CHAPTER 8

FINANCE:
ANALYZING FINANCIAL STATEMENTS
AND CREATING PROJECTIONS.

GROUP 6
 BASIC ACCOUNTING
EQUATION
The basic accounting equation is Assets = Equity + Liability . It is
also known as the balance sheet equation. The double-entry bookkeeping
system is founded on this very equation, as it represents that the total credit
balance equates to a total debt balance.

The following are the different types of basic accounting equation:

Asset = Liability + Capital

Liabilities = Assets - Capital
Owners’ Equity (Capital) = Assets – Liabilities
 BALANCE SHEET
A balance sheet is a financial statement that summarizes a
company's assets, liabilities, and shareholders' equity for a
specified date. The balance sheet provides a snapshot of a
company's financial condition.

THE BALANCE SHEET EQUATION IS:

1. ASSETS

1.2.
1.1. CURRENT INVESTMENTS ASSETS
ASSETS

1.5. OTHER
1.3. FIXED 1.4. INTANGIBLE
ASSETS
ASSETS ASSETS
 1.1. CURRENT
ASSETS

CASH NOTES RECEIVABLES

Cash is the most liquid of all the Notes receivables are similar to
assets, meaning it can be easily accounts receivables, but they involve
converted into other assets or used larger sums of money and have longer
to pay liabilities. repayment terms.

MARKETABLE SECURITIES INVENTORIES

Marketable securities are another Inventories are physical assets that a
type of liquid asset, but they are less .

company has in stock, and they can include

stable than cash and can lose value if finished goods, raw materials, and work-in-
the markets decline. progress.
.

NOTES RECEIVABLES NOTES RECEIVABLES

Notes receivables are similar to accounts Notes receivables are open accounts
receivables, but they involve larger sums of supported by formal written promises to
money and have longer repayment terms. pay
1. ASSETS

1.2.
1.1. CURRENT INVESTMENTS
ASSETS
ASSETS

1.5. OTHER
1.3. FIXED 1.4. INTANGIBLE
ASSETS
ASSETS ASSETS
 1.2. INVESTMENTS

Tangible and intangible assets which are

purchased which future benefits are expected.
Investment assets come in many different forms,
such as stocks, bonds, and real estate. They can be
bought and sold, and their value can go up or
down.
1. ASSETS

1.2.
1.1. CURRENT INVESTMENTS
ASSETS
ASSETS

1.5. OTHER
1.3. FIXED 1.4. INTANGIBLE
ASSETS
ASSETS ASSETS
 1.3. FIXED ASSETS

Fixed Assets is a long-term tangible piece of property

or equipment that a company owns and uses in its
business. Fixed assets are not for sale and are not
expected to be converted into cash. Ex. Land, buildings,
machineries and equipment and furniture and fixtures.
1. ASSETS

1.2.
1.1. CURRENT INVESTMENTS
ASSETS
ASSETS

1.5. OTHER
1.4. INTANGIBLE
1.3. FIXED ASSETS ASSETS
ASSETS
 1.4. INTANGIBLE ASSETS

Intangible assets are those assets that do not have a

physical form. They are often considered to be more
valuable than physical assets because they can
provide a competitive advantage.

Human intangible assets Organizational intangible assets Technological intangible assets

The knowledge and skills The systems and the intellectual property of an
of an organization’s processes that an organization. They include patents,
workforce. organization has in copyrights, and trademarks.
place.
1. ASSETS

1.2.
1.1. CURRENT INVESTMENTS
ASSETS
ASSETS

1.5. OTHER
1.4. INTANGIBLE
1.3. FIXED ASSETS ASSETS ASSETS
 1.5. OTHER ASSETS

the most common are:

Organizational cost, are expenses incurred in the forming, organizing or establishment of a
business.
- The cost of setting up the business.
- The cost of hiring staff.
- Legal (registration) fees

