Acknowledgments - agric.wa.gov.au

Department of Primary Industries and Regional Development Australia

Plan, Prepare, Prosper

Financial Management – Food Manufacturing

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Acknowledgments

This document is part of the Plan, Prepare, Prosper program that was developed under the Pilot of Drought Reform Measures (‘the pilot’), a joint initiative between the Australian Government and the Western Australian Government. The pilot was established to support farmers, rural communities and related food manufacturing and value-adding firms to deal effectively with the significant changes and challenges currently facing the food industry in Australia.

Plan, Prepare, Prosper is a strategic planning process that will help Food Businesses to assess their business and determine the best course of action in response to known and projected challenges to business performance.

Adaptation of the material originally authored by Lucy Anderton for the Agricultural sector was undertaken by Matthew Winter for Growing Australia Pty Ltd.

The Department of Primary Industries and Regional Development, would like to recognise and thank the Rural Business Development Corporation, Curtin University, Curtin Centre for Entrepreneurship, Agknowledge, Farmanco, Plan Farm, David Koutsoukis, Greg Barnes and others for their contributions in the development of this program and permission to use their intellectual property.

Acknowledgments for their invaluable contribution go to economist David Kessell (DAFWA), Tracey Ebert, South Coast Facilitation and AAAC WA members: BankWest’s John Sgambelleri and Andrew Zadow; Ashley Herbert, Steve Hossen, Rod Grieve, Andrew Ritchie and Tim Johnston.

IMPORTANT DISCLAIMER

The Chief Executive Officer of the Department of Primary Industries and Regional Development and the State of Western Australia accept no liability whatsoever by reason of negligence or otherwise arising from the use or release of this information or any part of it.

Copyright © Western Australian Agriculture Authority 2018

Financial Management –Food Manufacturing Page 2


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Department of Primary Industries and Regional Development:



Contents

Section One: Financial Management Reference Material ...................................... 6

1 Introduction ...................................................................................................... 8

2 The business of food manufacturing .............................................................. 9

Understanding what drives a successful business .......................................... 10

Business performance analysis ....................................................................... 12

Benchmarking ................................................................................................. 13

Using your profit and loss statement to increase net profit .............................. 16

Understanding your profit and loss statement - Seven key categories ............ 18

The one-percenter principle ............................................................................. 20

Profit drivers .................................................................................................... 21

Increasing the value of your business ............................................................. 30

Cash flow budget forecasting .......................................................................... 33

Balance sheet .................................................................................................. 36

Debt to equity ratio .......................................................................................... 38

Interest coverage ............................................................................................. 39

Current ratio .................................................................................................... 40

Quick ratio ....................................................................................................... 41

Funding working capital requirements ............................................................. 43

Net working capital as a percentage of sales .................................................. 44

Stock turns ratio .............................................................................................. 46

Debtor days ..................................................................................................... 47

Accounts payable ............................................................................................ 48

Borrowing money ............................................................................................ 49

Reducing debt levels ....................................................................................... 50


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3 Looking ahead and setting goals for your plan ............................................ 51

4 Additional Support .......................................................................................... 52

5 Business Structures ....................................................................................... 53

References ............................................................................................................... 61

Financial Glossary .................................................................................................. 62

Section Two: Financial Management Activity Book ............................................. 68

6 Assigning Costs .............................................................................................. 70

7 Profit drivers .................................................................................................... 71

8 Calculate profit ratios ..................................................................................... 72

Gross profit margin (Gross margin %) ............................................................. 72

Net Profit Margin or Net Margin (%) ................................................................. 73

9 Risk ratios........................................................................................................ 74

Calculate debt : equity ratio.............................................................................. 74

Calculate interest coverage.............................................................................. 75

10 Liquidity ratios ................................................................................................ 76

Calculate current ratio ...................................................................................... 76

Calculate quick ratio ......................................................................................... 77

11 Working Capital Ratios ................................................................................... 78

Calculate net working capital ........................................................................... 78

Calculate Stock turns ....................................................................................... 79

Debtor days...................................................................................................... 80

12 Accounts payable and borrowing money ..................................................... 81

13 SWOT analysis of content covered today ..................................................... 81


Section One: Financial Management Reference Material


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1 Introduction

The business of food manufacturing is undergoing unparalleled change.

The challenge facing the industry is to deal with these changes and ensure the ongoing success of the industry.

We all aspire for different things in life and much depends on our time of life, capacity for risk-taking, personality, circumstances and goals. No two businesses are the same.

The objective of strategic planning is to identify your aspirations and goals, then decide how to achieve them.

This Financial Management workshop is all about understanding how to measure your business performance and to identify what you can do to improve it. Regardless of your reasons for being in food manufacturing, it remains a business and a truly successful business should provide the income to support the lifestyle you want. Are you achieving this? How do you know if you are running a successful business? How do you evaluate the performance of your business?

This workshop introduces you to methods that will enable you to measure your business performance and evaluate its strength. We provide you with a framework and method of analysis using one year’s data, which you can apply to other years. Once you understand how well your business is performing, you will be able to make more informed decisions about your future.

We hope you enjoy this workshop and get enormous benefit from either learning new skills, or just reinforcing old ones, and taking the time and opportunity to spend much needed time working ‘on’ your business, as well as ‘in’ your business.

At the end of today, you will understand how to analyse your business’s financial performance and what the key profit drivers in food production / manufacturing businesses are. You will have some clear ideas about what you need to either continue doing well, or to improve upon to be more profitable and be able to set some clear goals and develop strategies to achieve those goals. You will understand the benefits of a cashflow forecast for your business, as well as the need to focus on building a strong Balance Sheet. Finally, you will understanding how the key financial ratios for your type of business are calculated, and how tracking these ratios can help you manage your business better.

A truly successful business should provide the income to support the lifestyle you want, and the time for you to enjoy it.


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2 The business of food manufacturing

Food manufacturing owners and managers have to wear two ‘hats’ to run a successful food manufacturing business - the production management ‘hat’ and the ‘business management’ hat.

This workshop focuses on the activities you do while wearing your business management uniform specifically – financial management.

Figure 1 The two sides of or business


Understanding what drives a successful business

The ability to generate profit is what drives a successful business — the more profit generated means more funds are available to:

reinvest the money in improving or growing the business

decrease debt and risk

become drawings for owners to improve their quality of life

build the personal wealth of the owners.

Ultimately, it is the profitability of a business — and an industry — over time that determines its long-term success, growth, productivity and resilience.

Profit is generated from the equation:

Profit is generated from the equation:

Sales (number of units sold x price obtained for each unit)

– Costs (costs of production, running the business, finance and depreciation)

= Profit

Equation 1 Profit

At first glance, this looks like a very simple equation. However, we know it is not quite that simple because each line comprises a number of complex interactions that contribute to the result. Table 2.1 shows some of the components that contribute to each part of the equation.

Table 1 Components of profit

Sales volumes Price Costs

Production capabilities Global markets Global markets

Sales force and skills Marketing decisions Type and quantity of inputs

Market trends and sentiment Quality of product Lifestyle choices

Relationships with customers Power of channel members Investment decisions

As a business manager, you may have 100 per cent control over some of these components - volume of ingredients in a recipe, for example. There are other components, such as rainfall, however, over which you have little or no control - nor any influence. It is important to distinguish between the two.


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The first habit in Steven Covey’s popular book Habits of highly effective people is: ‘be proactive’. This is particularly helpful advice when you feel powerless against life’s forces.

Covey recommends looking at what you can do instead of focusing on worries over which you have no control. He suggests that you first note all your concerns and then determine where you can take action. Your circle of influence increases and your circle of concern will shrink as you understand better what you can influence and what you can’t. By focusing on what you can do to improve profit, you become part of the solution and not part of the problem.

Which part of the profit equation do you have the most influence over?

Using Covey’s first principle, it becomes apparent where you can have most impact and where more effort should be applied to improve profit.

Figure 2 Covey’s circles of influence and concern

As you become better at concentrating on what you can influence, your circle of influence gets bigger.

Circle of Concern

Circle of

Influence


Business performance analysis

Whatever your situation, understanding your business goes a long way in helping you to succeed. You need to gather some information about the different aspects of your business before you sit down to analyse it.

The information needed to achieve this will ideally include:

sales over time, broken down by product types, customers and ideally different groups of customers

cash flow statement showing forecast and actual income and expenditure for each production year (ideally for the next three years)

profit and loss statements (past three to five years)

balance sheet (past three to five years)

key financial ratios (past three to five years).

This data will allow an objective analysis of the performance of your business over time. However, if you are uncertain what some of the above information relates to, do not be concerned; each aspect is covered in this workshop.

A three- to five-year analysis provides an understanding of trends and recognition of the financial impact of prices, and market and seasonal variation. A one-day workshop cannot cover every year. But we can provide a method using one year’s data that you can apply to your own data over time.

Cash Flow Budget

The business cash flow budget estimates your income and expenditure for each month and calculates your cash surplus. It tells you how much money you have on hand or available to draw on to stay in business while you remaining profitable. It also identifies when you do not have enough cash on hand to fund operations, and so when you need to arrange finance to cover these possible shortfalls.

