A crash course in financial management for startup businesses Presented by:

Matt H. Evans SCORE Mentor

Finance 101 for Startups Outline

• Module 1 – How Accounting Works

• Module 2 – Reading the Financial Statements

• Module 3 – Analyzing the Financial Statements

• Module 4 – Additional Financial Analysis

• Module 5 – Evaluating Long Term Investments

• Module 6 – Some Advanced Concepts

1

Workshop Roadmap Overview

2

Accounting

Financial Statements

Analyze the Financials

Start with Accounting

Generate the Financial Statements

Apply Analytical Tools and Techniques

Make Objective Decisions per the Numbers

Manage the Business

You as the Business Owner should spend time measuring

and managing the business based on the numbers

Module 1 How Accounting Works

3

Overview of how the accounting process works at

a detail transaction level

Think in Terms of Your Check Book Module 1

4

• All transactions pass through your Check Book

• All transactions must be recorded

• Businesses have a wide range of transactions:

- Customers buy your products or services = Cash

Inflows

- Vendors and Employees must be paid = Cash Outflows

Cash Inflows

(Deposits)

Cash Outflows

(Checks)

Accrual Accounting is Preferred Module 1

5

Most transactions are cash basis (pass through your cash

account), but . . .

• Accrual Accounting recognizes revenues when earned before

you collect the cash – Accounts Receivable Account

• Accrual Accounting recognizes expenses when incurred

before you make payment – Accounts Payable Account

• Cash Basis – Only post transactions when they go in and

out of your Check Book

• Tracking – Make sure you can control and track the

money you owe others in the future and collect all money

owed to you (customers pay on time when due).

Simple Cash Basis Accounting Module 1

6

Simple Spreadsheet for Cash Basis Accounting

Year:

Date Description Name Amount Category RefRevenues: (Cash Collected from Sales to Customers)

2/8/2018 Sold 18 bars soap at Eastern Market Various Walk By Traffic 54.00$ Sales Revenue

2/17/2018 Sold 20 bars soap to Rosa Ela Shop Rosa Ela Shop in College Prk 40.00$ Sales Revenue

2/22/2018 Sold 22 bars soap at Dupont Circle Various Walk By Traffic 66.00$ Sales Revenue

Feb-18 Online Orders of Soap - Etsy Various per Etsy 22.00$ Sales Revenue

TOTAL REVENUES 182.00$

Expenses: (Cash Paid for all business related expenses)1/6/2018 Soap Materials Sarah's Craft House (110.09)$ Materials Expense

1/15/2018 Booth Materials for Markets M-Displays Inc (75.00)$ Marketing Expense

1/22/2018 Promotion Flyers Office Max (36.55)$ Marketing Expense

2/6/2018 License Fee to County DC Dept of Cons / Reg Affairs (115.00)$ Legal Expenses

TOTAL EXPENSES (336.64)$

PROFIT OR (LOSS) (154.64)$

Five Major Groups of Accounts Module 1

Businesses invest in assets two ways: Liabilities and Equity.

Assets exist for one single reason: To Generate Revenues

1. Assets – Resources of the Business

2. Liabilities – Obligations

3. Equity – Investments by Owners

4. Revenues – Inflows from Sales

5. Expenses – Outflows for Costs

Balance Sheet

Income Statement

The Accounting Model can be summarized through two equations: Assets = Liabilities + Equity Revenues – Expenses = Profit or (Loss)

7

General Ledger Accounts Module 1

Chart of Accounts is the structure by which all transactions

are categorized and reported by the business

Cash Money in the bank

Accounts Receivable Amounts owed to the company for sales

Inventory Pants, Shirts, Hats, Shoes, Socks, Belts, etc.

Prepaid Expenses Amounts paid in advance

Furniture and Fixtures Storefront assets such as tables, racks, chairs, etc.

Machinery and Equipment Property used to manufacture clothing (Sewing Machines)

Accounts Payable Amounts that must be paid to vendors / suppliers

Loans Payable Amounts due to banks

Long Term Debt Amounts due to investors or bank against long term assets

Owners Capital Account Amount invested by the owner of the business

Retained Earnings Profits held by the business for reinvesting

Sales Revenue Amount of revenues from selling products / services

Cost of Goods Sold Cost of inventory that has been sold

Administrative Expense Cost of office support personnel

Selling and Marketing Expense Advertising, Sales Commissions, Trade Show Displays, etc.

