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Exam 3 Study Guide

by: Sarah Oglesby

Exam 3 Study Guide MGT 386-005

Sarah Oglesby
GPA 3.2

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About this Document

I have highlighted the information from my previous notes that she indicated would be on the test and added a ratio cheat sheet at the end. However, I highly recommend looking over the study guide ...
Foundations of Entrepreneurship
Dr. Jeffrey A. Martin
Study Guide
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This 19 page Study Guide was uploaded by Sarah Oglesby on Tuesday October 11, 2016. The Study Guide belongs to MGT 386-005 at University of Alabama - Tuscaloosa taught by Dr. Jeffrey A. Martin in Summer 2015. Since its upload, it has received 6 views. For similar materials see Foundations of Entrepreneurship in Business at University of Alabama - Tuscaloosa.

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Date Created: 10/11/16
MGT 386 TEST Friday, October 14 Chapter 7: Financing & Accounting Key Financial Issues Involved With Starting a Business 1. Funding - funding level 2. Establishing the accounting system 3. Flow of information I. Funding • Equity investments: a person provides funding in return for some ownership in the new business - equity = ownership - basic funding is split into two categories, equity and non-equity A. Non-Equity Funding • funds that don't involve the apportionment of ownership in the business • debt: any form of capital infusion that must be paid back with interest; it helps to manage cash flow especially when goods must be purchased and cash has not yet been received from customers 1. Loans a. bank or finance company b. individuals c. founders 2. Credit cards 3. Supplier credit - loan: involves a contractual agreement whereby the business receives some amount of money that must be repaid over a specified period of time at a specified interest rate 1 MGT 386 TEST Friday, October 14 - asset-based lending: a loan provided for the purchase of a necessary asset for the business (ie. inventory or equipment - assets that are subject to repossession should the company not make payments) - credit card: entitles one to revolving credit that is not tied to any particular asset (unattached), does not have a set repayment schedule, typically has a set upper limit, and is usually tied to a much higher interest rate than that of a bank loan • this is because there is no asset that the credit company can repossess if the debtor does not make payments so they inherently assume more risk - supplier credit: suppliers often will provide credit on both physical assets and the actual supplies provided grants: special funds that do not require repayment and are designed to aid • businesses in specific areas - typically target disadvantaged groups, economic areas, or particular industries • the cost of non-equity capital is generally less than that of equity investment - equity investors will often have more of a direct impact on the business operations and decisions B. Equity Investors • established businesses will invest in a start-up of ten with the intention of purchasing the firm, this allows the business to test the viability of a new idea with minimal risk and maximum potential for later profit • venture capital fund: a fund that is organized to make significant equity investments in high-growth ventures - partners may be wealthy individuals, businesses, or investment funds seeking high returns - general partner: investigates new businesses by seeking out extremely high- growth ventures that will have an opportunity to cash out - by IPO or buy out from a larger firm - in a set period of time (think Mark Cuban, in a sense) • angel investors: high net worth individuals who invest in businesses not as a business itself, but as an individual 2 MGT 386 TEST Friday, October 14 - may include entrepreneurs who have cashed out, business executives, professionals in high-income sectors (lawyers, doctors, etc.) - individuals offer valuable expertise and contacts to grow the business • crowdfunding: a relatively new means for raising capital that may result in either an equity approach or an in-kind exchange (ie. money for stuff) C. Other Financing Tools • asset leasing: a form of lease tied to a particular asset used by a business to conserve cash and maintain the latest versions of whatever equipment • factoring: accounts receivable that are sold at a discount to another company to receive immediate cash - businesses will provide a discount on the dollar amount on accounts based on quantity and quality - quality of the receivables is determined by: 1. who owes the new business money 2. debt age 3. size of the transaction 4. debtor’s credit rating D. Initial Funding • the amount of money needed to fund a new business must be calculated in the context of of the types of investments used and what the founder has to give up to obtain the money (ie. equity) • basic calculation for maximum amount of outside financing - calculate the entire cash flow projection (without equity investments) and find where the ending cash balance is at it’s lowest point, then multiply that by 150% - emphasizes the importance of the pro-forma cash flow statement discussed in chapter 6 II. Proper Accounting • the new business person must decide between accrual or cash-basis accounting system 3 MGT 386 TEST Friday, October 14 - cash-basis: recognizes expenses as they are paid and recognizes revenue as it is generated - accrual-basis: expenses and