1. Financial term to know when creating a company
Net earnings and net income both fall under the “bottom line” description. You may hear people talk about “affecting the bottom line” of the company and this is simply any action that may increase or decrease the company’s net earnings, or overall profit. The term “bottom” is in reference to the typical location of the number on a company’s income statement, below both revenues (top line) and expenses. Needless to say, this is an important term to know.
Gross margin is expressed as a percentage and represents the percent of total sales revenue that a company keeps after subtracting the cost of producing its goods or services. The higher the percentage, the more the company keeps on each dollar of sales (that will eventually go toward paying its other costs and obligations). In simple terms, if a company’s gross margins are 25 percent, for every dollar of revenue that is generated, the company will retain $0.25 before paying its overhead, which includes salaries, rent, and more.
Fixed versus Variable Costs
A fixed cost is exactly what is sounds like, a cost that does not change with increases or decreases in the volume of goods or services that are produced by your company. These costs are obviously the easiest to predict and plan for. Rent, salaries, and utilities all usually fall into this category.
Variable costs are just the opposite. They can vary depending on a what a company is producing (such as Amazon Web Services usage), and as a result are much harder to forecast.
Equity versus Debt
The “equity versus debt” comparison may seem silly to some, but you would be surprised at how many people have no idea what either really means. Equity is simply money obtained from investors in exchange for ownership of a company, while debt comes in the form of loans from banks that must be repaid over time. Both are necessary for growth, with their own pros and cons. Equity versus debt is a critical decision for any entrepreneur and it is important to know the difference as the future of your business may depend on it.
Leverage can be interpreted a couple different ways. In the financial world, leverage is most commonly known as the amount of debt that can be used to finance your business’ assets. In simple terms, the amount of money you borrowed to run your business. The balance you want to strike as an entrepreneur is that of your debt and equity. If you have way more debt than equity, you will be considered “highly leveraged” , “very risky” to potential investors.
Capital Expenditures (CapEx)
Capital expenditures are any items purchased by your business that create future benefits. Basically, if something you bought is going to be useful to your business beyond the taxable year in which you purchased it, capitalize the item(s) as assets in your accounting. Examples include computers, property, or acquisitions.
Concentration is simply the measure (usually a percentage) of how much business you are doing with a specific client or partner. Relying on one or a couple of clients and partners to do business is a prime example of over-concentration. This is a losing strategy for any business because if something goes wrong with those limited relationships your business will be in serious trouble. Focus on keeping low concentrations for your accounts and investors will be impressed.
2. How financial value is created
2.1 How to measure financial value based on income
Accounting is needed in order to assess the creation of value of the company through its result. Thanks to the income statement, you can explain the creation or the destruction of value of the company during the year, by comparing products and expenses of the company.
So, the income statement reflects the economic activity of the company and can be classified in:
- Expenses, i.e, definitive employment or consumption.
- Products, i.e., definitive resources or revenues.
The income statement includes expenses and revenues according to three main headings:
- Business concern: elements of normal or usual business activity (raw material purchases, sales of finished products);
- Financial: items related to financial transactions, i.e. bank transactions (interest paid on borrowing) or financial investments (paid interest);
- Exceptional: elements of unusual nature, i.e. out of the current business activity (penalties or fiscal fines, sale of a machine.)
Among the products is the turnover, corresponding to all sales made during a period: it is the main income of a company.
The final difference between the income and expenses represents the amount of the result achieved by the company during its accounting year. This amount usually corresponds to one year.
To get the result of the financial year, you must subtract total expenses from total revenues.
Whenever the products exceed the charges, the company gets richer and makes a profit. You get a credit result written down in the charges heading.
Whenever the charges exceed the products, the company is impoverished and realizes a loss. You get a debtor income written down in the products heading.
2.2 How to measure financial value based on property
Accounting is also needed in order to measure the value creation of the company through its heritage. At one point, a balance sheet is build, taking into account the assets and liabilities of the company. Assets are recorded as identifiable assets with a positive economic value for the company, and on the liabilities are described the resources that enabled the company to own assets listed as assets.
