Instructional Area: Financial Analysis (FI) Standard:

Understands tools, strategies, and systems used to maintain, monitor, control, and plan the use of
financial resources

1. Performance Element: Use risk management products to protect a business’s financial

wellbeing. Performance Indicators: Obtain insurance coverage (FI:082) (ON)

2. Performance Element: Acquire a foundational knowledge of accounting to understand its nature

and scope. Performance Indicators: Explain the concept of accounting (FI:085) (CS)

3. Performance Element: Implement accounting procedures to track money flow and to determine
financial status. Performance Indicators: Explain the nature of balance sheets (FI:093) (SP)
Describe the nature of income statements (FI:094) (SP) Prepare cash flow statements (FI:092)
(MN)

4. Performance Element: Implement financial skills to obtain business credit and to control its use.
Performance Indicators: Explain the purposes and importance of obtaining business credit
(FI:023) (ON) Analyze critical banking relationships (FI:039) (ON) Make critical decisions
regarding acceptance of bank cards (FI:040) (ON) Determine financing needed for business
operations (FI:043) (ON) Identify risks associated with obtaining business credit (FI:041) (ON)
Explain sources of financial assistance (FI:031) (ON) Explain loan evaluation criteria used by
lending institutions (FI:034) (ON) Complete loan application package (FI:033) (ON)

5. Performance Element: Manage financial resources to ensure solvency. Performance Indicators:

Describe the nature of cost/benefit analysis (FI:357) (MN) Determine relationships among total
revenue, marginal revenue, output, and profit (FI:358) (MN) Develop company's/department's
budget (FI:099) (MN) Forecast sales (FI:096) (MN) Calculate financial ratios (FI:097) (MN)
Interpret financial statements (FI:102) (MN) File business tax returns (FI:652) (ON) Verify the
accuracy of business financial records (FI:653) (ON)

Describe the nature of cost/benefit analysis (FI:357) (MN)

Cost benefit analysis: What is it?

A cost benefit analysis (also known as a benefit cost analysis) is a process by

which organizations can analyze decisions, systems or projects, or determine a
value for intangibles. The model is built by identifying the benefits of an action
as well as the associated costs, and subtracting the costs from benefits. When
 completed, a cost benefit analysis will yield concrete results that can be used to
develop reasonable conclusions around the feasibility and/or advisability of a
decision or situation.

Scenarios Utilizing Cost Benefit Analysis

As mentioned previously, cost benefit analysis is the foundation of the decision-

making process across a wide variety of disciplines. In business, government,
finance, and even the nonprofit world, cost benefit analysis offers unique and
valuable insight when:

 Developing benchmarks for comparing projects

 Deciding whether to pursue a proposed project
 Evaluating new hires
 Weighing investment opportunities
 Measuring social benefits
 Appraising the desirability of suggested policies
 Assessing change initiatives
 Quantifying effects on stakeholders and participants

Identify and Categorize Costs and Benefits

It’s time to sort your costs and benefits into buckets by type. The primary categories
that costs and benefits fall into are direct/indirect, tangible/intangible, and real:

 Direct costs are often associated with production of a cost object

(product, service, customer, project, or activity)
 Indirect costs are usually fixed in nature, and may come from overhead
of a department or cost center
 Tangible costs are easy to measure and quantify, and are usually related
to an identifiable source or asset, like payroll, rent, and purchasing tools
 Intangible costs are difficult to identify and measure, like shifts in
customer satisfaction, and productivity levels
 Real costs are expenses associated with producing an offering, such as
labor costs and raw materials

Determine relationships among total revenue, marginal revenue, output, and profit (FI:358)

Total revenue is the amount of total sales of goods and services. It is calculated by
multiplying the amount of goods and services sold by the price of the goods and
services. Marginal revenue is directly related to total revenue because it measures
the change in the total revenue with respect to the change in another variable.
In addition, the calculation of total revenue frequently takes timetables into
account. A restaurateur, for example, might tabulate the number of hamburgers
sold in an hour, or the number of orders of medium-sized french fries sold
throughout the business day. In the latter case, the total daily revenue would be the
quantity (Q) of fries sold—say 300, multiplied by the price (P) per unit—say $2, per
day. Therefore, the simple formula for this calculation would be:

With the values plugged in to the equation, Total revenue is $600—figured by the
simple arithmetic of 300 X $2.

