Financial Management

Financial Management
Personnel Management Business Description
Financial Management Goals and Outcomes
Sales & Marketing Management Business Offerings

BIZBITE CONSULTING GROUP
Financial Management
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incorporate in future printings any corrections communicated to it.
Copyright 2003, 2004

BizBite Consulting Group
A division of CorNu Enterprise
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All Rights Reserved

Printed in Canada
Table of Contents
A. Introduction to Financial 1. Monthly Financial
Management .................................. 1 Performance Review and
Analysis .................................. 131
1. Planning For Business
Success........................................ 2 2. Income Statement Analysis
139
2. Financial Datathe Heart
of the Business ........................... 7 3. Balance Sheet Analysis . 154
B. Financial Analysis of 4. Testing the Financial
Operations ................................... 18 Strength of Your Business.... 162
1. Job Costing Analysis E. Financing, & Risk
Preparation.............................. 21 Management, Business Planning
196
2. Financial Feasibility Study
of the Business's Offerings ..... 30 1. A Guide to Finance ....... 199
3. Break-even Point (BEP) 2. Risk Management
Analysis .................................... 37 Strategies................................ 209
C. Operational Financial 3. Business Plan Format
Management ................................ 51 Sample.................................... 223
1. Inventory Management .. 54 Summary of Financial
Management .............................. 231
2. Accounts Receivable (AR)
and Credit Policy..................... 75 Glossary ................................. 234
3. Preparing Pro-forma Cash
Flow Statements .................... 112
D. Monitoring the Financial
Health of the Business............... 127
.
i
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ii
Credit Page
The founders of BizBite Consulting Group and developers of BizBite's

dynamic approach to business education are:
Graeme Robertson and Dr. Shirley Chapman
The following people contributed to this document:
Content Specialist
J. Graeme Robertson
Graeme Robertson is a seasoned business management professional
with over 30 years of experience. He has held senior positions in
retail, wholesale, and distribution operations. Additionally, Mr.
Robertson was Regional Manager for a national personnel/consulting
firm and he has been actively engaged in business management
consulting for over 20 years.
Designer and Developer

Dr. Shirley Chapman
B. Ed. M.Ed. Ph.D.
Dr. Shirley Chapman is a veteran educator with over 30 years of

experience. She is an expert in course/program design and
development. Her experience covers public schools, colleges, and
universities. Shirley is experienced in designing and developing
training specifically for delivery via face-to-face, on-line (Internet), and
manuals for organizations, colleges, and businesses. She is
responsible for the page layout and format as well as the graphics in
any materials that she designs.
ProofreaderPrecision ProofreadingDeborah Wright

edit@preproof.bc.ca
http://www.preproof.bc.ca
iii
Table of Contents
Major Headings Sub Headings
A. Introduction Financial Planning for Business Success

Management Financial Datathe heart of the
business
B. Financial Analysis of Operations Job costing analysis preparation

Financial feasibility study of the
business' offering
Break-even point (BEP) analysis
C. Operational Financial Inventory management

Management Accounts receivable & credit
policy
Preparing pro-forma cash flow
statements
D. Monitoring the Financial Health Monthly financial performance
of the Business review and analysis
Income statement analysis
Balance sheet analysis
Testing the financial strength of
your business
E. Consideration in Financing, A guide to finance

Business Planning, and Risk Business plan format sample
Management
Risk management strategy
Glossary of Terms
iv
A. Introduction to Financial Management
Introduction
There are two parts to the introduction Financial Management
1. Planning For Business Success

2. Financial Datathe Heart of the Business
Financial Management 1
1. Planning For Business Success
Introduction
The term financial management of a business means managing the invested

money in the business. The invested money in any business will include:
Physical assetssuch as facilities, furniture,
equipment, machinery, or fixtures
These assets allow the business to function
in a physical location.
Working capitalinvested in inventory,
intellectual property, delivering services.
The business revenue manages inventory,
uses intellectual property, and delivers services in the process of earning
for the business.
How well the business manages the money invested in the business determines:
How profitable the business will be
The return on investment (ROI) money to the owners
The long-term success of the business
The focus of Financial Management will be operational. That is, it will focus
on what managers need to pay attention to on a daily and monthly basis to be
good managers of the money invested in the business.
Many business managers assumed their positions without having formal
training in business, accounting, or finance.
We designed Financial Management for managers regardless of their
background or training.
The intent here is not to train you to be an accountant but to introduce you
to ideas and methods of financial management and controls that will help
your business.
For example:
Financial management concepts
Financial management methodologies
How to apply some common financial management methods
How to use and interpret financial information
Some options and approaches that may be applicable to your business
Questions you should ask of your accountant
As well, this material will assist small businesspeople to:

Ask better questions of their accountant
Be better able to interpret the financial reporting their accountant
provides
Make better business management decisions
How to use Financial Management
When you completed the internal business plan for your company, the final
step was to prepare detailed financial projections. These financial projections
show financial information related to the execution of the marketing plan but
includes all of the fixed and variable costs of your business. Your accountant
may have assisted you to complete this.
Financial Management will help you to do a better job of preparing some of

the information for your accountant. It will help you to analyze and interpret
the results.
It is important for any business to use historical financial statements for
reference and guidance in preparing financial projections.
It is essential that the business owners refer frequently (at least monthly) to
the company's business plan by comparing the pro forma reports to the
current actual reports (supplied by the accountant) so make the inevitable
adjustments.
This financial data provides a financial picture of where the business is as of

the date of the reports and where the business expects to be at various time
intervals in the future.
More detail is provided in the section Financial Data

The Heart of the Business.
Additionally, there are a number of other reporting tools, methods, and

procedures that are useful to the manager monitoring the business's financial
health. We introduced several of these along with their uses and application.
Compare this information to the way that you presently operate your business.
We recommend that you refer to your business plan at least quarterly. It is not
as likely that the business will stray too far from the predicted path in less than
a quarter. However, the exception to this would be if the company was making
a big change in its direction involving things such as:
Completely new business style
A new division of the company
Introduction of major new offerings or perhaps the discontinuation of
traditional offerings
A radical change in advertising and marketing the company
Any change that has the potential for a major impact on the company (ether
positively or negatively) is cause for a frequent reference to the business plan
as well as checking how any changes affect the use of the money invested in
the business. This is financial management of the business.
Types of business financial data
Business financial data and reports are tools that keep you on the right track
when managing your business. Broadly speaking the data and reports fall into
three categories:
Planning and organizational tools
Operational tools
Summary and analysis tools
The financial data included in the internal business plan is of a planning and
organizational nature. It should show where your business is now and where
the business expects to be at intervals in the future.
An internal business plan does not usually demand as much detail as the
external business plan that is also a planning and organizational tool designed
for presentation to a lender. Nevertheless, the financial information in your
business plan should include:
Current audited financial statements if it is an existing business.

A 3-year financial projection, first year by quarters, or remaining years
annually
The projection should include:
Pro-forma income statements (sometimes called operating statements)
Balance sheets Cash flow statement
Capital expenditure estimates Projection of any project
Current development costs such as:
Consulting fees Packaging design
Manufacturing
Design and preparation of marketing materials
Explanation of the use of any investment funds and the expected
results from the application of those funds
Financial Management will discuss in some detail operational methods, ideas,
and tools that you will use on a daily basis in the financial management of your
business.
It also will talk about summary and analysis tools, and the financial reports
that you will use to measure and monitor the performance of your business.
Summary
The foregoing is only a general outline and overview of the purpose and use of
financial data. Many business owners will require professional help in
preparing, organizing, and interpreting their financial data. We strongly
recommend this.
To be effective and relevant, review financial data regularly. Complete it in an

organized way. Prepare a formata schedule for reviewing financial
information:
Monthly
Quarterly
Annually
This material offers suggestions. Discuss with your accountant what an

appropriate review and analysis schedule would be for your business.
Laws of Businesson organization

A business organization is a group of people brought together for the
sole purpose of creating and keeping customers.
Again, the main purpose overrides all else.
2. Financial Datathe Heart of the Business
"Wherever you see a successful business, someone once made a
courageous decision."Peter Drucker
Introduction
Before you turn a wheel, sell a widget, or accept a contract, it is essential that
you decide how you will keep track of the business transactions.
Good accounting for your business is important because of
legal and tax requirements.
A good accounting system provides you with the tools you
need on a daily basis to take the pulse of your business and
make the positive business decisions that will keep it healthy
and on track.
It should be tailored to your business needs and be simple
enough so that it can be maintained on a daily basis. This is
how you control your business, know where it has been, and
know where it is going.
Control is essential!
If you don't control your business, your business will control
you!
If you don't have the training or experience to assess your needs and set up an
adequate bookkeeping system, hire a competent, certified accountant to do it. It
will be money well spent.
How to use this information
Financial data will explain the basic business reports necessary to run any
business. The purpose is to familiarize you with these reports and their function
in managing the business.
We will not attempt to do an in-depth analysis of the reports.
You will learn some common definitions of terms found on financial

statements.
You will study some common tests for the financial health of the
businessthe tests that you should perform on a monthly basis.
The intent is to increase your understanding of financial terms and enable
the daily monitoring of business activities. Beyond this, you should consult
with your certified accountant for in-depth clarification of actual business
data.
The new business owner will find this useful background information in
working on the preparation of the Pro-forma financial statements.
The information will help in dealing with your accountant in the set up of
the business and in interpreting the reports, the accountant prepares for you.
Besides, it will be useful in closely monitoring the start and on-going
growth of the business.
The existing business owner will likely have some level of knowledge of the
information contained in this section. However, frequently small business
owners have never had the benefit of formal business management training. In
that event, this material should be helpful in better understanding the reports
prepared by your accountant. Moreover, it will be useful in monitoring business
performance and making sound business decisions on a daily basis.
Business reports
Your business needs a specially designed accounting system. However, there is

essential reporting that every business must have to effectively plan and direct
the business. These key reports are the:
Balance sheet
Income statement
Cash flow statement
Additionally, the business needs to perform regularly a:

Deviation analysis
Break-even point (BEP) analysis
A review of capital expenditure estimates
Correctly used, these reports and analyses act as budgeting tools, an early
warning system, a problem identifier, and a solution indicator.
Use regularly and consistently because they are the backbone of the
business.
Several hours every month must be spent checking and analyzing these
reports.
The reports need not be very complicated and the level of detail will vary with
every business. They are a reflection of your business and they are working
models of your business.
The more you work with these reports on a monthly basis, the greater your
understanding and insight will be as to what your business needs to be healthy
and profitable.
A discussion of the some of these reports will follow.
Making business decisions based on poor, incomplete, or superficial
information can be disastrous.
A business manager has two prime objectives and they are:

1. To make a profit
2. To pay the bills as they become due
The two key financial statements that convey this information are
1. The income statement (also called the profit & loss statement or the
operating statement)
2. The cash flow statement
Capital equipment list
In addition to the above statements, every business should have a capital

equipment list. A capital equipment list is a listing of the physical assets of the
company.
Examples of capital equipment are:

Office furniture and equipment Manufacturing machinery
Store fixtures Company vehicles
Maintaining a capital equipment list is important because it helps to:

Maintain control over depreciable assets
Ensure that the reserve for replacement of capital equipment is
maintained
Ensure that the reserve for replacement of capital equipment doesn't
become a slush fund to cover all sorts of other expenses other than
what it was created for
Facilitate the budgeting process as it comes time to replace equipment
None of these expected capital equipment items may wear out for at least
several years. However, their cost is depreciable as their life is used up.
Assume that every asset in a company has a useable life and replaced at
some point in the future.
An estimate is made of the expected life of the asset and a portion of the
original value of the asset deducted each year. This deduction is called
depreciation.
The depreciated value of an asset is the value after deducting the
depreciation and it shows on the balance sheet.
The depreciation expense is the amount of depreciation deducted each year
and shown on the income statement as a used up value.
The capital equipment list can be very simple and should include columns to
record the following information:
The date of purchase
Item description
Model numbers
Cost price including sales taxes and installation fees
As well, columns should be included to record recovery and disposal costs in

the event that sold items either before or after it is fully depreciated or costs are
incurred in disposing of it.
For some types of equipment, such as vehicles, provide columns for detailing
the maintenance and repair costs that are incurred over the life of the asset.
Many computer software accounting programs provide for managing the asset
management information.
Summary
In Financial Data, we have provided an overview of the financial reporting

needed to monitor the financial health of your business.
We have discussed the relative importance of some of the reports and the
need for keeping good records for capital assets.
As well, we have stressed the importance of seeking the advice of your
accountant in the financial management of your business.
The main purpose of this financial data is to set the stage for the following
sections:
1. Financial analysis of operations

2. Operational financial management
3. Monitoring the financial health of the business
4. Consideration in financing, business planning, and risk management
Below are two sample forms:

1. Capital Equipment Record
2. Capital Expenditure Request
Capital Equipment Record
Asset Group: Equipment #: ___ Record Date: ____
Location: Dept: Req #: PO#: ____
Item Description: Make: ____________________
Model#__________________ Serial#_________________ Purchase Date: _______
Supplier: Phone: __
Address: Fax: ______________
E-Mail: ______________________________________
Contact: Title: __
Purchase detail: Company: ________________________

Purchase price ______________ Address: _________________________
GST _______________ Phone: ___________________________
PST ______________ Fax: _____________________________
Total Cost ______________ E-mail: __________________________
Install service fees _____________ Contact: _________________________
Total installed cost __________ Title: ____________________________
Accumulate depreciation __________
Depreciated value ___________
% Depreciated ___________
Installer/Service Provider:
Estimated Asset Life: Amortization Period:
Maintenance/Repair Record
Date Maintenance/Repair Vendor Cost GST PST Total

Description
Totals
Record additional maintenance and repairs on additional pages
Asset Disposal and Expense
Date of Disposal: __________________ Asset purchaser:

Disposal/selling price: _________ Name: ____________________________
GST ________ Address: __________________________
PST _________ Phone: ____________________________
Total redeemed value _________ Fax: ______________________________
Less Disposal expense _________ E-mail: ___________________________
GST _________
Total Disposal expense _________
Net Asset cost recovery _________
Capital Expenditure Request
[Company Name]
ACE.# Date: _____
Authority for: Capital expenditure Major repairs ______
Department name: Dept.# ______
Request authority for the following:
Supplier name: ______
Description Estimated Cost
Labour
Materials
Sub-total
PST
GST
Final total
Justification for expenditure:

Safety Replacement equipment ___Necessary repairs ________
Cost saving Business expansion __________________________
Civic code requirements _____________________Other ___________________________
Payback period calculations:

Initial cost: _______________________________________________________________
Annual savings [details attached]: _____________________________________________
Payback period [cost + savings]: ______________________________________________
Estimated date required: _______________Charge to: ____[Dept.]___________________
Requested by: _____________________________________________________________
[Title]
Approved by: ____________________________________________________________
[Title]
Approved by: ____________________________________________________________
[Title]
a. Attach written estimates whenever possible.
b. Distribution: 1. To Controller for approval
2. To President for approval
3. To Accounting for coding
c. Upon completion of the project, return to Accounting Manager.
Date Completed: _________________Dept. Manager _____________________________
------------------------------------------------------------------------------------------------------------
This Capital Expenditure Request Form is included as an example of how to
use a company internal document to justify the need to purchase an asset. It is a
good idea for any business to use a form like this to:
Think through the reason for the purchase

What will be accomplished by making the purchase
How long it will take to recover the cost of the purchase
This form is part of the homework done by a manager prior to purchasing

capital equipment. Estimates, product information, and attach anything else
pertaining to the purchase to this form including in the Capital Equipment list
file.
In a small business, the owner or manager of the business would be using this
form. In a larger business with several departments or divisions, the department
or division manager would complete the form and submit it with all pertinent
background information to senior management and the Controller.
After the purchase is approved and completed, the details of the purchase are
recorded on the capital equipment form.
The Law of Moneyof abundance

There is an ample supply of money for all who want it.
To get your share, decide to be rich, and obey the
Laws of Cause and Effect
as they apply to money.
Celebrate!!
B. Financial Analysis of Operations
Introduction
In Financial Analysis of Operations, we will discuss three basic components

of operational financial analysis:
1. Job costing analysis preparation
2. Financial feasibility of business offerings
3. Break-even point (BEP) analysis
In these segments, you will learn how to apply methodologies for internal
analysis in any business. A brief outline of these segments follows:
(1) Job costing analysis preparation
Job Costing Analysis Preparation presents in detail the steps any business
would take to:
Determine the fixed costs of the business
Determine the variable costs of the business
Ensure that the business recovers both fixed and variable costs in the
pricing of its offerings
Ensure that the business owner prices offerings at a level that will
provide an adequate return on investment (ROI) after paying expenses
Based on an actual architectural service business, this sample shows the steps
taken in the analysis of fixed costs and the variable costs relating to projects.
Translating the analysis of the price of the offering is included in several
examples.
(2) Financial feasibility of business offerings
Financial Feasibility of Business Offerings discusses the factors that the

business owner should consider in:
Assessing the financial feasibility of new offerings
Assessing the financial feasibility of existing offerings
A few of the factors involved in assessing the financial feasibility of an offering

are:
Changing market conditions
Customer and client analysis
Changes occurring in the competitive environment
How the offering relates to the offering mix
What it will cost to effectively market the offering
Changes that may be occurring to the ROI of the offering
The examples in this material will enable you to relate the ideas to your
business. It will help you to determine if you will make a profit marketing your
offerings to your chosen market segments.
(3) Break-even point (BEP) analysis
The material discusses break-even point (BEP) analysis and the uses of
various ways to the monitoring of your business performance.
A business manager will apply break-even analysis in one of its variations in

many aspects of the business such as:
Testing the financial feasibility of a new business opportunity
Assessing the current financial viability of existing business segments
Pricing merchandise at a level that will fully recover costs and generate
a projected ROI
There are several examples of several forms of break-even point (BEP) analysis
and their possible use to your business.
When you finished this section, think about the many ideas by asking yourself
if:
Your business would benefit from a detailed analysis of the fixed and
variable costs
You are now realizing full-cost recovery in the pricing of your
offerings (product and services)
You always analyze the financial feasibility of new ventures
You frequently test the financial viability of operations using break-
even point (BEP) analysis
You are pricing for profit through the use of break-even point (BEP)
analysis
The Laws of Businessof innovation

Breakthroughs come from innovationoffering something better, cheaper,
faster, newer, or more efficient.
All you need to break through is one good idea.
1. Job Costing Analysis Preparation
Introduction
It is important for every business to determine accurately its fixed costs and
variable costs. After that, the business must ensure that the revenue the business
generates from the sale of its offerings counterbalances these costs.
In Job Costing Analysis Preparation, we will first demonstrate how a

business analyzes and determines the fixed and variable costs.
Later in break-even point (BEP) analysis, we will discuss how the business
uses information on fixed and variable costs to:
Test the profitability of the business
Project the viability and profitability of venturing into new markets
Project the viability and profitability of new offerings
Price offerings on a daily basis at levels that will ensure projected
profits
In Job Costing Analysis Preparation, we will explain how a company

analyzes its fixed and variable costs and then ensures that the business recovers
those costs and an adequate profit margin in the pricing of its offerings in every
segment of business activity.
For illustration purposes and simplicity, we will use a fee for service
business. It is an architectural services company managed by the owner and
five staff.
As you move through this example, ask yourself how the ideas and methods
presented here would apply to your business.
Any type of business may use the ideas discussed. Every business situation
will be different so be prepared to customize this process to meet your
company's needs.
The job costing process
The job costing process has six steps:

1. Research fixed costs
2. Determine revenue necessary to offset fixed costs
3. Calculating employee charge rate to recover costs
4. Segmenting services
5. Analyzing employee involvement and variable costs
6. Arriving at a price
Step #1Research fixed costs
Begin by thoroughly researching the fixed costs of the business for at least the
past two years.
The purpose is to arrive at a base figure that accurately represents the total
annual fixed costs.
With some expenses, you may want to take an average of the cost over the
two-year period. It is really for you to decide if periodic fluctuations in a
cost warrant averaging the cost.
You should adjust the base fixed-cost figure to reflect any estimated growth
or decline in fixed costs to arrive at your estimated annual fixed costs.
Fixed-cost items would include:

Rent Mortgages Long-term loans
Heat Light Telephone
Building maintenance Administrative expenses
There may be many other items depending on the situation of each business.
Whatever the base or total fixed cost figure is, you should review it every year
and make any necessary adjustments using the same simple methodology.
Step #2Determine revenue necessary to offset fixed costs
The second step is to express the total of the fixed costs in terms of how much
money the office must generate to offset those fixed costs.
If the office functions on a 40-hour week, that translates to 40 x 52 weeks
or 2,080 hours of operation per year.
Therefore, if you divide the estimated annual fixed costs by 2,080 hours,
the result is the absolute minimum charge-out fee to recover those costs.
For example:
If the total fixed costs are $250,000, then the minimum hourly charge is
$250,000/2,080 hours = $120.19/hour
This is the absolute minimum amount of revenue that the business must
generate to recover only the fixed costs.
As well, it is useful to know what the charge-out rate would be if salaries
and benefits are removed from the formula.
For example:
Estimated total fixed costs(salaries + benefits)/total hours
Assuming salaries + benefits are $150,000, the hourly rate
would be:
$250,000 $150,000/2080 hrs = $48.08/hour
These hourly charge figures represent how much the office must generate every
hour that it is open to offset the operating costs.
No allowance has been made for profit or ROI (Return on investment).
Therefore, the actual hourly rate charged for projects must be substantially
more.
Step #3Calculating employee charge rate to recover costs
Now, calculate the basic recovery charge-out rate for every employee in the
operation including his or her portion of benefit costs. If the total benefits are
15% of the salary expense, here is what your analysis would look like:
For example:
Employee #1 $70,000/2,080 hrs = $33.65 + 15% = $38.70/hour
These figures represent how much the business must charge for each employee
for every hour that the business is open.
Therefore, the charge-out rate on projects must be substantially higher to
allow for variable costs, profit, and ROI.
The example assumes declining salary levels from the owner at $70,000 to
the lowest employee at $30,000.
Step #4Segmenting services
Segment all service components provided by the business. In the case of this
example, a company providing architectural services, the components might be:
Design
Municipal approval
Construction documents
Construction services
Perform a two-year review of each of these service components for each

business segment and break them down into each cost item.
For example:
Time each employee contributed directly in office preparation
Time each employee contributed in meetings
Production materials Site services time
Travel costs Telephone attendance time
Telephone expense Additional insurance costs
The office time contributed for each employee is partially offset by salary
expense but the other items are all variable costs that must be recovered
through the hourly charge-out rate for the project.
By analyzing the history, you can usually predict (quite accurately) the
percentage of variable costs to each type of total project cost.
For example:
If a certain type of project:
Takes an average of 100 hours to complete
The variable costs average is about 25% of the total job cost
The average revenue generated is $10,000
In this scenario, calculate the variable cost recovery factor as follows:
$10,000 x .25/100 hours = $25.00/hour
Each year, review the project history so that any necessary adjustments are
made to this factor.
Step #5Analyzing employee involvement and variable costs
At this point, analyze how much of each employee's time is typically involved
in each service component on each project.
Extend and total the salary and benefit cost that it represents
Now, you can calculate the typical percentage of revenue that it represents and
the hourly rate recovery factor.
For example:
Total salaries + benefits/100 hours = salary/benefit hourly recovery
factor
For the sake of illustration, this might work out to be $55.00/hour
Step #6Arriving at a price
To be able to arrive at a project charge out rate that will recover the fixed and
variable costs you must look at the typical production of the company.
For example:
If the company is operating at or near capacity, has been completing 15
18 projects a year, and the projected volume for the year is 20
projects, then take a middle-of-the-road approach and use 18 projects
as your reference point.
With reference to how many of each project type are involved, calculate
the total number of hours for all projects.
Multiply the total project hours x (salary/benefit recovery factor +
variable cost recovery factor)
If total project hours were 1,500 hours, then the calculation would look
like this:
1,500 project hours x ($55.00/hour + $25.00/hour) = project expense
recovery
Therefore, the project expense recovery = 1,500 x $80.00 = $120,000
How does this compare to the projected operating costs for the company that
we estimated in step #2?
Recover the total operating expenses by the work that is completed.
Therefore, the project expense recovery factor must be increased so that
based on the projected volume (total operating costs + gross profit) are
achieved.
In the beginning, we said that fixed costs were $250,000.
To offset this, based on productivity, the project expense recovery rate
(PERR) must
be: $ 80 = PERR
$120,000 $250,000
Therefore: PERR = $80 x $250,000 = $166.67/hour
$120,000
This factor is grossed upward to generate the gross profit margin you wish
to achieve by dividing it by the difference between 100% and the % gross
profit goal.
If you wish to achieve a gross profit of 15%, you would divide the PERR
rate by 1.00 .15 = .85 to arrive at the project hourly charge-out rate
(PHCOR).
The calculation is:
PHCOR = PERR = $166.67 = $196.08/hour
.85 .85
Now, if you apply this rate to your projected 1,500 hours of project time,
the result is $294,120.
All of your expenses are covered and also you have allowed for generating
a gross profit of $44,115.
Of course, your analysis for your business will result in quite different figures
but the methodology is the same. Completed this analysis periodically
throughout the year ensures that the cost recovery and project goals are
achieved.
Summary
In Job Costing Analysis Preparation, we have demonstrated how to calculate

a job costing analysis for a business. The process illustrated here is the same for
any business.
We used a fee-for-service business as an example because it made it easier
to demonstrate the ideas involved.
However, in a business that sells products derive the revenue from the sale
of products. In that situation, consider only the net revenue or gross profit
derived from the sale of the products when computing the calculations.
Knowing the fixed and variable costs of the business is a key factor in
performing break-even point (BEP) analysis (discussed later).
In Monthly Performance Review and Analysis, we will look at how a

business would use the job cost analysis and break-even point (BEP) analysis to
measure the current performance of the business.
The Laws of Moneyof exchange

Money is the medium for exchanging goods and services.
It replaces barter.
What you earn in an open market shows the value others place on what you
Celebrate!
Anyone for a
little surfing?
2. Financial Feasibility Study of the Business's Offerings
Introduction
Whether it is a new business or an existing business, the decision-making

process regarding what offerings your business is going to market, or is
marketing, are the same.
Note:
We are using the term offerings to indicate either
products or services.
We have assumed that you have already completed:

Competition and your competitive edge
Market analysis
A customer/client profile analysis
Products and sources of supply
The marketing plan
The target market and target marketing plan
For detailed information about any of the above topics,

see The Business Plan
A financial feasibility study will determine if your offering mix or offering line
is financially doable. It answers this question:
Will you make a profit with this offering line or offering mix to these
designated market segments?
Assume that you have already made tentative decisions about what offerings
the business will sell. Take the last step to complete a financial feasibility study
of the offerings before coming to a final decision about what offerings will sell.
This feasibility analysis will determine if you can make a profit using this
market segment with these offerings.
For a new business, project the offerings and the calculation estimates based on
industry norms derived from your market research.
An existing business has the advantage of having historical data. Furthermore,

it has a great deal of local knowledge about the market it serves. However,
every time a business plan is prepared, it is important to go through the same
process. It is important to:
Test the current offerings mix
Examine and consider new offerings that may be available or offered
by competitors
Through the financial feasibility process outlined below, your business will
decide at regular intervals (yearly business plan process) whether to:
Add new offerings
Expand, curtail or eliminate current offerings
This analysis is an important forerunner to the development of goals and results

(objectives) and especially to the marketing strategy of the business plan.
The reason is to direct the major commitment of the resources of a company
towards the marketing of whatever offering mix is selected.
The analyzing process
Use this analyzing process to determine if it is financially doable to sell the

offerings
To the various specified market segments
At the specified prices
The six steps of this analyzing process are:

1. List and describe the various offerings of your business (either the ones
that you already have on hand or those that you tentatively have chosen.)
There is an example below that demonstrates the next three
steps. (2, 3, and 4)
2. Describe the relationship, if any, between each market segment of your
business
Describe the part each market segment plays in the business
Identify the relative importance of each market segment of your
business
3. State the volume contribution of each market segment versus the time
spent and expenses incurred
4. State the profit contribution of each market segment versus the time
spent and expenses incurred
5. Show a break-even point (BEP) analysis of each market segment
(See Break-even Point Analysis)
6. Draw conclusions about your offering mix and your market segments
No two businesses are the same. In addition, the relationship between business
segments is often constantly changing.
Here is an example of three of the steps (2, 3, & 4) mentioned above and how
decisions can be made because of the analysis.
The chart below provides the answers to the first five questions listed above:
The five market segments in this example are retail, commercial, industrial,
government and institutional.
The volume's contribution of each market segment is
25%, 45%, 15%, 5%, 10% respectively
What proportion of revenue does each market segment contribute to
the business? (See number 1 in the chart below.)
What is the profit contribution of each market segment?
(See number 2 in the chart below.)
What is the proportion of the expenses used by each market segment?
(See number 3 in the chart below.)
Institutional
Commercial
Industrial
Retail
Gov't
1. Proportions of 25% 45% 15% 5% 10%
revenue
2. Profits 55% 30% 3% 5% 7%
contributed
3. Expenses used 30% 45% 10% 10% 5%
You, or your business manager, may well decide that the sales volume and
profit contribution of the industrial, government, or institutional business is not
worth the drain on the resources of the organization.
Because of the analysis, decide if it could cut back or eliminate these market
segments.
In this example, the commercial business segment uses 45% of the
expenses and only contributes 30% of the profit. However, in this type of
business often volume buying required to service the commercial business
segment lowers the overall cost of the offerings.
The commercial business segment enhances the profit margin of the retail
market segment. If the company reduces the commercial business, it could
have an adverse effect on the total profit of the company.
Therefore, the decision will likely be to retain the commercial market
segment.
As you can see from this simple example, the relationship between market
segments can be complex and have many variable factors to consider. It is,
therefore, very important that these relationships be analyzed frequently.
You have completed the market researchnow you can make some final
decisions about the specific offerings with which you will provide your
customers. Make those decisions.
Complete this analysis more frequently than once a year. Add these other
analyses to your business plan as addenda.
It should include all the details that are pertinent to the offerings
like the:
Exact quality of offerings Name brands
Volume Sizes
Names of wholesalers Size of inventory
If you are an existing business, indicate the ones added, modified, or changed
from the last business plan. (Use colour for this step.)
Uses of the analysis
There are several uses for the offering analysis. Use it to:
1. Assist you in developing goals and outcomes for your business plan
2. Make decisions about retaining or dismissing either market segments or
specific offerings
3. Make decisions about adding or modifying offerings or market segments
4. Make decisions of which market segments and offerings your new
business will have
5. Write your marketing plan
Summary
In Financial Feasibility Study of the Business' Offering, we had discussed

the process of determining what the targeted market segments are and
marketing which offerings. This provides you a framework for making
decisions about the offerings your business would market.
The process discussed here is one that all businesses should do at least once a
year. As well, if you are contemplating:
A change of direction for the company
An expansion to new facilities or new markets
An addition of a major product line
The Laws of Moneyof capital

Your most valuable asset is your earning ability.
It's physical, its mentalit's your capital.
And, your most precious resource is your time.
Celebrate!!
3. Break-even Point (BEP) Analysis
Introduction to break-even point (BEP) analysis
The break-even point (BEP) analysis is one of the most important tools in
assessing the viability of pursuing new market segments as well as the relative
return on investment (ROI) of various existing market segments.
A break-even point (BEP) is the point where the business' total costs will just
equal its total revenue.
If you know the break-even point (BEP), you have a definite target to shoot for
and can put a step-by-step strategic plan together to achieve the goal.
For example
Legend
Red bracket indicates the loss area Orange bracket indicates profit area
Pink bracket indicates total variable costs Yellow oval indicates the break-even
point (BEP)
Green bracket and line indicates total fixed
costs
A break-even point (BEP) analysis can evaluate possible prices.
Express the objective in dollars or units of product. A business should do a

break-even point (BEP) analysis frequently. Then, it can be constantly aware of
what has to be achieved before the business begins to make a profit.
Certainly, before embarking on new programs or focusing on new markets,

take in account all the expected costs and complete a break-even point (BEP)
analysis. Sometimes, what looks like an attractive business opportunity is not
so great upon closer examination.
Increased sales do not necessarily mean increased profits. This is because a

dramatic increase in sales, or the launch of a new program, may necessitate the
purchase of additional equipment or the funding of additional internal or
external resources.
The result could be that the bottom line or net profit to the company will stay
much the same. In other words, the return on investment (ROI) is not worth
the additional expense. Sometimes, this is only a short-term effect and, in the
long run, making the investment may be a good decision.
Every business case is different and only the business owners or managers can
make that decision. What often happens is the additional investment creates
unused capacity in the business; thus, the significant increase amount of
business required to break-even or reach profit goals.
The break-even point (BEP) analysis helps the business owner or manager to
make intelligent decisions when considering new programs or any additional
investment in the company.
Some of the figures you need to calculate the break-even point (BEP) will have
to be estimates. It is often a good idea to use very conservative sales figures and
overstate the expenses somewhat.
Performing a break-even analysis
Calculating the break-even point (BEP) can be simple for a single offering
business, but more complex for multi-line or multi-service businesses.
Whatever the complexity, the basic technique is the same.
The basic break-even point (BEP) formula
Formulae Meaning of the formulae Example
S = FC + VC S = Break-even level of sales in dollars $221 = $55 + $166

FC = Fixed costs in dollars FC = $55
VC = Variable costs in dollars VC = $166
Examples of fixed costs are
Rent Property tax and insurance

Management salaries Interest on loans
Office and administrative expenses Depreciation
Examples of variable costs are
Raw material Advertising and promotion

Labour (wages) and payroll taxes Expenses for parts
Packaging materials Utilities
Outgoing freight Equipment maintenance
Sales commission Miscellaneous expenses (office supplies,
Contract people garbage removal)
Note that both fixed and variable costs are part of operating expenses and they
appear on the monthly operating statement (sometimes referred to as the profit
and loss statement). A business selling offerings buys and sells inventory.
Inventory is not part of operating expense. It is part of cost of goods sold
(CGS). The examples that follow show the application of a gross margin
(GM) to the sales price in order to determine break-even point (BEP) s and
profit goals.
The methodology is valid in either a fee-for-service business with no
inventory or a business selling offerings. However, in businesses with
inventory, there are other issues related to accounting for inventory,
inventory management, and offering turnover that will not be dealt with in
this section.
Assignment of Costs
Complete the assignment of costs as detailed or generally as necessary.

However, always complete it on the basis of percent (%) of sales (revenue).
If property tax and insurance were $40,000

And the total sales revenue were $600,000
Then, property tax & insurance represents
$40,000/$600,000 = .066 or 6.6% of sales
In a business, that has several divisions or aspects to the business, (such as

offering sales, a service department, and product installations) properly assign a
fair share of the common overhead expenses. This assignment or pro-rating of
common expenses is accomplished on the basis of the sales contribution of the
different divisions.
For example
If the offering sales account is 45% of the total revenue
The service department is 30% of total revenue
And the product installations is 25% of total revenue
Then, divide the office and administrative expense of the company
in the same proportions between those divisions.
Take the same approach within a department in order to assign costs to a
particular major offering group or a special project.
Examples of variable costs

1. In a manufacturing business where acquiring raw materials is necessary,
these commodities probably fluctuate in price. Labour costs may vary, and
sales commissions or shipping costs may change.
2. In retail or wholesale businesses, the cost of goods sold (CGS) could
increase or a new labour agreement with warehouse staff would increase
labour costs. If the public carrier you use has to increase their rates
suddenly, it will obviously increase shipping costs and affect the
profitability of the business.
3. In a service business, starting a new project or service may require a
greater amount of the business' resources than expected. Without careful
analysis of the internal and external costs that would be involved, the
business could be in for a nasty surprise. Some typical factors to examine
are:
The extra people necessary
The additional resources devoted to servicing the client in the office
The additional resources devoted to servicing the client in the field
The additional marketing costs to launch a new program
The possible increased liability exposure to the company
The possible current and future costs imposed by regulatory agencies
To what extent will the new program impact the financial resources
and people resources of the company and, for what period?
Without developing careful estimates of the expected costs and applying a

break-even point (BEP) analysis test, the business could embark on a new
program that could prove to be disastrous for the business.
When doing these tests, develop at least three projections:

An optimistic result projection
An average result projection
A pessimistic result projection
Variation of the break-even point (BEP) analysis
Considering all the variable costs can require detailed analysis and very
thoughtful consideration. This is necessary if you really want to know the true
profit picture of the business.
If you are calculating a projected break-even point (BEP), you may not know
all of the variable costs, that being so, you may want to estimate various
scenarios. In other words, prepare an optimistic, an average, and a pessimistic
scenario. To perform these, a variation of the break-even formula may be used.
There are at least three variations of the break-even point (BEP) analysis. Open
up the Break-even analysis in Microsoft Excel on your CD and work through
the interactive sheets with these variations.
(1) When the gross margin (GM) is known
Formulae Definitions of the elements of Example

the formula
S = FC+VC/GM S = break-even level of sales in S = $2,579.55
dollars
FC+VC = fixed and variable FC+VC = $227.00
costs in dollars
GM = gross margin as a % of GM = 8.8% (.088)
sales
In the above example $2,579.55 (S) = $227 (FC+VC) divided by .088

(GM)
Alternatively, stated in another way:
.088 (GM) times $2,579.55 (S) = $227 (FC + VC)
Therefore, if you know what gross margin (GM) you normally expect to
generate, you can test to see whether you recovered your basic costs.
You may get this information from previous years' financial statements.
You may also obtain it by consulting industry standards for your type of
business.
Then, based on this historical information and actual percentage to sales
relationships of expense items, you can estimate how much gross margin (GM)
those expenses will likely consume. Equipped with this information, you can
now make any necessary adjustments to gross margins or expenses to ensure
the profitability of the business.
In the example above, we illustrated:

.088 (the GM) x $2,579.55 (Sales) = $227.00
(the sum of the FC+VC)
If you are selling products, you may translate the dollar break-even point (BEP)
into units of product by simply dividing by the unit cost of the product.
(See the two examples below)
To arrive at sales objectives for your sales people, you now are able to calculate
how many units they must sell before the company starts to make a profit
For some businesses, you may want to extend the exercise to show how many
customers are needed to be profitable. See the example that follows.
Here are two examples of using the break-even point (BEP) analysis formula:
Example 1
Money needed per year/month for a break-even point (BEP)
FC + VC = fixed costs + variable costs $14,700 per year

GM = gross margin 20.7%
BEP = FC + VC/GM (per year) $14,700/.207 = $71,014.50 (per year)
(BEP means break-even point (BEP)
*BEP per mo. = BEP per year/12 $71,014.50/12 = $5,917.87 (per month)
Example 2
You need the number of customers per day for a break-even point (BEP). There
may be hundreds of items, all at different prices. This example simply assumes,
for illustration purposes, that the average per unit is $3.00 in order that you can
determine an approximate number of sales necessary for BEP.
If the average unit selling price is $3.00
The average customer purchases two times per week $6.00
There are 4.3 weeks/month therefore, the average customer $25.80

sales/month = 4.3 x $6.00 =
BEP = FC/GM (per month) $5,917.87
Consequently, the customers needed for a break-even point (BEP) are: 7.6
$5,917.87/$25.80 = $230 x 12 month = $2,760 per year/365 days = customers
per day
We rounded off the above figures off for simplicity. In addition, the example is
typical of a business that sells products rather than a fee-for-service business. In
a fee-for-service business, the GM percentage would be much higher, perhaps
60% or more and the necessary sales would then drop significantly.
For example
$14,700 (expenses)/.60 (GM) = $24,500 (sales)
(2) Profit planning formula
The break-even analysis can be adapted to profit planning by simply altering

the formula slightly.
The basic formula is P = S - (FC + VC)
This formula shows that if you subtract the sum of the fixed costs and the
variable costs from sales, the left over is the profit to the company.
Of course, if S - (FC + VC) = 0, then P in this formula is actually the break-

even point (BEP) because the sales are exactly offset by the fixed costs and the
variable costs.
In practice, use the profit-planning version of the formula when the GM is

known or assumed to be at a certain level.
There are several uses of the profit planning formulae:

1. To illustrate the process, refer to our previous Example #1 where we show
how a GM of 20.7% of sales is necessary for the business to break-even.
Most people would not be satisfied with only breaking even.
(GM = gross margin)
After all, they may have their life savings invested in the business and could
probably get a better return on their money by making other investments or
simply leaving the money in the bank and drawing interest on it.
2. Let us assume that the owners of the business in Example #1 feel that they
should earn a 10% return because that is comparable to what they could
earn on their money elsewhere.
So now, rather than the GM being 20.7% of the selling price to equal the
expenses, the GM will have to be approximately 31.0% of the selling price in
order to offset the expenses and provide a profit of approximately 10%. In other
words:
.31 of the selling price (S) = profit (P) + costs (FC + VC)
Formula Example
.31S = P + (FC + VC) .31 x $71,014 = P + $14,700

$22,014.49 = P + $14,700
P = $22,014.49 $14,700
P = $7,314.49
(3) Pricing product to achieve profit margin goals
Now that you have established the gross margin (GM) necessary to cover costs
and achieved the desired profit, how can you easily use this information to
properly price products?
The following formula will illustrate this as it applies to the example above:
S - .31S = C
The selling price (S) .31S = cost of S - .31S = C

inventory (C)
.69S = C
.69 x $71,014.50 = C
C = $49,000
What we have shown here is that:

If the GM is 31%, the cost of inventory is $49,000/$71,014.50 = .69 or 69%
of the selling price.
Accordingly, divide the cost price of any inventory item by .69; we will
know the appropriate selling price to yield the desired GM of 31%.
The formula is S = C/.69
The formula presented here is useful in maintaining selling prices at levels
consistent with the levels of GM percentage yield desired. This approach is also
consistent with the way the business operating statement shows the financial
data.
The profit-planning formula is a useful tool in determining what sales are

required to achieve a desired profit goal.
You can see how useful and important the break-even point (BEP) analysis and
the related formula are to daily operations and to business planning. There are
many ways to use this technique and we have only discussed a few here.
For instance
If you were thinking of making a significant capital investment in
the business, you might apply the above formulas to:
Project a worst-case business scenario
Project a best-case business scenario
Project a most probable case scenario for your future business
After consultation with your accountant, and performing a break-even point

(BEP) analysis, you may decide to lease that expensive piece of equipment
rather than buy it. Be creative and use the break-even point (BEP) analysis in
areas of the business other than sales. You often have more control over
expenditures than you do over sales.
A break-even point (BEP) analysis is helpful but do no follow it blindly. It is

useful for analyzing costs and for evaluating alternatives. The prudent business
owner or manager should also relate any analysis to a 'gut feeling' for the needs
of the marketplace.
Points to consider when using break-even analysis and related formulae
The break-even point (BEP) analysis does not consider the effect of
price on the quantity that customers/clients will want (the demand
curve).
It evaluates whether the company will be able to break-even with a
particular price, on a specific offering, at a particular point in time.
It is usual to base the factors used in the formulae on historical data.
The marketplace is unpredictable and conditions can, and do, change
very rapidly.
Thus, although break-even analysis and the related formulae are very
useful tools, the business owner or manager must use them in relation to
her/his best estimate of the changes in market conditions.
Sudden increases in operational costs can impact profitability.
Sudden increases in offering cost prices can necessitate big increases in
pricing that may result in plummeting sales.
Unexpected consumer demand may result in shortages of supply or the
need to commit greater resources to customer service. In either event,
the impact on profitability could be significant.
Suddenly confronting the business with extremely strong price
competition could drive prices down and affect profits.
It is a good idea to get in the habit of testing and monitoring the
performance of the business on, at least, a quarterly basis.
Risk assessment and break-even analysis should be part of any business plan
along with the development of contingency plans in case of the worst-case
scenario occurring.
Uses of the break-even point (BEP) analysis
The break-even point (BEP) analysis can to be used to:

Evaluate possible prices of the various product lines
Monitor the viability of existing business segments
Assess the viability of pursuing new market segments
Assess the relative return on investment (ROI) of various existing
market segments
Test the effect of changing market conditions on business segments
Test the viability of any expansion plans such as adding new
equipment or entering a new market
Assess after adding additional production equipment
Assess after increasing staff for any reason
Assess if there are sudden increases in fees, licences, or taxes from
government or regulatory agencies
Assess afterincreasing marketing costs to promote an offering.
Assess afterincreasing marketing costs to service a new market.
Summary
In this material, you have learned how important break-even point (BEP)
analysis is as a business-monitoring tool. We have discussed variations of the
break-even point analysis and examples of how to use them within the
business. We have shown you how to use break-even analysis and its variations
to:
Test the feasibility of new business ventures and offering introductions
Test the effect of changes in market conditions
Price offerings at a profitable level
The Laws of Moneyof time perspective

The most successful people make their day-to-day decisions by
considering the longest time period.
Delayed gratification is the key to financial success.
Celebrate!!
C. Operational Financial Management
Introduction
In Operational Financial Management, the focus will be on the following

three topics:
1. Inventory management
2. Accounts receivable and credit policy
3. Preparing pro-forma cash flow statements
Operational Financial Management is particularly concerned with managing

the flow of cash in and out of the business. It is also concerned with how to
utilize the cash by the business to provide the best return on investment (ROI).
As you move through this section, think of how you presently manage your
business in relation to these three subject segments. A brief outline of these
segments follows:
1. Inventory management
In Inventory Management, you will learn the different ways in which

inventory is evaluated. Samples will provide you with examples that will help
you in properly evaluating the inventory in your business.
Managing the product mix in a business can be a complex issue. Inventory

Management will present ideas on how to manage the product mix to obtain
the best return.
As well, you will learn the importance of maximizing inventory turnover. You
will see ideas and examples that you can apply to your business.
2. Accounts receivable and credit policy
In this segment, you will learn the importance of designing a credit policy that
will best serve the needs of the business and market it serves. You will learn
that creative use of credit policy can be an important part of both:
The sales and marketing management of a company
The financial management of a company
We will discuss the effect on the business of effective credit policy and
management.
You will learn about the typical accounts receivable (A/R) reporting tools and
their use.
You will also learn methods of managing credit sales and the resulting accounts
receivable (A/R).
3. Preparing pro-forma cash flow statements
In Preparing Pro-forma Cash Flow Statements, we will present in detail the

elements of a cash flow statement and its preparation. You will learn, step by
step, how to prepare a cash flow statement and will be able to apply this
directly to your business.
We will discuss the importance of using the pro-forma cash flow statement to:
Forecast the expected revenue and expense for the fiscal year
Plan for potential shortfalls in business revenue
Communicate financing needs to a lender
At the end of this material, we provide sample spreadsheets to assist you in

preparing a cash flow statement for your business.
When you have finished, think carefully about the ideas presented. Consider
how you operate now and what ideas would improve your business now or in
the future.
The Laws of Businessof obsolescence

Whatever is, is already becoming obsolete.
Change prevailsit's unavoidable.
A successful business adapts quickly; even better,
it helps create change.
1. Inventory Management
Introduction
For any company that handles inventory, the inventory represents a major
investment for the company. For many companies, the value of the inventory is
the value of the company. It may be the largest asset of the company.
Therefore, inventory deserves careful attention and proper management in
order for it to yield the maximum return on investment (ROI) to the company.
The purpose of Inventory Management is to generate more awareness of

common approaches to managing inventory. We will discuss some inventory
management ideas in income statement analysis in relation to the cost of goods
sold (CGS)ideas such as inventory turnover and the evaluation of inventory.
Now, we will build on those ideas and discuss other ideas related to good
inventory management.
We will focus on four important areas:

1. Inventory evaluation
2. Managing the product mix in inventory
3. Inventory investment
4. Inventory turnover
As you read this material, you should think about:

How you presently manage the inventory in your business
What you presently do to manage the amount of money invested in
each product category
What do you now do to manage and control the quality of your
inventory
What do you do now to promote inventory turnover
a. Inventory evaluation
Evaluation of the inventory can vary with the industry and the type of business.
Natural resources, manufacturing, distribution, and retailall of these
industries may evaluate inventory differently.
Within these industries, evaluate some groups of products differently
because of the nature of the product and the handling of it.
If your industry or business has special inventory evaluation concerns, you

should consult your accountant for direction.
For the purpose of discussion in this segment, we will only be concerned with
presenting the main approaches to inventory evaluation.
There are three methods of inventory evaluation:

a. First in first out (FIFO)
b. Last in first out (LIFO)
c. Weighted average
From an accounting point of view, it usually doesn't matter the choice of

method as long as its use is consistent. However, each method can affect cost of
goods sold (CGS) differently. In addition, the rate of inventory turnover and tax
considerations may influence the choice of method.
For the purpose of illustration of these three methods, in the next three
segments we will use the following example:
Acme Mercantile inventory records show the following information.
Beginning Inventory Units 1000 @ $1.00 ea. = $1,000
Purchase #1 Units 2000 @ $1.12 ea. = $2,240
Purchase #2 Units 2000 @ $1.22 ea = $2,440
Total Units 5000 Total value $5,680
Ending Inventory Units 2000
Units Sold 3000
This example indicates only two purchases; however, in practice, there may be
many purchases.
(1) First In first out (FIFO)
The FIFO method of inventory evaluation assumes that:

The first items (purchase for inventory) are the first items sold.
Therefore, using the assumed figures for Acme Mercantile, the following
scenario illustrates how the FIFO method works.
If 3000 units are sold:

Units Sold 1st Units sold 1000 @ $1.00 ea.= $1,000
nd
2 units sold 2000 @ $1.12 ea. = $2,240
Cost of Units sold $3,240
Cost of units remaining in inventory $2,000 x $1.22 ea.= $2,440
(2) Last in first out (LIFO)
The LIFO method of inventory evaluation assumes that:

The last items purchased for inventory are the first items sold.
scenario illustrates how the LIFO method works.

1st units sold 2,000 @ $1.22 ea. = $2,440
nd
2 units sold 1,000 @ $1.12 ea. = $1,120
Cost of units sold $3,560
-----------------------------------------------------------------------------------------
Cost of units remaining in inventory 1,000 x $1.22 ea = $1,220
1,000 x $1.00 ea = $1,000
Total cost of remaining units in inventory = $2,220
(3) Weighted average
The weighted average method of inventory evaluation assumes that:

Unit cost of inventory is the total cost of inventory divided by the number
of units.
scenario illustrates how the weighted average method works.
Weighted average cost is $5,680/5,000 units = $1.136/unit

Therefore, cost of units sold is 3,000 x $1.136 = $3,408
Total cost of units remaining in inventory is 2,000 x $1.136 = $2,272
In the three methods of inventory evaluation, you can see that:

The cost of units sold is different
The cost of the units remaining in inventory is different
The reason is that the evaluation assumption is different. None of the three
methods are wrong, but the method chosen will affect the cost of goods sold
(CGS) calculation and hence the profit calculation for the period.
1. The FIFO method is the most widely used. It produces values closer to
current market values since it includes costs that are more current.
You could say that this method encourages the turnover of inventory
because the better the turnover rate, the closer the inventory valuation will
be to current market costs.
However, it still slightly underestimates current market value because it
does include earlier costs.
2. The LIFO method generally results in undervalued inventory.

If you use this method, you are not allowing for the replacement cost of
your inventory.
LIFO may not be acceptable by governments in some jurisdictions because,
by undervaluing inventory, the CGS is overstated and this has the effect of
lowering the taxable income of the company.
3. The weighted average method tends to produce values that are similar to
FIFO because it blends the cost of all the items in inventory. However, this
does depend on the type of business and the turnover rate.
(4) Periodic and perpetual inventories
The inventory calculation examples (shown above) assume that on a periodic

basis, the inventory is counted and evaluated. It is a legal requirement in most
jurisdictions that at least once a year or in a 12-month period, there should be a
complete physical inventory
In practice today, many businesses use a perpetual inventory system where the
cost of blending existing inventory constantly with the cost of new items
acquired for inventory.
Electronic inventory management systems and accounting software handles
perpetual inventory systems with ease.
Many such systems will allow inventory calculations using the different
methods of evaluation.
Sometimes, within a particular business, evaluating product categories
differently can present a more accurate picture for tax purposes.
Managing the product mix in inventory
The product mix is a term that refers to the product selection that a company
stocks and the amount of those products that are stocked. The product mix in
the inventory of a company is very important. If you don't have the right
amount of each product at the right time, it can have a significant effect on the
profitability of the company.
Managing the product mix involves:

Selecting main product lines that will complement each other in terms of
quality range and price range
Selecting the right accessory and related products to go with the main
products
Accurately projecting the required stock quantities at all times and
determining the amount of additional stock required in peak or
seasonal periods. Establishing minimum and maximum inventory
levels for all items for each period of the fiscal year
Accurately determining the inventory value of each part of the product
mix
Ensuring that units of product in all segments of the product mix are in
saleable condition
Promoting the turnover of inventory to ensure that the majority of
product units are fresh and as recently purchased as possible
Consciously and aggressively moving overage, damaged or poor quality
inventory
b. Inventory investment
Being constantly aware of the amount of money necessary to maintain

established inventory levels is a key factor in managing inventory. Without
awareness and exercising spending control, a business could easily spend
profits or even the proceeds from gross sales on items other than inventory.
In this event, the problems resulting could be:

Lack of funds to reinvest in inventory
Borrow money to reinvest in inventory. This increases expense
and, therefore, can lower profits
Less inventory to sell of important product lines and, therefore,
lower sales
Inability of the business to react to customer demand for new
products
Loss of customer confidence in the business as a supplier
Loss of market share
These points illustrate how important it is to maintain inventory levels at

acceptable levels in all segments of the product mix.
Maintaining inventory levels of key products is vital to the success of your
business.
To ensure that your business maintains inventory at required levels, you should
prepare detailed inventory reports.
The frequency of preparing the reports may vary with some businesses.
Businesses with higher turnover rates need to prepare the reports monthly,
but many businesses would likely find that quarterly inventory reports are
sufficient.
These reports should show the inventory value of each item in inventory as
well as the total value for the product segment of which it is a part. The
report should show comparative figures to the previous period so identify
changes in value.
These reports will be labour intensive to produce by hand, but many
accounting software programs or business managerial software programs
will easily produce detailed inventory reports at the push-of-a-button.
Consult your certified accountant on the accounting needs for your
business.
Based on the inventory reports, you need to budget money for monthly
maintenance of the inventory investment in each product.
A portion of this money really represents a portion of the cost of goods sold
(CGS).
To maintain inventory investment, replace the CGS each month.