On the balance sheet, items are united together according to two main headings:
To the assets:
- Immobilized assets: elements sustainably held by the company (more than one year) to carry out its activity. They will be found over several successive years.
- Current assets: elements held by the company, not intended to stay there for long (less than one year), i.e. less than one business cycle.
In the liabilities:
- Own capital: composed of capital (contribution of partners or shareholders), of stock (cumulative undistributed prior results), and of the result of the fiscal year.
- Company debts: these are debts with banks, providers, State, etc.
Thus, this is what you can find in the balance sheet:
- Assets in order of increasing liquidity (from the position with the less liquidity to the one with the more liquidity): asset at more than one year (immobilized asset) and asset at less than one year (current asset). The liquidity of an asset can be determined by its ability to be quickly converted into currency;
- Liabilities in order of increasing due (from the lowest to the most exigible position): own capital (capital is not intended to be returned to shareholders) and debts (loans will have to be paid but over a longer period than the debts of the suppliers.) The degree of repayment of a debt is related to the time available to the company before having to repay this debt.
With the balance sheet, it is possible to calculate the net book value:
To get the net book value, you must subtract total debts from total assets.
The net book value corresponds to the financial or heritage value of the company: it is the share of the assets of a business owned by the partners or shareholders.
Thus can companies seek an increase in their net book value, i.e., financial value, in order to satisfy the capital contributors. On the other hand, public organizations and associations do not seek any increase in their financial value, since they do not have to please capital providers.
2.3 How is it possible for organization management to contribute to the creation of different forms of value?
The following abilities and notions are needed:
- Distinguish different types of value and relate them to the expectations of the persons taking part in the process;
- Use a balanced sheet and an income statement to identify the financial value produced by an organization (mainly a company)
- Based on income (from the income statement)
- Based on property (from the financial balance sheet)
2.4 One example
The Ramond company is specialized in the marketing of lawnmowers. The accountant informs yoof his balance sheet at the 31/12/N (in thousands of euros.)
Balance Sheet of the Ramond company at the 31/12/N
|Immobilized asset||Own Capital|
|Grounds||960||Financial year result||578|
|Buildings||1200||Total of own capital||3388|
|Other tangible fixed assets||2640||Debts|
|Loans||276||Borrowing from credit institutions||927|
|Total of immobilized asset||8376||Debts to suppliers||2925|
|Current assets||Debts on fixed assets||2085|
|Stock of goods||360||Other debts||2327|
|Customer claims||2034||Total debts||8264|
|Total current assets||3276|
|Total amount||11652||Total amount||11652|
The Ramond Company owns, at the 31/12/N, items held for the long term to carry out its activity (immobilized asset), with more amount than those meant to stay for less than one year (current assets), i.e., 8 376 000€ versus 3 276 000€.
Moreover, the Ramond Company, at the 31/12/N, has debts (liabilities), a total amount of 8 264 000€.
Eventually, the result of the fiscal year N for the Ramond Company corresponds to a profit of 578 000€: therefore, the company has created value during the fiscal year N, since the result of the company’s fiscal year is positive.
The net book value of the Ramond Company amounts to: 11 652 – 8 264 = 3 388 thousands of euros, i.e. 3 388 000€.
This corresponds to the financial or patrimonial value of the Ramond Company: it is the share of the assets belonging to partners or shareholders. It can be found when you look again at the amount of own capital.
