Vous êtes sur la page 1sur 21


" /
I ,,'
.f'" tbeir business was supposed to be a cash cow.

,, They started to suspect that they might have

been pricing their products wrongly because
, most of the time, they had been using only
cost estimates instead of actual historical
\\ '

costs. They also began to fear that something

)\ might be wrong with their inventory system,
and that perhaps some of their warehouse staff
might not have been doing a tmthful inven-

accounting fter many years of working

toty of their supplies. They also began enter-
taining the idea that because they had not es-
tablished a firm marketing budget, they might
have been overspending on their marketing
expend itures.
for a multinational compa-
ny, Jane, a successful mar-
Ivfany owners of small businesses are, in
fact, like Jane and Amie. Despite having
I, '
keting executive, quit her I , " built good businesses, they sooner or later
job and partnered with " "I ,,---' find themselves struggling with their financ-
her best friend in col-
lege, Amie, a culinary graduate who used to
" I
,,~.. \

., ",
es. They are unable to keep track of where all
their funds have been going; worse, they are
work for a five- tar hotel in Makati City. They unable to figure our if the business is making
then opened a pizza restaurant in the univer- ers particularly from the university area. A its any idea either of how much income tbey were any money at all or actually losing-and by
sity area along Katipunan Avenue in Quezon sales grew, Jane and Amie continued to make making monthly, even after already paying the how much. The reason is that they don't have
City. Confident of her previous training in a improvements in the business. They intensified salaries of the restauranx staff and all their other a sound accounting system.
reputable marketing firm, Jane did tbe market- their promotional efforts and raised their food operating expenses. The only thing they knew For entrepreneurs to succeed in a busi-
ing research for the business herself, includ- standards. Indeed, they were so happy witb the was the amount of cash sales they were gener- ness, however, they need to focus nor only
ing choosing the location and determining its results of the business venture that they already ating daily, which they would then use to pay on operating it but on making money from
market potential. On the other hand, Amie started planning to expand it. for supplies and purchases. And the strangest it, and a good \vay to know if the business is
took charge of the operation side, handling While doing their expansion planning, bow- thing of all was that sometimes, after disburs- indeed making money is to keep reliable re-
menu design and staff recruitment. ever, the partners discovered something odd: ing their payroll, they would have very little cords of its income and expenses that can be
The pizza restaurant proved to be an early Despite the fact that their sales had been grow- cash left in the bank. reviewed regularly.
success. Just a few months after opening day, ing steadily, they were not generating enough The partners then began to wonder how This record-keeping process is what we call
it had already developed many loyal custom- cash to finance a new outlet. They didn't bave come they were always short of cash when accounting.
Entrepreneurs are willing to put it all on the line to make their dreams come true.
And their success is not just their own.
It is the triumph of a nation.
Whyacc04nting Entrepreneur presents
"67 Heroes of the Economy"
iscrUCIO - in this special bookazine .

.to your business

. . ,.

counting is important to you ate from your accounting records, such as your

A and your business for many balance sheet, income statement, and cash
reasons. To begin with, when flow. A qualified accountant in your compa-
you have an accounting sys- ny can help you interpret the financial figures
tem, you will know how your in the report correctly for evaluation and de-
business has performed financially during a cision-making purposes.
particular period, and you can also evaluate Also, if you are planning to expand and
how you had managed your cash flows and would like to raise money by taking in new
other assets. You can do this by reading the investors, you need to consult your account-

different financial reports that you can gener- . ing records regarding the net worth of your
business. Net worth is the residual capi- new investors, your ownership will b diluted
tal left when you deduct all of your liabili- to 50 percent. This is because the net worth
ties from your assets. Now, when you have of the business would expand to PI million
a clear idea of how much your net worth is, against your original equity contribution of
you can use that as a starting point for valu- P500,000. Without proper accounting of its
ing your business. The valuation that you assets and liabilities, however, you would not
arrive at will then become the basis of the know the true net worth of your business.
selling price that you will offer to your pro- If you are unwilling to give up part owner-
spective investors. ship of your business, on the other hand, you
Assume, for example, that you found would need to borrow money from the bank
your net worth in the balance sheet to be instead. Even in this case, however, you still
P500,000. Depending on how much equi- would need to prepare your financial state-
ty in the business you are willing to sell, you ments because your bankers will want to
can raise additional funding based on your
net worth. In this particular case, if you raise
examine them to determine your financial
standing. Normally, banks will only lend you
P500,000 in additional capitalization from the amount they think you can afford to pay.
They will also check how much assets you

, I
have in your business and how much ca h " I
, ,;.
Using the
income statement
to discover
flows your business is generating.
There may be instances, in fact, when
banks or investors would ask for your business
plan. To make a business plan, of course, you
need to project your financial performance
" .. ...- _--- ,
.... - ....... "

The first five

into the future. And to do the projections
n the case study presented in the properly, you need to have reliable historical
introductory chapter, Janeand financial data that you can only get from your
Amie could have discovered their financial statements. By reviewing past finan-
problems earlier if they had an
income statement that they could review
regularly. An income statement is simply a
cial performance, you can discover so much
information about the behavior of your sales,
costs, and expenses. Indeed, understanding
basic accounting
financial statement of a business showing the factors behind the numbers will help you

the details of revenues, costs, expenses, make your forecast better.
losses, and profits for a given period. You can therefore see that without ac-
Forexample, upon finding a significant counting, it is almost impossible for you to
know how your business is doing. It is ac- yOll prepare to set up an ac- the accrual basis of accounting, the material-

variance between their budgeted gross
profits and the actual result, the partners counting that will help you understand the counting system for your com- ity principle, the disclosure principle, the ob-
could have investigated it further to see financial dynamics of your business. Ind ed, pany, it will be good to first jectivity principle, the consistency principle,
ifthere was something wrong with their when you know how your business behaves, know the 11 basic account- and the conservatism principle.
pricing or inventory system. And they could you would be in a much better position to ing concepts behind the prep- \Y.Je will discuss the first five basic account-
have fixed this inaccuracy by implementing manage it properly and control your risks. aration of financial statements. These basic ac- ing concepts in this chapter.
proper costing procedures and internal Having an accounting system will help you counting concepts are as follows: business enti-
controls. see to that. ty, going concern, the historical cost principle,
the revenue principle, the matching principle, 1 Business Entity This is the most basic
assumption in accounting. Thus, when
you are in business, you don't ask your com-
pany to pay for your personal credit cards or
ward to recover the following year and make
a profit eventually. Even if you are losing now,
that the furniture you plan to buy was sell-
ing at P150,OOO but you were offered by your
for your expenses at home. This is because you your goal in the business is to eventually make friend a discounted price of only PlOO,OOO.
are your own entity-an entity that is separate money over time. Using the historical cost principle, you should
The historical
from your business. record this acquisition at the actual cost of cost principle also
This principle is critical in accounting be- Historical
Cost Principle The prin-
cause it is necessary to account properly for 3 ciple of historical cost simply states that
PlOO,OOO,not at the cost of P150,OOO which
you believe is its real market value at the time
applies to
all expenses related only to your business op- all assets and services you acquired should be you acquired it. borrowed money
erations. It would be misleading if your per- recorded at their actual cost at the time when Once recorded in the books, the histori-
sonal expenses at home-expenses that have the transaction occurred. Assume, for exam- cal cost of the assets you have acquired shall The historical
nothing to do with your business-are includ- ple, that you want to buy secondhand office remain in the records as long as the business cost principle also
furniture for your new business and you hap- applies to liabilities
ed in the income statement. Doing so will in- exists. For example, suppose you bought a
when you borrow
crease the expenses of your business, creating pen to have a friend in the furniture business property in Makati City for P5 million. Sev-
money in foreign
the impression that your business didn't do who could give you a big discount. You checked eral months later, because of the high de-
currency. Suppose
well even if it did. mand for properties in the area, the market
that to finance
Following the concept of business entity, price of your property increases to P8 million.
your importation
the ownership of assets must also be kept sepa- Should you adjust the value of your price to
requirements, you
rate. If the car or the laptop computer that you retlect the current price at P8 million? Based
borrowed US$20,OOOat the prevailing
are personally using was paid for by your com- on the cost principle, the value of the prop- exchange rate of P40 to a $1.Youwould
pany, it belongs to the company, not to you. If erty should remain at its historical price re- then record this liability at P800,OOOat
you have made a cash advance front your com- gardless of its fair market value at any time the time of the transaction. This is the
pany, you have the obligation to pay it back in the future. amount that should appear in your balance
to your company in due time. And if you use The reason behind the use of the historical sheet when yourfinancial statement
the services of your company for your person- cost principle is to remove any potential bias is prepared at the end of the month. By
al use, you need to pay for it just like an ordi- that you may have when valuing assets. The the time you are ready to pay your loan,
nary customer. argument for this practice is that when you use however, it might happen that the peso
your actual cost, the report will be more objec- had by then weakened to PSOto a $1.Under
Going Concern Because the company tive and fair. This is still the widely prevailing the historical cost principle. you should
2 is separate from you, it is assumed that
your business will continue to operate indef-
practice in many accOlmting systems, although record that you are have pa id off your
loan at its actual value of P800,OOO,not
the current trend in accounting standards is
initely even if you are no longer its owner. moving towards updating certain types of as- PI,OOO,OOO, but you should also record a
Your business can be transferred to anyone sets to current market price. loss of P200,OOObecause of the currency
in the future if you decide to sell your owner- conversion under a lowervalue for the peso.
ship, and it shall continue to exist regardless
of your personal situation. This is the concept
of going concern.
4 Revenue Principle The revenue prin-
ciple requires you to record sales when it
is fulfilled and earned, not when cash is col-
This is because you have already completed
the sales at that point.
This concept also provides that in account- \ lected. For example, if you sold merchandise Now, let's change the situation. Suppose
ing, no matter how much in losses a business \
\ I
to your client on credit and the latter prom- your client gave you cash as deposit today to
may have accumulated over the years, it is al- 'l- ises to pay you next month, how are you go- make sure that you deliver the merchandise to
ways expected to continue running. As the I ing to record this transaction? Under the rev-
him when it arrives next month. Do you record
owner of a business, even if you have a bad \
enue principle, you should record sales during the cash you received as sales? Under the rev-
year this year, you need to always look for- the month you sold the merchandise regard- enue principle, you cannot treat the cash col-
less of whether you have received cash or not. lection as sales because you have nor delivered
The other six
the merchandise yet; that is, the sale transac- ation expense can be matched against sales for
tion is not yet fulfilled. The cash you received the month. The same also applies to the fran-
fmm your client should be treated as a liability chise fee. In this case, the franchise fee you paid
instead because you need to return the money will be amortized over the number of years that

