Module 2: Basic Financial Tools for Entrepreneurs

2.1 About Finance and Accounting

Finance and Accounting is the process of recording, summarizing and reporting the myriad of transactions resulting from business operations over a period of time. These transactions are summarized in the preparation of financial statements, including the balance sheet, income statement and cash flow statement, that encapsulate the company's operating performance over a specified period.

2.2 Objectives of Accounting: The main objectives are as listed below;

1. To keep systematic records: The primary motive of Accounting is to keep a systematic record of financial transactions. Human memory would be burdened heavily in the absence of accounting.

2. To protect business properties: Accounting provides protection to business properties from unjustified and unwarranted use. This is possible on account of accounting supplying the following information to the manager or the proprietor:

The amount of the proprietor's funds invested in the business. How much the business has to pay to others? How much the business has to recover from others? How much the business has in the form of (a) fixed assets, (b) cash in hand, (c)

cash at bank, (d) stock of raw materials, work-in-progress and finished goods?3. To ascertain the operational profit or loss:Net profits earned and loss

suffered can be ascertained with the help of accounting which helps in evaluation. This is done by keeping a proper record of revenues and expense of a particular period. The Profit and Loss Account is prepared at the end of a period

Balance SheetTaxesComponents of GSTMSME Act 2006

and if the amount of revenue for the period is more than the expenditure incurred in earning that revenue, there is said to be a profit.

4. To ascertain the financial position of the business: The Profit and Loss Account gives the amount of profit or loss made by the business during a particular period.

5. To facilitate rational decision making: Accounting these days has taken upon itself the task of collection, analysis and reporting of information at the required points of time to the required levels of authority in order to facilitate rational decision-making.

6. Information System: Accounting functions as an information system for collecting and communicating economic information about the business enterprise. This information helps the management in taking appropriate decisions.

Purpose of Accounting

The purpose of accounting is to gather financial information and report about the performance and financial position of a business. The information gathered is used to reach decisions about how to manage the business, or invest in it, or lend money to it. The financial information is accumulated in accounting records through transactions such as customer invoices or supplier invoices, or through specialized transactions known as journal entries.

Accounting mainly helps to ascertain profit or loss during a specified period, show the financial condition of the business on a particular date and help control the firm's property.

An accountant designs the accounting system of a company and interprets the report based on the records. He also supervises the work of book-keeping. Nowadays, he is also expected to participate in matters of management, controlling and planning of economic resources.

Summary:

Accounting is the language of financial decisions. It is a continuous process of performance measurement, preparing analysis and reporting the results to decision makers. The history of accounting can be traced back to very early times of human civilization. Accounting has been formalised and structured with the advancement of industry and technology in the modern day. A person who maintains accounts is known as the accountant. The information generated by accounting is used by various interested groups like, individuals, managers, investors, creditors, government, regulatory agencies, taxation authorities, employee, trade unions, consumers and general public.

Keywords:

2.3 Balance Sheet

A Balance Sheet is a statement of the financial position of a business which states the assets, liabilities, and owners' equity at a particular point in time. In other words, the balance sheet illustrates your business's net worth.

The balance sheet is the most important of the three main financial statements used to illustrate the financial health of a business. The others are:

a. The Income Statement, which shows net income for a specific period of time, such as a month, quarter, or year. Net income equals revenue minus expenses for the period.

b. The Cash Flow Statement, which shows the movements of cash and cash equivalents in and out of the business. Chronic negative cash flow is symptomatic of troubled businesses.

Incorporated businesses are required to include balance sheets, income statements, and cash flow statements in financial reports to shareholders and tax and regulatory authorities. Preparing balance sheets is optional for sole proprietorships and partnerships, but is useful for monitoring the health of the business.

An up-to-date and accurate balance sheet is essential for a business owner that is looking for additional debt or equity financing or wishes to sell the business and needs to determine how much it is worth.

The balance sheet is based on the fundamental equation: Assets = Liabilities + Equity

AccoutingIt is the means of collecting, summarising and reporting in monetary terms, information about the business. Financial AccountingMaintenance of books of accounts with a view to ascertain the profitability and financial status of the business is part of financial accounting.TransactionA transaction is a stimulus from one person and a related response from another.