Marginal revenue measures the change in revenue that results from a change in the
amount of goods or services sold. It indicates how much revenue increases for
selling an additional unit of a good or service. To calculate marginal revenue, divide
the change in total revenue by the change in the quantity sold. Therefore, the
marginal revenue is the slope of the total revenue curve. Use the total revenue to
calculate marginal revenue.

For example, suppose a company that produces toys sells one unit of product for a
price of $10 for each of its first 100 units. If it sells 100 toys, its total revenue would
be $1,000 (100 x 10). The company sells the next 100 toys for $8 a unit. Its total
revenue would be $1,800 (1,000 + 100 x 8).

Suppose the company wanted to find its marginal revenue gained from selling its
101st unit. The total revenue is directly related to this calculation. First, the
company must find the change in total revenue. The change in total revenue is $8
($1,008 - $1,000). Next, it must find the change in the toys sold, which is 1 (101-
100). Thus, the marginal revenue gained by producing the 101st toy is $8.

Develop company's/department's budget (FI:099) (MN)

New small business owners may run their businesses in a relaxed way and may not
see the need to budget. However, if you are planning for your business' future, you
will need to fund your plans. Budgeting is the most effective way to control your
cashflow, allowing you to invest in new opportunities at the appropriate time.
If your business is growing, you may not always be able to be hands-on with every
part of it. You may have to split your budget up between different areas such as
sales, production, marketing etc. You'll find that money starts to move in many
different directions through your organisation - budgets are a vital tool in ensuring
that you stay in control of expenditure.

A budget is a plan to:

 control your finances

 ensure you can continue to fund your current commitments
 enable you to make confident financial decisions and meet your objectives
 ensure you have enough money for your future projects

It outlines what you will spend your money on and how that spending will be
financed. However, it is not a forecast. A forecast is a prediction of the future
whereas a budget is a planned outcome of the future - defined by your plan that
your business wants to achieve.

Key steps in drawing up a budget

There are a number of key steps you should follow to make sure your budgets and
plans are as realistic and useful as possible.

 Make time for budgeting

 If you invest some time in creating a comprehensive and realistic budget, it
will be easier to manage and ultimately more effective.
 Use last year's figures - but only as a guide
 Collect historical information on sales and costs if they are available - these
could give you a good indication of likely sales and costs. But it's also
essential to consider what your sales plans are, how your sales resources will
be used and any changes in the competitive environment.
 Create realistic budgets
 Use historical information, your business plan and any changes in operations
or priorities to budget for overheads and other fixed costs.
 It's useful to work out the relationship between variable costs and sales and
then use your sales forecast to project variable costs. For example, if your
unit costs reduce by 10 per cent for each additional 20 per cent of sales, how
much will your unit costs decrease if you have a 33 per cent rise in sales?
 Make sure your budgets contain enough information for you to easily
monitor the key drivers of your business such as sales, costs and working
capital. Accounting software can help you manage your accounts.
 Involve the right people

It's best to ask staff with financial responsibilities to provide you with estimates of
figures for your budget - for example, sales targets, production costs or specific
project control. If you balance their estimates against your own, you will achieve a
more realistic budget. This involvement will also give them greater commitment to
meeting the budget.

What your budget should cover

Decide how many budgets you really need. Many small businesses have one overall
operating budget which sets out how much money is needed to run the business
over the coming period - usually a year. As your business grows, your total operating
budget is likely to be made up of several individual budgets such as your marketing
or sales budgets.

What your budget will need to include

Projected cash flow -your cash budget projects your future cash position on a
month-by-month basis. Budgeting in this way is vital for small businesses as it can
pinpoint any difficulties you might be having. It should be reviewed at least monthly.

 Costs - typically, your business will have three kinds of costs:

 fixed costs - items such as rent, salaries and financing costs
 variable costs - including raw materials and overtime
 one-off capital costs - purchases of computer equipment or premises, for
example

To forecast your costs, it can help to look at last year's records and contact your
suppliers for quotes.

Revenues - sales or revenue forecasts are typically based on a combination of your

sales history and how effective you expect your future efforts to be.

Using your sales and expenditure forecasts, you can prepare projected profits for
the next 12 months. This will enable you to analyse your margins and other key
ratios such as your return on investment.

Use your budget to measure performance

If you base your budget on your business plan, you will be creating a financial action
plan. This can serve several useful functions, particularly if you review your budgets
regularly as part of your annual planning cycle.

