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CHAPTER 7 : FINANCIAL FOR ENTREPRENUERS

As an entrepreneur, it is OK if you do not know how to prepare the financial statements. But the
minimum skill that an entrepreneur MUST have is that he /she can read an Income Statement, a Balance
Sheet, and a Cash Flow Statement, and able to make any business decision from the figures stated in the
statements.
Profit isnt the same as Cash. (Profit Cash)

CONCEPTS AND TERMINOLOGIES


Assets = what the company owns. It consists of Current Assets and Fixed Assets. [Formula : A = CA + FA]
Current Assets = anything that can be converted into cash in less than a year.
Fixed Assets = any assets that have a useful life of more than one year.
Balance Sheet = a statement that reflects the Assets, Liabilities, and Owners Equity at the point of time (a
month, a quarter, or a year). In other words, it shows, on a specific day, what the company owned, what it
owed, and how much it was worth. It is called Balance Sheet because it balances i.e. ASSETS always
must equal LIABILITIES plus OWNERS EQUITY. [Formula : A = L + OE]
Capital Expenditure = is the purchase of an items thats considered a long-term investment, such as
machineries, equipments, or computer systems. Operating expenses show up in the Income Statement, and thus
reduce profit. But Capital Expenditures show up in the Balance Sheet; only the depreciation of a piece of
capital equipment appears on the income statement.
Cash = money a company has in the bank PLUS anything else that can readily be turned into cash (such as
stock and bonds).
Cash Flow Statement = a statement that shows cash coming in, cash going out, and the difference between
them.
Equity = the shareholders stake in the company as measured by accounting rules.
Income Statement = a statement shows Revenues, Expenses, and Profit for a period of time, such as a month,
a quarter, or a year. It is also known as Profit & Loss Statement. The bottom line of Income Statement is
whether we get Net Profit or Net Loss.
Liabilities = whatever owed by a company to other entities. It is divided into 2 categories i.e. Current
Liabilities and Long-term Liabilities. [Formula : L = CA + LTL]
Operating Expenses = are the costs that are required to keep a business going day to day. They include
salaries, benefits, insurance costs, rental, utility expenses (electricity, water, gas, etc.), depreciation, etc.
Operating expenses appear on the Income Statement.
Profit = the amount left over after Expenses are subtracted from Revenue. There are 3 basic types of profit:
Gross Profit, Net Profit Before Tax (also knows as Earning Before Interest and Taxes or EBIT), and Net Profit
After Taxes.
Revenue or Sales = the value of what a company sold to its customers during a given period of time.
Gross Profit = Sales minus Cost of Good Sold or Cost of Service. [Formula : GS = S - COGS]
1

Net Profit Before Interest and Taxes (also known as Earning Before Interest & Taxes @ EBIT) = Gross
Profit minus Operating Expenses (including depreciation). In other words, it shows the profit made from
running the business. [Formula : EBIT = GP - OE]
Net Profit After Taxes (also known as Earning After Tax) = Net Profit Before Interest and Taxes minus
Interest and Taxes. It shows what left after all costs and all expenses are excluded from revenue. [Formula :
Net Profit = EBIT - (Interest + Taxes)]

FINANCING YOUR BUSINESS


1)

Owner Financing
Finance business using entrepreneurs own money e.g. own saving, take a second mortgage out on the
entrepreneurs own houses. This entrepreneurs contribution of cash can be structured as equity
investment in the business (hence will increase the companys paid up capital), or just as loan from the
entrepreneur to the business.

2)

Other Equity Investment


Any friends, family, or so-called angel investors who put (invested) their money into the business with
the expectation that they will get their return (in the form of shares) from the business through that
investment. That is, they will be co-owners of the business with the original entrepreneur. If their
investment is large enough, they may be entitled to a seat on the Board of Directors with a say in major
decision. If the business succeeds, their shares/stocks will grow in value. But if the business fails, they
may lose their investment.

3)

Debt Financing
Lending money from financial institutions, e.g. banks, or agencies that provides financial assistance
such as MARA, TEKUN, etc. Banks wont normally lend money to start-up businesses, but they will
often lend to a start-up entrepreneur provided that the entrepreneurs personal finances are healthy
enough to ensure repayment of the loan whatever fate of the business. Banks who lend money to the
entrepreneur are NOT part of owners of the business and ARE NOT entitled to a say in major decisions.
But the entrepreneur (as the borrower) do have to pay them (the banks) back on the agreed-upon terms. If
the entrepreneur fails to do so, the banks are likely to have legal claim on the business assets.

