Guidelines for Business Financial Management and Accounting

Business Financial Management and Accounting
Business Financial Management and Accounting

Financial management and accounting are very sensitive areas of your business, and most new entrepreneurs and small business owners struggle to manage this aspect properly. Lack of knowledge and resources in this area is likely to lead to blunders that will in turn result in business failure. A full 9 out of 10 startups will go out of business, out of which 19% is due to high competition, and 23% fail because they hire the wrong talent. But 29% of startup failures are due to insufficient capital.

If you want to get your business finances and accounting in order, focus on these four things:

  •        Build a Business plan;
  •        Raise business funding from govt agencies, investors, partners, lenders and others;
  •        Get Tally – India’s most popular accounting software to handle your accounts, tax, payroll and inventory management; and
  •        Get an Accountant to help you with everything from tax advice to auditing, bookkeeping, and basic accounting.

Ratios Useful For Business Financial Management and Accounting

The calculations and key ratios mentioned below will help you keep track of various parts of your business. Your accountant or Tally or whatever accounting software you are using will do all your financial calculations and show you the results, but you should still know what each one means.  

Break-even analysis: Is used to determine the point at which your business will start generating a profit. Knowing your break-even point will help you in a number of ways, including setting pricing, grown plans and managing inventory.  The formula below gives you the breakeven point as the number of products or services required to break even.

  •        Break-even point = Total fixed/average sale price of each product or service – Average production/delivery cost of each product or service;

Margin:  Gives you the percentage of profit for each sale. It also helps in making pricing and budgeting decisions, and is used to calculate your business profitability.

  •        Margin = (Sale Price – Cost of goods sold)/Sales x 100

Markup:  Percentage of the amount contributed to the cost price of goods to reach the selling price. You can use this to set the price of your service or product, so that your pricing is not too low or high.

  •        Mark Up = (Sale Price – Cost of goods sold)/Cost of goods sold x 100

Margin Versus Mark Up: The simple way of calculating the difference is by putting both figures side by side.

Mark down: It is the percentage discount offered for a product. Markdowns are generally used during a sale or promotion for pushing out discontinued or surplus inventory, and to attract volume sales.

  •        Mark down price = Original Price – (Original price X Mark down)

Business Financial Management and Accounting Profit Ratios

Gross Profit Margin: A gross profit margin ratio gives the balance of profit for each rupee in sales before expenses payment.

  •        Gross Profit margin = Gross Profit/Sales : 1.0

Net Profit Margin: A net profit margin ratio gives the balance of profit for each rupee in sales after expenses payment.

  •        Net Profit Margin = Net Profit/Sales : 1.0

Gross Profit Margin vs. Net profit margin: The difference between the net profit and gross profit is available to us on the profit and loss statement.

Return on Investment: the ROI delivers the business efficiency in profit generation from the original investment provided by shareholders or owners. It also helps your lenders to determine the financial strength of your business.

  •        ROI = Net Profit/Owner’s Equity

Business Financial Management and Accounting Formulas for Calculating Liquidity Ratios

Current Ratio: The working capital ratio or current ratio calculates your business liquidity. This ratio determines how soon your business can convert assets into cash, and can be useful for deciding when to pay your current bills and liabilities.

  •        Current Ratio = Current Assets/Current Liabilities: 1.0

Quick Ratio:The quick ratio compares the total amount of cash + marketable securities + accounts receivable to the amount of current liabilities.

  •        Quick Ratio = (Current Assets-Inventory)/ Current Liabilities: 1.0

Debt to Equity Ratio: Debt to equity ratio tells you about what kind of finance your business is more dependent on, such as equity or debt.

  •        Debt to Equity Ratio = Total Liabilities/ Total Equity: 1.0

Loan to Value Ratio: LVR is the amount for loan depicted as the percentage of assets that will be purchased or the market value of the property.

  •        LVR = (Loan Amount/Property or Asset value) X 100

Business Financial Management and Accounting Efficiency Ratios

The Accounts Receivable Turnover Ratio calculates your strength at collecting consumer debts, and a lower ratio denotes that you have to work more to collect your debts.

  •        Accounts receivable turnover = Total Sales/Accounts Receivable: 1.0

The Accounts Payable Turnover ratio calculates your strength at paying your debts.

  •        Accounts payable turnover = Cost of goods sold/ Accounts Payable: 1.0

The Inventory/Stock Turnover Ratio calculates your strength at turning over your stock.

  •        Inventory/Stock turnover = Cost of goods sold / 0.5 X (Opening Inventory + Closing Inventory): 1.0

How to Calculate Gross Profit

Gross profit is the profit you have made from selling your inventory. It doesn’t take into account overhead costs. Computing your gross profit is the section of completing profit and loss statement.

  •        Gross profit/net sales = Total Sales – Cost of Goods Sold

Then calculate your gross profit margin:

  •  (Net Sales – Cost of Goods Sold) ÷ Net Sales.

You may not actually have to do all these calculations, but you need to be able to understand the reports and figures put in front of you by your accountant and the accounting software.

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