The items listed on balance sheets vary from business to business depending on the industry, but in general the balance sheet is divided into the following three sections:

A. Assets

As in the balance sheet example shown below, assets are typically organized into liquid assets—those that are cash or can be easily converted into cash—and nonliquid assets that cannot quickly be converted to cash, such as land, buildings, and equipment.

The list of assets may also include intangible assets, which are much more difficult to value.

Generally accepted accounting principles (GAAP) guidelines only allow intangible assets to be listed on a balance sheet if they are acquired assets that have a lifespan and a clearly identifiable fair market value (the probable price at which a willing buyer would buy the asset from a willing seller) that can be amortized. These are reported on the balance sheet at the original cost minus depreciation. This includes items such as:

Franchise agreements Copyrights Patents

B. Liabilities

A liability is an amount that a company owes. Typically, a liability involves money borrowed in order to support business activities; so can also include accounts payable and general debt.

In the balance sheet, the total liabilities is the total money owed, whether to a lender, bank, or supplier. In relation to the assets, it provides an idea of how stable a business is, as well as whether accounts are overdue.

Liabilities can be broken down into current and long-term categories. Current liabilities are those due within one year and include items such as:

Accounts payable (supplier invoices) Wages Income tax deductions Pension plan contributions Medical plan payments Building and equipment rents Customer deposits (advance payments for goods or services to be delivered)

Utilities Temporary loans, lines of credit, or overdrafts Interest Maturing debt Sales tax and/or goods and services tax charged on purchases

C. Equity/Earnings

Equity, also known as shareholders' equity, is that which remains after subtracting the liabilities from the assets. Retained earnings are earnings retained by the corporation—that is, not paid to shareholders in the form of dividends.

Retained earnings are used to pay down debt or are otherwise reinvested in the business to take advantage of growth opportunities. While a business is in a growth phase, retained earnings are typically used to fund expansion rather than paid out as dividends to shareholders.

COMPANY NAMEBALANCE SHEET as at __________ (Date)ASSETS Rs. LIABILITIES Rs.

Current Assets:   Current Liabilities:  

  Cash in Bank Rs.18,500.00   Accounts Payable Rs.4,800.00

  Petty Cash Rs.500.00   Wages Payable Rs.14,300.00

  Net Cash Rs.19,000.00   Office Rent —

  Inventory Rs.25,400.00   Utilities Rs.430.00

  Accounts Receivable Rs.5,300.00   Federal Income Tax Payable Rs.2,600.00

  Prepaid Insurance Rs.5,500.00   Overdrafts —

Total Current Assets Rs.55,200.00   Customer Deposits Rs.900.00

      Pension Payable Rs.720.00

Fixed Assets:     Union Dues Payable —

  Land Rs.150,000.00   Medical Payable Rs.1,200.00

  Buildings Rs.330,000.00   Sales Tax Payable  

  Less Depreciation Rs.50,000.00 Total Current Liabilities Rs.24,950.00Net Land & Buildings Rs.430,000.00     

    Long-Term Liabilities:  

Equipment Rs.68,000.00   Long-Term Loans Rs.40,000.00

Less Depreciation Rs.35,000.00   Mortgage Rs.155,000.00

Net Equipment Rs.33,000.00 Total Long-Term Liabilities Rs.195,000.00

        

    TOTAL LIABILITIES Rs.219,950.00

       

    Owners' Equity:  

      Common Stock Rs.120,000.00

      Owner - Draws Rs.50,000.00

      Retained Earnings Rs.128,250.00

    Total Owners' Equity: Rs.298,250.00

       

TOTAL ASSETS Rs.518,200.00 LIABILITIES AND EQUITY Rs.518,200.00

For a startup business it is a good idea to have an accountant do your first balance sheet, particularly if you are new to business accounting. A few hundred rupees of an accountant's time may pay for itself by avoiding issues with the tax authorities. You may also want to go over the balance sheet with your accountant after any major changes to your business.

Balance sheets are easy to do if you use accounting software. Accounting software designed for small businesses can keep track of all your accounting information and generate balance sheets, cash flow statements, and other reports automatically as needed.