revenues are recorded when they actually occur, regardless of when the cash is received (most common system) • must be used if business has inventory A. Chart of Accounts • a master system for tracking the activity of the business a listing of each type of activity (income or expense) and each type of asset • within the company to be updated as the business grows - see below for more detail B. Petty Cash Register • used for expenses that are too small to write a check for, or when a check would be inappropriate • petty cash funds operate basically the same as a bank savings account • funds are replenished as they become depleted over time C. Check Register • a listing of all checks that have been written and all checks that have been cleared through the bank • should be balanced on at least a monthly basis D. Expense Accounts • companies may have either daily or weekly expense listings based on volume of business these are used to track monthly expenses and eventually form an annual • record of all expenses - including petty cash and check register • interest expense accounts must also be recorded as line items with notations as to the specific account (ie. bank loan, credit card types) • per IRS requirements, travel expenses are handled differently (not covered further in chapter) 4 MGT 386 TEST Friday, October 14 E. Inventory Account • lists a description of the item, the quantity, item number, unit cost, and total cost • inventory records should be updated throughout the year with starting amounts, units sold, and ending inventory • a second record should be kept to track inventory ordered and inventory received - shrinkage: the difference between what is sold and what was brought into the business F. Accounts Payable • separate records maintained for each creditor • all invoices must be recorded with a record of payment included - date paid, amount paid, check number G. Payroll • separate records should be maintained for each employee - tracking time for hourly workers and attendance for salaried employees • records for each payroll check must include: - date, check number, hours worked, base pay, overtime hours worked, overtime pay rate, gross pay, taxes, benefit deductions, net pay • profit and loss statement: a financial statement that summarizes the revenues, costs, and expenses incurred during a specific period of time III. Managing Data Flow reasonable time frames for monitoring relevant data can be determined by • observing similar firms within the industry • just-in-time (JIT) inventory: seeks to minimize excess capital investment in inventory by having inventory present only shortly before it is used - used mostly by well-established firms, not as practical for new ventures • the key is to obtain data in a timely manner that is tied to the strategic needs of the organization 5 MGT 386 TEST Friday, October 14 Chapter 8: Financial Analysis Importance of a Solid Financial Foundation • evaluation of a firm starts with the mission of the organization relative to the industry in which is competes • the firm should focus on the key aspects with which the firm hopes to build its competitive advantage • the firm’s outcomes should be measured at intervals relevant to the business I. Techniques for Measuring Performance • company analysis should start general and become more specific • the most important analysis to be made is related to the business’s ability to make significant profits A. Ratio Analysis - a tool for the entrepreneur to use to examine the overall health of the organization - ratios must be evaluated in comparison to similar organizations, an industry average, or previous performance 1. Liquidity Ratios: measure the short-term ability of the firm to meet its obligations, including debt or accounts payable 2. Activity Ratios: measure the efficiency with which you are handling the resources of the business, interpretation should be focused on relative change 3. Leverage Ratios: used to examine the relative level of indebtedness of the entrepreneurial business 4. Profitability Ratios: examine the performance of the firm and its ability to make economic rents over and above its costs B. Deviation Analysis - analysis of the differences between the predicted and the actual performance 1 MGT 386 TEST Friday, October 14 - typically tracks various performance measures from one time period to the next in the form of a chart - shows two additional metrics: actual change and percentage change - should be maintained frequently C. Sensitivity Analysis - a chart using current cash flow statement, or balance sheet to create a pro forma projection based on a dramatic increase in sales, a dramatic decrease in sales, or the complication of a major change in the business - allows the entrepreneur to look at how sensitive the business is to various factors - provides an opportunity to test out assumptions and view the potential impact of those assumptions prior to committing any new resources D. Short Surveys - and their use in business - non financial method of analysis that can provide contextual information about suppliers, customers, and employees that is not easily categorized and is subject to interpretation - provides an opportunity to evaluate the company’s performance on dimensions that may lead to financial success - surveys will contain some bias and must reflect a margin of error to be properly interpreted - data can be tabulated and examined with some fairly simple statistical techniques, such as percentages - cross tabulation allows for a more