978-1259912191 Chapter 7 Lecture Notes

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Chapter Seven: Financing and Accounting

Table of Contents

Brief Chapter Outline…………………………………………………………………………………….. 2

Chapter Outline and Lecture notes…………………………………………………………………..3

Key Terms………………………………………………………………………………………………….. 12

Suggested Text

Responses………………………………………………………………………………14

Review

Questions……………………………………………………………………………………….15

Class Activities and Sample Assignments………………………………………………………..17

Discussion Questions for Online/Hybrid classes……………………………………………….18

Lecture Links……………………………………………………………………………………………… 21

Lecture Link 7.1: Federal Accounting Standards Board (FASB)……………………..21

Lecture Link 7.2: Venture Capital for the New Entrepreneurial Business………..22

Lecture Link 7.3: Social Security and Medicare Tax Rates…………………………….23

Bonus Internet Exercises……………………………………………………………………………… 25

Bonus Internet Exercise 7.1: Grant Opportunity at the New Small Business……25

Bonus Internet Exercise 7.2: Lending Sources for the New Small Business…….26

Bonus Internet Exercise 7.3: Accounting Software for the New Entrepreneur. . .27

Critical Thinking Exercises…………………………………………………………………………….28

Critical Thinking Exercise 7.1: Lending Resources for the New Small Business. 28

Critical Thinking Exercise 7.2: Cash Accounting Versus Accrual Accounting……30

Critical Thinking Exercise7.3: Chart the Accounts……………………………………….32

Bonus Cases………………………………………………………………………………………………. 34

Bonus Case 7.1: Creative Taxes and the IRS………………………………………………34

Bonus Case 7.2: Online Networking and Accounting Considerations……………..36

Bonus Case 7.3: Finance and Accounting Obstacles……………………………………37

Endnotes…………………………………………………………………………………………………… 39

Brief Chapter Outline

I. Learning Objectives (text page 122)

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Chapter Seven: Financing and Accounting

Identify key financial issues involved with starting a business.

Discuss the basics of funding a business.

Explain the importance of proper accounting when starting a business.

II. Key Financial Issues Involved with Starting a Business (text page 124)

Learning Objective 7-1: Identify key financial issues involved with starting a

business.

III. Basics of Funding a Business (text pages 124 through 132)



Learning Objective 7-2: Discuss the basics of funding a business.

IV. Importance of Proper Accounting When Starting a Business (text pages 132

through137)



Learning Objective 7-3: Explain the importance of proper accounting when

starting a business.

V. For Review (text pages 137 and 138)

Chapter Outline and Lecture notes

1. Learning Objectives (text page 122)

Identify key financial issues involved with starting a business.

Discuss the basics of funding a business.

Explain the importance of proper accounting when starting a business.

2. Identification of Key Issues

Learning Objective 7-1:Identify key financial issues involved with starting a

business

A. Key financial issues involved with starting a business:

i. The funding and funding level of the firm

ii. The establishment of an accounting system

iii. Attention to the flowing of information in the new business

B. The entrepreneur has to address all these issues when starting the

business or else these issues will be a distraction while the business is

being built.

C. The entrepreneur must evaluate the pros and cons of any shift in the

business plan.

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Chapter Seven: Financing and Accounting

D. The nature and sources of the firm’s funding should provide a financial

cushion if needed.

3. Basics of Funding a Business (text pages 124 through 132)

Learning Objective 7-2: Discuss the basics of funding a business

A. A source of funding may or may not want equity in the business.

B. Non-Equity funding

i. Defining debt

1. A generic term to describe any type of non-equity funding

tied to the business

2. This is a major funding source

3. Most common forms of debt for new businesses

a. Loans from banks, finance companies, individuals,

founders

b. Credit cards

c. Supplier credit

ii. Loans

1. Loan definition

a. Contractual agreement whereby the firm receives some

amount of money that must be repaid over a specified

period of time at a specified interest rate

i. A loan is repaid monthly from cash flow

ii. A loan is secured by assets or a personal

guarantee

b. Loans are paid back before distribution to equity investors if

the company goes under

2. Obtained from banks

a. Loans to start-up firms re restrictive

i. Start-ups are high risk

3. Asset-based lending from banks

a. A loan is provided for the purchase of a necessary asset

needed for the business

b. The bank estimates the residual value of the equipment in

case the new small business folds

4. Revolving line of credit

a. Inventory

i. The lender performs an on-site examination of

the inventory to ensure that inventory is

accounted for properly

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Chapter Seven: Financing and Accounting

