Social Enterprise Learning Toolkit (Financial Analysis Module)

Social Enterprise pLearning Modules:

Financial Analysis

Social Enterprise Learning Modules

Social enterprises are businesses operated by non-profit organizations for the dual purpose of generating income through sales and achieving a social outcome. Social enterprises blend social and financial objectives.

Their success requires a unique set of governance, management and operation tools, and skills and resources that utilize, adapt and integrate from both the traditional business and non-profit sectors.

The Social Enterprise Learning Modules, included in this toolkit, cover the basic elements that a person or organization should pursue and understand if they are going to participate as a board member, manager, paid staff or volunteer at a social enterpriseenterprise.

While the Social Enterprise Learning Modules can stand alone, it is very important to always keep in mind the need to integrate the various components, and to realize that they are dynamic and evolving areas of learning and practice.

The PowerPoint presentation covers basic principles and discussion points; pursuing the recommended resources and links will p p p p ; p gtake you much further into the depth and detail of each area:

• Governance• Leadership• Business Operations• Products and Markets• Sales and Customer Relations• Financial Analysis• Risk Analysis

1© 2011 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

Overview of Financial Analysis Module

Introduction– Importance of financial analysis– Cultural integration– Identifying financial goals– Identifying financial roles

Budgeting & Monitoring– Budgeting – expenses– Budgeting – revenues – Monitoring the budget– Monitoring the budget

Financial Analysis– Income statement– Statement of Cash FlowsStatement of Cash Flows– Balance sheet– Ratios


IntroductionIntroduction

Importance of Financial Analysis

• Provides information to form a basis for management decisionsg

• Overall, it will affect the following areas of the organization:

– Sustainability

– EfficiencyEfficiency

– Effectiveness


Cultural Integration

• Shift to sales and profitsp

• Independence from the not-for-profit organization

– Formalize the relationship

– Clear and separate reportingClear and separate reporting

– Think like a business


Identification of Financial Goals

• Standard business profitabilityp y

• Social enterprise financial goals could be:

– Self-sufficiency

– ProfitabilityProfitability

– Contribution


Identification of Financial Roles (cont’d)

• Important to identify roles, responsibilities and accountabilitiesp y , p

• Identification to be done in conjunction with allocation of tasks

• Segregate the duties of preparing financial information and reviewing the financial information

– For example:

A bookkeeper – preparer of financial information

An accounting manager – reviewer of financial informationg g


Budgeting andBudgeting and Monitoring

Budget and Forecast

What it is:– An important part of the planning and forecasting processp p p g g p– A key document that translates plans into money– Estimate (informed guess)– A document that is updated and reviewed based on new information (with proper p ( p p

approval from the Board of Directors)

What it is NOT:– A copy of last year’s + 10%– Administrative work– Optimistic and unrealistic picture

Budget becomes more accurate through the yearsBudget becomes more accurate through the years

Break the budget for coming year into a monthly budget


Steps to Preparing a Budget

1. Align the budget with the Chart of Accounts for Revenue and Expense

2. List items on which you spend moneyy p y

3. Estimate the unit cost of the line items, then annual costs

4. List likely sources of income

5. Identify any drivers for variable revenues and expenses5. Identify any drivers for variable revenues and expenses

6. Prepare budget format

7. Add in notes to explain items and key assumptions

8 Obtain feedback8. Obtain feedback

9. Finalize the budget

NOTE: If your social enterprise does not operate as a separate entity from your Not For Profit, consider setting up your social enterprise as a separate subsidiary or department for budgeting purposes


Determine True Expenses

Expenses:• Fixed versus Variable

• Direct versus In-direct

• In-Kind/Hidden Expenses

– Allocation of these expensesAllocation of these expenses


EXAMPLE – ABC Thrift Store Inc. (Fixed & Variable Expenses)

Please complete “Handout #1 Worksheet – Budget for ABC Thrift Store Inc.”, using the following information below.

1. ABC uses a portion of the building owned by its NPO parent to run the store, but p g y pdoes not pay for this space. The portion ABC rents is 10% of the total building. The rental expense for the entire building is $150,000 per year.

