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Financial management

The backbone of any business is financial management. Many businesses are making loss while they think they are making profit. Poor financial management can hinder the success of your business.

Basically finance is like a crucial part of any businessall the activities of the company goes down to the finance part

finance has to deal with the management to how the inflows and the outflows are managed and the quality of investment decision that can be made.

A company’s finance is as important as its customer and employee satisfaction.

Some people measure a company by those three factors.

In order to make a good investment decision, it’s good to have an ability to read financial statements.

Financial statements have 5 components

  • first is the income statement
  • second the statement of financial position (balance sheet)
  • cashflow statement
  • statement of changes in equity
  • and the notes to the account

Those are the components of every complete financial statements

we will discuss them in details as we proceed

 

Also, we have five elements of financial statements

  • First is the Asset
  • Second is the liability
  • third is the equity

next is the revenue or income and the last is the expense

Once you digest and understand all of these, you are a step closer to reading a financial statement

with an in depth understanding of the components and element of the financial statements mentioned above, we are good to go with reading any financial statement

financial management helps owners of business to evaluate the performance, position and the liquidity of the business. As we know that business has different phases a d each phase has it’s own chatacteristics

Some businesses are doing well based on customer base and turnover but they are performing so poor.

Financial management is one of the most important responsibilities of owners and business managers. They must consider the potential consequences of their management decisions on profits, cash flow and on the financial condition of the company. The activities of every aspect of a business have an impact on the company’s financial performance and must be evaluated and controlled by the business owner.

As said earlier, income statement or statement of profit or loss account is one of the key accounts

The essence of the income statement is to evaluate the performance of a company

out of all the elements of financial statements, it’s only two you can find on the income statement

 

Income and expenses

Until you arrive at your profit or loss, you can never tell if a company performs bad or good

if the income is more than the expenses we can then say the company’s performance is good. However, if the expenses is more than the income we say the company’s performance is bad or poor.

This same performance is what investors use to analyze the feasibility of a business and they make their investment decision whether to invest in your business or not

To be precise, how viable your business is depends on its performance and that is what investors want to know

From this they can ascertain their payback period, Return on investment and other investment decision tools

So if in any situation you heard something like feasibility/ viability. Have it at the back of your mind them at it’s tending towards performance.

On the phase of income statement, you can have trade income and other income

Trade income is the income that is generated solely from your business activities

And it’s derived by multiplying the selling price with the number of unit sold

other income are income from sources other than your business line.

It includes income like interest on fixed deposit, gain on asset disposals am d some other sources

The sum of the two gives you the total income/revenue

Also cost are divided into segments

we have direct cost and indirect costs

The direct costs are also the cost of sales

while the indirect are the overhead costs

that’s cost that are incurred not particularly because of the product you deal in but because of other activities that deal with your existence in business

two prominent example of direct cost are cost of raw material and cost of direct labour

However, transportation, electricity, advertisement, admin cost, legal fee and others are overhead costs

the summation of the two gives total cost

This kind of classification is called Classification of Cost by Nature

We can also classify cost based on the behaviour of the costs

in this case, costs can either be fixed or variable costs

Variable costs are cost that change as you alter your scale of operation

they change with changes in production level

The examples of such costs are direct material, direct labour and direct chargeable expenses, such as electric power, fuel, etc.

The fixed cost however do not vary with your production process

they are relatively stable at different production stages

e.g rent, depreciation of machinery and other equiptments

Once we are able to account for our income and also our costs, the next thing to do is to ascertain if our performance is poor or good

That’s just the summary of the income statement

Some key metrics

to evaluate and compare performance are

  • gross margin
  • net margin
  • Return on investment
  • Return on equity
  • Return on asset
  • and for a listed company we can consider earnings per share

The gross margin is calculated by subtracting cost of sales or direct cost from the revenue to arrive at the gross profit…. we will now divide the gross profit by the total revenue

what this one is telling us is that after deducting the cost of sales from the revenue, what percentage of the revenue is remaining

So if your gross margin last year was 65% and it’s 50% This year, we will say the performance or the previous year is better than the current year

the net margin is basically your profit divided by the revenue

This means the percentage of revenue left after the company has cover all it’s direct and indirect costs

The return on investment is the same thing as the return on equity.

and it’s calculated by dividing the net profit by the equity balance

we will dwell more on equity once we get to balance sheet explanation

and the return on asset is the net profit divided by the Asset value

let’s go ahead to discuss the concept of breakeven in part two of Financial Understanding.

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