ii. Problem associated with inventory

1. Old inventory would have to be

discounted as a result of market

decline

5. Loans from individuals could rupture relationships

a. Friends

b. Family

c. Self

iii. Credit cards

1. Card entitling one to revolving credit that is not tied to any

particular asset, does not have a set repayment schedule,

typical has a set upper limit and is usually tied to a much

higher interest rate than that of a bank loan

2. Good resource if the founder pays it off each month

3. Almost always tied personally to an individual

4. Business-issued credit cards provide a good tracking system

a. Divided up between founders and employees

iv. Supplier credit

1. Another form of non-equity funding that is available.

Suppliers often will provide credit on both physical assets

and the actual supplies provided

2. It ties the business to the supplies

v. Grants

1. Special funds that do not require repayment and are

designed to aid businesses in specific areas

a. Grants target disadvantaged groups

b. Economic areas

c. Particular industries

d. Target groups (i.e.: veterans)

C. Equity funding

i. Selling a percentage of the business to an outside party

1. An attorney should be consulted

2. Outside parties could be founders, investors, established

business and suppliers

a. Established business could require taking over the

new business against the will of the owner

ii. Venture capital (VC) funds are popular

1. A form of equity investment seeking high returns

2. A fund that is organized to make significant equity

investments in high-growth new ventures

3. Organized by limited partners

a. Wealthy individuals

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Chapter Seven: Financing and Accounting

b. Insurance companies

c. Other businesses

d. Retirement funds

4. The general partner is the venture capitalist

a. Investigates and invests in new businesses

b. Seeks high-growth businesses with an opportunity to

cash out, participating in an IPO or sale to a larger

company in a short time period

c. Expects a significant return on an investment usually

greater than $2 million

iii. Angel investors

1. High-net-worth individuals who invest in businesses not as a

business, but as an individual

2. Form of equity investors widely available to small business

3. Entrepreneurs who have sold their businesses, retirees,

doctors, lawyers, and individuals who have received

significant inheritances

4. They can add knowledge to the firm

5. Their experience and contacts should be evaluated as well

as potential intrusion

iv. Crowdfunding

1. Funds received by a business by soliciting a large number of

very small investors usually via the internet.

2. Sites include Kickstarter.com, EquityNet.com,

Indiegogo.com

3. Investors usually receive a product, service or gift for a small

investment.

D. Other financing tools

i. Asset leasing

1. A form of lease tied to a particular asset used by a business

to conserve cash and maintain the latest versions of

whatever equipment is available

2. Lease from the manufacturer

3. Lease from a third-party reseller

4. Advantages

a. Acquires of asset leasing assets to begin operations

with minimal cash payments

b. Do not age

c. Company pays lease from what it produces using

the equipment

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d. Company can trade up for higher-quality, newer

machines

5. Disadvantages

a. The business may end up spending more money for

the equipment lease than buying the equipment

b. The business owner evaluates

i. Cash amount required to purchase the

equipment

ii. Given the equipment obsolescence in the

industry, leasing or owning may be better

ii. Factoring

1. Accounts receivable that are sold at a discount to another

company in order to receive immediate cash

2. Evaluate quality of receivables

a. Determined by who owes money to the new business

b. The age of the debt

c. The size of the transaction

d. The debtor’s credit rating

3. Advantages

a. Money is generated immediately from accounts

receivable

b. No time or effort is required to collect receivables

4. Disadvantage

a. The new company does not receive the full amount of

the bill that is due

E. Initial funding

i. The founder calculates the amount of money required to start the

new small business

ii. The founder evaluates what has to be given up to get the money

iii. Capital funding can get complex as the new business requires

external investment in order to begin operations

iv. Calculate the amount of outside funding required

1. The maximum amount of outside funding needed should be

calculated

2. The entire cash flow projection without adding equity

investment should be calculated

3. The point at which the ending cash balance is at a low point

should be determined

4. The rule of thumb is to take that number and multiply it by

150 percent

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5. The resulting amount is the recommended amount for the

initial equity or equity-plus-debt-investment.