Deferred charges, also known as prepayments, are payments made in advance for goods or
services that will be received in the future. Deferred charges are classified as assets on a
company's balance sheet because they represent a future economic benefit. examples are:
- Plant management costs
- Deferred pension cost
- Research and development costs
- Organization cost
2. LIABILITIES

2.3. OTHER LONG-

2.1. CURRENT
TERM LIABILITIES
LIABILITIES

2.2. LONG TERM 2.4. DEFERRED

LIABILITIES REVENUES
2. LIABILITIES

2.2. LONG TERM

LIABILITIES

2.1. CURRENT LIABILITIES

CURRENT LIABILITIES are obligations that are

2.3. OTHER LONG-
due within one year. This means that they are short-
TERM LIABILITIES
term obligations. Second, current liabilities are
typically paid with current assets. This means that
they are paid with cash or assets that will be
converted to cash within one year.

2.4. DEFERRED
REVENUES
2. LIABILITIES 2.1. CURRENT LIABILITIES
CURRENT LIABILITIES are obligations
that are due within one year. This means
that they are short-term obligations.
Second, current liabilities are typically paid
with current assets. This means that they
2.2. LONG TERM LIABILITIES are paid with cash or assets that will be
converted to cash within one year.

LONG TERM LIABILITIES are also called non-current liabilities

which are obligations or debts of an organization or a business that
are due in over a year’s time or in other words, these are liabilities
that need not be payable in the current accounting period. 2.3. OTHER LONG-
TERM LIABILITIES
The most common of these are:
1.Bounds payable are formal promises made under seal, to pay a specified
amount of money at a specified future date.
2.Premiums on bonds payable, refers to unpaid balances of bonds purchased
in excess of their face value.
2.4. DEFERRED
REVENUES
2. LIABILITIES 2.1. CURRENT LIABILITIES
CURRENT LIABILITIES are obligations
that are due within one year. This means
that they are short-term obligations.
Second, current liabilities are typically paid
with current assets. This means that they
are paid with cash or assets that will be
converted to cash within one year.

2.2. LONG TERM LIABILITIES

2.3. OTHER LONG-TERM LONG TERM LIABILITIES are also called non-
current liabilities which are obligations or debts of an

LIABILITIES organization or a business that are due in over a year’s

time or in other words, these are liabilities that need
not be payable in the current accounting period.

OTHER LONG-TERM The most common of these are:

1.Bounds payable are formal promises made under seal, to pay a
specified amount of money at a specified future date.
LIABILITIES may be in the form of 2.Premiums on bonds payable, refers to unpaid balances of bonds
purchased in excess of their face value.

pensions, which retirement benefits

are given to the retired employees of
the company.
2.4. DEFERRED
REVENUES
2. LIABILITIES 2.1. CURRENT LIABILITIES
CURRENT LIABILITIES are obligations
that are due within one year. This means
that they are short-term obligations.
Second, current liabilities are typically paid
with current assets. This means that they
are paid with cash or assets that will be
converted to cash within one year.

2.2. LONG TERM LIABILITIES

2.4. DEFERRED REVENUES LONG TERM LIABILITIES are also called non-
current liabilities which are obligations or debts of an
organization or a business that are due in over a year’s
2.4 DEFERRED REVENUES - are income received time or in other words, these are liabilities that need
not be payable in the current accounting period.
by the company but which it did not yet earn. The most common of these are:
1.Bounds payable are formal promises made under seal, to pay a
examples include: specified amount of money at a specified future date.
2.Premiums on bonds payable, refers to unpaid balances of bonds

●long term leasehold advances purchased in excess of their face value.

