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MGT602 - Entrepreneurship - Lecture Handout 41

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PREPARING FOR THE NEW VENTURE LAUNCH: EARLY MANAGEMENT
DECISIONS (Continued….)

LONG-TERM VS SHORT-TERM DEBT

The entrepreneur may need to borrow funds to finance assets and meet cash needs. Fixed assets are usually financed by long-term debt borrowed from a bank. Alternatives include borrowing from family members, having partners contribute more funds or selling corporate stock. Many of these options require the entrepreneur to give up some equity.

MANAGING COSTS AND PROFITS

An interim income statement helps to compare the actual with the budgeted amount for that period. The most effective use of the interim income statement is to establish cost standards and compare the actual with the budgeted amount for that time period. Costs are budgeted based on percentages of net sales. These percentages can be compared with actual percentages to see where tighter cost controls may be necessary. This lets the entrepreneur manage and control costs before it is too late. In later years, it is also helpful to look back on the first year of operation and make comparisons month-to-month. When expenses or costs are much higher than budgeted, the entrepreneur may need to determine the exact cause. Comparison of actual and budgeted expenses can be misleading for ventures with multiple products or services. For financial reporting purposes, the income statement summarizes expenses across all products and services.
This does not indicate the marketing cost for each product nor should the most profitable product. Allocating expenses over product lines be done as effectively as possible to avoid arbitrary allocation of costs.

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MGT604 - Management of Financial Institutions - Lecture Handout 35

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Related Content: MGT604 - VU Lectures, Handouts, PPT Slides, Assignments, Quizzes, Papers & Books of Management of Financial Institutions

Role of Insurance Companies

Insurance, in law and economics, is a form of risk management primarily used to hedge against the risk of a contingent loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for a premium. Insurer, in economics, is the company that sells the insurance. Insurance rate is a factor used to determine the amount, called the premium, to be charged for a certain amount of insurance coverage. Risk management, the practice of appraising and controlling risk, has evolved as a discrete field of study and practice.

Principles of insurance

Commercially insurable risks typically share seven common characteristics.

  1. A large number of homogeneous exposure units. The vast majority of insurance policies are provided for individual members of very large classes. Automobile insurance, for example, covered about 175 million automobiles in the United States in 2004.[2] The existence of a large number of homogeneous exposure units allows insurers to benefit from the so-called “law of large numbers,” which in effect states that as the number of exposure units increases, the actual results are increasingly likely to become close to expected results. There are exceptions to this criterion. Lloyd's of London is famous for insuring the life or health of actors, actresses and sports figures. Satellite Launch insurance covers events that are infrequent. Large commercial property policies may insure exceptional properties for which there are no ‘homogeneous’ exposure units. Despite failing on this criterion, many exposures like these are generally considered to be insurable.
  2. Definite Loss. The event that gives rise to the loss that is subject to insurance should, at least in principle, take place at a known time, in a known place, and from a known cause. The classic example is death of an insured on a life insurance policy. Fire, automobile accidents, and worker injuries may all easily meet this criterion. Other types of losses may only be definite in theory. Occupational disease, for instance, may involve prolonged exposure to injurious conditions where no specific time, place or cause is identifiable. Ideally, the time, place and cause of a loss should be clear enough that a reasonable person, with sufficient information, could objectively verify all three elements.
  3. Accidental Loss. The event that constitutes the trigger of a claim should be fortuitous, or at least outside the control of the beneficiary of the insurance. The loss should be ‘pure,’ in the sense that it results from an event for which there is only the opportunity for cost. Events that contain speculative elements, such as ordinary business risks, are generally not considered insurable.

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