basic accounting
in case you fail to deliver the merchandise. the term agreement will be subsisting.
We will take up the other six basic account-

5 Matching Principle Assume that you ing concepts in the next chapter .

are planning to buy a franchise to open
a restaurant. You paid PI million for the fran-
chise fee and spent another PIO million for Applying
the can truction. Now the question is: Do you
record these expenditures as expenses during
the month even though you don't have any
sales yet?
Under the matching principle, you cannot
the matching
principle to food
supplies usage ~


book the franchise fee and cost of construction upposeyouhave already sta rted
as expenses because there are no sales to match your franchised food business ~'?'
them with. To match the expenses with sales and have made your initial
properly, you need to depreciate the cost of purchase offood supplies from
construction over the useful life of the struc- your franchiser. Bythe end of the month.
ture. For this example, in particular, you can however, you found out that you still have
depreciate the construction of your restaurant food supplies left in storage. Should you
for, say, five years so that the monthly depreci- book the total food purchases during the
month against your sales for that month?
Under the matching principle, what
should be considered as the cost of sales
should only be that portion of your food
purchases that has been consumed and
actually sold. The unused portion should
be treated as inventory to be carried over e will now discuss the business. These expenses can therefore be rea-
to the following month for consumption. other six basic concepts sonably charged against sales for the current
If you disregard this principle and in accounting, namely period, but to properly recognize these expens-
book all the food purchases to the cost the accrual basis of ac- es in your income statement, you need to use
of sales for that particular month. there counting, the materiali- the so-called accrual basis of accounting.
would be a mismatch of cost and sales. ty principle, the disclosure principle, the ob- \Vhen you accrue an. expense, you assume
This mismatch would increase your food jectivity principle, th consistency principle, that the expense occurred during a pal-ricular pe-
cost and lower your income, and you and the conservatism principle. riod even if no cash payment was actually made
would be misled into believing that the to cover that particular expense. A good exam-
restaurant is not doing well. With proper
matching of cost and sales, however, you 1 The Accrual Basis of Accounting
business, there are expenses such as sala-

ries of staff, rentals, and other administration-

ple is that in your business, you are supposed to
pay your monthly rental and association dues.
will be disciplined to regularly count your In practice, before issuing your check payment
inventory-which, by the way, will also related expenses that have no direct relation for these dues for, say, the monthof]uly, you will
serve as a deterrent against pilferage. to sales but are necessary costs for running the wait for the billing to reach you-maybe two
weeks after the end ofjuly. Now the question er it misleading for you to expense the whole probable that the company may end up paying Under the consistency principle, this is dis-
is: Are you going to record your July rental ex- P8,500 in the first year instead of depreciating huge damages should it lose in court. Will you allowed unless inevitably necessary. Should a
pense during the month of August? No. Under it for PI, 700 in the next three years against your still invest in the company after finding this out? change be implemented, an explanation un-
the accrual method, you should accrue the July annual sales of, say, P50 million. Obviously not. der the notes to financial statements should be
rental expense during the month ofJuly even if The disclosure principle normally is used made showing how the change will affect the
you have not been billed for it yet. when your financial statements are audited. overall results.
The accrual basis of accounting, which Does the materiality But when you are preparing your financial state-
Conservatism Principle You need to
helps simplify the matching of sales with ex-
penses, is the method preferred by accounting
principle apply to ments for your own use, and particularly if they
are meant for management use only, you may 6 understand that accountants are trained
standards for the preparation of financial state- purchases of a food not need to follow this principle strictly. to be pessimistic when they perform their work.
ments. However, many small business owners The reason for this is that they want to be fair
cart business?
find it simpler and easier to use the cash basis
of accounting, which recognizes sales and ex- f you own a food cart business in 4 Objectivity Principle In accounting, all
transactions must be supported by verifiable
and reasonable when making decisions that in-