The important uses for the cash flow budget are:

monitoring budget v. actual data - how far does actual performance deviate from our plan?

calculating operating surplus for the year

identifying when best to schedule planned purchases or expenditures

identifying how you can reschedule payments through the year to minimise cash shortfalls

identifying when you will need to arrange finance to cover cash shortfalls.


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Profit and loss statement

This statement gives the actual profit (or loss) generated by your business yearly. It takes into consideration non-cash costs like depreciation and under - or overpaying of owner-managers (Your accountant will use a variation of this for preparing your tax returns).

Balance sheet

You may know this as a statement of position, or as an assets and liabilities statement. The balance sheet states the type and value of assets owned by the business and the amount of debt owed. Net worth or equity, usually expressed as a percentage of assets, is calculated using the information in this statement.

We will discuss all of these financial statements in more detail throughout the workshop.

Benchmarking

Benchmarking is “the process of comparing one's business processes and performance metrics to industry bests or best practices from other companies. Dimensions typically measured are quality, time and cost. In the process of best practice benchmarking, management identifies the best firms in their industry, or in another industry where similar processes exist, and compares the results and processes of those studied (the "targets") to one's own results and processes. In this way, they learn how well the targets perform and, more importantly, the business processes that explain why these firms are successful.”

Sourced: http://en.wikipedia.org/wiki/Benchmarking

Benchmarking helps you to identify best management practices, explore operating deficiencies and understand where you are currently relative to your goals. Benchmarking primarily focuses on profitability.

Using benchmarks to manage your business

The benchmarks or financial ratios used in this workbook are from a variety of industry sources because of the variety within the food manufacturing sector itself. They need to be used with caution, because they are an average, rather than a prescription for what is best for your business. In other words, they are a guide only.

When using the ratios, your priority should be to track how your business has been performing with regards to a specific ratio over time. Then compare your results to the indicative ‘target’ and ‘warning’ benchmarks provided.


Table 2 Summary benchmarks for food businesses

Target* Warning*

Gross margin

What proportion of every dollar in sales does the business keep, after paying the costs of making what it sells?

Variable Variable

Net margin before tax

What proportion of every dollar in sales do the business owners get as a reward for being in business?

8% 4%

Return on assets ratio

How good is the business at generating a return from its assets? (Calculated using Net Profit BEFORE Income Tax)

8% 5%

Debt:equity ratio

How many dollars of debt for every dollar of owner's equity invested

0.50 1.00

Interest coverage

How many times can Net Profit cover existing obligations to pay interest, HP and lease payments

2.0 1.2

Current ratio

How much cash or assets convertible into cash within 12 months does the business have to pay off its debts that are due in the next 12 months?

1.5 1

Quick ratio

How much cash and assets readily converted to cash does the company have to pay off its debts in a crisis?

0.75 0.25

Working capital as % of sales

How much of the business's cash is tied up funding its operations?

8% 10%

Stock turns

How many times does Stock get turned over during a 12 month period?

(> 12) (< 6)

Debtor days

How many days after being invoiced are debts owing to the company actually paid?

45 60

Please note: Target and Warning ratios intended as an indicative guide only. These vary very

substantially between different types and sizes of food manufacturing firms, firms who do and do not own their own land, and firms targeting different types of customers. Refer to your accountant or consultant for optimal target and warning benchmarks for your business to use. There are many additional financial ratios that may be very useful to you for managing the different areas within your business. Please talk to your accountant about this.


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Relationship between Profit & Loss / Balance Sheet & Cash Flow

Figure 3 P&L, BS, and CF Relationship


Using your profit and loss statement to increase net profit

Every business has significant opportunities to increase net profit. The challenge is identifying these, and focusing first on the ones that best fit with the business.

Your profit and loss statement provides an effective tool to determine how you can effectively go about improving your profitability. However, to do this, you need to be able to ‘read’ and understand your statement.

Different Types of Expenses

Variable costs are those costs that vary depending on a company’s volume of production. They increase if the company produces more and decrease if the company does less.

Fixed costs are costs that do not vary if production increases or decreases. That is, they are fixed in relation to production volume.

The difference between the two can be seen as the difference between the costs of doing something (i.e. your variable costs, that are only incurred when you do something) and the costs of doing nothing (i.e. your fixed costs, that are incurred even if you don’t get out of bed in the morning!).

Importantly, the business cannot sell a product without first incurring its variable costs. One way of looking at these is they reflect a sales ‘partnership’ between the firm and its variable cost suppliers, where sales revenue is split between them. The variable cost supplier must get paid for its inputs first, and the business gets to keep what is left over — known as its ‘gross profit’. From this perspective, the gross profit reflects the ‘real income’ of the business. Its sales revenue was never actually ‘owned’ by the business, as it knew it had to pay its variable cost suppliers a share even before it made a sale. (For this reason, sales revenue is perhaps more effectively thought of as an indication of business activity, rather than an indication of success.) Ultimately, variable costs are usually lower risk than fixed costs because they are incurred to produce income-earning products.

Fixed costs must be paid regardless of levels of production or sales. They are riskier in that they must be paid regardless of the business’s ability to make a sale, while variable costs can be reduced during hard times. However, once fixed costs have been paid for in full, the gross profit from each sale is pure net profit, regardless of how much more the business produces or sells.

For a small, growing business with small reserves of capital or in a tight market with relatively high uncertainty, a high variable cost base is generally desirable; it reflects a lower level of risk. However, for a larger business with significant funds available to cover market fluctuations, a higher fixed cost base provides it with the opportunity to achieve significantly higher net profit margins (i.e. how much the owners get to keep of each dollar in sales.)


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Three Types of Fixed Costs:

Business expenses / overheads: These are incurred to provide the business ‘platform’ required for the organisation to operate. This platform needs to be built and paid for, regardless of how much the business subsequently produces or sells.

The platform needs to be big enough that the business can produce and sell its products in sufficient volumes to generate adequate rewards for the owners. However, it also needs to be small enough to be able to be viable should the ever- present possibilities of adverse market conditions or rapidly increasing costs or an unexpected financial crisis occur.

Finance costs: These are the costs of using borrowed money to fund a business growing at a more rapid rate than the owners can or are prepared to fund by themselves. In general, such finance enables the business to ‘enjoy’ its future earlier, by making things possible that the business cannot afford to pay for by itself. Finance costs include Interest payable on loans, lease costs, hire purchase repayments and credit card interest repayments.

Non-cash costs are costs the business has incurred that have not yet been paid for. Traditionally this covers depreciation expense — how much less your assets are actually worth at the end of the year, compared to the start of the year. This expense doesn’t have to be paid for until the asset needs replacing, but it is very real, and must be taken into account when determining the profitability of a business.

One other non-cash cost — management allowance — is actually incurred when the owners underpay themselves for their role in the business. If the owners pay themselves $50 000 as general manager when the salary package they could earn working as an employee for a similar business would be $75 000, they are incurring an actual cost of $25 000 in personal income by doing this. Additionally, the true costs of the business are not being reflected, as the owners are subsidising its profits by this amount of their personal income. Many business advisers recommend business owners take this underpayment into account when determining the net profits of their business.


Understanding your profit and loss statement - Seven key categories

Figure 4 Seven key categories

Table 3 Your financial dictionary

Your profit language dictionary

1 Sales (= units *price / unit) Revenue, receipts, income, etc.

2 – Costs of sales Costs of making what you sell — also called ‘costs of production’ or variable costs (because they go up more when sales go up, and down when sales go down); cost of goods sold, etc.

3 = Gross margin The real income of your business — what’s left after you’ve paid your suppliers for what you’ve sold.

4 – Costs of running your business

Overheads or business expenses, including interest and finance costs; fixed costs that don’t vary regardless of production or sales.

5 = Cash surplus What money is left over after paying all cash expenses?

6 – Non- cash costs Expenses you have incurred but haven’t had to pay for — yet.

7 = Net profit (before tax) What’s left over for the owners from being in business?


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A simple question…

Which business do you want to own?

Figure 5 Net profit compared

Sales are not related to success. Profit most definitely is. A business with less sales and the same profits may be a significantly better business than one with rapidly increasing sales. (Sales may best be thought of as a reflection of how levels of activity within the business change over time.)

It is critical for the business owner and manager to realise that it is net profit that determines the long-term success and viability of a business (and an industry). Net profit is all that is left from sales income after the rest has been paid to financiers, employees and suppliers. (The ATO is still to take its share!)

And it is net profit that ultimately determines the ability of a business to:

pay off its debts

fund the drawings of business owners and pay dividends, so improve the owners’ quality of life and personal wealth

invest in growing and expanding the business

fund innovations, research and development and business improvements and upgrades

decrease business risk

be sold to a purchaser at an attractive price for the owner.


The one-percenter principle

Increasing net profit becomes a critically important focus to a successful business. However, due to the ‘one-percenter’ principle of business finance, there are almost always significant opportunities for a business to achieve this.

Figure 6 One-percenter principle


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Profit drivers

By working through six profit drivers, and the key factors influencing each of these, you may identify affordable and readily achievable ways to go about increasing net profit in your business. These profit drivers are:

Figure 7 Profit drivers

1. Sell more: Increase sales volume (units sold).

2. Get more: Increase the price you are paid.

3. Keep more: Decrease how much it costs you to make what you sell (i.e. decrease variable costs).

4. Focus more: Sell more above-average profit margin products; do more

business with above-average profit margin customers.

