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Chapter 4- FBO Finance

By Ellen Mason,2014-05-15 16:15
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Chapter 4- FBO Finance

    Chapter 4- FBO Finance

Contents:

-Financial Statements

     Balance Sheet (balance sheet equation)

     Income Statement

    -Financial Ratios

    -Depreciation

    -Break-even analysis

    -Reasons new businesses fail

    -Increasing Cash Flows

    -Profit Centers

    -Profit

    -Overhead vs. direct costs

    -Cash Flows

1. Financial Statements

Balance sheet

Most Businesses/corporations will have a balance sheet (business plans for a start-up

    business will have a projected balance sheet). A balance sheet is a “snapshot” of the

    financial situation (assets, liabilities, and equity) of a business at any given point in time

    since it is constantly changing with the day-to day operations of a business similar to a

    picture of a moving car, you can’t tell where it’s been or where it’s going from just one

    picture.

A balance sheet must “balance” following the “accounting equation which is:

Assets = Liabilities + Owners Equity

In other words: Everything the business has (assets) is either owned by that business

    (owner’s equity) or they owe someone else for that asset (A liability such as making

    payments on your car).

As an example: You buy a $10,000 car with a $2,000 down payment of your own

    money. You owe $8,000 on that car to someone else such as a bank. That car (a $10,000

    asset) equals the $8,000 you owe (liability) plus your $2,000 down payment (Owner’s

    equity). In equation form it would look like this:

Assets = Liabilities + Owner’s Equity

$10,000 = $8,000 + $2,000

That’s it! Each financial transaction of the business must balance (purchases, payments,

    etc.)

Other Balance Sheet Notes:

Assets and Liabilities are divided up into two basic types:

    1. Current

    2. Long Term

(Total Assets = Current Assets + Long Term Assets).

Current Assets are those that can be converted into cash (i.e. sold) within 90 days.

    These include items such as inventory on-hand (fuel etc.) and accounts due from

    customers etc.

Current Liabilities are those that are due within 90 days. Items include bills and

    accounts that are payable, certain taxes etc.

Long Term Assets include things like real estate (land) buildings etc. which may take

    longer to convert to cash.

Long Term Liabilities would include long term bank loans (i.e. a 30 year mortgage

    etc.) Other terms for owner’s equity include: retained earnings and shareholder’s equity

    Income Statement

Revenues

     Net sales ____________________$3,400,000

     Rent revenue _________________ 40,000

     Interest revenue _____________ 12,000

     Total revenue _____________ 3,452,000

Expenses (usually sorted by amount)

     Cost of goods sold ___________ 2,000,000

     Selling expenses _____________ 450,000

     Administrative expenses ______ 350,000

     Interest expense _____________ 45,000

     Total expense _____________ 2,850,000

Income before taxes ____________ 602,000

    Income taxes ___________________ 180,600

    Net income _____________________ 421,400

For any given period of time, the income statement shows where money comes from,

    where it goes, and what’s left over (if any).

Income Statement Notes:

Total Revenue - Total Expenses = Net Income (loss) before taxes ($602,000 in the

    above example)

    The terms “revenue” and “sales” are often used interchangeably.

Operating income is equal to the sales revenue minus the expenses which are directly

    related to the sales of the products- the variable costs or those that change with volume.

Financial Ratios

With your knowledge of the above two financial statements you can now begin

    calculating financial ratios for your business. Financial ratios are simple calculations

    which allow you to measure the overall health of your business. Once you have

    calculated a ratio you need to measure it against a pre-determined standard for it to

    make sense. Ratio standards are published for given sectors of the economy (service,

    manufacturing, air transportation, etc. some of these are available at

    www.bizratios.com)

As an example:

    1. Current Ratio- A measure of a firm’s short-term ability to pay it’s current debts. A firm is likely to be in financial trouble of it can’t generate enough cash to pay its short-

    term financial obligations. The benchmark for this ratio is 1:1 (one asset to one liability)

    or greater. If there are more liabilities than assets (i.e. .5:1) then this is generally not

    good.

The formula for the Current Ratio is: Current Assets divided by Current Liabilities or:

Current Assets

    Current Liabilities

In our example, the numbers will be taken from the above balance sheet:

Current Assets = $13,500,000 thus: Current Assets = 13,500,000 = 1.5:1

    Current Liabilities = $9,000,000 Current Liabilities = 9,000,000

Thus, this business has a positive current ratio having 1.5 current assets to each current

    liability.

    2. Let’s look at the firm’s operating profit margin- (OPM)- a measure of profitability before paying interest and taxes. The benchmark for this ratio varies from industry to

    industry.

OPM = Operating Income divided by total sales revenue or: Operating Income

     Sales

Operating Income (from the income statement) is income before interest and taxes. In

    our example they have only shown income before taxes, $602,000 which will work for us.

The “sales” figure comes from the income statement line labeled “net sales” which is

    $3,400,000

    Thus the OPM for our company is $602,000 = .177 (rounds to .18)

     $3,400,000

    This means they are making 18% on their sales before paying interest and taxes. A

    company would obviously like this percentage to be as high as possible.

3. There are several other ratios which can be calculated such as:

    a. The Debt to Equity ratio- a measure of a firm’s long-term ability to pay all debts. This ratio should definitely be less than 1 (having more equity than liabilities). This ratio

    comes from the balance sheet.

