Ch. 13: Management of Financial Resources

Types of Budgets

A budget is a plan for operating a business expressed in financial terms or a plan to control expenses and profit in relation to sales. Budgeting is the process of budget planning, preparation, control, reporting, utilization, and related procedures. Managers in profit-generating organizations usually compile a forecast income statement, often termed a pro forma statement, as part of their budget planning. This pro forma statement is a composite of the sales and expenditure budgets and includes a projection of profit. Foodservice operations often will have several different budgets. Most common are the operating and capital budgets; cash budgets also are important. Operating Budget. The first step in preparing the operating budget in most organizations is the development of the sales or revenue portion of the budget. Various internal and external influences must be considered in constructing the sales budget, which includes an estimate of revenues expected during the budget period. Past experience should be examined, including both past performance and past budgets, and any unusual aspects clarified. Capital Budget. The development of the capital expenditure budget usually is completed at the same time the operating budget is being planned. Improvements, expansions, and replacements in building, equipment (ex: if more than $5000), and land are the major capital expenditures. These major capital investments may be for purposes of expanding or improving facilities. Cash Budget. Many operations also will develop a cash budget, which is a detailed estimate of anticipated cash receipts and disbursements throughout the budget period. The cash budget will assist managers in coordinating cash inflow and outflow and in synchronizing cash resources with need. Can predict how much revenue you think you'll need

Ratios Categorized by Primary Use

A ratio analysis, or analysis of financial data in terms of relationships, facilitates interpretation and understanding. Computation of various types of financial ratios is an important tool in analysis. A ratio is a mathematical expression of the relationship between two items that may be expressed in several ways: as a common ratio, as a percentage, as a turnover or on a per unit basis. Ratio analysis constitutes an effective tool for evaluating financial stability and operating effectiveness, providing managers with the information they need to make decisions and control operations. Ratios frequently are categorized according to primary use; the major categories include the following: Liquidity. Liquidity ratios indicate the organization's ability to meet current obligations—in other words, its ability to pay bills when due. Solvency. Solvency ratios are used to examine an establishment's ability to meet its long-term financial obligations and its financial leverage. Activity. Activity ratios are designed to examine how effectively an organization is using its assets. These ratios usually are expressed as either percentages or turnovers. Profitability. Profitability ratios measure the ability of an organization to generate profit in relation to sales or the investment in assets. Profit or net income is an absolute term expressed as a monetary amount of income remaining after all expenses have been deducted from income or revenue; profitability is a relative measure of the profit-making ability of an organization. Operating. Operating ratios are primarily concerned with analysis of the success of the operation in generating revenues and in controlling expenses.

Vocabulary

Assets Resources of a company. Auditing An area of accounting concerned with an independent review of accounting records involving examination of records that support financial reports and formulation of an opinion regarding the fairness and reliability of these reports. Balance sheet Statement of assets, liabilities or debts, and capital or owner's equity at a given time or at the end of the accounting period. Break-even analysis Technique for assessing financial data to determine the point at which profit is not being made and losses are not being incurred. Budget Plan for operating a business expressed in financial terms. Common-size statements Financial statement in which data are expressed as percentages for comparing results from one accounting period to another. Contribution margin Proportion of sales that can contribute to fixed costs and profits after variable costs have been covered. Fixed costs (FCs) Costs that do not vary with changes in the volume of sales. Income statement Financial report that presents the net income or profit of an organization for the accounting period. Liabilities Debts of a company. Owner's equity Money value of a company in excess of its debts that is held by the owners. Pro forma statement Statement that projects expected income and expenditures. Time value of money Money has a differing value over time; having $1 today is worth more than receiving $1 in the future. Variable costs (VCs) Costs that vary directly with changes in sales.

Key Aspects of Accounting

Auditing is an area of accounting concerned with an independent review of accounting records. An audit involves examination of records that support financial reports and formulation of an opinion regarding the fairness and reliability of these reports. Make sure everything is documented. Usually an outside company that comes in for audit. Cost accounting involves the determination and control of cost. It focuses on assembling and interpreting cost data for use by management in controlling current operations and planning for the future. Traditionally, the cost of production processes and products has been cost accounting's emphasis, but increasing attention is being given to distribution costs. In a foodservice organization, service costs also are of particular concern. Financial accounting is concerned with the reporting of transactions for an organization and the periodic preparation of various reports from these records. Income statements and balance sheets are examples of statements prepared by the financial accountant. How you record your transactions. Managerial accounting uses historical and estimated financial data to assist management in daily operations and in planning future operations. Identifying the cost of alternative courses of actions is one important function of managerial accounting. Another is budgeting and the reports comparing performance to budget.