Utility Expense Gas, Water & Electric expenses

Depreciation Expense Expense a portion of the cost of a long term asset

Assets

Liabilities

Equity

Revenues

Expenses

8

Posting Entries - Debits vs. Credits

9

Module 1

Account Type DEBIT CREDIT

Asset Increase Decrease

Liability Decrease Increase

Equity Decrease Increase

Revenues Decrease Increase

Expenses Increase Decrease

Every transaction has two sides in the world of accounting – Debit (Left Side) and Credit (Right Side). Everything must balance out!

Most Transactions Go Thru the Cash Account Module 1

10

1-6-2014 Purchase office supplies

1-1-2014 Beginning Balance

Cash

1-16-2014 Run Bi Weekly Payroll

1-12-2014 Deposit payment from customer

1-26-2014 Pay Monthly Electric Bill

1-22-2014 Insurance Premium Paid

$ 4,220.55

$ 142.20

1-31-2014 Ending Balance

$ 3,600.00

$ 2,640.00

$ 265.00

$ 516.30

$ 4,257.05

Debit (Left) Credit (Right)

Let’s walk through a few accounting entries as it relates to the Cash Account

The Overall Process Module 1

11

Accounting

System

Financial

Statements

End of Period

Accrual Entries

Transactions

(Mostly Cash Basis)

Post to General

Ledger Accounts

Accounting is a very iterative process that captures transactions (inputs)

to generate Financial Statements (outputs)

Balance

Sheet

Income

Statement

Economic Activity of the

Business

Exercise 1 – Accounting Entries Module 1

12

Let’s go through a startup business and see how accounting transactions get posted over time Three phases take place over time when starting a business: 1. Fund the Business – Financing Transactions 2. Acquire the Right Mix of Assets to Generate Revenues –

Investment Transactions 3. Generate Revenues and Expenses – Operating Transactions

Someone in your business must be responsible for

posting accounting transactions on a regular basis

Module 2 Financial Statements

13

Read and understand the three financial

statements associated with your business

Three Financial Statements Module 2

• Financial condition of a company at a given point in time

• Consists of three components: Assets, Liabilities and Owners Equity

• Profit or Loss of a company over a period of time

• The critical indicator of company performance!

• Consists of two components: Revenues and Expenses

• Sources and uses of cash over a period of time

• Consists of three activities: Operating, Investing, and Financing

Income

Statement

Statement of Cash Flow

Balance

Sheet

14

Balance Sheet – Asset Side Module 2

These accounts should Turnover in the Current Year

15

Long term investments in the business should generate positive returns

Current Assets

Cash 850

Receivables 2,300

Inventories 6,600

Prepaid Insurance 400

Total Current Assets 10,150

Long Term Assets

Furniture and Fixtures 1,950

Vehicle 12,400

Special Equipment 6,450

Intangible - Patent 1,200

Total Long Term Assets 22,000

Total Assets 32,150

Group assets between current and long term when presenting the Balance Sheet

Balance Sheet – Liabilities and Equity Side Module 2

Pay within the next 12 months

16

Be careful – High debt level equates to a high risk of default

Currrent Liabilities

Accounts Payable 1,760

Salaries Payable 1,500

Short Term Loan Payable 3,500

Total Current Liabilities 6,760

Long Term Liabilities

Bank Loan on Vehicle 9,800

Total Long Term Liabilities 9,800

Total Liabilities 16,560

Equity

Owners Capital Account 14,690

Retained Earnings 1,100

Owners Withdrawal (200)

Total Equity 15,590

Total Liabilities + Equity 32,150

Group liabilities between current and long term when presenting the Balance Sheet

Income Statement Module 2

Operating Expenses

Non-Operating Expenses

Non-Operating line items add “noise” to Income

Statements – they can be both revenue and expense 17

Sales Revenues 6,800

Cost of Goods Sold 2,600

Gross Profit 4,200

Selling and Marketing Expenses 1,824

Rent and Utilities 2,600

Administrative Support Expenses 750

Other Operating Expenses 300

Operating Income (1,274)

Interest Expense 81

Special Legal Fee 300

Net Income (1,655)

TOP LINE

BOTTOM LINE

Distinguish Operating vs. Non Operating when presenting the Income Statement

Reporting Cash Flows – Three Categories Module 2

18

Operating Activities

• Cash received from customers

• Payments made to vendors and employees

• Tax payments, rent payments, utilities, etc.