5. Spend less: Cut overheads (i.e. decrease fixed and finance costs) without damaging your business.

6. Lose less: When things go wrong.


Profit driver 1: Increase sales (sell more)

Increasing volume sold by 1%

Sales Income 100 Increases by 1%

101.00

Variable costs 36.9 Increases by 1%

37.3

Gross Profit 63.1 Increases by 1%

63.7

Fixed & Finance 58.8 Stays the same

58.8

Net profit 4.3 Increases by 15% 4.9

Figure 8 Sell more

In figure 8, a 1% increase in sales generates a 15% increase in net profit (assuming the business is not operating at full capacity and not including the costs of any additional sales or marketing activity).

Increasing sales relates to the sales and marketing activities of a business. Sales can be increased by:

attracting new customers

increasing the total dollar value of sales from existing customers

reactivating ex-customers.

When evaluating possible sales and marketing efforts, it is important to estimate both likely impact on sales and likely costs. (It is the norm to overestimate sales increases from marketing efforts, so being conservative is the way to go.)


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Profit driver 2: Increase price obtained (get more)

Increasing price obtained by 1%

Sales Income 100 Increases by 1%

101.00

Variable costs 36.9 Stays the same

36.9

Gross Profit 63.1 Increases by 1.6%

64.9


58.8


Figure 9 Get more

In figure 9, a 1% increase in price generates a 23% increase in net profit (assuming no additional costs of getting the additional 1% price).

Increasing price can be as simple as putting prices up, or as complex as building a more attractive brand over time that customers are prepared to pay a greater premium for. Changes to terms, sizes, quality or service levels, etc. are also all ways of potentially getting a higher price for what is being sold. Being able to negotiate better also often helps.


Profit driver 3: Decreasing costs of sales (keep more)

Decreasing your costs of sales by 1%

Sales Income 100 Stays the same

100

Variable costs 36.9 Decreases by 1%

36.5

Gross Profit 63.1 Increases by 0.6%

63.5


58.8


Figure 10 Keep more

In figure 10, a 1% decrease in cost of sales generates a 9% increase in net profit (assuming no additional costs).

There are a variety of different ways to decrease cost of sales, including decreasing wastage, better buying, shopping around, better negotiations, increasing productivity, and changing raw material inputs.

Profit driver 4: Focus on profitable customers and products (focus more)

Identify and focus on profitable sales

Product Gross Profit % Total Sales

Grain 35% 25%

Lamb 40% 15%

Wool 20% 40%

Beef 35% 20%

Figure 11 Focus more

This is fully covered in the previous Plan Prepare Prosper workshop – Introduction to Strategic Planning and further explored in the Plan Prepare Prosper workshop – Sales and Marketing.


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Profit driver 5: Decreasing fixed, finance and non-cash costs (spend less)

Optimising fixed and finance costs by 1%

Sales Income 100 Stays the same

100.00


36.9

Gross Profit 63.1 Stays the same

63.4

Fixed & Finance 58.8 Decreases by 1%

58.2


Figure 12 Spend less

In figure 12, a 1% decrease in fixed costs generates a 14% increase in net profit (assuming no additional costs).

There are a variety of different ways to decrease fixed, finance and non-cash costs, including decreasing wastage, better buying, shopping around, better negotiations, increasing productivity and decreasing amount or quality purchased.


Profit driver 6: Reduce frequency or impact of bad things happening (lose less)

Lose 25% less of a 2% discount on all sales

Sales Income 100 Decreases 0.5 %

99.5


36.9

Gross Profit 63.1 Decreases by 0.8%

62.6


58.8

Net profit 4.3 Decreases by 12% 3.8

Figure 13 Lose less

In this example, the business sales rep was offering a 2% discount to all customers as a matter of course during taking orders, rather than using this as a way to secure bigger sales, stronger relationships or new customers only.

By stopping the discount on 25% of sales, the business owner was able to increase net profit by 12%.

Calculating your Profit Ratios

There are two key profit ratios for tracking a firm’s performance over time:

1. Gross Profit Margin or Gross Margin (%)

Gross margin shows the percentage of every dollar in sales earned by the business, after paying all the costs of making the sale.

Determining whether your gross margin % is good or bad, or indeed any financial ratio is good or bad, is assessed in two ways. The questions to ask are:


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Is the ratio for the business increasing or decreasing over time? How can this trend be explained by what has recently happened within the business? Is the change a positive or negative indication of performance?

Is the ratio high or low compared to the particular industry average? Industry benchmarking is becoming increasingly popular as a way of assessing performance and focusing the business on improving in areas where its benchmark ratios are relatively weak.

However, it is important to note that due to the considerable variability within the food manufacturing industry, between different subgroups, sizes of firms, capital investment in land, buildings and plant, and the geographic focus of a particular business, industry benchmarking is an indicative process only. Results need to be carefully evaluated in light of historical performance of the firm over time.

Gross margins specifically are very hard to benchmark at an industry level, where the only truly useful comparison would be with a direct competitor adopting a similar strategic approach to doing business, or similar organisations in other markets. For this reason, we suggest you focus on comparing your gross margin % over time.

Table 4 Gross margin

Profit ratios (1) For the 20_ _ /_ _ financial year

For the 20_ _ /_ _ financial year

Income from sales $ $

minus

Costs of sales $ $

equals

Gross profit $ $

divided by


multiply by 100 to get a percentage equals

Gross margin % % %


Net Profit Margin or Net Margin (%)

Net margin shows the percentage of every dollar in sales left after paying all costs associated with running the business before paying tax.

Table 5 Net margin



Gross profit $ $

minus

Fixed and finance costs $ $

equals

Non-costs and drawings (Depreciation and drawings)

$ $

equals

Net profit $ $

divided by



Net margin % % %

Based on the performance of a diverse range of food manufacturers both in Australia and in various developed nations, ‘target’ and ‘warning’ net margin percentages are provided as part of this program. These have been generated to serve as an indication of performance relative to an industry average. However, specifics relating to individual food manufacturing businesses mean there may be very good reasons why a firm performs considerably above or below the target or warning benchmarks provided.

Table 6 Net margin % indicators

Net margin Indication only

Warning 4%

Target 8%


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Ansoff’s Matrix

One way of planning your growth is to evaluate which of the four ways of growing a business is best suited to your business, given its current market and competitive positioning, and the opportunities available to it. Ansoff’s Matrix (1957) (see below) provides an effective summary of these options:

Figure 14 Ansoff’s Matrix

Option One: Market penetration

Increase sales revenue from selling MORE existing products to existing customers. Relative likelihood of failure / risk = Low. Typically cashflow positive — i.e. cash invested in increasing market share in effective ways likely to be generate cash surpluses relatively quickly.

Option Two: Market development

Increase sales revenue from selling existing products to new customers — i.e. either customers in new geographic areas to that currently served by the firm, or to groups of customers significantly different to those the firm is currently selling to. Relatively likelihood of failure is Moderate. Typically cashflow negative during the initial stages of market expansion so access to surplus or additional funds required to generate growth in this fashion.

Option Three: Product development


Increase sales revenue from selling new, additional products and services to your existing customers. Relatively likelihood of failure is High, so a high level of potential return required to justify this growth strategy. Typically cashflow negative during the initial stages of new product development so access to surplus or additional funds required to generate growth in this fashion.

Option Four: Diversification

Sometimes called “the business owner suiciding through excessive ego”, this growth strategy involves selling new products to new groups of customers. Relative likelihood of failure is Very High, so a VERY high level of potential return required to justify this growth strategy. Typically cashflow negative in the short- to medium-term stages so access to considerable surplus or additional funds required to generate growth in this fashion.

Increasing the value of your business

The balance sheet (or statement of assets and liabilities or statement of position) summarises the value of your assets and liabilities. If all assets were sold and all debts paid, the balance remaining is the net worth of the business to the owner(s) — or what is referred to as the owner’s equity.

However, in reality, owner's equity is not an accurate reflection of the value of many businesses. From a practical perspective, how much a business is able to be sold for depends solely on how much a buyer is prepared to pay for it.

This is critically important to many small business owners as the shares in their business represents a high proportion of their personal wealth, and may also be their main source of funds for retirement.

Given this, most business advisers strongly recommend business owners and managers focus on maximising how much they will get for their business when they sell from the day it starts. (In reality, a two- or three-year lead-up to selling a business often gives the owners the opportunity to significantly increase the amount they are paid for it.)

The basis to valuing a business

There are literally hundreds of ways of valuing a business. Most of these are ultimately based on a simple formula using net profit and a score that indicates the attractiveness of the business to a buyer. (This in turn depends heavily on the confidence they have that the business will continue to make its current net profit into the future, after they have purchased it.)


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Summary:

Increasing the value of your business

Each industry has its own ‘rule of thumb’ for valuing a business. Most are based around:

Annual profit *profit multiple

Where: Annual profit = Net profit after tax +/– commercial reality adjustments

Profit multiple = Quality score for the business

How good a business is it?

Levels of confidence buyer has that annual profits will keep happening

Possible synergies, blue sky potential, asset sales possible, etc.

