1. READ ARTICLE
https://www.moodys.com/web/en/us/insights/banking/open-banking-real-time-analytics-for-small-and-medium-sized-enterprises.html
2. Summary:
Open Banking initiatives allow SMEs to access and share their operating account data, enabling real-time credit assessments and financial planning. Moody’s, with partners, has developed a tool that leverages this data to create real-time financial metrics, supporting lenders in loan origination and monitoring while helping business owners with financial management. This system aims to bridge the financing gap faced by SMEs, offering tailored, data-driven credit solutions to enhance the availability and cost-effectiveness of funding.
3. Answer Questions
a. How does Open Banking improve access to liquidity for SMEs, and what challenges does it address?
b. What role do real-time financial metrics play in assessing SME creditworthiness?
c. How does the categorization of transactional data contribute to the accuracy of SME financial assessments?
d. What are the potential impacts of real-time analytics on the SME lending landscape, for both borrowers and lenders?
2-3 pages, Source: Article & PPTX attached
DUE: 3/16
Small Business Management in the 2
1
st Century
By David T. Cadden and Sandra L. Lueder
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© 2012, published by Flat World Knowledge
COPYRIGHT PAGE
Published by:
Flat World Knowledge, Inc.
One Bridge Street
Irvington, NY 10533
© 2012 by Flat World Knowledge, Inc. All rights reserved. Your use of this work is subject to the License Agreement available here
http://www.flatworldknowledge.com/legal. No part of this work may be used, modified, or reproduced in any form or by any means except as expressly permitted under the License Agreement.
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Chapter 9
Accounting and Cash Flow
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© 2012, published by Flat World Knowledge
Learning Objectives
Understand why a basic knowledge of accounting is important for a small business.
Understand the importance of selecting an accountant to enhance the overall operation of a business.
Define the two major approaches to accounting systems: cash versus accruals.
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Learning Objectives
Understand what is measured on a balance sheet.
Understand the term depreciation.
Understand what goes on an income statement.
Understand what is measured in a cash-flow statement.
Appreciate the importance of forecasting in the development of a cash-flow projection statement.
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Learning Objectives
Understand why the numbers found on the balance sheet and an income statement may not be enough to properly evaluate the performance of a business.
Understand the concept of financial ratios and the different categories of financial ratios.
Acquire the ability to calculate financial ratios and interpret their meaning.
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Learning Objectives
To understand that a functioning accounting system can provide customer value through accurate billings and records.
To understand that there are several techniques that can help a small business maintain a positive cash flow.
To appreciate that small businesses can use sophisticated, low-cost computer accounting systems to manage their accounting and operational operations.
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Understanding the Need for Accounting Systems
Accounting is the language of business. (Warren Buffett)
Without a fundamental understanding of this language of accounting and its set of rules you are a significant disadvantage in starting and successfully operating a business.
One should be able to take a look at the key elements of an accounting system and interpret how well their businesses doing.
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Definition of Accounting
Essentially accounting is an information system.
Accounting provides critical information to potential investors and businesses managers.
The basis of modern accounting’s double-entry book keeping can be traced to Luca Pacioli, a Franciscan friar and polymath, wrote Summa de Arithmetica, Geometria, Proportioni et Proportionalita in 1494.
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Use of an Accountant
Hiring an accountant or an accounting firm is an important decision for small business.
Employing an accountant does not translate into this individual being a full-time employee of the business.
Try to find an accountant that has some working familiarity with your type of business or industry.
Try to find an accountant with whom you have some rapport.
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Use of an Accountant
Your accountant
will play an important role in assisting you in the creation, purchase and development of an accounting information system for the business.
can assist you in developing appropriate policies with respect to cash control and inventory control.
can play a critical role in developing business’ plans, particularly with respect to budgets and financial statements.
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Accounting Focus
Your accounting systems will be important in
providing the appropriate information to the external community – this is referred to as Financial Accounting.
your internal controls – this is referred to as Managerial Accounting.
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Accounting Systems
The manner in which we record transactions defines the difference between a cash or accrual accounting system.
In the cash basis accounting system, a transaction is recorded when money is either received or spent.
Under the accrual basis accounting system transactions are recorded when they occur.
