Entrepreneurial Accounting

and Financial Management

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Agenda

Basic Costing and Evaluating Sources of

Accounting Pricing Investment Financing
Concepts Options
Basic Accounting Concepts
• Separate Entity Concept
• Internal Control
• Financial Statements
• Financial Ratios
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Separate Entity Concept

BUSINESS USE PERSONAL USE

• An owner cannot remove funds from business

without recording it
• An owner cannot extend funds to a business without
recording it

Basic Accounting Concepts

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Internal Control
Systematic measures by an organization to
(1) conduct its business in an orderly and efficient
manner,
(2) safeguard its assets and resources,
(3) deter and detect errors, fraud, and theft,
(4) ensure accuracy and completeness of its
accounting data
(5) produce reliable and timely information
(6) ensure adherence to its policies and plans.
Source: businessdictionary.com

Basic Accounting Concepts

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Basic Accounting Concepts

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Components of
Internal Control

Basic Accounting Concepts

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Basic Accounting Concepts

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Authorization

Record
Keeping

Custody

Segregation of Duties

Basic Accounting Concepts

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Supervision

Basic Accounting Concepts

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Supervision

Basic Accounting Concepts

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Balance Sheet

Basic Accounting Concepts

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Balance Sheet
Assets

Liabilities Equity

Basic Accounting Concepts

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Balance Sheet

• Summarizes a company’s financial position at

a point in time
• Helps assess financial strength and
capabilities

Basic Accounting Concepts

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Source: myaccountingcourse.com

Basic Accounting Concepts

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Income Statement

R Profit
E
V Cost of Materials
E
Salaries
N
U Rent
E Interest
Etc.

Basic Accounting Concepts

 17

Income Statement

• Measures a company’s performance for

a certain period of time
• Will show what drains the company’s
revenue
▫ May be useful in cost management
 Identifying inefficiencies
 Identifying points for improvement

Basic Accounting Concepts

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Basic Accounting Concepts Source: myaccountingcourse.com

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Statement of Cash Flows

Basic Accounting Concepts

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Statement of Cash Flows

•Expresses business results in

terms of cash
▫Cash keeps a business
functioning
▫Allows budgeting of cash
Can be useful in timing
payments of obligations
Basic Accounting Concepts
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Basic Accounting Concepts

Source: myaccountingcourse.com
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Statement of Cash Flows – Simplified

Direct Method Illustration

Operating

Investing

Financing

Basic Accounting Concepts

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Basic Accounting Concepts

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Profitability Ratio

A low gross margin ratio may indicate the ff:

• Price paid for inventory or raw materials is
too high
• Markup is low

Basic Accounting Concepts

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Profitability Ratio

A low profit margin ratio may

indicate that
cost management measures need
to be done.

Basic Accounting Concepts

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Liquidity

Basic Accounting Concepts

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Liquidity Ratio

A ratio of less than one

indicates a possible difficulty
to pay short-term liabilities
when they come due.

Basic Accounting Concepts

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Activity Ratio

May indicate the quality of credits sales and

receivables

Basic Accounting Concepts

Costing and Pricing
• Variable Cost
• Fixed Cost
• Breakeven and Target Profit Analysis
• Cost-based Pricing
• Operating Leverage
• Economies of Scale and Economies of
Scope
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Variable Cost

•Cost that directly varies

with changes in activity
•Constant on a per unit
basis

Costing and Pricing

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Variable Costs
Costing and Pricing
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Fixed Cost

•Cost that does not change

with changes in activity
•Constant in all levels of
activity

Costing and Pricing

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Fixed Costs
Costing and Pricing
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Marginal Cost

•Additional cost of
producing one unit of
product
•For business with high
capital investment
(e.g. machinery), this tends
to be low
Costing and Pricing
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Marginal Cost

Costing and Pricing

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Breakeven

•The level of sales at which

profit is zero

Costing and Pricing

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Breakeven Analysis : Illustration

A master baker prices his cupcakes at P60 per

piece. Average variable cost is P30. Fixed cost
averages P6,000 per month. How many
cupcakes must he sell in order to breakeven
(profit = 0)?