Investment Activities • Invest in Real Estate

• Sell Off Equipment

Financing Activities • Secure Long Term Financing (Loan)

• Distribute Income to Owners

For financial reporting purposes, cash flows have three categories:

Statement of Cash Flow Module 2

You eventually want your business to be cash flow positive from its operations so you can avoid having to finance day to day operations

19

Cash Flow from Operations

Net Income 2,300

Add back Depreciation 800

Changes in Current Assets and Liabilities

Receivables 900

Payables (1,200)

Inventories 3,200

Cash from Operations 6,000

Cash Flow from Investments

Purchase of Plant Equipment (7,800)

Sale of Fixed Assets 1,300

Cash from Investments (6,500)

Cash Flow from Financing

Proceeds from Issuing Debt 2,500

Pay down bank loan (1,190)

Capital contribution by owner 2,000

Cash from Financing 1,310

Change in Cash for Year 810

Exercise 1 – Generate Financial Statements Module 2

20

Now let’s close out the accounting period and generate financial statements per the balances that are outstanding in the various general ledger accounts The goal is to continually review the financial statements on a regular basis (monthly or at least quarterly) to assess where we stand and take corrective action

Sales is the most important enabler for producing

favorable financial results. You must spend time and

effort on acquiring customers – selling!

Module 3 Analyze the Financials

21

Apply analytical techniques to your financial

statements to better assess where you stand

Financial Terminology Module 3

22

Debt – Liabilities such as Loans, Mortgages, Bonds, and Commercial Paper (large public corporations). High debt levels equates to high risk.

Equity – The amount of funds invested by owners of the business + profits that are retained by the business for future growth.

Liquidity – The ability of a company to convert assets into cash for meeting short-term obligations

Leverage – How a company finances its assets; debt vs. equity

Net Income or Profits – The residual income remaining after all expenses.

Rate of Return – How much return does the investment generate for the business; residual income after all costs. It is important for long term assets to generate positive returns.

Turn Over – The ability of a company to turn over and convert an asset into something else, such as sales or cash. It is important to turn over current assets into cash.

Working Capital – The funds available to the business within the current operating cycle, expressed as current assets in excess of current liabilities.

Every business owner should be financially smart. This will require an understanding of some important concepts such as:

Another Important Concept is Turnover Module 3

Any asset that is “current” needs to turnover – the shorter the cycle the better which in turn reduces the need to finance the current operations of the business.

Accounts

Receivable

Cash

Inventory

Sale

Eventually everything will flow through your cash account!

23

Three Useful Analytical Techniques Module 3

24

Ratio Analysis • Divide one number by another number • Easy to benchmark and understand performance Horizontal Analysis • Track Trends over Time • Key Trends include Sales Revenues, Net Income, Debt Levels Vertical Analysis • Track Relationships (between accounts) over Time • Monitor proportion of debt and equity to assets – too much debt equates to

higher risk • Monitor proportion of non-operating expenses to operating expenses – most

of your costs should be operating with minimal non-operating expenses

Analyze a set of financial statements:

Four Types of Ratios Module 3

25

Liquidity Ability to meet short-term

obligations of the business

Leverage Degree to which assets are

financed by debt

Asset Management Management’s ability to manage

assets

Profitability Degree of profitability generated

You need both a Balance Sheet and Income Statement

in order to calculate ratios

Ratios help you measure the following:

Liquidity – Meet Short Term Obligations Module 3

26

Measures the ability of a company to meet its short term obligations

Current Ratio =

Quick Ratio =

Current Assets

Current Liabilities

Current Assets - Inventory

Current Liabilities

These ratios should be greater than 1.0 since you have to

have sufficient liquid assets that cover your current

liabilities

Asset Management Ratios Module 3

27

Use Ratios to measure how well a company manages its current assets

Accounts Receivable Turnover

Sales

Accounts

Receivable

Days Held in Accounts Receivable

A / R Turnover

365 Days

Inventory Turnover

Cost of Goods Sold

Inventory Days Held in Inventory

365 Days

Inventory Turnover

Measuring Risk (Debt Levels) Module 3

28

Measure the degree to which the company is leveraged in terms of debt and equity

Debt to Equity

Debt to Assets

Total Liabilities

Owners Equity

Total Liabilities

Total Assets

Greater than 100% means company is using more debt than equity – more risk to the company

Greater than 50% means the company is using more debt than equity – more risk to the company

Calculate Your Margins Module 3

29

Profit Margin

Net Income

Sales

Operating Margin Sales

Operating Income

Return on Assets

Net Income

Total Assets (1)

Gross Margin

Gross Profit

Sales

(1) Average balances for the year are often used

Know your margins – every industry has an approximate

margin it should generate

Use Ratios to measure profitability and benchmark to your respective industry

Horizontal - Track Your Historical Trends Module 3

30

Another easy way to read and understand financial results is to

look at trends from period to period

2004 2005 2006

Sales Revenues $ 120,000 $ 135,000 $ 146,000

Operating Expenses $ 68,000 $ 73,000 $ 78,000

Net Income $ 22,000 $ 26,000 $ 29,000

$-

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

$140,000

$160,000

2004 2005 2006

Sales Revenues

Operating

Expenses

Net IncomeIt can be easier to read trends when you show it graphically

Vertical Analysis – Income Statement Module 3

31

Express the balances as a percentage of Total Revenues to size up the breakdown of all line items on the Income Statement

%

Revenues Breakdown

Sales Revenues 4,000.00$ 100%

Total Revenues 4,000.00

ExpensesCost of Goods Sold 1,320.00 33%

Office Supply Expense 680.90 17%

Depreciation Expense 458.33 11%

Interest Expense 278.96 7%

Tax Expense 312.50 8%

Total Expenses 3,050.69 76%

Net Income 949.31$ 24%

Vertical Analysis – Balance Sheet Module 3

32

Percentage Breakdown of all assets

Assets %

Current Assets Breakdown

Cash 32,714.60$ 32%

Accounts Receivable -$ 0%

Inventory 9,680.00$ 9%

Total Current Assets 42,394.60 41%

Long Term Assets

Furniture & Fixtures 6,104.50 6%

Warehouse Facility 55,000.00$

Less Accumulated Depreciaiton 458.33$

Net Warehouse Facility 54,541.67 53%

Total Long Term Assets 60,646.17 59%

Total Assets 103,040.77 100%

Minimize and Turnover

Generate a Return

Vertical Analysis – Balance Sheet Module 3

33

Percentage Breakdown of all liabilities and equity

Liabilities

Current Liabilities

Accounts Payable 591.46 1%

Mortgage Payable - Current 305.81 0%

Total Current Liabilities 897.27 1%

Long Term Liabilities

Mortgage Payable 51,194.19 50%

Total Long Term Liabilities 51,194.19 50%

Total Liabilities 52,091.46 51%

EquityCapital Account 50,000.00 49%

Retained Earnings 949.31 1%

Total Equity 50,949.31 49%

Total Liab + Equity 103,040.77 100%

Benchmark Your Performance Module 3

34

Per the Arlington Public Library, two sources that can help you benchmark are:

RMA (Risk Management Association) Annual Statement Studies – Financial Ratios

2017 Almanac of Business and Industrial Financial Ratios, 48th Edition

1. Know your NAICS Code: 448110 = Men’s Clothing Retail 448120 = Women’s Clothing Retail 448140 = Family Clothing Retail 448150 = Clothing Accessories 448210 = Shoes Retail 448310 = Jewelry Retail 2. Know your size by total assets and total sales

1. Know your Industry Code: 315215 = Clothing Manufacturing 448115 = Clothing Retail Store 2. Know your size by total assets and total sales

http://www.bizstats.com/

Here are some online sources:

https://www.sba.gov/tools/sizeup

Exercise 2 – Calculate Ratios Module 3

35

Let’s go through an example of calculating three ratios using the financial statements that we compiled from Exercise 1 This is how you gain insights into your financial performance – you cannot just read the financial statements; you need to analyze the financials!