Therefore, allocate that portion of your sales revenue represented by the
CGS each month to replace the inventory investment.
It is a good idea to compare the % to sales of CGS from one period to
another on the income statement.
In Income Statement Analysis, we will discuss the inventory section of the

income statement. Revisit or visit that section and review the discussion about
inventory, CGS, and the statement of inventory value.
c. Inventory turnover
The question of monitoring and controlling inventory turnover has come up a

number of times in our discussions about inventory management. Inventory
turnover affects all the items we have discussed so farevaluation, product
mix, and investment.
In reference to the examples above, we have referred to inventory turnover

effecting the calculations and they will widely differ.
You will find little difference in the calculation methods in businesses with:
Higher turnover rates and low inventory values
You will find bigger differences in the calculation methods in businesses with:
Lower turnover rates and higher inventory values
In either case, it is evident that inventory turnover rates are a key factor in
business profitability. To facilitate inventory turnover, every business should:
a. Use inventory identification methodsInventory identification
b. Assign a length of time an item may be in inventoryLength of time in
inventory
c. Produce inventory movement reports each monthInventory
d. Produce monthly overage inventory reportsOverage inventory report
We will now discuss these four items:
(1) Inventory identification
Identify every item in inventory needs as to:

An inventory ID number
When the item was brought into inventory
The cost price of the item
In addition to the product ID number, use a product code of some sort to mark
the purchasing information on a tag attached to the item or use a stamp to
stamp it on the package.
For example:
Product codes may be alpha numeric and the variety of systems is
unlimited. A typical example of using a code in a retail store is as
follows.
Assign a number to each month of the year#1 for Jan. #2 for Feb.
until each month of the year has a number.
Choose a word with 10 letters or perhaps two words that total 10 letters
and assign each letter a number in sequence from 19 + a letter for 0
as follows:
B LA C K H O R S E
1 2 3 4 5 6 7 8 9 0
Purchasing an item of inventory at a purchase price of $24.90 the

store would code the information as follows: #2LCSE99
Many stores use this simple method so that without the aid of electronic
scanners a clerk in the store can see at a glance how long the product has been
on the shelf and the cost price. The clerk would use this information to:
Sell first the items that have been in inventory the longest.
Even if several items on a shelf are identical, it is important to have the most
fresh, recently purchased inventory on hand.
To make on-the-spot price adjustments, if necessary, while still
maintaining a minimum GM.
Knowing exactly how much profit there is in an item is an advantage
when dealing with a customer.
Clerks using a product code like this become very proficient at reading the code
without any hesitation. It becomes second nature to them as they are working
with it all the time.
Usually incorporated into the barcode is exactly the same kind of information
you see on price tags in stores and on most packaging today
A barcode is a strip of lines of various widths that represent all the product
and pricing information for that inventory item.
When the barcode is scanned (with a barcode scanner at the point of sale
(POS) or read by a clerk), all of the product and price information on the
code is retrieved.
Here is an example of a barcode:
Example:
Another device that is useful in identifying Inventory at the point of sale (POS)
is colour coding. Colour codes can help a sales clerk to identify the oldest
inventory and its purchase date.
For example:
Tracking the age of inventory in the retail clothing business can make a
big difference in inventory turnover and the salability of inventory.
Clothing inventory becomes obsolete very quickly because of:
Seasonal demand
Changing styles in fashion
If clothing stores did not promote high turnover of inventory, the overage
inventory would soon choke it. This is why you frequently see inventory-on-
sale at clothing stores.
Producing inventory movement reports at the push of a button on your
computer works well in getting a global picture of the inventory in the store.
However, at the POS, a clerk serving a customer in front of a rack of similar
jackets will benefit from a quick visual method of determining the age of
inventory.
A simply device that is used by some retailers is to colour code the tags on the
inventory. Coloured price tags are readily available from store fixture and
supply wholesalers.
Assign each month of the year a colour. You might decide upon:
Red January
Green February
Light yellow March
Blue April
A clerk looking at a rack filled with similar jackets would know at a glance that
the jacket with a light yellow tag had been in inventory the longest. The clerk
would then try to promote the sale of those items.
There are many ways to identify inventory. The system used will depend on the
type of business and the inventory stocked. Be creative in your business. You
should think of ways that you can do a better job of identifying your inventory
in order to promote turnover.
(2) Length of time in Inventory
Assign each product group in inventory a maximum time in inventory. Assign a

shorter or longer time for some items within a product group.
Even items that you think are very durable or won't become obsolete in a
short time should be assigned a maximum time that you will keep them in
stock.
Sitting on a shelf or hanging on a rack inventory will:

Become ingrained with a certain amount of dust
Become soiled from handling by customers
Acquire nicks or chips from jostling against other products
Not look fresh and new to customers
It is important to maintain inventory in as good condition and appearance as

possible as well as to promote inventory turnover.
Once you have assigned a time limit to the inventory, use a visual method
similar to that previous discussed to identify it.
In assigning a time limit to products, consider the following points:

Look at inventory movement standards for the product in your industry
Consider that it is your money that is invested in and tied up in the
product as long as it sits in inventory
Consider how perishable the product is. Will it deteriorate in value over
a short time such as vegetables?
Consider the seasonality of the product. That means to consider if it is
an item that mainly sells in spring, summer, and fall or winter season
How soon will the product become obsolete? Is it likely to become out
of fashion in 36 months?
Many industries consider that if a product has not sold for a year, the
business has lost at least 30% of the value of the product by not turning
over the money invested and reinvesting the money in new products.
For example:
A hardware store has hammers that were purchased for $15.00 and sell
at a 33% GM at $22.50 each.
If these hammers do not sell for a year, the store has:
Not made the expected GP of $7.50 each on these hammers
Not been able to apply this GP against operating expense
Not been able to reinvest the stores own money in other products
Although a hammer would not be considered a perishable item or subject to

changes in fashion, the store must turn the money invested in inventory in a
timely fashion in order to be profitable.
In this business, the time assigned for the hammers should not be longer than
six months.
For example:
A clothing store has purchased dresses for summer sale. The dresses
arrived in stock in March. The purchase price was $35.00 each and,
at a 50% GM, the regular retail price is $70.00 each
If these dresses do not sell within 30-60 days at regular price the store:
Has not made the expected GP of $35.00 each on these dresses
May miss the narrow window of opportunity when most customers will
buy summer clothing
Must consider the prospect that the dresses may be out of season and out
of fashion within a couple of months
Must start an aggressive on sale strategy to make sure within another
3060 days, the dresses are sold.
Seasonality and fashion dictate stock considerations in the clothing industry. It

is why regular selling prices yield 50% GM. The business needs to have
enough GM at the regular price to be able to offer 15%, 20%, and 35%
discounts off the regular price and still make some GP.
In this example, the clothing business would likely assign a time in inventory of
no more than two months.
We urge you to use these two very different examples to think about your
business and what time limits you would assign to items in your inventory.
As you can see, the time limits can be very different and for different
reasons. However, whether your product is a bar of steel, wire mesh,
clothing, or perishable grocery items, you need to think it through carefully
and assign inventory time limits that meet the needs of your business.
(3) Inventory movement reports
Inventory movement reports are very helpful in closely monitoring inventory.

These days they are easy to access because any accounting software program
should have the ability to produce these reports.
As well, many available business managerial programs will do a better job than
an accounting software program in managing daily operations.
An inventory movement report should categorize inventory in product groups.

Within the main product, show the groups and products in sub-categories
separately.
This is because when you view the report, you can focus your analysis on
one group at a time and not get lost in a mass of unconnected information.
An inventory movement report should show on a per item basis:

Beginning inventory number units and value
The minimum and maximum inventory level for each item
The pack size for each item. That is, how the item comes packaged for
shipmentis it supplied in cases of 6, 12 or 24 items per package
Number of inventory units sold of each item each month of the fiscal
year-to-date and the value
Number of inventory units on hand of each item and the value
After each inventory category or product group, it is useful to know the total
value in inventory of that group of products.
Produce different versions of an inventory movement report for various users

of the information in the business. The following three examples will illustrate
this:
Example 1:
In this first example, a manager only wishes to view the movement history of an item. Therefore, the only information shown is the
item description, ID# and the movement history. The movement history shows the manager the seasonal fluctuation in the
movement of the item. A rat-tail file is an item of merchandise commonly found in hardware stores.
Inventory Movement Report
Product Group/Class Date:
Item Prod Jan Feb March April May June July August Sept Oct Nov Dec
description ID#
8 rat-tail file 1234567 6 15 24 30 20 26 15 12 18 30 22 10
Example 2:
In this second example, the manager wishes to see the value of the inventory items in stock, the preset stock level information, and the
established ordering point along with the inventory movement history. One reason for this might be that changes in demand are
cause for considering adjustments to stock levels and ordering figures.
Product Group/Class: Date:
Item Prod Pack Min Max Order On Jan Feb Mar Apri May June July Aug Sept Oct Nov Dec
Description size Inv Inv Pt Hand
ID#
8 rat-tail 1234567
file
Example 3:
In this third example, the manager wants most of the detail on the previous two example forms, but what's more, wants to produce a
form that can be used to record ordering information.
Note that on the extreme right of the form that the last four columns are to record the quantity ordered, ordered when, who did the
ordering and the requisition reference number.
In some businesses, there may be only one department doing all purchasing. In that case, only one PO# or purchase order number
is used.
Some businesses have several departments that are preparing orders for submission to the purchasing department.
In this case, these departments prepare requisitions for the purchasing department.
The purchasing department consolidates the requisitions on PO's before forwarding the orders to the suppliers.
Product Group/Class: Date:
Item Prod ID# Pac Min Max Ord On Jan Feb Mar Apr Mar Jun Jul Aug Sep Oct Nov Dec Qty Date Req Emp
Size Inv Inv Pt hand Ord # #
Desc.
8 rat- 1234567 12 24 36 18 16 6 15 24 30 20 26 15 12 18 30 22 10 12 17/2/ 123 23

00
tail file 456
Using the information on this last example note the following:
Mar-June movement is 100 items divided by 4 months = 25 items/month
average
Sept-Dec movement is 80 items divided by 4 months = 20 items/month
average
Total items moved per year is 228 items divided by 12 months = 19 items
average
Therefore, because the pack size is 12, the order point has been set at 18 in
order to accommodate the minimum and maximum inventory movement.
Another factor that will influence ordering is the length of time it typically
takes to receive an order from a supplier.
Before choosing a business managerial software program, seek advice from

your accountant as to what features and information would best serve the needs
of your business.
Using the inventory movement report information
You should study the data presented on the inventory movement report and
answer the following questions about each item:
Does the item move at a consistent rate each month?

Does the demand for the item vary in some months of the year?
Is the inventory investment too high or too low in relation to the
inventory movement?
Could inventory turnover be improved by adjusting the inventory
investment in certain periods of the fiscal year?
Based on sales and the time it takes to replace inventory, what is the
minimum number of units that should be stocked, and how many
more units (the maximum) is it necessary to stock at certain times of
the year?
Overage inventory reports
An overage inventory report is another report that the business managerial

software and most accounting programs will produce.
Based on the length of time in inventory you have assigned to the item, the
software will produce a report showing how many of each item you have in
stock in excess of the assigned length of time in inventory.
This report will typically include the following information:

A listing of all overage items by product category
The number of units and the value of each overage item
The total value of the overage inventory by product category
The grand total value of all the overage inventory
As well, some overage inventory reports state information such as:

The earliest purchase date and quantity remaining of the original purchase.
The reports do vary in level of detail. Some software programs may be

configured to provide additional information you may need.
What to do with the overage inventory report information
If your business has never regularly monitored overage inventory, you may be
surprised at how much inventory is slow moving and could be classified as
overage.
If you are able to produce an overage inventory report easily every month,
you can scrutinize every listed item and make decisions as to:
Is the item necessary to have in inventory? Must you have it satisfy
customers?
Do customers expect your business to have the item?
Is it the right product or is there a similar product that would sell
better?
Was the item displayed or promoted properly?
Are the inventory level quantities realistic in relation to the product
movement?
If, after considering the answers to all of these questions, your decision is to
remove the product from inventory, then do so as quickly as possible.
Cull slow-moving or overage inventory from inventory constantly. Display this

stock and its discounted price prominently to whatever degree necessary to
move it.
You are better off to sell overage inventory at a loss

and re-invest the money in inventory that will yield good turnover rates.
Summary
In Inventory Management, we have discussed ideas and methods

related to the management of inventory. You have learned how to:
Evaluate inventory
Manage the product mix
Manage the inventory investment
Manage and promote inventory turnover
Compare the ideas and methods presented here to the ways in which you
manage inventory in your business now.
Ask yourself these questions:

What ideas and methods would likely have the most positive effect on
your business?
What do you project that the financial effect could be?
What ideas and methods can be implemented now?
What ideas and methods will need to be phased in?
What ideas and methods will require assistance from your accountant?
Laws of Moneyof saving

Financial freedom comes to those who save 10 percent of more of their income
all their lives.
The way to do this is to pay yourself first.
Celebrate!!
2. Accounts Receivable (AR) and Credit Policy
Introduction
Managing how accounts receivable (A/R) and credit policy in a company can
have a major impact on the business. Here, we will discuss these important
aspects of the financial management of the business. We will present common
procedures and ideas in managing A/R and credit policy.
As you read this material, consider carefully the elements of the credit policy in
your business. Think about how your present credit policy and the effect it has
on your business. As well, think about how much of your business is charge
sales and how important those accounts receivable (A/R) are to the business.
Ask yourself these questions:

How do the ideas presented on A/R management compare to the A/R in your
business?
Could a redesigned credit policy better serve the financial needs of the
business?
Could some of the ideas and procedures present help you design a better credit
policy?
Would implementing some of the ideas presented improve the profitability of
your business?
We have divided the material into two major parts:

A. Accounts receivable (A/R)
B. Credit policy
a. Accounts receivable (A/R)
Analyzing your accounts receivable (A/R) is an important part of monthly

financial performance review and analysis.
Reports often refer to Accounts Receivable by the abbreviation, A/R.
Accounts receivables (A/R) are accounts with customers that the business
has sold goods or services to on credit terms.
The amount of money represented by accounts receivable (A/R) can have a
significant effect on the cash flow of the business because as long as those
accounts remain unpaid, the money:
Is unavailable for use by the business

Cannot be reinvested in inventory
Cannot be used to pay the monthly expenses of the business
Cannot be used to acquire capital equipment needed
Cannot be used to implement marketing programs
Until accounts receivable (A/R) is paid, the money is not part of the cash flow
of the business.
Unpaid accounts receivable (A/R) can increase the need for the business to
borrow money to finance operations.
The cost of borrowing this operating capital is an added expense to the
business.
Essentially, financing the accounts receivable (A/R).
A manager must justify this expense by balancing the expense against the
other possible benefits to the business of borrowing money to finance the
shortfall in revenue created by accounts receivable (A/R).
These benefits may be:
Increased turnover of inventory
Moving larger amounts of inventory may allow the business to buy products in
larger volumes at lower prices
Buying at lower prices may result in a competitive advantage, which can result in
increased sales
Balancing these factors to arrive at a decision is not always easy. In addition to

the cost of borrowing, there can be other possible expenses involved with
moving larger volumes of product by increasing accounts receivable (A/R).
Some of these may be::

Increased staffing expense
Increased shipping and handling expense
Increased advertising and promotion expense
Increased warehousing and storage expense
Consequently, a manager must weigh all the costs versus the benefits to having
accounts receivable (A/R) and increasing accounts receivable.
This is an important factor in developing a credit policy for the company.
A company credit policy is a statement of the terms and conditions under
which a company will allow customers to buy on credit. We will discuss
credit policy later.
It is very important that a business be constantly aware of dollar value of

unpaid accounts or accounts receivable (A/R). Controlling the amount of
accounts receivable (A/R) and improving upon the rate of payment by
customers can have a major effect on the cash flow and profitability of the
business.
To facilitate analyzing accounts receivable (A/R) it is useful to produce an
Aged Accounts Receivable Report.
Named an Aged Accounts Receivable Report because it presents a history
of purchases by a customer and how much remains unpaid.
An Aged Accounts Receivable Report is usually a spreadsheet with
columns for each month of the year.
It includes the name of the account and the amount that remains unpaid
each month. Delinquent accounts are customers who have not paid their
accounts within the terms of the company's credit policy.
In a column on the far right does a space for the total amount of the money
owe by the customer.
Aged Accounts Receivable (A/R) Report #1
Date
Account Name CR. Limit Terms Total Amt. +/- Current 30 days 60 days 90 days 120 days Prior
App. Owing CR. Month Month
Acme Supply $5,000 60 days $8,700 +$3,700 $500 $700 $1,200 $1,800 $2,000 $2,500
Superior Service $500 30 days $600 +$300 $200 $100 $300
Quality $500 60 days $900 +$400 $300 $500 $100

Contractors
A-1 Builders $15,000 60 days $27,300 +$12,300 $8,000 $6,500 $5,800 $4,000 $3,000
Totals $37,500 +$16,700 $9,000 $7,700 $7,200 $1,800 $6,300 $5,500
Aged Accounts Receivable (A/R) Report #2

This example shows some of the same information as the report above but presents only the balances owing for each period and a total amount owing.
Some companies may provide a report that only shows this amount of detail to employees that deal with customers.
Name Current 30 Days 60 Days 90 Days 120 Days Prior Month Total Owing
Acme Supply $500 $700 $1,200 $1,800 $2,000 $2,500 $8,700
Superior Services $200 $100 $300 $600
Quality $300 $500 $100 $900
Contractors
A-1 Builders $8,000 $6,500 $5,800 $4,000 $3,000 $27,300
Totals $9,000 $7,700 $7,200 $1,800 $6,300 $5,500 $37,500
The viewer of a report like this would want to acquire more knowledge about
the accounts and the reasons for their purchasing and payment history.
If this were an example of the aged accounts receivable (A/R) report for your
business, here are the following observations concerning the accounts.
Acme SupplyThis delinquent account is getting further in debt to your company

every month.
It is clear that only partial payment was received for each months purchases.
The reason for this should be determined immediately.
If the customer has kept the account more current in the past and is a valued
account, you may wish to negotiate a regular payment schedule to retire the
past months owing.
You may even wish to continue selling to the customer as long as they adhere
to the payment schedule.
If the circumstances dont warrant a negotiated repayment schedule, then the
customers account should be suspended until the account is brought into
line with the credit terms policy of your company.
If no effort was made to repay the amounts owing, it may be necessary to either
sue the customer for the money or send the account to a collection agency.
Superior ServicesThis delinquent account is not buying large amounts and in
some months, there are no purchases.
This account may like to shop around for the best deal.
The amount 60 days past due is not large and likely not to be concerned about.
However, the $300 that is 120 days past due should be of concern.
As much as the $300 is important, it is important to know the reason why a
relatively small amount was not paid.
When this situation exists, there is usually a story. The customer may be unhappy
with the product or service that they bought. They may have expressed their
dissatisfaction to someone in your business and they still are not satisfied.
Long before this account reaches the stage of being 120 days past due, a vigilant
manager should be contacting the customer to determine their reasons for non-
payment of the account.
Quickly identifying the reasons for a credit problem and resolving it maintain good
customer relations and build the reputation of your business.
Quality ContractorsThis delinquent account is a small builder that does small

handyman projects and renovations.
This account typically pays the account off regularly but is always waiting
for payment after a job is completed.
A job could take 3060 days to complete so most of the time payment is
made in about 60 days.
The account is loyal to your business so there should be little concern that
payment is always 60 days after purchase.
A-1 BuildersThis delinquent account is similar to Quality Contractors, only the
business is larger.
Most of their business is sub-contracting to larger general contractors.
A little extra communication and attention may be necessary with this type of
account.
You need to know the reason for the non-payment of the amounts that are 120
days and prior months past due. It could be that there is some
dissatisfaction with a product or service.
However, it may be that the general contractor has not paid them for some
reason and so they are not paying you.
If the reason for non-payment is not directly related to product or services
supplied by your company, then it must be made clear to A-1 Builders that
you are not in the business of financing them and they must pay the
account or risk suspension of credit privileges.
As part of assessing the value of this account to the business and deciding on a
course of action, the manager would want to look also at the accounts
purchasing history. The following is an example of a Customer Purchase
History Report.
A Customer Purchase History Report
Customer Purchase History Report Date
Account Acct Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec YTD PYTD
Name #
A-1 Builders 42351 $6,000 $7,000 $5,800 $6,500 $8,000 $33,300 $29,000
These examples are just a few of the typical situations that a manager and a
credit manager deal with every day. You can see that doing a good job of
managing accounts receivable (A/R) requires:
Constant attention
Current knowledge of customers business and their changing needs
Being able to analyze and determine underlying reasons for the way customers pay
their accounts
Application of good people skills and questioning techniques
Good decision-making skills
In Testing the Financial Strength of Your Business, there is a discussion of

common business management ratios.
Two useful ratios for monitoring accounts receivable (A/R) are the
accounts receivable turnover formula and the average collection period
formula.
Completing a detailed analysis of accounts receivable (A/R) on a monthly basis

is important.
As part of the analysis, it is a good idea to test the effect on your business if
accounts receivable (A/R) increased or decreased or if the average
collection period was greater or less.
Good management of accounts receivable can have a major impact on::

The cash flow of a business
The amount of financing needed by the business
The cost of borrowing operating capital
Such an analysis may indicate that it is worth the expense of hiring a full-time
person to manage accounts receivable (A/R) and collect delinquent accounts.
Other ratios of interest relative to accounts receivable (A/R) are the current
ratio, the acid test, and the debt to asset ratio are found in Testing the
Financial Strength of Your Business.
In using these ratios, the quality of the accounts receivable (A/R) is
important.
The term quality means how collectable is the money from the receivables
or how quickly the receivables are converted into cash.
If overage accounts receivable represent a significant amount of money,
then inclusion of those accounts in calculating the ratio may not give a true
picture of the financial position of the business.
Summary of accounts receivable (A/R)
In Accounts Receivable, we have discussed how selling offerings on credit and

creating accounts receivable can benefit a business. We have discussed some of
the problems that can be involved with accounts receivable and some common
tests for monitoring them.
Effect management of accounts receivables is a balancing act for many

businesses. In designing a credit policy, a manager is always striking a balance
between:
Allowing enough purchase on credit to stimulate sales and promote
inventory turnover
Maintaining positive cash flow and liquidity in the business
b. Credit policy
A company's credit policy is a statement of the terms and conditions under

which a company will allow customers to buy on credit.
The credit policy of a company influences many aspects of the business.

The credit policy can have the effect of stimulating or inhibiting sales.
It can result in increasing or decreasing inventory turnover.
It can have an effect on the cash flow of the company.
Indirectly, it can have an effect on the amount of borrowed operating
capital a company requires. In other words, it influences the:
Sales and marketing of the business
The financial management of the business
Tailor the credit policy of the company to the needs of the company and the
market it serves. Key considerations when designing a credit policy are:
Industry norms for the market served by the business
Competitive credit policies of businesses in your market
Your business's specific financial needs
Determine your business's specific financial needs by the results of your break-
even analysis and estimates of what the business requires in order to achieve an
acceptable level of profit and ROI.
Three ways to use credit policy
Most small businesses have a very simple credit policy.

Often there hasn't been a lot of thought put into formulating the policy.
A small company could derive its credit policy from:

What others in the industry seem to be doing
Adapt another company's policy
The basic reason to have a credit policy is to have some measure of control
over the granting of credit.
Example of common credit terms:

It is very common for a company to have credit terms on consumer credit sales as
follows:
Normal credit terms require that full payment in 30 days.
Making a payment within 15 days after purchase, may provide a discount of
1% or 2%.
Interest on past due accounts is 1% per month on the past due balance.
A written credit policy (as stated in the previous three points) is common on
company statements as: Credit terms are 1%15 days. Net 30 days; 1%
month interest on past due accounts
The type of credit terms may vary slightly in the time period and percentage of
interest due, but the terms usually relate to the cost of borrowing money.
This type of credit policy affords a measure of control. However, we will

discuss using credit policy more creatively in the next three segments:
1. Credit policy used as a sales tool
2. Credit policy as a cash flow management tool
3. Credit policy as a profit generating tool
(1) Credit policy used as a sales tool
Credit policy can be a powerful sales tool. A company may want to do this in
order to:
Stimulate sales during slow seasonal periods
Increase sales of high-priced items
Keep a manufacturing plant operating in the off season
Buy market share by offering better credit terms than the competition
Examples of businesses that do this are:

Companies that will take booking orders in the fall for shipment the following
spring usually do so because they want to keep their manufacturing plant
operating in the winter months.
If the company doesnt manufacture products, it may want to qualify for discounts
from the manufacturer and may be willing to pass on some of that discount to
their customers.
Companies selling high-priced items such as furniture, jewelry, automobiles, or
major appliances may advertise that no payment is necessary for six months or
even a year. Larger volumes of merchandise are sold under these terms.
(2) Credit policy as a cash flow management tool
The strictness or flexibility of the credit policy has a direct impact on the cash
flow of the company. Relating the strictness of the credit policy to:
The gross margin (GM) generated by the products sold by the business
The cash needed by the business to meet its monthly obligations
The length of time that the capital invested in accounts receivable
(A/R) remains unpaid
Examples of businesses that do this are::
A business that makes a low GM on its products may not allow purchases on
credit or the time before payment is due is very short. The time allowed
before payment is due may be as little as 510 days.
A major reason for this is that if large amounts of sold merchandise on credit, the
business would have to borrow money to meet its monthly obligations.
If the company is making a low GM, it cant afford to pay the interest charges on
the borrowed operating capital for more than a very short period of time.
Businesses that make a large GM on their products can afford to extend credit for
longer periods of time.
The reason for this is that the amount of borrowed money that may be necessary
to meet monthly obligations is less.
In addition, a larger GM will allow the company to use a lesser portion of that
GM to pay the interest charges on the borrowed capital and have enough left
to meet the monthly obligations of the business.
(3) Credit policy as a profit generating tool
In certain instances, a profit-generation tool uses a credit policy.

