Finance and Cash Flow Management Covenant Capital Business Prof Oyedokun.pptx

Finance and Cash Flow Management Covenant Capital Business Prof Oyedokun

Being A Paper Presented at Covenant Capital Business School on Saturday, 10th of September, 2022

1. Finance and Cash Flow Management Being A Paper Presented at Covenant Capital Business School on Saturday, 10th of September, 2022

2. ND (Fin), HND (Acct.), BSc. (Acct. Ed), BSc (Acct. & Fin.), BSc. (Bus. Admin), MBA (Acct. & Fin.), MSc. (Acct.), MSc. (Bus & Econs ), MSc (Tax), MTP (SA), PhD (Acct), PhD (Fin), PhD (FA), FCA, FCTI, ACIB, ACS, ACIS, MNIM, FCNA, FCFIP, FCE, FERP, CICA, CFA, CFE, CIPFA, CPFA, ACAMS, ABR, CertIFR , IPA, IFA, FFAR, FPD-CR, FSEAN

3. Finance and Cash Flow Management

4. Finance and Cash Flow Management

5. The Difference between Cash Flow and Profitability

6. How to Calculate Profit The first step to calculating profit is to take your total revenue and then subtract the cost of goods sold. The difference is your gross profit. Revenue – Cost of Goods Sold = Gross Profit Revenue : N 100,000 Cost of Goods Sold   -N50,000 Gross Profit: N 50,000 Of course, you would probably have other expenses beyond buying the chairs. For example, you’d need a place to store the chairs, and you might want to run some ads to get more sales. These expenses are called operating expenses, and they get subtracted from your gross profit. Operating expenses include most costs that don’t directly connect to what you sell—things like rent, equipment, payroll, and marketing. The second step is to subtract operating expenses from gross profit. The difference is net profit. Gross Profit – Operating Expenses = Net Profit Revenue: N 100,000 Cost of Goods Sold:  -N50,000 Gross Profit: N 50,000 Operating Expenses:  -N35,000 Net Profit: N 15,000 If your net profit is a positive number, you made money. If it’s a negative number, you lost money. This report as a whole is called the income statement or profit and loss (P&L).

7. The “problem” with Profit In relation to small business Cash Flow Management , the problem with income statements is that they don’t show your whole business A few essential pieces of information are missing 1. Debt repayment If you have any business loans or other startup capital to repay, it won't show up here Only the interest on those loans is included on a P&L, even though debt repayments can eat up a lot of cash . 2. Equipment payments Similarly, if you make a significant equipment purchase, the entire cost will not show up in this section Instead , that cost will get spread out over the lifetime of the equipment If you spend N 100,000 on a canning line and you think it will last you 10 years, your income statement will show an expense of N 10,000/year for 10 years, even if you had to pay all of it upfront

8. The “problem” with Profit 3. Taxes Note that your net profit isn’t taxed at this point, which means it will shrink even more. Even if all of your profit is available in cash, you won’t be able to run out and spend it all in one place . 4. Cash received Finally, many businesses use accrual accounting, which records revenue even if you haven't received the money yet. On paper, you might have N 200,000 in sales, but if no one has paid you yet, you’re still going to have a hard time paying your bills . Further, if you carry inventory, all that product has value and gets included on your income statement as well. Of course, to extract cash from your inventory, you need to sell it first.

9. How to Manage Cash Flow and Profit

10. Benefits of Cash Flow Management

11. Benefits of Cash Flow Management

12. How to Improve Cash Flow

13. Understanding Essentials of Bookkeeping

14. Understanding Essentials of Bookkeeping Liabilities Anything that decreases the value of a business is a liability. The liabilities of a business are the debts owed by the business, accounts payable to the vendors, etc. Revenue/Income Revenue or income is the amount earned by the business through selling its products or rendering services. Expenses The expenses are the amount spent by the business for running the business. The electric bill, salary given to the employees, utility bills, etc., are considered expenses. Equity The business liabilities are deducted from the business assets. The deducted sum is the equity, and it reflects the financial interest of the business.