Ratios are the most common technique used to analyze a set of financial statements

36

Take a Break

Module 4 Additional Analysis

37

Additional concepts related to financial analysis

Cost Analysis Module 4

Sales Volume

Cost Variable

Fixed

Variable Cost – Varies or changes with changes in sales. Includes production labor, raw materials and various discretionary items such as advertising.

Fixed Cost – Remains the same regardless of activity levels. Tends to be long-term commitments or non-discretionary items such as Rent, Insurance, Interest, Depreciation and Senior Management Salaries.

A scalable business is one where you increase the volume sold and you see lower marginal cost. If your sales grow and your total cost continue to go up, you do not have a scalable business

38

Know Your Breakeven Point Module 4

Simple Concept: How much business do I have to do to breakeven (recover all of my costs)?

Breakeven Volume = Fixed Costs / (Sales Price – Variable Cost per Unit)

Breakeven Sales Amount = Fixed Costs / Contribution Margin Ratio

Contribution Margin Ratio = (Sales Price – Variable Cost) / Sales Price

EXAMPLE: Sales Price = $ 45.00 per shirt | Materials = $ 6.00 per shirt + Labor = $ 9 per shirt + Variable Overhead = $ 3 per shirt = Total Variable Cost per Unit of $ 18.00

$ 70,470 of costs are incurred no matter how much you sell

Breakeven Units = $ 70,470 / ($ 45.00 - $ 18.00) = 2,610 shirts must be sold

Contribution Margin = $ 27.00 / $ 45.00 = 60%

Breakeven Revenues = $ 70,470 / .60 = $ 117,450 (2,610 units x $ 45.00)

39

Relevant Cost = Variable Cost Module 4

40

Make or Buy Decision Analysis: Make price of $ 68.95 vs. Buy price of $ 60.00

Cost to Manufacture Products

Direct Materials 18.20$

Direct Labor 21.60$

Overhead - Variable 12.60$

Overhead - Fixed * 16.55$

Total 68.95$

* no change in Fixed OH anticipated since we have

unused surplus capacity for making products

Make or Buy Differential Analysis

Purchase Price for Products 60.00$

Cost to Manufacture Products:

Direct Materials 18.20$

Direct Materials 21.60$

Overhead - Variable 12.60$

Total 52.40$

Cost Saved by Making 7.60$

When comparing profitability across products, projects,

customers or services, only the variable cost are relevant. The

fixed cost continue regardless of the decision.

Return on Investment (ROI) Module 4

41

Residual Benefits *

Total Amount Invested **

Looking at the overall business, ROI is usually expressed as Return on Capital or Return on Equity

ROI

Net Income

Average Equity for the Year

* Total Benefits less Total Amount Invested

** All costs to place the asset into service

Quantify the Future Benefits Module 4

Organizational Benefits Builds company reputation Creates new customer opportunities Fosters company vision and mission Improves market position relative to competitors Improves the ability to serve customers Increases competitiveness Financial Benefits Creates additional/new revenue Creates cost savings through tax avoidance Enables cost avoidance Faster return on investments Increases cash flow Increases profitability of existing products/services Increases revenue of existing sources Increases stock price/shareholder value Lowers cost of production Lowers cost of servicing

Operational Benefits Decreases employee work loads for undesirable work Eliminates non-value added activities Improves employee morale / team spirit Improves internal communication Improves use of workspace Reduces cycle time Reduces cycle time of production/process Reduces external inputs to processes Reduces person-hours Reduces process steps

Information Technology Benefits Decreases maintenance/support costs Improves application/system performance Improves application/system utilization rate Increases efficiency of support activities Increases productivity through automation Reduces paper documentation requirements Strengthens application/system security

Identifying costs (outflows) is fairly straight-forward. Trying to quantify the benefits (inflows) can be very challenging. Examples of benefits include:

42

Simple Example of ROI Module 4

43

Proposed new marketing program cost $ 200,000. It will give the company much more exposure to new potential customers. Past programs have proven to increase a company’s revenues by 5% over a three year period. What is the Rate of Return for this investment?

