Equity: Accounting for the Stuff
January 7th, 2010
Copyright © 2010 Integrated Profitability TM
Accountants are indispensable for setting up and maintaining the financial records of your business. They are never more valuable than when accounting for the capital in your business.
Earlier, we covered the two main sources and uses of capital. Here is a high-level overview of how one accounts for the two main sources of capital:
1. Initial Investment
Event:
● Issue 100,000 shares of stock at $1.00 each
● Investors buy the 100,000 shares for an average, net-price of $17.83 per share
● All investors pay for their shares in cash
Balance Sheet
Asset Liabilities
Cash $1,783,000 Liabilities $ 0
Capital
Par Value $ 100,000
Excess over Par $1,683,000
Total: $1,783,000 Total: $1,783,000
2. Retained Earnings
Good news! The first year of business was excellent and your business made money. Being the first year, no dividends were paid and you poured net profit, after tax, back into the business.
Income Statement
Revenue $1,000,000
Expenses $ 875,000
Pre-tax Net Income $ 125,000
Tax $ 43,750
Net-Profit $ 81,250
Since this is a high-level overview, all the in-&-outs of all the activity of the business are not included: for example, cash from the initial stock offering was used to pay the expenses to generate the revenue; as well as buying a few assets necessary to the running of the business.
So, focusing on the capital accounts:
Balance Sheet
Asset Liabilities
Cash $ 112,000 Liabilities $ 0
Capital
Equip $ 552,000 Par Value $ 100,000
Other $1,200,250 Excess over Par $1,683,000
Retained Earnings $ 81,250
Total: $1, 864,250 Total: $1,864,250
That’s the accounting in a nutshell. The migration of “Net Profit” from the Income Statement to the capital account on the Balance Sheet is one of the most intricate accounting processes.
But it is, for owners, the bottom line.
Bill
William A. Stong
Email: william.a.stong@gmail.com
SBF&P # 48
Telephone: 925-202-6244
Copyright © 2009 Integrated Profitability TM
Equity: Its Uses & Sufficiency
December 22nd, 2009
Copyright © 2009 Integrated Profitability TM
A previous article, “Capital: Its Purposes & Sources” covered:
| Purpose | Uses |
| Initial seed money for new ventures | Purchasing assets, paying for operations & processes, acquiring customers |
| Ongoing buffer for adverse impacts | Covering losses in the ongoing business |
Initial infusion of Capital: used for setting up the company, acquiring office or factory space, hiring personnel, obtaining contracts and service agreements with companies who will provide manufacturing, services or risk protection (e.g., insurance), buying equipment, furniture and other assets.
Ongoing buffer for business: used for adverse market, business or self-inflicted problems that are large enough to cause a loss, i.e., net-profit becomes negative. There is an unending list of such adverse impacts. Here are a few market-based ones:
● You lose your largest customer and can’t reduce expenses fast enough to offset the loss of revenue
● A competitor brings a materially better product to market and buries you
● Your manufacturing process produces a major flaw and you are required to do a massive recall
● Your key supplier goes bankrupt and it costs significantly more to replace the goods
● The national and world economies fall into recession and demand for your product or service dries up
The Antioch Unified School District is in the midst of adverse conditions right now.
When any of these events cause your net-profit to go negative, the amount of retained earnings accumulated during earlier, more profitable years are used to cover the losses.
Given these purposes and uses, how much capital is sufficient for any given company? Calculating this amount depends on the profit dynamics of each business and the market it is in. Some businesses have fairly steady profit profiles (e.g., grocery stores), while others have wildly erratic ones (e.g., investment banking).
Irrespective of the business’ profitability profile, the first step is understanding, estimating and quantifying the types of risk facing your company. With these scenarios and estimates in hand, the following questions need to be asked:
1. what is the largest loss possible if all the risks converged at the same time on the company?
2. how long would the risks adversely impact the business of the company?
Based on intimate experience with your company’s business and its market, probabilities may be applied to different scenarios involving the various risks.
The amount of capital needed for a particular business should be the amount needed to stay in business for at least one year; two years is a much more prudent goal. With this amount of capital available, the company will have two years to deal with whatever business challenges it is facing.
Bill
William A. Stong
Email: william.a.stong@gmail.com
SBF&P # 47
Telephone: 925-202-6244
Copyright © 2009 Integrated Profitability TM
Equity-capital: Financial Definitions
November 2nd, 2009
Copyright © 2009 Integrated Profitability TM
The second in a series based on a request to cover “capital”:
“Good! Finally all of this is coming together for me. How about more on capital? What is it? where does it come from, is it actual & stored somewhere physically and separately or virtual like the net or sum of two or more numbers?”