Your budget can serve as:

 an indicator of the costs and revenues linked to each of your activities

  a way of providing information and supporting management decisions
throughout the year
 a means of monitoring and controlling your business, particularly if you
analyse the differences between your actual and budgeted income

Benchmarking performance

Comparing your budget year on year can be an excellent way of benchmarking your
business' performance - you can compare your projected figures, for example, with
previous years to measure your performance.

You can also compare your figures for projected margins and growth with those of
other companies in the same sector, or across different parts of your business.

Key performance indicators

To boost your business' performance you need to understand and monitor the key
"drivers" of your business - a driver is something that has a major impact on your
business. There are many factors affecting every business' performance, so it is vital
to focus on a handful of these and monitor them carefully.

The three key drivers for most businesses are:

 sales
 costs
 working capital

Any trends towards cash flow problems or falling profitability will show up in these
figures when measured against your budgets and forecasts. They can help you spot
problems early on if they are calculated on a consistent basis.

Review your budget regularly

To use your budgets effectively, you will need to review and revise them frequently.
This is particularly true if your business is growing and you are planning to move
into new areas.

Using up to date budgets enables you to be flexible and also lets you manage your
cash flow and identify what needs to be achieved in the next budgeting period.

Two main areas to consider

 Your actual income - each month compare your actual income with your
sales budget, by:
  analysing the reasons for any shortfall - for example lower sales volumes, flat
markets, underperforming products

considering the reasons for a particularly high turnover - for example whether your
targets were too low

comparing the timing of your income with your projections and checking that they
fit

Analysing these variations will help you to set future budgets more accurately and
also allow you to take action where needed.

Your actual expenditure - regularly review your actual expenditure against your
budget. This will help you to predict future costs with better reliability. You should:

look at how your fixed costs differed from your budget

check that your variable costs were in line with your budget - normally variable
costs adjust in line with your sales volume

analyse any reasons for changes in the relationship between costs and turnover

analyse any differences in the timing of your expenditure, for example by checking
suppliers' payment terms

Forecast sales (FI:096)

Sales Forecasting is the process of estimating what your business’s sales are going to
be in the future. A sales forecast period can be monthly, quarterly, half-annually, or
annually.

How to Create a Sales Forecast

A sales forecast is an estimate of the quantity of goods and services you can
realistically sell over the forecast period, the cost of the goods and services, and the
estimated profit.

Typically this is done by:

 Making a list of the goods and services to be sold

 Estimating of the number of each to be sold
 Multiplying the unit price by the estimated number of goods or services to
be sold
 Determining the cost of each good or service
  Multiplying the cost of each good or service by the estimated number to be
sold
 Subtracting total cost from the total sales 

Sales Forecasting for New Businesses

Sales forecasting for a new business is more problematical as there is no baseline of

past sales. The process of preparing a sales forecast for a new business involves
researching your target market, your trading area and your competition and
analyzing your research to guesstimate your future sales.

Calculate financial ratios (FI:097)

Evaluating the key financial indicators is something every business owner should
become well versed in. By understanding what each key financial ratio is assessing,
you can more easily derive the ratios with a quick look at the financial statements.

 Liquidity Measurement Ratios: These ratios define if a company is able to

meet short-term financial obligations. It takes into consideration liquid assets
to short-term liabilities. 
 Profitability Indicator Ratios: These ratios consider the amount of profit
derived from the cost of goods sold or the operating expenses. There are
both gross and net profit margin ratios. 
 Debt Ratios: Debt ratios are like the debt-to-equity ratio described above
that consider how much debt a company has and the assets it possesses to
pay debts off. 
 Operating Performance Ratios: These ratios look at numbers like the fixed
asset turnover or sales-to-revenue per employee numbers to determine
efficiency. An efficient company generally improves profitability. 
 Cash Flow Indicator Ratios: Companies need to generate enough cash flow
to pay operating expenses, grow the business and create a safety net of
retained earnings. Operating cash flow divided by sales ratio determines how
much it costs to acquire new clients. 
 Investment Valuation Ratios: These ratios help investors determine the
viability of existing or new investment into a company. For example, the
price-to-earnings ratio provides the amount a company is paying per $1 of
earnings to shareholders. 

Companies large and small use ratios to evaluate internal trends in the company and
define growth over time. While a publicly traded company may have much larger
numbers, every business owner can use the same data to strategically plan for the
next company fiscal cycle.
Interpret financial statements (FI:102)

Analyzing and interpreting financial ratios is logical when you stop to think about
what the numbers tell you. When it comes to debt, a company is financially stronger
when there is less debt and more assets. Thus a ratio less than one is stronger than
a ratio of 5. However, it may be strategically advantageous to take on debt during
growth periods as long as it is controlled.