Step 1 - Quantify the Benefits: Current Annual Revenues are $ 1,600,000 x 5% = $ 80,000 benefits per year x 3 years = $ 240,000 Total Benefits Step 2 – Quantify all of the Costs: Total investment cost is up front, one time fee of $ 200,000 Step 3 – Calculate the ROI: Total Benefits of $ 240,000 - $ 200,000 costs = $ 40,000 residual benefits divided by $ 200,000 = 20% ROI

Returns Must Exceed Cost of Capital Module 4

44

All businesses have a cost of financing the business:

1. Cost of Debt – Interest Payments on Loans

2. Cost of Equity – Owners expect to get a return on what they’ve invested into the business

Cost of Capital = Cost of Debt + Cost of Equity

Cost of Capital Create Value

Destroy Value

Returns on Investment (ROI)

10%

12%

14%

16%

8%

6%

Module 5 Evaluating Long Term

Investments

45

How to evaluate the economics of a long term

investment

Contrasting Accounting vs. Finance Module 5

46

Accounting Finance

Historical Value (Looks Back) Future Values (Looks Forward)

Input = Transactions Input = Financial Statements,

Estimates, Analysis

Output = Financial Statements Output = Forecasts, Budgets, etc.

Not Analytical (Process

Transactions)

Very Analytical

Advocates Profits Advocates Creating Value

Enforce Rules and Comply Few Rules / More Creative

Short Term Focus Long Term Focus

What is the Value Today? Module 5

47

Accounting

Historical

Values

Constant Dollars –

does not change

over time

Why the differences in value (Accounting vs. Finance)?

1. Risk – I promise to pay you $ 100,000 five years from now!

2. Inflation - $ 100,000 five years from now will lose purchasing power!

3. Opportunity Cost – If you had $ 100,000 now (not five years from now), you could do something with it – lost opportunity!

Finance

Present

Values

What is the value

today?

Future

Values

What is the value

tomorrow?

48

Three Economic Criteria Module 5

Three important economic indicators in finance for evaluating long term investments:

1. Return on Investment – We discussed this earlier > Investors must earn a rate higher than the cost of capital; otherwise the investment is not attractive.

2. Net Present Value – Discount the cash flows of both the costs and the benefits of the investment. The more positive the value, the more attractive the investment.

3. Discounted Payback Period – How long does it take for the investor to recover his investment. The shorter the payback, the more attractive the investment.

49

Simple Example of Discounting Module 5

Three Important Steps:

1. Identify the cash inflows (benefits) and cash outflows (costs) over the useful life of the investment

2. Identify your cost of capital

3. Discount the cash inflows and outflows using your cost of capital

i = 8% Year 1 Year 2 Year 3 Totals

Inflows $ 120,000 $ 84,000 $ 36,000 $ 240,000

Outflows $ (200,000) $ - 0 - $ - 0 - $ (200,000)

Difference $ (80,000) $ 84,000 $ 36,000 $ 40,000

Discount .9259 .8573 .7938

Present Value $ ( 74,072) $ 72,013 $ 28,576 $ 26,517

Net Present Value

50

Discounted Pay Back Period Module 5

A simple economic indicator – when will I recover all of my costs?

Net

Present Cumulative

Year Value Value

1 (74,072)$ (74,072)$

2 72,013$ (2,059)$

3 28,576$ 26,517$

You reach pay back in Year 3 for this investment

Per the Previous Slide

Example 3 – Evaluate Long Term Investment Module 5

51

Let’s walk through a complete example of evaluating a long term investment. The goal is to project out both the cost and benefits of the investment over its useful life. Once we know the cost and benefits, discount the amounts to reflect risk. A positive Net Present Value indicates that this investment adds value. A negative Net Present Value indicates that the investment destroys value within the business.

