EMSL Training Courses

1. Financial term to know when creating a company

Bottom Line

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

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

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

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.

Activity: Create a game with cards (text and pictures) that sum up and illustrate each definition. The game will consist in pairing the definitions with the 7 financial terms.

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:

  1. Business concern: elements of normal or usual business activity (raw material purchases, sales of finished products);
  2. Financial: items related to financial transactions, i.e. bank transactions (interest paid on borrowing) or financial investments (paid interest);
  3. 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:

  1. 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.
  2. 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:

  1. Own capital: composed of capital (contribution of partners or shareholders), of stock (cumulative undistributed prior results), and of the result of the fiscal year.
  2. 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:

Abilities:

  • 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)

Notions:

Financial value:

  • 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

Assets Amount Liabilities Amount
Immobilized asset Own Capital
Capital 500
Commercial property 3300 Stocks 310
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
Other claims 375
Investment securities 66
Availability 411
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

Context:

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
Expenses N N-1 Products N N-1
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
Taxes 38662 39473
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
14735 10285
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
Capital asset Equity
– Intangible assets – Social capital 150000
Concessions, patents and similar rights 6585 6585 – Share premiums, merger bonus, brought bonuses 14282
Goodwill (1) 5580 5580 5580
Other intangible assets 534 534 534 -Reserves 256134
– Tangible capital assets
Land 60347 28654 31693 37727
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

Activity 1: Over which period is the Codiasse Voyages company’s income statement established?

Activity 2: What did the accountant enter in the right part of the income statement? Explain what it means. How many headings can you identify?

Activity 3: What is the main constituent element of the products? Specify its amount in year N.

Activity 4: What is it made of? Explain by referring to the activity of the Codiasse Voyages company.

Activity 5: Complete the table below to calculate the evolution of the turnover and its composition.

Elements Account in N Account in N-1 Change in value Percentage change
Sale of goods
Sold production (services)
Turnover

Activity 6: What did the accountant enter in the left side of the income statement? Explain what it means. Illustrate your answer using the heading “Other purchases and external charges”. How many headings can you identify?

Activity 7: Comparing products and expenses, how can you tell whether the Codiasse Voyages company created or destroyed value in one year? Specify its amount in year N and in year N-1.

Activity 8: How was it calculated? Justify your answer using the data from year N.

Activity 9: Complete the table below to calculate the change in value and percentage of expenses, income and result of the accounting year.

Elements Account in year N Account in year N-1 Change in value Percentage change
Total products
Total expenses
Result of the accounting year

Activity 10: Compare the evolution of the turnover obtained in question 5 with that of the result for the accounting year. Explain.

b) Financial value based on property

Activity 1: Over which period is the balanced sheet of the Codiasse Voyages company established?

Activity 2: What did the accountant enter in the left side of the balance sheet? Explain what it means. How many headings can you identify?

Activity 3: What is the total value of the asset? Specify its amount at the 31/12/N, analysed in rubrics.

Activity 4: What did the accountant enter in the right side of the balanced sheet? Explain what it means. How many headings can you identify?

Activity 5: Can you find any link between the two accounting documents? Justify your answer.

Activity 6: Calculate the net book value of the company using the following formula: To get the net book assets, you must subtract total debts from total assets.

Activity 7: What is the accounting asset? Who does it belong to?

Activity 8: Is it possible to determine the net book value by another method of calculation? If so, which one?

Activity 9: Can you explain why total assets equal total liabilities?

3. How to write a Business Plan

Activity 1: A-Reflect about the following questions, propose answers:

  1. Why is it necessary to write a business plan?
  2. Why can some businesses fail?

Activity 2: Match the steps with their contents.

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

Activity 3: Reorder chronologically from 1 to 9 the steps that constitute a business plan:

  • 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

Activity 4: Check your answers by watching the following video.

4. Final activities

Activity 1: Glossary, match the exact term with its definition:

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.

Activity 2: Debit or credit?

Cash Sale of goods
Insurance Depreciation of equipment
Deposit Service delivery
Customer delivery Taxes
Supplies Advertising
Merchandise return Bank interest
Raw materials Electricity
Employee salary Rent

Activity 3: Income statement, complete the income statement with the following data and find net income (or net loss) :

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
Tax expense
Net income (Net loss)

Activity 4: Projected income statement, You are making sales forecasts for the next 6 months. You have determined your price but you know the sales will change every month. Your operating costs (rates, insurance etc.) are fixed at 1000 € per month. Complete the project income statement and find the projected profit for the next 6 months.

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
Gross Profit
Operating Costs 1000 1000 1000 1000 1000 1000
Net Profit before tax

Activity 5: Balance sheet, place different balance items in the right place: Accounts payable – Buildings – Cash – Furniture – Interest payable – Inventories – Land – Long term borrowings – Long-term investments – Long-term provisions – Mortgage – Plant and equipment – Retained earnings – Share capital – Short-term loans and advances – Short-term notes – Taxes payable – Temporary investment – Trade receivables

Assets Amount Liabilities Amount
Fixed Assets Shareholders’ Funds
Long-term Liabilities
Current Assets
Current Liabilities

5. Annex: solution to activities

Download training course and solution to activities