This may be particularly so where the difference between bank interest and
consumer credit rates are greater than normal.
In this case, a company may decide that it is worthwhile to maintain the
total value of accounts receivable (A/R) at a certain level so as to:
Stimulate sales volume
Improve buying power of the company
Improve inventory turnover
Generate enough monthly interest income to offset a substantial
portion of the operating costs of the credit department.
Therefore, the credit policy of a company can have the effect of offsetting a
good portion of the operating expense of the credit department.
For example:
The value of accounts receivable (A/R) to which interest may be applied is
$300,000.
The credit policy states that the interest applied to past due accounts is 1% per
month
Therefore, the gross amount of interest income generated from A/R is: $300,000
x .015 = $4,500
In a small company, this amount of money may very well pay for two people to
administer the credit policy of the company. In paying for itself, this cost of
operating the credit department directly reflects the bottom line profit of the
company.
Note: In this example, 300 customers who owe $1,000 or 1,000 customers who
owe $300 may represent the $300,000 in A/R.
Therefore, the amount of work involved for the credit department to manage
$300,000 of A/R will depend upon the number of customers owing the
money.
Each business needs to assess the most profitable ratio between total A/R,
past due A/R, and the operating cost of the credit department.
Six key elements to consider in granting credit
Deciding what customers are allowed to buy on credit and under what terms is
a key part of developing a credit policy for your company.
You may decide to have one policy for all customers or you may decide to
have different policies for certain groups of customers.
Whatever your decision, consider the following key factors:

1. Qualification
2. Credit limit
3. Time frame for which credit is granted
4. Repayment incentives
5. Default and delinquent penalties
6. Payment instruments
We will now discuss each of these six factors:
(1) Qualifications
All customers must be required to qualify for the privilege of buying on credit.
This means that they must prove that they have the ability to pay for their
purchases within the terms of the credit policy of the company.
They also must show that other companies have granted them credit in the
past and that they have honoured their commitments to those companies.
To qualify for purchasing on credit, a customer is required to fill out an

application form.
This form will gather information about the customer and their credit
history that the manager or credit manager will verify.
Carefully check the references given.
As well, you should check the applicant's history with a credit-reporting
agency in your area.
Carefully screening credit applicants is very worthwhile.
In spite of the most careful investigation, some accounts will default on
their accounts and you will either sue for the money or send the account to
an agency for collection.
In either case, it is costly to the business.
What's more, deducting the net amount collected after collection fees or
legal fees will sometimes be a fraction of the owed money.
Businesses usually use four types of forms for their customers:

a. The Personal Credit Application
b. The Commercial Credit Application
c. The Personal Guarantee
d. Joint Payment Agreement
In all cases when the applicant fills out the application, there is a statement at
the bottom of the application form, which:
Details the terms under which credit will be granted
Requests signed authorization by the applicant for the vendor to make
any necessary investigations with references or credit granting
agencies.
The applicant is required to acknowledge and sign that they understand the
terms and conditions outlined in the statement.
(2) Personal credit application
Typically use the personal credit application for individuals applying for credit
rather than a company applying for credit.
However, if the individual is making an application for their company to
buy on credit and their business is less than two years old, it is common
practice for them to be required to fill out both a Commercial Credit
Application and a Personal Credit Application.
The reason for this is that their business does not have enough credit
history.
Personal credit applications may vary in the information required, but most
include information such as:
Place of residence, past and present Employment history

Personal income Personal asset value
Bank reference Spousal relationship
Credit accounts with other companies
The following are examples of:

A Personal Credit Application
A Business Credit Application
A Personal Guarantee
A Personal Credit Application
[COMPANY]
Personal Credit Application

Last name: First name: SIN. No.
Address: Tel. No.
City: Postal code: How long:
Previous address: Postal code:
Marital status: Spouse's name
Date of birth: Monthly income: No. Dependants:
Employer: Address:
How Long:
Current Obligations
Creditor Original Amt. Balance Due Monthly Payment
Home: Leased-Monthly Rent $

Rented-Monthly Rent $ Mortgage Amt.
Owned-Market Value $ Held By _______
Automobile(s): Year Make Amt. Owing Value _
. $
. $
Bank: Address:
References where Charge Accounts operated:
1. Address:
2. Address:
3. Address:
The above data is for the purpose of obtaining credit and is warranted to be true
I request credit from you to a maximum of $___________ at any one time for goods and/or
services to be furnished by you, and I agree if credit is given, payment shall be made by the
15th of the month following the month in which credit is given. If payment is not made
within one month of the month in which credit is given, the amount unpaid shall bear
compound interest at the rate of eighteen percent (18%) per annum (1% per month),
effective the first day of the month following the month in which credit is given until paid.
Either party may terminate this arrangement forthwith upon notice, whereupon all balances
including interest shall become immediately due and payable.
I hereby authorize _____________________ (Company Name) to obtain such credit
reports or other information as may be deemed necessary in connection with the
establishment and maintenance of a credit account or for any other direct business
requirement.
This consent is given pursuant to Section 12 of the Personal Information Reporting

Act.
Signature of Applicant: ____________________________ Date: ________________
Schedule
Interest of (cost of borrowing) will be added to your account each month in accordance
with your outstanding balance and calculated at eighteen percent (18%) per annum (1%
per month).
Balance is Mo. Cost Balance is Month Cost
will be will be
(You may insert a table showing cost of borrowing, as some jurisdictions require.)
For office use only
Credit Department Department Manager's Approval
____ Approved Credit Limit | ________________________________
Charge Card # |Signature _________________________
Charge Card Expiry Date: |

Notes:
(3) Commercial credit application
Use the commercial credit application for a company that is applying to

purchase on credit.
The information required is similar to the personal credit application in some

respects, but requires more detail on:
The type of companyproprietorship, partnership, corporation
The ownership structure of the company
Past history and experience of the owners
Bank references
Average bank balance on the deposit
Overdrafts or loans owing
Trade referencesother companies the business buys from on credit.
The following is an example of a Commercial Credit Application.
A Business Credit Application
[COMPANY]
Business Credit Application
Name Acct.: | ____ Proprietorship

Address: | ____ Partnership
City: Postal Code: | ____ Corporation
Mailing Address: | GST #
Postal Code: ________ | PST #
Type of Business: __________________________ Phone No. _________ ______________
Time in Bus. ________________________________________________________________
Names: Address: __________ _______
Owners: Address: ______________
Shareholders: Address: _______
____ Leased - Monthly $_____________
Premises ____ Owned - Market Value $ ____________ Mortgage $ _____________________
Mortgage held by: ______
______
Name of Bank: ______
Address: ______
References Address: ______
Address: ______
Trade Address: ______
Names Address: ______
Are Financial Statements Available To Us? ____ Yes ____ No
If No, Give Reason ______________
Number of invoices required ______Purchase orders required ___ Yes ___ No
We request credit from you to a maximum of $ __________ at any one time for goods
and/or services to be furnished by you, and we agree if credit is given, payment shall be
made by the 15th of the month following the month in which credit is given. If payment is
not made within one month of the month in which credit is given, the amount unpaid shall
bear compound interest at the rate of eighteen percent (18%) per annum (1% per month),
effective the first day of the month following the month in which credit is given until paid.
Either party may terminate this arrangement forthwith upon notice, whereupon all balances
including interest shall become immediately due and payable.
Credit Dept. Copy ___________________Authorized Signature _____________________
For Office Use Only

Application Completed At Dept. No. ________ By: _________________________________
Print Name
Sales Dept. Recommendations, Present Jobs, Potential, etc.

Credit Department Dept. Manager's Approval
____ Approved Credit Limit:
____ Declined (See Below) _________________________________
Signature
(4) Personal guarantee
A vendor (a company granting credit) in some instances requires a personal

guarantee where:
The customer has exceeded their credit limit by a significant amount
The customer is expected to exceed their credit limit by a significant
amount
The customer is not able to adhere to the credit terms for a period of
time because they are waiting for funds from sources such as project
progress payments, liquidation of assets, or additional investment
capital.
The vendor is concerned that factors in the personal or business life of
the customer may jeopardize the ability of the customer to pay their
account.
The personal guarantee is a legal document that secures the interest of the
vendor. It makes the customer personally responsible for the debt of their
business no matter what type of business it isCorporation, Limited Company,
Partnership, or Proprietorship. It commits the customer to paying off the debt of
their business from their personal assets.
The following is an example of a personal guarantee. The requirements of such

a legal form may vary in the jurisdiction. Consult a lawyer as to the use of the
proper form in your jurisdiction.
A Personal Guarantee
TO: [Vendor] (hereinafter referred to as _________________)
I/WE, the undersigned (hereinafter called "the Guarantors") in consideration of your

supplying _______________________________________ (hereinafter called "the
Company) a body corporate, ________(Address)_______________________, with such
goods as _______(Vendor)____________ may be willing to sell the Company from time
to time, upon such terms of credit or for cash, as ______(Vendor)________ shall think fit,
or in consideration of ______(Vendor)________________ not immediately requiring
payment of such indebtedness as may be owed by the Company to ______(
Vendor)________, JOINTLY AND SEVERALLY GUARANTEE payment to ______(
Vendor)__________ of such present indebtedness as is owed by the Company to
__________________(Vendor)_______ and payment to ________(Vendor)__________ of
all future indebtedness of the Company for all goods that
__________(Vendor)___________ may supply to the Company in the future.
AND I/WE AGREE that ________(Vendor)_________ shall be at liberty to accept

the note or acceptances of the Company for the price of such goods, or any part thereof, to
compromise the Company's liability to _______(Vendor)_________, to exercise or
relinquish other securities as ___________(Vendor)___________ may think proper and to
give the Company such extensions of time for payment for the said goods without notice to
or communication with me/us and without prejudicing the rights of
_______(Vendor)__________against me/us under this guarantee.
AND I/WE AGREE that _________(Vendor)_________ need not give me/us notice
of default by the Company, nor shall _______(Vendor)___________ be bound to exhaust
its recourse against the Company or any other persons or against any securities
________(Vendor)_________ may hold, before requiring payment from me/us.
ALL debts and liabilities, present and future, of the Company to me/us are hereby
assigned to __________(Vendor)____________ and postponed to the liability of the
Company to ______(Vendor)_______, and all securities received from the Company or
held for the Company by me/us from this date shall be held or received in trust for
______(Vendor)__________.
AND I/WE AGREE that ________(Vendor)_________ shall have the right at any
time to refuse further credit to the Company without notice to me/us, and without
discharging or affecting my/our liability hereunder.
AND I/WE DECLARE AND AGREE that this Guarantee shall be a continuing
Guarantee and shall extend to and be security for any sum or sums of money which shall or
may at any time be due from the Company to ________ (Vendor) __________ and shall
remain in force and cover all liabilities of the Company to _________ (Vendor)
_________, inclusive of those liabilities incurred or arising down to the expiration of three
(3) months after notice in writing of discontinuance of this Guarantee shall have been
given by double registered mail, postage prepaid, addressed to _______ (Vendor) ______

at its registered office and notwithstanding the discontinuance of this Guarantee as to one
or more of the undersigned, I/WE agree that this Guarantee shall remain continuing as to
the other or others of the undersigned.
THERE are no representations, collateral agreements, or conditions with respect to

this Guarantee, affecting the liability hereunder of me/us to ________(Vendor)__________
except as are contained in writing in this Guarantee.
Dated at__________, British Columbia, this _______ day of ____, 200 _
Signed: ____________________ Guarantor: ______
in the presence of Guarantor: ______

(5) Joint payment agreement
There are certain cases where a joint payment agreement may be necessary as
additional security that the customer will pay their account.
Situations where such an agreement is used are::

The customer is relying on the payment they will receive from a contract or a
project to pay their account
The customer has a history of being delinquent in payment of their account
There is a concern that the customer may use the payment they receive from the
contract to pay other debts before paying what they owe to your business
In a case like this, the customer may still sign a personal guarantee. However, a
personal guarantee or a promissory note still does not ensure prompt payment
of the account. To collect an account using notes and guarantees can still
involve a lengthy legal process.
The person or company that your customer is contracted for signs a joint
payment agreement.
The joint payment agreement states that the signer of the agreement will
only issue cheques jointly to your company and your customer in payment
for the work performed by your customer.
The payee on the cheque will read 'Pay to the order of Your Company and
Your Customer's Company'. When this is completed, your customer may
not cash the cheque. Both you and your customer would go to the bank,
endorse the cheque and the bank would then cash the cheque in your
presence.
Joint Payment Agreement:
The following is an example of a joint payment agreement. The form may vary
in some jurisdictions. You should consult a lawyer in your area to ensure that it
conforms to the legal requirements in your area.

A Joint Payment Agreement
Date: _____________
In consideration of the advance of materials and/or money necessary for the completion of
the job known as _______________________,
located at __________,
which the undersigned Contractor has contracted to do for me, I hereby agree that all
payments for said job will be remitted jointly to [company name] and the undersigned
Contractor until total indebtedness due said [company name] from the undersigned
Contractor relating to said job or contract is paid in full.
It is further agreed that in the event the undersigned should abandon said job or contract or
transfer or make an assignment of it or any rights thereunder before said sum has been
paid, said payments still due or unpaid or due the successor of the undersigned thereon, or
the transferee or assignee of said contract or rights thereunder, shall be made payable to
such successor, transferee or assignee and [company name] as aforesaid, until said sum or
the balance thereof shall have been paid.
Owner or General Contractor

By______________________________________
________________________________________
Address _________________________________
Accepted and agreed to this _____ day of ____________ 200 ______________________
Contracted by _____________________________________________________________
Address: _________________________________________________________________

(2) Credit limit
The customer applying for credit will state on the credit application form how
much they expect to be purchasing on a monthly basis. After reviewing the
credit application and checking the references given, the business makes a
decision on the ability of the customer to adhere to the credit policy of the
company.
Example:
A customer may state on the credit application that the amount of their
account will be approximately $800/month. Therefore, they are asking for a
credit limit of $1,000/month.
After reviewing the application and checking the references, the manager of
the company granting credit may find that the customer does not have a
credit limit over $500 with those references and has occasionally fallen
behind in the payment of their account with those companies.
In this case, the decision of the manager might be that credit approval
would be given, but only for a $500 credit limit because the customer's
history indicates that amount is as much as can be handled.
Make exceptions if the vendor is willing to accept additional security for
the amount of the account in the form of a personal guarantee, a note
payable, or an assignment of assets as security.
After opening an account and charging a customer's limit if they demonstrate

that:
They establish a history of paying their account on time
Communicate future purchasing needs and work closely with the
credit department
If they expect to temporarily exceed their credit limit, they inform the
credit department in advance and get approval
A business should value customers that view credit as a privilege and

communicate their needs.

(3) Time frame for which credit is granted
Granted the period for which credit depends on:

The GM the company makes on its products
The cash flow situation in the company
Whether or not using credit policy as a sales tool, a financial
management tool, or a profit-making tool.
We have already dealt with various aspects of these points in the context of
previous segments.
(4) Repayment incentives
At the outset of this section, we outlined a basic credit policy, which included
an incentive for repaying the A/R owing earlier than the required time limit.
Some companies use repayment incentives more creatively than just
offering
1-2% for repayment within 15 days.
Of course, as mentioned previously, the amount of incentive that can be
offered will depend on the GM the company makes on its products.
Some illustrations of the use of repayment incentives are providing a graduated

scale of progressive discounts.
For example:
Offer a discount of:
3% discount if payment is made within 15 days
Some companies take booking orders. A booking order is a term that means an
order taken well in advance of the shipping date) for shipment several months
later may offer a similar progressive repayment incentive.

For example:
If a company is taking fall booking orders in October to be shipped March 1st the
following year, they may offer a discount of:
15% discount if the order is prepaid
10% discount if payment is made upon receipt of the order
Gross amount is due in 60 days from date of shipment
There are two major reasons for a credit policy like this on a special booking
order. If bank interest rates on loans were 1% per month, a company may be
quite willing to give a 15% discount for prepayment of the order because a
company is:
1. Using the customer's money to finance their business
If the company were borrowing the money to buy or manufacture the
products for the booking order, it would cost the company 4% for interest
charges for the four months from November 1st to March 1st the following
year.
2. Earning interest on the customer's money prior to paying the factory for
the order
Let us assume that interest on deposits at the bank is at least 6% per annum.
In the four months before shipping the booking order, the company earns
approximately % per month if the customer's prepayment is only put on
deposit in the bank, because in four months the company earns 4 x = 2%
on the customer's money.
On the other hand, higher rates of return are often available in other
investment instruments.
In both of the above examples, there are very good reasons why some
customers would find the repayment choices attractive.
The rate of inventory turnover of the products bought
How much of the products are bought

Ideally, the customer buying the product should only buy sufficient quantities
as will be sold within the period before payment is due the supplier.
In this event, the customer is using the supplier's money to finance their
business.
If the customer buys too much product, they may be paying the supplier out
of the profits of future business rather than current business.
(5) Default or delinquency penalties
If a customer's account is past due, their account is termed a delinquent

account. The account may be referred to as being in default. The amount that is
past due is assessed interest charges.
This is done because:

The unpaid money is unavailable for use by the business
The business would have to pay interest charges on the money if it were borrowed
money
By not paying the money owed, the customer is using the money of the
business. The customer should pay a fair charge for the use of the money the
same as they would if the borrowed money came from a bank.
In view of the above, companies will usually charge at least the same rate of
interest as the bank.
However, it is more common that companies will charge a higher rate than
the bank because the company could have made more money if they had
the money to reinvest in the business.
Therefore, businesses will often charge 12% per month on the past due
portion of A/R.
This would translate to an annual interest rate of 1824% per annum.

(6) Payment instruments
In conducting daily transactions, most businesses have a choice of accepting

the following payment instruments:
Cash Cheque
Money orders/bank drafts
Debit card Credit card
Other forms of payment that are emerging and becoming popular are:
Smart cardsa type of debit card that is preloaded electronically from
your computer with small amounts of cash. Typically, it is used for
small purchases.
Electronic transfer of funds using a computer
Cash or cheques incur little handling cost to the business.

However, accepting cheques does carry the risk. A few of those cheques are
returned as NSF (Not Sufficient Funds).
In addition to the loss of the amount of the cheque, there is a charge to the
business for the processing of bad cheques. This fee may be $10$15 or
more. If customers have an account, then place charges on the account.
There is a cost to the business of handling electronic transactions that needs

recovering from the profit of the business. Typical charges are:
A monthly bank charge for the use of the electronic terminal and
printer
A transaction fee that will vary with the volume of transactions
However, the transaction fee for most business will be at least 2% of the net
value of the transaction before any added taxes.
If the business accepts payment by credit card, it is not receiving the same
amount of money as it would from customers paying cash.
For this reason, some businesses will charge a customer the amount of the
credit card transaction fee.

However, in practice in daily transactions, most businesses will not charge for a
transaction fee because:
Accepting credit cards tends to stimulate sales
Credit card purchases are not carried as A/R by the business
The amount of the purchase is guaranteed by the credit card company
However, many companies will take a different attitude towards customers

paying A/R with a credit card. Some companies will not accept credit cards in
payment of A/R for the following reasons:
By accepting the credit card, the business is actually accepting a
discount of at least 2% on the sales
By not paying the A/R for a month or two, the customer has already
used the company's money for that period and that has probably cost
the business at least 12%.

Summary
In the latter part of Accounts Receivable and Credit Policy, we have

discussed the elements of a credit policy and using a credit policy in a business.
We have discussed in some detail how to screen applicants for credit and
ways to protect your business against non-payment of accounts.
As you studied this material, you should have compared the ideas and examples
to the way you manage credit policy in your business now.
You should ask yourself:

What ideas and methods are you using now?
What present methods and procedures can be improved?
What new ideas and methods would be useful to your business?
The Laws of Moneyof conservation

It's not how much you make but how much you keep that counts. Successful
people save lots in prosperous times to have a financial cushion for bad
times.

Celebrate!!

3. Preparing Pro-forma Cash Flow Statements
Introduction
A pro-forma cash flow statement is sometimes called a cash flow projection or

simply a cash flow statement. We will use the term pro-forma cash flow
statement here.
Effective cash flow management is essential to the continued health and

survival of any business.
Good cash flow management assists in:

Financial planning
Inventory purchases
Formulating credit and collection policies
Renewing business lines of credit
Making an effective presentation to your lender
Keeping on top of operating capital needs
Providing early indications of when expenses are getting out of line

Function of pro-forma cash flow statements
A pro-forma cash flow statement compares projected income and expenses

with actual income and expenses on a monthly basis throughout the fiscal year.
It is one of the most effective tools an owner or manager has to control their
business.
When asked how they manage their cash flow, many small business people
will admit that they really don't have a formalized plan.
They will often say that they sort of know or they have a feel for the
seasonal changes in their business and cut back or make adjustments
accordingly.
Comparing the actual cash flow of the business to a 12month cash flow
projection can reveal any sudden changes that have occurred in your expenses
and the effect that may have on your current and future cash position.
Good cash flow management can take a lot of pressure off the business.
The cash flow projection is simply a budgeting tool that, if used properly,
can smooth out the highs and lows in your business because of cyclical or
seasonal changes.
It is not a cure-all, but it does help to give a sense of direction and, along
with a written business plan, clears the mind for more productive and
creative thinking.

The pro-forma cash flow statement is just as important for the existing
business. However, the existing business has the benefit of business history
and, therefore, the projected figures should be a more accurate estimate of the
expected business performance.
The business will use the pro-forma cash flow statement to forecast the
effect on the business of:
Adding products or services to the business
Addition of personnel A change of location
Increases in taxes
Consult the pro-forma cash flow statement every month to monitor and
compare actual and projected results. This is an essential part of good business
management and planning.

Preparing a pro-forma cash flow statement
We will take you step-by-step through the process of preparing a pro-forma

cash flow statement. You will be using the following three spreadsheet forms in
this process:
1. Projected cash and accounts receivable (A/R)
2. Projected accounts payable
3. Pro-forma cash flow statement
All the forms are worksheets and intended to primarily be used internally.
However, review periodically these forms with a lender.
To simplify the illustration, the example used will be the format used for a fee-
for-service business. That is a business where revenue is not derived from the
sale of products but rather is generated from fees for work performed.
Examples of people in this type of business are:

Lawyers Accountants Health professionals
Security services Consultants Personnel services
Real Estate Delivery service
In these businesses, derive the total sales revenue from the services provided to
the customers/clients.
In a business selling products, deduct the cost of the product and all the directly
related expenses from the selling price in order to determine the net revenue or
income derived from sales.
In other words, in a business selling products net sales revenue is the
selling price less the cost of goods sold (CGS). See the details of doing this
calculation on the income statement of the business. We will not be dealing
with the income statement in this section.
A pro-forma cash flow statement (cash flow statement) is only concerned with
the net cash receipts and expenditures of the business.

Steps in preparing a pro-forma cash flow statement
There are ten steps in the pro-forma cash flow statement process. They are:
1. Estimate sales and fees-for-service. 8. Calculate the total cash in,

cash out for each month, and
2. Estimate your revenue received from enter the surplus or deficit on
accounts receivable. the worksheet.
3. Decide how much of your business will 9. Enter the opening cash balance
be for cash or thirty day terms. in the first month and carry this
4. Repeat the same process as 13 only forward in each months
for expense items. calculation to arrive at the
'actual surplus or deficit'
5. Closing relating accounts payable
planning to expected revenues. 10. Enter the amount of your
business opening cash balance
6. Enter the estimated total cash received in the first month of your fiscal
and estimated total expenses on the year and carry this forward
Cash Flow Worksheet. through your calculations to
7. Fill in all other estimated income and arrive at the 'actual' projected
expense items on the Cash Flow surplus or deficit each month.
Worksheet.

You may find it necessary to print either the set of directions and/or the three
spreadsheet forms (See below) hence, you can relate the instructions to the
worksheet.
Note:
The reference on the Projected Cash and Accounts Receivable Worksheet to 'Enter
on line 1'
'Enter on line 2' refers to specific lines on the following Pro-Forma Cash Flow
Statement where you enter the summary information.
Also, the reference on the Projected Accounts Payable Worksheet to
'Enter on line 22' refers to the specific line on the following
Pro-Forma Cash Flow Statement where the summary information is entered
4. First, estimate the sales or fees-for-service for each month of the fiscal
year by factoring in those seasonal variations, or changes that you expect
in the business cycle.
The previous year's results can be a forecasting guide but you may
want to apply other standards.
For example:
Use conservative forecasts if you are in, or expect to be entering, a recession
period.
On the other hand, use an optimistic forecast if you are in a growth period or,
expect to be entering a growth period.
However, the best approach (most of the time) is the middle-of-the-road. Enter
these figures on a spreadsheet
(See example belowProjected Cash and Accounts Receivable)

5. Next, estimate your revenue received from the accounts receivable (A/R)
for each month of the fiscal year.
To do this, include:
What you would usually expect to receive from the previous month's
sales/fees?
What you would expect to receive from 60-day accounts?
What you expect to receive from all sales/fees prior to 60 days?
Total these figures and enter them on the Projected Cash and Accounts
Receivable Spreadsheet.
6. Decide how much of your business will be for cash or thirty day terms,
and how much will be carried for longer terms.
For example:
If, your business has been 10% cash/30 days and 90% longer credit terms it
likely will remain the same if you don't plan to make changes to your credit
policies.
If, however, this is obviously putting a strain on the business and you don't wish
to increase your operating loan, you may well want to review your credit
policies.
You have to decide whether the cost of carrying the additional business on
account is worth it.

7. Now, you do the same exercise for your expenses and prepare a
spreadsheet if your business involves the purchase and resale of products.
(See example belowProjected Accounts Payable)
For example:
First, estimate the purchases you plan to make each month and enter the figures.
Then estimate the payments normally made on purchases made on the current
month's purchases, the payments normally made on the previous month's
purchases, the payments normally made on 60-day purchases and, finally,
the payments usually made on purchases over 60 days.
Total the accounts payable and enter this on the spreadsheet.
8. Complete the accounts payable planning in close relationship to the

revenues expected from sales/fees.
For example:
Very favourable payment terms at very low or no interest can ease the burden on
the business and the expense of each month's payment is reflected in the
month that it will be paid.
If, however, a large purchase is made at a special price but must be paid for now,
it may not be a good deal if the goods will not be used up for several months.
A very rough rule-of-thumb would be, don't buy more than you need for the next
60 days unless you are getting an additional 5% discount for each additional
month you will carry the product.
For example, if you were not going to use the product up for 6 months, you
would need at least a 20% discount to make the same net profit.

9. Now that you have, your total cash received and cash payments estimated,
go to your pro-forma cash flow statement, (See example below) and enter
your totals.
10. Your next step is to fill in all the other items related to income and
expense.
Under Income is: Under Expenses is: Other Operating

Expenses:
Loan proceedsthis is the Rent Payments on purchases of
monthly amount received fixed assets
Management salaries
from the operating loan
Interest paid on loans
and will be filled in last Other salaries and wages
(short-term loans, lines of
Sale of fixed assets Legal and audit fees credit, overdrafts)
Other cash received Utilities (heat, light, Payments on
water) mortgages/term loans
Telephone Income tax payments
Repairs and maintenance Cash dividends paid
Licences and municipal Payments on accounts
taxes payable
Various insurances Other cash expenses
11. Enter all of this data and then you should calculate your
total cash in and the total cash out for each month throughout the fiscal
year and determine in which months there may be a cash surplus or
deficit.
12. Enter the amount of your business opening cash balance in the first month
of your fiscal year and carry this forward through your calculations to
arrive at the 'actual' projected surplus or deficit each month.
This figure is, therefore, an estimate of the least amount you will require as
an operating loan to run your business. For now, enter this amount under
Loan Proceeds in the Cash In section in order to balance the statement.
Once this is completed, you are prepared (along with your financial statements
and your business plan) to meet with your lender.

Each month, you will enter the actual figures for the items listed on your
worksheet. The items will vary somewhat with the business and this is only an
example.
Communicate closely with your Lender and make them aware of any
significant changes, particularly if it may affect your need for operating
capital.
A well-informed Lender can be a powerful resource. However, frequently
you hear small businesses complaining about the support of their Lender.
Usually, the real story is that business owners do not do their homework
and provide their Lender with the needed detailed information.
Pro-forma cash flow statement
Now you have a projected pro-forma cash flow statement.

The pro-forma cash flow statement has columns to show the projected
income and expense for each month of the fiscal year and blank columns
beside each month's projection to record the actual figures.
The projected figures are your one-year operating budget. Careful analysis
of any deviations from this budget can help to minimize expenses and
maximize profitsreferred to as doing a budget deviation analysis.
It only takes a few hours each month to review and it should be a regular
part of your business management activity.
It is easy to forget to do some of these business planning and direction
activities when times are good and the business is flying high. Nevertheless,
budget deviation analysis is an essential part of effective business
management.
Perform a budget deviation analysis on a monthly basis to be meaningful and

useful. If a business has several projects on the go at one time, it may be a good
idea to devise separate budgets for each project.
This is one of the best sources of current operating information for your
business and, if the budgets have been prepared carefully and thoughtfully, the
budget deviation analysis will tell you at a glance, which parts of your business,
are getting out of control. Experience will teach you
Which deviations are significant
What magnitude of variance is important
Carefully examine any change, whether positive or

negative, and the reasons for it determined.

If the change is negative, then implement a corrective plan of action. If the
change is positive, then you should ask yourself:
What did I do right?
With a little digging, you may discover something that, if controlled and
directed, could have a major impact on the future profitability of the company.
While doing your pro-forma cash flow statement for the month, it is important
to cast also your eye back upon previous months to identify any trends or
offsets. A review and analysis of any monthly fluctuations will often reveal:
The negative deviation in one month is offset by a positive deviation in
the following month
Seasonal fluctuations or business cycle factors that are, perhaps,
because of the variable timing of projects
With experience, your budgeting and your analysis will become more exact and
you will have greater control over the profitability of your business. All
financial control documents should be adapted to the needs of your business in
terms of the items included and the degree of detail, but the format should
adhere to generally accepted accounting principles.
Your accountant will help you in this area but, you must be the one to
decide what information is most useful to you in running the business, and
what information reflected by the budget deviation analysis is most
significant.
Sample spreadsheets
Below are three samples of:

1. Projected Cash Sales and Accounts Receivable
2. Projected Accounts Payable
3. Pro-forma Cash flow Statement (worksheet)
You have on your CD a file labeled Projected Spreadsheets. This Microsoft

Excel file is interactive so follow the directions on the title page. Below are the
same spreadsheets but they are not interactive.

Projected Cash and Accounts Payable
Month Jan. Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec.
Projected Sales $10,000

Cash Sales (line 1) $9,500
Coll. Of Sales 1 mo. Prior $5,000
Coll. Of Sales 2 mo. Prior $2,000
Coll. Of Sales Over 2 mo. $500
Total Accts. Rec. (line 2) $27,000 0 0 0 0 0 0 0 0 0 0 0
Projected Accounts Receivable
Month Jan. Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec.
Planned Purchases $2,000

Pay On Current Mo. Purch. $1,000
Pay On Purch. 1 Mo. Prior $200
Pay On Purch. 2 Mo. Prior $200
Pay On Purch. Over 2 Mo. $100
Total Accts. Payable(line 22) $3,500 0 0 0 0 0 0 0 0 0 0 0
Pro-Forma Cash Flow Statement
Income (Cash Only)
Month January January February February March March April April May May
Planned Actual Planned Actual Planned Actual Planned Actual Planned Actual
1.Cash
2.Collection from Accounts Receivable
3.Loan Proceeds
4.Sale of Fixed Assets
5.Other Cash Received
6.Total Cash In 0 0 0 0 0 0 0 0 0 0
7.Rent (for premises, equipment, etc.)

