Ekaterina Litau

1. Financial Management Course: KEY ISSUES IN SME MANAGEMENT Ekaterina Litau PhD in Economics(St. Petersburg university of management technologies and economics, Russia)

2. WELCOME to the SUMMER SCHOOL St. Petersburg university of management technologies and economics KEY ISSUES IN SME MANAGEMENTDAY 1

3. MICRO-ENTERPRISES AND SMALL ENTERPRISES MAKE UP ABOUT 98% OF THE TOTAL NUMBER OF ECONOMIC ENTITIES: THE MAJOR QUESTION: 3 The major questionof a small-scale enterprise development THE MAJOR QUESTION FACED BY SCIENTIFIC COMMUNITY: What determines the success of a small-scale enterprise development? Subsidy assistance billions Special treatments >90% $ of government support Creation of special economic areas

4. SURPRISE:THE PERCENTAGE OF SMALL-SCALE ENTERPRISESIS VIRTUALLY THE SAME IN ALL DEVELOPED COUNTRIES 4 ? The problem of small-scale enterprise development may have a common genesis and doesn’t fundamentally depend on external factors… We can assume that there is other factor – an internal one. And this factor is an entrepreneur’s personality HYPOTHESIS The USA – 97,3% Germany, France – 98,7% Great Britain– 98,1% Russia – 98% Source: U.S. Census Bureau, Eurostat and Russian Federal State Statistics Service

5. 5 “GAZELLES” Many scientists, including winners of the Global Award for Entrepreneurship Research such as David L. Birch, Zoltan J. Acs, David B. Audretsch, William B. Gartner conducted research for several years and found out that there is a small group of firms that combine high dynamic and sustainable growth. They were named “Gazelles” SO-CALLED "GAZELLES" Based on the above data it follows that only a small number of economic entities manage to overcome transition of a small-scale enterprise to the category of medium-scale ones (according to different sources the share of medium-scale enterprises in the developed economies, varies from 1 to 4%) According to their calculations, “gazelles” didn’t exceed 4% of the total number of firms

6. 6 Global Award for Entrepreneurship and Small Business Research Winner The internal factorisan entrepreneur’s personality Howard Gardner Peter Ferdinand Drucker Joseph Alois Schumpeter Arnold Cooper Entrepreneur is the main asset of an enterprise Opposes an Entrepreneur with a Manager Entrepreneurial ability is one of the production factors Singles out the entrepreneurial ability as a special kind of talent

7. 7 Entrepreneur vs Manager(psychological profile)

8. INFORMATIONALCHALLENGE: 8 Informationalchallenge Informationalinflows (…) Bifurcation point (…) Achievement of a critical level of the informational flows exceeding the “channel capacity” of an entrepreneur due to the objective laws of human mentality !

9. 9 INFORMATIONAL CHALLENGE THEORY Informational Challenge is attainment of the critical level of informational flows exceeding an entrepreneur’s capacity in view of objective laws of human mentality INFORMATIONAL CHALLENGE THEORY: Inevitable emergence of Informational Challenge, characterizing development processes of an organization as a system, is the stimulus for subsequent transformation of the system The efficiency of the Informational Challenge solution is defined by the direction of these transformations. High efficiency of the Informational Challenge solution determines the positive vector of the organization’s development

10. 10 INFORMATIONAL CHALLENGE THEORY The model of effective application of knowledge was created in the form of algorithm of the problem resolution by means of redistribution of Entrepreneur’s informational flows Application of the proposed method will definitely allow formation of the organizational structure taking into complete account individual requirements of a small developing enterprise in accordance with an industry specific character and market conditions Methodological recommendations can be applied by a small business entities to increase their development effectiveness in the context of situational approach, as well as for the teaching and learning activities when preparing training courses on disciplines: “Corporate management”, “Fundamentals of entrepreneurship”, “Entrepreneurship”, “Financial Management”

11. 11 Informationalchallenge ! Increase in informational flows for an entrepreneur The stage of further development of an enterprise Informational Challenge is a signal that it is time to build a professional management system Bifurcation point How many entities will be able to overcome the “informational challenge”? <2% The reached limit of channel capacity Physical and human recourses are used up