Costing and Pricing

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Solution

Breakeven (units)
= Fixed Cost / (Price – Variable Cost)
= P6,000/(P60-P30)
= 200 pieces

Costing and Pricing

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Target Profit Analysis

Costing and Pricing

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Target Profit Analysis : Illustration

A master baker prices his cupcakes at P60 per
piece. Average variable cost is P30. Fixed cost
averages P6,000 per month. How many
cupcakes must he sell if he wishes to earn
P3,000 monthly?

Costing and Pricing

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Solution
Target Profit (units)
= (Fixed Cost + Target Profit) / (Price –
Variable Cost)
= (P6,000 + P3,000)/(P60-P30)
= 300 pieces

Costing and Pricing

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Operating Leverage C
O Economies of Scale

Economies of Scope S

T
Costing and Pricing
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Operating Leverage

•Measures the degree to which a project

incurs a combination of fixed and
variable cost (Investopedia)

Costing and Pricing

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Low Leverage
E
A
R
N
I
N
G
S

Fixed
Cost
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High Leverage
E
A
R
N
I
N
G
Fixed S
Cost
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Operating Leverage: Illustration

A master baker prices his cupcakes at

P60 per piece. Average variable cost is
P30. Fixed cost averages P6,000 per
month. This results to 200 breakeven
units.

Costing and Pricing

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Operating Leverage : Illustration

The baker decides to buy various industrial
baking equipment. Variable cost decreases to
P25 primarily due to lesser labor time per unit.
Fixed cost, however, increases to P8,000,
primarily due to depreciation. What is the new
breakeven in units?

Costing and Pricing

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Solution

Breakeven (units)
= Fixed Cost / (Price – Variable Cost)
= P8,000/(P60-P25)
= 229 pieces
Increase by 29 pcs

Costing and Pricing

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Operating Leverage: Illustration

Assume the baker sells 1,000 cupcakes

in a month. How much did the baker
earn before buying the equipment and
how much after?

Costing and Pricing

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Solution

Earnings (before buying equipment)

= (Price – Variable Cost) *Units sold –
Fixed Cost
= (P60-P30) *1,000 – 6,000
=P24,000

Costing and Pricing

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Solution

Earnings (after buying equipment)

= (Price – Variable Cost) *Units sold –
Fixed Cost
= (P60-P25) *1,000 – 8,000
=P27,000
Increase by P3,000

Costing and Pricing

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Degree of Operating Leverage

DOL (before buying the equipment)
= Quantity*(Price – Variable Cost)/
Quantity*(Price – Variable Cost) – Fixed Cost
= P1,000*(P60-P30) / 1,000*(P60-30) – 6,000
= 1.25

Costing and Pricing

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Degree of Operating Leverage

DOL (after buying the equipment)
= Quantity*(Price – Variable Cost)/
Quantity*(Price – Variable Cost) – Fixed Cost
= P1,000*(P60-P25) / 1,000*(P60-25) – 8,000
= 1.30
Higher by 0.05

Costing and Pricing

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Economies of Scale

• Is the cost advantage that arises with

increased output of a product (Investopedia)
• The greater the quantity of output, the
lower the per unit fixed cost because
these are spread out over a larger
number of goods

Costing and Pricing

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Economies of Scope

• Is an economic theory that the average

total cost of production decreases as a
result of increasing the number of
different goods produced (Investopedia)
• Operational efficiency is gained
through related diversification as
products can share the same
production facilities and expertise

Costing and Pricing

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Finance in Action : Cost Management

How does a micro entrepreneur take

advantage of operating leverage,
economies of scale and economies of
scope?

Risk
Evaluating Investment Options
• Risk
• Diversification
• Time Value of Money
• Quantitative and Qualitative
Factors
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Investment Options

Accept Lease
Special or
Order? Buy

Make Investment
A or
or Investment
Buy B?

Stop
Temporary
Shutdown? Business
?