2. ABC incurs supplies expense (i.e., purchase of shopping bags and price tags) of $5,000 per year. y

3. ABC incurs cleaning/maintenance expense of $2,000 per year.4. ABC sorts all donated goods as received, which costs approximately $200 per

month.5. ABC incurs utilities expense of $5,000 per year.6. ABC incurs the following salary expenses:

• One manager is in charge of operating ABC Thrift Store. The manager’s annual salary (including benefits) is $40,000.

• There are two part-time sales associates. Their hours vary depending on the season; however, their hours and salary equate to one associate working working at all times when ABC is operating, paid $10/hour (including benefits).

7. ABC operates 8 hours a day and for 30 days per month.


Determine True Revenues and Cost of Goods Sold

Revenues• Recurring versus One-timeg

• Other Revenues – revenues not obtained directly from operations such as rental income or the sale of an asset

Cost of Goods Sold (COGS)• Refers to the inventory costs of those goods that a business has sold during a particular

period


EXAMPLE – ABC Thrift Store Inc. (Revenue & Cost of Goods Sold)

Please complete “Handout #1 Worksheet – Budget for ABC Thrift Store Inc.” using the following information below.

1. ABC Thrift Store sells 3 products – T-shirts, Dresses and Jeans2. For T-shirts:

• ABC receives a donation for the t-shirts with an “in-kind value” (assumed price) of $5 each if purchased

• ABC will receive1,200 t-shirts per month, and expects to sell 1,000 t-shirts per month3. For Dresses:

• ABC pays $10 each for the dressesC pays $ 0 eac o t e d esses• ABC will buy 700 dresses per month, and expects to sell 500 dresses per month

4. For Jeans:• ABC pays $7.50 each for the jeans• ABC will buy 400 jeans per month and expects to sell 300 jeans per month• ABC will buy 400 jeans per month, and expects to sell 300 jeans per month

5. ABC marks up its products 100%


Budget Exercise Review

Di i i t

Answers on “Handout #2 Answer Key Worksheet Budget for ABC Thrift Store Inc.”

Discussion points:• What is the budget telling us?

• Seasonality versus average monthly budget

• Donated items: value assigned because if removed, it would be an expense to the social enterprise

• Inventory: inventory remains on the balance sheet until sold at which point it is expensed


Budgeting Year to Year

Amount last year Increment

Current year budget

Revenue Revenue T-shirt 120,000 10% 132,000 Dresses 120,000 9% 130,800 Jeans 54,000 -50% 27,000

ExpenseExpense Cost of Sales

T-shirt 60,000 5% 63,000 Dresses 60,000 9% 65,400 Jeans 27,000 -50% 13,500

Salaries 70,000 3% 72,100 Rent 15,000 3% 15,450 Utilities 5,000 2% 5,100 Maintenance 2,000 3% 2,060 , ,Supplies 5,000 0% 5,000 Sorting cost 2,400 5% 2,520


Monitoring the budget

To monitor the budget prepare a variance report (preferably on a monthly

Refer to “Handout #3 – Variance Analysis for ABC Thrift Store”, to review the information below.

To monitor the budget, prepare a variance report (preferably on a monthly basis)• Report on:

– Monthly income and expenses compared to monthly budget amountMonthly income and expenses compared to monthly budget amount

– Year-to-date actual comparison with year-to-date budget amounts

– Compare to last year

Add percentage variances– Add percentage variances

– Add explanations

• Key report to be reviewed by the organization’s Board of Directors

• Ke report to help the organi ation assess hether the are achie ing their goals• Key report to help the organization assess whether they are achieving their goals


FinancialFinancial Analysis

Note to Participants

The following slides on financial analysis contain financial statements that have been presented under accounting standards used by for profit businesses. This format of

i fi i l i i i f l f i l d i i ki b h l ireporting financial activity is useful for internal management decision making by helping your organization gain a true picture of the sustainability of your social enterprise.

If you have chosen a non-profit legal structure for your social enterprise, or your social t i i t f fit i ti ll t l ti t b t denterprise is part of a non-profit organization, all external reporting must be accounted

for under non-profit accounting standards as specified in the Canadian Institute of Chartered Accountants’ Handbook, not as presented in the following slides.