2.5 One exercise
The Codiasse Voyages company is a limited liability company, in operation for 26 years. Located in Lorris (45260), its main activity is the business sector of regular road transport of passengers. Different types of services are offered by this company, such as excursions organization, travel on behalf of school and sports associations, or school transport. The company owns two active commercial establishments, and its workforce is 17 employees. The company is managed by Mr. Frédéric Codiasse.
|PROFIT AND LOSS ACCOUNT year N||Codiasse travel agency|
|Operating cost||Euros||Euros||Exploiting products|
|Purchases of goods||Selling of goods||94||627|
|variation of stocks of goods||Service delivery||2345121||2206027|
|purchases of raw materials and other supplies||63597||75311||Net revenues||2345215||2206654|
|Variation of stocks of raw materials||20286||6699|
|Other purchases and external expenses (1)||1340968||1233982||Capitalised production||2152||640|
|Salaries and wages||Operating subsidy||743||6690|
|Social security contributions||Recovery for depreciation and provisions||52209||49804|
|Sums for depreciation and provisions|
|Other expenses||Other products||2|
|Sub total 1||2369631||2229447||Sub total 1||2400384||2263788|
|Finance costs||Financial products|
|– Interests on loans||2754||5031||– perceived interests||156||97|
|Sub total 2||2754||5031||Sub total 2||156||97|
|Exceptional costs||Exceptional products|
|– on management operations||6892||8640||– on management operations||44||235|
|– on operations of capital||23572||109563||– on operations of capital||17000||98846|
|Sub total 3||30464||118203||Sub total 3||17044||99081|
|Total expenses of credit balance (benefits)||2402849||2352681||Total expenses of the products Debit balance (losses)||2417584||2362966|
|GRAND TOTAL||2417584||2362966||GRAND TOTAL||2417584||2363966|
|Annex 1: Balance sheet: year 31/12/N||Codiasse travel agency|
|ASSET||Gross||Depriciation and provisions||Net 31/12/N||Net 31/12/N-1||PASSIVE||Net 31/12/N|
|– Intangible assets||– Social capital||150000|
|Concessions, patents and similar rights||6585||6585||– Share premiums, merger bonus, brought bonuses||14282|
|Other intangible assets||534||534||534||-Reserves||256134|
|– Tangible capital assets|
|Constructions||13389||8828||4561||5621||– Profit for the year||14735|
|Technical equipment, equipments and industrial machinery||27127||19293||7834||10870|
|Other tangible assets||427388||217445||209893||231111|
|– Financial fixed assets||5990||5990||5836|
|Total of the capital asset||546890||280805||266085||297279||Total of the equity||435151|
|Current assets||Debts (1)|
|Stock of raw materials, supply||42886||42886||63172||– Loans from credit institutions||64969|
|Deposit and advances received for the commands||9283||9283||515||– Adances and deposit received for current orders||1364|
|Customers’ receivables||129246||129246||103966||– suppliers’ debts||116461|
|Other receivables||79291||79291||80029||– Social and fiscal debts||123127|
|Available funds (bank and cash)||171018||171018||141878||– Other debts|
|Total of the current assets||431724||431724||389560||Total of the debts||305921|
|Prepaid expenses||43263||43263||50633||Prepaid products|
|Total of the assets||1021877||280805||741072||737472||Total of the passive||741072|
According to you, how is it possible for the manager of the Codiasse Voyages, Mr. Frédéric Codiasse, to ensure that financial value is created by his company?
a) Financial value based on income
|Elements||Account in N||Account in N-1||Change in value||Percentage change|
|Sale of goods|
|Sold production (services)|
|Elements||Account in year N||Account in year N-1||Change in value||Percentage change|
|Result of the accounting year|
b) Financial value based on property
3. How to write a Business Plan
|1- Think big.
Target the population, the age group
Define the short- term goals, the mid- term goals, the long term goals
|a- TAKE ACTION|
|2-Find out how many competitors you have||b- SET YOUR MARKETING GOALS|
|3- Define what your ideal customer wants
Put yourself in your customers’ shoes
|c- KNOW YOUR CUSTOMERS|
|4- How will your product look like?
What will it cost?
How will you distribute it?
What is the number of products will you sell?