Businesses must use the accrual basis accounting method if they have inventory of any component of items that they sell to the public, and if the sales are more than $5 million a year.
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Accounting Systems – Cash Basis
The major benefit of cash basis accounting is its simplicity. It greatly reduces the demand on bookkeeping.
The cash basis system also provides a much more accurate indication of your current cash position.
There are drawbacks to the cash basis approach – the most serious being that it may provide a distorted or inaccurate indication of profitability.
The reality is that cash basis accounting systems are really only appropriate for businesses with sales under $1 million and that function basically on a cash basis.
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Accounting Systems – Accrual Basis
Accrual basis accounting is in great in conformance with IRS and GAAP regulations.
Although more complex and generally requiring greater bookkeeping in a more sophisticated approach to accounting, the accrual basis provides a more accurate indication of the profitability of the business.
The major drawback of the accrual basis system comes with respect to understanding the businesses cash position.
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The Balance Sheet
Balance sheet statement should be thought of as a photograph, taken at a particular point in time, which images the financial position of the firm.
The balance sheet is dominated by what is known as the accounting equation (separates what is owned from who owns it):
Assets = Liabilities + Owner’s Equity
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Accounting Equation
Assets are “economic resources that are expected to produce a benefit in the future”.
Liabilities are the amount of money owed to outside claims, meaning to money owed to those people outside of the business.
Owner’s Equity – also known as Stockholders’ Equity – represents the claims on the business by those who own the business.
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Current Assets
Current assets are the assets that will be held for less than one year.
They include: Cash, Marketable Securities, Accounts Receivables, Notes Receivable, Inventory and Prepaid Expenses.
These are listed in a specific order. The order is based on the degree of liquidity of each of these assets.
Liquidity measures the ease to which an asset can be converted into cash.
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Current Assets
Marketable securities are stocks and bonds that of business may hold in the hope that they would provide a greater return to the business rather than just letting cash “sit” in a bank account.
Accounts Receivables represent the amount of money due to the business from prior credit sales.
Prepaid expense is an accrual accounting term that represents a payment in advance of their actual occurrence
Inventory is the tangible goods held by a business for the production of goods and services. Inventory can fall into three categories: raw materials, work-in-process (WIP) and finished goods.
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Current Assets
Total Current Assets =
Cash + Marketable Securities + Accounts Receivable + Prepaid Expenses + Inventory
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Long Term Assets
Long-term assets are those assets that are not going to be turned into cash within the next year.
They include: Investments, Fixed Assets, Depreciation and Intangible Assets.
Investments are items that management does not intend to sell within the upcoming year.
Fixed assets include Plant, Equipment and Land.
Generally these are valued at their original cost.
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Long Term Assets
Depreciation is a non-cash expense that specifically recognizes that assets decline in value over time.
Accumulated depreciation is a running total of all depreciation on assets.
Intangible assets are assets that provide economic value to the business but which do not have a tangible, physical presence they include items such as patents, franchises, copyrights and goodwill.
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Long Term Assets
Long Term Assets =
Investments + Fixed Assets –
Accumulated Depreciation + Intangible Assets
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Current Liabilities
Current liabilities are debts and obligations that are to be paid within the year.
These include: Notes Payable, Accounts Payable, Other Items Payable (this includes taxes, wages and rents), Dividends Payable and Current Portion of Long-Term Debt.
Notes payable represents money that is owed and which must be repaid within the year.
Accounts payable are the short term obligations that the business owes to suppliers, vendors and other creditors.
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Current Liabilities
Other Items Payable can include items such as the payroll and tax withholdings owed to employees or government but which have not as of yet been paid.
Dividends payable is a term that is appropriate for business structured as corporations. This category represents the amount that the business plans to pay its shareholders.
Current portion of Long-Term Debt represents how much of the long-term debt that must be repaid within the upcoming fiscal year.
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Current Liabilities
Current Liabilities =
Notes Payable + Accounts Payables + Other Items Payable + Dividends Payable + Current Portion of Long-Term Debt
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Long-term Liabilities
Long-term liabilities are debts payable over a period greater than one year.
It includes: Long-Term Debt, Pension Fund Liability and Long-Term Lease Obligations.