penses only when a cash transaction is made. which you invested P350,OOOand you
bought a printer for P8,500, would
documents such as vouchers, invoices, and offi-
cial receipts. This is because financial dara must
In this method, all cash receipts are booked as
sales and all cash payments are treated as ex- the materiality principle apply to the be as accurate and as reliable as possible. Aside
penses. Thus, at the end of the day, rhe small purchase? Yes.The cost ofthe printer is very from establishing the integrity of the informa-
material in relation to the size of your food- You need to
business owner only has to check how much tion, the documentation also serves as a good
cart business, so you need to capitalize it provide for
cash is left in the cash register or bank ac- internal control mechanism. It helps create an
as an asset and depreciate it accordingly, uncollectibles
count-if there is some, it is treated as a prof- audit trail that you would need when confirm-
When applying the materiality principle, it's so you are not
it; if there is none, it is treated as a loss. important to use your professional judgment ing certain transactions in the future. \Vithout
Other businesses use a modified method of in deciding whether an item is material- this principle, accounting information would be
if any of your
the cash basis of accounting, where they use the meaning significant-or not. generally subjective, for the recording of the data clients fail to
accrual method only for certain portions of the would then be based largely on opinion. pay you.
recording process. Examples of this practice are
the use of depreciation for fixed assets or not
treating as outright expense certain inventory
or assers acquired through cash purchase.
Disclosure Principle The preparation
of a financial statement does not end with
reports stated in numbers alone. It also requires
5 Consistency Principle Because every
industry is unique, a business has the dis-
cretion to choose which method of account-
valve opinions, estimates, and selection of pro-
cedures. Being conservative, accountants would
notes and supplementary information that need ing practice it deems appropriate. However, the always choose the method of accounting that re-
Materiality Principle There are times to be disclosed so users can meaningfullyappre- principle of consistency suggests that as much sults in a lower profit or a higher liability.
2 when you don't need to follow the match- ciate the financial statement, Indeed, some fi- as possible, for your business to have compa- One good example of this accounting prac-
ing principle strictly, particularly if the amount nancial facts not reflected in the numbers may rable financial results, you need to employ the tice is making allowances for bad debts. You
to be recorded is not significant enough to af- be significant enough to influence the judgment same accounting procedure year after year. may be confident that you can collect all your
fect the financial results of the business. For ex- of the user of the financial statement. For exam- For example, assume that you have a depre- receivables from clients, but your accountant
ample, if you own a multimillion business and ple, suppose you are planning to invest in a com- ciation policy that requires all acquired transpor- may not be as positive as you are. Following
you acquire a printer for your office for P8,500, pany. As part of your due diligence, you asked tation vehicles be subject to a useful life of five the principle of conservatism, your accountant
should you record this as an asset and depreci- for and were presented its financial statements yeal'S,such that the annual depreciation expense would normally suggest that you provide a cer-
ate it for its useful life of three years? Accord- from last year. Based on the income statement, for your vehicles would be PlOO,OOO.The fol- tain percentage of your total receivables as un-
ing to the materiality principle, the cost of the the company appeared to be profitable to you lowing year, however, your management decided collectible so you would not be so disappointed
printer relative to the size of your business is im- and you were on the verge of deciding to invest to change tl1e depreciation period to ten years if any of your clients fails to pay you.
material, so you can decide to charge the whole in it. When you looked at the notes to the fi- to cut d1e annual depreciation expense down to Now that you know the 11 basic accounting
cost of the printer as an expense for the year. nancial statements, however, you found out that PSO,OOO,thus giving you an extra PSO,OOOin net concepts, you should be ready to set up the ac-
The reason for this is that no one will consid- "the company is under litigation and that it was income. Is this practice allowable? counting system for your business .
Every accounting system deals with books will save you the trouble of creating a new ac-

Setting up of account and ledgers. So, before planning to

set up an accounting system, it is important for
you to first get familiar with the accounting
cycle and with the books and ledgers needed
count for every transaction you make.
The design of a chart of accounts involves
assigning of numbers to particular types of ac-
counts for easy reference. For example, asset ac-

an accounting to track and sustain that cycle. At the start of

the month, the two major accounting activ-
ities you need to perform are, first, recording
counts start with the digit "1," liabilities with
"2," owner's equity with "3," sales with "4," and

transactions in the book of accounts and, sec-

5 ond, posting these transactions on the ledger.

Recording a transaction is simply to input in
the book following a template header as it oc-
A chart of accounts
curs; posting means recording all similar trans-
actions in a ledger that summarizes and totals accounting for you
them at the end of the month.
By the end of the month, you need to re- Assume that
view all of the accounts you have recorded and you want to
summarize them in a worksheet that you can record your
use to create a trial balance. At this point, you payments for
will sometimes find accounting errors or in- brochures,
complete capture of transactions, so you need direct mailers,
to analyze each accOlmt and make the neces- advertising
sary corrections and adjustments. Only after
and promotional
you have done all the adjusting entries should
items to three different suppliers. If
you prepare your financial statements.
you don't have a chart of accounts,
This is how accounting is done manual-
you would be recording each
ly, of course. Nowadays, though, many orga-
transaction bycreating account
nizations-even small businesses-use com-
titles such as ;'brochure expense,"
puterized accounting systems. If you can't
"direct-mail expense,' "advertising
afford to get an accounting software pack-
expense," and "promotion expense."
age off the shelf, you can at least use a simple The list can go on and on depending
spreadsheet program to automate the compu- on the number of payments you have
tations and posting of balances to the ledger. made for particular transactions
Since a spreadsheet program automatical- of this type, making your financial
hen you are just starting and more difficult for you to remember all ly generates a trial balance, you don't even statements very long and unwieldy.
your business, a simple the details of your finances. You will need have to prepare one to produce your finan- If you have a chart of accounts,
record-keeping system to put up a better system for tracking your cial statements. however, you only need to record all
may suffice to monitor finances. Perhaps you may have to hire a The first thing to do in designing your ac- transactions for similar activities
your collections and ex- qualified accountant or even invest in com- counting system is to set up your chart of ac- under just one type of account. In
penses. You may even be able to do all the puterized accounting software. Whichev- counts. A chart of accounts is simply a list of this case, that account would be
bookkeeping yourself. However, as your busi- er of these you decide to do, however, you all the accounts in your general ledger, and that "marketing expense.'
ness grows and the transactions that you deal will need to set up an accounting system for list will serve as your guide as to which account
with every day multiply, it will become more your business. to use when recording a specific transaction. It
able you to summarize total sales to date and
Another advantage of having a chart of
accounts is that it also serves as an inter- at the same time monitor your customer ac-
need to identify whether it is from accounts
receivable or from cash sales. At the end of M SAYS:
nal control mechanism. Once a chart of ac- counts. When you add up all the entries in the month, you need to summarize the total
counts is implemented, no one in your com- the sales book, you will get the total amount amount of accounts receivable collected and Four musts when
pany can introduce a new account or make of credit sales, which you can then post to the post it as a deduction to the general ledger ac- designing your
any changes in it without your approval as general ledger under accounts receivable. count of accounts receivable. To update the
the owner. But how do you identify which customer account of individual customers, the specif- accounting system
When you have set up a chart of accounts, owes you how much at any time? You can do ic collection from that customer entered in
Every accounting
you can start planning how to classify similar this by getting the specific entr ies for a par- the cash receipts should also be posted to that
system is unique
transactions for efficient recording. Basical- ticular customer from the sales book, then customer's subsidiary ledger in the accounts
to a business. but
ly, there are five books of account you need posting them to the accounts receivable sub- receivable ledger.
no matter how
to keep: the sales book, cash receipts book, sidiary ledger that contains the supporting
sophisticated or
purchases book, cash disbursement book, and details for each individual customer. Purchases book Although similar in form
simple you want
the general journal. to the sales book, the purchases book works
you r system to be,
Cash receipts book This book is used to the other way around by accounting for all
there are four very
Sales book All of your sales should be re- record all cash receipt transactions. Every purchases of inventory, supplies, and other
important things
corded under the sales book. This will en- time you record cash collections, you also assets on account. Everything that you pur-
you need to remember when designing it:
chase from a supplier needs to be recorded
NO.1 Your system must enable you to exert
under this book.
control over transactions. In particular, the
system must help you prevent unauthorized
Cash disbursement book This book re-
payments or theft from cash collections.
cords all cash payments made by the busi-
NO.2 Your system must be compatible
ness for its accounts payable and other busi-
with your business operations and
ness expenses. As this relates to accounts
organizational structure. What is the use of
payable, preparation of subsidiary ledgers is
acquiring expensive accounting software
required for all suppliers with credit terms
when you can only use 20 percent of its
to help you stay current with payments and
balances. The mechanics for posting to the
NO.3 Your system must be flexible enough
general ledger and subsidiary ledger of the ac-
to allow you to upgrade it without doing
counts payable are the same as those of sales
a complete overhaul. Your business
and cash receipts book.
may expand in few years' time with new
products and services. Your current system
General journal For transactions that you
should be able to adapt to possible changes
can't classify under any of the four journals
in the business.
above, you can post them under the gene-
NO.4 Always do a cost-benefit analysis
ral journal book. Indeed, there are account-
when designing an accounting system.
ing entries that can't be considered as sales,
Do the benefits of buying an off-the-
as a purchase, or as a cash transaction. Typ-
shelf computerized system outweigh the
ical examples are depreciation expense and
cost? Are you better off simplifying your
an accrual entry for electricity expense that
accounting with a manual system rather
has not been billed yet.
than investing in software packages given
your current business setup?
Income statement This is your most im- are financed by liabilities and equity. This re-

Thevarious portant source of information about the

profitability of your business. In the income
statement, you will see how much sales your
lationship is expressed by the famous account-
ing equation below:

business has generated and the correspond-
ing costs and expenses it incurred over a spe-
cific time period. When we say a portion of ~'our business is
The income statement follows a simple financed by liabilities, it only means that even