Manufacturing companies often sold at profit multiples of 2.0 to 5.0 times net profit

So in addition to maximising the net profits of a business, maximising its attractiveness is also critical. Excitingly, the actions involved in increasing its attractiveness is just good business regardless — even if the owner is not planning on selling, doing these things builds a much better business.


How to increase the value of a business

Business brokers will often provide guidance as to how a specific business may be able to increase its sale price. Here are a range of possible actions that may increase a food manufacturer's business:

Figure 15 Increasing the value of a business


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Cash flow budget forecasting

The business cash flow budget estimates your income and expenditure for each week or month and calculates your cash surplus. It tells you how much money you have on hand or available to draw on to stay in business while you remaining profitable. It also identifies when you do not have enough cash on hand to fund operations, and therefore shows when you need to arrange finance to cover these possible shortfalls.

Important uses for the cash flow budget are:

ensuring you are not trading while insolvent

dealing with the impact of the unexpected well before it becomes a crisis for the business

monitoring budget v. actual data — how far does actual performance deviate from your plan; why and what can you do about it?

being able to plan, purchase well and make good business decisions

ensuring cash surplus generated is adequate to meet stakeholders’ requirements

identifying when best to schedule planned purchases or expenditures

enabling the business to reschedule planned payments to minimise cash shortfalls

being able to arrange access to finance well in advance of when it is needed

minimising financial risks to the business and you.


A very basic example of a cash flow budget follows:

Cash flow July August September October

Receipts (30 days) 250,000 200,000 450,000 480,000

Payments

Creditors 200,000 190,000 190,000 340,000

Wages 41,000 41,000 41,000 41,000

Lease payment - Principal 8,000 8,000 8,000 8,000

Lease payment - Interest 5,000 5,000 5,000 5,000

Other expenses 35,000 35,000 38,000 40,000

ATO GST 24,000 0 0 28,000

ATO PAYG Withholding 16,000 16,000 16,000

ATO Tax

Drawings 0 0 0 0

Total Payments 329,000 295,000 298,000 478,000

Net cashflow (79,000) (95,000) 152,000 2,000

Opening Cash 89,000 10,000 (85,000) 67,000

Closing Cash 10,000 (85,000) 67,000 69,000

Figure 16 Sample cash flow


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Many manufacturing businesses regularly ‘run out of cash’ because of one or more problems with managing their cash flow.

Some of the actions that can be taken to improve cash flow include:

decrease payment terms from 30 days to 14 or 7, or even better go cash (mobile credit card terminals) or COD

request increased payment terms from your suppliers as part of next round of negotiations

collect accounts receivables quicker, chase up debts as soon as overdue

invoice earlier in the month — on day of sale or weekend rather than end of the month

minimise inventories carried — cut back on stores of raw materials, quantity of work in progress, time taken to complete a product, and stocks on hand

decrease repayment amounts for loans

reschedule payments to different times of the year following cash surpluses


Balance sheet

The balance sheet (or statement of assets and liabilities, or statement of position) summarises the value of the assets and liabilities of a business, and the owner’s ‘equity’ in the business.

The statement derives its name from the need for the total value of the company’s assets to ‘balance’ or equal the total value of its liabilities and borrowings, and the amount of money the owners have invested into the business over time. (This makes sense in that assets are what the company uses its funds for, while these same funds must come from either borrowing the money (i.e. a liability) or from the owners investing their own money into the business (i.e. the owner’s equity).)

Figure 17 Why is it called a Balance Sheet

So, if all the company’s assets were sold and all debts paid, the balance remaining represents the net worth of the business to the owner(s) — how much of the value of the assets of the business that the owners actually own.


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Using the balance sheet

The balance sheet is an important document if you wish to understand the financial position of a business. It is used with cash flow budgets and profit and loss statements to assess the strength of a business, the success of a business, its resilience, and how to go about improving all three.

Banks use the balance sheet to assess the level of risk associated with the business and ensure the business has adequate security to cover monies lent.

A number of key financial ratios are used to evaluate the balance sheet. (Figures used to calculate these ratios may also be sourced from the organisation’s profit and loss statement or cash flow budget simultaneously.) These ratios enable the business, its creditors and its investors, to assess:

how viable, resilient or risky the business is

how easily the organisation can borrow additional funds, if required

how well the business is being managed and how well it is performing.

We will now cover some of the key financial ratios used that relate primarily to the organisation’s balance sheet. These include:

debt to equity ratio

interest coverage ratio

liquidity ratio

quick ratio (or acid test ratio).

There are other very useful financial ratios that can be used to enable the business to improve performance and resilience over time. We highly recommended that you talk to your accountant or financial advisers about what other ratios may be useful to you specifically.


Debt to equity ratio

The debt to equity ratio is used to assess the relative risks being taken by the lender and the shareholders or owners. It calculates how many dollars the company has borrowed for every dollar of their own money the owner has invested in the business.

Table 7 Debt to equity indicators

Debt to equity ratio Indication only

Warning 1.0

Target 0.5

That is, a debt : equity ratio of 1:1 debt : equity is a ‘warning’ or potential cause of concern to a business, and action should be taken to explain or rectify this situation as soon as practicable. Conversely a debt : equity ratio of 0.5:1 or better indicates that lenders may be more willing to provide a loan to the company as required.

Lenders consistently require the majority of the funds of a business to be sourced from the owners. However, this ratio does not reflect whether there are alternative forms of security for the lender to consider, including the owner's home or other personal investments.

Table 8 Debt : equity ratio

Debt : Equity Ratio

Shows how many dollars of debt for every dollar owners have invested.



Total debt $ $

(Long term and short term) Divided by Divided by

Total equity $ $

(Shareholder funds + retained earnings)

equals

Equals Equals

Debt: equity ratio $ $


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Interest coverage

Interest coverage indicates how easily a business can pay the additional interest expense associated with new borrowings, and how easily it is meeting its existing interest payments.

The ratio calculates how many times the business can pay its existing interest payments, based on this figure and its net profit before tax. (Note that both of these figures come from the profit and loss statement of the business.)

Table 9 Interest coverage indicators

Interest coverage ratio Indication only

Warning 1.2

Target 2.0

An interest coverage ratio of 1.2 or less indicates the business is likely to struggle making any additional interest payments for a new loan, and indeed may be struggling to meet existing loan commitments. On the other hand, an interest coverage ratio of 2.0 or greater indicates the company can readily cope with new loan repayments.

Table 10 Interest coverage

Interest coverage

Number of times the company can make its interest payments from its net profits..



Net profit

added to

Interest expense (Finance costs)

$

$

$

$

then divide TOTAL by

Interest expense (finance costs) $ $

equals

Interest coverage ‘times’ ‘times’


Current ratio

Current ratio indicates the extent to which the company is readily able to meet its short-term liabilities (including debt repayments falling due in the next 12 months).

The ratio calculates how many times your current assets (those that can readily be converted to cash over the next 12 months) can pay off your current liabilities (all liabilities that need to be met in the next 12 months).

Table 11 Current ratio indicators

Current ratio Indication only

Warning 1.0

Target 1.5

A current ratio of 1 or less indicates the business does not currently have the current assets needed to pay off debts it needs to over the next 12 months. This means it either needs to borrow money, liquidate operating assets or source additional investor funds. (This makes it less financially secure.) On the other hand, a current ratio of 1.5 indicates the business can pay off its debts due in the next 12 months 1.5 times over based on the value of its current assets.

Table 12 Current ratio

Current ratio

Company’s ability to meet its

current liabilities (i.e. debts due

in the next 12 months).



Total current assets

(Debtors, stock, cash, etc.)

$ $

divided by

Total current liabilities

(All debts payable over next 12 months)

$ $

equals

Current ratio ‘times’ ‘times’


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Quick ratio

The quick ratio (or ‘acid test’) indicates the extent to which the company can quickly pay off debts falling due over the next 12 months, should the need arise.

The ratio calculates how many times the business's very liquid assets (its cash and accounts receivables) can pay off its current liabilities (all liabilities that need to be met in the next 12 months.)

Table 13 Quick ratio indicators

Quick ratio Indication only

Warning 0.25

Target 0.75


A quick ratio of 0.25 or less indicates the business would be able to meet 25% or less of the debts falling due over the next 12 months, should the need arise (i.e. it would need to borrow money, liquidate operating assets or source additional investor funds very quickly to be able to do this). This makes it less financially secure. On the other hand, a quick ratio of 0.75 indicates the business can pay off 0.75 or 75% of the debts due in the next 12 months just using its cash reserves and accounts receivable.

Table 14 Quick ratio

Current ratio






Current assets


Minus

Inventories

(Stock)

$

-

$

$

-

$

then divide the TOTAL by



$ $

equals

Quick ratio ‘times’ ‘times’


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Funding working capital requirements

The cash flow of a business is complicated by its ‘funding gap’ — the difference in time between the start of producing a product to sell, and when the money a customer owes for purchasing that product is finally deposited into your bank account. The cash flow cycle can be represented graphically as follows:

Figure 18 Cash flow cycle

Almost every business needs to invest a significant sum of its cash into covering this ‘funding gap’ to:

pay for its inventories of raw materials, work in progress and completed stock until sold

cover the delay between making a sale and getting the monies from this sale actually deposited into its bank account (accounts receivable).