15. Importance of Bookkeeping in businesses Proper bookkeeping helps you maintain accurate financial records, which businesses are required by law to do for taxation purposes. Besides the legal requirement, good bookkeeping offers practical business benefits. Some of the reasons why good bookkeeping is essential to a successful business are: Budgeting: When income and expenses are recorded, it is easier to review your financial resources and estimate cash flow. Organization: Bookkeeping is an important tool for others – the IRS, investors, accountants and lenders – who have an interest in your financial records. When your records are well organized, it is easier to locate and provide information when needed, it can be easier to file your taxes, and it can improve your chances of securing funding. Analysis: Bookkeeping helps your company generate financial statements. These statements can be used as a tool to track cash flow and assist you in analyzing your company’s strengths and weaknesses. Planning: Financial statements can also indicate initiatives that have or haven’t worked, which can help business owners and shareholders plan for the future.

16. Principles of Bookkeeping The basic principle of bookkeeping is to record the financial transactions of business on a day-to-day basis. The bookkeeping principles ensure that all financial transactions are comprehensive, up to date and provide the information required for preparing the accounts. The following are the principles of bookkeeping: Revenue Principle The revenue principle states at what time the bookkeeper can record a transaction as revenue in the books of account. As per the principle, a transaction is recorded as revenue earned for the business at the time of point of sale. The revenue principle states that the revenue occurs at the time when the business/buyer takes legal possession of the item/goods sold or when the service is performed. It implies that revenue occurs for the business when the goods are received, or the services are performed irrespective of the time of payment for the transaction to the seller. This concept is also known as the revenue recognition principle. Expense Principle The expense principle states the point of time at which the bookkeeper can record a transaction as an expense in the books of account. The expense of a business occurs at the time when it accepts the goods or services from another entity/seller. It implies that the expenses occur when the goods are received, related or service is performed, irrespective of when the bills or payments are made for the transaction.

17. Principles of Bookkeeping Matching Principle The matching principle states that when the bookkeeper records the revenues, all the related expenses must also be recorded at the same time. Thus, the inventory is charged to the cost of the goods sold at the same time that the revenue from the sale of the inventory items is recorded. Cost Principle The cost principle states the historical cost of an item should be used in the books of accounts and not the resell cost. For example – If a business owns property or vehicle, these assets should be recorded at their historical costs and not the current fair market value of the property. Objectivity Principle The objective principle states that the bookkeeper should use only factual and verifiable data in the books of accounts and not the subjective measurement of values. Even when the subjective data appears better than the verifiable data, only the verifiable data must always be used.

18. Elements of Bookkeeping Journals The journals are an essential part of the bookkeeping system. The complete information about a transaction can be found in the journals. The general journal is used by many businesses to record the debit and credit amounts of each transaction that occur under the double-entry bookkeeping system. It may also state a short description of the transactions. Ledger The ledger groups the transactions of a business as per the account and its effect on the business. Such categories or grouping in the ledger include liabilities, assets, revenue and expenses. The business transactions from the journals are recorded or posted to the ledgers periodically. The financial position of the business can be ascertained with the help of the ledgers. Financial Statements The financial statements state the information about the financial situation of a business/company to the outside parties. Most bookkeeping systems use the following four main financial statements: • Balance sheet – It provides the description of a businesses or company’s financial position for a specific date by listing details of the liabilities, assets and shareholder’s equity. • Income/profit and loss statement – It shows the businesses or company’s net earnings for a particular period. • Cash flow statement – It reflects the increases and decreases in cash of a business for a period related to investments , business operations and financing activities of a business. • Statement of shareholders – It shows the changes in the company’s retained earnings by listing items like dividends paid to shareholders and net income for the year.

19. Debit and Credit in Bookkeeping Process In the single entry system of bookkeeping, all financial transactions are directly entered under the respective heads of income and expense in the cash book The accounts are consolidated from the total amount of incomes and expenses to arrive at the business’s estimated profit or loss and final statement. In the double-entry bookkeeping system, all the financial transactions are debited in one account and credited to another account in a journal The journal entries are essential as they form the basis for preparing the accurate final statements of the business. The transactions are debited and credited in the journal as per the rules of the following three accounts: a). Real Account The assets and liabilities come under the real accounts The assets are debited, and liabilities are credited. The rule of the transactions recorded under the real accounts is – debit what comes in and credit what goes out. b). Personal Account Under the personal accounts, the transactions with natural or artificial persons like individuals, firms, companies and associations are recorded The rule of the personal account is – debit the receiver and credit the giver. c). Nominal Account All the incomes, expenses, losses and gains are recorded under the nominal account The nominal account rule is – debit all the incomes and gains and credit all the expenses and losses.