The last article, Capital: An Introduction, painted a high-level picture of the arena in which one finds capital. To put some meat on those bare-bones, here are definitions for the main concepts—in a kind of reverse order:
● Revenue: money that comes into a business. This represents the value of what customers are paying for products and services provided by your business; a.k.a.: income.
● Expense: money that goes out of a business, particularly funds spent to make, deliver and support products and services purchased by customers; a.k.a.: cost.
● Net-Profit: what is leftover from revenue after all expenses are paid. “Net-profit” is merely a mathematical equation and depending on the two inputs, it can be positive (a good thing) or negative (not such a good thing).
● Income Statement: the summary statement that contains revenue and expense, and ends with the difference between the two (revenue minus expense). Net-Profit is either positive or negative. There may not be consensus on what the former is called, but the latter is universally known as “a loss.” Which is why the Income Statement is also known as The Profit and Loss Statement.
● Assets: what you own.
● Liabilities: what you owe.
● Capital: the difference between what you own and what you owe. Like with Net-Profit, this is a mathematical calculation. If Assets are greater than Liabilities, the company has positive capital. If, however, a company’s effort and investment haven’t worked out, Assets may be lower than Liabilities which leaves the company with negative capital.
● Balance Sheet: a summary statement that contains all of a company’s assets, liabilities and capital. In the wonderful world of T-accounts, double-entry bookkeeping, journals and ledgers, Assets are shown on the left half of a page (Note: as you are looking at it; not from the page’s perspective) while the Liabilities and Capital are on the right half of the page. The convention is that Liabilities are always on top—possibly in homage to the fact that if a company goes into a death spiral and splats into bankruptcy, the people holding Liabilities get paid before those holding Capital.
With perfect timing, The Contra Costa Times this morning (November 2, 2009), had an article covering the bankruptcy filing for the CIT Group (Morning Report; “Key Lender files for Chapter 11”; page AA1). Two pertinent points related to capital:
“…, CIT’s bankruptcy filing shows $71 billion in finance and leasing assets against total debt of $64.9 billion.”
“Treasury Department spokesman Andrew Williams said the government will be closely monitoring the bankruptcy proceedings, but acknowledged that “recovery to preferred and common equity holders will be minimal.””
Apparently, good and bad news are twins.
Please let me know if there are other terms for which definitions would be beneficial, or helpful, or add clarity.
Next in the series: The Market & Other Names for Capital
Bill
William A. Stong
Email: william.a.stong@gmail.com
SBF&P # 44
Telephone: 925-202-6244
Copyright © 2009 Integrated Profitability TM
Equity-capital: An Introduction
October 26th, 2009
Copyright © 2009 Integrated Profitability TM
The “Small Business Finance & Profitability” (SBF&P) blog has received a request to cover “capital”:
“Good! Finally all of this is coming together for me. How about more on capital? What is it? where does it come from, is it actual & stored somewhere physically and separately or virtual like the net or sum of two or more numbers?”
“Capital” is a great topic and one the SBF&P blog hasn’t touched upon. Not even gotten close, although passing reference has been made to it from time to time. Capital is a critically important part of a company’s financial books. However, it can be somewhat esoteric; which means, it will take a few blogs to define, explain and clarify what capital is, why it is important and how it can be used.
This first article will be an introduction, providing a definitional foundation for more detailed articles in the future.
The prospect of a series of articles on financial capital will no doubt send some people screaming for any button on your keyboard that will return you to where you came from, close the browser or shut-down your computer. A pity.
To begin the discussion of capital, an introduction is in order. Of all the financial statements created to report on companies, two stand head-and-shoulders above the rest:
● The Income Statement
● The Balance Sheet
These may trigger big yawns for many, but do your best to stifle them. If these two reports don’t raise your heart rate, hang in there. Things get better. Trust me: I’m in finance.
Got Numbers People?
August 27th, 2009
Copyright © 2009 Integrated Profitability TM
If your business is squarely on the road to riches and you “don’t need no stinkin’ Numbers People,” then STOP READING! Go straight to your favorite entertainment place and reward yourself with whatever you enjoy the most.
On the other hand, if your numbers are not everything you would like them to be, then feel free to read on. If your numbers don’t exist, are unknowably mysterious or are plummeting out of control, then definitely continue reading.
You’re in good shape when you have:
● a business model that is clear, easy to understand and comprehensive
● accounting books that are accurate and timely
● financial reporting that is timely, insightful and which acts as an actionable bridge between the accounting numbers and your business processes
● planning that links the financial numbers to the future of the business and incorporates the experience and knowledge of key stakeholders
You’re not in good shape if none of the above exists.
