Entrepreneurial Financial Management Midterm
Production Budget (Purchases Budget)
Shows the number of units that are expected to be acquired during the budget period. The specific number of units that must be bought in each period is a function of how many units are on hand at the beginning of the period, how many are projected to be sold, and the desired number of units to be held in inventory at the end of the period.
Liquidity
A measure of how quickly a company can raise money through internal sources by converting assets to cash. A complete liquid asset is one that can be converted instantly to cash at its full value. An illiquid asset is one that cannot be sold quickly without suffering a significant discount from its true value.
Time Out of Cash EFM 6 - P 91
A measurement that can be used for assessing progress and that is sometimes asked for by potential investors and how long the current amount of cash will theoretically last
Disconnect Rate EFM 4 - P 62-63
A measurement tool needed to assist in monitoring the customer's behavior and to forecast revenues. It is the inverse of the average customer's economic life
Accounting Equation
A statement that assets equal liabilities plus owners' equity. (Assets = Liabilities + Owners Equity) The entire system of accounting, entries, reports, and financial statements are developed from equations.
"Language of Business" - EFM 1 - P. 3-4, & 49
Accounting is the language of business
Managerial Accounting
Accounting methods that are specially intended to be used by managers for planning, directing, and controlling a business. Forward-looking and attempts to predict the results of management decisions
Tax Accounting
An accounting approach based on specific accounting requirements set by government taxing agencies is produced to make tax returns and schedules—-is important for avoiding penalties for noncompliance and for minimizing how much money you have to pay in taxes.
Accrual Accounting EFM 8 - P 142
Revenue and expenses are recognized when the activities associated with them occur, rather than when cash is received or expended.
Factoring
Selling the rights to collect accounts receivable to an entity outside your business. A factoring company will usually pay you about 75-80% of the total amount that can be collected—then the factor collects the receivables
Microinventory
The purchase of inventory only after a sale is made, very typical with Internet firms. Special form of JIT
Economic Ordering Quantity (EOQ)
The statistical technique that determines the quantity of inventory that a business must hold to minimize total inventory cost. P. 523 - formula to determine EOQ
How to find Avg Customer Life in months
= [(# of customers this month - # of new customers - # of customers last month) / # of customers last month]
Three Types of Inventory in Manufacturing Firm
1) Raw materials 2) work in process 3) finished goods
Return On Investment (ROI) - - P. 531-2
A capital budgeting equation used to measure the relationship between initial investment and the profits that are expected to be received from making the investment.
How do you find disposal value?
Accomplished by subtracting from the estimated sale price the estimated costs of selling, disassembly, shipping, in other words, all costs necessary to dispose of the asset. This is the residual of many estimates
Categories of Fixed Costs:
Committed & Discretionary
Assumptions EFM 7 - P 123-4
Demand for the product or service, pricing, staffing requirements, the cost of materials, rents, etc., all have to be estimated, and these estimates are based on assumptions
How to find Disconnect Rate
Disconnection rate = ( l / avg. customer life in months)
EBITDA
Earnings Before Interest, Taxes, Depreciation & Amortization
What does Fair Market Value attempt to do?
Fair market value is an attempt to determine the price that the asset will bring, in its current location and condition, in an arms-length transaction between a willing buyer and a willing seller assigned from the point of view of the buyer, and thus includes the selling price and all costs to install, test, and prepare the asset for productive use
Income
Income is the cash that is available from the business to pay the entrepreneur's salary, whereas wealth is the value of the business if sold. Income is the day-to-day, month-to-month, year-to-year monetary needs of the entrepreneur and her family.
Stakeholders - EFM 1 - P12
Interested parties beyond the owners of a business who have a stake in the decisions made in that business and in the outcomes of those decisions
Pro Forma statement
Latin for: "in the form of" when used to describe financial statements, indicates estimated or hypothetical information. When they are linked and printed as a single set of financial statements, they are identical to the familiar business plan pro forma statements
What determines whether a cost is committed or discretionary?
Management strategy and the culture of the business Ex: If plant workers are considered to be discretionary costs, they will be laid off more quickly than if they are considered committed costs.
Burn Rate EFM 6 - P 91
Operating cash flow from the current month's statement of cash flow and it represents the amount of cash used that month just for running the business.
Master Budget
P. 434 Assumptions for Budget Illustration)A budget, also referred to as a comprehensive budget, consists of sets of budgets that detail all projected receipts and spending for the budgeted period.
Business Entity Concept
The concept that business has an existence separate from that of its owners. Separate business transactions from your own personal transactions. It is the Business Entity Concept that underlies the legal forms of establishing businesses, such as corporations, limited partnerships, and limited ability companies.
