notes-smallBusinessFinancialManagmentKitForDummies

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Notes on Small Business Financial Management Kit For Dummies by Tage C. Tracy CPA, John A. Tracy CPA

Chapter 1

"the three primary financial imperatives of every business are to make profit, generate cash flow from making profit (which is not the same as making profit), and control financial condition and solvency. Accordingly, a separate financial statement is prepared for each purpose"

skills the small business manager needs:

person on staff (your accountant) who handles accounting, who makes your financial statements, is called the "controller"

Generally companies reach $50 to $100 million in annual sales before hiring a CFO. Until then, the CEO must do this job, too.

parts of finance:

formatting conventions of financial statement presentation:

Chapter 2: profit and loss report

u should know typical "annual sales per square foot of retail space" and "annual sales per employee" for ur line of biz

if, between two years, you lower your markup, and sell more units, then sales revenue will increase by a smaller percent than the increase in cost of goods sold and vice versa: selling additional revenue at a higher markup will push up sales revenue by a larger percent than the increase in cost of goods sold

standard form of profit and loss report (income statement) doesnt vary much aside from which expenses are included. it doesnt differentiate between fixed and variable operating expenses. in addition to producing one of the standard format, you can make a second p&l statement which does variable op. expenses first, and then fixed op. expenses. the number after cost of goods sold is subtracted is "gross margin"; the number after all variable costs subtracted (of which cost of goods sold is one) is "contribution margin"; that is, contribution margin = sales revenue minus all variable expenses.

once you pick which of the three expense accounting methods u use for reporting cost of goods sold, the government doesnt let you change it; and similarly for other things

recommend to keep the length of your p&l statement short; if you want to break down expenses more, make a separate report

unusual, nonrecurring gains and losses, e.g. selling a building, losing a lawsuit, are called "extraordinary gains and losses" and get a separate line in the p&l

remember: many biz transactions are profit neutral and don't show up in the p&l report. e.g. capital expenditures; cost of unsold inventory that was bought this year.

some quiz questions: here's your income statement from last year. the next year, everything is the same, except you bought a new computer. what's the statement for the next year look like? a: no change

quiz q: your markup was 100% of the cost of goods last year. this year, you have a 10% off sale, and you sell twice as much. what's your markup this year? what's the percentage increase in cost of goods sold? in sales revenue?

question: why are building leases and employee wages considered fixed expenses? surely if you grow enough these will have to increase? i think: b/c these expenses increase along with sales CAPACITY, not actual sales. you could hire someone else and not sell any more. but cost of goods sold, sales commissions, shipping, never have to be paid unless you are selling

breakeven point = fixed expenses * 1/(contribution margin)

quiz q: given the figures shown (show supplementary income statement which includes contribution margin), and you sell $100,000 more, then how much more profit would you get? what's your marginal profit per unit sold? a: $100000 * contribution margin

markup = "gross margin", also called "gross profit"

"markup on cost" = gross margin / cost of goods sold = (revenue - cost of goods sold) / cost of goods sold ?: dblcheck

"markup ratio" = gross margin divided by sales revenue

there are 4 ways to improve profit:

recommendation: "the most realistic ways to improve profit are found mainly in the first two option -- increasing markup and sales volume" becuase "most operating costs are victims of irresistible cost inflation pressures.. in our experience, most small business managers (though not all) are pretty good at expense control. furthermore, they don't take on more fixed operating costs than are justified by their level of sales..."

recommend doing what-if scenarios to analyze ur profit-improvement alternatives

note: these first show up in:

"operating profit" is also called "operating earnings" or "earnings before interest and income tax"

p&l report also called income statement, earnings statement, or operating statement. not called p&l when reported externally (usually called income)

useful to calc the ratio of each of various quantities on the income statement to sales revenue

quiz q: give an example scenario, and then ask: should you increase price or improve volume?

(not in book but my inference:) assuming inelastic demand, increasing sales price by x% always increases profit more than increasing sales volume by the same x%, b/c in the latter case variable costs increase by x% also this is a good quiz question too

Chapter 3: cash flow from profit

"Deep down in your psyche you probably believe that profit equals cash flow. You may want to believe this, but it ain't so."

some options for how to have cash flow information reported to you:

1) report just cash flow: tell ur controller to add 1 line at the bottom of your P&L that reports ur total cash flow. pros: simple. cons: doesnt tell you where ur cash flow/profit discrepency is coming from 2) report diffs b/t (cash flows) and (revenue and expenses) in an additional column in your P&L. note: this is not a standard report so ur accountant will have to make it custom if u want it 3) try to read the first section of the statement of cash flows. pro: ur controller has to make this anyway b/c it's one of the 2 primary financial statements reported externally. cons: very hard to read

recommend: (2) extra column in P&L w/ the diffs

if (2), which accounts correspond to the cash flow diffs for which rows in the P&L:

p&l row accounts that cause cash flow to differ (not all in the same direction, i think) (i.e. asset and liability accounts, except 4 depreciation)


sales revenue accounts receivable

cost of goods sold inventory, accounts payable

operating expenses (excluding depreciation) prepaid expenses, accounts payable, accrued expenses payable

depreciation expense depreciation expense interest accrued expense payable (b/c interest is usually paid in arrears, i.e. at the end of the period, so in the meantime, it accumulates as a liability in accrued expense payable)

(bayle: i would also add a separate line for capital expenditures, altho i understand that this is distracting in that the income statement is supposed to be about profit, and about the repeating component of the business modle; but this way all cash sinks are accounted for; after all, if it's really only about non-financing and repeating subset of biz model, then the income statement wouldn't include interest either (operating profit); so just like operating profit is near the bottom of the income statement, u could put cap expenditure below that)

the subset of cash flow that matches in the way described in the book is called "cash flow from profit" or "cash flow from operating activities"

this is a good source of quiz questions. also, depreciation quiz questions (u buy a capital asset, what happens to ur p&l, expenses, and cash flow? ??)

operational expenses excluding depreciation can be a separate calculated line in ur p&l