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Easy Business Finance: From Bookkeeping To Financial Reports And Ratios 

Easy Business Finance: From Bookkeeping To Financial Reports And Ratios 

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Easy Business Finance: From Bookkeeping To Financial Reports And Ratios 

ratings:
5/5 (2 ratings)
Length:
166 pages
1 hour
Publisher:
Released:
May 16, 2014
ISBN:
9781909652644
Format:
Book

Description

This edition of the book is tailored specifically to US business finance. Do you break out into a cold sweat at the sight of company accounts? Do you ignore the financial aspects of your job, hoping they’ll go away? Is lack of financial confidence holding you back? The fact is that you can learn how to read company accounts as well as picking up sound financial management techniques in just a couple of hours, and Painless business finance is the way to do it. Balance sheets and profit and loss accounts needn’t be mysterys any longer. You don’t have to be tortured by colleagues’ conversations about key financial ratios and cash flow statements. You’ll soon be able to participate fully and confidently in every aspect of your company’s financial performance and understand how to measure it. With Painless business finance at hand you need never be frightened by finances again!
Publisher:
Released:
May 16, 2014
ISBN:
9781909652644
Format:
Book

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Easy Business Finance - Ken Langdon

Answers

Part One

Introduction

It is truth universally acknowledged that finance professionals have at their disposal a mass of jargon which can take trainee accountants, new managers and new business owners some time to learn. Managers who are promoted and facing new challenges are trained for the physical task they have been assigned, but may have no experience of the bunch of financial hurdles and measures that come with the job. Trainee accountants have to get the basics absolutely right if they are to become dependable sources of the financial assistance that it is their role to supply. And someone who has just started running a business needs to understand what’s going on. Knowledge of the applications of the inevitable jargon is an essential tool.

Everyone feels they ought to know some of this financial information, especially since we probably learned some of the basics at school or college. This book will help you to recall those basics and then build on them in order to be as financially literate as you can possibly be. If you’re totally new to the subject then this is a great introduction. You may, of course, be an aspiring accountant in which case a solid understanding of bookkeeping is not just nice to have, it’s a must. Bookkeeping is to accountancy what arithmetic is to mathematics.

In the bookkeeping section I cover everything from trial balances to journals, from bank reconciliation to depreciation. Then, to make quite sure you’ve really got it, there are exercises at the end of the book that you can use to test your knowledge.

If you’re a line manager you ought to have a reasonable knowledge of the bookkeeping section – certainly enough to approach the second part of the book which covers income statements, balance sheets and cash flow statements. From these statements you can derive the ratios you need to take the financial pulse of a business. After all, your bosses are going to measure your performance by a subsection of these ratios, so you had better understand them.

In short, in this book lie the universal truths of bookkeeping and financial statements…

1 The business model

To understand business finance it is useful to have a diagram of how money flows round a business. Here is the business model:

Sources of money

The money used (or capital) in the business comes from stockholders (the owners) and lenders. Initially, the owners will pay for shares of stock and this money is invested in the business. As profits are earned, some of these profits are returned to the stockholders by way of dividends. If a company wishes to grow, it will retain profits within the business. These retained profits still belong to the stockholders but are being used to finance growth.

In the past, the term ‘stockholders’ funds’ was used to describe the amount of stockholders’ money invested in the business. The modern term is ‘equity’. Equity is therefore made up of the stockholders’ initial investment plus retained profits. The company owes this money to the stockholders but has no obligation to pay it back.

A company can borrow cash from a variety of sources. In a small business, the owners will often provide loans to the company – sometimes at a low rate of interest. The line of credit from the company’s bank is a popular form of financing since the company can access cash according to the needs of the business. However, lines of credit will usually carry a higher rate of interest than a long-term loan.

There is a wide range of other financial institutions seeking to lend to businesses. For the purposes of this book about basic finance, we will consider only the straightforward case where the loan is for a fixed term.

The implications of these two sources of money are different. In one sense, money from stockholders is cheaper. Return on the stockholders’ investment comes in the shape of dividends that are normally paid twice a year. In the early stages of a business the owners may very well drop the requirement for dividends and allow the managers to retain all the profits to allow them to grow the business. At that stage the money could be said to be free.

There is also no need for the managers to plan to have the cash to buy back the stock; in practical terms the money is in the company forever. The only downside in using stockholders’ funds to get a major business going is the cost of raising money in this way, since lawyers and accountants don’t come cheap. Another problem is that the business has to find someone willing to take the risk of putting money into an enterprise which, who knows, may fail. If the business does fail the owners lose all the money they have invested. It is this risk of failure which makes stockholders demand, in the long term, that their overall returns should be higher than the providers of loans. They get this return through the growth of dividends that the company pays out. In the long term, of course, if the company’s stock is traded on a stock market exchange the stockholders are hoping that the price of the shares will go up.

Loan finance (usually referred to as debt) is cheaper to arrange. Banks and financial institutions assess the risk of the company, make loans and charge an interest rate to reflect the perceived risk. It seems reasonable that they should tailor their interest charges to protect themselves against the risk of default; the problem is that a business in dire straits and in desperate need of cash has to pay more to get it – adding to the downward spiral.

Also, with debt, don’t forget, you have to plan how you’re going to repay the money within the agreed timescale.

Leverage

Leverage is a term that accountants use to confuse people. It is used in a variety of situations but always has the same implication. The easiest way to explain leverage is to describe a familiar situation. Suppose I buy a house for $100,000 with a 90% interest-only mortgage. I have put in $10,000 of my own money and that is my ‘equity’ in the house. Consider what happens if the value of the property goes up by 10%.

The value of the property has gone up by 10% but my equity has gone up 100%. Excellent: easy money! The risk, of course, is that the price of the property may fall by 10%, in which case all of my equity is wiped out. If the value falls further, then I am into the position known as negative equity – note how financial terms are often used in everyday life.

The effect of leverage is to multiply my gains. In this case a 10% increase in the value of the house gave me a 100% increase in equity. Leverage is 10x (ten times). Notice that this multiplier can be applied to any percentage change in the value of the house. So, for example, a 25% increase in the value of the house in our example will give a 250% increase in equity.

Where the money is invested

The equity and debt come into the company as cash. Managers spend this on, for example, raw materials, labor and expenses in

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