8.Management Salaries
9.Other Salaries and Wages
10.Legal and Audit Fees
11.Utilities (heat, light, water)
12.Telephone
13.Repairs and Maintenance
14.Licences and Municipal Taxes
15.Insurance
16.Other Operating Expenses
17.Payments on Purchases of Fixed Assets
18.Interest Paid on Loans
(short-term loans, lines of credit, overdrafts)
19.Payments on Mortgages/Term Loans
20.Income Tax Payments
21.Cash Dividends Paid
22.Payments on Accounts Payable
23.Other Cash Expenses
24.Total Cash Out 0 0 0 0 0 0 0 0 0 0
25.Surplus or Deficit 0 0 0 0 0 0 0 0 0 0
(subtract cash in minus cash out)
26.Opening Cash Balance
27.Closing Cash Balance 0 0 0 0 0 0 0 0 0 0
Summary
In Preparing Pro-forma Cash Flow Statements, we have discussed what it is

and how it is used. We have presented in detail how the pro-forma cash flow
statement is prepared.
You have studied how that the pro-forma cash flow statement provides the
business owner with a quick barometer of the financial health of a business. It
gives the business owner a snapshot every month of the businesses:
Ability to meet current financial commitments
Changes and trends that are developing in business cash flow
These can give early warning signs that will trigger an in depth investigation
into the reasons for the results. The business manager can then take remedial
action.
You should have considered the importance of communicating with your

banker. Keeping your lender informed about the performance of the business
and its cash flow will help you to obtained needed financing.
The Laws of MoneyParkinson's Law

Expenses always rise to meet income. It happens to most people.
It's why most people aren't rich. To be rich, you must flout this law.

Celebrate!!

D. Monitoring the Financial Health of the Business
Introduction
In Monitoring the Financial Health of the Business, we will discuss what a

business manager needs to do on a monthly basis to monitor the financial
health of the business. You will learn about interpreting financial statements
and using financial ratios to monitor your business performance.
The four segments are:

1. Monthly financial performance review and analysis
2. Income statement analysis
3. Balance sheet analysis
4. Testing the financial strength of your business

It is very important for the business manager to learn how to work with and
interpret financial information and reporting. Developing these skills enables
the manager to:
Interact more effectively with accountants
Interact more effectively with lenders
Identify problem areas early and take remedial action
Maximize the ROI to investors
Make better business decisions
We have provided examples of several spreadsheets in Microsoft Excel in a

separate file on your CD. This interactive worksheet file has formulae macros
inserted into the spreadsheet so they will do your calculations for you. Open up
the file named Income and Balance Spreadsheets and follow the directions on
the title page.
a. Monthly financial performance review and analysis
Month l Financial Performance Review and Analysis emphasizes the need

to do a monthly review of the financial performance of your business.
It covers:
The preparation necessary before doing the financial review
How to use the information resulting from the financial review
Covering how to organize the information in the financial review
In addition, it includes examples and tips on relating the information to
your business.

b. Income statement analysis
In Income Statement Analysis, you will learn:

What information the income statement presents
How the parts of the income statement are related
Ways in which the income statement information may be presented
to best serve the needs of your business
What sort of information will you be looking for on the income
statement?
How to interpret the importance of the information
How the information on the income statement is used
We will use an example of a typical income statement. Throughout this section,

we have based the examples on the figures of Well Known Merchandise Inc.
so there is some continuity and relationship to the various reports we will
discuss.
You will find the figures for Well Known

Merchandise Inc. are presented in the following
section, Testing the Financial Strength of Your
c. Balance sheet analysis
Business.
The Balance Sheet Analysis segment discusses the components of a balance

sheet, where the information comes from, and how the information is related.
In this material, you will learn:

What the figures on a balance sheet tell you
An introduction to simple tests of the balance sheet information to
determine the strength or weakness of the business
How to interpret the results of the tests
How to use the results of your balance sheet analysis

In addition, examples of conclusions are drawn from the balance sheet analysis.
As with the segment on Income Statement Analysis, we will use the figures of
Well Known Merchandise Inc. and the figures are also in a following section,
Testing the Financial Strength of Your Business.
We will discuss the use of ratio analysis in this segment as an introduction to

this subject prior to covering the subject in more detail in the following section,
d. Testing the financial strength of your business
In Testing the Financial Strength of Your Business, you will learn many
financial ratios to use in monitoring your business performance. The four ratios
are:
1. Operational ratios
2. Liquidity ratios
3. Leverage ratios
4. Profitability ratios
We will discuss various ratios that fall into these categories, where they are
used, and why they are used. In some cases, we will give examples of:
How these ratios are used in a business situation
The conclusions that might be drawn
The action that might be indicated
We will continue to use the figures of Well Known Merchandise Inc. as we did
in Income Statement Analysis and Balance Sheet Analysis.
The Laws of Businessof quality

Customers demand the very highest quality for the very lowest price.
Quality is whatever the customer thinks it is.
And the customer decides how much it's worth.

1. Monthly Financial Performance Review and Analysis
Introduction
A monthly performance review and analysis is an essential part of good

business management. It is very important to get in the habit of doing a detailed
review and analysis of your business each month.
You should set aside the same time each month and don't let anything
interfere with the process!
The purpose of the review and analysis is to compare the results to your
expectations written in your business plan.
Examine any deviations or exceptions to your plan closely to determine the
reasons for any exceptions so you can take any remedial action if it is
necessary.
For illustration purposes, we will use a professional services companyan

architectural services company that has several different segments to the
business. Each business segment involves different resources of the company,
therefore, yields different gross profit margins, and thus has a different break-
even point (BEP).
As you go through this section, think about your own business. Compare what
you do now to assess the performance of your business to the ideas and
methods presented in this section.

Prior preparation for a monthly performance review and analysis
Before the financial review and analysis can begin, you will have:
Reviewed past years operating statements
Reviewed the business plan projections
Prepared pro-forma operating statements and cash flow projections
You will have analyzed your fixed costs and calculated the historical
percentage of gross revenue that they represent
You will have reviewed past projects to arrive at an estimate of typical
variable costs for different types of work
Prepared a job cost summary sheet that will take all of these factors
into account including the varying contribution of people and resources
within the company
You will know any generated net profit on each project and each
business segment.
Now, you have the basic information necessary to do a monthly financial

performance review.
Using a monthly financial performance review and analysis
Armed with these new systems in place and the new insights they provide, you
will factor a portion of estimated fixed and variable costs into all of your
pricing. You will price for profit and use pricing as part of your marketing
strategy.
You will create more financial strength in the business by developing

contingency funds for the replacement of capital assets or funding future
growth.
Record and manage all capital assets managed by use of a capital asset
register and any planned new acquisitions are justified by use of a capital
expenditure justification form.
You could have a capital asset summary report each month but a quarterly
review is probably sufficient in most cases.

Financial Analysis
For quick review you can prepare a one- or two-page spreadsheet form that will
record and present comparative analysis summaries in a historical context.
Your secretary or office manager may prepare this. Deviation analysis of cash
flow and income statements vs. forecasts can also be prepared in advance for
your review.
Here is how your financial review spreadsheet might look. The following chart
is an example of only a partial year.
The two abbreviated headings on the chart are:

YTD - Year-to-date
PY - Prior year

Financial Review Spreadsheet
Jan Feb Mar April YTD PY
Current ratio
Acid test
Break-even analysis ratios for:
Service A
Service B
Service C
Service D
Service E
Business segment A
Business segment B
Business segment C
Business segment D
Total business

Complete each month the calculations for the headings in the left column of
each row of the spreadsheet and result recorded under the appropriate month.
This allows you to see the changes that may be occurring in each business
segment, each service the business provides, and the business as a whole.
We will discuss the current ratio, acid test, and other useful financial ratios in
the next section.
In addition to calculating these business ratios each month and recording them
on the spreadsheet, you should review and analyze your monthly cash flow
statement and income statement to identify:
Cash flow deviations
Income statement deviations
When you analyze both of these reports, you are looking for deviations from
your forecasted results. When you discover a deviation, always try to determine
its reason.
For example:
If the profit result for a service, a business segment, or the business
as a whole, is higher or lower than forecasted for the month, the
reasons might be:
Product was purchased from a supplier at a lower or higher cost
Different office or plant procedures resulted in an improvement or
decline in production efficiency
Rent, taxes, utilities, insurance fees or other fixed costs suddenly
increase or decrease
Whatever the reason for the deviation, once it is identified you are better able to
look for ways and means of changing the results.

Significant historical variances
When you go through this exercise each month it is a good idea to also assess
the potential financial or liability exposure of the business and take appropriate
action.
For example:
If you have been replacing or acquiring assets recently, make sure
that you are adequately covered by insurance.
Or, if you just took on an unusually large contract perhaps you
should check with your insurance agent that you would be
adequately covered.
You should keep in mind (as a very general rule of thumb) that most
businesses, including professional services businesses, should generate gross
revenues equal to 23 times their net expenses.
If they are consistently below this rate, it is not a healthy situation and that
indicates remedial action is required. Of course, this is a very broad
statement and some industry and seasonal variances will apply.
However, to bring it close to home, if your gross annual revenue is
$400,000, then your net annual expenses should not be more than
approximately $200,000.
If they are, you have only three alternatives and they are:
Cut expenses
Increase the volume of business without raising costs significantly
Increase the margin of profit on existing sales volumes
A combination of all of these approaches is probably the best solution.
In your break-even analysis for each month, if the ratio entered each month for
the relationship between revenue and fixed costs + variable costs is
consistently slipping below a ratio of 2:1, and then a more detailed analysis is
in order.

Summary
Monthly Financial Performance Review and Analysis explained how you

would monitor the performance of the business on a monthly basis. It briefly
discussed the assembled data to complete correctly a performance analysis and
apply the common tests to the data. Every business will be different but the
approach outlined here is common to most businesses.
Laws of Moneyof three

Financial security is like a three-legged stool:
it rests on savings, insurance, and investment.
You must tend to all three to become financially independent and secure

Celebrate!

2. Income Statement Analysis
Introduction
The income statement of a business is another key tool that managers use to
measure and analyze the health of their businesses. The income statement is
commonly known as the operating statement or the profit and loss statement. In
this discussion, we will use the term, income statement.
The income statement is a statement of the changes that have occurred from
one period to another.
It shows, in financial terms, a summary of:

The transactions that have occurred in the business during that period
The income generated by those transactions
The changes in valuation of the inventory carried by the business
The expenditures made by the business
The profit or loss to the business at the end of the period
There will be no discussion of any complex statistical analysis here or

forecasting methods in relation to the income statement. Consult your certified
accountant on those matters.
Rather, we will discuss some of the things that you, as a manager, should be
looking for when your accountant presents you with your monthly
statements.

How to use this section
As you study the income statement analysis, consider how the ideas presented
compare to how you now view the monthly statements your accountant gives
you.
Ask yourself these six questions:

1. How are my statements prepared? How are they presented?
2. What items on the income statement do you currently look at, and
what do they mean to you?
3. What kinds of information do you usually get from your Income
Statement?
4. What conclusions do you draw from the information on the income
statement?
5. How do you use the information and conclusions to improve your
business or what sorts of decisions do you make based on your
conclusions?
6. How can the ideas presented in this section help you to do a better job
of analyzing your Income Statement and making good business
decisions?

Income statement presentation
An income statement may be prepared for any period of time in the fiscal year.
A fiscal year is an accounting period of 12 months.
The income statement is commonly prepared:

Monthly
Quarterly (3-month period)
Annually
However, it really could be prepared for any period of the year. It is important
that you ask your accountant to prepare statements for your business in a form
and with the level of detail that will be most useful to you in your business.
Accounting software programs used in computerized accounting systems today
will easily generate accounting reports in almost any form and level of detail
that you wish.
A report covering the specific period is useful, but comparing the reports to
previous reports or previous periods is much more useful. Accountants will
often show comparisons to figures for the same period of the previous fiscal
year. This is useful. However, it is much more useful if a manager can see on
one page:
The figures for each of the previous months of the fiscal year
The total of the figures for the year-to-date (YTD)
A total for the prior-year-to-date (PYTD)
We call this type of presentation a spreadsheet.
A spreadsheet will have a column for each month of the fiscal year. If you
wish, you can also have an additional column for each month for comparison to
the forecasted (pro-forma) figures for the fiscal year. A direct comparison like
this is useful when preparing monthly forecasts for the next fiscal year.
At the far right of the spreadsheet are the columns for the totals for the YTD
and the PYTD.

A B C D E F G H
1 Income Statement
2 Well Known Merchandising Inc.
3 Comparison of Dec. 31/99 to Dec. 31/98
4
5 1998 % / Sales 1999 % /Sales
6 Gross Sales 700,000 100.00% 800,000 100.00%
7 Less: Discounts 30,000 4.29% 40,000 5.00%
8 Allowances 9,000 1.29% 10,000 1.25%
9 Net Sales 661,000 94.43% 750,000 93.75%
10
11 Cost of Goods Sold
12 Beginning Inventory 160,000 22.86% 170,000 21.25%
13 Purchases 450,000 64.29% 500,000 62.50%
14 Less: Discounts 13,500 1.93% 15,000 1.88%
15 Allowances 4,500 0.64% 5,000 0.63%
16 Net Purchases 432,000 61.71% 480,000 60.00%
17 Less: Ending Inventory 170,000 24.29% 150,000 18.75%
18 Cost of Goods Sold 422,000 60.29% 500,000 62.50%
19
20 Gross Profit 239,000 34.14% 250,000 31.25%
21
22 Operating Expenses
23
24 Selling:
25 Sales staff salaries 23,750 3.39% 25,000 3.13%
26 Sales staff benefits 4,750 0.68% 5,000 0.63%
27 Travel and entertainment 1,500 0.21% 1,500 0.19%
28 Advertising and promotion 8,000 1.14% 9,500 1.19%
29 Vehicle expense 2,300 0.33% 2,500 0.31%
30
31 Administration:
32 Staff salaries 38,000 5.43% 40,000 5.00%
33 Staff benefits 7,600 1.09% 8,000 1.00%
34 Rent 20,000 2.86% 20,000 2.50%
35 Utilities 2,300 0.33% 2,500 0.31%
36 Janitor 1,500 0.21% 1,500 0.19%
37 Building maintenance 2,500 0.36% 3,000 0.38%
38 Office equipment 2,000 0.29% 1,500 0.19%
39 Office supplies 1,600 0.23% 1,500 0.19%
40
41 General Mfg. Plant:
42 Plant staff salaries 42,750 6.11% 45,000 5.63%
43 Plant staff benefits 8,550 1.22% 10,000 1.25%
44 Plant fuel oil 9,700 1.39% 10,500 1.31%
45 Machinery maintenance 4,000 0.57% 3,000 0.38%
46 Total Operating Expense 180,800 25.83% 190,000 23.75%
47 Operating Profit 58,200 8.31% 60,000 7.50%
48
49 Non-Operating Expenses 2,500 0.36% 3,000 0.38%
50
51 Profit before tax 55,700 7.96% 57,000 7.13%
52 Corporation tax 13,925 1.99% 14,250 1.78%

53 Net Profit 41,775 5.97% 42,750 5.34%

A B C D E F
1 Income Statement
2 Well Known Merchandising Inc.
3 Comparison of Dec.31/99 to Dec.31/98
4
5 1998 % / Sales 1999 % / Sales
6
7 Net Sales 661,000 100.00% 750,000 100.00%
8 Cost of Goods Sold 422,000 63.84% 500,000 66.67%
9 Gross Profit 239,000 36.16% 250,000 33.33%
10
11 Operating Expenses
12 Selling 40,300 6.10% 43,500 5.80%
13 Administration 75,500 11.42% 78,000 10.40%
14 General 65,000 9.83% 68,500 9.13%
15 Total Operating Expense 180,800 27.35% 190,000 25.33%
16
17 Operating Profit 58,200 8.80% 60,000 8.00%
18
19
20 Non-Operating Expenses 2,500 0.38% 3,000 0.40%
21 Profit before tax 55,700 8.43% 57,000 7.60%
22
23 Corporation tax 13,925 2.11% 14,250 1.90%
24 Net Profit 41,775 6.32% 42,750 5.70%
25
26
27
28 Statement of Earned Surplus
29 Well Known Merchandise Inc.
30 Comparison of Dec. 31/99 to Dec. 31/98
31
32 1998 1999
33
34 Balance brought forward 15000 31,775
35 Net profit fot the year 41775 42,750
36 Total 56775 74,525
37
38 Less: Dividends paid 25000 20,000
Balance carried forward
39 to the Balance Sheet 31775 54,525
40

The above Income Statement example is a summary form of the previous
example, and in addition, it has a statement of earned surplus, attached to it.
This simple example indicates how earned surplus is calculated. Refer to
Balance Sheet Analysis to see earned surplus on the balance sheet.
As well, in the section Testing the Financial Strength of Your Business
you should refer to this example when you review the sub section
Profitability Ratios.
Useful tip:
Have your accountant prepare income statement spreadsheets with all items
expressed as a % of gross income (sales).
This allows the manager to quickly compare figures from one period to another as
well as compare those figures to norms for the industry.
The % is usually listed beside each figure in a column.
For example:
The first item in a column on the income statement, in the part recording
income, might be:
Gross income (sales) $800,000 100%
It is 100% of itself.
Lower down the column in the above income statement, in the part
recording expense items for the period, might be a listing for travel and
entertainment expense as follows:
Travel and entertainment expense $1,500 0.188%
The 0.214% beside the $1,500 indicates that the amount of the travel and
entertainment expense spent in the period was 0.214% of the gross income
(sales) of $800,000.

A manager, looking at a spreadsheet with several past months and the current
month presented, can easily spot if the % to sales is in line with:
Forecasted amounts for the month
Forecasted amounts for the year
Comparison to rates of expenditure in the PYTD
Industry norms
The dollar value can be much higher or lower than any of these comparisons,
but if the % to sales ratio is similar, it indicates the business is spending a
normal amount in relation to the gross income (sales) of the business.
Consider asking your accountant for spreadsheet presentations such as we have

described here. You will find it much easier to identify quickly anomalies on
your Income Statement that need investigation.
What are you looking for on the income statement?
We said, at the beginning, that the income statement presented changes that
have occurred from one period to another.
However, when you analyze your income statement:

What kinds of changes are you looking for on your income statement?
What items are more likely to change?
Where should you start in your analysis of the income statement?
First, you will be looking for changes in significant income or expense items. A
'significant' item is one where the total value of the item is significant as a % to
sales. Sometimes even a small change in that item as a % to sales can have an
effect on the profit of the company.

For example
% of
Sales
A small company has gross income (sales) of $200,000/Year 100%
The GM on sales is 30% so gross profit (GP)= $ 60,000/Year 30%
Total expenses are $ 50,000/Year 25%
Therefore, net profit is $ 10,000/Year 5%
Assume that included in the total expenses is an item, which is normally $200/month
The total expense most years would then usually be 12 x $200 = $2,400/year 1.2
The manager compares total expenses YTD to the PYTD on the spreadsheet
and finds there is little variation in % to sales ratio.
The manager then examines each item in the income statement YTD and
PYTD columns and spots a variance in the % to sales ratio for the item that
is normally 1.2% to sales.
The PYTD is 1.2% but YTD is 2.6%. A close look at the figures for each
previous month reveals that this item was within a historically normal % to
sales ratio for the first three months of the year and then suddenly doubled in
cost.
In a small company, such an increase can have a big impact on the profit of
the company. An increase of 1.4% (from 1.2% to 2.6%) to sales in this
expense item represents an additional $2,800 of expense or 28% of the NP
of the company.
In this example, the small company has a NP of $10,000/year. As a result, an
increase of 1.4% (from 1.2% to 2.6%) to sales in this expense item represents
an additional $2,800 of expense or 28% of the NP of the company.
The analysis indicates taking action immediately to:

Investigate the reason for the increase
If the expense item is a key product or service needed by the company to

function, then alternative sources for the product or service need to be found or
a better price negotiated on the item.

Consider for a moment, what the effect would be if the expense item increases
by the same dollar amount, but the sales of the company were now $400,000
rather than $200,000. Is it considered a significant increase in expense?
The answer is yes!
In this event, the % to sales increase is from .6% to 1.3%. While the dollars
represented by the increase won't have the same impact on the NP of the
company, enough items like this on an income statement will add up to a
significant variance overall. Therefore, this variance should still be investigated
and action taken.
This example illustrates how to analyze every item on the income statement,
particularly variable cost items.
Expense items that are monthly expressions of fixed costs are not as likely
to change.
However, you should always look at these items briefly just in case
something extraordinary has happened.
However, arrange items like rent, utilities, and insurance for long periods of
time and the monthly charges associated with these charges rarely change
much from one period to another.
The items that are most subject to change are sales and the variable expense
items. Scrutinize these items very carefully each month. Check even small
variances and a satisfactory explanation for the variance determined.
In particular, pay attention to significant changes in:

Revenue itemssales, other income from items, for example,
securities, sale of assets, or interest income. It is important to be aware
of how much income has come from operations and how much from
non-operating events.
In a certain period, you could have a situation where total revenue seemed
to be in line with forecasts, but income from operations was actually down
and the total revenue was inflated because of the inclusion of non-operating
revenue.
y Purchases y Gross margin (GM)

y Discounts and allowances on y Variable expense items
sales or purchases y Net profit (NP)
y Gross profit (GP)

Analyze your income statement spreadsheet in the order listed above. Acquire
the habit of doing it the same way all the time and you will not only become
very familiar with the procedure, but you will tend to be more thorough in your
analysis.
What's more, it is a good idea to compare your company performance with

industry standards for your area.
While the % to sales ratios will vary between companies, it does give you a
perspective on how your company compares to others in your industry and
perhaps the competition in your area.
Most libraries have small business profile information that is a good source
for this information. (See The Business Plan for a list in the Appendix.)
The two items analyzed were because we will now discuss them in:
1. Inventory
2. Cost of goods sold (CGS)
Inventory and the cost of goods sold (CGS)
Inventory is a significant investment for most companies and has to be

managed carefully to optimize the return on investment (ROI) to the company.
Selling and replacing the inventory is a must to ensure the business makes a
profit.
Every time the total average inventory value is replaced, the inventory is
said to have turned over. This is what is meant by the common business
terminventory turnover.
Maintaining and improving the inventory turnover rate is a focus of any
business that handles inventory because even small changes in inventory
turnover can have a significant effect on profits.
If your business handles inventory, you should be aware each month of the
turnover rate for the month, the quarter and year-to-date (YTD), and how those
ratios compare to the same periods in the prior year.

The formula for calculating this ratio is:
Cost of goods sold (CGS) for the period/average inventory
This formula says to divide the CGS for a measured period by the average
inventory.
For example:
If the CGS for the period is $600,000
And, the value of the average inventory stocked during the year is
$200,000
Therefore, the annual inventory turnover rate is $600,000/$200,000 =
3 turnovers
The average inventory may be close to the same value for each period
measured, but the CGS for the period would be quite different.
For instance, in this example, the CGS for a month might be $50,000 and the
Average Inventory, $200,000.
So the inventory turnover rate for the month would be $50,000/$200,000 = .25
turnovers.
As we said, even fractional improvements can have a dramatic impact on profit.

Consider in this example,
If inventory turnover was improved by .05 turnovers, that would mean that
.05 x $600,000 = $30,000 more inventory, at cost value, was sold.
If the selling price of that inventory were $45,000 (a 33% GM), the
improvement in the company profit would be $15,000.
For more information on calculating Inventory Turnover

and other financial management ratios, see Testing
the Financial Strength of Your Business.

Calculate the cost of goods sold (CGS) as follows:
Beginning inventory for the period
Plus Purchases for the period
Less discounts and allowances on the purchases
Minus Ending inventory for the period
Equals Cost of goods (CGS) sold (CGS)
Discounts are supplier incentivesa % off the purchase price
Allowances are the value of the inventory returns to suppliers or perhaps a

discount taken off the purchase price for reasons such as the inventory being
obsolete, inferior, or damaged.
There may be an allowance for inventory shrinkage.
Inventory shrinkage is a term for shortages or losses of inventory due to

spoilage of perishable goods, but it can be an allowance made for losses due to
stealing by customersan allowance for shoplifting.
For example:
Acme Mercantile inventory records show the following information:
Inventory value January 1, 2000 is $ 600,000
Total purchases from Jan. 1/00 to Dec. 31/00 is
$1,080,000
Less discounts and allowances $ 25,000
Net purchases $1,055,000
Total $1,655,000
Less ending inventory Dec. 31/00 $ 750,000
Cost of goods sold (CGS) $ 905,000
On your income statement, the CGS is subtracted from net sales. The
result is your gross profit (GP).
Therefore, if we assume that Acme Mercantile net sales (NS) are
$1,300,000
Then gross profit (GP) is $1,300,000 - $905,000 = $395,000
Therefore, gross margin (GM) is $395,000/$1,300,000 = .3038 or 30.38%

From this example, you have seen:
How CGS is calculated
How NS, CGS, GP, and GM are related.
When you are analyzing your income statement, you should note the changes in
inventory valuation.
Some factors to watch for are:

If purchases are much larger than usual because the company has taken
advantage of a volume discount opportunity, the result could be inflated
Ending Inventory values in ensuing months.
If the excess inventory isn't sold as quickly as expected, it will have the
effect of decreasing the company's profitability until inventory levels are
brought into line as a % to sales.
Stated another way, excess inventory levels lower inventory turnover rates and
result in lower profits.
Another important factor to consider is the quality of the inventory and the
value assigned to it.
For example:
A company may have a significant quantity of poor quality inventory.
If this remains recorded at the same value, as it would be in good
condition, the income statement will not give a true picture of the
profitability of the company.
In this event, the inventory is said to be overvalued.
An overvalued inventory will result in the ending inventory value being
higher than it should be
The cost of goods sold (CGS) will be lower
The net profit will be higher
In other words, the result will be that overvalued inventory will result in
an overstated net profit. Conversely, if inventory is undervalued,
CGS will be higher in value and the result is that net profit is
understated

A key point to be made here is that if you have inventory that is of poor quality
or not as saleable for other reasons, it should be evaluated and written down to
its correct value.
You should consult your certified accountant for direction in this matter
because rules governing evaluation of inventory may vary in different
jurisdictions.
Another way of monitoring inventory is by use of the days of sales in inventory

ratio.
For more information on applying this method, see

Summary
In Income Statement Analysis, we have discussed the income statement and

the information that it provides.
As well, we have discussed:

Ways the income statement may be organized
What kinds of information you are looking for on the income statement
How some of the information on the income statement may be interpreted
and used
You should compare the ideas presented here to the way you presently view
your income statement and interpret the information on it.
Testing the Financial Strength of Your Business will provide more

information business reports and measuring the performance of your business.
Laws of Moneyof compound interest

Allowing money to grow at compound interest will make you rich.
The key to making this work is to put it away and never touch it.

Celebrate!!

3. Balance Sheet Analysis
Introduction
The purpose here is not to provide a detailed analysis of the balance sheet as it
is beyond the scope of this material; however, discuss it in depth with your
accountant.
However, it is important for small business owners to have a basic

understanding of financial statements and be able to apply some simple tests to
determine the strengths and weaknesses of the business.
Here are a few simple measuring tools:

1. Working capital
2. Historical comparisons
3. Ratio analysis
3.1. Current ratio
3.2. Acid test or quick ratio
We will discuss these tools briefly. However, we discuss these and other
financial measurement tools in more detail in Testing the Financial Strength
of Your Business.

