Understanding the Economics of One Unit  One way to analyze profitability is to look at how much profit the business makes every time a customer buys a unit of sale.  The economics of one unit is a calculation that determines the profit, or loss, that a business earns every time a customer buys a unit of sale.  You calculate the economics of one unit by subtracting the expenses for the unit of sale from its selling price. Selling Price – Expense = Profit (or Loss)  For a business to be successful financially, the economics of one unit must result in a profit. 1 Chapter Financial Calculations for Business 19

Identifying Your Break-Even Point  When net income is zero, you are at the break-even point—the business has sold exactly enough units to cover all expenses.  To identify the breakeven point, perform a break-even analysis, which lets you determine how many units of sale you must sell to cover all of your expenses.  To perform the break-even analysis, calculate your gross profit per unit and then calculate your break-even unit.  Use your income statement to calculate your gross profit per unit—the amount of profit you use to pay operating expenses.  The formula for calculating your gross profit per unit is: Selling Price per Unit – Cost of Goods Sold per Unit = Gross Profit per Unit 2 Chapter Financial Calculations for Business 19

Calculating Your Break-Even Point  Once you know your gross profit per unit, use your income statement to determine your break-even unit.  A break-even unit is the number of units of sale you must sell to arrive at the break-even point.  If you sell fewer than your break-even unit, you will lose money.  If you sell more, you will earn a profit.  The formula for calculating your break-even unit is: Operating Expenses ÷ Gross Profit per Unit = Break-Even Unit  A break-even analysis and realistic sales forecasting can help a business estimate how long it will take to earn a profit.  Knowing your break-even point will help you make sure your business becomes and remains profitable. 3 Chapter Financial Calculations for Business 19

Forecasting Cash Flow Cash flow is the money received minus the money spent over a set period of time. To set up a cash budget: 1.List and total any expected incoming cash payments over the next month. 2.List and total any expected outgoing cash payments for the next month. 3.Subtract the expected cash outflows from the expected cash inflows. 4 Chapter Financial Calculations for Business 19

Analyzing Financial Ratios  The operating ratio the percentage of each dollar of revenue, or sales, needed to cover expenses. (Expenses ÷ Sales) × 100 = Operating Ratio (%)  The return on sales (ROS) ratio shows how much of each dollar of sales a company keeps as profit. (Net Profit ÷ Sales) × 100 = ROS (%)  A same-size analysis ratio is a comparison of the total revenue or other financial data against that same data converted into percentages. (Line Item ÷ Sales) × 100 = % of Sales 5 Chapter Financial Calculations for Business 19

More Financial Ratios  The debt ratio is the ratio of a business’s total debt, or liabilities, divided by its total assets. (Total Debts ÷ Total Assets) × 100 = Debt Ratio (%)  The debt-to-equity ratio shows the relationship between total debts and the owner’s equity. (Total Debts ÷ Owner’s Equity) × 100 = Debt-to-Equity Ratio (%)  The return on investment (ROI) ratio shows how well a business is doing in relation to the amount of money invested. (Net Profit ÷ Initial Investment) × 100 = Return on Investment (%) 6 Chapter Financial Calculations for Business 19

Chapter Review  The economics of one unit is a calculation that determines the profit, or loss, that a business earns every time a customer buys a unit of sale.  When net income is zero, you are at the break-even point.  A break-even analysis lets you determine how many units of sale you must sell to cover all of your expenses.  A break-even unit is the number of units of sale you must sell to arrive at the break-even point.  Cash flow is the money received minus the money spent over a set period of time.  One of the most effective ways to analyze the data from financial records is to use financial ratios. 7 Chapter Financial Calculations for Business 19