This form of reporting is onl to be sed e ternall if o r social enterprise is registeredThis form of reporting is only to be used externally if your social enterprise is registered as a for profit business.


Income Statement

• Statement of operations under NPO reporting

Refer to “Handout #4 –ABC Thrift Store Financial Statements”, when reviewing the information below.

p p g

• This report shows the amount of revenue that was earned over a period of time and the amount of expense incurred over the same period

• The difference between revenue and expenses is the net income/loss from the periodp p

• Income Statement divided into three sections:

– Revenue: The dollar sales amount of the product over the period of timep p

– Cost of Goods Sold: Direct costs associated with creating the goods sold

E– Expenses: Costs spent to carry out the activities of the organization


Statement of Cash Flows

• The Statement of Cash Flows shows how the organization’s cash position changed during


g p g gthe year

• As an analytical tool, the Statement of Cash Flows is useful in determining the short-term viability of a company, particularly its ability to pay bills

• Varies from income in that it measures whether cash has actually been received or paid for the revenues and expenses recorded in the income statement

• Statement of Cash Flows is divided into three sections:

Operating Activities– Operating Activities Production, sales and delivery of the product

– Investing Activities Purchase or sale of income producing assets Purchase or sale of income producing assets

– Financing Activities The flow of cash between the organization, its owners and its creditors


Balance Sheet

• Statement of Financial Position under NPO reporting


• Balance Sheet shows total assets, liabilities and equity of an organization at a point in time

• Balance sheet is divided into three sections:

– Assets: Listed in order of most current and liquid to longer term and fixed

– Liabilities: Listed in same manner as assets. Classifies as either short or long term depending

on timing of payment (Less than 1 year = Short-term Liability)

– Equity: The resulting value of the company after all obligations have been paid. This is

i il t th ‘N t A t’ iti f NPOsimilar to the ‘Net Asset’ position of a NPO

Consists of Contributed Capital and Retained Earnings


Ratio Analysis

Profit Sustainability Ratios Assess the ability to generate earnings d t itProfit Sustainability Ratios as compared to its expenses

Liquidity Ratios Assess ability to pay off short-term debts obligationsq y obligations

Operational Efficiency Ratios Analyze how well a company uses its assets and liabilities internallyp y assets and liabilities internally

23

Ratio Calculations

Profit Sustainability Ratios• Sales Growth = (Current Year – Prior Year) / Prior Year ( )

• Gross Profit Margin = (Revenue – COS) / Revenue

• Net Profit Margin = (Revenue – (COS + Operating Expenses)) / Revenue

Operational Efficiency• Operating Expense Ratio = (Expense / Revenue)

• Inventory Turnover = (Average COS / Average Inventory)Where: Average Inventory = (Ending balance – Beginning) / 2

• Breakeven Analysis = Total Fixed Cost / (Unit Sale Price Unit Variable Cost)• Breakeven Analysis = Total Fixed Cost / (Unit Sale Price – Unit Variable Cost)


Ratio Calculations (continued)

Liquidity Ratios

• Current Ratio = Current Assets / Current LiabilitiesCurrent Ratio = Current Assets / Current Liabilities

• Quick Ratio = (Current Assets – Inventories) / Current Liabilities


Exercise – ABC Thrift Store

• Pl f ti l i f ABC Th ift St ith th fi i l t t t h d t

Refer to “Handout #5 Ratio Analysis for ABC Thrift Store Inc.” for answers.

• Please perform ratio analysis for ABC Thrift Store with the financial statements handout using the ratios discussed in the previous slides

• Note: We will assume that if ABC Thrift Store had been in operation for 2 years, the total sales in the previous year would be $260,000sales in the previous year would be $260,000

Analysis

• Obtain industry ratios online to gauge if your social enterprise will be competitive

• May be appropriate to set different ratios than industry average depending on your mission


Summary of Financial Analysis Module

Introduction• Importance of financial analysisp y

• Cultural integration

• Identifying financial goals

• Identifying financial rolesIdentifying financial roles

Budgeting and Monitoring

Financial Analysis

Key resource: www.demonstratingvalue.org


Thank you

Q ti ?Questions?

28

© 2011 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International

Cooperative (“KPMG International”), a Swiss entity. All rights reserved.