Financial Management for Entrepreneurs

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Financial Management forEntrepreneurs
Introduction and Financial Statement Overview
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What is Small Business?

• SBA Definition
• Wholesale 100 employees or less
• Manufacturing 500 employees or less
• Retail sales less than 5 million (flexible to
  21 million)
• Service sales less than 1.5 million (Flexible
  to 21.5 million)

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Need for Personal Guarantees

• Required by banks
• secured by business assets
• secured by personal assets
• Business and Owner are One
• Why?

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Lifestyle Businesses

• Not Growth Oriented
• Goal is Survival and Income for Owner
• Also called Mom and Pop Businesses
• Concerned with Personal Goals of Owner
• About 95 of small firms are Lifestyle businesses
• What is the Primary Motivation of the Owner of
  these types of Businesses?

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Entrepreneurial Businesses

• Growth and Profit Oriented
• Try to Attract Outside Investors (most funds will
  come from them)
• Eventual Goal is to Go Public
• About 5 of small firms are Entrepreneurial
  Businesses

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Forms of Business Organization

• Sole Proprietorships
• Partnerships
• S Corporations
• Limited Liability Companies (LLCs)
• C Corporations

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Sole Proprietorships

• Account for majority of small
• businesses
• Most Businesses start out as Sole Proprietorships
• 15.1 million in 1993

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Advantages of Sole Proprietorships

• Inexpensive to Start
• Complete Management Control
• Income flows through to Owner and is taxed at
  Owners Personal Marginal Tax Rate

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Disadvantages of Sole Proprietorships

• Limited Availability of Capital
• Unlimited Legal Liability of the Owner
• Difficult to Transfer Ownership
• Limited Life

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General Partnerships

• Two or more owners
• 1.6 million Partnerships in 1993

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Advantages of Partnerships

• Easier and Greater Access to
• Capital
• Pooling of expertise
• Thats all folks!

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Disadvantages of Partnerships

• More Expensive and More Difficult to Manage and
  Control than Proprietorship
• All Partners are Jointly and Severally Liable!
• Cannot Change Ownership Composition
• Difficult to Transfer Ownership

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Limited Partnerships

• One General Partner with unlimited personal
  liability
• Limited Partners
• cannot actively manage
• not personally liable
• primarily created for tax purposes

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Sub-Chapter S Corporations

• Characteristics of both Corporations and
  Partnerships
• limited liability of corporate form
• taxed like partnerships
• 35 or fewer shareholders
• Other Corporations or Partners cannot be
  shareholders
• Shareholders must be US Citizens

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Limited Liability Companies (LLCs)

• Corporations Taxed as Partnerships
• Similar to S-Corporations but
• can have more than 35 owners
• can have foreign owners
• Currently Adopted by 43 States
• Will Eventually Replace S-Corps

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C-Corporations

• Separate Legal Entity
• 25 of all Businesses
• Most Growing Small Businesses Eventually Become
  Corporations
• Dominate in terms of Value of Assets

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Advantages of Corporations

• Limited Liability (but not necessarily for small
  firms)
• Greater Access to Capital
• Unlimited Life
• Ease of Transfer of Ownership

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Disadvantages of Corporations

• Double Taxation
• More Complex to Manage
• More Expensive to Maintain

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Objectives of a Small Business

• Financial
• To Provide Maximum Income to the Owner
• To Grow - That is, to increase future after-tax
  income
• Non-Financial
• To provide a job
• For other Lifestyle reasons
• to achieve independence
• to be challenged and creative

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Financial Statements, Depreciation and Cash Flows
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Financial Statements
Levels of Sophistication

• Audited Statements
• Reviewed Statements
• Compiled Statements
• Tax Returns

The statements you receive from your clients
will vary in terms of their sophistication. One
of your first tasks will be to ensure that they
are in good form.
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Financial Statements
Types

• Income Statement
• Balance Sheet
• Cash-Flow Statement

Small firm income (profit loss) statements will
be the same or similar to audited corporate
financial statements. However, balance sheets
are less frequently compiled and cash flow
statements may never be. In addition, the equity
section on the balance sheet will vary depending
on whether the firm is a proprietorship,
partnership, or corporation.
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Cash versus Accrual Accounting
Financial Statements

• Cash
• revenues recognized only when collected
• expenses recognized only when paid
• Accrual
• Revenues recognized when realized
• Expenses recognized when realized
• Most small businesses prefer cash-basis
• Analysts generally prefer accrual-basis

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Cash Transactions
Financial Statements

• Transactions related to business activity
• inventory
• payroll
• interest payments
• Transactions related to capital activities
• asset purchases
• debt repayment
• borrowing

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Items of Interest from the Income Statement

• Cost of Goods Sold
• CGS beginning inventory purchases -
  ending inventory

Gross Margin gross margin gross profit
sales revenue
Mark-Up mark-up gross profit cost of
goods sold
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Equity The Sole Proprietorship
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Equity The Partnership
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Equity The Corporation
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Statement of Cash Flows
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Components of Cash Flow
Cash Flows from Operating Activities
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Components of Cash Flow
Cash Flows from Financing Activities
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Components of Cash Flow
Cash Flows from Investing Activities
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Components of Cash Flow
Cash Flows from Summary
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