20. Single vs. Double-Entry Bookkeeping

21. The Nature of Working Capital The amount tied up in working capital is equal to the value of raw materials, work in progress, finished goods inventories and accounts receivable less accounts payable The size of this net figure has a direct effect on the liquidity of an organization Working capital characteristics of different businesses Holding inventory (from their purchase from external suppliers, through the production and warehousing of finished goods, up to the time of sale) Taking time to pay suppliers and other accounts payable (creditors) Allowing customers (accounts receivable) time to pay

22. Objectives of Working Capital Management

23. Role of working capital management

24. Liquidity Ratios Working capital ratios may help to indicate whether a company is over- capitalised , with excessive working capital, or if a business is likely to fail A business which is trying to do too much too quickly with too little long-term capital is overtrading 1. The current ratio Current ratio = Current assets Current liabilities 2. The quick ratio Quick ratio or acid test ratio = Current assets less inventories Current liabilities 3. The accounts receivable payment period Accounts receivable days or accounts receivable payment period, or average collection period = Trade receivables x 365 days Credit sales revenue 4. The inventory turnover period Inventory turnover = Cost of sales Average inventory

25. Liquidity Ratios The inventory turnover period can also be calculated: Inventory turnover period (finished goods) = Average inventory x 365 days Cost of sales Raw materials inventory holding period = Average raw materials inventory x 365 days Annual purchases Average production (work-in-progress) period = Average WIP x 365 days Cost of sales 5. The accounts payable payment period Accounts payable payment period = Average trade payables x 365 days Purchases or Cost of sales 6. The sales revenue/net working capital ratio The ratio of Sales revenue Receivables + Inventory – Payables

26. Illustration: Working Capital Ratios Calculate liquidity and working capital ratios from the following accounts of a manufacturer of products for the construction industry, and comment on the ratios. 20X3 20X2 N m N m Sales revenue 2,065.0 1,788.7 Cost of sales 1,478.6 1,304.0 Gross profit 586.4 484.7 Current assets Inventories 119.0 109.0 Accounts receivable (note 1) 400.9 347.4 Short-term investments 4.2 18.8 Cash at bank and in hand 48.2 48.0 572.3 523.2 Accounts payable: amounts falling due within one year Loans and overdrafts 49.1 35.3 Corporation taxes 62.0 46.7 Dividend 19.2 14.3 Accounts payable (note 2) 370.7 324.0 501.0 420.3 Net current assets 71.3 102.9 Notes 20X3 20X2 N m N m 1 Trade accounts receivable 329.8 285.4 2 Trade accounts payable 236.2 210.8

27. Solution 20X3 20X2 Current ratio 572.3 523.2 501.0 = 1.14 420.3 = 1.24 Quick ratio 453.3 414.2 501.0 = 0.90 420.3 = 0.99 Accounts receivable payment period 329.8 x 365 = 58 days 285.4 x 365 = 58 days 2,065.0 1,788.7 Inventory turnover period 119.0 x 365 = 29 days 109.0 x 365 = 31 days 1,478.6 1,304.0 Accounts payable turnover period 236.2 x 365 = 58 days 210.8 x 365 = 59 days 1,478.6 1,304.0 Sales revenue/net working capital 2,065.0 1,788.7 572.3 - 501.0 = 28.96 523.2 - 420.3 = 17.38 The company is a manufacturing group serving the construction industry, and so would be expected to have a comparatively lengthy accounts receivable turnover period, because of the relatively poor cash flow in the construction industry .

28. b) The company compensates for this by ensuring that they do not pay for raw materials and other costs before they have sold their inventories of finished goods (hence the similarity of accounts receivable and accounts payable turnover periods ) c) The company's current and quick ratios have fallen but are still reasonable, and the quick ratio is not much less than the current ratio This suggests that inventory levels are strictly controlled, which is reinforced by the low inventory turnover period d. The ratio of sales revenue/net working capital indicates that working capital has not increased in line with sales This may forecast future liquidity problems It would seem that working capital is tightly managed to avoid the poor liquidity which could be caused by a high accounts receivable turnover period and comparatively high accounts payable. However, revenue has increased but net working capital has declined due in part to the fall in short-term investments and the increase in loans and overdrafts