2.4 Break Even Point

“The worst crime against working people is a company which fails to operate at a profit - Samuel Gompers‖

Main economic motive for starting a business is to earn profit. That is the objective. Now, one needs to have a goal in mind in achieving this objective – How much profit do I need to make and by when should I make it?

Majority of the businesses do not make profit from the beginning. Some take longer while others do it quicker – all depends on the business model, type of industry and many other factors. This period of not making any profit is known as the gestation period.

A company's breakeven point is the point at which its sales exactly cover its expenses. To compute a company's breakeven point in sales volume, you need to know the values of three variables:

Fixed costs: Costs that are independent of sales volume, such as rent Variable costs: Costs that are dependent on sales volume, such as the cost of

manufacturing the product Selling price of the product

How to Calculate Breakeven Point

In order to calculate your company's breakeven point, use the following formula:

Fixed Costs ÷ (Price - Variable Costs) = Breakeven Point in Units

In other words, the breakeven point is equal to the total fixed costs divided by the difference between the unit price and variable costs. Note that in this formula, fixed costs are stated as a total of all overhead for the firm, whereas Price and Variable Costs are stated as per unit costs—the price for each product unit sold.

The denominator of the equation, price minus variable costs, is called the contribution margin. After unit variable costs are deducted from the price, whatever is left—the contribution margin—is available to pay the company's fixed costs.

Let us understand this further through a simple example of Ram and his tea vendingbusiness considering the following facts or assumptions:

Ram, who was earlier working in a restaurant, has now decidedto start a tea vending business. He was getting Rs. 300/- per dayas his wages, while working in the restaurant.

Ram is thinking in terms of a mobile hand cart for his tea vendingbusiness, which he will take around to the various constructionsites in the given locality and during day light only.

Before starting the business he needs to buy vessels, cart, stove,fuel, strainer, thermos flask etc. for which he needs Rs. 12,000/-.

He will need to buy the initial supply of milk, sugar, cups, tealeaves for which he will need around Rs. 1,000/-.

Ram had Rs. 1,000/- which he used for buying variousconsumable items. He borrowed Rs. 12,000/- from a friend andagreed to pay him Rs. 4/- per day as interest. (approximately12% per annum).

The cost of producing tea from one litre milk for Ram is as shown below:One Litre Milk = Rs. 30/-Two Litre Water = Rs. 2 /-Sugar (300 gms) = Rs. 30 /-Tea leaves (100 gms) = Rs. 20 /-Fuel = Rs. 2 /-Total = Rs. 84 /-

From this, Ram will be able to get 30 cups of 100ml quantity. Now we also have to consider the wastage aspect where there will be evaporation while boiling water andmilk, there may be spillage etc. Hence, the actual number of cups of tea, which can bemade from one litre of milk will come down to 28 cups. Which means it costs Rs. 3/- per cup (84 divided by 28)

Each disposable cup costs 50 paise.

So, the unit cost will be Rs. 3.50/- per cup.

Ram has surveyed the place and finds that all similar vendors are charging Rs.5/- per cup.

He also decides to sell his tea at Rs.5/- per cup.

The Gross Profit or Margin per cup is Rs.1.5/- (= 5.00- 3.50).

Ram employs a helper on a daily wage of Rs. 99/-. He pays no rent but Rs. 10/- per day of protection money to be able to do business in that area. He pays interest of Rs.4/- per day. Also his own wages of Rs. 300/- per day.

Ram knows that he needs to recover the initial investment of Rs. 12,000/- over aperiod of time. He decides to do this over 5 years or 60 months. This translates toapproximatelyRs. 7/- per day.

Total fixed costs per day for Ram are: (Rs. 300 + Rs. 99 + Rs. 10 + Rs. 4 + Rs. 7) = Rs. 420/-

As per the Income Statement we observe that: On Day 1, Ram sells 200 cups, the Gross Margin is Rs 300/- and Total FixedExpenses is Rs.420/-. So on the first day there is a loss of Rs. 120/.

On Day 2 , Ram sells 280 cups, the Gross Margin is 420 and TotalFixed Expenses is Rs. 420/-. So on the second day, there isneither a loss nor profit, because total revenue is equal to thetotal expenses.