A cash flow margin ratio calculates how well a company can translate sales into
actual cash. It is calculated by taking the operating cash flow and dividing it by net
sales found on the income statement. The higher the operating cash flow ratio or
percentage, the better.

The same is true with profit margin ratios. If it costs $20 to make a product and it is
sold for $45, the gross profit margin is calculated by subtracting the cost of goods
sold from revenue and dividing this result by the revenue [0.55 = ($45- $20) / $45].
The higher this ratio is, the more profit there is per product.

File business tax returns (FI:652) (ON)

First off, be aware that every corporation operating in Canada has to file a T2
corporate tax return every year even if the corporation has been inactive and/or has
no income tax payable that particular tax year.

When Corporate Tax Has to Be Filed

So your corporation will need to file a T2 corporate tax return every year within six
months of the end of its fiscal year.

How to File Corporate Income Tax

Most corporations can file their returns electronically using the Internet. If this is
your choice, be aware that you have to use tax preparation software and/or
applications that have been certified by the Canada Revenue Agency (CRA) as
suitable for Corporation Internet Filing.

Whichever way you choose to file your T2 corporate return, remember that you
need to keep all your related receipts and documents for six years, as the Canada
Revenue Agency may want to see them at some point.

Verify the accuracy of business financial records (FI:653) (ON)

Accurate financial statements are important because management, investors,

creditors and external auditors depend on reliable and complete information to
assess the financial health and performance of companies. Accuracy starts with
journal entries and ends with the chief executive certifying the reliability of the
information.

Ensure the accuracy of the data entry process, which involves journal entries of
financial transactions and the posting of journal entries to the ledger. If your data
entry professionals are making math errors or entering the data in the wrong
accounts, even a sophisticated accounting package will not detect it. Training and
random monitoring are two ways to ensure quality control in the data-entry
process. In a November 2010 "Northern Nevada Business Weekly" article, certified
public accountant Mike Bosma recommends that you provide the data entry clerks
with a printed chart of the company's accounts to use as reference so they enter the
data in the correct accounts.

Reconcile your accounting records with external records, such as bank statements,
supplier invoices, credit card statements and other documents. The numbers should
match. For example, the cash balance on your balance sheet should match the
ending balance on your bank statement. Similarly, the long-term liability balance
should match the total balances on mortgage and other long-term loan documents.

Check for obvious balance-sheet errors. In a guidance note published on its website,
the Illinois Small Business Development Center at Illinois State University
recommends that small-business owners look for obvious errors on the balance
sheet, such as a negative cash balance.

Review the income statement for possible errors. Cost of goods sold should not be
the same each month, because your sales composition is likely to vary each month.
If you have fixed assets, there should be an entry for depreciation expenses. Verify
that you have made the adjusting entries for accrued but unpaid expenses, such as
interest expense and salaries expense.

Verify that you have made adjustments for non-cash expenses in the statement of
cash flows. The difference in the net cash balance between the previous and current
periods should match the change in your bank statements, assuming that loan
proceeds go through your business's bank accounts.

Follow up with your bookkeeper, store manager or the warehouse supervisor if you
spot anomalies. For example, a higher-than-normal inventory balance might be the
result of too many obsolete or discontinued items in stock. A high sales return
amount may indicate a quality control problem in your manufacturing facility or in
your supplier's facility.
6. Performance Element: Manage financial resources to ensure solvency. Performance Indicators:
Monitor business's profitability (FI:542) (MN)

In strategic planning, profitability ratios tell you how well you create financial value for
your company. Although net profit is your bottom line, profitability is what you’re aiming
for year after year. This activity looks at the profitability of your company as a whole,
which includes net profit margin and return on equity (ROE):
 Net profit margin: Net profit margin is calculated by dividing gross sales into net
profit. If your net profit margin is low compared to your industry, that means your
prices are lower and your costs are too high. You aren’t efficient. Lower margins are
acceptable if they lead to greater sales, more market share, or future investments,
but make sure that they don’t go too low. High margins are typically never a bad
thing. Watch this ratio each year and use your industry average as a gauge to monitor
your performance.
 Return on equity (ROE): ROE measures how much profit comes back to the owners
for their investment. This ratio is calculated by dividing net profit by the owner’s
equity investment.
The fictional Konas Corp. has a net profit of $65,000 and gross sales of $778,000 for a pre-
tax profit margin of 8.3 percent. In other words, the company is making 8.3 cents on
every dollar. The owners of Konas have an equity investment of $294,000 in the
company, so with a net profit of $65,000, their ROE is 22 percent. This percentage means
that the owners make almost 22 cents on every dollar invested in the company as equity.
A 20 percent ROE is a reasonable return for risking $294,000.