●fees received in advance for long term service

●deferred gross profit on installment sales
2.3. OTHER LONG-
TERM LIABILITIES

OTHER LONG-TERM LIABILITIES

may be in the form of pensions, which
retirement benefits are given to the retired
employees of the company.
 3. STOCKHOLDERSEQUITY AND OWNERS
CPITAL
01 STOCKHOLDERS’ EQUITY 02 PAID-IN-CAPITAL 03 CAPITAL STOCKS

Stockholders' equity is the portion of a It refers to the money that are the portions of paid-in capital
company's assets that is owned by the shareholders have invested in a representing the total
shareholders. This can include items company. This can come from a
such as share capital, retained variety of sources, including the
earnings, and treasury shares. sale of shares, reinvestment of
profits, and borrowing.

04 TREASURY STOCKS 05 RETAINED EARNINGS

Refers to the company’s own The cumulative balance of periodic These may be:
stocks issued and then re-acquired earnings, dividend distributions, prior - Unappropriated Retained Earnings are those that are not
allocated to specific expenses or investments; or
(but not canceled) by the company period adjustments and special
- Appropriate Retained Earnings is the number of profits
distributions to stockholders. that a company has decided to set aside for a specific purpose.
This money can be used for things like expanding the
business, paying off debts, or investing in new products or
technologies.
 FORECASTING REVENUE AND GROWTH

Forecasting is the process of making predictions about future events. It is often

used in business to help decision-makers plan for the future.
Revenue is the total income received by a company from its business activities.
This can include money earned from sales, interest, and investments.
Growth is a stage in the process of growing, it is a result of growth, producing
especially by growing. It is anticipated progressive growth especially in capital
value and income.

Forecasting is an essential tool for businesses of all sizes. By predicting future

revenue and growth, businesses can make informed decisions about where to
allocate resources and how to best position themselves for success.
 BUILDING FINANCIAL FORECAST

Start with expenses, not revenues. It is much easier to

forecast expenses than revenues.
The most common categories of expenses are as follows:
• Fixed Cost/Overhead
• Rent Variable costs
• Utility bills • Cost of goods sold
• Phone bills/communication costs • Materials and supplies
• Accounting/bookkeeping • Packaging
• Legal/insurance/licensing fees
• Postage Direct Labor Costs
• Technology • Customer service
• Advertising & marketing • Direct sales
• Salaries • Direct marketing
 RULES IN FORECASSTING REVENUES
1. Double the estimates for advertising and marketing costs since they always escalate beyond expectations.
2. Triple the estimates for legal, insurance and licensing fees since they are very hard to predict without experience
and almost always exceed expectations.
3. Keep track of direct and customer service time as a direct labor expense even when doing these activities during
the start-up stage to forecast this expense with more clients.

KEY RATIOS IN FORECASTING

1. Gross margin is the total direct costs to total revenue during a given quarter or given year. A high gross margin
indicates that a company is efficient in its production and/or sales process and is generating good profits. A low
gross margin, on the other hand, may indicate that a company is overspending on its direct costs, and is not
generating enough profits.

2.Operating profit margin is a financial ratio that measures a company's profitability. It is calculated by dividing a
company's operating profit by its revenue. Operating profit margin is a financial ratio that measures a company's
profitability. It is calculated by dividing a company's operating profit by its revenue.
 TWO TYPES OF EXPENSES
1. Fixed costs are those that do not change with production volume, such as rent, insurance, and salaries.
2. Variable expenses are those that do change, such as the cost of raw materials, packaging, and shipping.

FORECAST THE SALES

Sales forecasting is the process of estimating future sales. Companies use sales forecasts to make decisions about
inventory, staffing, and budgeting. Sales forecasting is a difficult task because it requires companies to make
assumptions about the future.
STEPS TO MEASURE SALES VOLUME

1. Determine how sales are calculated for the industry.

2. Create a profile of an ideal customer. For regional businesses, use the data from the Census Bureau to
determine how many of them live within a reasonable radius of the business.
3. Estimate the market share, determine the total number of available customers and predict how many of them
will be buying.
4. Determine how often the customers will buy. For example, the company can easily count the customers
booking the service of a beauty parlor every four to six weeks. But if the business is a tree-trimming service,
once a year customer head count would be a good estimate.
5. Predict the average amount of each purchase for each product or service category.