( \..-
- ',refjQrts
format that shows you the amount of sales of
your business minus its expenses to yield the
net profit or loss.
To better appreciate the details of an in-
if you control it, you don't necessarily own all
the assets of the business. The presence of li-
abilities in the business simply tells you that
your supplier or your bank creditor technical-
0 /,- ... \
\ I" '" 1 come statement in expanded format, consider ly owns a piece of your business and that they
\ } \ \ I the financial statement of a trading company could actually force you to give them a share
'", " \ \ I that we will call the ABC Corporation. of it if you don't pay them.
'" '-...J! \ ~ The balance sheet is your primary source Your ownership in the business is repre-
'" " ..... \ j\
......( :'.,Ci" ~ / I of information about your company's finan- sented by equity, which is the amount left after

.". .". - --' . - T I '\
\ \. ,I
\ 1,,1, _
~7-')' ....
, ,

\ ,
cial position. This is where you get a snapshot
of your company's asset holdings and liabili-
ties. The balance sheet follows a simple for-
you deduct liabilities from total assets. Just like
your creditors who expect to be repaid at some
future date and earn interest on their loans
mat that shows how the assets of a business they have extended to you, you as owner also

ABC Corporation
Income Statement
For the Year Ended December 31,2008
Sales----- ._----
85 0,000
Less Cost of Goods Sold
45 0,000
Gross Profit 40 0,000
Less: Operating Expenses
f can analyze the debits and cred- independent auditing firm not only to ensure Salaries Expense 120,000

I its of your own checking account, thar the figures are correct but also that they SSS, Philhealth and Pag Ibig 9,600
then you should be able to read finan- are presented according to the International Rental Expense 35,000
cial statements. Financial statements Financial Reporting Standards. Marketing Expense 25,000
simply tell you where your money For your own consumption, however, you ~esExpense 15,000
came from, where it went, and where it is now. can simply generate your own report from you I' Insurance Expense 5,000
They come in many forms depending on how company's accounting system. In any case, the Depreciation Expense 7,500 217,100
you want to customize it. However, when fil- report has to be generated on a regular basis so Operating Incame 182,900
ing your financial statements with such regu- it can help you effectively evaluate the finan- Other Income and Expenses
latory agencies as the Securities and Exchange cial performance of your company. Interest Income 2,500
Commission or the Bureau of Internal Reve- The three types of financial reports that Interest Expense 5,000 (2 ,500)
nue, you need to formalize the reports accord- you need to prepare regularly are the income Income Before Tax 180,400
ing to the standard forms. You may even have statement, the balance sheet, and the cash Less: Income Tax 63,140
to get your financial statements audited by an tlow statement. Net Income 117,260
ABC Corporation
Statement of Cash Flows
Year Ended December 31,2008
Cash Flows from Operating Activities
Collection from customers ____ 250,000
Interest received ____ 2,500
Dividends received 9,000
Total cash receipts 261,500
To suppliers (130,000)
To employees [120,000)
For interest expense [5,000)
For income tax [63,150)
Total cash payments~~~ _(318,150)
Net cash outflows from operating activities [56,650)

Cash Flows from Investing Activities

Acquisition of fixed assets __ (306,000)
Proceeds from sale offixed assets 150,000
Net cash outflows from investing~ctivities (156,000)

Cash Flows from Financin~Activities

Real-estate income isn't part of a food Proceeds from issuance of capital stock
Proceeds from bank loans _ 150,000
retailer's regular operations, but. .. Payment of bank loans [250,000J
f are in the food retail business and the business happens to own a couple of real Payment of Dividends [50,000J

I estate investments for rental, should you consider the rental income part of your
operations? You shouldn't; it should be treated as "Other Income" instead. Since your
company's core business is retailing, rental income is not part of your regular operations.
However, when you sell real estate owned by your business, your main business may
incur an operating loss but still manage to report a net income in the end. This is if the
Net cash outflows from financing activities

Net (decrease)/increase in cash

Cash balance, December 2007

nonrecurring income from the sale of the real estate is higher than your operating losses. Cash balance, December 200_8_ 350,000

require a certain rate of return on your invest- side. In the balance sheet, the amount of to- can be derived from your balance sheet and increase would also require a corresponding
ment. Indeed, you would be rewarded by an in- tal assets must be equal to the sum of the lia- income statement. deduction from your cash balance. This is be-
crease in the value of your equity if you decide bilities and equity. How'ever, because the preparation of a cash cause by selling merchandise on credit, your
to sell your ownership shares someday. The explanation for the cash movements flow statement involves conversion of certain business is in essence lending cash to your cus-
Look at the balance sheet of ABC Corpo- in your business-where the cash came from financial data from the accrual basis of ac- tomer to buy products from you.
ration (table on this page). You can see that all and how it was spent-can actually be found counting to cash basis, doing the cash flow When you read a cash flow statement, you
of the assets owned by the company are list- in the cash flow statement. The cash flow state- statement is actually not a very easy task. For must keep in mind that you need to evaluate
ed at the left side of the balance sheet, while ment can actually be created without requir- example, when you record an increase in ac- your business in terms of three types of activ-
all of the liabilities and equity are on the right "ing new data because the needed information counts receivable from additional sales, that ities: operating, investing, and financing .
ness results? A common way to do it is by ratio guarantee that you are managing your resources
analysis, which is the extraction of a meaning- efficiently. For example, you may have accumu-
ful relationship between any two numbers in the lated so much cash in your bank account, thus
financial statement. Ratio analysis is, in fact, a bringing your current ratio to a high level. This
good way of identifying potential problem areas means tl1at you are financially very liquid, but
and opportunities within the company. it also shows that you may not be maximizing
, To track your financial position without
getting overwhelmed with a welter of details,
your opportunities to earn. Instead of just allow-
ing your excess cash to lie fallow in the bank,
\ you can analyze your financial ratios accord- you could have made it earn more by investing
\ ing to three measures: liquidity, leverage, and it in another business or in a high-interest-bear-
, profitability. ing money-market fund.
" 0

0' o
Current ratio You can measure the ability
Acid test ratio As a rule under the acid test
ratio, the total of cash and receivables must at
least equal the total cunent liabilities. This is a
of your business to pay its short-term suppliers more conservative measure of liquidity of a busi-
through the current ratio, which is computed ness tl1an the current ratio, which tends to be
by dividing current assets by current liabilities. misleading when the cun'ent assets account is
As previously defined in Chapter 6, current as- bloated by excessive inventory.
sets are those assets that your business expects to For example, assume that your business
convert to cash within the year, such as cash, ac- has cash of P50,000; accounts receivable of
counts receivable, and inventoty. Current liabil- PIOO,OoO, and inventory of P350,000. When
ities, on the other hand, are those financial ob- you add this up, you get total cunent assets of
ligations that you expect to pay within the year, P500,000. Then, when you compare their sum

such as accounts payable and accruals. with the current liabilities of P250,000, you get
For example, from your balance sheet, you a current ratio of2:!. By just looking at this ra-
find that you have current assets of PI50,OOO tio, it would appear that the business meets the
liquidity criteria and can therefore be consid-
JliEOBMULA: __ '__ '_'_'__~.

ered as liquid. But a closer look reveals that its
r CURRENT _ CURRENT ASSETS "I most liquid assets-the cash and accounts re-
I, RATIO - CURRENTS LIABILITIES , ceivable-amount to only P150,000 as com-
pared to current liabilities of P2S0,OOO.
ntrepreneurs need to develop your company may soon be heading for trouble and current liabilities ofPIOo,oOO. Your cunent W'hen we apply the acid test ratio, we