As you move through this material, think of your own business. Think of the
financial statements that you receive from your accountant each month and
how you review the material in those reports.
What do the figures actually tell you about your

business?
How do you analyze the data?
Ask What tests do you apply to the data now?
yourself: What conclusions have you drawn from your
analysis?
How have your conclusions benefited your

business?
This material will introduce you to some basic measurement ideas and tools
Balance Sheet example
For the purpose of discussion, here is an example of a balance sheet.
The figures used are those presented for Well

Known Merchandise Inc. in the following section,
The balance sheet below is not interactive.

Well Known Merchandise Inc.
Balance Sheet -
ASSETS Dec. 31/98 Dec.31/99 LIABILITIES Dec. 31/98 Dec.31/99
Current Assets Current Liabilities
Cash In Bank 11,000 14,000 Bank Overdraft 0 0

Cash On Hand 2,000 3,500 Trade Accounts Payable 15,000 10,050
13,000 17,500 Other Accounts Payable 2,000 3,000
Marketable Securities 15,000 15,000 Provision For Taxation 13,925 14,250
Value @ Dec. 31/99) Reserves For Unbilled Expenses 2,000 2,000
Interest Due on Fixed Liabilities 700 700
Customer Accounts 18,275 17,600 Total Current Liabilities 33,625 30,000
Deposits 600 700
Employee Accounts 2,000 1,200 Fixed Liabilities(Long Term)
Other Receivables 700 500
Less;Doubtful Accts 2,000 2,000 Development Bank Loan @ 10% 50,000 50,000
Total Receivables 34,575 33,000 (repayable 2008-secured on current
and fixed assets)
Inventory
Mortgage Loan @ 8% (repayable 10,000 10,000
Finished Products 55,000 60,000 2005-secured on Fixed assets)
W ork In Progress 14,000 15,000
Raw Materials 69,000 75,000 Total Fixed Liabilities 60,000 60,000
Other Supplies 1,500 2,000
Less:Inventory losses
(Shrink/damage/pilferage) 2,000 2,000 Total Liabilities 93,625 90,000
Total Inventory 137,500 150,000 Shareholders Equity
Total Current Assets 185,075 200,500 Capital Authorized

400,000 common Shares
Deferred Assets
Capital issued: 150,000 150,000 150,000
Fuel Oil 4,000 4,500 Shares @ $1.00 each
Total Deferred Assets 4,000 4,500
Fixed Assets Capital Surplus 10,475 10,475
Land @ cost 20,000 20,000 Earned Surplus 31,775 54,525

Buildings @ cost 40,000 40,000
Plant, Machinery @ cost 26,000 30,000 Total Shareholders Equity 192,250 215,000
Manufacturing tools@cost 6,500 7,000
Vehicles @ cost 8,000 8,000
Furniture&fixtures @ cost 6,000 6,000
Less: Accum.Depreciation 12,700 14,000
93,800 97,000
Goodwill 3,000 3,000
Total Fixed Assets 96,800 100,000
Total Assets 285,875 305,000 Total Liabilities & Shareholders Equity 285,875 305,000
a. Working capital
Calculate the working capital by subtracting current liabilities from current

assets. Cash on hand is part of the working capital.
If the result of this calculation is a negative figure, it is something to be
seriously concerned about.
It is not uncommon for businesses of any size to have this situation periodically
but a low or negative working capital position is a major danger signal.
A business in this situation has a liquidity problem or is illiquid.
Because owner's equity is less than the debt, the creditors (in effect) own the
business. Bankers would be reluctant to lend any more money to the business.
Some of the possible solutions to this problem might be:
Seek more funds through long-term borrowing
Additional equity investment by the owner/s
Selling fixed assets and leasing them back from the buyer
Finding a way to finance some of the accounts payable through
suppliers
Express this relationship between liabilities and assets as the working capital
ratio. [Refer to Testing the Financial Strength of Your Business]
b. Historical comparisons
Comparing balance sheets quarterly and at year-end with those of the same
periods in prior years can often reveal trends and weaknesses. You may
discover a favourable change that, upon investigation, will lead to making
positive changes in the way you do business.

c. Ratio analysis
Ratio analysis is a term for techniques and formulae that allow the
businessperson to make quick mathematical tests of the business. This
simplifies comparisons with other similar companies in your area and with
industry standards.
Varieties of ratios are discussed in Testing the

Financial Strength of Your Business.
Two of the more useful ratios are the current ratio and the acid test, sometimes
called the quick ratio.
(1) Current ratio
Current ratio measures the liquidity of the company or the company's ability to
meet its obligations during the fiscal year.
Divide the current assets by the current liabilities.
If the sum of the current assets is $30,000 and the sum of

the current liabilities is $45,000, then the current
ratio is 0:67 or a negative, liquid situation.
For example: A rule-of-thumb that many analysts use is a current
ratio of 2:0, but this can vary with the business, the
season, and what the figures used actually
represent.

The composition of the inventory may be that it is
For either very easily moved in a short period or it
example: may be dead stock that will be very difficult to
sell.
As well, the quality of the accounts receivable (A/R) is important. A high

percentage of the accounts may be past due in excess of 90 days or they may be
predominantly 30-day accounts with customers who have a history of prompt
payment.
Therefore, having an aged analysis of accounts receivable (A/R) is
important to have prior to calculating the current ratio.
(2) Acid test or quick ratio
The acid test or quick ratio is a measurement of the liquidity of the business but
it is calculated by dividing the most liquid assets (such as cash, securities, and
perhaps accounts receivable (A/R), if they are very current-by-current
liabilities.
When acid test is applied, it may reveal quite a different picture than that
revealed by the current ratio.
A common rule-of-thumb (used by analysts for a desirable ratio) is a ratio of
1:0.
However, do not consider this rules-of-thumb a rigid standard to go by; they are
only guidelines.
It depends a great deal on the type of business, for example, the seasonality of
the business. On the other hand, how closely the business compares to
recognized industry cycles.
To be considered liquid, some businesses may need a

For current ratio of 2.7:0, while another business may
need a ratio of 1.5:0 or even less.
example:

Do your homework.
Always be aware of what is normal for your business and how your
business compares. Your banker, accountant, and trade publications are
good sources for this information. As well, many regional governments
have available detailed business profile information.
Summary
There was an introduction to the balance sheet financial

report in Balance Sheet Analysis. There are three
common tests to apply to a balance sheet. Likely, you
draw conclusions from these tests too.
Did you think about your business as you went through this material?
Apply the ideas presented here to your business.
In Testing the Financial Strength of Your Business, we will present many

more ways to analyze and test the financial reports you receive from your
accountant each month.
The Laws of Moneyof investing

Investigate before you invest.
Spend as much time studying an investment as you do earning the money
you put into it.
Never let yourself be rushed.

Celebrate!!

4. Testing the Financial Strength of Your Business
Introduction
In Balance Sheet Analysis, we discussed how a business:

Analyzes its costs
Builds cost recovery and profit into its pricing
Monitors monthly business performance
Performs basic financial performance tests
In Testing the Financial Strength of Your Business, we will expand on what

you have learned so far and present many other ways to test the performance of
your business and make better business decisions.
Use the financial test methodologies illustrated here to test your own business.
You should apply these tests to your business on a regular basisat least
every fiscal quarter.
Compare the results of your tests to accepted standards of performance for
businesses of your size, in the same industry.
You may pick up information on industry standards from your accountant
or you can obtain it at most libraries.
As well, there are a number of government and industry publications
detailing profiles of financial information for businesses of all kinds for
various regions of the country.
When you make these comparisons, ask after each test:

How does your business compare to the norms for your industry and
region of the country?
If you do not compare favourably, what remedial action is needed?
What are the things you are doing well?
What are the specific areas where you are not performing well?
What action would be necessary to improve the results?

You may wish to consult with your accountant to help with a detailed analysis
and the answering of these questions.
For the purpose of illustration, we will assume some financial figures for a
fictitious company called Well Known Merchandise, Inc. The data is not seen
as it would be on a real balance sheet or income statement, but is only used for
illustration of the financial tests.
Below is financial data for Well Known Merchandise Inc.:
Current assets $35,000

Fixed assets $100,000
Beginning inventory $170,000
Ending inventory $150,000
Average inventory $160,000
Average accounts receivable (A/R) $20,000
Current liabilities $30,000
Long-term liabilities $60,000
Shareholder's equity $200,000
Number of common shares 200,000
Preferred share dividends $20,000
Net sales $750,000
Net credit sales $140,000
Average accounts payable $10,000
Total credit purchases $170,000
Cost of goods sold (CGS) $500,000
Net profit (net income) before interest and bank charges $60,000
Net profit (net income) $50,000
Interest and bank charges $10,000

Common tests of business performance
Refer to these tests that we will discuss here to as business ratios. The term
ratio refers to the proportional relationship between values.
For example:
A farmer may say that he has sheep and cows in the ratio of
10 to 3.
This means that he has 10 sheep for every 3 cows.
Or, he has 3 times as many sheep as he has cows. Often, a ratio is
expressed as a fraction.
The ratio of 6 to 10 may be stated as 6/10 or as 6:10.
The business ratios we will discuss are:

a. Operational ratios
b. Liquidity ratios
c. Leverage ratios
d. Profitability ratios
We will discuss various ratios that fall into these categories, where they are
used, and why they are used.
In some cases, we will give examples of:

How these ratios are used in a business situation
The conclusions that might be drawn
The action that might be indicated

a. Operational ratios
We have divided this operational ratio information into the following headings:
Headings Related formula
a. Turnover on accounts Total net credit sales/average accounts

receivable receivable
b. Average accounts collected in Days in the period x, average accounts
person receivable/total net credit sales
c. Average days payable Days in the period x accounts payable/total
credit purchases
d. Utilization of assets Total net sales/total assets
e. Sales to fixed assets ratio Net sales/average net fixed assets
f. Inventory turnover Cost of goods (CGS) sold (CGS)/average
inventory
g. Days of sales in inventory Days in the period x average inventory/cost
of goods (CGS) sold (CGS)
h. Sales of employees Net sales (for the year)/average number of
employees
You may wish to print these ratios and their formulae. In addition, the Glossary
lists them.
The operational ratios discussed here relate to:

Management of accounts receivable
Management of accounts payable
Management of inventory
Management of company assets
Management of employee productivity
These ratios provide you with insight into how to use the business funds and
assets within the business.

(1) Turnover on accounts receivable (A/R)
This ratio is a measurement of the liquidity of the accounts receivable (A/R) in

the business. This tells you the rate at which credit sales are turned into cash.
A higher ratio is an indicator that the company does not have as much
money tied up in accounts receivable (A/R) and that customers are paying
their accounts quickly.
A lower ratio is an indicator that the company has a large amount of money
tied up in accounts receivable (A/R) and that customers are slower in
paying their accounts.
Accounts receivable turnover formula

Total net credit sales/average accounts receivable
This formula means that the total of the net credit sales for the year is divided by the
average accounts receivable that was on the books in the year.
Example:
Well Known Merchandise Inc. has average accounts receivables of $20,000.
Add the beginning and ending balance of the accounts receivable and divide
by 2.
The total of the charge sales or net credit sales for the year was $140,000.
Therefore, applying our accounts receivable turnover formula:
$140,000/$20,000 = 7
Alternatively, the net credit sales are 7 times the average accounts receivable and
the ratio is 7:1
Assume that having a high turnover number is always a good thing. However,
ratios show the balance that exists between the factors examined.
In the next ratio, we will demonstrate how the balance is important.

(2) The average account collection period
The average account collection period is sometimes called receivable days

outstanding or RDO for short. This is a measurement of the number of days it
takes for customers to pay their accounts.
If the measurement indicates that customers pay their bills in a short period
of time, it could mean that the credit and collection policies of your
company are functioning very effectively.
However, it could mean that the credit policies of the company are
restrictive and may be affecting sales.
Credit policies have to be flexible enough to both stimulate sales and meet
competitive credit policies.
The key and the challenge for the credit department is to ensure the quality
of the Accounts receivable (A/R) by only extending credit to customers
with good credit histories.
It is important to the health of the business to strike

a balance.
Effective credit policies can:

Stimulate sales
Promote inventory turnover
Maintain cash flow
Improve profitability

Average account collection period formula
Days in the period x, average accounts receivable/total net credit sales
The period is a year so the number of days is 365. Calculate the average
accounts receivable by adding the beginning and ending balance for
accounts receivable and dividing by 2.
The formula says to multiple the average accounts receivable by 365 and the
result then divided by the total net credit sales.
Example:
Well Known Merchandise, Inc. has average accounts receivable of $20,000.
The charge sales, or net credit sales, are $140,000 for the fiscal year.
Therefore, applying the average account collection period formula:
365 x $20,000/$140,000 = 52
What the formula says to multiple the average value of accounts receivable
carried on the books of the company every day by 365 days in the year.
Divide the results by the total of the net credit sales for the year.
The result is the number of days that it takes for customers to pay their
accounts.
In this illustration, it takes the customers of Well Known Merchandise Inc.

52 days to pay their accounts.

Consider the 52 days as good or bad. It really depends on the industry standards
and the particular needs of the business at the time.
For instance:
The management of a company may have low inventory turnover.
This means that the company will have money tied up in inventory.
As long as there is tied up money, it is not earning a return on that investment.
The company may decide to make regular credit terms more flexible or
alternatively apply more flexible credit terms to some promotions during the
year.
This action may improve inventory turnover and therefore favourably affect the
cash flow, profitability, and average days payable of the company.
Assume that paying your bills promptly upon receipt of the invoice is desirable.
However, as with many of these financial tests, it depends on the business
situation and various factors need to be balanced.
Some of these factors are:

Maintaining the credit rating of the company
Taking advantage of supplier payment incentives
Improvement of cash flow in the company
Improvement of the return on investment (ROI) of cash resources in
the company
Below are three examples of average days payable:

Example 1:
Using money costs money
If you borrow money to finance inventory, the lender will charge interest
for the use of the money. This interest charge effectively reduces the profit
margin realized on the sale of the merchandise.
Longer payment terms on purchases from a supplier can have a significant
effect on profitability. The advantages are:
Not using the cash assets of the business
Re-deployment of the funds that would have been used
The merchandise purchase may be mostly sold before payment has to
be made so, in effect, the supplier is financing your business
Therefore, negotiating an additional 30, 60 or 90 days terms on a purchase
can have an impact on profit.
Example 2:
Taking advantage of supplier volume purchasing discounts and early
payment incentives can have an impact on profitability.
A typical example is a supplier offering an additional 5 or 10% discount for
a particular volume of merchandise purchase. Making a payment by the 15th
of the month following the purchase could bring an additional incentive of
12%.
If a business sells merchandise normally yielding a gross margin (GM) of
33%, even improving the cost by 2% means an improvement of 3% in the
gross margin at the selling price. As a result, the business now would make
a gross margin of 36% on the selling price.

Example 3:
A company buys a volume of merchandise that would normally be valued

at $10,000. The company's normal gross margin (GM) on selling price is
33%.
The supplier offers a discount of 5% off the normal price for the volume
purchase.
Making a full payment by the 15th of the month following purchase, the
supplier offers an additional incentive of 2%.
The calculation demonstrating profit improvement is as follows:
Regular purchase value $10,000
Less 5% discount $ 500
Total $ 9,500
Less payment incentive 2% $ 190
Total $ 9,310
This last example demonstrates that taking advantage of the volume discount
and payment terms improves the purchasing price by 6.9%
(100% - 5% - 2% = 93.1%).
Purchasing at a 6.9% better price means that at the normally selling price that
generated 33% gross margin (GM), the gross margin is improved by
10.34% (069 divided by .0667 = .1034).
The average days payable is a measurement of how long it takes your company
to pay its bills. These two illustrations point out why analyzing the average
days payable is important and then taking action that is appropriate to the
company's needs.

Average days payable formula
Days in the period x accounts payable/total credit purchases
The period is a year so the number of days is 365. Calculate the average accounts
payable by adding the beginning and ending balance for accounts payable and
dividing by 2.
The formula says to multiply the average accounts payable by 365 and the result then
divided by the total credit purchases.
Example:
Well Known Merchandise Inc. has average accounts payable of $10,000. The
total inventory purchased on credit, or the total credit purchases, are
$170,000 for the fiscal year.
Therefore, applying the average accounts payable formula:
365 x $10,000/$170,000 = 21.47
What the formula says to multiple the average value of accounts payable carried
on the books of the company every day by 365 days in the year.
Divide the total of the total credit purchases for the year.
The result is the number of days that it takes for the company to pay its bills.
In this illustration, it takes the company, Well Known Merchandise Inc.

21.47 days to pay its bills.
Considering this good or bad depends on the industry and the particular
company's needs. However, in this illustration, the company is paying its bills
less than a month after purchase. In most cases, a company like this can gain
significant profit advantages by negotiating better payment terms with its
suppliers.

(3) Utilization of assets
Measuring how efficiently assets are utilized in the generation of sales income
is a measurement of the financial health of a business. It is a way of comparing
the efficiency of the use of capital assets to others in your industry. The
analysis is a measurement of the sales dollars that are generated for every dollar
invested in assets.
The age of assets and the way they are valued can be an important
consideration when doing this analysis.
For example:
You will get very different results in measuring asset utilization if:
The original or historical value of fixed assets is used
The depreciated or 'book value' of the assets is used
The replacement value of the assets is used
Utilization of assets formula

Total net sales/total assets
The formula says the value of the total net sales of the company is divided by the
value of all the assets of the company.
That is the total of the current assets and the fixed assets of the company.
Example:
In the case of Well Known Merchandise Inc., the current assets are valued at
$35,000 and fixed assets are valued at $100,000 = 135,000. The total net
sales of the company are $750,000.
Therefore, applying the utilization of assets formula:
$750,000/$135,000 = 5.55.
This example calculation is saying that for each $1.00 of asset value, $5.55 is
generated in net sales and the ratio is 5.55:1.

Compare this analysis in your business to standards for your industry.
If the calculation results in a low ratio compared to others in your industry
it might mean that your company is not using its assets as efficiently as it
could.
Alternatively, it might mean that you have too much money invested in
assets and would look for ways of trimming the fat.
Look carefully at how fixed assets are valued. As well, look at the condition of
those fixed assets. Using undervalued fixed assets because you are using
historical or depreciated values will ensure your calculations result in a higher
ratio.
A higher ratio than industry norms can sometimes mean that your company is
operating efficiently and getting the most out of the assets employed in the
business.
However, it can mean that the assets employed in the business are overused
or stretched to capacity. In this event, short-term gains in profit may result
in additional wear and tear on production equipment.
When this equipment is replaced sooner than necessary, the replacement
cost could lower profitability.
When you analyze the utilization of assets in your company, look for the
underlying reasons why a ratio is high or low. It is a very good idea for any
company to plan for the orderly replacement of assets by allocating at least a
portion of the accumulated depreciation of assets to a reserve for the
replacement of capital assets.
(4) Sales to fixed assets ratio
This measurement is similar to the utilization of assets formula but with the
focus on how, efficiently fixed assets are utilized in the generation of sales
income.
It is a way of comparing the efficiency of the use of capital assets to others
in your industry.
The analysis is a measurement of the sales dollars that are generated for
every dollar invested in fixed assets.
Again, higher ratio values could mean that the business is using fixed assets
efficiently, but it can imply that fixed assets are being overused.

In the event that fixed assets are overused, it could hasten the need to replace
them and could, by doing so, prejudice future profits.
Sales to fixed assets formula

Net sales/average net fixed assets
The formula says to divide the net sales after discounts, returns, and allowances into
the average net fixed assets.
The average net fixed assets are an average of the beginning and ending balances for
fixed assets.
Example:
Well Known Merchandise Inc. has net sales of $750,000 and fixed assets of
$100,000. For this illustration, we will assume the beginning and ending
balance for fixed assets was the same.
Therefore, applying the sales to fixed assets ratio:
$750,000/$100,000 = 7.5.
This example calculation is saying that for each $1.00 of fixed asset value,
$7.50 is generated in net sales and the ratio is 7.5:1.
Apply this analysis to your business and to standards for your industry.
If the calculation results in a low ratio compared to others in your industry,
it might mean that your company is not using its assets as efficiently as it
could.
Alternatively, it might mean that you have too much money invested in
assets. In that event, you should look for ways to dispose of redundant or
superfluous assets.
Plus, look for ways to use assets more efficiently.
All of the other cautions and recommendations discussed in relation to the

utilization of assets formula apply to the sales to fixed assets ratio.

(5) Inventory turnover ratio
For any business selling merchandise, promoting inventory turnover has a

major impact on profitability.
The ratio measuring inventory turnover is one of the most important to your
business if your business sells products.
This is because the gross profit of your business increases every time the
value of your inventory dollars is turned over.
The term turnover means each time the value of the inventory is sold or
replaced.
Inventory turnover formula

Cost of goods sold (CGS)/average inventory
Calculate the cost of goods sold (CGS) as follows:
Beginning inventory + net purchases ending inventory = CGS
Calculate the average inventory as follows:
Beginning inventory + ending inventory/2 = average inventory
(In a few cases, this calculation may not reflect average inventory throughout
the year. In that event, dividing the total of the monthly inventory balances by
12 will give a more accurate average.)
The inventory turnover formula says that the value of the inventory at the
beginning of a fiscal period is added to the value of all the purchases during the
fiscal period after all discounts, allowances and returns are taken into account.
Then, from this total, the value of the ending inventory is subtracted to
obtain the value of the cost of goods sold (CGS) during the fiscal period.

Divide the result of this calculation by the average inventory value for the fiscal
period.
Example:
In the case of Well Known Merchandise Inc., the cost of goods sold is
$500,000 and the average inventory is $160,000.
Therefore, applying the inventory turnover formula:
$500,000/$160,000 = 3.12.
This example calculation is saying that the average inventory value turned over
3.12 times during the fiscal period.
Turnover rates vary greatly in different industries.

Compare the turnover rate for your business with the standards for
inventory turnover in your industry.
In general, the turnover rates are high in businesses that sell perishable goods
like fresh vegetables, meat, or flowers.
Turnover rates will be high in businesses carrying seasonal products such as
gardening products (in some climates). In addition, those products that are
subject to rapid changes in fashion or that may become obsolete in a short
period of time.
Turnover rates are usually lower in businesses handling durable goods such
as machinery, tools, construction products, or heavy appliances.
If the inventory turnover rate for your business varies greatly from industry
standards it may be an indication that:
Purchasing practices need improving
Marketing policies and strategies need to be analyzed
Very slow moving or obsolete (dead stock) has been allowed to
accumulate and the value of this inventory is lowering your turnover
rate

The inventory turnover formula is a good indicator of the general status of the
inventory in your business.
However, a detailed examination of the inventory turnover of each product
group is necessary on a regular basis.
Remove slow moving or dead stock from inventory constantly. Don't make
this an annual task.
Selling off slow moving items, even below cost price, and reinvesting the
proceeds in faster moving inventory can have a dramatic effect on turnover
rates and profits.
(6) Days of sales in inventory ratio
The days of sales in inventory ratio tells the business owner how many days
that the business could operate with the inventory that is on hand.
It is not likely that the business would go for long periods without replacing
stock because business would suffer by not having the items customers
need.
Rather, this measurement is a measure of the company investment in
inventory. Along with the inventory turnover ratio, the days of sales in
inventory can help to determine whether the business has too many dollars
invested in inventory.
Days of sales in inventory formula

Days in the period x average inventory/cost of goods sold (CGS)
The formula says to multiply the days in the period (which is usually 365 days)
by the average inventory, and then divided into the result of the cost of goods
sold.
In the case of Well Known Merchandise Inc., the average inventory is
$160,000 and the cost of goods sold is $500,000.
Therefore, applying the days of sales in inventory formula:
365 x $160,000/$500,000 = 116.8.
The example calculation is saying that the number of days of sales in inventory is
116.8.
As with the inventory turnover rate, you may consider this measurement as
high or low depending on the industry. Again, the measurement will vary with
the type of merchandise.

The major point of frequently applying the Inventory turnover formula and the
days of sales in inventory formula to your business is:
To obtain a better return for the money invested in inventory
To improve the liquidity of the inventory investment
To improve the freshness and quality of the inventory
(7) Sales per employee ratio
The sales per employee ratio are a very general measurement of the
productivity of the employees in the company. If your business is profitable
and the performance of the business compares to norms in your industry, this
ratio will tell you how much revenue needs to be generated for each employee
in the business.
Sales per employee formula

Net sales (for the year)/average number of employees
This formula says to divide the average number of employees into the net sales for
the year.
For the purpose of illustration, we will assume that Well Known Merchandise Inc.
has six employees.
Example:
Well Known Merchandise Inc. has net sales of $750,000 and the average
number of employees is 6.
Therefore, applying the sales per employee formula:
$750,000/6 = $125,000
This formula says that each $125,000 in net sales may be attributed to each
employee in the company.
If your business is not profitable or if you apply this formula to your business
and find that, you do not compare to industry standards, look for reasons why
your productivity per employee is not up to par.
If you are considering the addition of an employee, apply this formula to your
business. It will tell you how many more dollars in net sales will be necessary
to offset the cost of the employee if you want to maintain your level of
productivity.

Ask if:
The additional employee is really necessary
The additional employee will generate the necessary additional revenue
The additional revenue, after expenses, will result in additional profit
b. Liquidity ratios
The ratios discussed in liquidity rations relate to the ability of the business to
meet its financial obligations. They measure how quickly the business could
convert assets into cash to meet short-term obligations or take advantage of
opportunities that required the availability of quick cash. A typical example
would be taking advantage of supplier early payment discounts.
We have divided liquidity ratios into three headings:
Headings Related Formulae

a. Current ratio Current assets/current liabilities
b. Acid test ratio Quick assets/current liabilities
c. Inventory to meet working capital Average inventory/(current assets +
ratio average inventory current liabilities)
You may need to print these ratios and their formulae. The Glossary lists these
formulae.

(1) Current ratio
The current ratio measures the ability of the business to meet its short-term
obligations. Consider short-term obligations as those that are due within the
next 12-month period. The current ratio is a measurement of the working
capital in the business. Businesses with a favourable current ratio will normally
qualify for better credit terms with suppliers and lenders.
Current ratio formula

Current assets/current liabilities
This formula says to divide that the current assets by the current liabilities.
Consider current assets to be:

Cash
Notes receivable
Accounts receivable (A/R)
Marketable securities (stocks, bonds)
Inventory that may be immediately converted to cash
Accounts receivable (A/R) that can be readily converted to cash
Consider current liabilities to be:

Accounts payable
Notes payable within the next 12 months
Term loans payable
Lease amounts payable
Mortgage monthly payments

Example:
Well Known Merchandise Inc. has current assets of _____ and current
liabilities of _____.
Therefore, applying the current ratio formula: $35,000/$30,000 = 1.16
This formula says that the current assets exceed current liabilities by a ratio of
1 16:1
A current ratio over 1 is usually acceptable in most businesses. However, you

should consult business profiles for the norms in your industry and your size of
business.
In many businesses, if the ratio is greater than 2, it may be an indication that the
investment in inventory is too high and the capital (cash) in the business is
being underemployed.
It is not a good sign if the current ratio is under 1, certainly not on a consistent
basis. That would possibly indicate that the business will have difficulty
meeting its short-term obligations and wouldn't be able to take advantage of
special purchasing opportunities or suppliers' early payment discount terms.

(2) Acid test ratio
The acid test ratio is similar to the current ratio; however, the acid test ratio
includes only those current assets that can be immediately converted to cash.
Therefore, prepaid items and inventories are not included in the calculation.
The acid test ratio measures the company's ability to meet immediately the
demands of creditors.
Acid test ratio formula

Quick assets/current liabilities
This formula says to divide the quick assets by the current liabilities.
Quick assets are:
Cash Marketable securities (stocks, bond)
Notes receivable accounts receivable
(All overage accounts excluded)
Example:
Well Known Merchandise Inc. has current assets of $35,000. For the purpose
of simplicity in these illustrations, we havent made any judgments as to the
liquidity of accounts receivable or inventory.
However, you should do this when doing the calculations for your business.
To illustrate the acid test ratio, let us assume that the quick assets of Well
Known Merchandise Inc. are valued at $28,000.
Therefore, applying the acid test ratio formula:
$28,000/$30,000 = .933.
This formula states that the acid test ratio is .933:1.
In other words, the company could meet the immediate demands of its creditors
if all of the current obligations were suddenly due and payable.