Long-Term Liabilities =
Long-Term Debt + Pension Fund Liabilities + Long-Term Lease Obligations
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Owners Equity
Owners Equity represents the value of the shareholders’ ownership in the business.
It is sometimes referred to as net worth.
It is composed of items such as Paid in Capital and Retained Earnings.
Paid in Capital is the amount of money provided by investors through the issuance of common or preferred stock.
Retained Earnings is the cumulative net income that has been reinvested in the business and which has not been paid out to shareholders as dividends.
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The Balance Sheet
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The Income Statement
The Income Statement provides an examination of the overall profitability of the firm over a particular length or period of time.
It begins with identifying the sales or income for the designated period of time.
Sales would be all of the revenues derived from all of the products and services sold during that time.
Cost of Goods sold (COGS) which is composed of all costs associated with the direct production of the goods and services that were sold during the time period.
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The Income Statement
With these two values, the first measure of profit – gross profit – can be calculated.
Gross Profit = Income – Cost of Goods Sold
The next element in the income statement is operating expenses.
These are expenses that are incurred during the normal operation of the business.
Operating expenses can be broken down into: selling expenses, general and administrative expenses, depreciation and
other overhead expenses.
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The Income Statement
After identifying all the components of the operating expenses, you can now compute a second measure of profitability – operating profit.
This is sometimes referred to as earnings before interest and taxes (EBIT).
Operating Profit (EBIT) = Gross Profit – Operating Expenses
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The Income Statement
The next section of the income statement is designated Other Revenues and Expenses.
This segment would include other non-operational revenues (such as interest on cash or investments) and interest payments on loans.
When the other revenues and expenses are subtract from the operating profit one is left with Earnings Before Taxes (EBT).
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The Income Statement
Earnings Before Taxes =
Operating Profit – Other Revenues and Expenses
Taxes are then computed on the EBT and then subtracted. This includes all Federal, State and Local tax payments.
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The Income Statement
This brings us to our last measure of profitability – Net Profits.
Net Profit = Earnings Before Taxes – Taxes
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The Income Statement
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Cash Flow Statement
There are two types of cash flow statements
Historic cash flow statement which is similar to the income statement in that it looks at the cash inflows and the cash outflows for a business during a specified period of time.
Cash flow projections statement which attempts to identify cash flows into the firm and cash flows out of the firm for some future period.
From the standpoint of the small business owner, the cash flow statements provide an insight to where cash flows are coming and going.
The cash flow projections statement may be the most important component of all of the financial statements.
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Cash Flow Statement
A properly developed cash flow statement will show if the business will be generating enough cash to continue operations, whether it has sufficient cash for new investments and whether it can pay its obligations.
Cash flow statement is broken into three major categories: operations, financing, and investing.
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Cash Flow Statement
Cash inflows from operating activities consist of:
cash derived from the sale of goods or services;
cash derived from Accounts Receivable;
any cash derived from interest or dividends; and
any other cash derived that’s not identified with financing or investments.
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Cash Flow Statement
The cash outflows from operating activities consist of:
cash outlays the goods purchases in the creation of the goods and services;
cash outlays for payment to suppliers;
cash outlays to employees;
cash paid for taxes or interest paid to creditors.
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Cash Flow Statement
Cash inflows associated with financing activities consist of:
cash from the sale of the company’s stock; and
cash received from borrowing (debt).
Cash outflows associated with financing activities consist of:
cash outlays to repay principal on long and short-term debt;
cash outlays to repurchase, preferred stocks; and
cash outlays to pay for dividends on either
common or preferred stock.
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Cash Flow Statement
Cash inflows from investing activities consist of:
cash received from the sale of assets;
cash received from the sale of equity investments; and
cash received from collection on a debt instrument.
Cash outflows associated with investing activities consist of:
cash outlays to a choir some debt instrument of another business;
cash payments the by equity interest in other businesses; and
cash outlays to purchase a productive asset.
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Financial Ratios
Financial ratios can be grouped into five categories:
Liquidity ratios
Financial Leverage ratios
Asset Management or Efficiency ratios
Profitability ratios
Market Value ratios
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Liquidity Ratios
Liquidity ratios provide insight on the firm’s ability to meet in short-term debt obligations.