You’re in poor shape if:
● your business model isn’t written down. Or your written business model doesn’t show, precisely, how you make money and where you might lose money.
● your “accounting” is a shoebox full of paper that you (or somebody else) go through once a year…to keep the Tax People happy and off your back
● financial numbers are only pulled together when taxes are due, a government filing is needed, or a potential lender/investor needs background information
● planning is done over coffee and a donut each morning…if ever
You’re in really bad shape if all the conditions of “in poor shape” exist AND you’re losing money hand-over-fist.
Numbers People in Action: Finance Analysis
August 18th, 2009
Copyright © 2009 Integrated Profitability TM
A further continuation of the suggestion that came in to “…include a simple but meaningful scenario which you’d have the three Numbers People work through to posting, reporting and interpretation and planning…” The first article set up the simple scenario, the second dealt with Accountants & Bookkeepers, the third with basic Finance reporting. This article focuses on the analysis that Finance does.
The third step for Finance is to provide analysis and interpretation of the numbers. To the extent possible from the general ledger accounts, Finance will dig into changes in the numbers and provide explanations as to what is causing those changes, as well as identifying interconnected events. They use the information they have reported: what the number are and how they have turned out. The analytical stage focuses on explaining the numbers, and their movement, in terms of what is happening with the business creating the numbers.
For example,
● if the expense figure for the snacks has increased, it would be good if sales revenue has also increased. Even better if it has increased at a faster pace.
● if the amount in inventory is increasing, a fall off in sales would help explain what is going on
● if net profit is increasing, a decrease in expense or an increase in revenue would help explain the beneficial outcome
But what if things aren’t moving in expected, or at least hoped for, ways?
Cash Flow: Revenue (Timing)
June 22nd, 2009
Copyright © 2009 Integrated Profitability TM
As mentioned in “Cash Flow (Intro),” the only way to increase cash flow consistently in the long-run is to ensure that revenues are growing faster than the underlying expenses. For this to happen, “net revenue” is what counts: gross revenue (e.g., sales made) less discounts, processing fees, rebates, returns and anything else that prevents the sale from getting converted into hard cash that you can hold in your hand.
For both revenue and expense, there are two ways to improve cash flow:
● timing changes
● actual changes
The first primarily helps temporarily. The second helps permanently.
For revenue, timing changes help cash flow when the receipt of incoming cash is accelerated; actual changes help when incoming revenue from business activities increases. Focusing on the revenue portion of cash flow, here are some ideas:
Timing:
● Tighten up terms of payment for your sales (examples follow)
● Shorten the amount of time between billing the customer and receiving their payment. Most companies list standard terms on their invoices, stating how long the amount has been outstanding and at what point finance charges kick up (e.g., after 60 days).
● Add finance charges to late paying accounts
Got Profit? TM
June 11th, 2009
If your business is going gangbusters and you are making more profit than you can possibly handle, then STOP READING! Go straight to your favorite coffee shop and congratulate yourself with your drink of choice for your outstanding success.
On the other hand, if you’re not making as much as you would like, or think you should be making more, then feel free to read on. If you’re losing money, then definitely continue reading.
If your business’ Net Profit is:
● overwhelmingly positive,… why are you reading this? You’re supposed to be enjoying your favorite beverage
● muddling along, then now is the perfect time to take action
● losing you money, then better late than never
And finally, if you don’t know your business’ Net Profit, then you are starting at Square One; which, if you have been in business for some time, is not a good place to be.
The BIG Question
June 4th, 2009
Over the past two months, we’ve covered the basics of profit and profitability.
We’ve touched on the concept of profit and how to calculate profitability. We’ve looked at the two components that drive net-profit: revenue and expense. Examples have been taken from the Contra Costa Times relating to current examples of each. And we touched on how individual businesses are part of a vast world that impacts commercial success, or not, every day throughout the year.
Now’s the time for the BIG QUESTION: how does all this high-level, definitional “stuff” relate to you? To paraphrase Rob Zazueta, the owner of TechKnowMe TM: “let’s cut to the chase.”
What is your business’ Net-Profit? More importantly, what is its trend? Is it going the way you want it to? Like the stock market, there are only three choices: up, sideways, down.
Everybody likes good news, so let’s say it’s going UP. Great! That’s fantastic given the current state of the economy.
What’s driving your higher net-profit? Is it increasing revenue? Decreasing expense? A combination of the two? What opportunities do you have to increase net-profit even more? What issues or problems do you need to work on to continue increasing your net-profit?
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