7. Performance Element: Manage financial resources to ensure solvency. Performance Indicators:

Describe types of financial statement analysis (e.g., ratio analysis, trend analysis, etc.) (FI:334)
(MN) Discuss limitations of using financial statements to assess business performance (FI:655)
(MN) Spot problems in/issues with financial statements (FI:335) (MN)

Describe types of financial statement analysis (e.g., ratio analysis, trend analysis, etc.)
(FI:334)

Horizontal Analysis

A horizontal analysis compares two or more years of a company's financial

statements. The analyst can find the same information from different years by
reading across the page. In comparing dollar figures and percentages in this way,
differences from year to year are easy to find. A variation of the horizontal
analysis is called the trend analysis. The trend analysis starts with the first year a
company is in business, also known as the base year. The base year percentages
are shown as 100 percent, and the increase or decline in percentages can be
easily shown.

Vertical Analysis

Vertical analysis is called such because the corporation's financial figures are
listed vertically on the financial statement. This type of analysis involves the
calculation of percentages of a single financial statement. The figures on this
financial statement are taken from the company's income statement and
balance sheet. Vertical financial statement analysis is also known as component
percentages.

Ratio Analysis

There are several types of ratio analysis that can be used in interpreting financial
statements. Ratios may be computed for each year's financial data and the
analyst examines the relationship between the findings, finding the business
trends over a number of years.

Balance sheet ratio analysis determines a company's ability to pay its debts and
how much the company relies on creditors to pay its bills. This is an important
indicator of the financial health of the corporation.

Liquidity ratios show how well the company is able to turn assets into cash.
When evaluating the liquidity ratio, an analyst looks at the working capital,
current ratio and quick ratio.

Discuss limitations of using financial statements to assess business performance (FI:655)

The limitations of financial statements are those factors that a user should be
aware of before relying on them to an excessive extent. Knowledge of these
factors could result in a reduction of invested funds in a business, or actions
taken to investigate further. The following are all limitations of financial
statements:
 Dependence on historical costs. Transactions are initially recorded at
their cost. This is a concern when reviewing the balance sheet, where the
values of assets and liabilities may change over time. Some items, such as
marketable securities, are altered to match changes in their market
values, but other items, such as fixed assets, do not change. Thus, the
 balance sheet could be misleading if a large part of the amount
presented is based on historical costs.
 Inflationary effects. If the inflation rate is relatively high, the amounts
associated with assets and liabilities in the balance sheet will appear
inordinately low, since they are not being adjusted for inflation. This
mostly applies to long-term assets.
 Intangible assets not recorded. Many intangible assets are not recorded
as assets. Instead, any expenditures made to create an intangible asset
are immediately charged to expense. This policy can drastically
underestimate the value of a business, especially one that has spent a
large amount to build up a brand image or to develop new products. It is
a particular problem for startup companies that have created intellectual
property, but which have so far generated minimal sales.
 Based on specific time period. A user of financial statements can gain an
incorrect view of the financial results or cash flows of a business by only
looking at one reporting period. Any one period may vary from the
normal operating results of a business, perhaps due to a sudden spike in
sales or seasonality effects. It is better to view a large number of
consecutive financial statements to gain a better view of ongoing results.
 Not always comparable across companies. If a user wants to compare
the results of different companies, their financial statements are not
always comparable, because the entities use different accounting
practices. These issues can be located by examining the disclosures that
accompany the financial statements.
 Subject to fraud. The management team of a company may deliberately
skew the results presented. This situation can arise when there is undue
pressure to report excellent results, such as when a bonus plan calls for
payouts only if the reported sales level increases. One might suspect the
presence of this issue when the reported results spike to a level
exceeding the industry norm.
 No discussion of non-financial issues. The financial statements do not
address non-financial issues, such as the environmental attentiveness of
a company's operations, or how well it works with the local community.
A business reporting excellent financial results might be a failure in these
other areas.
 Not verified. If the financial statements have not been audited, this
means that no one has examined the accounting policies, practices, and
controls of the issuer to ensure that it has created accurate financial
statements. An audit opinion that accompanies the financial statements
is evidence of such a review.
 No predictive value. The information in a set of financial statements
provides information about either historical results or the financial status
of a business as of a specific date. The statements do not necessarily
provide any value in predicting what will happen in the future. For
 example, a business could report excellent results in one month, and no
sales at all in the next month, because a contract on which it was relying
has ended.