It draws information from the business’ current assets and current liabilities that are found on the balance sheet.
The most commonly used liquidity ratio is the Current ratio given by the formula:
(Current Assets) / (Current Liabilities)
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Liquidity Ratios
Since a firm might find it impossible to immediately translate the dollar value of inventory into cash in order to meet short-term obligations.
To recognize this fact the Quick ratio or Acid Test, in effect, values the inventory dollar value at zero. The quick ratio is given by the formula:
(Current Assets – Inventory) / (Current Liabilities)
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Financial Leverage Ratios
Financial leverage ratios provide information on the firm’s ability to meet its total and long-term debt obligations.
It draws on information from both the balance sheet and income statement.
The first of these ratios – the Debt Ratio – illustrates the extent to which the business’ assets are financed with debt.
The formula for the debt ratio is as follows:
(Total Debt) / (Total Assets)
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Financial Leverage Ratios
A variation on the debt equity ratio is the ratio of debt to the total owner’s equity.
(Total Debt) / (Total Owner’s Equity)
As with the other ratios, one cannot target a specific, desirable value for the debt to equity ratio.
Median values will vary significantly across different industries.
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Financial Leverage Ratios
One can refine the prior ratio by examining just the long-term portion of total debt to the owner’s equity.
Comparing these two debt-to-equity ratios gives an individual an insight into the extent to which the firm is utilizing long-term debt versus their use of short-term debt.
The formula for the long-term debt to owner’s equity ratio is as follows:
(Long Term Debt) / (Total Owner’s Equity)
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Financial Leverage Ratios
The interest coverage ratio examines the ability of the firm to cover or meet the interest payments that are due in the designated period.
The formula for the interest coverage ratio is as follows:
(EBIT) / (Total Interest Charges)
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Profitability Ratios
Profitability ratios look at the amount of profit that’s being generated by each dollar of sales (revenue).
The first profitability ratio examines is the gross profit margin and is given by the following formula:
Gross Profit Margin = Gross Profit / Revenue
The next examines operating profit margin and is calculated in the following manner:
Operating Profit Margin =
Operating Profit / Revenue
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Profitability Ratios
The last profitability ratio is the net profit margin – the one that is mostly used to evaluate the overall profitability of a business. It is determined as follows:
Net Profit Margin = Net Profit / Revenue
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Asset Management Ratios
The last category of financial ratios is the asset management or efficiency ratios.
These ratios are extremely important for management to determine their own efficiency.
The sales to inventory ratio computes the number of dollars of sales generated by each dollar of inventory.
Sales to Inventory = Sales / Inventory
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Asset Management Ratios
The sales to fixed asset ratio looks at the number of dollars of sales generated by the business’ fixed assets.
Sales to Fixed Assets = Sales / Fixed Assets
The receivables ratio shows the average number of days it takes to collect your accounts receivables. It is determined as follows:
Days in Receivables = Accounts Receivable / (Sales/365)
The 365 in the denominator represents the
number of days in the year.
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Customer Value
A business that provides accurate and prompt billings, that can control its costs which results in lower prices or a business that improves its overall efficiency because it can accurate monitor and track its operations provides far greater value than those with a haphazard approach to accounting controls.
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Cash Flow Implications
Small businesses must be much more proactive in attempting to eliminate or reduce negative cash flows.
This can be done by:
Restrict credit and credit terms
Conduct credit checks
Make credit terms explicit
Provide incentives to expedite customer payment
Request partial payment in advance
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Influence of Technology, E-commerce and E-business
Computerized accounting system holds many advantages over a manual based. These advantages include:
Accuracy
Speed
Report Generation
Cost Reduction
Backup
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Influence of Technology, E-commerce and E-business
When examining accounting software for small business, include:
Will the software run on the computers that the business currently uses?
How often the company provide updates of the software?
Are there specific versions the accounting software for the industry in which the business operates?
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Influence of Technology, E-commerce and E-business
Small businesses should also consider cloud computing options with regard to accounting software.
Cloud computing refers to the fact that the program and the data is stored off-site at another location.
This means that accounting transactions can be entered from any computer, in some cases from smartphones, and are accessible anywhere in the world.
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