12. MOST OF ENTREPRENEURSARE NOT ENTREPRENEURS “IN ESSENCE” 12 It is difficult to recognize that “Adam Smith’s baker” is an entrepreneur, even though “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest”. “Adam Smith’s baker” is not an entrepreneur. He doesn’t scale his business. He just works for himself. It is a kind of self-employment. If somebody takes a violin it doesn’t mean that he is Paganini. ADAM SMITH’S BAKER ~80% Such an entrepreneurial activity is a way of self-employment ~80% of entrepreneursare“Adam Smith’s baker” (a short in the dark)

13. 13 THE MAIN QUESTION IS:HOW A NONPROFESSIONAL MANAGER-ENTREPRENEURCAN CREATE AN EFFECTIVE SYSTEM OF MANAGEMENT? Only a few exceptional enterprises have a potential for development. And only a few of them will be able to develop The process of management can be in some way explained as an activity aimed at the arrangement of informational flows The theory of “informational challenge” provides practice way to solve this question. Based on this theory, the method of “informational challenge” solving was developed As a result of the method implementation successful results were achieved and adaptability of the method was substantiated

14. WELCOME to the SUMMER SCHOOL St. Petersburg university of management technologies and economics KEY ISSUES IN SME MANAGEMENTDAY 2

15. The majority of commercial organizations intend to survive as long as possible. In order to achieve this goal an organization has to adjust to the changeable needs of society 15 Goal setting Going concern principle underlies activity of the majority of commercial organizations Activity of a company is conditioned on its target goals. Within the framework of the present lecture we consider a company successful if it has achieved its target goal Warren Commission Investigation of the murder of John Kennedy Roman Catholic Church > 2000 years French wineries Exist for centuries Great Brittan monarchy Limitation of power

16. Organizations are classified as follows: 16 Different organizations are guided by different objectives Classification of organizations Micro-enterprises(the main subject is Entrepreneur himself) ~ 92.2% • there is no task sharing at this stage of development; • the main acting entity is Entrepreneur; • survival is the primary goal of a company Small enterprises(creation of management system) ~ 6.5% • Entrepreneur is still the main subject; • at this stage the process of hiring of staff begins; • the main objective of a company is implementation of Entrepreneur’s ideas Medium-sized enterprises(development of professional management) ~ 1.1% • management functions gradually transfers to hired management; • the primary goal of the company is sustainable development Large-scale enterprises(formation of the systems of management has completed) ~ 0.2% • usually a company is managed by professional top managers; • the objective of the company is maximization of shareholders‘ wealth

17. 3 1 2 … The common purpose of an organizationis profit earning 6 5 Financial manager’sobjective Effective managerial decisions making Other departments’objective Any other tasks 4 Accountant’sobjective Preparing true and complete financial reports Sales department’sobjective Sales of goods and market promotion Production department’sobjective Production of goods according to the specified plan Tax accountant’sobjective Correct and timely payment of taxes and other dues Purchasing department’sobjective On-time purchase of necessary resources Financial management is the management of finances. There is no clear borderline between management and financial management in reality. Any decision influences finance of organization to a greater or lesser degree 17

18. 18 Financial statements/analogies Terrain is a system of possible destinations and roads between them An organization can be represented as a system of information flows Road map Financial statements Model of organization Terrain model is a symbolic depiction highlighting relationships between elements of some space, such as objects, regions etc. / allows to find out the effective way to get goal simplify complicated system of information flows to the quantity of data (number of variables) that is possible to analyze and manage give an opportunity to observe the existing processes and reveal the tendency Financial reporting is the source of information for analysis at all stages of organization’s existence (growth, development) Model is a theoretical construct representing economic processes by a set of variables and a set of logical and / or quantitative relationships between them. Model is a simplified framework designed to illustrate complex processes

19. Summa de arithmetica, geometria 19 Luca Bartolomeo de Pacioli (1445–1517) was an Italian mathematician, Franciscan friar, collaborator of Leonardo da Vinci, and seminal contributor to the field which is now known as accounting. He is referred to as the Father of Accounting and Bookkeeping (he was the first to publish a work on double-entry system of book-keeping and had given a definition of balance sheet). Since 15th century to the present days a balance sheet remains the most perfect model of an organization Leonardo da Vinci & Luca Pacioli = + Interesting fact In 1497 Pacioli accepted an invitation from duke Ludovico Sforza to work in Milan. There he met, collaborated with, lived with, and taught mathematics to Leonardo da Vinci. Leonardo da Vinci drew the illustrations in “About the divine proportions” while he lived with and took mathematics lessons from Pacioli