comprehensive interpretation in comparison to competitors and past performance II. Importance of Having a Measurement Focus • the understanding of key competitive advantages and the ability to develop measurements that ensure strategic goals are fulfilled • two parts of business: standard (competitive and industry) and unique • standard business only needs to be handled as well as the rest of the industry 2 MGT 386 TEST Friday, October 14 • unique areas of business must be used to differentiate from the competition in a successful and convincing way • there should be a focus on those areas that provide competitive advantage to the firm • concentrating analysis on those areas areas that are unique puts the founder’s focus on those areas that can create a differentiation for the business compared to those of the competitors *see pages 140-142 on the ratios covered in the ratio analysis portion of the chapter 3 MGT 386 TEST Friday, October 14 Chapter 9: Establishing the Legal Foundation Realities of Legal Issues in Business • legal issues may coincide with other events or issues relating to the business and, as a result, may impact financial decisions • mature economies are based on laws, therefore legal structures in society are critical for businesses • the entrepreneur has the ability to use the court system for a legal remedy that is bound by precedent and the Uniform Commercial Code • several legal issues impact the founding of a new business: - forms of business - contracts - leases - regulations and licensing - copyrights, trademarks, patents - insurance - board of directors I. Various Legal Forms of Business • three basic types of legal business organization: sole proprietorship, partnership, and corporation A. Sole Proprietorship - the simplest form of business to establish, as the person who owns it and the business itself are treated as the same entity, it essentially allows an individual to legally transact business - communities generally encourage the development of new business as it is good for the local economy, as a result many communities have made the process of obtaining a sole proprietorship license relatively simple and quick - all business income and losses are treated as part of the individual’s overall income and are reported on the regular tax form 1 MGT 386 TEST Friday, October 14 - Drawbacks: 1. a business that involves more than a single founder cannot be a sole proprietorship, this means the business may not have any other equity investors which can stunt growth and limit outside investments in the company 2. all of the liabilities of the sole proprietorship are the direct responsibility of the owner, this limits the risk that the entrepreneur can take in making business decisions to expand 3. given that this form is easily dissolvable, a firm may struggle with issues of legitimacy with suppliers and customers, the result is that the value of the business is limited since it is so tightly tied to the founder B. Partnerships - a type of business formed between individuals directly, it includes both general and limited varieties 1. General Partnership: if two or more people are involved in the founding of an organization, they can form a partnership in a relatively simple manner - formation requires a partnership agreement which generally specifies who is involved; expected contributions from each party, how profits, losses, and draws by the partners are to be treated; how one partner can buy out the other(s) if that individual decides to leave; how new partners are brought in; and how disputes are settled - draw: a distribution of funds from the business, usually in the form of a cash dispersion in advance of salary, bonus, expected year- end distribution and the like - partnership agreements should be developed early to establish clear and legally binding dimensions of the partnership - if a partnership is not developed and signed, the partnership will be governed by either the Uniform Partnership Act or the Revised Uniform Partnership Act 2 MGT 386 TEST Friday, October 14 - like in a sole proprietorship, owners report their shares of losses or profits on their own personal income returns in proportion to their interest in the firm - each partner is assumed to be involved with all decisions, which translates into a fiduciary relationship between partners - new partners may be brought in by essentially “buying out” a portion of the existing partners’ equity in the firm 2. Limited Liability Partnership (LLP): still has at least two individuals who are partners in a venture, however, there are two classes of partner - the general partner is considered the manager of the firm and has unlimited liability for any debts or judgements against the firm - limited partners are considered to be passive investors and their liability is limited to their investment in the business; these partners may work for the firm, but may not be active in management of the organization - LLPs require that there be at least one general partner C. Corporations - a form of business that addresses the personal liability issues that can hurt founders of sole proprietorship or partnerships - it views the business not as synonymous with the individual but as a separate entity; if the corporation suffers substantial losses, the founder(s) will lose only his investment in the business 1. Subchapter S Corporation: an organizational form that treats the firm as an entity separate from the individuals, this allows the owners to treat the income as they would if the