Otto Ch 1, Slide 1

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ACCT 200A

Financial Accounting:

A New Perspective

Dr. Joseph Otto

CHAPTER 1

Introduction to a Business

Otto Ch 1, Slide 3

STARTING NEW BUSINESS:Initial Motivation

Susan Newman wants to: Do what she loves Turn a hobby into a business Make full use of her college education Interact with customers

CARDS & MEMORABILIA UNLIMITEDNature of business Retail sales of sports cards & collectibles New business Sole proprietorship

Otto Ch 1, Slide 4

PLANNING A NEW BUSINESS: Research the Industry

Interview industry personnel

Research internet

Otto Ch 1, Slide 5

MARKETING STRATEGY: Four Factors (4 P’s)

Product: good or service

Price: cost of good or service

Promotion: communication with customers

Place: market where buyers meet sellers

Otto Ch 1, Slide 6

PLANNING A NEW BUSINESS: Four Factors (4 P’s)

ProductSports cards & collectibles

Price Identify suppliers

PromotionAdvertising, website, etc.

Place

Otto Ch 1, Slide 7

PLANNING A NEW BUSINESS: Other Considerations

Target market: Hobbyist, Investor Register name of business for protectionFind suppliersManufacturersWholesalersRetailers, dealersConsumers

Otto Ch 1, Slide 8

PLANNING A NEW BUSINESS:Location

Absence of competition

High concentration potential customers

Space

Cost

Otto Ch 1, Slide 9

PLANNING A NEW BUSINESS:Choose Form of Business

Sole proprietorship-Single owner

Partnership –2 or more owners

Corporation-Ownership through stock

Otto Ch 1, Slide 10

FINANCING NEW BUSINESS:Estimating Costs

Item Low cost High cost

Equipment $10,000 $10,000

Inventory 12,500 15,500

Rent

Totals

1,188

$23,688

1,463

$26,963

Otto Ch 1, Slide 11

FINANCING NEW BUSINESS: Sources of Funding

Personal savings - $14,000

Money from uncle - $30,000

Bank loan - ???

Otto Ch 1, Slide 12

FINANCING NEW BUSINESS:Apply for Bank Loan

Business versus personal loan

Personal loan information required

Otto Ch 1, Slide 13

FINANCING NEW BUSINESS:Bank Loan Approval

CollateralThings of valued pledged by

borrower

Subordinated liabilityDebt repaid after other debt

Secured liabilityDebt backed with collateral

Otto Ch 1, Slide 14

FINANCING NEW BUSINESS:Business Plan

Written document; decision-making tool

Specifics of businessGoods & servicesMarketing plan

Analysis of industry

Operating plan

Estimate of revenues, expenses, cash flows

Otto Ch 1, Slide 15

USER FOCUS Writing a Business Plan

Decision making tool to make choicesIncludes specifics about a businessDescription of goods, servicesMarketing Industry analysisOperating planEstimates of revenues, expenses,

cash flows

Otto Ch 1, Slide 16

OPERATING BUDGET DEFINED

Future-oriented plan expressed in financial termsBalance sheet

Future assets, liabilities Income statement

Future operating results

Otto Ch 1, Slide 17

PREPARE OPERATING BUDGET: Sales Revenue

Gather information fromOther retailersExperts-a CPA

Calculate estimate# items sold * (average cost + markup)

Otto Ch 1, Slide 18

OPERATING BUDGET:Estimating Revenues

Estimate Cost of goods soldQuantity goods sold x Ave. unit cost

Cost of goods sold x $40,000 *

Markup = 1.60 =

Estimated Revenue $64,000

Otto Ch 1, Slide 19

PREPARE OPERATING BUDGET: Expenses

Gather information fromOther retailersExperts-a CPA

Calculate estimate# items sold * average costRent, rent related costsEquipmentOther

Otto Ch 1, Slide 20

OPERATING BUDGET:Estimating Expenses

Inventory

(Cost of Goods Sold)

$40,000

Rent (1 year)

Rent related

12,000

2,700

Other

Equipment

1,300

10,000

Total expenses $66,000

Otto Ch 1, Slide 21

CMUOperating Budget

For year ending 12/31/1

Sales revenue ($40,000*1.6) Expenses:

Cost of goods sold

Rent

Rent related

Equipment

Other

Net Income

$64,000

40,000

12,000

2,700

10,000

1,300 66,000

<2,000>

Otto Ch 1, Slide 22

DISTINGUISH COSTS FROM EXPENSES

Expense: used up in the operating period

Cost has future useful lifeDivide benefits over future operating

periods

Otto Ch 1, Slide 23

ALLOCATING COSTS TO EXPENSES

Cost allocation example: Equipment

Expected useful life: Benefits 5 operating periods

Depreciation Allocating cost over 5 periods $10,000/5 = $2,000

Otto Ch 1, Slide 24

OPERATING BUDGET:Corrected Expenses

Inventory

(Cost of Goods Sold)

$40,000

Rent (1 year)

Rent related

12,000

2,700

Other

Depreciation

1,300

2,000

Total expenses $58,000

Otto Ch 1, Slide 25

CMUCorrected Operating Budget

For year ending 12/31/1Sales revenue ($40,000*1.6)

Expenses:

Cost of goods sold 40,000

Rent 12,000

Rent related 2,700

Depreciation 2,000

Other 1,300

Net Income

$64,000

$58,000

$6,000

Otto Ch 1, Slide 26

OPERATING BUDGET:What If?

