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The Final Blog in a Series on Budgeting and Finance for the Non-Financial Manager

The Income Statement

Revenues, expenses, the matching principal and accrual-based accounting from Blog#1 come into play in the Income Statement. It measures whether the products or services that your company provides are profitable when everything is taken into account. A Pro Forma Income Statement indicates it’s either: 1) projected; or 2) it excludes any unusual or one-time write-offs.
Income Statement equations:

• Total your Sales and subtract the Cost of Goods Sold = Gross Profit
• Gross Profit minus Operating and Depreciation Expenses = Operating Profits
• Operating Profit minus Interest and Taxes = Net Profit

Operating Profit shows whether the core of the business is functioning at a profit or loss. It is possible for a company to have a high Gross Profit (25-50%), but have a relatively low Operating Profit due to marketing the product and/or managing the company. Think of Operating Profit as a measure of how efficient management is at generating revenues and controlling expenses.

The Balance Sheet

The Balance Sheet indicates on a given day what the company owns (assets), what the company owes (liabilities) and how much it is worth (equity). The Balance Sheet illustrates the fundamental accounting equation: Assets = Liabilities + Owners Equity. It indicates how efficiently a company is utilizing its assets and managing its liabilities, and is critical because it indicates a company’s net worth.
Balance Sheet equations:

• Total your Assets (Current and Fixed) and subtract Total Liabilities (Current and Long-Term) = Stockholders Equity
• Stockholders Equity minus Preferred Stock = Net Worth or Book Value of the company

If a company sustains a loss on the Income Statement, the equity on the Balance Sheet will decrease. Conversely, if the P&L shows an increase, the equity section on the Balance Sheet shows the accumulation. A company’s goal is to increase profits both on the Income Statement and Balance Sheet.

The Statement of Cash Flows

This financial tool demonstrates how cash came in and how it was used. There are a lot of in’s (adds) and out’s (subtracts) to the Statement of Cash Flows, so I thought it best to illustrate it via the following flow chart:

As we’ve discussed before, the Income Statement is about accounting profitability,not cash profitability. That’s where the Statement of Cash Flow comes in – it translates the actions taken in the income statement and balance sheet (i.e., company purchases, sales, etc.) into cash flow. In this economy, cash is king, and this is an important tool to understand where the company’s money is going.

Next Steps

This blog is the 30,000 foot view of the big three financial statements. There is a WEALTH of detailed information on the subject. One book I have found particularly useful is Financial Intelligence: A Manager’s Guide to Knowing What the Numbers Really Mean by Karen Berman and Joe Knight, © 2006.It is an excellent reference, and won’t overwhelm you with accounting equations!

Stay tuned as next week we begin a three-part series on how to blog. If you’ve been thinking about starting your own company blog (or a personal blog for that matter), you won’t want to miss insights from Carrie Roberts, Project Manager at Val Grubb & Associates, Ltd. on how to set-up, market and create content for your blog.

Part 4 of a 5 Part Series on Budgeting and Finance for the Non-Financial Manager

ROI calculations have extensive application in the financial world. If you’ve been involved in capital expenditure (CapX) budgeting, such as large equipment purchases, acquisitions or the development of new products, you’ve probably done ROI calculations before committing to the expense.

These calculations are typically quite extensive, as they involve a concept called the time value of money. In its simplest definition, it means a dollar today is worth more than a dollar collected tomorrow, which is worth a WHOLE LOT more than a dollar collected in ten years. The challenge with future money is that there are risks associated with actually collecting it.

If you’re involved in CapX budgeting, I’m guessing you have financial tools to calculate ROI which take into consideration the time value of money. A pretty comprehensive spreadsheet is offered for a small fee from Engineering Solutions On-line if you’re in need.

Next, let’s look at ROI calculations (also called cost/benefit analysis) for smaller projects that may be included in your Operating Expense budget. The calculations are basically the same; however, the payback period is within the same year, thus the time value of money is not in play.

The top chart illustrates the calculation for outsourcing benefits administration. ROI calculations start by determining the total costs and benefits for the initiative. In this example, the costs would be $900k with $1.2 million in savings. The Net Yearly Benefit is $300k, which equates to $33,333/month in savings to the company. However, it cost the company $100,000 to transition to an outsourced model, thus the ROI is $100,000/$33,333, or three months. This means that the breakeven point (or payback period) is three months. This means the company does not see a financial benefit until month four, because it took three months to recoup the $100k investment.

The second example here details the ROI for offering a presentation skills class to junior sales associates designed to increase their selling abilities. Take a look, and let me know if you have any questions. These charts are easily duplicated (and expanded) in Excel depending on your needs.

ROI calculations are a powerful resource when making decisions between competing projects, and should be used whenever possible.

Tune in next week for the final blog on Budgeting, which will detail fundamental elements of the three key financial statements.

Part 3 of a 5 Part Series on Budgeting and Finance for the Non-Financial Manager

The chart at the right summarizes 10 critical factors to help you prepare your budget presentation.

