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INTRODUCTION

Business success requires “financial fitness.” You must understand basic financial concepts and their application, and be able to converse intelligently with those who possess financial expertise.

Finance makes the world turn. Inflows and outflows keep the global economy moving. Finance is related to nearly every aspect of business: start-up, daily operations, and planning for the future. This chapter aims to give you a basic understanding of how finance works in the world of business.

If you’re not well-versed on the terminology used in this chapter, see Appendix A, “Basic Financial Definitions.” It provides a glossary of common financial terms.

“A good financial plan is a road map that shows us exactly how the choices we make today will affect our future.”

–Alexa Von Tobel

TYPES OF FINANCIAL STATEMENTS

There are three basic financial statements. These are as follows (Financial statement, n.d.; Inc., n.d.):

  • Balance sheet: This statement shows a firm’s assets, liabilities, and net worth on a stated date.

  • Income statement: Also called profit and loss accounting, this statement shows how the net income is derived in a stated period.

  • Cash-flow statement: This statement shows the inflows and outflows of cash caused by a firm’s activities during a stated period.

Balance Sheet

Typical items on a balance sheet (see Figure 3.1) consist of the following (Waddill-Goad, 2015):

  • Assets

    • Cash and investments

    • Accounts receivable (AR), measured in days

    • Materials/inventory/consumables in stock (the supply chain’s current assets)

    • Fixed assets (machinery and equipment)

    • Real property (real estate)

    • Work in progress (manufacturing)

    • Finished goods (products)

  • Liabilities

    • Loans (short- or long-term)

    • Taxes (due)

  • Equity

    • Beginning balance

    • Profit/loss (the cycle for the current year)

Figure 3.1

An example of a balance sheet.

Income Statement

Typical items on an income statement (see Figure 3.2) consist of the following (Waddill-Goad, 2015):

  • Sales or revenue: Income from goods sold or services rendered

  • Cost of goods sold: A delineation of the cost of labor versus materials

  • Contribution margin: Common costs such as overhead, depreciation, unsold capacity, etc.

  • Operating expenses: Costs associated with doing business (producing a product or service)

    • Operating margin: Revenue left after paying variable expenses (see the categories in Figure 3.2)

    • Net income (the bottom line): Net profit or loss

Figure 3.2

An example of an income statement.

In some instances, another category may reflect the term EBITA or portions thereof. This stands for “earnings before interest, taxes, and amortization.”

Cash-Flow Statement

The management of cash flow in ...

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