4.

3
What is a Financial Plan?

The financial plan includes the financial projections of the new venture. First, it must provide a summary of
the projected sales, the cost of goods sold, and general and administrative expenses of the business, at least for
the first year, and typically for the three years. Second, it must anticipate the amount and timing of expected cash
inflows and outflows over a period of several years so as to ensure that the business will have sufficient working
capital to sustain operations. Third, it must provide a summary of the assets the business will own, its projected
liabilities, and the potential retained earnings.

Simple Bookkeeping

The business performs various activities every day starting from the day it is created until it ceases
operation. The volume of transactions of the business depends entirely on its size, complexity, and scope. This
lesson introduces the simple bookkeeping procedures that will help future entrepreneurs to record the different
business transactions of their small proposed entrepreneurial ventures. Complicated business transactions
involving investment, derivatives, mergers, or consolidations of businesses are discussed in higher accounting
subjects.
Bookkeeping refers to the recording of business transactions in the books of the business. It is based on the premise that
business transactions must be properly recorded. However, only those business transactions that are considered quantifiable
are given accounting recognition. A transaction is considered quantifiable when it affects the elements of accounting, namely,
assets, liabilities, capital, income, and expense. In addition, a transaction is given accounting recognition when its effect can be
expressed in peso.

Bookkeeping involves the chronological writing or recording of business transactions and events in the books of accounts
for the first time. Chronological recording implies that the business transactions are written in the book according to the order of
their occurrence; hence the first transaction will be recorded first.

The term transaction in this context refers to events where there are exchanges of values that are measurable in one
common denominator. In this case, the Philippine peso. All business transactions are recorded in the books of accounts and
not in an ordinary bond paper or yellow pad. The two (2) books of accounts are the journal and the ledger. The journal is the
book of original entry, while the ledger is the book of the final entry. As such, all business transactions recorded first in the
journal and later transferred to the ledger.

To further discuss the guidelines in using the journal, kindly refer to our textbook on pages 255-256.
 Two-Column General Journal

Account Titles

The recording of business transactions involves the use of account titles. The account title provides the description of the type and nature of
the business transactions. The account titles are grouped into five (5) categories technically referred to as the accounting elements. The five
categories of accounts or elements of accounting are as follows:

1. Assets – refer to everything that the business owns that can be used to create value. Assets are further classified as Current and Fixed
Assets.
2. Liabilities - represent everything that the business owes to banks and other creditors. Those that must be paid within the year are
current liabilities, while those that must be paid beyond one (1) year can be considered long-term liabilities.
3. Capital – refers to the wealth in the form of money or other assets owned by a person or organization or available or contributed for a
particular purpose such as starting a company or investing. Other terms for capital are Owner’s equity or Shareholder’s equity which
also refers to as the excess of all assets over all liabilities or also known as the net worth of the business.
4. Income – refers to the money the business earns from selling a product or service, or from interest and dividends on marketable
securities.
5. Expenses – are expenditures that allow a company to operate; it reduces the net assets of the company.
Asset Account Titles

The following are the typical asset account titles that are normally used to record business transactions of small business:

1. Cash – describes money, either in paper or in coins.

2. Accounts receivable – describes collectibles from customers who make sales transactions on credit.
3. Notes receivable - describes collectibles that are supported with promissory noted.
4. Supplies on hand – describes unused office or store supplies.
5. Unused factory supplies – describe unutilized manufacturing supplies.
6. Inventory – describes unsold goods that are intended for sale. The types of inventories for manufacturing business are
Raw materials inventory, Work-in-process inventory, and Finished goods.
7. Equipment – describes tools and equipment like calculators, computers, or any equipment directly related to the
production of goods.
8. Furniture and fixtures – describe assets like chairs, tables, and display cases.

Liability Account Titles

1. Accounts payable – describes the financial obligations arising from goods purchased or services
received.
2. Notes payable – describes the financial obligations supported with notes.
3. Utilities payable – describes the unpaid obligations on light and water consumptions.
4. Salaries payable – describes the unpaid salaries of the workers.
Capital Account Titles

1. Capital – describes the original and additional investment of the owner.

2. Drawing – describes the temporary withdrawal of capital by the owner.

Income Account Titles

1. Service income – describes general services rendered.

2. Rental income – describes the income arising from lease or rent of property.
3. Sales – describe the sale of goods or products to the customers.