What if more products were sold?

Create operating budget based on $55,000 cost of goods sold

Otto Ch 1, Slide 27

CMUOperating Budget

What if?

Sales revenue ($55,000*1.60)

Expenses:

Cost of goods sold $55,000

All other expenses 18,000

Net income

$88,000

73,000

$15,000

Otto Ch 1, Slide 28

OPERATING BUDGET:What If?

What if fewer products were sold?

Create operating budget based on $35,000 cost of goods sold

Otto Ch 1, Slide 29

CMU Operating Budget

What if?

Sales revenue ($35,000*1.60)

Expenses:

Cost of goods sold $35,000

All other expenses 18,000

Net income

$56,000

53,000

$ 3,000

Otto Ch 1, Slide 30

OPERATING BUDGET:More Analysis

Compare the 3 operating budgets.

Why did “All other expenses” remain the same ($18,000) when the number, cost of products sold changed?

Answer: CMU will have to buy more product but will not have to rent more space or buy more equipment.

Otto Ch 1, Slide 31

WHAT IS ACCOUNTING?

Accounting Is a measurement & reporting information

systemHelps users make business decisionsCommunicates information about financial

activities

Otto Ch 1, Slide 32

HOW IS ACCOUNTING USED IN BUSINESS?

Credit decisionsLending, leasing

Investment decisionsSales estimates imply inventory

purchases

Otto Ch 1, Slide 33

FINANCIAL vs. MANAGERIAL ACCOUNTING

Financial accountingProcess of collecting, measuring, processing,

communicating financial effects of business transactions for external users

Managerial accountingProcess of collecting, measuring, processing,

communicating quantitative & qualitative information for internal use of management

Otto Ch 1, Slide 34

FORECASTING SUCCESS WITH REWARDS

Financial rewardsReturn on investmentReturn on equity

Nonfinancial rewards

Otto Ch 1, Slide 35

FORECASTING SUCCESS: Return on Investment

Measures rate of return on investment Investment is owner’s equity investmentROE = Net Income/Equity

Otto Ch 1, Slide 36

FORECASTING SUCCESS: Return on Investment

Example

ROE = Net Income/Equity$6,000/$30,00020%

What other investment alternatives provide a 20% rate of return?

Otto Ch 1, Slide 37

INTERNAL CALCULATION OF ROE: CMU

Requires adjustment for opportunity cost* (Net Income – Opportunity Cost)/Equity ($6,000 - $27,000)/$30,000<70%>

Consideration: profit does not make up for lost salary

*Cost of salary given up

Otto Ch 1, Slide 38

NONFINANCIAL REWARDS

Apply learning from college

Learn new things Importance of accounting

Trade-offsRisk-to-reward

Be your own boss

Otto Ch 1, Slide 39

LEARNING LANGUAGE OF BUSINESS

Test your understandingLimited liabilityFinancing

Lease, collateral Balance sheet

Assets, depreciation Income statement

Revenues, expenses, cost of goods sold, net incomeBudget

APPENDIX 1-1

CMU Business Plan

Otto Ch 1, Slide 41

CMUBusiness Plan

Executive summary

Current market environment

Objective

Management

Market analysis

Description of CMU

Otto Ch 1, Slide 42

CMUBusiness Plan (cont.)

Marketing strategy

Financials

Conclusion

Otto Ch 1, Slide 43

CMUCurrent Market Environment

Product demand has increasedManufacturers thrivingMarket growing

Market conditions in Phoenix ripe for new businessPhoenix Democrat (newspaper)Personal research

Otto Ch 1, Slide 44

CMUObjective

Become leading seller of trading cards & sports memorabilia in Phoenix area byTargeting customers & providing unique

products, servicesHaving choice location & latest technologyHaving strong advertising, promotionUsing financial management tools,

techniques

Otto Ch 1, Slide 45

CMUManagement

Sole proprietorship

Owner only employee

Owner has degree in business administration

Otto Ch 1, Slide 46

CMUMarket Analysis

Targeted customers Collectors

Focus group To determine habits of collectors

Competition 11 stores within 40 mile radius All significantly different in size & specialization

Use of technology to give customers inventory access

Otto Ch 1, Slide 47

CMUMarketing Strategy

Advertising & promotionNewspaper storiesFliersPress releasesTrade shows

Otto Ch 1, Slide 48

CMUFinancials

ResourcesBank loan applicationOperating budget (projected income

statement)ROE

Projected as 20% for first yearSales projected to increase by 25% each of

Years 2 - 5

Otto Ch 1, Slide 49

CMUCorrected Operating Budget

For year ending 12/31/1Sales revenue ($40,000*1.6)

Expenses:

Cost of goods sold 40,000

Rent 12,000

Rent related 2,700

Depreciation 2,000

Other 1,300

Net Income

$64,000

$58,000

$6,000

Otto Ch 1, Slide 50

Assign #1Questions, pg. 34 - #4, 5, 8, 11, 20

Assign #2Reinforcement Exercises, pg. 35-38 - #3, 4, 6

Critical Thinking Problems, pg. 38-40 - #1, 2, 3.

Otto Ch 1, Slide 51

Assign #3Read chapter 9 - pg. 394-405