(3) Inventory to net working capital ratio
It is important not to have too much of the working capital of the business tied
up in inventory, because it can be expected that only a portion of the inventory
could be immediately converted to cash. The balance of the inventory would
take some time to liquidate.
Too high a level of cash invested in inventory would indicate that:
The business is not making full use of suppliers' terms
Is not negotiating favourable terms with suppliers
The business may not be able to meet short-term obligations
Inventory to net working capital formula

Average inventory/ (current assets + average inventory current liabilities)
This formula says to divide the average inventory by the sum of the current
assets plus average inventory minus the current liabilities.
Example:
Well Known Merchandise Inc. has an average inventory value of $160,000
current assets are $35,000. Current liabilities are $30,000.
Therefore, applying the inventory to net working capital formula:
$160,000/($35,000+$160,000) $30,000 = .969.
This formula says that the average inventory value is 96.9% of the working
capital in the business.
Apply this formula to your business.

Compare the results to standards for a business of your size in your
industry.
It is usually considered a bad sign if, consistently, average inventory value
exceeds the sum of current assets minus current liabilities.
In this event, the company will have too much money tied up in inventory
and won't be able to meet the current demands of its creditors.

c. Leverage ratios
The ratios discussed here measure the degree to which:

The company uses outside capital sources to finance the business
The company uses the investment of shareholders to finance the
business
These ratios are an indication of the ability of the business to repay its creditors
and investors.
Two headings divide the leverage ratios:
Headings Related formulae
a. Debt asset ratio Current liabilities + long-term liabilities/(current

assets + fixed assets)
b. Debt equity ratio Current liabilities + long-term liabilities/shareholders

equity
(1) Debt to asset ratio
The debt to asset ratio measures how much of the assets of the business have
been financed from outside lending sources.
This is a key ratio from the perspective of potential lenders.
They want to know how much of the capital in the business has come from
the shareholders.
Low debt to asset ratios = better ability to repay creditors
Debt to asset ratio formula

Current liabilities + long term liabilities/ (current assets + fixed assets)
This formula says to divide the total liabilities by total assets (the sum of all
current and fixed assets).
Example:
Well Known Merchandise Inc. has current liabilities of $30,000 and long-term
liabilities of $60,000 for total liabilities of $90,000. Current assets are
$35,000 and fixed assets are $100,000.
Therefore, applying the debt to asset ratio formula:
($30,000+$60,000)/ ($35,000+$100,000) = .667.

Apply the debt to asset ratio to your business. Compare the result to standards
for your industry and your size of business. If the ratio is high, look for ways of
improving the ratio such as:
Reducing and/or eliminating slow moving and dead stock
Use some of the proceeds of stock reduction to generally pay down
debt
Paying off notes and loans that are not directly financed from current
revenues
Use some of the proceeds of stock reduction to reinvest in higher
turnover inventory items
Reducing or eliminating overage receivables
Use some of the proceeds for debt reduction as with the proceeds from
inventory reduction
If you are contemplating expansion of your business and are likely to require
outside financing, you want to make your business as attractive to an investor
as possible.
Lowering the debt to asset ratio is an important factor in making your
business attractive to an investor.

(2) Debt to equity ratio
Consider the debt to equity ratio as very important by most lenders. It measures
the amount of shareholders' investment in relation to the liabilities of the
business. Lenders prefer to see low debt to equity ratios because it means the
business has been able to finance itself without a great deal of reliance on
creditors. However, there is no rule of thumb for debt to equity ratios and the
ratio will usually vary depending on whether the business is a young business
or a mature business.
Debt to equity ratio formula

Current liabilities + long-term liabilities/shareholders equity
This formula says to divide the total liabilities (current liabilities + long-term
liabilities) by the shareholders' equity.
Shareholders equity may take various forms (cash, bonds, stock, or property).
There are a number of ways to structure the investment.
If the company incorporates, issue the stock to the participants on the basis of
their investment. We will not deal with this here.
For the purpose of illustration of the debt to equity ratio, we will assume that the
business is not a corporation and the partners are equal investors.
Example:
Well Known Merchandise has current liabilities of $30,000 and long-term
liabilities of $60,000. The shareholders' equity is $200,000.
Therefore, applying the debt to equity ratio formula:
$30,000 + $60,000/$200,000 = .45.
This formula says that the ratio of total liabilities of the business to the
shareholders' equity is .45:1.
Alternatively, the total liabilities are 45% of the shareholders equity.
Apply the debt to equity ratio to your business. Compare the results to
standards for your industry and the size and maturity of your business.

d. Profitability ratios
The profitability ratios relate to how much net profit that is generated by the
business in relation to the investment in the business and the assets that are
employed.
Profit is, after all, the reason for the existence of most businesses. Business
owners frequently invest and risk their life savings.
They spend long hours managing their businesses.
In most cases, at the end of the day, they do not want to just make wages'
for their efforts.
If the business does not generate an acceptable bottom line' profit, the
owners may be better off financially to invest their money and efforts in
another enterprise.
Five headings divide profitability ratios:
Headings Related formula
a. Return on sale ratio Net profit after taxes/net sales
b. Return on shareholder's Net income/shareholder's equity

equity ratio
c. Number of times interest Net profit before interest and taxes/annual

earned ratio interest and bank charges
d. Return on total assets ratio Net profit before interest and taxes/annual
interest and bank charges
e. Earning per share ratio Net income preferred dividends/number

of common shares
You many want to print these ratios and their formulae. The Glossary lists these
formulae.

(1) Return on sales ratio
The rate of sales ratio is a measurement of how much profit the business
generates, after taxes, on each dollar of net sales. In other words, how much
after tax net income (net profit) is generated for each dollar in net sales.
Return on sales ratio formula

Net profit after taxes/net sales
This formula says that after operating expenses, interest expenses, and taxes are paid;
divide the net profit of the company by the net sales.
xample:
Well Known Merchandise Inc. has generated a net profit of $50,000 and had
net sales of $750,000.
Therefore, applying the return on sales ratio formula:
$50,000/$750,000 = .067.
This formula says that after all expenses and taxes are paid, Well Known
Merchandise Inc. earned a return on sales of $.067 per $1.00 of sales or, a
ratio of .067:1.
Consider this result as good or bad. It really depends on what is normal for
businesses of the same size in the same industry. It may seem that 7 cents on
the dollar is a low return. However, there are a number of industries where the
return on sales is 12 cents on the dollar.
Apply this formula to your business. How do the results compare to other
businesses in your industry?

(2) Return on shareholder's equity ratio
The return on shareholder's equity ratio is a measurement of how much money,

on an annual basis, the shareholders receive for every dollar they have invested
in the business.
Return on shareholders equity formula

Net income/shareholders equity
This formula says to divide the net income of the business (after all expenses
and taxes are paid) by the shareholders equity
Example:
Well Known Merchandise Inc. has a net income of $50,000 and the shareholders
equity in the business is $200,000.
Therefore, applying the return on shareholders equity formula:
$50,000/$200,000 = .25
This formula says that at the end of the fiscal year shareholders of Well Known
Merchandise Inc. received $.25 for each $1.00 invested in the business.
That is a 25% return on their investment for the year.
In most cases, consider 25% an excellent return. However, is that the case every
year or do the results in that industry fluctuate greatly from year to year?
Apply this formula to your business. Compare the result to other businesses of
similar size and shareholders' investment in your industry.

(3) Number of times interest earned ratio
The number of times interest earned ratio measures the ability of the business
to pay the interest on its borrowed capital.
The larger the value of this ratio the more confident lenders are in the
ability of the business to handle their debts.
A low value for this ratio would tell lenders that the business could have a
problem meeting its financial obligations.
Number of times interest earned formula

Net profit before interest and taxes/annual interest and bank charges
This formula says to divide the net profit of the company (before interest and
deducted taxes) by the total interest and bank charges.
Example:
Well Known Merchandise Inc. has a net profit before interest and bank
charges of $60,000. Interest and bank charges for the year were $10,000.
Therefore, applying the number of times interest earned formula:
$60,000/$10,000 = 6.
The formula says that the net profit of Well Known Merchandise Inc. was six
times the value of the interest and bank charges that were paid during the
year.
Lenders would likely consider Well Known Merchandise Inc. a limited risk
and would be willing to loan further funds to the company.
Apply this formula to your business. Compare the results to other companies in
your industry of similar size.

(4) Return on total assets
The return on total assets is a measurement of the efficiency of the business in

using its assets to generate income. Seasonal variations in income need to be
taken into account when the calculation is made. You may want to apply the
formula using the total for assets owned and, again, excluding those assets the
company leases.
Return on total assets formula

Net income (from operations)/average total assets
Net Income from operations does not include expenses that are not part of
operations. Exclude expense items such as income taxes and interest
charges.
An average total asset is the sum of average current assets + average fixed
assets. It is important in this calculation to use the averages because the
valuation of these assets could fluctuate during the year.
The formula says to divide the net income of the company by the average total
assets.
For the purpose of the illustration, we will use the value for current assets and
fixed assets of Well Known Merchandise Inc. to calculate the average
total assets.
Example:
Well Known Merchandise Inc. has net income of $60,000. Current assets are
$35,000 and fixed assets are $100,000. Therefore, assuming these are the
averages, average total assets are $135,000.
Therefore, applying the return on total assets formula:
$60,000/$135,000 = .4444
The formula says that the net income of Well Known Merchandise Inc. for the
fiscal period was 44.44% of the average total asset value.
Apply the formula to your business. Compare the result to norms for your
industry and size of business.

(5) Earnings per share ratio
The earnings per share ratio are a measurement of the company earnings per
share of common stock. The measurement is taken after taxes are paid and any
dividends paid to preferred shareholders.
Preferred shareholders are usually investors outside the company or at least

not part of the ownership of the company.
Typically, their investment is preferred as to a rate of return on any earnings
generated but preferred shareholders can be guaranteed a rate of return for a
period of time.
In some cases, it may involve an option to convert the preferred stock to
shares of common stock on a pre-established conversion ratio.
Preferred shareholders do not usually have voting rights and have any say
in the daily operations of the company.
Common shareholders have direct ownership of the company.

The common shareholders do have a say in the operations of the company
and they share in the net income after tax profits that may be disbursed by
the company.
Earnings per share formula

Net incomepreferred dividends/number of common shares
This formula says to divide the number of common shares into the net income of the
company, minus the preferred dividends.
Example:
Well Known Merchandise Inc. has a net income of $50,000 and pays preferred
dividends of $20,000. The number of common shares is 200,000, which
represents the investment of the owners of $1.00 per share.
Therefore, applying the earnings per share formula:
$50,000 $20,000/200,000 = $.15.
This formula says to divide the net income of the company minus the preferred
share dividends by the number of common shares
The result is that the earnings per common share were $.15/per share.
This means that for every $1.00 the common shareholders have invested, they
earned 15 cents or 15%.
This is not always disbursed to the common shareholders.
Usually some of this money is held as retained earnings or reserves for capital
projects.

Apply this formula to your business. Compare the result to other similar
businesses in your industry.
Summary
In Testing the Financial Strength of Your Business, we discussed methods of

testing and monitoring the financial strength of your business. You may not use
all of these tests every time you do your monthly performance review;
however, as you discover variances in your financial statements and reports,
you will find these ratios useful in testing your business.
As you move through the material in this section, did you think of your own
business? Did you think about how you now review your financial reports?
Did you apply some of the ratios to your business and ask yourself:
What tests should you apply to the data now?
What do the ratios actually tell you about your business?
How do you analyze the data?
What conclusions should you draw from your analysis?
How will your conclusions benefit your business?
This material has introduced you to some basic measurement ideas and tools
that will help you make better business decisions. Using these methods will
allow you to compare your business performance to other businesses in your
industry.
Laws of Moneyof accumulation

Great financial achievement is an accumulation of hundreds of small efforts.
You should build a momentum to your savings plan and let nothing get in its
way.

Celebrate!!

E. Financing, & Risk Management, Business Planning
Introduction
In this section, we will be discussing common types of business financing and

factors that the business manager should consider when arranging financing for
the business.
A business will frequently require financing to implement the business
plan. A section of the business plan should present how the financing will
be used or how the funds will be applied in the implementation of the
business plan.
As well, we will discuss the format of a business plan and provide a sample
of the elements of a business plan. An important part of a good business
plan is risk analysis. Therefore, one of the sub-sections will discuss typical
risks that must be considered when a business manager prepares a business
plan.
The intent of this material is to discuss important factors that a business

manager must consider when putting together the business plan after the
completed basic research and analysis.
The following three segments provide an overview of the section:

A guide to financing
In A Guide to Financing, we will discuss key issues that need to be addressed

when a business seeks financing.
This material is divided into three major parts:

Financial considerations
Banking finances
Other types of finances
A Guide to Financing stresses the importance of determining the right type of

financing for the business. As well, it stresses the importance of establishing
good communication with your lender.
Risk management strategies
Risk management is an important part of business planning. In Risk

Management Strategy, we detail many of the possible common risk
management situations.
Many examples of risk situations are presented in detail and possible solutions
are given.

Business plan format sample
The Business Plan Format Sample is included because interpreting financial

statements and performance-monitoring methods are part of business planning.
A business plan format is provided that can be used by many businesses.
The main areas covered are:

1. The key elements of the business plan
2. How the elements should be presented
3. The way the content of the material should be presented
4. The role of the financial statements and reports
Briefly discussed is risk management but dealt with more fully in the following
segment.
Laws of Businessof the customer

Customers always seek the very most at the lowest possible price. Proper
business planning demands that you focus on the self-interest of the
customer.

1. A Guide to Finance
Introduction
If you have completed a detailed business plan and it indicates that financing
will be required to successfully carry on the business and meet the objectives of
the plan, then you will need to adapt your business plan for use as a financing
proposal to your lender/s.
Consider a few things when you do this. The difference between the business
plan and the financing proposal is:
The intention of the business plan is to clarify understanding of the
business. It also outlines the actions necessary to achieve the goals of
the business.
The intention of the financing proposal is to show prospective lenders
that you know what you are doing and are an attractive investment.
After A Guide to Finance, we will present a typical business plan format that
most businesses use for either purpose.
Most bankers deal every day with small business people who do not understand
money and the various types of financing.
Your job is to convince the banker that you have completed your
homework.
Furthermore, that you understand what the bank requires to support and
approve your financing proposal. To do this is a matter of the emphasis that
is placed on aspects of the business plan.
Knowing what you need is the key!
It will save you a lot of trouble in the future and eliminate the two worst
problems in this area encountered by small business:
Getting the wrong type of loan for the right reasons
Working with a banker who will say Yes' to your proposal but will
approve inadequate financing for the business
This can be dynamite!

You need to know specifically why you are borrowing the money. You must
know how to apply funding and how this funding will provide a payback that
will enable the repayment of the loan. If you don't make this very clear to the
banker, you may wind up getting the wrong type of financing or financing that
is difficult for the business to sustain.
One of the reasons for including a detailed pro-forma cash flow is to show how
much cash will currently be available at any time to meet expenses and loan
payment obligations.
Be very sure that you do not commit to pay off a loan faster than the cash
flow can handle.
First and foremost, fit the financing to the need.
A business will have the business history to show a lender. This can be both
positive and negative.
An existing business only needs financing if it has to support current
operations or needs financing for future projects or expansion.
In either case, the business needs to prepare a strong business plan with
well thought out and detailed current and projected financial statements.
Again, it is important to understand and speak the language of the lender. The
business will have to convince the lender that they have charge of the business
and will be able to achieve the projected objectives.
A Guide to Finance will discuss key issues for an existing business seeking
financing.
This material is divided into three major parts:

1. Financial considerations
2. Banking finances
3. Other types of finances

Financing considerations
The chief consideration when considering financing for an enterprise is

determining the debt vs. equity ratio that is right for the business.
How much capital are the owners of the business contributing to the
business?
How much capital will be required from outside sources?
When you go to a banker for financing, you are going there for debt financing
in the form of a loan that must be repaid over a predetermined period at a
definite additional interest cost.
The investment made in the business by the owner of the business is the equity
financing. This is money that will not be repaid unless all or a portion of the
ownership of the business is sold.
When you debt finance you don't give up any part of the ownership of the
business as you do with equity financing, but you will give up some measure of
control over the affairs of the business for a length of time.
It is good to remember that, with debt, you pay interest for a time, but equity
can yield profits forever.
The banker wants to know the existing debt vs. equity ratio and what it
will be if the proposed financing is approved. A high debt vs. equity
ratio indicates high risk.
Debt money is rented money and must be repaid no matter how well
the business does.
Do not commit to a more costly or wrongly structured loan.
The cash flow may not be sufficient to meet the payments. In this event,
you could lose the business.
Highly leverage businesses, that is, businesses with a higher debt vs.
equity ratio, must earn more money to survive.
Don't be fooled by get rich quick schemes that recommend the use of
borrowed money.
Many small business people are taken in by loan sharks, and then find
themselves on a treadmill that they can't get off.

If you have insufficient capital and very long-term debt that is almost
impossible to pay off, you will spin your wheels forever.
Call this problem over trading.
Consult your accountant for advice on typical debt vs. equity ratios for
your type of business and as the old clich says, don't bite off more
than you can chew.
If a short-term loan goes sour, the banker knows it will probably be
detected quickly and perhaps remedial action can be taken.
However, a long-term loan is often for much larger amounts, so the
exposure is greater. The business may be sliding down hill over a long
length of time and this is difficult to detect until it is too late to do
anything about it.
When a pro-forma cash flow is prepared, you gain two essential pieces of
information that help determine what kind of financing you need:
1. The sum of the negative cash flow gives an indication of the basic amount
of money required (in some combination of debt and equity) to exactly
offset the difference between revenue and expense.
2. The projected cash receipts show how much money will be generated to
repay any debt that will be incurred.
It is very important to make sure to arrange sufficient financing to ensure

that the venture will be successful and profitable, but not over-financed to
the extent that the business cannot comfortably service the debt.
Bank financing
Banks typically divide their lending into three main categories. A bouquet of
flowers can represent these categories. Place a single flower in a vase or place
three flowers in a vase as a bouquet. It will depend on the business how many
flowers are used at any one time.
a. Short term financingthis usually takes the form of
paying off the notes within one year, often in one
lump sum. (Blue flower)
b. Intermediate term financingthis is usually for one
to five years and is normally repaid on a monthly basis.
(Red flower)

c. Long term financingthis is for periods of five or more years and
probably the best examples of this are financing real estate or major
pieces of capital equipment where the expected useful life of the asset is
many years. Therefore, the repayment schedule is over many years to fit
the life of the asset. (Yellow flower)
All of these loans may be secured or unsecured.
A secured loan is a backed up loan with collateral such as liens against the
property, savings accounts, investments; or a co-signer with a better credit
rating.
If you default on the loan, the bank will take the assets and the proceeds applied
against the amount outstanding on the loan.
On the other hand, no bank wants to be a second hand dealer and they will
usually try to help the borrower to overcome short-term problems. However, a
lien does add weight to the loan contract and makes it very hard for the
borrower to consider even defaulting on the loan.
An unsecured loan is a loan not backed by any sort of collateral.

These are virtually all short-term loans and only individuals with a solid
track record of credit worthiness receive them.
The bank backs the loan because of its confidence in the individual's
reputation and capability of repaying the loan. Long-term loans are never
unsecured.
Now, let us look at how and under what circumstances these three basic forms
of banking financing are used by the small business.
a. Short-term financing
b. Intermediate term financing
c. Long-term financing

(1) Short term financing
Short-term needs use short term financing.
Examples of this might be seasonal inventory loans or short run production

loans where paying out the loans out of the proceeds comes from the specific
transactions involved.
Financing them over a longer period could have a
serious effect on the business.
If the practice continued, it would gradually weaken
the business by negatively affecting the debt vs. equity
ratio and eroding the assets of the company.
A prime rule of financing is never pay for an exhausted asset, a

service, or a benefit.
A typical example of doing this would be borrowing money to pay
suppliers for sold inventory.
Banks are usually reluctant to do this because it clearly indicates
mismanaged finances.
However, in some businesses accounts receivable (A/R) days outstanding
(RDO) may normally run 60 to 90 days, in which case either appropriate
terms should be arranged with suppliers or a line of credit established at the
bank.
This can be a very useful tool if used properly. It allows you to bridge the
fluctuations that may occur in sales and/or the payment of receivables and
allows you to keep suppliers current and take advantage of all early payment
discounts that trade suppliers may offer.
The main thing to avoid, as a small businessperson, being caught paying for
last year's short term borrowing next year. The accumulative affect of this can
be devastating.

(2) Intermediate term financing
Use intermediate term financing to finance needs of three to five years in

duration.
Typical examples are loans for equipment that has a
short life span or perhaps will be obsolete or upgraded
within five years.
In addition, use intermediate financing for companies
needing additional working capital during periods of
rapid expansion.
In this case, convert the debt constantly from a portion of
the earnings on sales or services.
In this way, it is possible to use the bank's money, but most businesses should
not plan to be able to do this.
For one thing, it requires a banker with vision who will be willing to accept
the additional risk of gambling on the long-term success of the enterprise
and it requires a business with high enough profit margins to handle the
additional interest cost on top of operational expense.
(3) Long term financing
Long term financing is for long-term needs such as land, buildings, and major
pieces of capital equipment like manufacturing machinery.
These fixed assets have very long useable lives and Pay
these over a long period because these are fixed assets
have a long useable life.
It is usually unwise to pay off this kind of debt too
fast unless you are extremely well capitalized or
unexpectedly benefit from a windfall profit.
In any event, paying it off may not be the best use of additional
funding.
There may be tax implications to consider or perhaps better investments for
that capital that would generate more profits.
Before paying off any long-term debt, consult your accountant and your
banker and think through the ramifications of all the options available to
you.

Other types of financing
The intention of this discussion is not to be a complete treatment of debt

financing, but rather is an overview or guide to the types of financing normally
available to businesses. We will make a brief mention of other types of
financing.
For many businesses credit with their suppliers, or trade credit, is the biggest
source of credit and the bank is the most important single financing source.
Small businesses do not often use several other sources of credit but used
by intermediate and large businesses are factoring, discounting receivable,
stocks, and bonds.
There are other debt instruments but we will not deal with them here. If you
want more information on these other options, you should discuss the
matter with your banker and accountant.

Summary
Properly financing your business is one of the most important considerations of

the businessperson. Prepare your business plan and carefully analyze what the
cost of accomplishing each and every stage of that plan will be. Then, based
upon the cash flow of the business, determine the proportions of debt vs. equity
funding that will be required to make the business viable.
Know exactly what the borrowed funds will be used for,

how they will be applied, and in each instance for what
time.
Break this down in terms of short term, intermediate
term, and long term financing.
When you go to the banker, make sure that:

You get the money that you know that you need to run the business
successfully and profitably.
Listen to advice on modifying the amount of money needed, but think it
through and if you don't feel the arguments are sound, see another banker.
Remember that you're the one that knows your business best and ultimately
must make it successful.
Take your time. Do your homework. Consider all of your options before
making a decision. Don't be rushed into making a decision on financing that
you will regret later.
Fit the financing to the need. The loan period should always fit the expected
use and application of the funds.
Never commit to a loan with payments that will be difficult for the cash flow to
handle after paying all current expenses.
Laws of Moneyof attraction

As you accumulate money you begin attracting more money to yourself.
Thinking about money as you save makes you a magnet;
you attract more money into your life.

Celebrate!

2. Risk Management Strategies
It is very important for the business owner or manager to think through as
thoroughly as possible the potential risks that the business may encounter.
Then, the company needs to develop preventative strategies and contingency
plans to deal with these problems if they occur.
This is an important part of the business plan. It is impossible, in this
discussion, to identify all of the risks a business may encounter, as some
risks will vary with the business. However, many risks are common to
every business.
We will deal with some of these here and put forth some suggested
solutions.
When you review the business plan, give special attention to this area of the
plan to make sure that conditions have not changed and the business takes
all of the variables into account that it can.
Risk management strategy is divided into five major headings:

Personnel Assets
Administration Business fluctuations
Competitive activity
Each heading is divided into two smaller parts:

1. Risks
2. Suggested solutions

Personnel
What if a key employee leaves the company?

Risks
Impact on workload and office efficiency
Loss of proprietary knowledge
Loss of client and project knowledge
Loss of continuity of relationship with a client or project
Expense of replacing and training a new employee
Suggested solutions
Cross training of staff to build more depth and flexibility.
Develop a staff training and development program for the company.
Use of staff contracts (Non-Disclosure, Employment Contract, or
Commission Sales Agreements) to protect against theft of knowledge,
customers, etc.
Involve the staff in their colleagues' projects for the protection of
project knowledge and client relationships.
Develop an incentive program strategy to further involve and retain
good staff.
Develop a roster of professionals available to do contract work.
This can provide more flexibility of staffing, provide back up in case of
emergency and have the effect of lowering overall annual salary
expense.

What safety policy and procedures program is in place?
Risks
WCB (Workmen's Compensation Board) requires that every company
have a safety policy and procedure program.
Failing to do this can result in fines of $2,500 or more for first offences.
Exposing the company to legal liability by not having a safety policy
and procedures program in place
Suggested solutions
WCB puts out a booklet on how to start and maintain a safety program.
They also put out a number of other booklets on safety in the
workplace that can be helpful in putting the program together.
Form a safety committee even in a small company. It should consist of
one person from management and one from each area of the company.
Field or grass roots personnel must be involved in the safety process.
Regular, documented meetings are required.
For some companies the establishing and running of a safety program is
too time consuming and they do contract out most of the process.
However, the company must participate in the running of the program.

Assets
How often is the company insurance policies reviewed?

Risks
Property and equipment evaluations change and the existing insurance
may not cover current replacement cost.
Changing legislation or claim awards may make present insurance
coverage inadequate.
Suggested solution
Regularly review the company's insurance policies with your agent to
ensure that any new personnel, site conditions, equipment,
requirements of legislation, etc., are covered.
What measures are in place to protect the Intellectual Property and

administrative records of the company?
Risks
A fire or other disaster could wipe out or severely damage key business
records.
Inefficient or inadequate protection of computer data could lead to
significant losses to the company due to damage to the relationship
with a client or perhaps even a lawsuit.
In the extreme, at some point you may even have a disgruntled
employee that sabotages your data.
Suggested solutions
A hard copy, microfilm, computer disk, or some form of back-up
record must be made of all business records. These should then be
stored in a fireproof vault, preferably at a remote location.
All computer data on Intellectual Property, back up current projects
and past projects daily and a copy kept in a secure, fireproof location.
Regularly maintain the computer network system and periodically
perform an assessment of the integrity of the system.

What has the company done to protect itself against the financial impact of
having to replace worn-out equipment or suddenly needing new equipment?
Risks
Existing capital equipment will eventually wear out or become
obsolete.
The replacement of these assets may put a strain on the financial
resources of the company.
Remaining competitive may demand that the acquisition of certain
equipment.
Maintaining security, efficiency and reducing potential liability of the
operation may demand acquisition of new equipment.
Suggested solutions
All capital assets should be tracked in a register that records the initial
cost, expected useful life of the asset, the annual rate of depreciation,
any maintenance or repairs that are done and the recovered value in the
event that it is sold.
A three- to five-year projection should be made of the total value of
assets that will reach the end of their useful life each year.
Of course, completing a yearly review and making adjustments to the
next year that account for inflation.
A reserve or contingency fund for the replacement of capital equipment
should be set up.
Each month credit an amount equal to the accumulated depreciation on
capital assets to this reserve.
Depending on the value of the assets projected to need replacing,
estimated new equipment needs and the rate of inflation, you may wish
to increase the contributions to the reserve.
Taking this approach protects the business against unbudgeted capital
costs and ensures that the business has the resources it needs when it
needs them.
As well, these reserves build financial strength into the business and
increase the options when a need arises.