E some sense of control in their fi-

nancials to keep their business-
es durable and healthy. One way
of taking control is, ot course, by
analyzing the financial information generated
by the company's accounting system. Through
if your profit margins keep on falling for succes-
sive months. This may be due to uncontrolled
expenses or to the rapid rise of your invento-
ry and accounts receivable levels without your
realizing it. Indeed, if no management action is
taken, these impending problems could seriously
rario is therefore 1.5: 1, meaning that for every
P1.50 worth of cash, receivables, and invento-
ry in your current assets, you have PI.GO worth
of payables. This looks all right initiall I' because
you have more assets than liabilities. As a rule,
however, it is preferable to achieve a current ra-
add the total cash and receivables-P5o,000
plus PIOO,OoO-to come up with the sum of
PI50,OOO, which is far below the total current
liabilities of P250,OOO. This means that the
business is far from being liquid as the current
ratio suggests.
comparative analysis, data that you can find in affect your productivity and even threaten your tio of 2:1 or higher.
the financial statements may provide some in- company's survival. Generally, the higher the current ratio you Leverage ratios. After evaluating liquidity,
teresting signals that you can act on. How do you go about controlling your finan- get, the better for you because it means you have we also need to analyze the extent to which the
For example, you may not be aware that' " cials through the analysis of the company's busi- a stronger financial position. However, it is no business is relying on other people's money to fi-
nance its investments and operations. The degree by dividing net profit with sales. For example, the bank rate, it means that you have creat- In tlie restaurant business, in particular, the
of hnancial risk you are taking when taking debt if your net income is P50,000 and your sales is ed value for your business. If your return on eq- most critical ratio is the food cost percentage,
to help hnance the business can be measured by P1S0,000, your net profit margin is 33 percent. uity goes below market rate, however, it could which is computed by dividing the cost of food
the so-called leverage ratios. The higher the le- This figure becomes more meaningful when mean that even if the business is making mon- by the food sales and multiplying the quotient
verage ratio, the higher the risk and the greater compared to that of the previous period. If your ey, you might nor have been managing your in- by 100. This percentage is so sensitive that very
the probability of a huge loss if sales projections net proht margin is increasing, it means that you vestment efficiently. strict controls need to be implemented to ensure
don't turn out the way the business expects. are managing your resources efficiently. If it is proper releases of food inventory and supplies.
An example of the leverage ratio is the debt declining, however, it means that something is EBITDA This term stands for Earnings Before Yours may be a unique industry, however, so
ratio, which measures the percentage of debt in wrong with your operations and you need to in- Interest, Tax, Depreciation and Amortization. you may need to also develop your o\.vn critical
relation to total assets. For example, if your to- vestigate and correct the situation. You use EBITDA analysis when you need to ratio to allow you to manage your business more
tal debt (includ ing those you had borrowed from know the earnings capacity of the business. It effectively and efficiently .
the bank to finance your business) is P750,000 Return on profit or assets This orher profi t- is often understood as "cash earnings" be-
and your total assets is P1million, your debt ra- ability ratio measures the rate of return, which cause it only considers actual cash expenses
tio would be 75 percent. indicates the percentage of money gained or lost without non-cash items such as depreciation
Alternatively, you can also compute for your relative to the invesment you put in the business. and amortization expenses. For example, you The limitations
debt to equity ratio. First, you derive your equi- This rate is commonly known as ROI or return have an operating income before interest ex-
ty by subtracting total debt from your total assets on investment. Strictly speaking, the return on pense and income tax of PSO,OOOout of to- of comparative
to give you P250,OOO in total equity. You then investment refers to the total proht or loss made tal sales of PI million. Upon closer examina- financial analysis
divide total debt by total equity, which yields by the business relative to the assets in vested, tion using the income statement, you notice
a ratio of 3: l. This means that for every P3.00 which can be financed by both borrowings and that the reason for such low income was due It's definitely
you borrowed to hnance the business, you have equity. For example, net profit is PSO,OOOand the to huge depreciation expense of P2S0,OOOand useful to do
put in Pl.OO worth of your personal capital. As total assets are worth P500,000. To compute for amortization expense ofP100,OOO in the total financial analysis
a rule, you should not borrow more than half of return on investment, simply divide net profit by operating expenses. To compute for EBITDA, for your business.
your total assets, which means not exceeding a total assets to get ROI rate of 10 percent. But if you add back the depreciation and amortiza- but it does have
debt ratio of 50 percent. tion expenses amounting to P3S0,OOO to the limitations. You
:rrQRMU~ ,-~--~ operating income to get total cash earnings need to remember
Net profit margin Because profit depends on RETURN NET PROFIT '! ofP400,000. When you know your EBITDA, that it may not be
a lot of factors-among them the nature of the r ON INVESTMENT = TOTAL ASSETS
J you will be able to compare the profitabili- easy to compare
business, the company's market share, and the ty of your company against its nearest com- your financial ratios accurately with other
competitive life cycle of the company's prod- you compute for return on equity or ROE, you petitors on "apples-to-apples" basis. You can companies because they may be using
ucts-there is no hxed rule as to how much prof- simply remove liabilities from total assets so you also evaluate the capability of your business to different accounting methods or different
it margin a business should earn. For decision use only your invested capital as the main divisor. repay interest expenses or recover your fixed accounting periods. For example, your
making purposes, however, you generally would Assume that total borrowings of the company is capital investments by looking at monthly or business may be follOWing the calendar
want to find out if your prohts are increasing and P300,000, your equity becomes P200,000, which annual cash earnings. yearfrom January lto December 31, but the
how they compare with those of your competi- you will use to divide net profit to compute for When you want to evaluate business perfor- business you are comparing it with may be
tors in the industry. your ROE, which comes out at 20 percent. If you mance, financial ratios as a tool for financial anal- follOWing a fiscal year that starts on July
The net profi t margin is one of the ratios have repaid all your borrowings, then your retum ysis can be very helpful indeed. But these ratios 1and ends on June 30 the follOWing year.
that you can use for this purpose. It is calculated on investment will be the same as your return on alone are not enough. As important to you as an Also. your competitor may also be engaged
equity. When you know your rate of return, you entrepreneur, you need to interpret them prop- in other product lines that you don't have,
i_1HE.IURMULA: __ ---. can use it to evaluate your investment. erly and discover which of the ratios is most cru- which of course would make direct financial
One way to appreciate this percentage is to cial to your particular business. This way, you can comparison between that company and
! ON EQUITY= TOTAL ASSETS-LIABILITIES compare it with the prevailing money-market focus on realizing the ideal ratio tliat will enable yours extremely difficult.
,,-------------------- . " interest rate. If your return on equity exceeds you to achieve your financial objectives.
For example, you can use the budget to analyze it to increase by 25 percent, you could set your
your financial performance by comparing budget- budget for this year at P250,OOO.You can then ad-
ed to actual results. Assume, for instance, that just last year's operating expenses upward by, say,
your budgeted salary costs for the previous year to- 10 percent in computing your net income target.
taled PlOO,OOObut your actual spending reached This method is good for a start, of course, but the
PlSO,OOO.You then can look for the reason for process should not stop here. Your team should
the variance of PSO,OOO;you might find out, for
example, that it was due to overtime costs that
were not fully anticipated. In any case, the out-
come of this process can provide you with valu- Budgets coupled
able information tor planning the next budgetcy-
cle and for keeping your business on track.
with incentives
Of course, variances will always occur be- motivate people
tween budgeted amounts and actual results. You
therefore need to trace the causes of these vari-
to do thei r best
ances so you can correct emplovee behavior that
Indeed, budgeting