A)

INCOME STATEMENT OR PROFIT & LOSS STATEMENT


Too many entrepreneurs dont understand what profit really is, let alone how it is calculated. Profit is
reflected in the Income Statement (or Profit & Loss Statement)
PROFIT = SALES - COST OF GOODS SOLD EXPENSES
Sales : Any income begins with SALES. When a business delivers a product or services to customers,
then it is said that it has made SALES, regardless whether or not the customers have paid the product
or not. Of course for cash-based businesses such as restaurants, sales and cash coming in are pretty
much the same. But most businesses have to wait until thirty days or more (this is called credit-term)
to collect their sales.

Cost : The costs and expenses appears in Income Statement (or P&L). Cost and Expenses are those
expenditures incurred in generating the sales recorded during the period, even though the cheque
has not signed yet.
PURPOSES OF INCOME STATEMENT
To measure whether the products or services that a company provides/sold are profitable or not.
To give indicator for the Managements decision (or Sales Manager) on whether or not he can give
discounts and how much discount to give (i.e. how much profit the business is willing to let go).
To assist HR Manager in deciding whether or not he can recruit new staff and which group of staff
need to be recruited (e.g. support, sales, etc.) based on the profitability.
Profit in Income Statement is not reflect real money because revenue is recognized when a product
or service is delivered, NOT when the price is paid. You can be making money as shown by the
income statement, but you may not be generating cash fast enough to pay your bills. This is one
reason why even a highly profitable company may find that its cash is tight.
FORMULA FOR INCOME STATEMENT
Sales
Less: Cost of Good Sold (COGS)

XX
(XX)

GROSS PROFIT
Less Expenses

XX
(XX)

NET PROFIT/LOSS (BEFORE TAX)


Less: Tax

XX
(XX)

NET PROFIT (AFTER TAX)

XX

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EXERCISE
Given:
Total liabilities
Total owner equity
Total sales
Total expenses
Total COGS

RM15,100.00
RM10,000.00
RM 8,000.00
RM 3,500.00
RM 3,200.00

Calculate:
a) how much the Gross Profit?
b) how much the Net Profit?

B)

UNDERSTANDING BALANCE SHEET

Balance Sheet is _________________________________________________________________________.


Equity is ____________________________________________________________________________ .
Assets is ___________________________________________________________________________ _ .
The formula of Assets is _____________ + _____________
Current Assets is ______________________________________________________________________ .
Fixed Assets is ________________________________________________________________________.

INDIVIDUALS VS. BUSINESS


To understand Balance Sheet, we relate with Individuals financial situation i.e.:
Individual Net Worth Owns Owes = Net Worth
What the company OWNS is called ASSETS
What the company OWES is called LIABILITIES
What it is WORTH is called OWNERS EQUITY or SHAREHOLDERS EQUITY
So:

Business Net Worth

Assets Liabilities = Owners Equity

PURPOSES OF BALANCE SHEET


To show a companys financial situation at a given point in time.
To show how much asset that the company owned.
To show how much liabilities that the company owed to banks. Also show can the company pay its
liabilities?
To show how much the value (worth) of the company. To shareholder, BS shows whether or not
their equity is growing over the time.
*****************************************************************
EXERCISE:
Given :
Total liabilities
Total owner equity
Total sales
Total expenses
Total COGS

RM15,100.00
RM10,000.00
RM 8,000.00
RM 3,500.00
RM 3,200.00

Calculate how much the Assets that the company owns?

EFFECT OF PROFIT & EQUITY OVER BUSINESS DECISION


Example 1:
Your Operation or Factory Manager hears of a good deal on an important raw material and decides to
buy a lot of it. Makes sense, right? Not necessarily! The inventory line on the Balance Sheet increases. The
accounts payable line increases a corresponding amount. Eventually, the company will have to draw down its
cash to cover the accounts payable possibly long before the raw material is used to generate revenue.
Meanwhile, your company has to pay to warehouse the inventory, and it may need to borrow money to cover
for decrease cash. Figuring out whether to take advantage of the deal requires detailed analysis: be sure
consider all financial issues when making (or allowing your Manager to make) these kind of decisions.
Example 2:
Your Sales Manager is looking to boost revenue and profit and decides to target smaller businesses as
customers. Is it a good idea? Maybe not. Smaller customers may not be as a good credit risks as larger ones.
Accounts receivable may rise disproportionately because the customers are slower to pay. The accountants may
need to increase that bad debt allowances, which reduces profit, assets, and thus equity. The financially
intelligent Sales Manager will need to investigate pricing possibilities: i.e. Can he increase gross margin to
compensate for the increased risk on sales to smaller customers?
Example 3:
Your IT Guy wants to buy a new computer system, believing that the new system will boost productivity
and therefore contribute to profitability. Is it true? How is this new equipment going to be paid for? If your
company is overleveraged that is, if it has a heavy debt load compared to its equity borrowing the money to
pay for the system may not be a good idea. Perhaps you will need to take on additional equity investment in the
company. When you make your decision about the computer system, you will need to consider the best way to
pay for it and its impact on your financial statements as well as the potential improvement in productivity.