Spot problems in/issues with financial statements (FI:335) (MN)

Red Flags to Look For

Now that you have an idea of how to read financial statements, here are eight red
flags that can indicate trouble for a business.

1. Rising debt-to-equity ratio: This indicates that the company is absorbing more
debt than it can handle. A red flag should be raised if the debt-to-equity ratio is over
100%. You can also take a look at the falling interest coverage ratio, which is
calculated by dividing net interest payments by operating earnings. If the ratio is less
than five, there is cause for concern.
2. Several years of revenue trending down: If a company has three or more
years of declining revenues, it is probably not a good investment. While cost-
cutting measures—such as wasteful spending and reduction in headcount—
can help to offset a revenue downturn, it probably won’t if the company has
not rebounded in three years.
3. Large “other” expenses on the balance sheet: Many organizations have
“other expenses” that are inconsistent or too small to really quantify, which is
normal across income statements and balance sheets. If these “other” line
items have high values, then you should find out what they are specifically, if
you can. You’ll also want to know if these expenses are likely to recur.
4. Unsteady cash flow: Cash flow is a good sign of a healthy organization but it
should be a flow, back and forth, up and down. A stockpile of cash can indicate
that accounts are being settled, but there isn’t much new work coming in.
Conversely, a shortage of cash could be indicative of under-billing for work by
the company.
5. Rising accounts receivable or inventory in relation to sales: Money that is tied
up in accounts receivable or has already been used to produce inventory is
money that cannot generate a return. While it’s important to have enough
inventory to fulfill orders, a company doesn’t want to have a significant
portion of its revenue sitting unsold in a warehouse.
6. Rising outstanding share count: The more shares that are available for
purchase in the stock market, the more diluted shareholders’ stake in the
company becomes. If a company’s share count is rising by two or three
percent per year, this indicates they are selling more shares and diluting the
organization’s value.
7. Consistently higher liabilities than assets: Some organizations experience a
steady stream of assets and liabilities as their business does not hinge on
seasonal shifts or is less affected by market pressure. For companies that are
 more cyclical (i.e. construction companies during the winter months),
however, it’s possible that its liabilities will outweigh its assets. Technically,
this should be something the company can plan around, thereby decreasing
the discrepancy. If a company is consistently assuming more liability without a
proportionate increase in assets, however, it could be a sign it is over-
leveraged.
8. Decreasing gross profit margin: As this measures a company’s ratio of profits
earned to costs over a set period of time, a declining profit margin is cause for
alarm. The profit margin must account not only for the costs to produce the
product or service, but the additional money needed to cover operating
expenses, such as costs of debt.
Analyzing a company’s financial statements, whether you own shares or might invest
in it later, is a valuable skill. Take the time to really delve into financial reports and see
what types of red flags you identify. Being able to understand the intricacies of a
company’s finances is just one more way to ensure success.

8. Performance Element: Use debt and equity capital to raise funds for business growth.
Performance Indicators: Describe the financial needs of a business at different stages of its
development (FI:339) (MN) Discuss factors to consider in choosing between debt and equity
capital (FI:340) (MN)

Describe the financial needs of a business at different stages of its development (FI:339)

Different firms at different stages of the business life cycle might require a different
approach to solicit investment capital.
Stages of financing
• Seed capital: the seed

capital stage or the pre-commercialisation stage is the phase at which the product or
service is analysed and tested for long-term viability. During this phase, the
entrepreneur requires capital to develop their prototype, conduct feasibility study,
evaluate the business idea thoroughly, and also protect their intellectual property,
which is a stage often overlooked by Jamaican product developers. The entrepreneur
should know whether or not the business is worthwhile at the end of the seed phase.

n Pre-launch phase: If the research indicates that the product or business is

worthwhile, then pre-launch creates the necessary foundation for the business. A
detailed business plan must indicate the overall plan and structure that the business
will follow. It is time to register the business and properly outline its legal structure.