Expense Account Titles

1. Salaries and wages – describe the expenses on payments or salaries.

2. Store supplies expense – describes the expenses on store supplies.
3. Taxes and licenses – describe the expense on taxes, permits, fees, and licenses.
4. Utilities expense – describes the expenses on light and water.
5. Travelling expense – describes the expenses on transportation or fare of personnel.
Business Documents

The business transactions that are recorded in the two-column general journal are based on business documents, which
basically support the existence of transactions. All entries appearing in the general journal are fully supported with business
documents. Before any recording process takes place, all the supporting documents must be arranged chronologically.

The most common types of business documents that support transactions and events are as follows:

1. Purchase order is an official business document issued by the buyer to the seller of goods.
2. Invoice is a commercial business document issued by the seller to the buyer.
3. Official receipt is a commercial document that indicates payment or receipt of cash.
4. Delivery receipt is a document that serves an evidence that the goods or services are received.
5. Receiving report is a document used within the business upon receipt of the goods shipped by the courier or forwarder.
6. Check is a document that orders a payment of money from the current account maintained in the bank.
7. Voucher is an internal business document that authorizes the incurrence or payment of obligations.

In the process of bookkeeping, remember the following fundamental concepts:

1. Support all transactions with business documents.

2. Record the transactions using the two-column journal.
3. Use the proper account title.
4. Observe the guidelines when using the two-column journal.
Below is an illustration in journalizing entries as the start of simple bookkeeping:

December 1 Jenny Toledo opened her small laundry shop with a legal trade name approved by DTI as Modern Laundry Center. The business
has been registered as a non-VAT taxpayer. Jenny rented a space for the business at Rizal street, Pigcawayan, Cotabato. The rental fee is
₱3,000.00 per month.

She made the following initial investment:

Cash ₱ 20,000.00

3 units of washing machine 45,000.00

5 units of electric iron 3,000.00

The entry in the journal will appear as follows:

It can be observed that the value

received has been debited and the
value parted with has been credited. In
other words, the debit in all instances
shall be equal to the credit. Hence, the
basic accounting equation that applies
to all types of transactions will be
represented as follows:
Value received (debit) = Value parted with (credit)
Basic accounting equation: Assets = Liabilities + Capital

The values of the washing machines and electric irons are usually evidenced by the official receipts issued by
the seller.

The journal entry appears to have two debit values, while credit has only one value. This type of journal
entry is called a compound entry. In case there is only one debit and one credit, the entry is called a simple
journal entry.

In writing the credit, the account title is indented. For the debit value, the account title is written almost
touching the line separating the date and the Particulars column.

To show more illustrations in journalizing entries, kindly refer to our textbook on pages 259-265.
Classifying

Classifying refers to the grouping of similar business transactions and events. It is the second mechanical phase of the
whole accounting process. In this process, the same information found in the journal will be transferred to the ledger. The
process of transferring the same information from the journal to the ledger is technically called posting.

The ledger is another book of accounts used to record business transactions and events. It is considered as the book
of the final entry. The ledger basically acts as an accounting tool that accumulates all the necessary information prior to the
preparation of the financial statements.

The ledger appears like a capital letter T. It has two (2) sides, namely the debit side and the credit side. Both sides,
however, consist of the same columns which are as follows:
The Ledger
1. Date
The account title of the ledger is written at the center. On the right most side is the
2. Particulars
page number of the ledger. Each account title must have a separate ledger.
3. Folio or post reference
4. Amount
Trial Balance

After all the accounts in the ledger have been

added and the balances have been computed, the
next bookkeeping procedure is to prepare the trial
balance. Trial balance is the listing of the debit or
credit balances of accounts from the general ledger
with following purposes:

1. To prove the equality of debit and credit.

2. To determine the nominal accounts to be
closed.
3. To serve as a basis for making draft financial
statements.
4.

Trial Balance for Modern Laundry Center

Preparing Projected Financial Statements

Financial statements are the summary of all transactions that

are carefully recorded and transformed into meaningful
information. It also shows the permanent and temporary
accounts.