To arrive at the projected sales volume, use the given formula:

Next, deduct total Projected Expenses and have Revenue Forecast

First,

Second.
 COSTS
PROJECT COST FORECAST PREREQUISITES
A project cost forecast is an estimate of the costs that THE SYSTEM DETERMINES COST TO
will be incurred during a project. The forecast is COMPLETE ONLY FOR ACTIVITY-ASSIGNED
typically made at the start of the project and updated as NETWORKS WHICH ARE BOTH APPENDED
the project progresses. The forecast is used to help AND APPORTIONED. PRELIMINARY
project managers and sponsors understand the expected PLANNING NETWORKS ARE NOT INCLUDED.
costs of the project, and to make decisions about how to
best allocate resources.

THE COST SIMULATION VERSIONS

Based on planned, actual, and commitment costs, the system determines what is still to be
done in network activities and costs this again. The system records the value so determined
as cost to complete, by period, in a forecast version for:
• Internally processed activities
• Externally processed activities
• General costs activities
• Material components not managed as part of project stock (whether valued or not)
 COSTS
The values are normally determined as of the first day of the current period, as part of period-end closing.
However, one can have the option of specifying their own key date for the cost forecast. The system uses the key
date to determine the cost distribution.
Residual costs are determined in the same way as planned values are calculated. The basis for the residual cost
calculation is the planned costing variant defined for the activity. If an activity is marked as complete or there is a
final confirmation for it, the system sets the cost to complete to zero.
The system copies the cost to complete to the forecast version, along with the actual and commitment values for
the project, which it reads from the database. Commitment values from periods before the period of the cost
forecast key date are recorded in the forecast version as of the period of the key date (default: current period).

Result
The following forecast version values are available for evaluation in the Project Information System:

1. Cost to complete.
2. Actual values at the time of the cost forecast.
3. Commitment values at the time of the cost forecast.
 COSTS
COST CONTROL STRATEGIES
Cost control is the method of reducing business expenses by managing and analyzing financial data.

Red Ribbon changed its distribution strategy and instead of expanding solely by opening more full branches, it
expanded by putting out more kiosks catering to the take-out market, which allows them to operate at a much
lower operating cost.
PRODUCT IMPROVEMENT
Product improvement is a process or set of activities that are undertaken in order to make a product better. This
can be done in response to customer feedback or market research, or it can be done proactively in order to stay
ahead of the competition.

Product Migration Strategy focuses on Vertical integration is a strategy that

maximizing the revenue potential of existing allows a company to streamline its
Product products. It supports the development of new Vertical operations by taking direct ownership of
Migration products that can capitalize on fresh market Integration various stages of its production process
Strategy opportunities and invigorate revenues. Strategy rather than relying on external contractors
or suppliers.
 COSTS

CORPORATE RETRENCHMENT
The goal of corporate retrenchment is to remove "excess fat" and
create a leaner organization. Two available strategies are Overhead Reduction
Strategy and Reorganization Strategy.

OVERHEAD REDUCTION STRATEGY

Overhead reduction is a process or set of activities undertaken to
streamline an organization's operations and reduce its costs. The goal of
overhead reduction is to improve the organization's bottom line by making it
more efficient and less expensive to run.

REORGANIZATION STRATEGY
Reorganization, also known as business restructuring, is the process
by which a company overhauls its current strategy, setup, and operations.
 PROFIT
Profit is defined as the difference between the revenue and the costs of a company. In
order to make a profit, a company must generate more revenue than it spends on costs.

ORIGIN OF PROFIT
Profit or normal profit is a component of implicit costs and not a component of business
profit at all. It represents the opportunity cost, as the time that the owner spends running
the firm could be spent on running a different firm.