Debt to Equity ratio = Total Liabilities

     Total owner’s equity

Another term for total owner’s equity is “total net worth”. See if you can figure this one.

b. Return on Assets- a measure of profitability is: ROA = Net Income

     Total Assets

For this one you need to look at both the income statement and the balance sheet.

    Again, see if you can calculate this one.

     Depreciation

    Depreciation in actual practice is fairly complicated. Here we will look at only the

    simplest aspects of depreciation. When it comes to paying taxes, all of us want to pay as

    little taxes as possible, including businesses. One of the largest taxes businesses have to

    pay is an asset tax which is based on the worth of their assets; thus, the less an asset is

    worth, the less the amount of taxes owed on it.

As an asset (let’s say an airplane) is purchased and used, the wear and tear it experiences

    during use inevitably reduces its value. Tax law provides for this reduction in value with

    use and this is called “depreciation.” Different pieces of equipment are allowed to depreciate at different rates and this is specified in the tax law. We’ll leave that to the

    accountants, but let’s say the airplane initially cost $200,000 and tax law allows me fully

    depreciate this asset in 10 years. That means that at the end of ten years, a company will

    owe no taxes on this asset because at that point it will have been “fully depreciated.”

    This doesn’t mean that the asset is worthless at the end of that time. We know that even a rental aircraft that is well-cared for will last much longer, but depreciation is figured for

    tax reasons only. I could sell this airplane at the end of that ten years and it might be

    worth $100,000 or more to me.

As an example: For tax purposes, at the end of the first year of use of my airplane, it

    will be worth $180,000 for the purposes of paying taxes on it (it is depreciated at a rate of

    $20,000 per year until it is fully depreciated). At the end of the second year of use it is

    worth $160,000 and so on until fully depreciated.

    Break-Even Analysis

Let’s say you, as an FBO manager are trying to decide if it will be worth your while to

    offer aerobatic training (or any other type of specialized training or other for-profit

    activity). It would be a good idea for you to know at what point you will break-even

    financially before you make the decision to move ahead with it. If you don’t know when

you will break-even you might continue to dump money into some project and never

    realize a return on it.

Break-Even Point- Point at which all costs are recovered.

Note: to figure the break-even point, you need to know the contribution margin which is

    the amount each unit of sales contributes to the fixed costs of sales.

Contribution Margin- Revenue made minus variable costs.

As an example: You are considering selling a new type of aviation navigation plotter

    you will get from Jeppesen. You plan to sell this plotter at $5. Each plotter costs you $2

    to buy from Jeppesen. In order to sell this plotter, Jeppesen requires you to make an

    initial investment of $800 in a display case (the case has a continuous playig DVD

    showing how this plotter is better than others and how it is worth the price).

Here is how the break-even analysis would look.

Let x = the number of plotters that must be sold in order to break-even on this venture.

    Here’s the formula which uses simple algebra:

$5.00x = $2.00x + $800.00

$3.00x = $800

     X = $800

     $3.00

X = (266.6666666) or 267

Thus, 267 plotters must be sold at $5.00 each to break-even on this venture. At that point,

    all of the fixed costs will have been recovered (each plotter contributes $3 to the fixed

    cost of the display case or has a $3 contribution margin).

Overhead costs: The $800 fixed cost is considered to be the “overhead” cost. The

    utilities that a business pays (lights, water, etc.) are other forms of overhead costs.

Direct costs: Another way of saying variable costs. Direct/variable costs are those that

    change with the volume sold. In the above break-even analysis, each plotter costs you $2

    therefore that is the variable cost for that plotter; if you don’t sell any then those costs

    don’t go up.

Most common reason for a new business to fail-

    80% of new businesses fail and here’s why:

    In a word: “undercapitalization” or lack of money to pay short-term financial obligations (bills, payroll, suppliers, etc.) while the business reaches a self-sustaining

    profitability level- a process which may take several months to a few years (in other

    words, not being able to feed the business until it can stand on its own two feet).

Often, inexperienced business owners will take too much in salary from the business thus

    starving it for cash.

    Reasons new businesses don’t generate enough cash-flow can be that:

    1. They may not focus enough on generating sales

    2. They may siphon off too much in salaries

    3. They may allow too many customers to rack up accounts payable.

    a. A certain percentage of accounts payable to you will never be realized.

    Others will come in several months after the good or service was rendered.

    This again, starves the business for needed cash to pay its obligations

    (again, payroll, bills, etc. and people who aren’t paid won’t come to work

    thus aggravating the situation).

To increase your cash flow potential into the business:

    1. Take only the basic salary you need to live

    2. Place strict limits on sales “on account” (buy now pay later etc.)

    a. (Realize that some customers won’t use your business if they have to pay

    up front so offering it as an option can increase business.)

    b. Charge substantially for past due accounts to discourage them

    c. Offer discounts for cash payments

Profit

A reward for a risk taken- usually financial. Most of the time a successful business goal

    is to maximize profits but sometimes an established business can modify those goals for

    the sake of providing a service to the community.

    1. As an example, providing transportation to and from distant treatment for a local

    child struggling with cancer can foster much goodwill in the community toward

    your business.

    2. Offering flight training at a cost which is below the maximum amount you could

    get in order to make flight training more available to more in the community can

    also foster goodwill and increase your business potential.

    Profit Centers

    Profit centers are the different revenue generating departments of a business such as:

    1. Flight Instruction

    2. Line Service

    3. Maintenance Shop

    4. Pilot Supplies

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