In preparing the financial projections, the

entrepreneur must make reasonable about revenues, costs,
and expenses. Therefore, he/she must prepare, among
others, a sales forecast and an operating budget, which will
feed into the projected income statement.

Below shows a sample of how sales is being

forecasted of a hypothetical shoe retailer named Pinoy
Corporation. For illustration purposes, we assumed that
each pair of shoes sells for ₱1,000.00. The reality is
that a retailer will sell different types of shoes at different
prices. Therefore, the sales forecast must consider the
product line and the varying price levels.
Sales forecast of Pinoy Corporation, First Year
by Month
In the second table, we can see the Pinoy Corporation’s proposed operating budget. This budget assumes that the company will have
five (5) employees who will each be paid ₱15,000 per month. It also assumes that the business will incur the following expenses: monthly
rental of ₱30,000 for office and store space, electricity and water bills amounting to ₱4,000 per month, a fixed sales expense of ₱15,000
per month for promotional activities, insurance expense of ₱2,000 per month, and depreciation expense of ₱5,000 per month.

Operating Budget of Pinoy Corporation for the First Three Months

Projected Income Statement

The sales forecast and operating budget illustrated above will then be transferred to the projected income statement, which summarizes the profit
(or loss) the company expects to generate within the year. This income statement also includes an estimate of the cost of goods of sold, which,
as shown in the next table, is assumed to be 40% of total sales per month.

Pinoy Corporation, Projected Income Statement, First Year by Month

In addition to the monthly projections, the entrepreneur must also prepare a three-year projection of income. The total for Year 1 were already
computed in the table above, and are simply transferred to the appropriate column in table shown below. Year 2 and Year 3 figures were
determined, using a separate set of assumptions. In the sample below, most of the items under operating expenses are assumed to remain
constant in the next 2 years. However, salary expense will increase on the second year because an additional employee is expected to be
hired; and will increase again on the third year because of the anticipated 5% salary increase. Sales expense is also expected to increase by
10% on the second year.

Pinoy Corporation, Projected Income Statement, First Three Years (in thousand pesos)
Cash Flow Projections

After projecting the income, the entrepreneur

should also anticipate the cash inflows and outflows. It
must be noted that profit and cash flow are not the same
thing. That is because there are transactions that do not
necessarily result into actual payments.

Calculating cash flow is actually straightforward,

as shown in the sample calculation below. For
the first year, this can be done on a monthly basis
so that the entrepreneur will be able to anticipate
his cash needs.

Sample Calculation of Net Cash Flow

Projected Balance Sheet

The entrepreneur must also be able to project the condition of his business by the end of the first year. This can be done by preparing a projected
balance sheet, which summarizes the assets, liabilities, and net worth of the business.

Below is a sample of a hypothetical corporation’s projected balance sheet:

FINANCIAL STATEMENT ANALYSIS

Financial Statement Analysis is used by the management for monitoring performance and for identifying strategies to further improve the
company’s operations.

Breakeven Analysis

Breakeven refers to the volume of sales at which the business neither makes a profit nor incurs a loss. The breakeven sales point
indicates how many units of the product the business must sell to cover both variable and fixed costs and expenses. Whenever sales exceed this
point, the business earns profit, as long as the selling price remains above the costs of producing each unit (variable cost). The breakeven
formula is shown below:

When calculating the break-even, the entrepreneur must use his judgment in determining which of the costs are variable, and which are
fixed. This will depend on the nature of the business. The following can be classified as fixed costs: salaries, rent, utilities, sales expense,
insurance, and depreciation. Variable costs, which typically include direct labor and materials, are captured in cost of goods sold.

Other financial statement ratio analysis also includes the following:

1. Profitability ratios - Profitability ratios include: Gross profit rate, Operating profit margin rate, Net profit margin rate, and Return on
investment.

2. Liquidity ratios - Liquidity ratios include the following: Current ratio, Acid test ratio, Receivable turnover, Average collection period, Inventory
turnover, and Average sales period.