• Start-up phase: The product is launched in the start-up phase. The firm hires
employees and production begins. Sufficient financing is needed to ensure the
smooth transitioning of the business from the pre-launch to the start-up phase.
Financing is necessary to bridge the gap between the time of production and the time
of making profit.
• Early stage: First-stage capital is needed to expand production to satisfy market
demand. At this phase, the firm ramps up production and sales. Venture capitalists
are more willing to lend to firms that display the ability to break even or earn a profit
at this phase.
• Expansion stage: Sometimes a company might be expanding but it is not yet
profitable. The second stage of funding is required at this stage to further expand
production, offset shipping and other distributional cost and satisfy accounts
receivables and payables.
• Third-stage capital: As the sales volume increases and the company becomes
profitable, it will need third-stage financing to facilitate plant expansion, increase
advertising and marketing, product improvement and further research and
development.

Discuss factors to consider in choosing between debt and equity capital (FI:340)
Both debt and equity financing have pros and cons for all new business owners. The
choice that is right for you will be very specific to your business. In this article, we will
briefly discuss seven factors to consider when choosing between debt and equity
financing options.
 
1. Long-Term Goals
As the owner of your new business, it will be critical for you to think about what you
actually hope to achieve in the long-run. What is the purpose of starting your
business? Where do you hope for your business to be in ten years? Twenty years? By
answering these questions, it will be easier for you to decide how financially
entrenched in your business you will actually be. Though you don’t need to come up
with a future “exit strategy” this very minute, it is certainly a good thing to think
about.
 
2. Available Interest Rates
Naturally, the opportunity cost of choosing equity over debt finance will be largely
determined by how much you will actually need to pay to borrow money. If your
business has access to low-interest rates or specialty loans (such as an SBA loan), the
total cost of borrowing will be relatively lower. In order to make sure you are getting
competitive quotes from potential lenders, it will be a good idea to compare multiple
options before making any final decisions. Working to improve your business’ current
credit score can also make a major difference.
 
3. The Need for Control
By surrendering partial ownership of your business you are, to a certain extent, giving
up control. In order to make sure they can still outvote all other stakeholders, many
business owners will maintain 51 percent ownership of the business while selling the
remaining 49 percent. If having total or significant control of your business is
something that’s important to you, be sure to limit the amount of equity you end up
distributing.
 
4. Borrowing Requirements
There are many different things lenders will look at when deciding whether to issue a
loan. In addition to a general financial background check, lenders will also want to see
some hard numbers on paper. The factors they may look at include things such as
your debt-to-equity ratios, your fixed monthly expenses, your overall business plan,
and various others. These requirements can often be rather rigid, which is why your
business needs to plan its financing strategy in advance.
 
5. Current Business Structure
Another variable that will impact the opportunity cost of borrowing (or issuing equity)
is your business structure. If your business is already formally structured as a
partnership, for example, this may complicate the process of selling equity.
Additionally, if you hope to secure your equity finance via public means—such as
selling stocks on the open market—you will need to formally declare your business to
be a public corporation. Though your business structure is something that can (and
likely should) be changed in the future, there is no doubt that the preexisting
structure will have a major impact on your short-term financing decisions.
 
6. Future Repayment Terms
While many business loans are simple, flat loans with a fixed interest rate, there are
many loans with repayment terms that are notably more complicated. For example,
some loans will not require any repayment for several years down the loan. When this
is the case, you will need to calculate both the average total interest rate as well as
the time value of money. If you are hoping to borrow from a single venture capitalist
or angel investor, they may be able to dictate additional terms that are not found in
traditional bank loans. Sometimes, these investors will offer a complex mix of debt
 and equity financing for new businesses.
 
7. Access to Equity Markets
If you do hope to finance your business via equity, it will be crucial that you have
access to people who are actually interested in buying. Contrary to what some
entrepreneurs initially assume, there isn’t a readily available “counsel” of venture
capitalists, ready to give fund new businesses without scrutiny. If you do hope to
finance via equity, you will need to significantly develop your business plan, meet with
a wide range of individuals, and also be willing to make compromises. For some
business owners, the time it takes to do this is justified by the lack of debt that only
equity financing can provide. For others, traditional lending is a more appealing
option.
 
Conclusion
With equity financing, you lose some control over your business, but you are able to
continue operating without debt. With debt financing, you will increase your future
liabilities, but the future of your business will remain in your hands. As you can see,
both decisions have clear appeals and trade-offs. Many business owners also use a
mixed financing model that is better tailored to their specific needs. Regardless, be
sure to remember these seven factors before making any permanent decisions.