What are your price margins?
|d- DEFINE YOUR VISION|
|5- Make sure you know exactly what you want to achieve with your business
Make sure you have clear goals
|e- KNOW YOUR MARKET|
|6- Even if you find that your idea isn’t viable, never give up!||f- SET YOUR GOALS AND OBJECTIVES FOR THE BUSINESS|
|7- Study the demand and supplies
Demand should be more than supply
|g- DEFINE YOUR MARKETING STRATEGY|
|8- How is your product or service different from others in the market?
Highlight the extras your customers are getting from you
|h- RESEARCH THE DEMAND FOR THE BUSINESS|
|9- How many products do you need to produce and sell?
What profit margin do you need so as to get your desired revenue?
|i- DEFINE YOUR UNIQUE SELLING PROPOSITION|
- SET YOUR MARKETING GOALS
- RESEARCH THE DEMAND FOR YOUR BUSINESSS
- DEFINE YOUR VISION
- DEFINE YOUR UNIQUE SELLING PROPOSITION
- KNOW YOUR MARKET
- SET YOUR GOALS AND OBJECTIVES FOR THE BUSINESS
- KNOW YOUR CUSTOMERS
- DEFINE YOUR MARKETING STRATEGY
4. Final activities
|Assets||A cost that cannot be directly attributed to the production of a good or service.|
|Balance sheet||A cost that changes depending on the number of goods produced or the demand for the products/service.|
|Capital||A document provided to a customer to request payment for a good/service received.|
|Cash||A financial obligation or amount owed.|
|Crowdfunding||A financial statement listing sales and expenses and is used to work out the gross and net profit of a business.|
|Depreciation||A prediction of future financial transactions, often used to help plan a more accurate budget.|
|Dividends||A long-term loan used to finance the purchase of real estate.|
|Earnings||An inventory of all the assets and liabilities owned or owed by an individual, government body or company.|
|Fixed cost||Includes all money that is available on demand including bank notes and coins, petty cash, certain cheques, and money in savings or debit accounts.|
|Forecast||Income paid to shareholders.|
|Gross income||Is a way of financing your business idea through donations of money from the public. This is usually done online, through a website.|
|Gross profit||The amount earned before expenses, tax and other deductions are taken out.|
|Interest||The amount of profit a company took in during a specific time period, after tax.|
|Invoice||The cost of borrowing money on a loan or earned on an interest-bearing account.|
|Liability||The difference between sales and the direct cost of making the sales.|
|Margin||The difference between the selling price of a good or service and the profit.|
|Mortgage||The process of expensing an asset over a period of time to spread the cost of the asset over its useful life.|
|Net Profit / bottom line||The total gross profit minus all business profit – the total revenue a business earns minus the total expenses.|
|Profit and loss statement / income statement||The total money earned by a business before expenses are deducted.|
|Revenue / turnover||Things you own. These can be cash or something that can be converted into cash such as property, vehicles, equipment and inventory.|
|Variable cost||Wealth in the form of money or property owned by a business.|
|Cash||Sale of goods|
|Insurance||Depreciation of equipment|
|Merchandise return||Bank interest|
|Sevices Rendered : 94 600 €||Insurance : 7 300 €|
|Salaries : 25 000 €||Advertising costs : 1 000 €|
|Rent : 15 000 €||Fuel : 2 500 €|
|Telephone & Internet : 6 500 €||Stationery : 412 €|
|Water & Electricity : 16 000 €||Bank Charges : 654 €|
|Property rates and taxes : 1 000 €||Income tax : 18 % (on income)|
|Expenses||Amount in €||Income||Amount in €|
|Total expenses||Total income|
|Income before tax|
|Net income||(Net loss)|
|Month 1||Month 2||Month 3||Month 4||Month 5||Month 6||Total|
|Potential Unit Sales||450||500||550||570||578||600|
|Average price per unit||5,6||5,6||5,6||5,6||5,6||5,6|
|Potential Sales (turnover)|
|Unit costs (manufacturing)||2,1||2,1||2,1||2,1||2,1||2,1|
|Cost of Sales|
|Net Profit before tax|
|Fixed Assets||Shareholders’ Funds|