6. This amount is connected to the percentage of the firm that

previously determined would be made available to investors

4. Importance of Proper Accounting When Starting a Business (text pages 132

through 137)

Learning objective 7-3: Explain the importance of proper accounting when

starting a new business

A. Accounting decisions to be made when starting the business

i. A cash-based accounting system is used

1. It recognizes expenses as they are paid

2. It recognizes revenue as it is generated

3. Only very small businesses use this system

ii. An accrual-based accounting system is used

1. It’s the more typical method

2. Expenses and revenue are recorded regardless of when

cash is received

3. This method is required for businesses with inventory

4. Subchapter C corporation requires it

5. A partnership requires it

6. A trust requires it

iii. Accounting programs are evaluated

1. The founder must understand what program is best for the

specific business

2. The founder must realize what is and what is not needed

3. The top accounting program selected must generate those

reports required for the business

B. Chart of Accounts report

1. The Master system is used to track activity of the business

2. System designed to customize business needs

3. It lists the income, expenses, and assets of the business

4. Account numbers are assigned by the business person

5. Income, expense and asset categories are usually listed in

that order

a. Account numbers for each of the categories should

leave space for new categories to be added later

C. Petty cash register report

i. It’s used for expenses too small to write a check

ii. It’s similar to a bank savings account

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iii. A small lockbox is used for petty cash

iv. This report records and documents expenditures

v. A check is written to replenish the petty cash fund

D. Check register report

i. It records all checks written

ii. It records checks that have cleared the bank

iii. It’s used to balance the books monthly

E. Expense accounts report

i. It tracks expensed by the month in order to form an annual record

ii. It records credit card purchases and payments including interest

expenses and a statement identifying the card used

iii. Travel expenses are handled differently in accordance with IRS

guidelines

F. Inventory account report

i. Maintains inventory records

ii. Lists a description of items by

1. Quantity

2. Item number

3. Unit cost

4. Total cost

iii. Inventory is taken at scheduled periods during the year

iv. An exact match should be completed between starting inventory,

units sold, and ending inventory

v. Second record should be kept to track inventory ordered and

inventory received

vi. Shrinkage will occur

a. The difference between what has been sold and what was

brought into the business

b. It can be the result of poor record keeping

c. It can be caused by employee or consumer theft

G. Accounts payable report

i. A separate record is maintained for each creditor

ii. Invoices received are recorded

iii. The payment of each invoice should be recorded by

1. Date paid

2. Amount paid

3. Check number/transfer tracking number

H. Payroll report

i. A separate record should be kept for each employee

ii. It tracks time and attendance for employees and each employee’s

time (hourly)/attendance (exempt)

iii. Each payroll check is tracked by

1. Date

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2. Check number

3. Number of hours worked(or 40 for exempt)

4. Base pay

5. Overtime hours worked

6. Overtime pay rate

7. Gross pay

8. Taxes

a. Federal

b. State

c. Local

d. Social Security

e. Medicare

f. Benefit deductions

g. Net pay

9. A software package documents payroll records

a. Provides control records for financial statements

b. Provides input records for financial statements

c. Provides records for the Profit and Loss Statement

(P&L Statement)

i. A financial statement used that summarizes the

revenue, costs and expenses incurred during a

specific period of time

ii. It represents the performance of the business

over a period of time

iii. It should be prepared monthly

I. Managing information flow

i. The time frame needs to be determined when data should be

maintained

ii. The time frame can be determined by a comparison to other similar

firms

1. How they obtain data is reviewed

2. How they monitor data

iii. Just-in-time inventory control can be used

1. It minimizes excess capital investment in inventory

2. The firm seeks to have inventory present only for a short

time before it is used

3. Small firms don’t have complex data measurement methods

used by large firms

4. It requires that data is obtained in a timely manner tied to the

organization’s strategic needs

5. For Review (text page 134)

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