firm were a sole proprietorship or a partnership, it has limitations in the number and type of shareholders - benefits include: limited liability for owners, tax benefits for owners by consolidating business and personal financial statements, easier formation than Subchapter C, legitimacy in the market as more established 3 MGT 386 TEST Friday, October 14 - negatives include: formation is cumbersome and expensive in comparison with partnerships or sole proprietorships, limits the number of shareholders to a maximum of 75 2. Subchapter C Corporation: an organizational form that treats the firm as a unique entity responsible for its own taxes, there are no limitations to shareholder participation and the “owners” are protected beyond their equity investment - the corporation pays a tax on its profits after which the profits are distributed as dividends to owners which are then taxed again on personal income causing double taxation - double taxation costs may be mitigated by paying out business profits as employee bonuses and salaries (owners are also considered employees of C corps.) which allows very little profits to be reported by the business which means little corporate income tax is owed - fringe benefits are not treated as income for employees, therefore these costs can be expensed as costs of business - there are no limits to the number of shareholders, there is a limit to the number of authorized and distributed shares at “par” value (shareholder equity = par value x number of shares distributed) - with either a subchapter S or C must have: a corporate name; headquarters location; general nature of business; founder and initial investor names, addresses, and titles; time horizon for the firm’s existence; authorized stock and capital; and by-laws of the corporation 3. Limited Liability Corporation (LLC): an organizational form that combines the pass-through taxation of a partnership or sole proprietorship with the limited liability of a corporation - allows the new venture to have more investors as well as allowing other corporations to hold stock in the company - may have as few as one individual listed as an officer of the company, referred to as a “member” 4 MGT 386 TEST Friday, October 14 - substantial flexibility regarding the amount of income that is designated for each individual, does not have to be in proportion to that owner’s holdings - cost of formation is relatively low, most states require simple paperwork to be submitted to the government before beginning operations II. Basics of Contracts • contract: an agreement between two parties to perform certain activities for some consideration should be a formal, written agreement created with the supervision and guidance of • an attorney • items that should be included: - who the parties are - what each party agrees to do and for what consideration (ie. payment, compensation) - when the transaction will take place - timing of the payment - when the activity is to take place and how long the contract is in place - warranties - how the contract can be terminated, including damages - whether the contract may be transferred - if the firms are in different states, which laws apply III. Leases a significant type of contract that a new business is involved in that negotiates • where the business will operate • lease contracts may be of any term length that is agreeable between parties • things that must be considered: - what exactly is the business owner leasing? (physical space and address - what about parking, external premises, etc.) 5 MGT 386 TEST Friday, October 14 - can the business owner renew the lease? the lease should specify how long it is in effect and if there is the opportunity to renew the lease. - who is responsible for improvements? who has the responsibility and authority for physical plan improvements? a lease that includes the responsibility for making improvements to the facility should be accompanied by a lower lease payment. - who has the responsibility for maintenance and other facility issues? - who has to carry the liability insurance and at what level? - can your landlord enter your place of business? most leases give the landlord some rights to enter your business and inspect it. - if there are problems, what are the procedures for addressing and resolving them? if you have unused space, is subleasing permitted? • a lease is multidimensional and should be carefully crafted before signing IV. Laws, Rules, and Regulations A. Regulations new businesses generally deal with fewer regulations than do established • larger businesses • many regulations enacted by the federal government do not apply to businesses with fewer than 50 employees • some industries are highly regulated regardless of size due to the sensitivity of the business activities (ie. medical, military, alcohol, national security, environmental, etc.) • all businesses must have an Employer Identification Number for tax purposes • a business with employees will be required to calculate and deduct various taxes for federal, state, and, in some cases, local authorities • specific cities may have unique sets of special regulations • Americans with Disabilities Act (ADA): specifies protections in business for those with disabilities (prohibits discrimination in hiring, management, or dismissal, also requires businesses to be accessible to those with disabilities) B. Licensing 6 MGT 386 TEST Friday, October 14 • examples of licenses and permits include: - business license - local ABC (booze) - occupancy permits - federal