PROFIT MAXIMIZATION
Profit maximization is the process by which businesses and enterprises determine strategies
to make more profits with lower expenditure.
 PROFIT

CALCULATE NET PROFIT

Income earned by the business:

-Sales
-Gross Profit
-Net Profit
 SENSITIVITY ANALYSIS
Sensitivity analysis is a technique used to determine how different inputs will affect the
output of a model. Sensitivity analysis can be used to determine which inputs have the most impact on
the output, and to what extent.

MARGIN RETURN MODEL

Another available profit guide model is the Margin Return Model, which links their
planning model to the requirement of firms to maintain a reasonable shareholder's value.
The two most common financial goals of all companies that measure shareholder's values are:
1.Net profit margin
2.Return on investment (ROI)

For purposes of understanding ROI, the most common approach is the percentage recovery of capital
by dividing net profits to net worth.
 SENSITIVITY ANALYSIS

ROI =

A review of the formula above reveals that ROI is highly dependent on four variables: Total Assets
and Net Worth (shown in the balance sheet), and Net Sales and Net Profit (shown in the income statement).
For profitable firms, a dangerously high leverage ratio, i.e. high debts (total asset-net worth-total liability,
remember?), will inflate a firm's ROI while increasing its future capital cost and decreasing its future value
unless backed up with adequate cash flow and consistently high profit.
STRATEGIES TO MAXIMIZE PROFITS
MARKET ENTRENCHMENT REPOSITIONING STRATEGY
The objective of market entrenchment is
for firms to maintain and improve its existing In marketing terms, repositioning is a
market standing. If a firm is financially strategy that businesses use to change the
satisfactory, there is a strong likelihood of perception of the targeted audience about their
competitive pressure. Firms can minimize products or services.
competitive vulnerability by either adopting
market share protection strategy (shorter-term) or
re positioning strategy (longer-term).

MARKET EXPANSION

Market expansion is the process of increasing the

MARKET SHARE PROTECTION STRATEGY size of a company's customer base by entering new
markets. This can be done through a variety of
Marketing decisions and actions taken by a means, such as opening new locations, developing
firm to protect its current market share from new products, or increasing marketing efforts.
competitors.
STRATEGIES TO MAXIMIZE PROFITS
MULTINATIONAL STRATEGY PRODUCT FULL LINE STRATEGY
The multinational strategy is a strategy A product full line strategy is a
by which a company operates as stand- alone marketing strategy in which a company offers a
business units in multiple countries to optimize the complete range of products in a particular
products or services based on the preferences of category. The goal of this strategy is to capture a
local customers and competitive conditions to gain larger share of the market by offering a complete
a competitive advantage. product line that meets the needs of all
consumers.

SALES STIMULATION STRATEGY

VOLUME IMPROVEMENT
Sales stimulation is a strategy used
Volume improvement is the process of
to encourage customers to buy more products
increasing the amount of business that a company
or services. This can be done through various
does. This can be done through a variety of means,
methods, such as discounts, coupons, or
such as increasing sales, expanding into new markets,
special promotions.
or improving efficiency.
STRATEGIES TO MAXIMIZE PROFITS
DISTRIBUTION PRODUCTIVITY
SYSTEM SELLING STRATEGY STRATEGY
The system selling strategy is a type of The distribution productivity strategy
marketing strategy that is used in order to sell a is a business model that focuses on improving
product or service. This strategy is based on the the productivity of a company's distribution
idea that a customer will be more likely to operations. The goal of this strategy is to
purchase a product or service if they are able to see increase the efficiency of the distribution
how it can be used in their everyday life. process, while reducing the cost of goods sold.