Investment Decisions

Expenditures included in the capital budget often require justification of the benefits to the organization of this capital expenditure. There are several methods that can be used to help evaluate capital budget requests; most commonly used are payback period and net present value (NPV). Payback period is an easy-to-compute indicator of the time it will take an organization to recover the money invested in a particular project or piece of equipment. Calculation of the payback period involves dividing the cost of the project or equipment by the expected annual income of cash savings. This result gives an estimate of the number of years that it would take for the income or savings from the project or equipment to equal the investment in that project or piece of equipment. Ex: How long will it take you to pay back money you used to buy yogurt machine? (Use money you made from yogurt machine to pay it back- Return on Investment (ROI)) Net present value (NPV) is considered a more sophisticated and preferred method for evaluating a proposed capital expenditure because it considers the time value of money. The NPV method determines the present value of expected future cash inflows and outflows related to a capital expenditure. Values money over time.

Controlling Costs

Improving the bottom line in an organization can occur either by increasing revenues or controlling or reducing costs. In many onsite foodservice operation, where opportunities to increase revenues are limited, the focus is on controlling or reducing costs. Controlling labor and food costs in a foodservice operation is a primary responsibility of the manager of that operation. Labor Costs. Controlling and reducing labor costs and simultaneously increasing labor productivity have been growing challenges for many years among managers of all types of foodservice operations. Labor cost is typically the most expense category of cost in a foodservice operation, so being effective in controlling labor costs can have a major impact on the financial performance of a foodservice operation. Full time people expensive because they get benefits. Overtime people = a time and a half, which is expensive. Control food costs. Use recipes that are standardized. Food Costs. Food costs are the second most expense category of cost in foodservice operations. The cost of food will vary depending on the quality of the items chosen, the quantity purchased, and the waste discarded. Managers can use a variety of strategies to help control or reduce the cost of food (See page 437 in the text). Cash Handling. Any foodservice operation that sells food must have sound cash handling practices in place. Cash in most organizations includes paper and coin currency as well as checks and credit/debit card transactions (See page 437 in the text). Make sure you trust whoever is handling cash because some people will steal. There are often cameras over cash registers and where employees are responsible for cash handling.

Menu Pricing Methods

Pricing menu items can be one of the most difficult decisions management makes. Menu pricing should cover the cost of food and labor and additional operating costs, including rent, energy, and promotional advertising. Other important factors to be considered when menu prices are set are perception of value and competition. Various methods are used to price menus; the one most often used is based on establishing a percentage of the selling price for food and labor. The three most often used in foodservice operations are discussed here: factor, prime cost, and actual-cost methods. Factor. The factor pricing method is also known as the markup method. Markup, the difference between cost and selling price, varies among types of foodservice operations. First, the desired percentage of food cost must be selected and divided into 100 to give a pricing factor; by multiplying the raw food cost by this factor, a menu sales price will result: Raw food cost * Pricing factor = Menu sales price Prime Cost. Prime cost consists of raw food cost and direct labor cost of those employees involved in preparation of a food item but not service, sanitation, or administrative costs. An accurate determination of prime cost for each menu item would require calculating the raw food cost and direct labor cost for pricing. In addition to cost records on raw food purchased for each menu item, time studies of the amount of direct labor would be required. Actual Cost. Actual cost is used in operations that keep accurate cost records. The initial step is to establish the food cost from standardized recipes and labor costs, which are the principal variable costs. Other variable costs, fixed costs, and profit can be obtained as a percentage of sales from the profit-and-loss statement. The menu price consists of the actual food cost + actual labor cost + other variable costs + fixed cost + profit.

Basic Financial Statements

Primary financial statements used by foodservice managers are the balance sheet and income statement. Each provides unique information necessary for analyzing the effectiveness of operations. The balance sheet is a statement of assets, liabilities or debts, and capital or owner's equity at a given time or at the end of the accounting period. Any assets you bought within year (including lands, building, furniture, glasses are considered assets) must be included in balance sheet. Monthly, quarterly, annually you can adjust it. The income statement is the financial report that presents the net income or profit of an organization for the accounting period. [See Slide 13-9] Takes profit and loss over specific period of time and puts it on statement so you can see it. Monthly, quarterly, and annually as well.