And importantly, this cash needs to be committed permanently, such that the company’s cash reserves are substantially and continually decreased. These funds become its working capital.

However, reducing the amount of overall cash needed to fund working capital is the accounts payable of the business. Accounts payable is literally money owed to (and so owned by) the suppliers of goods or services already provided to your business that it is yet to pay to them.


When considered as a whole, accounts receivable, accounts payable and inventories of stock, raw materials and work-in-progress determine the net working capital funding requirements of a business. A major threat to the cash flow of a business is diverting too much cash into working capital, to the extent that it runs out of cash to pay for its ongoing operations.

Net working capital as a percentage of sales

One way of tracking the amount of cash diverted into funding working capital is monitoring the net working capital as a percentage of sales ratio.

This ratio calculates what proportion of the cash generated from sales is required to fund ongoing working capital needs.

Table 15 Net working capital indicators

Net working capital as % of sales

Indication only

Warning 12%

Target 8%


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A net working capital as per cent of sales ratio of greater than 12% indicates a business has a potentially worrying proportion of its cash committed to its working capital. This may be a result of managing its accounts receivable or its inventories inefficiently (e.g. not collecting debts on time, or carrying overly high levels of raw materials, work in progress or accounts receivable). On the other hand, a net working capital as % of sales ratio of 8% is indicative of a business managing its working capital very efficiently.

Table 16 Net working capital

Net working capital as a % of sales



Raw materials Plus

Work in progress Plus

Stock Plus

Accounts receivable

$

+

$

+

$

+

$

$

+

$

+

$

+

$

minus

Accounts payable $ $

equals

Net Working Capital (NWC) $

divided by

Sale income $

equals

NWC as a % of sales % %


Stock turns ratio

The stock turns ratio indicates how efficient the current levels of stock (or inventories) carried by the business are. Basically, does the business have too much, too little or around the right levels of stock? (Too much means a considerable amount of its cash is sitting on its warehouse shelves waiting to be sold, which means less cash is available to fund other key operations.)

The ratio calculates how many times a year the stock carried by the business is turned over and sold. Because of the highly variable nature of the stock generated by food manufacturers, there is no single target or warning benchmark that is appropriate in all cases. Instead, what is useful is to track the stock turns ratio for the business over time, to find out if it is carrying higher or lower levels of stock, and why.

Table 17 Stock turns

Stock turns

turned over each year



Sales Income $ $

divided by

12-month average of

STOCK

Plus

RAW MATERIALS

Plus

WORK IN PROGRESS

$

+

$

+

$

$

+

$

+

$

equals

Stock turns % %


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Debtor days

The debtor days ratio literally states how many days between the date of invoicing for a sale and the date the money is deposited into your bank account. The longer it takes the company to collect its debts, the longer its ‘funding gap’ so the more working capital it needs.

Table 18 Debtor days indicators

Debtor days Indication only

Warning 60

Target 45

Assuming invoices are being issued on 30-day terms, a ratio of 60 debtor days or more suggests the average invoice is being paid to the company 30 days overdue. This effectively means the business needs to commit an additional one month of its sales to fund its debtors paying this 30 days late.

Conversely, assuming 30-day terms, and invoices being issued at the end of each month, a 45-debtor days ratio suggests the company is efficiently collecting its accounts.

Table 19 Stock turns

Debtor days

Number of days, on average, it takes a company to collect

its accounts receivable



365 days 365 365

multiplied by

Total non-cash sales

(Sales Income)

$ $

divided by

12 Month Average of accounts receivables

$ $

equals

Average Debtor Days days days


Accounts payable

As discussed above, accounts payable are an invaluable source of interest-free money for the business to use to help fund its cash flow cycle.

However, there is a significant difference between using accounts payable to fund cash flow, and not paying your bills as and when they fall due. The former is clearly consistent with the agreement between your business and your suppliers. The latter is clearly a breach of this agreement, and has the very real possibility of having a negative, ongoing impact on the productivity and profitability of this relationship over time.

Suppliers generally give better prices, more favourable terms, and preference of supply when shortages exist, to their better-paying customers. In addition, if you don’t pay your bills on time, your credit history may be affected, which will make accessing loans significantly more difficult in the future.

Not paying bills when due is the first test for whether a business is trading while insolvent. Legal action can then be taken against the directors of the business to hold them personally liable for the debts of the company.

Perhaps most importantly, such behaviour significantly increases the risk profile of your business. As debts mount, the demands on cash flow increases, to keep creditors happy.

Countering this, the resilience of the business — its ability to cope with an unexpected crisis effectively — is significantly reduced. Many small businesses have gone broke because of an inability to pay their debts when they are due, combined with a subsequent unexpected event that significantly affected the company’s sales or operations.


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Borrowing money

After the global financial crisis, a key challenge for many capital-intensive businesses has been accessing the funds needed to grow, expand and improve their business.

For some, just accessing the funds needed to survive has been difficult, and for others, impossible.

Understanding lenders, and how they go about making decisions, is a key part of the Golden Rule when it comes to borrowing money:

‘Those with the gold make the rules!’

Lenders are in the business to make money. They have relatively strict conditions that must be met for them to be willing to lend money. As an example of a bank’s lending criteria, a lender may require favourable findings to all of the following queries:

Is the enterprise sustainable in the long term?

Are production levels historically good compared to similar enterprises?

Is machinery and plant well maintained and housed?

What is the experience, track record and integrity of key people like?

Have the operators’ performance been acceptable in the past?

Have limits been respected?

Are operators up to date with techniques and industry developments?

Do they take an active part in their industry organisations?

Do they have a previous background and experience in food manufacturing?

Does the business have diversity where appropriate?

Does the business have a demonstrated ability to record, monitor and analyse financial data including:

o knowledge of break-even points and target pricing

o knowledge and application of appropriate risk management tools and strategies, including environmental risks.

Are budgets maintained for management and planning purposes?

Does the business use consultant enterprise specialists and professional advisers?


Does a second income stream exist or do sufficient reserves or liquid assets exist to cope with a downturn?

Are staff numbers and skills suitable for purpose?

Do the operators know and accept modern techniques and technologies?

Are they able to identify and complete critical tasks on time?

Are they aware of wider industry issues likely to affect their own business?

Are the scale and efficiency of operations adequate?

Is the influence of foreign exchange rates acknowledged and relevant precautions taken?

Does a succession plan exist? Has key man insurance been considered?

And on it goes.

These criteria have been developed in recognition of the age-old adage of lending:

It’s the loans that aren’t made that make the lender the most money.’

Given these lending criteria, a business seeking to borrow money needs to be able to effectively answer the following question to maximise the likelihood of success:

What can a food manufacturer do to favourably influence a lender’s decision whether to lend the money? Reducing debt levels

Due to a wide variety of situations, a business may need to significantly decrease the debt it owes as quickly as possible. There are a number of possible strategies for achieving this, including:

minimising working capital requirements (to fund stock, raw materials, work in progress, accounts receivable) and using the surplus funds generated to pay down debt

shifting ongoing balances of short-term debts into long-term debt. (Longer term debt usually attracts a lower interest rate and requires lower debt repayments to be made annually, so freeing up additional cash to pay down debt.)

selling surplus assets: sell and lease-back existing assets or sell existing assets and lease new ones

making more net profit to pay down debt


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investing more funds into the firm, through the owner selling off personal assets such as shares or investment properties and increasing the mortgage on their home. (This should be very carefully considered, in terms of the purpose of the asset to be sold, and whether it is in fact less important to the owner than the business itself.)

restructuring existing loans, leases and hire purchase arrangements to go to interest-only or to decrease loan repayments for a period

attract new investors (starting with ‘friends, families and fools’).

3 Looking ahead and setting goals for your plan

Once you have established your financial position and understand how well your business is performing, you are more empowered to know what, if anything, you can do to improve the production performance of your business.

Calculating your financial ratios should have given you an insight into the key trends in your business over time, and what needs to be done about these. You should have more knowledge about your strengths, weaknesses, opportunities and costs, and how to plan the future of your business based on these.


4 Additional Support

Rural Financial Counselling Service Western Australia

The Australian Government's Rural Financial Counselling Service Program provides grants to state and regional organisations to provide free rural financial counselling to primary producers, fishers and small related rural businesses who are suffering financial hardship and who have no alternative sources of impartial support.

The Australian and the Western Australian Governments jointly fund the Rural Financial Counselling Service Western Australia (RFCSWA).

The RFCSWA offers a free, confidential, mobile service which can assist you and your family to calm, clarify, regain focus and create solutions, including actions to:

help identify your financial and business situation and your preferred options

help negotiate with your lenders

help you develop an action plan

identify information about relevant government and other assistance schemes

help support you to access the Farm Household Allowance (FHA)

identify with you useful sources of advice and knowledge to achieve your goals including accountants, agricultural advisers, professional support and educational services.

There are currently rural financial professionals across your region and community who are able to visit you at home or business to discuss your financial situation.

To access a rural financial counsellor phone RFCSWA direct on 1800 612 004. Or visit www.rfcswa.com.au


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Enterprise Connect

Enterprise Connect is a division of the Department of Innovation, Industry, Science and Research.

