Understanding the Finance side of business

By

CA B.E.Kumar Prasad, B.Com., FCA

Background

• Financial awareness is fundamental to business success

• Financial knowledge is not just for accountants – it’s for

everyone

A survey found that 8 out of every 10 owners are trying to

manage their business without having the financial side under

control. That's a recipe for disaster! by Philip Campbell,

CPA

Common Misconceptions about Finance

• Non-finance people

• Complicated

Comparison

Finance

Accounts

...understanding the finance side of business

means the ability to understand the impact of

every decision you make on the organization’s

profitability...

Introduction

Types of business Entities

Sole Proprietorship/ Sole Traders

Partnerships Companies

How Business Gets Money?

“Never spend your money before you have earned it”

– Thomas Jefferson, Past president of USA

Buy Fixed Assets

Investments DepositsCurrent assets

How Business Uses Money?

Recording – Accounting and book keeping

People want to learn about finance because they want to

know what accountants are talking about – anonymous

How They Record...

Double Entry book keeping

Financial Statements

Balance Sheet

Is one of the key

financial statements

and is a snapshot of

the financial position

of a business at a

point in time

What a business

owns

What a business

owes

Profit & Loss Account

Why Profit and Loss account made?

What Does it contain?

What is top line and bottom line?

“Top line is merely a means towards achieving an end, and the end is to have healthy bottom line.”

Cash Flow Statements

Cash flow Statement

Profit does not mean

Cash Profits

Accounts are prepared on

matching concept

Cash flow from

operating activities

Cash flow from

investing activities

Cash flow from

financing activities

Cash Flow Statement ExampleCash Flow from Operating activities  Profit for the period 8500Adjustments for timing differences -1650Interest and taxes paid -3250  3600

Cash Flow Statement ExampleCash Flow from Operating activities  Profit for the period 8500Adjustments for timing differences -1650Interest and taxes paid -3250  3600Cash flow from investing activities  Purchase of property -9450Proceeds from sale of equipments 2250Interest and dividends received 900  -6300

Cash Flow Statement ExampleCash Flow from Operating activities  Profit for the period 8500Adjustments for timing differences -1650Interest and taxes paid -3250  3600Cash flow from investing activities  Purchase of property -9450Proceeds from sale of equipments 2250Interest and dividends received 900  -6300Cash flows from financing activities  Proceeds from issue of share capital 1500Proceeds from long-term borrowings 7500Dividends paid -3000  6000

Cash Flow Statement ExampleCash Flow from Operating activities  Profit for the period 8500Adjustments for timing differences -1650Interest and taxes paid -3250  3600Cash flow from investing activities  Purchase of property -9450Proceeds from sale of equipments 2250Interest and dividends received 900  -6300Cash flows from financing activities  Proceeds from issue of share capital 1500Proceeds from long-term borrowings 7500Dividends paid -3000  6000Net Increase in cash and cash equivalents 3300Cash at the beginning of period 6450Cash and cash equivalents 9750

Why the difference arises between profits and cash profits?

• Depreciation

• Amortization

Indian Accounting Standards

Generally Accepted Accounting Practice

[GAAP]

Accounting Standards and Regulations

Who Uses Financial Statements

Advisors & Analysts•Shareholders•Financial analysts, advisers and journalists•Credit Rating Agencies

Officials & Government

•Local Tax authorities•Governments•Providers of finance, such as banks

Stakeholders•Suppliers•Customers•Managers•Employees

Making Profits

If a man goes into business with only the idea of making money, the chances are he won’t

-By Joyce Clyde Hall, founder of Hallmark Cards

Costs

• Direct Cost

• Indirect Cost

Cost behaviour

• fixed and variable costs

• semi variable costs

Appendix

Gross ProfitsRevenue less cost of sales

Operating Profits Gross Profits less indirect operating costs

Net Profits Profit Before Tax [PBT] or Profit After Tax [PAT]

Profits

Forecast Costs, volumes and profits

• Contribution = Revenue – Variable Costs

• Profit = Contribution – fixed Costs

Break Even Point

Break Even point

• Contribution = Revenue – Variable Costs

• Profit = Contribution – fixed Costs

Increase In Price

Improve Margins/Contribution

Maintain Service Quality

Manage Interest Costs

Keeping Current

Reduce Fixed Costs

Changing Business Needs

Increase Sales Volume

How to manage Profits

Be aware [beware] of Taxes

‘of two things you can be certain; death and taxes’

-By Benjamin Franklin, American Philosopher

TaxesTax Classes

Income or Corporate Tax

Employment or Payroll Tax

Capital Gain Tax

Value Added Tax

Excise Duty and Customs Duty

Service Tax

Professional Tax

Entry Tax

Managing Cash

Turnover is vanity, profit is sanity, but cash is

reality

Cash Is King...

The most common reason that businesses fail is not through

lack of profit but through lack of cash

Key Aspects

• Profitability Vs Liquidity

• Cash is like oxygen

• Ideal goals

Overtrading - Overcapitalization Trap

finding a balance...

Success can kill a business

as quickly as failure can

Budgets

Integrate different activities

Centrally coordinated to ensure best allocation of limited resources

Allocates responsibility

Calculate variances from budget

Measuring Business Performance

Return on Investments

Time Value of Money

NPV & IRR

Measuring Business Performance

• Measuring Return –

Gross Profit Ratio = Gross Profit/Revenue * 100%

Net Profit Ratio = Net Profit/Revenue * 100%

• Measuring Investment

Asset turnover = Annual Revenue / Capital employed;

• Measuring Liquidity

Current Ratio = current assets / current liabilities

• Measuring Long term solvency

The debt equity Ratio

Interest Cover = Operating profit / Finance expenses

Investor Ratios

Earnings Per Share = Earnings available for distribution/Number of shares in

issue

Valuation

Business Valuation

• Present value of estimated future cash flows

Discounted cash flow

[DCF]

• Income * MultipleIncome multiples

• Net Asset ValueAsset based valuations

A few financial flashpoints…

2010 2011

712,745

861,176

Turnover

TurnoverRs. In Lacs

Segment-wise revenue

2010 20110%

10%20%30%40%50%60%70%80%90%

100%

Short Term Total AccessTelecom IncomeConsultancy IncomeTransmission Income

Rs. In Lacs

Number of Employees

2006-07 2007-08 2008-09 2009-10

7427 76458214

9162

Number Of Employees

Number Of Employees

Earnings Per Share

2005-06 2006-07 2007-08 2008-09 2009-10 2010-11

EPS 3.03 3.28 3.6 4.02 4.85 6.13

0.5

1.5

2.5

3.5

4.5

5.5

6.5

EPS

Market Price Per Share

2007-08 2008-09 2009-10 2010-11

Market Price Per Share

99 95.65 107.9 101.3

87.5

97.5

107.5

Market Price Per Share