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Intelligence
for
Leaders
9 practical
Finance ideas
that you
must know
AUTHOR
Vipin Khandelwal is an
entrepreneur, a discoverer, a
voracious reader. He is
constantly evaluating ways to
enable learning in innovative
ways.
Previously, he was involved in
doing business and financial
analysis and headed a
financial planning services firm.
Follow him on Twitter @vipinkh
Published by
FINANCE 3600
INTRODUCTION
One of the key reasons a large
number of organisations and their
leaders fail is their inability to
understand and question the
financial numbers?
They fail to understand a key aspect
on which their organisations
performance is measured.
Its true for leaders of any organisation, for profit ones as well
as non profit ones. If you are an entrepreneur, it is all the
more.
You cannot escape this fact that as a Leader you need to
learn the language. And that language is of
Numbers, of Finance.
Now to learn and talk this language, you dont need to be
an accountant or possess one of the famous finance
degrees.
You can know these secrets right now and add Financial
Intelligence as one of your key tools to enable you to
navigate.
So, ready. Here we go!
TABLE OF CONTENTS:
Index
Page No.
Accounting vs Finance
11
17
19
Is Profit = Cash?
21
26
29
33
Accounting or Finance
In a business transaction,
there is a transfer of value
from one party to another in
return for another item of
value, money, product or
service.
Source: flickr
Materiality and
Matching
Principle 1: MATERIALITY
Materiality literally means
importance. A financial transaction
or data could be materially
Unit
important if it has the capability to
influence the decisions one way or
Example: One rupee in
the other.
Materiality changes from business to one million is not material
but one rupee per unit for
business.
Source- dreamstime
Principle 2: MATCHING
It almost sounds like match making and in some ways it is
so. Just that in business finance, matching refers to incomes
and expenses.
All expenses should be matched to the incomes or products
that cause them and also to the appropriate period (month,
year). This is important because we want to know
what was spent to earn that revenue.
Example: If a customer pays in March 2013 but the service
is going to be delivered in June 2013, then you should count
the sale /revenue only in the year pertaining to June 2013.
Accounting Period
It is usually a period of 12 months for which the accounts
are prepared and balanced. At the end of this period, the
financial statements are also prepared.
The accounting period is either from January to December or
from April to March.
In India, either can be followed but for taxation purposes,
the year is April to March.
10
Balance
Sheet
Profit &
Loss
Statement
Cash Flow
Statement
3 Key
Financial
Statements
11
12
Topline
Operating Income
Bottomline
Source: Infoedge.co.in
13
BALANCE SHEET
If you have to look at your business and evaluate its
financial strength, how would you do it? How would you
know where the business stands today?
Through a Balance Sheet! Like its name it provides the
balances of your various accounts as on a particular date or
point of time. Read the emphasis.
Essentially, the balance sheet shows what the business
owes (liabilities) to others and what it owns (assets).
It is also called the Statement of Sources and
Application of Funds as it tells you from where all the
business obtained funds/capital, the sources and how did it
use those funds or the application.
The balance sheet helps you understand and analyse
important financial information about a business. (More
about that in the next guide)
14
Infoedge India
External
liabilities
15
Cash from
Operation
Cash from
Investment
Cash from
Financing
Buying or selling of
assets, Loans,
investment in stock
markets, etc.
Raising fresh
money through
stock markets or
loans, payment
of dividends, etc.
16
An income is also
called revenue,
sales, turnover and
is a result of the
normal business
activity wherein
products or services
are provided in
return for income.
Count expenses which
contribute to their
economic usefulness within
the period of measurement
(typically a year).
17
An expense is an
outflow of money
in return for a
product or
service. It is also
known as cost.
18
In the Balance sheet section, you read that Assets are what
the business owns and Liabilities are what the business
owes. So, how do we know what is an asset or a liability?
Asset
19
Liability
Note:
Working
Capital
Is Profit = Cash?
PROFIT
So, you might wonder that for all the sales that you have
brought into the company, when it is time for the bonus, you
are told that there is no cash to pay. Why?
Because you got the sale, not the cash! You sold the products
on 60 days credit. Means, your customer needs to pay only
after 60 days. So the real cash arrives after 60 days. And
thats when you get your share of bonus.
Note:
Now as per the accrual rule, the sale is done and recorded
so it increases topline and bottomline, but not CASH.
21
22
23
As per wikipedia,
depreciation refers to
24
Depreciation vs Amortisation
While depreciation is
used in reference to
physical or tangible
assets, amortisation is
used for intangible ones
like patents.
EBITDA
Also, Operating profit or profit from core
25
You are the head of the department. And you finally come
across this fabulous technology that will help the company
achieve its objective.
You rush to the CFO and talk to her about getting it.
She listens to you patiently and asks, Did you budget for it?
All your hopes suddenly fall flat on the ground. You had not
provided for this new technology in the budget.
26
27
29
Fixed Costs
These costs are incurred
irrespective of whether
the business has any
running operations or
not.
Variable Costs
Costs incurred as a result
of business operations.
As business operations
vary in size and scale,
these costs vary too. You
got the word, vary.
Right! Examples: Raw
materials, sales
commission and contract
employees.
Manufacturing businesses
tend to have a high fixed
cost structure. Think power
plants.
30
Break
Even
Margin
The point of business operations at which
incomes are equal to costs is known as
the break even point. It is useful in
evaluating whether a new project makes
sense or not.
B E Point is = Fixed Costs / Contribution Margin
Contribution
Margin
Also, Marginal profit per unit of sale
= Sales Price - Variable Cost
If this is positive, it makes sense to take
that bulk order at a discounted price.
31
32
When you take a business loan from the bank at 15%, you
know the cost of the loan, that is, 15% per year.
Now to be profitable, you have to deploy this money so as to
be able to earn more than 15%.
For example, if you earn 20%, then you make a profit of 5%
or a margin of 33% (5% / 15%).
Remember: A business exists to make a profit.
33
Equity
Debt
There are various forms and structure of equity and debt but for
the purpose of this ebook, we will stick to the simpler definition.
34
For example sake again, the cost of equity capital would be,
say 20% (a 5% additional return for the risk premium).
Now assuming 50% of the money comes through debt and
50% through owners equity, the true cost of capital would
be (50% x 15%) + (50% x 20%) = 17.5% (weighted cost)
The business will have to earn more than 17.5% to be
truly profitable. Else the owner is better off giving a loan for
a fixed return.
35
36
37
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