Enterprise Connect offers comprehensive, confidential advice and support to eligible Australian small and medium businesses to help them transform and reach their full potential.

With a national network of centres and around 100 experienced business advisers and facilitators, Enterprise Connect provides business improvement services to businesses in industries as diverse as manufacturing, clean technology, resources, defence, tourism and the creative sector.

Enterprise Connect’s services include business reviews delivered at no charge to businesses, grant assistance to implement recommendations flowing from the business review, and a range of tailored innovation services to meet individual business needs.

5 Business Structures

Before deciding on your business structure, it is important to seek professional advice from a business adviser, solicitor or accountant to ensure the structure you choose meets your personal circumstances and business objectives.

It is important to know that you're not locked into one business structure for the life of your business. As your business grows and changes, you may decide to move to a different type of business structure. Before changing structures, you need to be aware of the differences and obligations for each.

Sole trader

A sole trader business structure is a person trading as the individual legally responsible for all aspects of the business. This includes any debts and losses, which can't be shared with others. This is the simplest, and relatively inexpensive business structure that you can choose when starting a business in Australia. As a sole trader, you'll generally make all the decisions about starting and running your business, although you can employ people to help you.

Key aspects of a sole trader structure

Is simple to set up and operate.

Gives you full control of your assets and business decisions.

Requires fewer reporting requirements and is generally a low-cost structure.

Allows you to use your individual Tax File Number (TFN) to lodge tax returns.

https://www.business.gov.au/Info/Plan-and-Start/Start-your-business/Business-and-company-registration/Tax-file-number


Has unlimited liability - all your personal assets are at risk if things go wrong. Your assets can be seized to recover a debt.

Any losses incurred by your business activities may be offset against other income earned (such as your investment income or wages), subject to certain conditions.

Doesn't require a separate business bank account, unlike a company structure. You can use your personal bank account but must keep financial records for at least 5 years.

As the business owner, you're not considered an 'employee' of the business. You should pay yourself, which is usually a distribution of your profit, but this is not considered 'wages' for tax purposes.

If you're a business owner without employees, there's no obligation to pay payroll tax, superannuation contributions or workers' compensation insurance on income you draw from the business. You can choose to make voluntary superannuation contributions to yourself though, to help you build up your superannuation.

You can employ people to help you run your business. There are compulsory obligations that you must comply with, such as workers' compensation insurance and superannuation contributions.

It's relatively easy to change your business structure if the business grows, or if you wish to wind things up and close your business.

You can't split business profits or losses made with family members and you're personally liable to pay tax on all the income derived.

Company

A company is a type of business structure. You may consider a company structure when starting or growing your business.

A company is a separate legal entity, unlike a sole trader or a partnership structure. This means the company has the same rights as a natural person and can incur debt, sue and be sued. The company’s owners (the shareholders) can limit their personal liability and are generally not liable for company debts.

A company is a complex business structure, with higher set-up and administrative costs because of additional reporting requirements.

You need to register a company with the Australian Securities and Investments Commission (ASIC). Company officers and directors must comply with legal obligations under the Corporations Act 2001.

Key aspects of a company structure

Is a separate legal entity.

https://www.business.gov.au/Info/Run/Finance-and-accounting/Finance/Set-up-a-business-bank-account

https://www.business.gov.au/Info/Run/Superannuation

https://www.business.gov.au/Info/Run/Employ-people

https://www.business.gov.au/Info/Run/Insurance-and-workers-compensation

https://www.business.gov.au/Info/Run/Insurance-and-workers-compensation

https://www.business.gov.au/Info/Plan-and-Start/Start-your-business/Business-structure/Change-business-structure

https://www.business.gov.au/Info/Plan-and-Start/Start-your-business/Business-structure/Business-structures-and-types/Sole-trader

https://www.business.gov.au/Info/Plan-and-Start/Start-your-business/Business-structure/Business-structures-and-types/Partnership


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Has limited liability compared to other structures.

Is a more complex business structure to start and run.

Involves higher set up and running costs than other structures.

Requires you to understand and comply with all obligations under the Corporations Act 2001.

Means that business operations are controlled by directors and owned by the shareholders.

Must be registered for goods and services tax (GST) if the annual GST turnover is $75,000 or more. The registration threshold for non-profit organisations is $150,000.

Means the money the business earns belongs to the company.

Requires an annual company tax return to be lodged with the ATO.

Partnership

A partnership is a business structure that involves a number of people who carry on a business together. You may choose a partnership over a sole trader structure for example, if you'll be jointly running the business with another person or a number of people (up to 20). There are two types of partnerships - general and limited. Partnerships are governed by the relevant law depending on your state or territory:

ACT - Partnership Act 1963

NSW - Partnership Act 1892

NT - Partnership Act 1997

QLD - Partnership Act 1891

SA - Partnership Act 1891

TAS - Partnership Act 1891

VIC - Partnership Act 1958

WA - Partnership Act 1895.

Key aspects of a partnership structure

It's relatively easy and inexpensive to set up.

It requires a separate Tax File Number (TFN).

If you are carrying on an enterprise, you can apply for an Australian Business Number (ABN) but this is not compulsory.

It's not a separate entity - like a sole trader, you and your business partners are personally liable for the debts of the business.

You have shared control and management of the business with your partners.

https://www.business.gov.au/Info/Run/Tax/Register-for-Goods-and-Services-Tax-GST

http://www.austlii.edu.au/au/legis/act/consol_act/pa1963154/

http://www.austlii.edu.au/au/legis/nsw/consol_act/pa1892154/

http://www.austlii.edu.au/au/legis/nt/consol_act/p84a135/

http://www.austlii.edu.au/au/legis/qld/consol_act/pa1891154/

http://www.austlii.edu.au/au/legis/sa/consol_act/pa1891154/

http://www.austlii.edu.au/au/legis/tas/consol_act/pa1891154/

http://www.austlii.edu.au/au/legis/vic/consol_act/p84a1958135/

http://www.austlii.edu.au/au/legis/wa/consol_act/p84a1895135/

https://www.business.gov.au/Info/Plan-and-Start/Start-your-business/Business-and-company-registration/Tax-file-number

https://www.business.gov.au/Info/Plan-and-Start/Start-your-business/Business-and-company-registration/Register-for-an-Australian-Business-Number-ABN

https://www.business.gov.au/Info/Plan-and-Start/Start-your-business/Business-and-company-registration/Register-for-an-Australian-Business-Number-ABN

https://www.business.gov.au/Info/Plan-and-Start/Start-your-business/Business-structure/Business-structures-and-types/Sole-trader


The partnership doesn't pay income tax on the income earned. You and each of your partners pay tax on the share of the net partnership income you each receive.

Requires a partnership tax return to be lodged with the Australian Taxation Office (ATO) each year.

Each partner is responsible for their own superannuation arrangements - you are not an employee of the partnership.

You must be registered for GST if the annual income turnover is $75,000 or more.

Trust

A trust is an obligation imposed on a person - a trustee - to hold property or assets (such as business assets) for the benefit of others, known as beneficiaries.

Key aspects of a Trust

can be expensive to set-up and operate.

require a formal trust deed that outlines how the trust operates.

require the trustee to undertake formal yearly administrative tasks.

if you operate your business as a trust, the trustee is legally responsible for its operations. A trustee of a trust can be a company, providing some asset protection.

Knowing the main features of a trust business structure may help you decide if this structure is best for your business.

Sourced: Australian Government: https://www.business.gov.au/Info/Plan-and-Start/Start-your-business/Business-structure/Business-structures-and-types

https://www.business.gov.au/Info/Run/Tax/Register-for-Goods-and-Services-Tax-GST


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The tables below summarise the advantages and disadvantages of each type of business structure.

Table 20 Sole Trader – Advantages and Disadvantages

Sole Trader You're the boss. You have unlimited liability for debts as there’s no legal distinction between private and business assets.

You keep all the profits. Your capacity to raise capital is limited.

Start-up costs are low. All the responsibility for making day-to-day business decisions is yours.

You have maximum privacy. Retaining high-calibre employees can be difficult.

Establishing and operating your business is simple.

It can be hard to take holidays.

It's easy to change your legal structure later if circumstances change.

You’re taxed as a single person.

You can easily wind up your business.

The life of the business is limited.


Table 21 Partnership – Advantages & Disadvantage

Partnership Two heads (or more) are better than one.

The liability of the partners for the debts of the business is unlimited.

Your business is easy to establish and start-up costs are low.

Each partner is ‘jointly and severally’ liable for the partnership’s debts; that is, each partner is liable for their share of the partnership debts as well as being liable for all the debts.

More capital is available for the business.

There is a risk of disagreements and friction among partners and management.

You’ll have greater borrowing capacity.

Each partner is an agent of the partnership and is liable for actions by other partners.

High-calibre employees can be made partners.

If partners join or leave, you will probably have to value all the partnership assets and this can be costly.

There is opportunity for income splitting, an advantage of particular importance due to resultant tax savings.

Partners’ business affairs are private.

There is limited external regulation.


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It’s easy to change your legal structure later if circumstances change.

Table 22 Company Advantages & Disadvantages

Company Liability for shareholders is limited.