Replacement Value -P. 528
The cost incurred to replace one asset with an identical asset. You are estimating the value of a currently owned capital asset by determining the cost that would be incurred to replace it with an identical asset
Variance
The difference between an actual or budgeted revenue cost. Variances should be evaluated to determine the significance of a particular variance. Squaring the difference between the return from one period and the period that follows, then dividing the sum of squared differences by the number of periods. Variance = sum (Ri - Ravg) squared / N
What is the goal of capital budgeting?
The goal is to improve the quality of decisions about how to best use the scarce resources of the business.
Economy of Scale
The idea that it is cheaper (per item) to make many of an item rather than a few.
Variable Costs
Those costs that change with each unit produced, for example, raw materials. All costs that change with changes in output (which can be units made or sold, or sales revenue)
Fixed Costs
Those costs that remain constant regardless of quantity of output, e.g., rent. All costs that do not change because of changes in output. Those costs that cannot be (or are very difficult to be) assigned to a specific item sold or manufactured.
Time out of Cash calculation = Cash / Operating Cash Outflow per Month
Time out of Cash = Cash / Operating Cash Outflow per Month
Wealth
True wealth is the difference between what someone owns less the debits that are owed
Why is EBITDA used?
Used because it tends to reflect the cash profits that are generated by the operations of the business
Discretionary Fixed Costs
Usually annual in nature and can be cut back for short periods of time without too much impact on the company Ex: Company-sponsored Wellness Program
ROI Decision Rules
1) Accept only those alternatives for which the return on investment is equal to or greater than the business's weighted average cost of capital, which is the expected average future cost of funds 2) Accept the alternative with higher ROI among those that meet the first criterion.
Payback Period rules applied in choosing alternative investments:
1) Accept only those alternatives for which the time required to recoup the original investment is equal to or less than a maximum allowable time determined by management. 2) Accept the alternative with the shortest payback period among those that meet the first criterion.
How does JIT attempt to reduce inventory levels to the absolute minimum?
1) accepting inventory only as it is sold 2) assembling product in the absolute minimum time possible 3) shipping product to the customer immediately upon completion
Committed Fixed Costs
1) are long term in nature and 2) are difficult to cut back to zero without impacting profitability or long term goals Ex: Investments in facilities, equipment and basic infrastructure
Financial Accounting
A formal, ruled-based set of accounting principles and procedures intended for use by outside owners, investors, banks, and regulators.
Capital Lease - - P. 534
Are leases in which at the end of the lease period, the asset becomes the property of the lessee, possibly with an additional payment.
Net Present Value (NPV) Analysis
Based on the concept that a dollar to be received right now has more utility (value) than does a dollar to be received at some time in the future. To perform an NPV analysis, only cash flows are considered.
Payback Period - P. 531-2
The amount of time it takes a business to earn back the funds it paid out to obtain a capital asset. Only cash flows are considered
Sales Budget
First step in preparing a master budget. Shows the projected future level of sales in units multiplied by the sales price per unit
Pledging Receivables
Giving a 3rd party legal rights to debits owed your business in order to provide assurance that borrowed money will be repaid. To a commercial lender, this is usually less expensive than factoring. When you pledge receivables, your business is liable only for the borrowed amount and accrued interest on the loan, regardless of the amount that is subsequently collected from your customers.
Point-Of-Sales (POS) System - P. 526
Hardware and software combinations that integrate inventory management directly into accounting software. Comprises both hardware and software to integrate inventory management directly into your accounting system
Two Types of Financial Goals
Income and Wealth
Going Concern
The accounting concept that a business is expected to continue its existence for the foreseeable future. As a separate entity, the business may continue in business even if sold to other owners.
Break Even Calculation
Quantity = Fixed Costs / Price per unit - Variable cost per unit
Equation for ROI
ROI = (average annual profits) / (average investment)
Disposal Value - P. 528
The net amount realized after subtracting the cost of getting rid of an asset from its selling price.
Utilization Ratio - EFM 4 - P 61
The percentage of time spent in billable work. Factors such as time travel or ongoing required training will lead to lower utilization rate—from book
Just-In-Time (JIT) Inventory System
The practice of purchasing and accepting delivery of inventory only after it has been sold to the final customer. It is the ultimate extension of pull-through processing.
Fair Market Value - P. 528
The price at which goods and services are bought and sold between willing sellers and buyers in an arms-length transaction
Capital Budgeting - P. 531
The process of deciding among various investment opportunities to create a specific spending plan.
Retained earnings
The sum of all profits and losses, less all dividends paid since the beginning of the business. The monthly bank statement gives you the check and deposit information as well as any fees the bank charges you, or interest it pays into your account.
Current Ratio
The value of current assets divided by current liabilities. It is the most common ratio used to estimate liquidity. Rule-of-thumb for evaluating current ratio is that the minimum acceptable ratio is 2.0, and higher is better
How does capital budgeting work?
Works by determining the costs and benefits of each alternative investment, such as machinery or real estate.