FFoorr eexxaam
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The contingency fund for replacement of capital equipment may or may not
actually be depleted to satisfy the need. Rather, leveraging the money may
depend on the asset, its expected useful life, and the borrowing rate at the
time.
Depending on the situation, it may be better for the liquidity of the company to
lease the resource rather than buy it. In addition, tax consideration can affect
the decision on when and how to acquire an asset. The small business owner
or manager should discuss with their accountant or business consultant these
questions.
Administration
What if there are new government taxes or regulations that make it more
costly to do business?
Risks
Additional taxes may be required that have not been included in
estimates.
New requirements for bonding or liability insurance could be brought
in and have to be accounted for in pricing.
Professional associations could make new demands on members that
will add to the cost of doing business.
Additional employee benefit legislation could increase costs.

Suggested solutions
Client contracts must include clauses that allow for the addition of
charges for unforeseen government imposed charges or costly
compliances.
Quotations should always be time limited and include a disclaimer that
allows for the adding of charges not included in the quote.
Pricing reviews should include a factoring in of the projected rate of
inflation in salary and benefit expense.
It is a good idea to have a policy of undertaking salary reviews
effective on employee anniversary dates rather than performing this for
everyone at the same time. This tends to spread the impact of salary
and benefit expense over the whole year.
Business fluctuations
How would you handle a dramatic increase in your business?

Risks
Existing staff may not be able to cope with the workload.
Efficiency suffers and the potential for costly errors increases.
Demands on financial resources may greatly exceed budget
projections.
New or additional equipment may be required to meet the growing
demands of the businessequipment for which there is no budgeted
funds.
Suggested solutions
Cross training, career development programs, involving employees in a
number of projects and using contractors can alleviate the problem if
the expected surge in business is temporary.
Having a roster of contractors to draw on is a good way to deal with the
expected problem if it is to last six months to two years.
You buy the expertise you need without making a long-term
commitment. The downside is that contract employees don't have the
same commitment to the organization as that of full-time employees.
Older or semi-retired professionals are often a good source of contract
employees.

It may be a good idea to hire a new graduate to do junior work.
Even a 3rd year student (post-secondary) may take some of the pressure
off for a few months if you can arrange for this option between
semesters.
This approach may free the hands of more experienced employees for
more important work.
Establishing and maintaining a good relationship with your bank
manager is essential if any business is going to weather the periodic
ups and downs.
A key part of this is preparing a cash flow projection and arranging for
an operating line of credit.
If you communicate your monthly results to the bank, usually there is
no problem adjusting the line of credit if circumstances warrant it.
Building in proper capital equipment reserves into the business for a
sudden demand upon the business for additional resources will not
usually have a severe financial impact.
To maintain greater liquidity in the business, in certain circumstances it
may be advisable to lease rather than buy equipment.
For short-term needs, renting may be an option but rates are usually
much higher than leasing.
How would you handle a dramatic decrease in your business?

Risks
Key, terminating long-term employees may be a danger. It may have
taken years to build this team of people. These key employees, who
may take proprietary knowledge with them, may wind up working for
a competitor.
Valuable, hard-to-replace, knowledge, and expertise could be lost to
the business
Possible disruption of client relationships with key employees
The company may have recently depleted cash reserves by making
major investments in facilities or equipment. The lack of liquidity
created by this move could now threaten the business.
The company may be committed to long-term financing agreements
that are now very difficult for the business to handle

Suggested solutions
Again, the solution to the personnel problem is similar to the previous
situations described.
Maintaining flexibility in the workforce is crucial to the success of the
small business.
Incentive programs and career development programs can help to
retain key employees.
Involving the staff in the decision-making process builds their
commitment to the business. Their employment becomes more than a
job to them.
Use employment contracts as a way of controlling the loss of
proprietary knowledge.
Reviewing semi-annually the business plan, preparing annual cash
flow projections, and completing a detailed analysis of operations
every month, can identify most problems before they reach crisis
proportions.
Properly structuring financing to fit the current and future needs of the
business is an important way of avoiding a negative impact on the
business if business declines.
Maintaining the flexibility and liquidity of the business is very
important when structuring the financing of the business.
Before making a major capital investment or committing to financing
arrangements for facilities or equipment, a manager should review the
business plan and prepare a detailed analysis of current and projected
business results.
Discuss the results of this analysis with the accountant or business
manager to determine the best course of action.

What if there is a drastic change in client demands or the general needs of
the marketplace for your services?
Risks
The business may suddenly find that it does not have the properly
qualified or trained staff to cope with new market demands.
Changing technology may dictate the acquiring of new staff or new
equipment in order to remain competitive.
Suggested solutions
Ongoing career development programs for employees are a good way
of minimizing the effects of changing technology or changing market
demands on the business.
If the older staff is not supported in their efforts to broaden their
knowledge and upgrade their skills, the value of their expertise may
deteriorate.
Rather than an expense to the business, this support is really an
investment that will be returned to the business tenfold.
This support also builds loyalty among staff by demonstrating your
belief that they are valuable members of the team.
Hiring a contractor may temporarily best satisfy a sudden requirement
for new technological skills.
Depending on the skills required, sometimes acquiring a new graduate
trained in the latest skills is the best and cheapest approach.

Competitive activity
How will your competitors react to a new or aggressive marketing strategy?

Risks
Competitors may feel that their market share is threatened and take
retaliatory action through various strategies; for example, sharp pricing,
providing additional services at no extra cost, or aggressive advertising.
They may even purposely target some of your best clients with special
deals in order to get back at you.
It is not unusual with a initial new marketing strategy to have a decline
in business as the marketplace adjusts and becomes aware of the new
direction of the business
During this time, a few customers, particularly those that don't fit the
new approach of the business, may be lost, or perhaps picked-off by a
competitor.
Whenever there is a change in strategy there may be misinformation or
rumors circulated as to the dependability or viability of the business.
Suggested solutions
Make sure before embarking on a new marketing strategy to complete t
a detailed market analysis.
Know what your return on investment or ROI is on all of the current
market segments of your business.
Analyze what your market share is in each market segment; what
market share is realistically available to you; and how much it will cost
the business to achieve that level of performance.
Now do the same analysis for the new markets you intend to exploit.
Now you have a better idea of what you may be leaving behind, the
potential for growth of the new marketing approach and the cost of the
program to the business.

Make sure that your marketing strategy includes an effective media
plan to get the message out on your new approach to existing
customers, potential customers and your competitors.
Take charge; don't allow rumors in the marketplace to affect adversely
your strategy.
This also can defuse potential problems with competitors.
Occasionally, you can even build goodwill with competitors and
customers by referring some existing clients to them not best served by
the new business approach.
This is all part of a well-thought-out marketing strategy.
What if new competitors enter the market and dilute the potential market
share available?
Risks
The problems that arise in this situation are the same as explained
previously when there is a decline or even a dramatic downturn in
business.
Current completed projects may affect significantly the cash flow of
the business.
Key personnel may be at risk.
There may be an effect of the ability of the business to sustain its
financial commitments
Suggested solutions
A detailed marketing analysis is necessary.
Before making any changes to the approach of the business, it needs to
be determined if the affect on the market of the new competitors is
temporary or long term.
Is the total market potential static or extremely slow growing is it likely
to resume a steady growth pattern in the near future, or will it perhaps
be rapidly expanding in a few months?
Decide whether the pie is shrinking, growing, or staying the same.
Decide whether you should go after a larger share of the pie, try to
make the Pie expand, or go after a new pie.

Obviously, it is essential again to know what the ROI is on existing
market segments and analyze the expected ROI for any potential
market segments. (ROIreturn on investment)
At least temporarily, the same remedial steps apply regarding
personnel, assets, and financing (previously discussed).
It is important to position the business and to have the maximum number of options
in a given situation to realize the best possible ROI on the people and resources in
the company.
Summary
In Risk Management Strategies, we have discussed a number of common

problems that can suddenly confront the businessperson. We have discussed
some of the risks that might be associated with the problems and present
possible solutions.
Planning for risk management is an important part of business planning.

Anticipating potential risks and planning, and budgeting for the handling of the
problems will minimize the impact on the business.
Think about how you do your business planning now.
Ask yourself:
Do you do a good job of risk management and planning for
contingencies?
What have you learned from this section that you can use to improve
your business now?
How would you change your business plan to protect better your
business?
Laws of Businessof purpose

The purpose of a business is to create and keep a customer.
This takes precedence over making a profit.
Profits will follow when customers are created and kept.

Celebrate!!

3. Business Plan Format Sample
Business plans will vary in format and approach depending on the type of
company, its stage of development and what you are trying to accomplish with
the plan; e.g., attract investors, approaching a lending institution or as a
blueprint for planned growth.
The following sample business plan format is one that could be useful for many
businesses:
Introductory page
Company name, address, phone number, fax, email, and URL
Key contact people and their phone numbers
A brief paragraph or two about the nature of the market area
For example:
Geographical location, major economic factors, general demographical
information, style of doing business in the area and any significant
factors that you think affect your region differently in the way you
approach the marketplace

Executive summary
Highlights of a business plan

Summarize in point form your key results or outcomes over the next
three years for each of the key segments of your business
State for each segment:
What part it plays in your business now
Where you expect it to be in each of the next three years
The profit/loss you expect over the next three years
Note the additional resources (in general) that will be required to
achieve these goals and the ROI (return on investment) that you
project
State the competitive position and advantages to be gained by your
plans.
Table of contents page
List section titles and page numbers
Detailed business plan
A detailed business plan has five subheadings:
Industry descriptions
Major market activity planned in each business segment
Business goals 1-year actual3-year forecast
Market strategy
Assessment of risks

(1) Industry descriptions
Industry outlook in your region and the potential for growth in each of the key
business segments
Note apparent industry trends or new products, competitive activity you see
developing in your area.
State your sources.
Describe the potential size of the market over the next three years, rate of
growth and changing customer needs or trends.
Try to assess competitive activity, for example:

Who are the big players in each business segment?
What competitive strengths/weaknesses do they have?
Relative market share (state yours also)
Estimate of profitability, if known
Note if there are:

Population shifts
Changes in consumer trends
Business prospects of key industries
Other major economic factors that will affect your key business
segments

(2) Major market activity planned in each business segment
State major objectives for each segment in point form.
Describe the target markets for each segment and state the reason chosen,
developing needs and trends, and other relative information.
Outline your competitive advantage
For example:
What niche will you fill in the market?
How will you exploit these opportunities?
Why will you achieve success?
By what means and what do you estimate your share of the market will be
over the next three years?
Are your premises adequate to handle the projected growth in each business
segment?
Are they physically located in the best place to serve your target markets?
Detail the projected staff and equipment requirements to support the growth in
each business segment over the next three years.
Note any current market action in any of the business segments and the results.

(3) Business goals 1 year actual3 year forecast
Prepare a detailed spreadsheet income and expense budget for each business
segment reflecting the already stated changes expected in each segment.
For the first year only, a monthly forecast of income and expense is useful in
projecting cash flow and the timing support of needed marketing support funds.
It is important to know exactly what it is costing to do business in each

segment.
It helps keep priorities straight, to be aware of the drain on resources of less
profitable segments and to estimate the funding necessary to bring less
profitable segments up to speed.
State your assumptions and the basis for those assumptions in making the
forecast for each business.
(4) Market strategy
In detail, describe the action plan in each business segment to accomplish the
goals and activities that you wrote based on your market research and analysis.
How will you prioritize your efforts in each business segment to reflect the
needs and potential of your region in the first year and over the next three
years?
For the next three years, will your pricing strategy as it exists now meet the
economic needs of each business?
If not, why and what changes do you anticipate being necessary due to the
cost of doing business, competition, and other changes.
Prepare a 12-month advertising plan, for the first year only, in spreadsheet
form.
It is pointless to do it in detail beyond 12 months but add comments
separately to detail the expected changes to the plan to back up your budget
figures for the business.
Note how you will measure the results of your strategy.

What methods are in place now or that will be in place to measure customer
responses (logging of jobs received, ad responses, phone inquires, and other
customer responses).

(5) Assessment of risks
You always have to take a step back after you prepare a business plan and give
some thought to the following:
How will the competition react to the new approach?
What if there is a sudden downturn in the economy?
What if some new form of legislation adversely affects the business?
What if there is some unforeseen competitive activity?
What if there are drastic shifts in client demands that you, for which,
are not prepared?
Try to foresee any pitfalls, problems, and possible reaction after you have
committed resources to your new business plan and marketing strategy.
Examine also, things like:

If sales doubled or tripled, could you handle it?
What if sales suddenly dropped by 50 %, what would you do?
What if your key person, who accounts for a major portion of your
revenue, quits, what would you do?
It is wise to prepare contingency plans.
For many small businesses, particularly service businesses, they can stop now.

However, for larger businesses an organizational plan in graphic form would
usually be included and if the business is applying to a lender for an operating
loan, include a detailed financial plan:
The past 23 years balance sheets and income statements

Financial forecasts both balance sheets and income statements
Cash flow forecasts
Capitalization
Term loan required
Line or credit required
Details of current financing, if any
All references and documentation required by the lender
Take your business plan and design it as a spreadsheet so it is visual. It could

be complete with months and specific dates, activities/tasks, and those who are
responsible for each of them.
You could have one set of spreadsheets that include your marketing plan or
have two spreadsheets.
Post the spreadsheets on the wall of the office for easy viewing and monitoring.
As the year progresses, you might cross off the completed outcomes, tasks, or
deadlines. It is always good to know when something is completed and how
much remains.
The Law of Moneyof accelerating acceleration

The faster you move toward financial freedom,
the faster it moves toward you.
It's an offshoot of the Law of Attraction: what you want wants you.

Celebrate!!

Summary of Financial Management
The central point of the foregoing discussions on financial management is that
you only control your business to the degree that you have control over the
financial information upon which you base your business decisions.
It is imperative that any businessperson takes the time to think out carefully
and in detail, the objectives of the business and the implementation plan
(prepare a business plan).
Although we have spent some time on historical financial reports, the emphasis
is on operating financial data.
For example:
Inventory management report
Credit management reports
Income statements and cash flow statements
Deviation analysis
Analyzing fixed and variable costs
Break-even point analysis
Tests of the financial strength of the business
On a daily basis, these financial reports, tests, and methods provide the early
warning system you need to monitor your business and make the judgments
and decisions that will keep your business on the tracks in a profitable
direction.
Often businesspeople complain that they just don't have the time to do the
business planning and analysis (that we have discussed) because they are
too busy coping with the pressures of daily business. That is the clearest
indication that they are desperately in need of help!
Having a business plan and setting aside specific times for analysis of the
business actually liberates the manager and frees up time for
implementation of effective business strategies.
Planning is the key to business success!

Final celebration!!

Certificate

Glossary
Accounts receivable (A/R)Accounts receivables (A/R) are accounts with
customers that the business has sold goods or services to on credit terms.
Accounts Receivable Turnover Formula

total net credit sales/average
accounts receivable
Acid test ratio formulaquick assets/current liabilities

Amortizationthe process of gradually paying off a liability over time. For
example, a mortgage is amortized by periodically paying off part of the face
value amount of the mortgage.
Angel investorsThe term angel investor is usually used in reference to an

investor who is a family member or friend who will not be involved in the
operation of the business. An Angel Investor also may be lending money
with little security other than their trust in the ability of the debtor to repay
the funds.
Assetsitems of value owned by people or a business. The valuable resources

or properties and property rights owned by an individual or business
enterprise
Average account collection period formuladays in the period x, average

accounts receivable/total net credit sales
Average days payable formula

days in the period x accounts payable/total
credit purchases
Balance sheetan itemized statement that lists the total assets and the total
liabilities of a business to portray its net worth at a particular point in time
Booking orderis a term that means an order taken well in advance of the
shipping date
Booking ordersare orders that are place with suppliers for future deliver.
Usually the delivery date is several months in the future. Some supplier will
offer booking order programs at substantial discounts off regular prices, or
special payment terms, to maintain production levels during slow periods of
their Fiscal Year.
Break-even point (BEP)the sales quantity where the firm's total costs will
just equal its total revenue

Break-even point (BEP) analysisIt is a method used to determine the point
at which business will neither make a profit nor incur a loss. In other words,
profits derived from revenue will equal the fixed and variable costs of the
business.
Break-even point (BEP) formulaethe basic formula is: S = FC + VC

In this formula S = sales and FC + VC = fixed costs + variable costs.
Business plandescribes the business and identifies the core business'

activities. It presents the goals, the expected outcomes and the plan of
action the business will execute in achievement of the goals
Business styledescribes the sum total of how the business functions and how
it presents itself to the market
Capital assetsPhysical property such as land, buildings, machinery, and

almost all property owned by the business other than goods that are
purchased for sale.
In virtually all cases, a capital asset is an asset whose resources are used
over time and whose value is depreciated over the life of the asset until it
reaches a valuation of zero. The only exception to this rule is land, as land
may not be depreciated.
Capital equipment listis a listing of the physical assets of the company
Capital equipmentCapital equipment is that equipment that you use to

manufacture a product, provide a service, or use to sell, store and deliver
merchandise. It is not equipment which will be sold in the normal course of
business, but rather, it is equipment which will be used, wear out or be
consumed by the business over a period of time in excess of one year.
Cash flow statementThe cash flow statement is designed to show how well
the company is managing its cash. In other words, how liquid is the
company at that point in time. It does this by subtracting cash
disbursements for the period in question from the cash receipts. Is also
called the pro-forma cash flow statement
Cash flowthe actual movement of cash within a business
Commercial credit applicationis used for a company that is applying to

purchase on credit

Corporationis a business organization chartered by the province, owned by
one or more stockholders, and authorized to act as a private individual. It is
an artificial legal entity created by government grant and endowed with
certain powers.
Cost of goods sold (CGS)is an item that appears on the Operating Statement,
sometimes called either the Income Statement or the Profit and Loss
Statement. Adding inventory purchases during the accounting period to the
beginning inventory, then subtracting the ending inventory for the period
derives the CGS.
Credit policyis a statement of the terms and conditions under which a

company will allow customers to buy on credit
Current liabilitiesthe accounts payable, notes payable, bank loans, accrued

expenses such as wages and salaries, taxes payable, current portions due of
long-term debt and any other obligations that are coming due within the
year
Current ratio formulacurrent assets/current liabilities
Days of sales in inventory formuladays in the period x average

inventory/cost of goods sold (CGS)
Debt financingis financing for defined period of time at a specified rate of

interest. Debt financing does not affect ownership of the business but it may
influence business decisions.
Debt to asset ratio formulacurrent liabilities + long term liabilities/(current

assets + fixed assets)
Debt to equity ratio formula current liabilities + long term

liabilities/shareholders equity
Depreciable assetsare assets that, for accounting purposes, may be 'written

down' or reduced in value on the books over their useful life.
Depreciationdepreciation is a bookkeeping charge the purpose of which is to

write off the original cost of the asset (less any salvage value), over time, by
equitably pro-rating the depreciation charges over the expected useful life
of the asset.

Deviation analysisThe deviation analysis is a financial report, which may be
prepared by your accountant. It presents in detail significant variances that
may have occurred in the accounts of the business from one reporting
period to another.
Earnings per share formulanet income preferred dividends/number of

common shares
Equity financingis financing obtained from investors who for the period of
their investment will have a degree of ownership (equity) in the business
Equitythe monetary value of a property or business, which exceeds any

claims and/or liens against it by others
Fixed costsfixed costs are those costs not associated with, or the result of,
the acquisition and sale of business offerings
Formula for calculating the CGS ratiocost of goods sold (CGS) for the
period/average inventory
Gross margin (GM)the money left to cover the expenses of selling the
offerings and operating the business. GM is also known as the gross profit.
Gross profit marginthe difference between revenue and the cost of goods or
services sold
Gross salesthe total amount charged to all customers/clients during a time

period
Grossed upwardis a term used to describe the practice of increasing the

result of a calculation to a predetermined level. For example, a store may
wish to have their entire prices end in .77 so prices of various items might
be $10.77, $24.77, etc. If after calculating the normal gross margin the
selling price were $24.49, the price would be grossed upward to the
nearest 77 cents by assigning a price of $22.77.
IlliquidA business is illiquid if it is unable to cover its expenses on a

consistent basis

Income statement (also called the profit & loss statement or the operating
statement)statement of the changes that have occurred from one financial
measurement period (fiscal measurement period as in a fiscal year) to
another
The income statement provides a summary of the transactions made and the
income generated from those transactions. It also summarizes the changes
in Inventory value and the expenditures made by the business for that fiscal
period. Finally, the income statement presents the profit or loss made by the
business for the fiscal period.
Income statement analysis
Inventory movement reportillustrates the quantities of Inventory of an item

or a product group that have sold (moved) during a period or periods of
time during the fiscal year.
Inventory shrinkageis a term for shortages or losses of inventory due to

spoilage of perishable goods, but it can be an allowance made for losses due
to stealing by customersan allowance for shoplifting
Inventory to net working capital formulaaverage inventory/ (current assets

+ average inventory current liabilities)
Inventory turnoverthe rate at which the initial or beginning inventory

investment is sold. If the beginning inventory investment is replaced three
times during the fiscal year, the inventory turnover is said to be three or
sometimes expressed as three turns per year.
Inventory turnover formulacost of goods sold (CGS)/average inventory
Joint payment agreementis an agreement made with an end user of

products or services to insure that any payment that is made is made to all
parties that have indirectly or directly supplied goods or services. A joint
payment agreement states that the signer of the agreement will only issue
cheques jointly to your company and your customer in payment for the
work performed by your customer.
Liabilityis money owed to individuals or companies

Line of creditis a financing method whereby a lender, usually a bank, will
allow the person or business to overextend their account by an agreed
amount. In other words if a person or business had a $50,000 line of credit
on their bank account they would be allowed to exceed the balance of their
account by up to $50,000. There would be an interest charge for the amount
that the account was in a negative position.
Liquiditydescribes how readily a business could convert assets to cash
Market segmentsA relative homogeneous group of customers who will

respond to marketing mix in a similar way
Marketing mixThe controllable variables the business puts together to

satisfy this target group. It has four components: product, place, price, and
promotion.
MarketIs a place where buyers and sellers come together. The number of
people and their total spendingactual or potentialfor your offering(s),
within the geographic limits of your distribution capability
Net worththe difference between the assets and liabilities of a business or

individual. It may also be referred to as the owner's equity in a given
business as it represents the excess of the total assets over the total amounts
owing to outside creditors (total liabilities) at a given moment in time.
Number of times interest earned formulanet profit before interest and

taxes/annual interest and bank charges
Offeringsthe products and services that a business provides its clients'

customers
Overage inventory reportis a report that shows the quantities and the value
of designated inventory items of a product group that has been in inventory
for a period of time beyond the assigned maximum time in inventory
Partnershipa business owned by two or more individuals. It is a legal

relationship created by the voluntary association of two or more persons to
carry on as co-owners of a corporation for profit. It is a type of business
organization in which two or more persons agree on the amount of their
contributions, both capital and effort and, on the distribution of profits, if
any, of the organization.

Personal credit applicationis typically used for individuals applying for
credit rather than a company applying for credit
Point of sale (POP)to describe anything that occurs at the point where goods
are displayed or a transaction is made.
Product mixthe particular assortment of product lines and individual

product items chosen as the offerings of the company
ProfitA business' earnings after paying all expenses. The excess of the
selling price over all costs and expenses incurred making the sale.
Profit formulaeP = S - (FC + VC)
Pro-forma cash flow statementis sometimes called a cash flow projection

or simply a cash flow statement. We will use the term pro-forma cash flow
statement here
Pro-formais a term meaning a projection or estimate of what may result in

the future from actions in the present. A pro-forma financial statement is
one that shows how the actual operations of the business will turn out if
certain assumptions are realized.
PYabbreviation meaning Prior Year
Return on investment (ROI)is how much profit is generated by the

business in relation to the investment in the business. (See Profitability
Ratios)
Return on sales ratio formula

net profit after taxes/net sales
Return on shareholders equity formulanet income/shareholders equity
Return on total assets formulanet income (from operations)/average total

assets
Sales per employee formulanet sales (for the year)/average number of

employees
Sales to fixed assets formulanet sales/average net fixed assets
Salesis the revenue received for the offerings sold
Secured loana loan for which a balancing amount of cash, property or other
assets are offered as security in the event the loan is defaulted on

Sole proprietorship or proprietorshipis a business owned by one person.
Legally, the owner is the business and personal assets are typically exposed
to the liabilities of the business.
Statement of earned surplusa statement that shows the amount of money

derived from operations to date that is retained in the company after taxes
and dividends are paid out.
Term loana loan advanced by the lender for a defined period of time after
which the loan must be repaid in full
Total costsis the sum of the total fixed and total variable costs
Total fixed costs formulaeestimated total fixed costs(Salaries +

Benefits)/total hours
Total fixed costsis the sum of those costs that are fixed, no matter how much
is produced. These expenses that remain constant no matter what the sales
or fees from services are.
Trade creditis the amount of purchases on account with suppliers
Unsecured loana loan for which no collateral is offered as security in the

event that the loan is in default
URLis an abbreviation for uniform resource locator. The term refers to the
address of a World Wide Web information page.
Utilization of assets formulatotal net sales/total assets
Variable costsVariable costs are business costs related to the acquisition and
resale of offerings or the production of goods and services
Working capital ratioa measurement of the ability of the business to cover

its expenses. It is calculated by subtracting current liabilities from current
assets
YTDabbreviation meaning Year To Date

Acknowledgement
All of the Universal Laws quoted at the end of each module come from
Brian Tracy (1992). The Universal Laws of Success and Achievement. Chicago:
Nightingale-Conant Corporation.
They are from the supplement to the eight-audiocassette program

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Personnel Management Business Description

Financial Management Goals and Outcomes

Sales & Marketing Management Business Offerings

Copyright 2003, 2004

All Rights Reserved

This material is the intellectual property of BizBite, a partnership

Any modification or merged portion of this or any other BizBite course, in

The founders of BizBite Consulting Group and developers of BizBite's

Designer and Developer

Dr. Shirley Chapman is a veteran educator with over 30 years of

ProofreaderPrecision ProofreadingDeborah Wright

Major Headings Sub Headings

A. Introduction Financial Planning for Business Success

B. Financial Analysis of Operations Job costing analysis preparation

C. Operational Financial Inventory management

E. Consideration in Financing, A guide to finance

There are two parts to the introduction Financial Management

1. Planning For Business Success

The term financial management of a business means managing the invested

As well, this material will assist small businesspeople to:

How to use Financial Management

Financial Management will help you to do a better job of preparing some of

This financial data provides a financial picture of where the business is as of

More detail is provided in the section Financial Data

Additionally, there are a number of other reporting tools, methods, and

Current audited financial statements if it is an existing business.

To be effective and relevant, review financial data regularly. Complete it in an

This material offers suggestions. Discuss with your accountant what an

Laws of Businesson organization

You will learn some common definitions of terms found on financial

Your business needs a specially designed accounting system. However, there is

Additionally, the business needs to perform regularly a:

A business manager has two prime objectives and they are:

Capital equipment list

In addition to the above statements, every business should have a capital

Examples of capital equipment are:

Maintaining a capital equipment list is important because it helps to:

As well, columns should be included to record recovery and disposal costs in

In Financial Data, we have provided an overview of the financial reporting

1. Financial analysis of operations

Below are two sample forms:

Location: Dept: Req #: PO#: ____

Item Description: Make: ____________________

Model#__________________ Serial#_________________ Purchase Date: _______

Address: Fax: ______________

Purchase detail: Company: ________________________

Estimated Asset Life: Amortization Period:

Date Maintenance/Repair Vendor Cost GST PST Total

Record additional maintenance and repairs on additional pages

Asset Disposal and Expense

Date of Disposal: __________________ Asset purchaser:

ACE.# Date: _____

Authority for: Capital expenditure Major repairs ______

Department name: Dept.# ______

Request authority for the following:

Supplier name: ______

Description Estimated Cost

Justification for expenditure:

Payback period calculations:

Date Completed: _________________Dept. Manager _____________________________

Think through the reason for the purchase

This form is part of the homework done by a manager prior to purchasing

Model#________ Serial#_ Purchase Date: _

Date Completed: _Dept. Manager _____________