( IHE_EOBMULA:_ can change certain

behaviors, but
BUDGETED SALARY = Ploo,Ooo {\ those changes ca n

be either positive
or negative. Let's
assume that you
is proving unproductive to the business. For ex-
have an incentive

because budgeting isa very important part of goal-

ample, you might discover that your food costs ,....""t.. program that offers
udgetingis more than just putting have overshot your budget because the staff has

your salespeople a bonus each time they
numbers into your spr adsheet af- setting for the business. The process can elimi- not been controlling your inventory properly.
achieve their sales targets. If those sales
ter you have made your business nate a lot of confusion and misunderstanding in There may be times, though, when your staff is
targets are reasonable, your salespeople
pl,m. It's definitely not an activity the organization. It can also effectively impart not to blame for the variances. These variances
would obviously be positively motivated:
to be done only for a few days and the entrepreneur's business goals and vision to may have been caused partially by your compa-
they wi II work extra hard so they can get
then totally ignored afterwards. Because budget- the employees and provide rhem with a vehicle ny's lack of internal control. Whatever the out-
their bonus. However, if those sales targets
ing is based on assumptions regarding how sales for voicing their concerns and sentiments about come of the investigation, it is important that
are too high, your salespeople might get
and expenses will change in response to changes those goals and vision. Indeed, the participation the performance evaluation be done in a posi-
discouraged; they might think of those
in your business, it helps you manage your risks of the employees in the budgeting process could tive manner. Perhaps you may even considerre-
sales targets as impossible to achieve
and identify opportunities that may come along. help ensure the acceptance of those goals and vi- warding your employees every time they meet
in the first place, so they might just give
Having a budget allows you to specify which re- sion and eliminate any pockets of resistance. your budget; this is much better than the coun-
up without even trying. Thus, setting
sources to use in order to achieve your business Once a budget is approved, it becom s a stan- terproductive short-term corrective measure
targets requires you to make sure that
goals. Hence, budgeting should be part of a con- dard against which performance can be mea- of punishing them each time they fall short of
you have realistic assumptions, and such
tinuing planning process thar constantly monitors sured. As the budget becomes the basis for con- that budget.
assumptions ca n someti mes prove very
and measures all of the busin ss functions. trolling all business activities, it establishes the One quick way to create a budget is to look
difficult to make. Even if you may not get it
A good budgeting system is one that gets ev- parameters within which you and your employ- at your financials for the previous year and adjust
right the first time, though, you can improve
eryone in the organizarion involved in the bud- ees should function. You should therefore make them by a cerrain percentage to come up with
your chances through continuous planning.
geting process-from the business owner and key sure that it is immediately implemented as soon your budget for the succeeding year. For exampl ,
people all the way down to the employees. This is '. as it is finalized. if your sales last year was P200,OOOand you expect
estimate that your salaries expense budget will
increase by only 2 percent even if your sales
grows by 20 percent because you assume that any
Always put your increase would only be minimal and would like-
budget assumptions ly only come from overtime costs. As for selling
expenses, you may assume that it would increase
in writing! by 15 percent because you expect to spend more

in commission expense and marketing. '" .... ,
You also need to consider the economic fac-
assumptions \
tors that may affect your business. Rising compe- \
about the future
tition in your industry may affect your sales and \
is a critical part \
your ability to price higher. Higher inflation re-
of the budgeti ng
process. Based
sulting from a weakening peso and higher inter-
est rates may increase your operating expenses.

on experience, I
Changes in technology and government policy
the probability I
may also affect the way you run your business in
is high that you
the future. So, to come up with a good assump-
would forget the assumptions you had
tion, you may have to do research on economic
made several months after finalizing the
trends and assess how these will affect your fore-
budget. Forthis reason, it is wise to always
cast. You may also want to benchmark against
put your assumptions in writing. This way,
your competitors to get some ideas.
you can always refer to the document when
If you are in the manufacturing business, the
evaluating variances orwhen explaining
process is a little more tedious because you need
your budget to your investors. This will
to prepare additional budgets such as a produc-
also help you when you need to modify
tion budget, a direct materials budget, a direct
certain assumptions due to changes in the
labor budget, and a manufacturing overhead
macroeconomic climate.
budget. These budgets are critical as these will uccessful entrepreneurs with a good to generate enough funds to pay for your oper-

affect the costing of your product. Normally, business concept may consistently ating expenses. Sooner than you think, you will
thoroughly review the budget to find new ideas you will need the help of your production staff register record sales and profits, but be in financial distress and may even need to
and creative ways of controlling your costs, and to prepare these budgets because the process of they can still go bankrupt because close shop.
the inputs resulting from that review can then determining the cost behavior of these items of cash flow problems. Indeed, man- This is because the cash that goes in and out
be incorporated in the final budget. may be dependent on the technology of your aging cash flow is a critical area in finance, one of your company is actually what determines your
If you want to have a more detailed plan, manufacturing equipment as well as on the set- that can spell the difference between the success financial position. If you are in cash surplus, you
you can develop your final budget along with up of the manufacturing facility. and failure of a business. So, just like smart bas- can possibly invest the excess money in short-term
supplemental schedules for operating items. For Now that you know how a good budgeting ketball coaches who develop a winning strate- investments; ifyou are in cash deficit, on the other
example, after making your sales forecast, you system works, you have provided yourself with gy by reviewing their strengths and weaknesses hand, you may need to source financing to bridge
can create separate budgets for purchases, cost a map that shows you how far your company through the "stats" of their teams, entrepreneurs your cash shortfalls. Thus, for you to do good fore-
of goods sold, salaries, overhead, and selling ex- has grown and how much further you would should similarly monitor their cash flow "stats" to casts and effectively deal with changes in your
penses in accordance to your sales growth. Dur- want it to grow. But always keep in mind that develop an effective financial strategy. cash position, you need to dearly understand the
ing this process, it is important that you apply in budgeting, there is no absolute accuracy, only The lifeblood of any business is its cash flow. various factors that affect your cash tlow.
your personal knowledge and judgment in mak- plain educated guesswork. Indeed, you should Without it, the business is like a person drained In businesses where projected sales is the
ing estimates about the behavioral relationship use budgeting more as a guide rather than as a of blood. If you are always unable to collect your source of the cash receipts budget, managing
of your costs with sales. For example, you may "control tool. accounts receivable on time, you won't be able cash flow always starts with making sales fore-
casts. This is particularly the case if your busi- When doing a forecast for your cash flow, you the previous year, it would be good to assume a actual cash balance in the beginning of the month,
ness doesn't provide long-t rm credit to custom- may want to use the following template: Start seasonal pattern. For example, assume thar your but it ends with a projected cash ending balance.
ers. Good examples are businesses like food-cart with your actual cash ending balance from the sales in December last year was PSOO,OOO and you So, when you forecast for the second month, you
franchises, restaurants, candy shops, service cen- previous month. Add to this balance your cash noticed that there was a drop of 30 percent the fol- simply use the first month's cash ending balance as
ters, fashion garments, beauty salons, ice cream receipts during the month. After that, deduct lowing January. Then, when you make your sales the cash beginning balance for the next month.
parlors, and similar activities where sales trans- your cash disbursement from it during the cur- forecast for January in the succeeding year, you You need to follow this procedure for the rest of
actions are made in cash or by credit card. The rent month. You will then be abl to come up with need to apply a 30 percent downward adjustment the months of the year.
cash projection can be made simply by assuming your cash ending balance for the current month. on your preceding December sales. To complete a As business events unfold during the year, you
the amount of sales you expect to generate for a IZ-month forecast, you need to do the same pro- need to constant! y modify your cash flow forecasts.
particular period, then by aligning your expenses MR. ENTREP SAYS: cess for the remaining months of the year. You may have to lower your sales forecast in the
accordingly to estimate your cash flow. If you sell on credit terms or installment basis, middle of the year when, say, you learn that you
But when cash sales are not ufficient to cover Get expert advice make sure to consider in your cash forecast for a have lost some significant customer accounts to
your fixed expenses, cash flow problems can oc- particular month only the portion of the receiv- your competitors, Or you may have to adjust your
cur. Indeed, seasonality plays a key role in cash
when making able that you expect to collect on that month. expenses upward in the last quarter of the vear be-
flow forecasting because it affects the sales pat- your initial cash For your cash disbursements, you will need to cause of the additional sales staff that you expect to
tern for each type ofbusiness. For example, in the project your various expense categories, which you hire during the Christmas holidays. These adjust-
fashion garment business, monthly sales usually
flow forecast can identify from your accounting ledger. For som ments are necessary to make your cash-flow plan-
peaks during the holiday season but immediately expense items like rental, electricity, supplies, and ning accurate and up-to-date.
weakens during th following three months un- It's a good idea salaries, you may simplyget their historical monthly When you understand the concept of cash tlow
til it picks up again during the summer season. If to ask your averages during the previous year and project those andleam how to measure it accurately, you can im-
you are in the accounting business, there won't business advisor averages to the current year, with some lIlinor ad- prove the performance of your business and make
or accountant for
be so many activities during D cember, but your justments if need be. Another major disburse- it more competitive .
guidance when
business would start to pick up during the first ment item is your payments to suppliers. For this,
you are planning
quarter of the following year because of the tax
to construct
you will need to project how much inventory has MR. ENTREP SAYS:
season. Understanding your business is thus very your initial cash to be purchased monthly to meet your sales fore-
important in making realistic estimates for your flow fa reca st. cast. On that basis, you can then project your pay- Sources of
cash flow planning. Once the template has been made in mems to your suppliers based on your credit terms.
If you are in the wholesale business, your busi- consultation with him or her, you can For instance, if you need to pay your supplier after cash collections
ness would be Iikely to prov ide cred it to customers. thereafter simply put the figures in the 60 days, you have to input the amount you expect
template on your own to easily come up Yoursources
The typical credit you can give to customers rang- to pay for that particular month.
with your forecasts. In any case, always of cash
es from 30 days to over 90 day depending on your Once you have your forecast showing th to-
remember that having a cash flow forecast collections
willingness to invest in accounts receivable and on tal cash receipts and cash disbursements project- willeither be
can bring a sense of order and well-being
the level of competition in your industry. ed for each month of the year, you can get the d if- recurring or
not only to your business but also to
To accurately forecast your cash flow, of ference between them to determine your net cash nonrecurring:
yourself as an entrepreneur.
course, you need to know th pattern of cash col- flow. A positive net cash flow indicates thar you I Recurring