The company can be expensive to establish, maintain and wind up.

It's easy to transfer ownership by selling shares to another party.

The reporting requirements can be complex.

Shareholders (often family members) can be employed by the company.

Your financial affairs are public.

The company can trade anywhere in Australia.

If directors fail to meet their legal obligations, they may be held personally liable for the company's debts.

Taxation rates can be more favourable.

Profits distributed to shareholders are taxable.

You'll have access to a wider capital and skills base.


Table 23 Trust – Advantages & Disadvantages

Trust Limited liability is possible if a corporate trustee is appointed.

The structure is complex.

The structure provides more privacy than a company.

The trust can be expensive to establish and maintain.

There can be flexibility in distributions among beneficiaries.

Problems can be encountered when borrowing due to additional complexities of loan structures.

Trust income is generally taxed as income of an individual.

The powers of trustees are restricted by the trust deed.


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References

Anderton L 2012, ‘Farm financial management: understanding farm business finances and performance’, Plan Prepare Prosper Workbook, DAFWA.

Australian Government: https://www.business.gov.au/Info/Plan-and-Start/Start-your-business/Business-structure/Business-structures-and-types

Harvard Business Press; ‘Bloomberg Financial Glossary’

Harvard Business Review 2012, HBR Guide to finance basics for managers - Bloomberg Financial Glossary, Harvard Business Press

Moody’s Company; ‘Finance Basics’

Winter M 2009, ‘Profit planning: making significantly more profit from what you already do’, Small Business Workbook, Growth Plans Australia.

Wikipedia http://en.wikipedia.org/wiki/Benchmarking

https://www.business.gov.au/Info/Plan-and-Start/Start-your-business/Business-structure/Business-structures-and-types

https://www.business.gov.au/Info/Plan-and-Start/Start-your-business/Business-structure/Business-structures-and-types

http://en.wikipedia.org/wiki/Benchmarking


Financial Glossary

Table 24 Glossary

Accounting Policies The specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements.

Accounting Profit Profit or loss for a period before deducting tax expense.

Accountants Report Formal document that communicates independent accountants' expression of assurance (or lack thereof) on financial statements as a result of performing inquiry and analytical tests.

Accounting Recording and reporting of financial transactions, including the origination of the transactions, their recognition, processing and summarisation in the financial statements.

Accounts Payable (Trade Creditors)

Amounts owed to creditors for delivery of goods or completed services but not yet paid for in cash.

Accounts Receivable (Trade Debtors)

Claims against debtors for uncollected amounts, generally from completed transactions of sales or services rendered but not yet collected in cash.

Accrual Basis of Accounting

A method of recording accounting transactions in which revenue is recognised when earned and expenses are recognised when incurred without regard to the timing of cash receipts and expenditures.

Accrued Expenses Or accrued liabilities, represents that amount of a company's operating expenses that it has incurred and been recorded but not yet paid in cash.

Accumulated Depreciation

Total depreciation pertaining to an asset or group of assets from the time the assets were placed into service until the date of the financial statement or tax return. This total is the contra account to the related asset account.

Activity Ratios

Frequently referred to as turnover ratios. They measure how rapidly an asset or liability "turns over" or is converted into something else. Since the conversion is frequently to cash, activity or turnover ratios have significant implications for the cash position of the company.

Amortisation The systematic allocation of the depreciable amount of an intangible asset over its useful life.

Annual Report

Report to shareholders of a company which includes the company's annual, audited balance sheet and related statement of earnings, shareholders' or owners' equity and cash flows, as well as other financial and business information.


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Asset

Property or economic resource owned by a business. Assets are presented on the balance sheet in the order of liquidity. The usual major groupings are: current assets, non-current assets and intangibles.

Bad Debt All or portion of an account, loan or note receivable considered to be uncollectible.

Balance Sheet

Also known as Statement of Financial Position. Basic financial statement, usually accompanied by appropriate disclosures that describe the basis of accounting used in the preparation and presentation at a specified date. It includes the entity's assets, liabilities and the equity of its owners.

Bank Overdraft

Indicates that a company has written cheques in excess of the amount of cash it has on deposit. It is usually unclear whether such cheques have been presented for collection and honoured by the bank, even though there were insufficient funds in the company's account. A bank overdraft is a current liability.

Borrowing Costs Interest and other costs that an entity incurs in connection with the borrowing of funds.

Budget An organisations action plan, translating strategic objectives into measurable quantities that express the expected resources required and returns anticipated over a certain period of time.

Capital

Under a financial concept of capital, such as invested money or invested purchasing power, the net assets or equity of the entity. The financial concept of capital is adopted by most entities. Under a physical concept of capital, such as operating capability, the productive capacity of the entity based on, for example, units of output per day.

Capital Budget A schedule detailing planned investment in capital assets, property and equipment.

Capital Gain Portion of the total gain recognised on the sale or exchange of a non-inventory asset which is not taxed as ordinary income.

Cash Cash on hand and demand deposits.

Cash Accounting

A method for recording accounting transactions only when cash actually changes hands, not when the transaction occurs. Consequently, a record of cash transaction may differ considerably from a series of transactions recorded on an accrual basis.

Cash Flows Inflows and outflows of cash and cash equivalents over a specified accounting period


Compliance

Adherence to those statutory requirements, regulations, rules, ordinances, directives or other externally-imposed requirements in respect of which non-compliance may have, or may have had, a financial effect on the reporting entity.

Consolidated Financial Statements

The financial statements of a group in which the assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries are presented as those of a single economic entity.

Cost of Goods Sold (COGS)

Represents the cost of producing the product sold. Such costs will include the following general elements: goods and materials, labour, depreciation and amortisation expense associated with production and overhead associated with production.

Current Asset Assets that one can reasonably expect to convert into cash, sell or consume in operations within a single operating cycle, or within a year if more than one cycle is completed each year.

Current Liability A liability or obligation that will normally be liquidated by cash payment or the creation of other liabilities within one year or the next operating cycle.

Depreciation The reduction in value of a fixed or capital asset from use or obsolescence. The decline is recognised by a periodic allocation of the original cost of the asset as a current expense.

Dividends Distribution of earnings to owners of a company in cash, other assets of the company or the company's capital shares.

Expenses

The monetary figure reflecting goods or services consumed in operating the business, such as: cost of goods sold, operating expenses, miscellaneous expenses, tax expenses, income taxes and extraordinary expenses.

Equity Residual interest in the assets of an entity that remains after deducting its liabilities; the amount of an entity's total assets less total liabilities.

Extraordinary Item

Events and transactions distinguished by their unusual nature and by the infrequency of their occurrence. Extraordinary items are reported separately, less applicable income taxes, in the entity's statement of income or operations.

Fair Value The amount for which an asset could be exchanged or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.

FIFO (first-in, first-out)

The assumption that the items of inventory that were purchased or produced first are sold first, and consequently the items remaining in inventory at the end of the period are those most recently purchased or produced


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Finance Lease A lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred.

Financial Position The relationship of the assets, liabilities and equity of an entity, as reported in the balance sheet (statement of financial position).

Financial Statements

Or Financial Accounts. Presentation of financial data including balance sheets, income statements (or profit and loss accounts) and statements of cash flow, or any supporting statement that is intended to communicate an entity's financial position at a point in time and its results of operations for a period then ended.

Fixed Costs Costs that remain the same through a wide range of production and sales volume.

Gearing The relationship between a company's assets and the relative funding for those assets that is provided by the owners of the company.

Going Concern

The financial statements are prepared on a going concern basis (assumption the business can remain in operation beyond the current operating cycle) unless management either intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so.

Goodwill The premium paid in the acquisition of an entity over the fair value of its identifiable tangible and intangible assets less liabilities assumed.

Gross Margin Gross profit divided by total revenue. Gross Profit is total revenue minus cost of goods sold.

Historical Cost

A measurement basis according to which assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances (for example, income taxes), at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business.

Insolvent When an entity's liabilities exceed its assets.

Intangible Asset An identifiable non-monetary asset without physical substance yet has value to the company.

Investing Activities The acquisition and disposal of long-term assets and other investments not included in cash equivalents.

Inventory (or Stock) Tangible property held for sale, or materials used in a production process to make a product. Customarily recorded on the financial statements at the lower of its cost or market value.

Invoice A detailed list of goods shipped or services rendered, with an account of all costs; an itemised bill.


Joint Venture A contractual arrangement whereby two or more parties undertake an economic activity that is subject to joint control.

Liability

The claims of creditors against the assets owned or obligations to give assets or provide services to another. Liabilities are presented on the balance sheet in order of maturity. The usual major groups are current and non-current liabilities.

Liquidity The availability of cash in the near future after taking account of financial commitments over this period.

Liquidity Ratios Indicate the likely ability of a company to meet all of its liabilities coming due (the current liabilities) by conversion of the company's current assets to cash.

Lockup The time it takes to convert unbilled work in progress plus debtors into cash

Net Present Value The current value of a future stream of cash flows, based on specific interest rate assumptions.

Non-Current Asset Assets which will normally not be converted into cash within one year, includes fixed or capital assets

Non-Current Liability

Liabilities or obligations which mature beyond one year and normally will not be liquidated by cash payment within one year.