Users of Financial Statements

Seven groups of users of financial statements have been identified in profit organizations: owners, boards of directors, managers, creditors, employees, governmental agencies, and financial analysts. Each user group has a different need for financial data. Owners have invested in the business, and their primary concern is the state of their investment. Look at financial statements monthly or weekly. Boards of directors, elected to oversee operations and make business decisions for an organization, use financial statements to determine the effectiveness of managers supervising the daily operation. Managers are concerned with assessing the daily and long-term success of their decisions, and they use financial data to evaluate plans. Look at financial statements every month. Set a budget every year. Creditors, whose concern is the likelihood that payment obligations will be met, are those lending money or goods on credit to the operation. Employees have an interest in financial information to help assess the company's ability to meet wage and benefit demands. Governmental agencies are concerned with financial data as they relate to taxation and regulation. Financial analysts are persons outside the firm who desire information about a firm for their own or a client's purpose.

Balance Sheet

The balance sheet is a statement of assets, liabilities or debts, and capital or owner's equity at a given time or at the end of the accounting period. The balance sheet is considered a static statement because it presents the financial position at a specific date or time. The balance sheet, or statement of financial condition, is a list of assets, liabilities, and owner's equity of a business entity at a specific date, usually at the close of the last day of a month, quarter, or year. This statement is designated a balance sheet because it is based on a fundamental equation that shows that assets equal liabilities plus owner's equity. Assets. The first section of the balance sheet is a list of assets, which are generally categorized as current or fixed. Current assets include cash and all assets that will be converted into cash in a short period of time, generally 1 year. The cash accounts are cash on hand and in checking accounts and cash in savings. Other current assets include accounts receivable, inventory, prepaid expenses, and entrance fees receivable. Any marketable securities held would also be included as a current asset. Fixed, or long-term, assets are those of a permanent nature, most of which are acquired to generate revenues for the business. Fixed assets are not intended for sale and include land, buildings, furniture, fixtures, and equipment, in addition to small equipment such as china, glassware, and silver. Because fixed assets generally lose value over their expected life, their initial cost is reduced by a monetary amount each year called accumulated depreciation. Liabilities. Liabilities are categorized as current and long term. Current liabilities represent those that must be paid within a period of 1 year, including such items as accounts payable for merchandise, accrued expenses, and annual mortgage payment. Accrued expenses are due but not paid at the end of the accounting period, such as salaries, wages, and interest. Fixed, or long-term, liabilities, in contrast, are obligations that will not be paid within the current year. Owner's Equity. The owner's equity or capital section of the balance sheet represents that portion of the business that is the ownership interest, along with earnings retained in the business from operations. In profit-oriented enterprises, the ownership may be one of three kinds: A proprietorship, a business owned by a single individual. A partnership, a business owned by two or more people. A corporation, a business incorporated under the laws of the state with ownership held by stockholders. In a not-for-profit corporation, the members may be the owners.

Tools for Comparison and Analysis

The foodservice manager should use a variety of tools to analyze financial data, such as ratio analysis, trend analysis, common-size statements, and break-even analysis. The resulting operational indicators help managers understand financial information and compare performance to earlier periods. Internal standards of comparisons include a review of current performance in relation to budgeted performance, past performance, or preestablished department standards. External standards of comparison include a review of performance in relation to similar operations or comparisons with industry performance. Ratio Analysis. A ratio analysis, or analysis of financial data in terms of relationships, facilitates interpretation and understanding. [See Slide 13-11] When you report full and part time employees (3:1 ratio of full to part time employees) Inventory turnover (any turnover data) Do ratio analysis for anything that's reported as a per unit basis Trend Analysis. Trend analysis is a comparison of results over several periods of time; changes may be noted in either absolute amounts or percentages. It also is used to forecast future revenues or levels of activity. Trend analysis may use several of the various types of ratios discussed in the ratio analysis section. Common-Size Statements. Comparison among financial statements for various periods or from different departments within an organization may differ because of varying levels of volume. If financial data are expressed as percentages, however, meaningful comparisons can be made because data have a common base. Financial statements in which data are expressed as percentages are called common-size statements. These are especially useful in comparing results of the income statement of an operation from one accounting period to another or for comparing results among units of a multiunit operation. Break-Even Analysis. Break-even analysis is another tool for analyzing financial data; the name of this technique is derived from the term break-even point, or the point at which an operation is just breaking even financially, making no profit but incurring no loss. In other words, total revenues equal total expenses. Break-even analysis requires classification of costs into fixed and variable components. Fixed costs (FCs) are those costs required for an operation to exist, even if it produces nothing. These costs do not vary with changes in the volume of sales but stay fixed, or constant, within a range of sales volume. Insurance, rent, and property taxes are examples of fixed costs. Variable costs (VCs) are those costs that change in direct proportion to the volume of sales. As the volume of sales increases, a proportionately higher amount of these costs is incurred, as with direct materials or food cost.