At the level of sales of Day 2, Ram breaks even (no profit or loss). This is 280 cupsper day.

To calculate the breakeven point:

Fixed Cost (per day)

Break even volume (per day) = ---------------------------------------------------------

Gross Margin per Unit

420

Break even volume (per day) = --------------------------------------------------------

1.50

= 280

Breakeven level for Ram is 280 cups per day.

2.5 Loans

Every business requires an adequate amount of capital/ finance to fund the initial expenses. There might be a need for additional capital over and above your savings. Loans provided by Government and various banks help to get financial assistance in such cases.

As your business grows and your own assets enable your business to earn money, you can repay the working capital loan to the bank.

DO's

Always remember to clear your dues on time. Always take care that, after a credit card dues or loan is settled, next Credit

Information reports (CIRs) reflects the same. Always have a balanced mix of secured and unsecured loans. Beware of fluctuations in Income & low balance in the banks at the end of the

month. Low balance can lead to lower scores. CIRs may be taken at least six months prior to approaching for a loan or its

enhancement such that if any area requires to be attended, the same can be done. Do your spending or repayments (always make payment on or before due date)

carefully/timely. It impacts scores. Ensure that your credit card dues & payments get reflected in your statement.

Activities and Exercises 2.1

Activities

List out goals to achieve in first 12 months after floating your business. Make a vision and mission statement for your enterprise.

Exercise

What are the main objectives of accounting? What are the objectives of accounting? What is breakeven point? Explain with examples.

Make payment through RTGS/NEFT/IMPS. Make a provision on working capital account for interest posting. Sufficient credit every month to service interest of particular month. Maintain list of cheques issued. Check that scheduled payment got debited. Clear the dues before going on holiday.

DON’Ts

Default on your loan instalments. Making late payments or defaulting on your dues negatively affects your score.

Approach many banks simultaneously, each search may affect your chances. Open many new accounts at one go or open new account without knowledge of

your banker. This may not be viewed positively by lenders. Apply for loan without proper planning. Issue cheque if clear balance is not there. Overdraw the account. Disconnect the calls of banker. Forget your due date of all credit facilities. Pay a single penny of penal interest. It affects your credit habit. Withdraw cash for personal use. Take credit from unknown person. Just rely on memory. Do schedule your payment on system. Just rely on your employee to clear your dues on time.

Mudra Loans

PradhanMantri MUDRA Yojana (PMMY) is a scheme launched by Hon’ Prime Minister ShriNarendraModi on April 8, 2015 for providing loans up to Rs. 10 lakh to the non-corporate, non-farm small/micro enterprises. These loans are classified as MUDRA loans under PMMY. These loans are given by Commercial Banks, RRBs, Small Finance Banks, Cooperative Banks, MFIs and NBFCs. The borrower can approach any of the lending institutions mentioned above or can apply online through Mudramitra portal (www.mudramitra.in).

Under the aegis of PMMY, MUDRA has created three products namely Shishu (loans uptoRs. 50,000), Kishore (loans uptoRs. 50,000 to 5 lakh) and Tarun (loans uptoRs. 5 lakh to 10 lakh). The funding support from MUDRA are of four types :

Micro Credit Scheme (MCS) for loans upto 1 lakh finance through MFIs. Refinance Scheme for Commercial Banks / Regional Rural Banks (RRBs) /

Scheduled Co-operative Banks Women Enterprise programme Securitization of loan portfolio

For availing Mudra loans, the business should be either one of the following:

Small manufacturing enterprise Shopkeepers Fruit and Vegetable vendors Artisans 'Activities allied to agriculture', e.g. pisciculture, bee keeping, poultry, livestock,

rearing, grading, sorting, aggregation agro industries, diary, fishery, agriclinics and agribusiness centres, food & agro-processing, etc.(excluding crop loans, land improvement such as canal, irrigation and wells).

It is to be noted that Mudra loans can be availed of from nearby branch office of a bank, NBFC, MFI, etc. or by filing online application on www.mudramitra.in . There are no agents or middleman engaged by MUDRA for availing of Mudra Loans. For more details, visit Udyamimitra website (https://udyamimitra.in/MudraLoan).