liquor license - local business license - sign permits - OSHA permits (food handling) - fire safety permit • at a minimum, most businesses must acquire a license to do business in the county or city in which they will be operating • license is simple to acquire: fill out a form, pay a set fee, and agree to report basic information about the business’s performance on a set schedule • the business will also be requires to pay a license tax each year (often based on company sales) V. Importance of Copyrights, Trademarks, and Patents to a New Business • copyright: the legal means to protect intellectual property; it grants ownership on creative materials generated, such as books, magazines, advertising copy, music, artwork, or any other creative product, whether published or unpublished • trademark: claim of intellectual property that is associated with a specific business; this may be the name of the firm, a symbol representing the firm, or the names of its products patent: claim of intellectual property that covers a specific innovation • - utility patent: for a new process, machine, article of manufacture, or composition of matter, or any new and useful improvement of those - design patent: for a new, original, and ornamental design for an article of manufacture - plant patent: for someone who invents or discovers and asexually reproduces any distinct and new variety of plant 7 MGT 386 TEST Friday, October 14 - patents can be significant barriers to entry VI. Role of Insurance • the new business chooses the level of liability it is willing to risk • effective application of insurance can limit liability • property insurance covers the building, fixtures, and inventory in all of the buildings in which the business has a function - important to distinguish whether the insurance covers replacement cost or only current value greater insurance = greater cost, the firm must balance risk and cost • • other types of insurance: - liability insurance: helps to protect the business against lawsuit judgments - does not cover intentional acts of malice, but does cover accidents - bonding: covers the business in the case that workers cause any damage in the performance of their work - worker’s compensation: covers liability for workers who are injured on the job (required in many states) VII.Board of Advisors and Board of Directors • composed of people who have both insight and experience with which to advise founders • corporations must have a board of directors - these individuals have a fiduciary responsibility to the organization’s shareholders - in new corporations, the shareholders and board of directors are often the same board of advisors: a group formed at the discretion of the founders (regardless of • the legal form chosen) and composed of individuals outside the business who advise the founders • individuals on the advisory board should have experience in: - licensing requirements for the industry - regulations for your specific industry 8 MGT 386 TEST Friday, October 14 - new start-up experience and success - financial and accounting background with new start-ups - human resources experience • the board can meet formally or informally 9 Ratio Analysis Cheat Sheet Liquidity Ratios: measure the short-term ability of the firm to meet its obligations Current = Current Assets/Current Quick (or Acid) = Current Assets - Liabilities Inventory/Current Liabilities Measures those assets that can be Examines the pure cash position quickly turned to cash and used to for relative to the current liabilities. immediate liabilities (cash, accounts receivable, inventory) Activity Ratios: measure the efficiency with which the entrepreneur is handling the resources of the business Inventory Turnover = Cost of Goods Accounts Receivable Turnover = Credit Sold/Inventory Sales/Accounts Receivable As inventory turnover rises, the firm Examines how fast the company turns gets closer to a JIT system credit sales into cash. Total/Fixed Asset Turnover = Net Sales/Fixed Assets Measures how efficiently the business is using its fixed assets. Leverage Ratios: used to examine the relative level of indebtedness of the entrepreneurial business Debt to Equity = Total Liabilities/Total Debt to Assets = Total Liabilities/Total Assets - Total Liabilities Assets Provides the information on the portion Measures the percentage of the assets of the business owned by the lenders of the firm that are actually owned by the and the portion owned by the creditors founder(s) Times Interest Earned = Operating Income/Interest Estimates the number of times that the firm could repay the current interest owed on its debts Profitability Ratios: examine the performance of the firm and its ability to make economic rents over and above its cost Gross Profit Margin = Gross Profit/Net Sales Determines the overall profit that is obtained from all sales during the Net Profit Margin = Net Profit/Net Sales period being evaluated Presents a picture of the relative margin earned after all obligations and Operating Profit Margin = Operating expenses are considered. Income/Net Sales Looks at the gross profit minus all of the operating expenses. Return on Assets = Net Profit/Total Assets Examines the ability of the firm to return an overall profit compared to the Return on Equity = Net Profit/Equity amount of assets that the firm has invested into the effort Provides all investors with an evaluation of how much each dollar of their investment is generating in profit


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