Income Statement

The income statement is the financial report that presents the net income or profit of an organization for the accounting period. It provides information about the revenues and expenses that resulted in the net income or loss. The income statement is considered a flow or dynamic statement because operating results over time are presented. The income statement (also known as the statement of income or the profit-and-loss statement) is a primary managerial tool reporting the revenues, expenses, and profit or loss as a result of operations for a period of time. Sales or revenues include the cash receipts or the funds allocated to the operation for the period. In a foodservice establishment, the cost of sales section of the income statement reflects the cost of products sold that generated the revenue. Gross profit or income is determined by subtracting cost of goods sold from sales or revenue. Net profit or loss is determined by subtracting expenses from gross profit.

Selected Accounting Principles

Users of financial statements need a basic understanding of the principles underlying the preparation of these statements for proper interpretation. These generally accepted accounting principles (often referred to as GAAP) help provide consistency to the preparation of financial statements. Business Entity Concept. The business entity concept assumes that a business enterprise is separate from the person or persons who supply its assets, and the financial records of each are distinct. Without this distinction, determining the organization's true performance and current status would be impossible. Keeps business finances separate from personal finances. The Fundamental Equation. In accounting terminology, the resources, debts, and ownership interests of an organization are referred to as its assets, liabilities, and owner's equity, respectively. The relationship among them, "assets equal liabilities plus owner's equity," is known as the fundamental accounting equation. Going-Concern Concept. One of accounting's basic assumptions is that an organization will continue to operate for an indefinite time. This concept implies that the value of a company's assets is its ability to generate revenue rather than the value the assets would bring in liquidation. Money as a Unit of Measure. Money is the basis for business transactions and is the unit of measure commonly referred to as revenues. To lend uniformity to financial data, all business transactions are recorded as dollar amounts (in the US, other countries record transactions based on their currency). Cost Principle. The cost principle involves recording transactions or valuing assets in terms of dollars at the time of the transaction. Cost is the amount measured in dollars expended for goods or services. Cash versus Accrual Bases of Accounting. Two distinct methods can be used to determine when to record a transaction. The cash basis of accounting recognizes a transaction at the time of cash inflow or outflow. The accrual basis of accounting, which is used in most organizations, recognizes revenues when earned (regardless of when the actual cash is received) and expenses when incurred (regardless of when cash is dispersed). Matching Revenues and Expenses. The matching concept involves matching revenues with all applicable expenses during the accounting period in which they occur. For example, a restaurant owner may purchase food in one accounting period and sell it in the following period. If the matching concept is not used, the cost of the food would be recorded in the accounting period prior to when the sale was recorded, thereby overstating cost in the first period and profit in the next. Depreciation. Depreciation, an aspect of accrual accounting, is a systematic means by which costs associated with the acquisition and installation of a fixed asset are allocated over the estimated useful life of the asset. When you buy something new, as soon as you use it, its price will depreciate. Adequate Disclosure. Financial statements and their accompanying footnotes or other explanatory materials should contain full information on all data believed essential to a reader's understanding of the financial statement. Such disclosures might include accounting methods used, changes in accounting methods, and any unusual or nonrecurring issues pertinent to accurate interpretation of the financial statement. Consistency Principle. The consistency principle states that once an organization chooses an accounting method, it should be used from one period to another to make financial data comparable. Without consistent methods, financial statements could be interpreted incorrectly. Materiality Principle. Absolute accuracy and complete full disclosure may be neither practical nor economically feasible in presenting accounting information. The materiality principle means that events or information must be accounted for if they "make a difference" to the user of financial statements. Conservatism. Conservatism refers to the concept of moderation in recording transactions and assigning values. Historically, accountants have tended to be conservative, favoring the method or procedure that yielded the lesser amount of net income or of asset value.