20. consolidated financial statements (in case of a mother company) Primary financial statements LE ME • statement of changes in equity for the period; • statement of cash flows for the period; • notes, comprising a summary of significant accounting policies and other explanatory information; • report on proper use of funds received SE MCE Large-scaleenterprises • additionally may be provided notes to the financial statements containing only the most important information Medium-sizedenterprises • statement of financial position; • statement of profit or loss and other comprehensive income Small enterprises Micro-enterprises 20

21. Primary financial statements Statement of profit or loss Statement of financial position Statement of cash flows Financial statements are the reporting containing data on financial position, results of activity, cash flows of a company for the reporting period and other information 21

22. Financial statements– main subjects 22

23. 23 Balance sheet– statement of financial position The accounting balance sheet is one of the major financial statements used by accountants and business owners. The balance sheet represents a list of resources (assets) and sources of their appearance (liabilities). The balance sheet presents a company's financial position as of a specified date. Data are represented and estimated in money value 1 2 Assets Expected to be used within more than a year (> 1 year) Expected to be used within operating cycle (< 1 year) Non-current assets Current assets • land, land improvements, buildings; • equipment, goodwill; • intangible assets (license etc.) • cash and temporary investments; • accounts receivable; • raw materials inventory; • work in progress inventory; • finished goods inventory; • amounts receivable from customers; • advances to suppliers

24. 24 Balance sheet– statement of financial position The accounting balance sheet is one of the major financial statements used by accountants and business owners. The balance sheet represents a list of resources (assets) and sources of their appearance (liabilities). The balance sheet presents a company's financial position as of a specified date. Data are represented and estimated in money value Liabilities Liabilities 1 2 3 Trade accounts payable (are repayable within one year or less): taxes payable, dividends payable, short-term loans, long-term loans maturing within one year Trade accounts payable (are repayable more then in one year): long-term loans, long-term provisions, other long-term liabilities Equity is the source of financing assets of the company which is not to be repaid Equity Short-term liabilities Long-term liabilities Paid-in capital Share capital (ordinary shares, preference shares) Share premium Retained earnings Revaluation reserve Liabilities are not material. They answer the question: “How the assets were acquired?”

25. The great balance sheet equation: 25 Non-current assets Current assets Equity Short-term liabilities Long-term liabilities ACTIVE = PASSIVE = + + +

26. 26 Income statement – statement of profit or loss and other comprehensive income Income statement (US English) or profit and loss account (UK English; also referred to as a profit and loss statement (P&L), revenue statement, statement of financial performance, earnings statement, operating statement, or statement of operations) is one of the primary financial statements of a company and shows the company’s revenues and expenses por the period. It indicates how the revenues are transformed into the net income IFRS 15Revenue from contracts with customers An entity shall account for a contract with a customer only when all of the following criteria are met: the parties to the contract have approved the contract (in writing, orally or in accordance with other customary business practices) and are committed to perform their respective obligations; the entity can identify each party’s rights regarding the goods or services to be transferred; the entity can identify the payment terms for the goods or services to be transferred; the contract has commercial substance (i.e. the risk, timing or amount of the entity’s future cash flows is expected to change as a result of the contract); it is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer; in evaluating whether collectability of an amount of consideration is probable, an entity shall consider only the customer’s ability and intention to pay that amount of consideration when it is due.

27. Attention! 27 PROFIT ≠ MONEY • The following items are not taken into account when calculating the profit / loss: • terms of payment for production, goods, services; • terms of payment for raw materials; • investment costs; • borrowing and repayment the principal amounts of loans

28. 28 Situation– fashion house “Ilav” Condition 1 Condition 2 Purchase of fabrics at the beginning of 2015 (€ 50,000 shall be paid the 1st quarter of 2015) Purchase of equipment – € 60,000 (useful life is 5 years) Condition 3 Task Condition 4 Condition 5 Production of “Ilav” collection in 2015. Cost of the collection is € 145,000 Maintenance costs –€65,000 (shall be paid in 2015) Buyers have paid € 100,000. Accounts receivable - € 45,000 (will be paid in the 1st quarter of 2016) Calculate profit using cash method and accrual method of accounting

