Business Explain: May 2020

Limitations of Break-Even Analysis:

1. The assumption that all costs and revenues are represented by straight lines in unrealistic.
2. Not all costs can be conveniently classified into fixed and variable costs. The introduction of semi-variable costs will make the technique more complicated.
3. There is no allowance made for stock levels on the break-even chart. It is assumed that all units produced are sold. This is unlikely to always be the case in practice.
4. It is also unlikely that fixed costs will remain unchanged at different output levels up to a maximum capacity.

Benefits of Break-Even Analysis:

1. Charts are relatively easy to construct and interpret.
2. It provides useful guidelines to management on break-even points, safety margins and profit/loss levels at different rates of output.
3. Comparisons can be made between different options by constructing new charts to show changed circumstances.
4. The equation produces a precise break-even result.
5. Break-even analysis can be used to assist managers when taking important decisions, such as location decisions, whether to buy new equipment and which project to invest in.

What is the size, scope and economic contribution of small business?

Vital role in American economy, generating about half of the U.S. gross domestic product and accounting for 65% of all new jobs over past 17 years. In addition to employment growth, small businesses contribute innovations to the economy at a much higher rate than their big business counterparts, form the backbone of many inner-city economies by finding opportunities (and offering products and services) in places where most large firms opt not to operate. Entrepreneurship rate varies around the world dramatically based on national per capita income.

What are ways to become a business owner and facilitate success?

Less risky to buy an established business or franchise, but more satisfying to some to start a new venture from scratch. gain experience in your field, learn from others, educate yourself, access SBA resources, and develop a business plan.

What are the opportunities and threats facing small businesses?

Opportunities: market niches, personal customer service, lower overhead costs, technology.

THREATS: high risk of failure, lack of knowledge and experience, too little money, bigger regulatory burden, higher health insurance costs.

What are funding options for small business?

Personal resources of the founder (personal credit accounts, family, and friends) as well as bank loans, angel investors, and venture capital firms.

What is the typical entrepreneurial mindset and characteristics?

Vision, self-reliance, energy, confidence, tolerance of uncertainty, and tolerance of failure, among other things.

Why do entrepreneurs launch small businesses?

Advantages can far outweigh the risks and hard work, most who do are seeking financial success, independence, flexibility, and challenge, as well as survival and having no other options.

How do financial managers evaluate capital budgeting proposals?

Time value of money recognizes that sooner the cash is received, the sooner it can be reinvested to earn more money.

Financial managers take time value of money into account by computing the present values of all cash flows the proposal will generate.

Present value of a sum of money received in the future is the amount of money today that will become that future amount if it is invested at a specified rate of interest. Net present value (NPV) is sum of present values of all the estimated future cash flows, minus the initial cost of the investment.

How do financial managers acquire and manage current assets?

Firms must have cash, but cash earns little to no interest but can do other things with cash to earn more interest (T-bills, commercial paper, and money market mutual funds).

Accounts receivable are what customers who buy on credit owe to a firm, and firms must establish credit policies to ensure that credit customers will make their payments (or so they make a profit from this).

Inventories are stocks of materials, work in process, and finished goods a firm holds, and cost of storing and handling inventory items can be significant so these are kept as low as possible.

How do financial managers determine the firm's capital structure?

Debt financing enables firm to finance activities without requiring owners to put up more money. When firm earns more on borrowed funds than it pays in interest, excess goes to the owners which magnifies return on the investment. Interest payments on debt are tax deductible. Equity financing is safer and more flexible than debt financing.

How are the major sources of funds evaluated to meet a firm's short-term and long-term financial needs?

Established firms have several sources of short-term funds: bank loans (can be extended with good credit), trade credit (when suppliers ship materials to a firm on credit), factoring (provide immediate cash to firms by purchasing their accounts receivable at a discount), & commercial paper (short-term IOUs). Equity financing (funds provided by owners) and long-term debt financing can be done by firms to build up their permanent financial base.

What are the tools financial managers use to evaluate their company's financial conditions and develop future plans?

Computing ratios based on key accounts listed on their firm's financial statements, four types of ratios: liquidity ratios (will firm have enough cash to pay for its short-term liabilities), asset management ratios (how effectively firm is using various assets to generate revenues), leverage ratios (extent to which firm relies on debt in its capital structure), and profitability ratios (overall success at using resources to create a profit).

Budgeted income statement (develops forecast of net income for planning period), budgeted balance sheet (forecasts the types and amounts of assets the firm will need to implement its plans), and cash budget (identifies the timing of cash inflows and outflows to help firm identify surpluses/shortages of cash) are also key tools managers use to develop and present their financial plans.

What is the goal of financial management and what issues do financial managers confront?

GOALS: maximize the value of the firm to its owners, as well as upholding responsibilities to customers, employees, and other stakeholders.

ISSUES: conflicting goals between stakeholders and stockholders, balance between risk and return (risk-return trade off means that the higher the risk, the greater the return).

What are the advantages and disadvantages of franchising?

PROS: franchiser gains revenue without the need to invest its own money, franchisee gains right to use a well-known brand name and proven business methods and often receives training and support from the franchiser.

CONS: franchisers often find that dealing with a large number of franchisees can be complex and challenging, franchisees must pay fees and royalties to franchiser and do not have much control over management of their business.

Why are limited liability companies becoming an increasingly popular form of ownership?

Avoid problem of double taxation endemic to C corps but still giving all owners protection of limited liability. Fewer regulations than corporations and owners have flexibility to either manage the company themselves or hire professional managers.

Why have corporations become the dominant form of business ownership?

Most common form of corporation is C CORPORATION, all stockholders have limited liability.

C corps can raise financial capital by issuing bonds or shares of stock, giving a financial growth advantage.

Also, unlimited life, easy transfer of ownership, ability to take advantage of professional management; however, are complex and expensive than partnership, profits are double taxed, and subject to extensive government regulation.

What are the pros and cons of partnerships?

General Partnership

PROS: pooled financial resources, shared workload to take advantage of complimentary skills, earnings taxed only as income to the partners/no separate income tax on business itself.

CONS: each owner has unlimited liability for the debts of the company, disagreements can complicate decision making, death/withdrawal of a partner can cause instability/uncertainty in the management and financing of company.

Limited Partnership -- must have at least one general partner and one limited partner. General partners actively manage company and have unlimited liability, while limited partners have limited liability but may not actively manage the partnership.

Limited Liability Partnership-- all partners may manage their company and are protected by some degree of limited liability.