1. Chapter 8 Using Financial Statements to Guide a Business
Entrepreneurship
Chapter 8
Using Financial Statements to Guide a Business

2. Entrepreneurs Use Financial Statements
Income statement
Cash flow statement
Balance sheet
Data for the financial statements comes from the accounting journal.
The statements show the health of the business at a glance.

3. Income Statement: Scorecard for the Entrepreneur
Prepared monthly and at end of fiscal year
Also called “profit and loss statement”
Shows whether or not business is making a profit
Profit is entrepreneur’s reward for adding value to scarce resources

4. Eight Parts of the Income Statement
Revenue
Cost of Goods Sold (COGS)
Other Variable Costs
Contribution Margin (Gross Profit)
Fixed Operating Costs (USAIIRD)
Pre-Tax Profit
Taxes
Net Profit/(Loss)

5. Income Statement

6. A Simple Income Statement

7. Income Statement for a More Complex Business

8. Return on Investment (ROI)
Entrepreneurs “invest” time, energy, or money into something because they expect a “return” of money or satisfaction.
Return on investment (ROI) measures return as a percentage of the original investment.
Net Profit/Investment x 100 = ROI%
What is made over what is paid, times 100.

9. To Calculate ROI for a Business, You Need 3 Things:
Net Profit: found on bottom line of the income statement.
Investment: all money used to start the business (Start-Up Investment) plus additional money invested later.
The period of time for which you are calculating ROI (typically one month or one year).

10. Income Statement Ratios
Express each line of the income statement as a percentage by dividing sales into it and multiplying by 100.
This makes it easy to see how each item is affecting the business’s profit.
Return on Sales (ROS) =
Net Income/Sales
Operating Ratio =
Fixed Operating Costs/Sales

11. Same Size Analysis: Used to Compare Income Statements

12. The Balance Sheet A “point-in-time” statement
Shows how a business is financed
Prepared at end of fiscal year 3 items
Assets = things a company owns that are worth money
Liabilities = debts a company must pay, including unpaid bills
Owner’s Equity (OE) = Assets-Liabilities, also called “net worth”

13. Balance Sheet

14. Short and Long-Term Assets
Assets are all items worth money owned by the business:
Current assets—cash or items that can be quickly turned into cash
Accounts receivables
Inventory
Supplies
Long-term assets—items that would take the business more than one year to use
Equipment
Furniture
Machinery
Real estate

15. Current and Long-Term Liabilities
Liabilities are all debts owed by the business.
Current liabilities—debts that must be paid within one year
Bills
Lines of credit
Short-term loans
Long-term liabilities—debts that will be paid over more than one year
Bank loans
Mortgages

16. The Balance Sheet Equation
Assets – Liabilities = Owner’s Equity or
Assets = Owner’s Equity – Liabilities
Owner’s Equity is also called:
Net worth
Capital

17. Assets Must Equal (“Balance”) Liabilities + O.E.
If an item was financed with debt, the loan is a liability.
If an item was purchased with the owner’s money, it was financed with equity.
Liabilities and owner’s equity pay for all items owned by the business (assets).

18. Analyzing a Balance Sheet
The balance sheet shows how a business is financed.
Investors use ratios and “same-size” analysis to analyze a balance sheet.

19. “Same-Size” Balance Sheet Analysis

20. Quick and Current Ratios
Quick Ratio: Cash + marketable securities
Current Liabilities
Should always be greater than 1
Shows whether there is enough cash to cover all bills within 24 hours
Current Ratio: Current Assets
Shows whether a business could sell some assets to pay off its debts

21. Debt Ratios
Debt ratios show at a glance how much of the company is financed with debt and how much with equity.
Debt-to-Equity Ratio: Debt/Equity
Example: ratio of 1 means for every $1 of debt the company owns $1 of assets.
Debt Ratio: Debt/Assets
Example: ratio of 0.5 means company is in debt for 50% of its assets.
Entrepreneurs like to have a fairly high debt ratio, because it means they are financing the business not with their own money but with credit from creditors and suppliers.

22. Operating Efficiency Ratios
Collection Period Ratio:
Average accounts receivable (Balance Sheet)
Average daily sales (Income Statement)
Receivable Turnover Ratio:
Total Sales (Income Statement)
Average Accounts Receivables (Balance Sheet)
Inventory Turnover Ratio:
Cost of Goods Sold (Income Statement)
Average Inventory (Balance Sheet)
= # of days
= # of times
= # of times