected statistical reports Used to illustrate expected financial status of business in the future Information can be obtained from: Robert Morris Associates (RMA Annual Statement Studies) Dun & Bradstreet (several different publications) Prentice-Hall (Troy’s Almanac of Business and Industrial Ratios) HDCS 4369 8 Pro Forma Income & Expenses Sales Revenues Cost of Goods Sold Materials, Labor, Overhead Gross Margin Operating Expenses Selling (salaries, advertising), Research and Development, Depreciation Income (Loss) from Operations HDCS 4369 9 Potential Problems: Pro Forma Income Statements Estimate of sales revenue is critical Prepare two different statements Averages are not very encouraging in many cases Determine why your business will be different from the average HDCS 4369 10 Pro Forma Balance Sheets Try using averages derived from a number of similar businesses Remember that actual numbers will vary, sometimes drastically, from averages HDCS 4369 11 Pro Forma Balance Sheet Assets Current Assets Fixed Assets Liabilities Current Liabilities Long-Term Liabilities Equity HDCS 4369 12 Pro Forma Cash Flow Beginning Cash Balance Receipts Cash Disbursements HDCS 4369 13 Pro Formas = Excellent Tools Estimate capital to start and run firm for first 3 to 6 months Income Statement Balance Sheet HDCS 4369 14 Budgeting Two primary purposes: To help project when the firm can be profitable To help determine the cash flow expected from the operations of the firm HDCS 4369 15 Profit Plan Detailed list of expected sales revenue and expenses over the planning period Planning period Designed to set profit goals and steps to reach those goals List all production expenses Determine which expenses needed to generate desired level of sales HDCS 4369 16 Estimated Budget Objective: to increase the net income figure by examining each expenditure First, examine each item (operations, salaries, rent, advertising, interest, etc.) Make budget revisions to reflect changes Plan for the cash needs of the firm When, and for what, will cash be needed? HDCS 4369 17 Budget Process Consider all the expenses your firm will incur in the first few months of operation Cash flow - difference between cash receipts and cash payments If this is negative, then additional funds must be acquired HDCS 4369 18 Asset Requirements Tangible items required to produce sales Percentage-of-Sales Method Assumes that asset requirements grow in proportion to the growth in sales Problems All assets do NOT increase proportionately with sales Fixed assets tend to increase as capacity is reached by a major addition to equip/plant HDCS 4369 19 Break-Even Analysis Determination of the number of units sold, or dollar volume of sales, that must be generated before the firm covers all its operating costs (or……Breaks Even!) HDCS 4369 20 Break-Even Analysis: Contribution margin = revenue - variable costs Fixed costs Variable costs Semivariable costs HDCS 4369 21 Fixed Costs Direct materials and supplies Direct labor Overhead cost Indirect costs HDCS 4369 22 Variable Costs Expenses which vary directly with changes in sales levels Variable expenses are sales driven Do not depend on past management decisions HDCS 4369 23 Semivariable Costs Cannot be identified as either fixed or variable Arbitrary decision made to allocate amounts to fixed and how much to variable HDCS 4369 24