RESELLER ALIGNMENT STRATEGY

CAPITAL RESTRUCTURING The Reseller Alignment Strategy is
an effective way for companies to improve
Capital restructuring is a corporate their relationships with resellers. By clearly
operation that involves changing the mixture of debt defining their goals, assessing the resellers'
and equity in a company’s capital structure. It is performance, and developing a plan to close
performed in order to optimize profitability or in any gaps, companies can improve
response to a crisis like bankruptcy, hostile takeover communication and collaboration, leading to
bid, or changing market conditions. better outcomes for both parties.
STRATEGIES TO MAXIMIZE PROFITS
REPRISING STRATEGY
MARGIN IMPROVEMENT
In business, repricing is the process of setting
The objective of margin improvement is new prices for products or services in response to
to improve both the gross margins as well as the changes in the market. This can be done in
net margins of products and services. Two response to changes in the cost of inputs,
available strategies are Reprising Strategy and changes in consumer demand, or changes in the
Cost Control Strategy. competition.
Profit earned from sales increases through the following situations:
BUSINESS EXPENSES:
1. The number of customers
- Cost of goods
2. The volume of goods or services existing customers buy.
- Commissions/discounts
3. The sales price
- Variable and fixed expenses

To increase sales, objectives should include:

1. Ensure many potential customers know about business details and what have to offer
2. Ensure existing customers are happy with the product or service and want to buy more of it.
3. Review sales prices regularly to ensure covering all related costs and still making a profit, Find out how to calculate
margins, mark-up and break-even amounts. This will help set the right sales price to meet profit expectations.
COST OF GOODS SOLD BY INDUSTRY
Ways to calculate the cost of goods:
- Retail and wholesale is the difference between the stock at the start and end of an inventory reporting period. This would
include stock sold in between customer.
- Manufacturing is finished-goods stock, plus raw materials inventories, goods-in-process stock, direct labour, direct factory
overhead costs and goods sold in between.
- A service business is determined by labor used rather than sale of a product. So, calculating the cost of goods sold is
simpler due to the low-level use of materials required to earn the income.
HOW TO CALCULATE COST OF GOODS SOLD:

Expenses have an impact on profits. Review the expenses and look for ways that can cut back. Separating expenses into
categories will help calculate the costs. It also helps you see where they can be increased or can be reduced. Expense
categories include:
1. Cost of Goods Sold - These are expenses related directly to sales such as buying stock or components, freight costs if
goods are shipped to your business or wages if a staff member works directly on producing an item for sale
2. Fixed Expenses - These are expenses that stay the same when your sales increase such as rent, insurance, licensee fees,
utilities etc.
3. Variable Expenses - These are expenses that go up or down based on the sales you make such as advertising, delivery
charges and electricity if you are manufacturing.
PROFIT AND LOSS STATEMENT
A profit and loss statement, also called a P&L or income statement, is a financial report that shows a company's
revenue, expenses, and profit over a period of time. The report is typically used by business owners and managers
to assess the financial health of the company and to make decisions about where to allocate resources.

Tips for doing a profit and loss statement:

- Do a profit and loss statement in order to analyze all income and expense categories.
- Try to do a profit and loss statement monthly, You will get a better understanding of your income and costs.
- Recognize areas that need more analysis, and take action before small problems become big problems

CASH FLOW STATEMENT

A CASH FLOW STATEMENT IS A SUMMARY OF MONEY COMING INTO AND GOING OUT OF THE
BUSINESS FOR A SET TIME PERIOD. IT IS PREPARED MONTHLY AND AT THE END OF THE
FINANCIAL YEAR.

Cash Flow from Investing Activities

Investing activities include investments in future business activities, e.g.
buying and selling fixed assets. This type of cash flow can include items such as:
1. Payment for purchase of plant, equipment and property
2. Proceeds from selling the above
3. Payment for a new investment
4. Proceeds from selling an investment.
Cash Flow from Financing Activities
Financing activities are how a business finances itself. Examples include:
1. Extra money the owners inject into the business.
2. Money the business borrows.
3. Money others borrowed from the business they pay back.
4. Money the owners take out of the business.

The cash flow statement can provide helpful warning signals to avoid future financial troubles. Some potential
warning signs are when:

- Cash receipts are less than cash payments - you are running out of mo
- Net operating cash flow is an outflow - cash flow is negative.
- Net operating cash flow is less than profit after tax - you are spending more than you earn.