Chapter Fourteen

Basic Financial
Planning

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reserved
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 Learning Objectives, 1

• Explain the need for profit planning for a

small business.
• Discuss what causes changes in the financial
position of a company.
• Understand the financial structure of a
business.
• Apply the theory of cost of goods sold.

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 Learning Objectives, 2

• Learn how to plan to make a profit in a small

business.
• Plan for a profit for an actual small business.

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 What Is Profit Planning?
Profit planning is a series of prescribed steps to
be taken to ensure that a profit will be made.
• Determine how much profit you want and how to
achieve it.
• Learn how to set up an accounting system for your
firm and how to read, evaluate, and interpret its
accounting and financial figures.
• Evaluate, or estimate, your firm’s financial position.
• Profit Planning must precede other activities.

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 Tracing Changes in a Company’s
Financial Position, 1
• Accounts receivable may reflect profits, but
many of those accounts may not be
collectible.
• Too much money may be tied up in assets
and not available to pay bills as they come
due.
• The process of tracking cash flow.

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 Tracing Changes in a Company’s
Financial Position, 2
Some small firms make a
profit and still fail, since
profits are not necessarily in
the form of cash.

Benchmarking
• Setting up standards (for
reference) and then
measuring performance
against them.
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 Importance of Accounting
Accounting records are records of a firm’s
financial position that reflect any changes in that
position.
• The continued operation of your business also
depends on maintaining the proper balance among
its investments, revenues, expenses, and profit.
• Day-to-day business is reflected in the financial
statements.

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 What Is the Financial Structure
of a Business? 1
Financial structure describe the relative
proportions of a firm’s assets, liabilities, and
owners’ equity.
• Changes constantly as business activities occur.
• The total liabilities plus owners’ equity always
equals the total assets of the firm.

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 What Is the Financial Structure
of a Business? 2
Balance sheet is a statement of a firm’s assets,
liabilities, and owners’ equity at a given time.
• The balance sheet is a gauge of the financial health
of your company.
• Shows how assets are being used.
• Provides a snapshot of your company at a given
moment.

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 Balance Sheet

Jump to Balance Sheet, Appendix 1

Jump to Balance Sheet, Appendix 2
Jump to Balance Sheet, Appendix 3
Jump to Balance Sheet, Appendix 4
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 Assets
Assets Accounts receivable
• The things a business • Current assets
owns. resulting from selling a
• Includes cash, accounts product on credit.
receivable, inventory,
equipment, building,
and other things of
value to the company.

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 Liabilities
Liabilities
• The financial
obligations of a
business.

Accounts payable
• Obligations to pay,
resulting from
purchasing goods or
services.
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 Owners’ Equity
Owners’ equity
• The owners’ share of (or net worth in) the business,
after liabilities are subtracted from assets.
• Owners’ receive income from profits in the form of
dividends or an increase in their share f the
company through an increase in retained earnings.
• Owners’ also absorb loss, decreasing equity.

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 Profit-Making Activities
of a Business
Income statement (profit and loss statement)
• Periodically shows revenues, expenses, and profits
from a firm’s operations.
• Net income (profit) equals Revenue (income) minus
Expenses (costs)

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 Income Statement

Jump to Income Statement, Appendix 1

Jump to Income Statement, Appendix 2
Jump to Income Statement, Appendix 3
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 Revenue and Expenses, 1
Revenue (sales income)
• The value received by a firm in return for a good or
service.

Expenses
• The costs of labor, goods, and services.

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 Revenue and Expenses, 2
Cost of goods sold
• The total cost in terms of raw materials, labor, and
overhead of the business that can be allocated to
production

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 Profit
Profit (income)
• The difference between revenue earned and
expenses incurred.
• Depending on the type of expenses deducted, profit
may be called gross income, operating profit, net
income before taxes, or net income.

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 How to Plan for Profit in
a Small Business
A well-managed small business has the following
characteristics:

• It is more liquid than a badly managed company.

• The balance sheet is as important to the owner as
the income statement.
• Stability is emphasizes, instead of rapid growth.
• Long-range planning is important.

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 Steps in Profit Planning, 1

• Establish a profit goal.

• Determine the volume of sales revenue
needed to make that profit
• Estimate the expenses you will incur in
reaching that volume of sales.
• Determine estimated profit, based on plans
resulting from steps 2 and 3.

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 Steps in Profit Planning, 2

• Compare the estimated profit with the profit

goal.
• List possible alternatives that can be used to
improve profits.
• Determine how expenses vary with changes
in sales volume.

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 Steps in Profit Planning, 3

• Determine how profits vary with changes in

sales volume.
• Analyze your alternatives from a profit
standpoint.
• Select an alternative and implement the plan

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 Profit Planning Applied in a
Typical Small Business, 1
• Profit goal is the specific amount of profit
one expects to achieve.
• Sales forecast is an estimate of the amount of
revenue expected from sales for a given
period in the future.
• Kaizen costing sets cost targets for all phases
of design, development, and production of a
product for each accounting period.