lections and to also know your customers. There have generated additional cash to your cash bal- items are those
are customers who always pay on time, but there This will also be your starting cash balance for ance; in contrast, a negative net cash flow means "... ~ that come from
are also customers who always delay and make it the next month, with which you can start doing you have overspent during the month by that operations, such as sales to customers.
I Nonrecurring items are those that come
difficult for you to collect. A point may even be your projection of cash receipts and disbu rsement amount, which then has to be deducted fi'omyour
from investment and financing, such
reached when you need to consider certain ac- for that month. starting cash balance for the next month. The re-
as capital advances from your business
counts as bad because it i no longer possible to For cash receipts, you will need to establish suIting figure will be your net cash flow for the
partners or proceeds from bank loans and
collect them. You need to consider all of these a realistic basis for estimating the next month's momh in question.
other items of similar nature.
factors when planning your cash flows. 'sales figure. If you have hLstorical sales data from The first month in the forecast always uses the
the cash-to-cash cycle of your business. The But precisely how do you start detennining
cash-to-cash cycle is simply the number of youI' cash-to-cash cycle'
days it takes you to collect your cash back af- Let's first look at each component--start-
ter investing it in inventory and receivables. ing with accounts receivable-to see how com-
The longer you wait to get your money back, puting your average collection period can help
which means that you are either unable to your business.
sell your inventory or collect your receivables One good indicator of the credit profile of
from clients, the higher the risk that you may your customers is your average collection pe-

/ -- run out of cash. riod. To figure this out, you need to first com-

,I You can calculate your cash-to-cash cycle

from your financial statements on a regular ba-
pute your receivables turnover by dividing total

\ I
.... _~
sis, say monthly or quarterly. This cycle is the
average collection period plus average inven-
tory age less the average payable period. When
you have this infonnation, you can easily an-
Don't let your
account receivables
alyze which part of the business you n ed to
improve. For example, assume that based on bleed out your
your last months' results, you have determined
yourcash-to-cash cycle to be 180 days. You can cash flows!
then investigate which component of the cy-
If you always
cle is causing this and seek solutions on how
have a hard
to improve it by reducing the number of days time collecting
of the cycle. receivables from
Your long cash-to-cash cycle problems cou ld your customers,
be due to any or all of these situations: (a) most it is highly
of your accounts receivable have long been over- probable that

Managing due, (b) you have so many slow-moving items

in your inventory that couldn't be unloaded in
the market,and (c) you may be paying yoursup-
a significant
portion of your
outstanding accounts receivable is bleeding

out your cash flows. Difficult customers
pliers too soon. You can fix these situations by
who always pay late are actually borrowing
coming up with the necessary policy changes
your money interest-free. Indeed. every time
with respect to your accounts receivables. Af-
your customers fail to pay on the due date,
ter that, you should monitor the trend of your you incur costs that may not be obvious
oyou fear that you will wake This is because many entrepreneurs don't un- cash-to-cash cycle during the following period

to you. These costs could be in the form
up one day to find out that derstand that when their sales increases, the lev- to see if there is any improvement. of opportunities that you have missed
you have to close down your el of their inventory and receivables also increas- You can discover so many things about your Forexample, you could have earned extra
business because you don't es. When this happens, the entrepreneur simply business when you make cash-to-cash cycle Income by placing your collection proceeds
have enough cash to pay for has no choice but to put in more cash into the analysis part of your cash management strategy. in the money market. Orthe cost may be the
all of your financial obligations? And why is business to finance its growth. SpeCifically, the analysis will enable you to con- actual interest expense you pay for money
you borrow from the bank to support your
it that sometimes, the more you become suc- One way to finance occasional cash short- centrate on improving your accounts receivable
working capital requirements each time you
cessful in your business, the higher the prob- ages brought about by an increase in business collection as well as your inventory and payable
can't collect your receivables.
ability that you would go bankrupt when you activity is, of course, to manage your cash more management, thus minimizing your risk of ex-
stumble into a serious cash crisis) effectively. You can do this by undel'standing periencing cash tlow problems.
percent per month on your investment, then
your slow-paying customers are actually cost-
ing you as much as P40,000 a month'
You can manage your cash flow better by
shortening your average collection period. You
can do this either by implementing a stricter
credit policy so that your credit sales would de-
crease in favor of more cash sales, or by intensify-
ing your collection efforts to lower your accounts /
,i V
receivable balance. To have a stronger focus on I
collection, you can age your receivables by break- I
ing down your accounts receivable balance into
"cunent," "30 days overdue," "60 days overdue,"
I ....
and "90 days overdue or over. " Through this, you
I \

can identify me customers with whom your busi- I

ness has the biggest exposure. You can men prior- I
credit sales with average receivable balance. itize your collection efforts accordingly . \
Assume, for example, mat your total sales
for the month was P3.5 million, and that out
of that amount, P2.5 million was sales on ac-
count. Your accounts receivable at the start of You need to focus
the month was, say, P5.5 million and it end d
the monm at P3.5 million.
on collecting
To compute for me receivables turnover, your small accounts
you divide the total credit sales of P2.5 million
(sales on account) with the average receiv-
able balance ofP4.5 million (P5.5 million plus
Normally, you
P3.5 million, divided by 2). This gives you a
should focus
ratio of 0.56. You then use this ratio to divide on your small
the standard 30 days for a month, giving you accounts
an average collection period of 54 days. receivables
If your normal credit term for your custom- because they
J""" have a higher oyou often experience cash or when they project their sales targets too

ers is 30 days and your actual average collec-
tion period is 54 days, men your collection is probability shortages and feel that you high for a forthcoming holiday season. While
overdue by 24 days. When you multiply this by ,.."""t. of getting are losing when, according this could be financially beneficial, the risk of
your average daily sales of P83,333 (P2.5 mil- collected. You may treat larger accounts to your accountant's report, loss could som times be greater than the po-
receivables that have long been overdue as you are actually making good tentia I rewards.
lion divided by 30 days), you will get the fig-
uncollectible and therefore need to be written profits? If you do, you may be overstocking your Losses from overstocking can happen when
ure of P2 million as your total uncollected ac-
off from the balance. Of course. depending
counts receivable. merchandise inventory for an extraordinary inventory is purchased from the supplier on
on the outcome of your collection efforts
You can now compute the cost to you of length of time. credit and you are unable to pay on time, thus
on customers with bad debt accounts, you
the ov rdue accounts by multiplying that fig- Many entrepreneurs tend to overbuy inven- forcing you to borrow cash from your relatives
can always take legal action against them if
ure by the normal rate of return from your tory to take advantage of quantity discounts es- and friends often at high interest ratcs. \Vhen
business. If your business is earning, say, 2 peciall y if the merchand ise comes from abroad, the payment for the loan becomes due, you get
mance measure. If you are underperforming
against the industry standard, you may need
to consider reducing your inventory level. You
c::m do this by eliminating slow-moving prod-
ucts and obsolete items or by simply increas-
ing your sales.
\X1hen you are intimately familiar with the
behavior of your inventory levels, you have the
advantage of managing your inventory level
more efficientll'. You can anticipate changes
I in product demand ahead of time and at the