29. What is the real financial result of the activity?(accrual method) Calculation of profit in accordance with cash method of accounting 29 The annual amount of depreciation=€ 60,000 / 5 years (useful life) = € 12,000 Conclusion: in 2015 the company has earned profit in the amount of € 18,000. Such activity seems to be successful Conclusion: in the result of the company’s activity during the year 2015 the company has incurred loss in the amount of € 75,000. Whether it worth to continue such a loss-making activity? Profit calculation– accrual method vs cash method of accounting

30. 30 Accrual method is used when calculating profit because only this method can provide us with adequate information We have obtained contradicting results!

31. 31 Relationbetween profit and money The company can have large profit and incur deficit of cash at the same time (and vice versa) in the following circumstances: The company can have the significant amount of money and small profit or even loss in the following circumstances: Earned profit “has gravitated” in the amount of current assets (accounts receivable, inventories, finished goods) The company has made solid investments The company repaid loans The company has paid dividends Buyers have paid invoices faster than usually The company has bought less inventories than before The company has increased the trade payables The company has sold out some property The company has taken out a loan

32. 32 Principle of profit (loss) calculation Statement of profit and loss and other comprehensive income contains information about revenue, costs and profit / loss of the company for the period What isprofit (loss) ? Accrual method of accounting Income and expenses are recognized upon conducting transaction, not upon inflow / outflow of money Money ≠ Profit We can touch money but profit is not material. It is an abstract idea

33. 33 Capital (by Karl Marx) Karl Marx was a German philosopher, economist, sociologist and public figure. He is the author of the fundamental work “Capital” published in 1867 The general formula for capital : The general formula for capital: M – C – MI MONEYI MONEY COMMODITY Actually the apostrophe (in MI) – isthe profit Profit is an abstract notion showing the possibility of receipt of money

34. 34 Approach to calculation of profit Net profit Revenue PBТ Profit before tax Marginal profit EBITDA PBIT Operating profit Fixed costs (excluding amortization & depreciation) Variable expenses Amortization & depreciation Profit tax Dividends Financial income / expenses - - - - - ± Retained earnings Balance sheet

35. Direct method of preparing the statement of cash flows Indirect method of preparing the statement of cash flows 35 The statement is prepared based on the initial information on cash inflows and outflows The statement is prepared based on the data from statement of financial position and statement of profit and loss and other comprehensive income (transformation of these data) Statement of cash flows Statement of cash flows is one of the primary financial statements which shows the amount and sources of cash flows for the period. Cash flows are inflows and outflows of cash and cash equivalents 01 02 03 04 Shows the connection between cash balances as of the beginning and as of the end of the reporting period Shows sources of cash and direction of their spending. Cash flows are classified according to the areas of the company’s activity: operating activities, investing activities, financing activities Explains the inequality: money ≠ profit Allows to analyze and assess cash flow management policy

36. Financial analysis requiresdata of all 3 primary financial statements 36 None of the statements can provide comprehensive information on the company’s situation

37. 37 Operating activities are the principal revenue-producing activities of the entity and other activities that are not investing or financing activities: production and sales of goods, works, services Investing activities are the acquisition and disposal of long-term assets and other investment: construction and acquisition of buildings, purchase of land, equipment, vehicles, technologies, licenses, securities Financing activities are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity: receipt and repayment of loans, attraction of investors’ funds Areas of activity Operating activities Investing activities Financing activities

38. 38 What should be under control in the course of the company operation? Financial result of activity– profit / loss Profit management 1 Purchase or construction of non-current assets Management of material and finished goods inventory Management of accounts receivable and payable Management of finances 2 Taxes 3 Costs Financial expenses Financial income Other income and expenses Revenue Financial result from investments in securities and other financial instruments Sales volume and sale’s prices For instance, financial result from sale of non-current assets or foreign exchange differences Cost of borrowing Prices and resources consumption rates (controlling) 4

39. What is return on investment? Whether the company is profitable enough to continue development? 39 What do we need to know about financial standing of a company? Profitability Will the company be able to earn enough cash for operating activities in the nearest future (to purchase raw material for production, to pay invoices, taxes and salary in the nearest future)? Will the company be able to operate in the long-term? Will the company remain independent from external parties (creditors)? Liquidity Working capital ratios Financial stability (gearing ratios) All the mentioned characteristics are very important for managers, owners as well as for external parties (creditors, suppliers, investors)