More details on each point:

1. Budgeting is a monetary representation of your departmental goals. By making the connection between your spend and the company achieving its goals, it’s harder to cut funds because it impacts the company achieving its goals.
2. Return on Investment (ROI) calculations illustrate the payback period for individual projects. Compare ROI with company goals to rank and market initiatives by their impact on the bottom line.
3. For larger projects under consideration (such as expanding into a new product line), ensure gains in market share do not consume a disproportionate amount of cash from the company (i.e., more inventory, extended duration of accounts receivable, increased complexity, etc.) This philosophy is called cash efficiency and should actually be applied to your current product lines – where are you getting the biggest bang for your investment dollars?
4. Some projects are more about value-add than ROI. Tie that value-add into how it will help the company achieve its goals.
5. ALWAYS prioritize your initiatives then be prepared to scrap the project at the bottom of your list. If you don’t, senior management typically goes after those with the highest price tag. Control how your funds are cut.
6. Find out what cuts were made to other departments that may result in your ability to cut spend in your budget.
7. Demonstrate to executive management if there a dollar impact to the Company for not implementing a project or if you can push the spend to later in the year when company finances are better.
8. Companies are worried about cash flow or having enough credit to weather the downturn in sales, thus you need to link your spend to how it’s going to improve your company’s profitability.
9. Enlisting other department heads to champion your spend can be tough right now because everyone is scraping for dollars, but it’s to your benefit to have others tout your initiatives.
10. You want ANYONE who has ANYTHING to do with finance to thoroughly understand your spend so they can defend your budget if you’re not in the room.

Next week we’ll go into much more detail on how to calculate Return on Investment (ROI) for projects under consideration.

1.) From Leadership in the Era of Economic Uncertainty by Ram Charan, 2009.

Part 2 of a 5 Part Series on Budgeting and Finance for the Non-Financial Manager

The chart to the right illustrates the typical Company’s Master Budget process. Companies usually determine sales projections then determine the production costs associated with achieving their sales goals. The Administrative Expense bucket shown on the chart is comprised of all the individual overhead departments such as HR, Legal, Finance, Facilities, IT, etc., and are associated with the operation of the company, not the actual selling or production of your company’s products. The budgeting template Excel spreadsheets and instructions available to you when you register on my website will help you capture costs to create your Operating Expense Budget for both Non-Profit and For-Profit companies.

In my 1st budgeting blog post, Understanding Accounting Basics (before assigning #s), I mentioned accrual-based accounting. When compiling costs in the spreadsheets, this comes in to play, as you’ll need to account for costs in the month you receive the service (regardless of when you pay for it). As an example, if you pay $25k/mo for Workers' Comp for your employees, your finance dept will accrue for the charge each month regardless of when the invoice is paid. It’s the same on the revenue side of the house – the revenue exists when you invoice the client even if it takes 60 days to collect the money.

Prepaid expenses are another example of accrual-based accounting. If you prepay a contract 6 months in advance, Finance will book the total paid in a Prepaid Expense account then accrue the pro-rated amount (total $/6 mos) to your department’s budget each month. When compiling your budget, you merely list the monthly expense. That said, you need to communicate to finance the upcoming prepayment for cash flow projections.

To determine your department’s expenses, look at past expenditures and anticipated future activities that will result in expenses to your department. Examples include potential mergers and acquisitions, information gleaned from labor market reports, etc. In addition, as part of your budgeting due diligence, you should interview senior leaders and department heads to determine new initiatives that may affect your budget.

Next week: Let the negotiations begin! We’ll discuss how to bullet proof your budget and prepare for your presentation to the C-Suite.

Part 1 of a 5 Part Series on Budgeting and Finance for the Non-Financial Manager

Before putting #’s to paper, it’s important to understand a few basic accounting principles as they set the stage for how to prepare your budget. I’m sure most are familiar with the mother of all Accounting Equations:

Assets = Liabilities + Equity

Assets are what the company owns. Liabilities are what the company owes. Equity is the difference between assets and liabilities. Simply put, equity is what the company has left over after the bills have been paid.

An organization has two additional types of accounts: revenue and expenses. Revenues are 1) $ the organization earns for selling its products and services AND 2) revenues from investments or the sale of assets. Expenses are the costs the organization incurs to run the business. The difference between revenues and expenses – its profit or loss – goes into the equity of the business.

If you’ve worked with budgets, you’ve probably heard of GAAP or Generally Accepted Accounting Principles. GAAP is not a legal requirement, instead it allows for a wide variety of organizations to report their finances in the same way. If an organization’s financial statements are audited by an outside accounting firm, the auditors are required to disclose all deviations from GAAP. Such deviations can jeopardize a firm’s financial credibility. As a result, most organizations choose to comply with GAAP.

To conform to GAAP, a business must use accrual-based accounting (vs. cash-based). Accrual-based accounting means that revenues are recognized when they are earned (or invoiced) instead of when the payment is received. Meanwhile, expenses are “matched” with the time period when the services are used up NOT when you pay the invoice (the expense should be accrued in the month you received the service). This Matching Principle applies regardless of when cash changes hands!

Accrual accounting allows organizations to determine their profits more accurately, because it factors in that expenses are often paid in a different time period from when revenues are collected. As accrual accounting does not measure the cash flow of a business, the Statement of Cash Flow (which does) is as important as accounting profit detailed in the Income Statement.

Understanding basic budgeting concepts such as revenue, expenses, GAAP and accruals will help you put numbers to paper next week when we look at how to budget effectively.