9. Performance Element: Understand the fundamentals of managerial accounting to aid in financial

decision-making. Performance Indicators: Explain the nature of managerial cost accounting (e.g.,
activities, costs, cost drivers, etc.) (FI:657) (SP)

Explain the nature of managerial cost accounting (e.g., activities, costs, cost drivers, etc.)
(FI:657)

What Is Managerial Accounting?

Managerial accounting is the practice of identifying, measuring, analyzing,
interpreting, and communicating financial information to managers for the pursuit of
an organization's goals. It varies from financial accounting because the intended
purpose of managerial accounting is to assist users internal to the company in making
well-informed business decisions.

 Managerial accounting involves the presentation of financial information for

internal purposes to be used by management in making key business
decisions.
 Techniques used by managerial accountants are not dictated by accounting
standards, unlike financial accounting.
 The presentation of managerial accounting data can be modified to meet the
specific needs of its end-user.
 Managerial accounting encompasses many facets of accounting, including
 product costing, budgeting, forecasting, and various financial analysis.

Product Costing and Valuation

Product costing deals with determining the total costs involved in the production of a
good or service. Costs may be broken down into subcategories, such as variable, fixed,
direct, or indirect costs. Cost accounting is used to measure and identify those costs,
in addition to assigning overhead to each type of product created by the company.
Managerial accountants calculate and allocate overhead charges to assess the full
expense related to the production of a good.

The overhead expenses may be allocated based on the quantity of goods produced or
other activity drivers related to production, such as the square footage of the facility.
In conjunction with overhead costs, managerial accountants use direct costs to
properly value the cost of goods sold and inventory that may be in different stages of
production. Marginal costing is the impact on the cost of a product by adding one
additional unit into production. Margin analysis flows into break-even analysis, which
involves calculating the contribution margin on the sales mix to determine the unit
volume at which the business’s gross sales equal total expenses.

Break-even point analysis is useful for determining price points for products and
services. Although accrual accounting provides a more accurate picture of a
company's true financial position, it also makes it harder to see the true cash impact
of a single financial transaction. A managerial accountant may implement working
capital management strategies in order to optimize cash flow and ensure the
company has enough liquid assets to cover short-term obligations. When a
managerial accountant performs cash flow analysis, he will consider the cash inflow
or outflow generated as a result of a specific business decision.

For example, if a department manager is considering purchasing a company vehicle,

he may have the option to either buy the vehicle outright or get a loan. A managerial
accountant may run different scenarios by the department manager depicting the
cash outlay required to purchase outright upfront versus the cash outlay over time
with a loan at various interest rates.

Inventory Turnover Analysis

A managerial accountant may identify the carrying cost of inventory, which is the
amount of expense a company incurs to store unsold items. If the company is carrying
an excessive amount of inventory, there could be efficiency improvements made to
reduce storage costs. Managerial accountants help determine where bottlenecks
occur and calculate the impact of these constraints on revenue, profit, and cash flow.
Managers can then use this information to implement changes and improve
efficiencies in the production or sales process.

Financial Leverage Metrics

Financial leverage refers to a company's use of borrowed capital in order to acquire

assets and increase its return on investments. Through balance sheet analysis,
managerial accountants can provide management with the tools they need to study
the company's debt and equity mix in order to put leverage to its most optimal use.
Performance measures such as return on equity, debt to equity, and return on
invested capital help management identify key information about borrowed capital,
prior to relaying these statistics to outside sources. It is important for management to
review ratios and statistics regularly to be able to appropriately answer questions
from its board of directors, investors, and creditors.

Accounts Receivable Management

Appropriately managing accounts receivable can have positive effects on a company's

bottom line. An accounts receivable aging report categorizes AR invoices by the length
of time they have been outstanding. For example, an AR aging report may list all
outstanding receivables less than 30 days, 30 to 60 days, 60 to 90 days, and 90+ days.
Through a review of outstanding receivables, managerial accountants can indicate to
appropriate department managers if certain customers are becoming credit risks.

If a customer routinely pays late, management may reconsider doing any future
business on credit with that customer.

[...]

Budgets are extensively used as a quantitative expression of the company's plan of

operation. Managerial accountants utilize performance reports to note deviations of
actual results from budgets. Managerial accounting involves examining proposals,
deciding if the products or services are needed, and finding the appropriate way to
finance the purchase. It also outlines payback periods so management is able to
anticipate future economic benefits.

Managerial accounting also involves reviewing the trendline for certain expenses and
investigating unusual variances or deviations. This may include the use of historical
pricing, sales volumes, geographical locations, customer tendencies, or financial
information.