Evaluating Investment Options

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Risk

•A measure of uncertainty about

the outcome from a given event
•The greater the variability of
possible outcomes, on both the
high side and low side, the greater
the risk.

Evaluating Investment Options

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Risk
Riskier
Weather Sorbetes Cart Carenderia
Income Income

Rainy Day P300 P500

Cloudy Day P600 P600

Sunny Day P900 P600

Windy Day P500 P700

Range P300-900 P500-700

Evaluating Investment Options

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Risk Aversion
Risk averse is an investor who, when faced with two
investments with a similar expected return but different
risks, will prefer the one with the lower risk.

Weather Sorbetes Cart Carenderia

Income Income
Rainy Day P300 P500
Cloudy Day P600 P600
Sunny Day P900 P600
Windy Day P500 P700
Range P300-900 P500-700
Average P600 P600
Thus, a typical investor will prefer to invest in a
Carenderia in the above example.
Evaluating Investment Options
 63

Risk-Return Tradeoff

“The higher the risk, the

higher the expected
return.”

Evaluating Investment Options

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Diversification

Evaluating Investment Options

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Diversification

Evaluating Investment Options

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Diversification

• Reduces risk by allocating investments among

various financial instruments, industries and
other categories
• Aims to maximize return by investing in
different areas that would each react
differently to the same event. (Investopedia)

Evaluating Investment Options

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“Don’t put all your eggs in one

Evaluating Investment Options basket.”
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Finance in Action : Diversification

How does a micro entrepreneur

diversify?

Evaluating Investment Options

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Time Value of Money

Hanggang saan aabot ang bente pesos mo?

Evaluating Investment Options

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Hanggang saan aabot ang mo?

2016 1960

Evaluating Investment Options

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Time Value of Money

• The idea that money available at the present

time is worth more than the same amount in
the future due to its potential earning
capacity
• Provided money can earn interest, any
amount of money is worth more the sooner it
is received

Source: Investopedia

Evaluating Investment Options

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Present Value(PV) and Future Value (FV)

P20 with Compound Interest at 4%
FV
23
22.5
22.5

22
21.6
21.5

21 PV 20.8

20.5
20
20

19.5

19

18.5
Year 0 Year 1 Year 2 Year 3

TIME VALUE OF MONEY

Evaluating Investment Options
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Finance in Action : Inflation

• Inflation is the rate at which the general level of prices
for goods and services is rising and, consequently,
the purchasing power of currency is falling.

Average
3%

Evaluating Investment Options

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Finance in Action : Inflation

Year 2017 Year 2037

P9,000 EQUIVALENT TO P16,255

Appx. ---- 20 YEARS ----
minimum
wage

Evaluating Investment Options

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Quantitative and Qualitative Factors

Make or Buy
Quantitative Qualitative

Marginal cost of Lead time of

making supplier vs internal
manufacturing cycle

Cost, net of
discount from Quality of supplier’s
buying goods vs quality of
own goods

Marginal carrying
cost of inventory

Evaluating Investment Options

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Quantitative and Qualitative Factors

Lease or Buy
Quantitative Qualitative
Lease payments Risks of ownership
over a period of time (e.g. maintenance
and insurance)

Amount and timing

of payment from
buying Constraints in lease
agreement

Residual value at
the end of useful life

Evaluating Investment Options

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Quantitative and Qualitative Factors

Discontinue Product Line
Quantitative Qualitative
Impact of
Revenue and variable
discontinuation to the
cost from product line
business portfolio

Revenue and variable Market perception of

cost from best discontinuance and its
alternative investment effect on the brand

Evaluating Investment Options

Sources of Financing
• Internal
• External
• Equity
• Debt
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Internal Financing

•Surplus funds generated

through a firm’s operations

Sources of Financing
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Common Types of External Financing

•Equity (Additional Investment)

•Short-term loan
•Long-term loan

Sources of Financing
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Common Sources of Debt Financing

•Rural Banks
•Cooperatives
•Microfinance institutions
•State pension funds

Sources of Financing
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"In investing, what is comfortable is rarely

profitable."
- Robert Arnott