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 Profit Planning Applied in a
Typical Small Business, 2
• Breakeven point is that volume of sales
where total revenue and expenses are equal,
so there is neither profit nor loss.

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 Profit Planning Applied in a
Typical Small Business
While an analysis of past costs is helpful in
projecting future expenses, be aware that:

• The relationships exist only within limited changes in

sales volume.
• Past relationships may not continue in the future.

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 Breakeven Chart for
The Model Company

Jump to Breakeven Chart for

The Model Company, Appendix 1
Jump to Breakeven Chart for
The Model Company, Appendix 2

Jump to Breakeven Chart for

The Model Company, Appendix 3
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 Alternatives to Increase Profits

• Change sales price.

• Change media, and slash or amount
budgeted, for advertising
• Reduce variable costs.
• Change quality of products.
• Stop producing and selling low-margin
products.

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 Appendices

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reserved
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 Balance Sheet, Appendix 1
The balance sheet has two parts: assets and liabilities and
owners’ equity. Each section has certain parameters mentioned
with their corresponding values in terms of United States dollars.

The data from the assets section of the balance sheet as on

December 31 open parenthesis year not mentioned close
parenthesis are as follows:

Current assets
Cash: 7,054
Accounts receivable: 60,484
Inventory: 80,042
Jump back to Balance Sheet
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 Balance Sheet, Appendix 2
Prepaid expenses: 1,046
Total current assets: 148,626

Fixed Assets
Equipment: 100,500
Building: 40,950
Gross fixed assets: 141,450
Less: accumulated depreciation: 16,900
Net fixed assets: 124,550
Total assets: 273,176

Jump back to Balance Sheet

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 Balance Sheet, Appendix 3
The data from the liabilities and owners’ equity section of the
balance sheet as on December 31 open parenthesis year not
mentioned close parenthesis are as follows:

Current liabilities
Accounts payable: 51,348
Accrued payable: 3,060
Total current liabilities: 54,408

Long-term liabilities
Mortgage payable: 20,708
Jump back to Balance Sheet
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 Balance Sheet, Appendix 4
Total liabilities: 75,116

Owners’ equity
Capital stock: 160,000
Retained earnings: 38,060
Total equity: 198,060

Total liabilities and owners’ equity: 273,176

All the values mentioned in the balance sheet are in U S dollars.

Jump back to Balance Sheet

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 Income Statement, Appendix 1
The income statement contains many measure parameters with
their corresponding values in United States dollars. The data
shown in the income statement are as follows:

Net sales: 463,148

Less: Cost of goods sold: 291,262
Gross income: 171,886

Operating expenses
Salaries: 83,138
Utilities: 6,950
Jump back to Income Statement
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 Income Statement, Appendix 2
Depreciation: 10,050
Rent: 2,000
Building services: 4,920
Insurance: 4,000
Interest: 2,646
Office and supplies: 6,550
Sales promotion: 11,000
Taxes and licenses: 6,480
Maintenance: 1,610
Delivery: 5,848

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 Income Statement, Appendix 3
Miscellaneous: 1,750
Total expenses: 146,942

Net income before taxes: 24,944

Less: Income taxes: 5,484
Net income after taxes: 19,460

All the values mentioned in the income statement are in United

States dollars.

Jump back to Income Statement

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 Breakeven Chart for
The Model Company, Appendix 1
The x-axis on the line graph represents volume in terms of the
number of units sold, and it ranges from 0 to 700 units at
intervals of 50 units. The y-axis on the line graph represents the
revenues and expenses in multiples of 1,000 United States
dollars, and it ranges from 0 to 700 United States dollars at
intervals of 50 United States dollars.
There are two lines: the total expense line and the sales income
line. The total expense line starts at open parenthesis 0,100
close parenthesis and ends at open parenthesis 700, 618 close
parenthesis. The sales income line starts from the origin and
ends at open parenthesis 700, 700 close parenthesis. These lines
intersect at the center of the graph. This point of intersection
represents the breakeven point. Jump back to Breakeven Chart for The Model Company
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 Breakeven Chart for
The Model Company, Appendix 2
The area covered between the two lines, below the breakeven
point represents the loss, and the area above represents the
profit. The graph shows the following propositions in terms of
numerical representations:
The breakeven volume of sales and total expenses of 364 units is
equal to 364,000 United States dollars.
The estimated sales revenue is equal to 364,000 United States
dollars.
The estimated profit for approximately 530 units is 40,000
United States dollars. The estimated volume and the estimated
total expenses for approximately 530 units are equal to 490,000
United States dollars.
Jump back to Breakeven Chart for The Model Company
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 Breakeven Chart for
The Model Company, Appendix 3
The estimated sales revenues are equal to 530,000 United States
dollars.

The estimated profit is equal to 81,300 United States dollars.

The estimated sales revenue is equal to 700,000 United States
dollars.

Fixed expenses are equal to 88,100 United States dollars.

Variable expenses are equal to 530,600 United States dollars.
Total Expenses are equal to 618,700 United States dollars.

Jump back to Breakeven Chart for The Model Company

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