Module 6 Some Advanced Concepts

52

A few advanced concepts related to financial

management

Working Capital for Day to Day Operations Module 6

53

2016

Days in Receivables (per slide 25) 51

Days in Inventory (per slide 26) 59

Operating Cycle in Days 110

Less Accounts Payable (1) -33

Days to be Financed 77

(1) Days in Accounts Payables = 365 / Accts Payable Turnover

Accounts Payable Turnover = Total Purchases / Avg A/P Balance

A/R Held 1 Day (1/365 x Credit Sales for Year) 5,917$

Inv Held 1 Day (1/365 x Cost of Goods Sold for Yr) 22,575$

A/P Held 1 Day (1/365 x Purchases for Year) 3,150$

Most businesses cannot cover normal operating cycles. They must cover the short fall through high enough margins. In this example, if the company can turn the inventory over faster from 59 days to 55, this equates to $ 90,300 of more cash on hand for current operations ( 4 days x $ 22,575)

Working Capital represents the current funds to cover day to day operations and it comes from the excess of Current Assets over Current Liabilities

54

Ratio Model – Return on Investment Module 6

R O I

Capital Turnover

Profit Margin

Sales Invested Capital

Net Income

Long Term Assets

Working Capital

Revenues Expenses

How to drive higher returns on the total investment that has been made into the business – look at key drivers below:

55

Ratio Model – Sustainable Growth Module 6

56

Ratio Model – Financial Distress Module 6

Very predictive of financial distress and bankruptcy:

Inventory Analysis Module 6

57

Total Lead Time to produce, land, tag and place the apparel item is 12 days Throughout the year, the average units sold per day is 3 Absolute minimum inventory level = 12 x 3 = 36 units (reorder point) Add safety stock if inventory fluctuates @ 15% = 5 units + 36 units = 41 units

Six Months Sales in terms of Units Sold

Product Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17

Casual Pants 16 19 17 22 20 26

Bluejeans 35 38 46 41 42 44

Short Pants 12 8 9 11 7 8

Swim Trunks 6 8 4 4 5 3

Tee Shirts 75 92 112 107 137 128

ABC Inventory Segmentation

B B C C A

A = Spend most of your time trying to move this item, it generates your revenues B = Spend moderate time on this item C = Spend little time on this item, consider discontinuing

Calculate Inventory Reorder Level

57

Cost Reduction thru Process Improvement Module 6

58

Traditional approach to Cost Control – by General Ledger:

Better approach is to improve the Process!

General Ledger Account Balances

Year End Expense Accounts

Account Description Balance

4001 Cost of Goods Sold * 3,166,401.50

4003 Marketing & Promotion 377,560.00

4005 Salary Expense 474,906.82

4006 Payroll Tax Expense 86,089.15

4007 Equipment Maintenance 36,450.92

4009 Rent & Lease Expense 19,807.65

4011 Utilities Expense 11,050.86

4012 Insurance Expense 7,650.00

4014 Product Warranty Expense 6,672.00

4015 Depreciation Expense 22,880.00

4016 Interest Expense 26,404.20

4017 Tax Expense 101,678.89

Total Expenses 4,337,551.99

* consists of direct materials + direct labor + allocation of overhead

• Eliminate non-value added type activities (“Re” type activities)

• Compress hand-off’s in workflows

• Look for delays, wait times, waste, defects, holding inventory, etc.

• Too many manual processes – invest in technologies

• Look at how people spend their time – should be spent servicing an internal or external customer

Wrap Up

59

Summarize Key Points

60

1. Someone must keep the books – you must do accounting to understand if you are losing or making money.

2. Generate and review your financial statements on a monthly or quarterly basis

3. Analyze the financial statements with ratios, horizontal and vertical analysis – be analytical in how you look at numbers

4. Current Assets must turn over and go through cash 5. Long Term Assets must generate a Return greater than the cost to finance the

investment 6. Benchmark the financials to evaluate your financial performance according to

your industry (NAICS) code 7. Evaluate your long term investments – does it generate benefits greater than

the cost and if the life cycle is several years, consider discounting at the cost of financing or required return to see what the investment is worth to the business. This is what big companies do when they make major investment decisions.

61

Matt H. Evans matt.evans@scorevolunteer.org DC SCORE Office: 409 3rd Street, SW Suite 100 A Washington D.C. 20024 Phone: 202-619-1000