Stand up India Loans for SC / ST and Women Entrepreneurs

The Stand Up India scheme is aimed at promoting entrepreneurship at the grassroots sections of the society. The scheme was launched in 2015 to promote funding for green-field projects (first time ventures) promoted by SC/ST/Women entrepreneurs. The scheme facilitates bank loans between Rs 10 lakh and Rs 1 crore.

The loan scheme funds only 75% of the project cost. This means, 25% of the project cost still needs to be managed. As per the scheme, the borrower must bring 10% of the project cost from own funds. To bridge the deficit, he/she can seek assistance under eligible state/central schemes.

The maximum repayment tenure for Stand Up India Loans is 7 years. The bank may provide you moratorium on principal repayment for up to 18 months.

Loan Scheme Eligibility:

The loan is available to only women borrowers or to Scheduled Caste (SC) or Scheduled Tribe (ST) Borrowers.

You must be above 18 years of age.

The loan must be used to set up a greenfield enterprise. i.e., this must be the first venture of the borrower.

The enterprise should be in manufacturing, services or trading sector.

If the applicant is a non-individual (say a company), at least 51% of the shareholding or the controlling stake must be owned by the SC/ST or woman entrepreneur.

The Borrower shouldn’t be in default with any bank or financial institution.

For instance, if a lady has done a beautician course and wants to open a beauty parlour; she can apply for loan under the scheme provided she meets the other conditions.

How to Apply for Stand up India Loans?

You can apply for Stand Up India Loans in many ways:

1. At the branches of Scheduled and Commercial Banks

2. Through Stand Up India Portal (https://www.standupmitra.in/)

3. Through the Lead District Manager (LDM)

2.6TAXES

What are Taxes and who levies them?

A tax (from the Latin taxo; "I estimate") is a financial charge or other levy imposed upon a taxpayer (an individual or legal entity) by a state or the functional equivalent of a state such that failure to pay is punishable by law. It can also be explained as a fee charged or ("levied") by a government on a product, income, or activity.

The government needs money to operate, and taxes are a way for it to get this money. This money goes to fund many different types of programs. It may be used to fix roads and bridges. It may be used to pay for the military. It may be used to help your own education!

The Governments levy and collect taxes so as to later spend it for social welfare in the form of public expenditure like laying roads, providing social service, paying government workers, and providing other social amenities.

As an entrepreneur, one needs to know some fundamental rules about taxes and what the obligations are:

1. In business one might be required to act as a collection agent for the government and collect taxes from employees, service providers, vendors, customers/clients etc.

2. As a businessman/woman, one might have to pay taxes on purchases, sales and services (sales tax or Vat, service tax, excise or etc). If one is importing raw material, then Customs duty and related items need to be paid and included in the cost of goods sold.

3. For an export house the duty paid on any imported material may be eligible for Duty Draw Back. In this case, one does not include the custom duty in the cost of goods sold.

The details (quantum, exemption, exceptions etc) of the taxes levied by the government are too many and they keep changing every year based on the government budget. So as an entrepreneur, one should take expert guidance on these matters. One should however be clear in mind as to which taxes one is collecting on behalf of the government, which ones form part of the cost (whether variable or fixed) and which ones come out of the profit.

Types of Taxes:

There are fundamentally two types of taxes: Direct Tax and Indirect Tax.

1. Direct Taxes: A Direct tax is a kind of charge, which is imposed directly on the taxpayer and paid directly to the government by the persons (legal or natural) on whom it is imposed.

TaxesDirect TaxIncome TaxProperty TaxIndirect Tax

2. Indirect Taxes: An indirect tax is a tax collected by an intermediary (such as a retail store) from the person who bears the ultimate economic burden of the tax (such as the customer).

3. Goods and Services Tax (GST)

The goods and services tax (GST) paves way for a single national market by merging several central and state taxes. It is also expected to make Indian products more competitive in both domestic and international markets and at the same time, it will be transparent and easier to administer. GST is explained in detail in next section.

2.7Goods and Services Tax

GST is an indirect tax levied in India on the sale of goods and services. Goods and services are divided into five tax slabs for collection of tax - 0%, 5%, 12%, 18% and 28%. Petroleum products and alcoholic drinks are taxed separately by the individual state governments. There is a special rate of 0.25% on rough precious and semi-precious stones and 3% on gold. In addition a cess of 22% or other rates on top of 28% GST applies on few items like aerated drinks, luxury cars and tobacco products.