40. Special relativity theory 40 Albert Einstein was a theoretical physicist, one of the founders of modern theoretical physics, a public figure-humanist. Time is not absolute. It may be different for different observers Take a look into the future looking back Future Past Subject of analysis Subject of prediction A time point Where you want to “transfer”

41. +Δ% 41 What do we need to know about financial standing of a company? Analysis of financial position is an instrument of management involving calculation and interpretation of various financial ratios Financial ratios (liquidity ratios, working capital ratios (turnover ratios), gearing ratios, financial stability ratio, efficiency and profitability ratios) can be calculated for any company from any field and at any stage of development The company's growth With increasing scale of operation of the company it becomes necessary to calculate additional ratios intended specifically for shareholders (for instance P/E ratios, dividend yield etc.) In some situations other unique information can be required. Such information must be provided by management accounting of the company

42. Liquidity position of a company Solvency Asset liquidityis ability of assets to be quickly converted to cash at market price 42 is the actual implementation of the potential ability of a company to meet its short term debt obligations is the measurement of the company’s ability to meet its short term debt obligations (the ability of the company to pay off its short-term liabilities when they fall due) Liquidity and gearing Will the company be able to earn enough cash for operating activities in the nearest future?

43. Investment appraisal Cost of capital Working capital management Business finance Risk management Financial management function Relational diagram of main capabilities Financial management environment Business valuations 43

44. WELCOME to the SUMMER SCHOOL St. Petersburg university of management technologies and economics KEY ISSUES IN SME MANAGEMENTDAY 3.CASE STUDY

45. 45 A group of investors has organized trading and purchasing business and invested own funds in the amount of€ 10,000 Preparation of financial statements Statement of financial position of the company as of the date of creation (at the beginning of the 1st month of work) € 10,000 Equity capital

46. 46 Preparation of financial statements The company has rented office and storage premises and purchased goods to the amount of € 50,000 (25,000 units of goods * € 2per unit – purchase price including the cost of delivery). Purchasing conditions stipulated the prepayment in the amount of € 40,000 and delay of the final payment (€ 10,000) for up to 1.5 months. The company had available money in the amount of € 10,000 and had to take out a loan in the amount of € 40,000 – € 10,000 =€ 30,000. The company have received the short-term loan at the coast of 16% per annum. The principle amount of the loan has to be repaid as follows: repayment of 2/3 of the amount during the month and repayment of 1/3 of the amount in the next month with monthly payment of interest. During the 1st month of work the company has dispatched / sold to the customers 15,000 units of goods at the sale price of € 4 per unit. Turnover for the month has amounted to 15,000 * € 4 = € 60,000. The cost of dispatched goods has amounted to 15,000 * € 2 = € 30,000. Buyers have paid € 25,000. Invoices to the amount of € 35,000 remained unpaid (deferred payment is the usual practice). 25,000 – 15,000 =10,000 units of goods at the cost of € 2 per unit have remained in stock after dispatch of goods to buyers. Cost of goods remaining in stock is€ 20,000.

47. 47 Preparation of financial statements Salary of the staff accrued for the month has amounted to € 2,000. Only € 1,000 was paid from this amount (the second part will be paid at the beginning of the next month). Rental cost per month has amounted to € 3,000. The company has paid € 1,500 from this amount. Advertising costs of the company have amounted to € 1,000. They have been paid in full during the month. Loan interest for the month has amounted to € 30,000 * 16% / 12 months = € 400. The interest (€ 400) and a part of the principle amount of the loan (€ 20,000) were repaid within the month.The remaining amount of the loan debt is € 30,000 – € 20,000 = € 10,000. Profit tax for the current month will be paid by the company at the beginning of the next month. Profit ?

48. 48 Preparation of financial statements Income statement (for the 1st month of work) Отчет о прибыли (за 1-ый месяц работы) Investors expect to receive dividends in the amount of 10% of net profit (approximately € 2,000), but the financial director states that there is no money for this purpose. Is it true?

49. 49 Preparation of financial statements Statement of financial position of the company (as of the end of the 1st month of work)

50. 50 Preparation of financial statements Cash flow statement (for the 1st month of work) – direct method