--..aJtL same time control your costs and manage your

cash flows better. Indeed, creating an efficient
so pressured to raise cash that you are forced may need to start building your inventory in With that information in mind, you can inventory system is the ultimate key to your
to cut your selling price just so you can get rid anticipation of the summer season. manage the lead time of merchandise deliv- business success .
of your inventories. Wh n this cycle goes on In managing inventory, you need to con- ery. You can determine your ordering day by
and on without your noticing it, you are ac- sider the average turnover period of your prod- deducting the lead time from your turnover
tually incurring real losses from interest costs ucts. Some items move quickly, others move period. If it takes five days for your supplier
and lower gross profits-a situation that could only after some time. Because different items to deli vet after you place your order, you can Use your turnover
lead to a serious cash flow problem. are bought by different buyers, not all of your compure the ordering day by deducting 5 days
merchandise would have the same invento- from the turnover period of 13 days to give
period to work
SO HOW DO YOU MANAGE YOUR ry turnover. You can compute your inventory you 8 days. In this example, you can order your terms
INVENTORY BETTER? turnover by dividing your cost of sales by the your merchandise every 8th day of the aver-
Every entrepreneur, regardless of size of bus i- average inventory. The cost of sales is th cost age turnover period. This way, you can receive
with your supplier
ness, needs to understand the importance of ef- of the products you sold during the period; the the new purchases at a time when you expect
You can also use
ficient inventory management. When we say average inventory is the average of the begin- your old inventory to be sold out.
the turnover
efficient management, it doesn't mean that in- ning inventory and the ending inventory. Different industries have different turn- period as
ventory must be kept at low levels at all times; For example, assume that your sales for the over periods. There are situations when the your basis for
doing that could actually be detrim ntal to your month was P500,000 and that your cost was payment term is less than the average turn- determining
company in terms of lost sales and missed op- about 40 percent of it, or P200,000. If the bal- over period. When you know j'our inventory terms with
portunities. What it means is that there should ance of your inventory at the start of the month turnaround time, you can have a rough idea of your supplier.
be a system that could enable your company to was PIOO,OOOand your inventory at the end of how to negotiate your terms so you can prop- deally. the
balance its inventory requirements. the month was P75,000, your averag inven- erly control and manage your inventory level. payment terms
Depending on the industry where you be- tory would be P87 ,500. To compute for th in- If you are just starting in the business and you should be at least equal to or greater than
your turnover period. Under this example,
long, you should identify the factors that af- ventory turnover, you simply divide P200,000 still don't have any idea of your turnover pe-
you can negotiate with your supplier that
fect your inventory demands so you can con- by P87,500, which gives you 2.29 times. This rioel, it may be good to establish benchmarks
you will settle your account after 15 days. In
trol and manage them better. To begin with, figure means that you sold more than twic by spending some time researching and deter-
this scenario, you need not shell out cash to
demand for inventory is affected by seasonal your average inventory during the month. mining the industry average turnover period. purchase the inventory. Instead. after you
factors. For example, since retail sales are ex- To convert this ratio into turnover days, You can then use this as basis for your negoti- dispose of all of your inventories in 13days.
pected to be weak right after the Christmas you simply divide 30 days by 2.29 to give you ations with your supplier. you can use the proceeds from your sales for
season, you may need to relax your invento- the average turnaround time, which is 13 days. When your actual ratio is benchmarked some other purpose.
ry-buying during the first quarter of the follow- This figure suggests that on the average, you are with that of the industry, the industry <lV-
ing year. By the second quarter, though, yOLl'. able to sell out your inventory every 13 days. erage turnover period is also a good pelfor-
"",.--- .... ..
. You can manage your accounts payable tions just in time when you are about to pay

,V " \
better by stretching out the payment terms
as long as possible without damaging your
your suppliers.
In this example, let us say you can con-

credit standing with your suppliers. There vert all your inventories into cash in 12
are some business owners who pay their pay- days. This would mean that all. the 12th
I ables too early simply because they have so day, you would already have the available
I much cash in the bank, but what they don't cash to pay your suppliers and enjoy three
r alize is that they arc losing the opportuni- more days before your accounts payable be-
ty to earn extra interest income from their comes due. You can then take advantage of
cash. On the other hand, there are entre- this by depositing the cash in all. interest-
preneurs who pay their suppliers too late bearing bank account ..
and end up being slapped with penalties Sometimes, to encourage you to pay
and charges. It is thus important that you early rather than all. the due date, suppli-
manage your payables to the best interest ers lnay offer you a trade discount of, say,
of both you and your suppliers. 2 percent if you pay within 10 days for all.
As a general guide, you can determine account payable due in 30 days. In gener-
your days payable outstanding by first com-
puting your payable turnover. For exam-

ple, assume that your accounts payable at
the start of the month was PISO,OOO and When business
that during the month, you made total
, , merchandise purchases of P2S0,OOO. Af-
is slow, stretch out
I,' ter one month of operation, you found out your credit terms
~\ '
that the balance of your accounts payable
by month's end was PlOO,OOO. To compute
with su pliers
for the payable turnover, you need to di-
If business

vide your total purchases of P250,OOO by is slowing
the average accounts payable of PI2S,000, down and you
giving you a ratio of 2.0x. This ratio simply V are finding
tells you that you are paying for your put- it difficultto
chases twice a month. To get the number unload your

of days payable outstanding, divide 30 days inventory and
by the ratio 2.0. This will give you the av- to collect from
erage of IS days.
,..."""t. your customers,
you may consider stretching out your
What this means is that on the average,
credit terms with suppliers. From the same
it takes about 15 days for you to pay your
ave you ever wondered why time your suppliers come knocking all. your example, ifthe number of days to convert
suppliers. With this information on hand,
you sometimes experience your inventory to cash is rising to 18 days
door. The cause of the problem may be poor you can now check how many days it takes from 12days, you may need to negotiate your
cash shortages even if your accounts payable management. \'X/hen man- you to sell your inventory and collect all credit terms with your suppliers. for instance
business is booming? No aging cash flows, therefore, you should re- your receivables. Ideally, the total number by having the term extended by at least three
matter how m.uch money member that timing your accounts payable of days of inventory and receivables should more days up to 18 days to protect your cash
your business generat s, perhaps you always payments is as crucial as collecting your ac- position
not exceed your days payable outstanding;
feel that you are always short of cash every . "ounts receivables. this way, you would receive all cash coHec-
al, trade discounts are good because it
allows you to take advantage of it to
lower your purchase costs. But there
are times when trade discounts are not
favorable. How would you know if it is
good or not?
You can do this by computin the
effective interest cost on the assump-
tion that you are going to borrow the
money to pay your account in 30 days.
You then should compare this to the
prevailing borrowing rate from the
bank. The formula for effective annu-
alized interest cost is EAI = (discount
/100 percent - discount) x (365/ pay-
ment period - discount period).
Suppose the prevailing borrowing
rate is 16 percent per annum and you
are offered a 2 percent discount if you
pay in 10 days an account that is oth-
erwise payable in 30 days. Using the
above formula, we will find that the
effective annualized interest cost is 37
percent as compared to only 16 per-
cent, so it is wise to take advantage of
the discount. If you have negotiated
your credit terms to 60 days, your ef-
fective interest cost would be 14.9 per-
cent, lower than the prevailing bank
rate of 16 percent. In this case, you can
afford not to take the 2 percent dis-
\ count because it is cheaper to stretch
out your payment.
\ It is perfectly all right for you to
I control the terms of accounts payable
I so they are to your advantage. It wi II
I also be helpful if you can put a mon-
I itoring system where you can sort all
/ accounts payable that will soon be due;
this way, you will know just how much
cash you will need to prepare to pay
your suppliers on time.