Notes

Notes contain information in addition to that presented in the statement of financial position, statement of income, separate income statement (if presented), statement of changes in equity and statement of cash flows. Notes provide narrative descriptions of items presented in those statements and information about items that do not qualify for recognition in those statements.

Operating Activities The principal revenue-producing activities of an entity and other activities that are not investing or financing activities.

Operating Cycle The time between the acquisition of assets for processing and their realisation in cash or cash equivalents.

Operating Income Revenue less cost of goods sold and selling, general, and administrative costs.

Operating Lease

Essentially rental payments: a company gets the use of various capital assets without claiming ownership and without showing the asset or obligations on its financial statements. The assets are never owned by the company; it just wants access to their use for a period of time.

Provision A liability of uncertain timing or amount.


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Ratio Analysis Comparison of actual or projected data for a particular company to other data for that company or industry in order to analyse trends or relationships.

Realisable Value The amount of cash or cash equivalents that could currently be obtained by selling an asset in an orderly disposal.

Residual Value (of an Asset)

The estimated amount that an entity would currently obtain from disposal of an asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life.

Revalued Amount of an Asset

The fair value of an asset at the date of a revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses.

Revenue

The gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants.

Revenue per Employee

A measure of productivity, calculated by dividing total revenues by the number of full-time employees.

Sensitivity Analysis Analysis of the impact on a pro forma or forecasted statement by a change in one or more of the input variables.

Solvency The availability of cash over the longer term to meet financial commitments as they fall due.

Subsidiary An entity that is controlled by another entity.

Taxable Profit (tax loss)

The profit (loss) for a period, determined in accordance with the rules established by the taxation authorities, upon which income taxes are payable (recoverable).

Variable Costs Costs that fluctuate with incremental changes in output.

Work-In-Progress Inventory account consisting of partially completed goods awaiting completion and transfer to finished inventory. Also known as work in process.

Working Capital

Excess of current assets over current liabilities. Represents the amount of long-term funding (long-term liabilities and owner's equity) over and above that required to support long-term assets that is used to support working (current) assets.

Sourced from: Moody’s Company; Finance Basics - Harvard Business Press; Bloomberg Financial Glossary


Section Two: Financial Management Activity Book


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Circle of concern and influence

Write down in these circles what your concerns are and what you can influence, e.g. where would you put ‘weather’?

Where do you spend your time and energy?

4Covey’s circles of influence and concern


6 Assigning Costs

Allocate each cost listed in the table below, to the category it belongs to.

Sales and marketing costs Lease costs

Raw materials GST

Power Casual factory labour

Depreciation Repayments on loans

Rent Telephone and internet costs

Water Salaries

Repairs and maintenance Bank charges

Insurance Professional fees

Drawings Audit fees

Interest repayments on loans Sales commissions

Income tax Distribution subcontractor

Payments by the business to be allocated to these different categories

Cost of sales Fixed costs / overheads

Finance costs Non-cash costs And non- expenses!


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7 Profit drivers

Write down any ideas you have for increasing the sales of your business:

Write down any ideas you have for possibly getting a higher price for what you sell:

Write down any ideas you have for possibly decreasing your cost of sales:

Write down any ideas you have for possibly decreasing your fixed costs:


Write down the main things that are happening that may cause you to lose money unnecessarily, and any ideas you have for making them happen less often, or decreasing the impact when they do happen:

8 Calculate profit ratios Gross profit margin (Gross margin %)

Gross margins specifically are very hard to benchmark at an industry level, where the only truly useful comparison would be with a direct competitor adopting a similar strategic approach to doing business, or similar organisations in other markets. For this reason, we suggest you focus on comparing your gross margin % over time.

Gross margin




minus

Costs of sales $ $

equals

Gross profit $ $

divided by



Gross margin % % %


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Net Profit Margin or Net Margin (%)

Net margin shows the percentage of every dollar in sales left after paying all costs associated with running the business before paying tax

Net margin



Gross profit $ $

minus

Fixed and finance costs $ $

equals

Non-costs and drawings

(Depreciation and drawings)

$ $

equals

Net profit $ $

divided by



Net margin % % %

.

Based on the performance of a diverse range of food manufacturers both in Australia and in various developed nations, ‘target’ and ‘warning’ net margin percentages are provided as part of this program. These have been generated to serve as an indication of performance relative to an industry average. However, specifics relating to individual food manufacturing businesses mean there may be very good reasons why a firm performs considerably above or below the target or warning benchmarks provided.

Lenders consistently require the majority of the funds of a business to be sourced from the owners. However, this ratio does not reflect whether there are alternative forms of security for the lender to consider, including the owner's home or other personal investments.


9 Risk ratios

Calculate debt : equity ratio

Debt : equity ratio

Debt : Equity Ratio

Shows how many dollars of debt for every dollar owners have invested.



Total debt $ $

(Long term and short term) Divided by Divided by

Total equity $ $

(Shareholder funds + retained earnings)

equals

Equals Equals

Debt:equity ratio $ $


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Calculate interest coverage

An interest coverage ratio of 1.2 or less indicates the business is likely to struggle making any additional interest payments for a new loan, and indeed may be struggling to meet existing loan commitments. On the other hand, an interest coverage ratio of 2.0 or greater indicates the company can readily cope with new loan repayments.

Interest coverage

Interest coverage

Number of times the company can make its interest payments from its net profits..



Net profit

added to

Interest expense (Finance costs)

$

$

$

$

then divide TOTAL by

Interest expense (finance costs) $ $

equals

Interest coverage ‘times’ ‘times’


10 LIQUIDITY RATIOS

Calculate current ratio

Current ratio

Current ratio






Total current assets


$ $

divided by



$ $

equals

Current ratio ‘times’ ‘times’

A current ratio of 1 or less indicates the business does not currently have the current assets needed to pay off debts it needs to over the next 12 months. This means it either needs to borrow money, liquidate operating assets or source additional investor funds. (This makes it less financially secure.) On the other hand, a current ratio of 1.5 indicates the business can pay off its debts due in the next 12 months 1.5 times over based on the value of its current assets.


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Calculate quick ratio

Quick ratio

Current ratio






Current assets


Minus

Inventories

(Stock)

$

-

$

$

-

$

then divide the TOTAL by



$ $

equals

Quick ratio ‘times’ ‘times’


11 Working Capital Ratios Calculate net working capital

A net working capital as per cent of sales ratio of greater than 12% indicates a business has a potentially worrying proportion of its cash committed to its working capital. This may be a result of managing its accounts receivable or its inventories inefficiently (e.g. not collecting debts on time, or carrying overly high levels of raw materials, work in progress or accounts receivable). On the other hand, a net working capital as % of sales ratio of 8% is indicative of a business managing its working capital very efficiently.

Net working capital

Net working capital as a % of sales



Raw materials Plus

Work in progress Plus

Stock Plus

Accounts receivable

$

+

$

+

$

+

$

$

+

$

+

$

+

$

minus

Accounts payable $ $

equals

Net Working Capital (NWC) $

divided by

Sale income $

equals

NWC as a % of sales % %


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Calculate Stock turns

The ratio calculates how many times a year the stock carried by the business is turned over and sold. Because of the highly variable nature of the stock generated by food manufacturers, there is no single target or warning benchmark that is appropriate in all cases. Instead, what is useful is to track the stock turns ratio for the business over time, to find out if it is carrying higher or lower levels of stock, and why.

Stock turns

Stock turns

turned over each year



Sales Income $ $

divided by

12-month average of

STOCK

Plus

RAW MATERIALS

Plus

WORK IN PROGRESS

$

+

$

+

$

$

+

$

+

$

equals

Stock turns % %


Debtor days

Conversely, assuming 30-day terms, and invoices being issued at the end of each month, a 45-debtor days ratio suggests the company is efficiently collecting its accounts.

Stock turns

Debtor days

Number of days, on average, it takes a company to collect

its accounts receivable



365 days 365 365

multiplied by

Total non-cash sales

(Sales Income)

$ $

divided by

12 Month Average of accounts receivables

$ $

equals

Average Debtor Days days days


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12 Accounts payable and borrowing money

What can a food manufacturer do to favourably influence a lender’s decision whether to lend the money?

13 SWOT analysis of content covered today

Take 10 to 15 minutes to review your business from the viewpoint of the major topics covered today:

● using your profit and loss statement and profit drivers to increase profits

● increasing the value of your business to increase your personal wealth

● strengthening your balance sheet

● improving your cash flow

● tracking your key financial ratios to enable better decision making.

Then consider:

● How can you use the strengths of your business to take advantage of the opportunities identified?

● How can you use these strengths to overcome the threats identified?

● What do you need to do to overcome the identified weaknesses in order to take advantage of the opportunities?

● How will you minimise the weaknesses of your business to overcome the identified threats?


Last, consider which of these possible courses of action are of the highest priority for your business (there may be several). Develop appropriate goals, strategies and actions in your strategic plan to ensure that these are acted upon.

Helpful Harmful

Inte

rna

l o

rig

in

Strengths Weaknesses

Ex

tern

al

ori

gin

Opportunities Threats

SWOT analysis

Documents

Acknowledgments - agric.wa.gov.au