The tax came into effect from July 1, 2017 through the implementation of one hundred and first amendments by the Government of India. The tax replaced existing multiple cascading taxes levied by the central and state governments. The tax rates, rules and regulations are governed by the Goods and Services Tax Council which comprises finance ministers of centre and all the states. GST simplified a slew of indirect taxes with a unified tax and is therefore expected to dramatically reshape the country's 2 trillion dollar economy. With the implementation of Goods and Services Tax (GST) from 1st July 2017, all the Taxpayers are expected to file their periodic returns. CSC e-Governance Services India Limited has rolled out GST Return filing service through its network of more than 2.5 Lakhs Common Services Centres (CSC).

CSC SPV has built a filing application on Digital Seva Portal and a support function has been created to help the Village Level Entrepreneur (VLE) operating these CSCs across India in filing periodic returns of the Taxpayers. VLEs can deregister for GST number if the turnover is less than 20 lakhs as the notification from Government of India specifies that the ecommerce operators having an aggregate turnover of less than Rs 20 lakhs/10lakhs (Special states) are not required to register under GST.

2.8Components of GST

2.9GST Registration and who should get registered under GST?

Any business whose turnover exceeds the threshold limit of Rs. 20 lakhs (Rs 10 lakhs for North Eastern and hill states) will have to register under GST. Businesses registered under any of the pre-GST laws: VAT, Excise/Service Tax have to register under GST by default. Apart from the normal taxpayer (as defined above), there are few special cases (as explained in section 3) that have to register for GST irrespective of their turnover.

Documents/details required to register under GST

PAN is mandatory to apply for GST registration (except in case of non-resident).

The document/details required to register for GST are:

Benefits of GST Registration

GST Registration Fees

Businesses can register for GST and obtain GSTIN free of cost.

However, GST Registration is a tedious 11 step process which involves submission of many business details and scanned documents.

You can opt for Clear Tax Goods and Services Tax (GST) Registration services where a GST Expert will assist you end to end with GST Registration.

Provision of Composition scheme under GST law

There is a provision of opting for Composition scheme under the GST law for small businesses.

The aim of composition scheme is to bring relief to small businesses from the compliance provisions under the law.

Small businesses have been provided an option wherein they can pay a fixed percentage of turnover only as fees in lieu of tax and do not have to be burdened with detailed compliance of the provisions of the GST law.

Composition scheme can be opted by persons who are supplying goods & services or both to the end consumer.

The conditions for opting Composition scheme under GST are as follows:

a) You should be a registered person.

b) Your cumulative turnover in the preceding Financial Year should not exceed Rs.50 Lakh.

c) Ensure that you are eligible to opt for Composition Levy.

MSME Act 2006

MSME (Micro, Small & Medium Enterprises) are classified in two ways :-

Manufacturing Enterprises engaged in the manufacture or production of goods pertaining to any industry or deploying plant and machinery in the process of value addition to the final product having a distinct name or character or use and

Service Enterprises engaged in providing or rendering of services

The Manufacturing Enterprise are defined in terms of investment in Plant & Machinery and Service Enterprises are defined in terms of investment in equipment Let’s understand it in a better way

EnterprisesManufacturing Sector(Investment in plant & machinery)

Service Sector(Investment in equipment’s)

Micro Enterprises

Does not exceed twenty-five lakh rupees

Does not exceed ten lakh rupees

Small Enterprises

More than twenty-five lakh rupees but does not exceed five crore rupees

More than ten lakh rupees but does not exceed two crore rupees

Medium Enterprises

More than five crore rupees but does not exceed ten crore rupees

More than two crore rupees but does not exceed five crore rupees

Activities and Exercises 2.2

Activities

Without a plan, anyone can lose his or her focus on a goal. In order to understand what it takes to start a business, write a detailed business plan.

List out the licenses you may need to start the enterprise.

Exercise

Why do government levy taxes? Give a brief on Goods and Service Tax. Explain about Mudra Loan