1. Entrepreneurship and Small Business Management

2. USING FINANCIAL STATEMENTS TO GUIDE A BUSINESS Income Statement & Balance Sheet

3. Learning Objectives Understand an income statement.
Examine a balance sheet to determine a business’s financing strategy.
Use the balance sheet equation for analysis.
Perform a financial ratio analysis on an income statement.

4. Learning Objectives (continued)
Calculate return on investment (ROI).
Perform “common-sized” analysis of an income statement.
Use quick, current, and debt ratios to analyze a balance sheet.

5. Financial Statements
Entrepreneurs use three basic financial statements:
Income statement
Balance sheet
Cash flow statement
Together, these financial reports show the health of a business at a glance.

6. Income Statement Profit is a reward for making the right choice.
Shows profit or loss over a particular time period.
Revenues > Expenses = Positive Balance
Expenses > Revenues = Negative Balance
Serves as a scorecard; helps reveal problems.
Profit is a reward for making the right choice.

7. Parts of an Income Statement
Revenue
COGS/COSS
Gross profit
Other variable costs
Contribution margin
Fixed operating costs
Earnings before interest and taxes
Pre-tax profit
Taxes
Net profit/(loss)

8. Basic Income Statement

9. A Simple Income Statement

10. The Double Bottom Line Going beyond making a profit:
Be a good citizen.
Encourage local investment.
Treat others as you want to be treated.

11. An Income Statement for a More Complex Business

12. Balance Sheet
Called a “point-in-time” financial statement because it shows the state of a business at a given moment.
Typically prepared quarterly and at the end of the fiscal year (12-month accounting period chosen by the firm).

13. Parts of a Balance Sheet
Assets—things the company owns that are worth money.
Liabilities—the company’s debts that must be paid (including unpaid bills).
Owner’s Equity (OE)—
Assets – Liabilities = OE.
Also called net worth.
The amount of capital in the company.

14. Balance Sheet (Horizontal Format)

15. Types/Examples of Assets
Current assets—cash, items easily turned into cash, and items used within one year.
Accounts receivable
Inventory
Supplies
Long-term assets—items that would take the business more than one year to use.
Equipment
Furniture
Machinery
Real estate

16. Types/Examples of Liabilities
Current liabilities—debts scheduled for payment within one year (includes portion of long-term debt due within the year).
Long-term liabilities—debts to be paid over a time period longer than one year.
Examples of liabilities:
Accounts payable (bills).
Loans from banks, family, or friends.
Mortgages.
Lines of credit.

17. The Balance Sheet Equation
Assets – Liabilities = Owner’s Equity (OE) or Assets = Liabilities + Owner’s Equity Liabilities = Assets – Owner’s Equity (Net worth and capital are other names for OE.)

18. Total Assets Must Equal (“Balance”) Total Liabilities + Owner’s Equity
If an item was financed with debt, the loan is a liability.
If an item was purchased with the owner’s (or shareholders’) money, it was financed with equity.
Liabilities and owner’s equity pay for all assets.

19. Analyzing Balance Sheet Data
Compare balance sheets from two different points in time to see progress.
Use ratios for a quick understanding.
Calculate the percentage of change between the reports for each line item.
An increase in owner’s equity is one way to measure success.

20. Depreciation
Reflects loss of value through wear and tear or obsolescence.
Consult with accounting or tax professionals to identify best depreciation method.

21. Income Statement Ratios
Express each line item as a percentage of sales to see the relationship between items.

22. Return on Investment (ROI)
Entrepreneurs “invest” time, energy, and money 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%

23. Things Needed to Calculate ROI
Net profit—amount the firm has earned beyond what it has spent to cover costs.
Total investment—start-up investment plus any additional money invested later.
Period of time for which you are calculating ROI—typically one month or one year.

24. Profit Margin
Profit margin is an important measure of business profitability.
Profit Margin = Net income ÷ sales
To express this ratio as a percentage, multiply it by 100.

25. Volume and Price Impact ROS

26. Common-Sized Statement Analysis
Lets you compare income statements, even if sales amounts vary.
Compare your expenses with those incurred by other businesses in your industry, or for your own company at different points in time.
Operating ratio—expresses what percentage of sales dollars a particular expense item is using up.

27. Quick Ratio Quick Ratio:
(Cash + Marketable Securities) ÷ Current Liabilities
Marketable securities—investments such as certificates of deposit or Treasury bills.
If the quick ratio is greater than one, there is enough cash to cover all bills (but not loans) within 24 hours.

28. Current Ratios Current ratio Current Assets ÷ Current Liabilities
If the current ratio is greater than one, the business could sell some assets to pay off its debts.

29. Debt Ratios Debt-to-Equity Ratio: Total Debt ÷ Equity
Indicates how many dollars in the business were provided by owners/investors.
A ratio of 1-to-1 means for every $1 of debt, the company owns $1 of assets.
Debt Ratio: Total Debt ÷ Total Assets
Indicates how many dollars in the business were provided by creditors.
A ratio of 0.5 means the company is in debt for 50% of its assets.

30. Formulas for Calculating Operating Efficiency Ratios
Collection-period ratio—measures the average number of days that sales are going uncollected.
Average Accounts Receivable (Balance Sheet) =# of days
Average Daily Sales (Income Statement)

31. Formulas for Calculating Operating Efficiency Ratios
Receivable turnover ratio—measures the efficiency of your company’s efforts to collect receivables.
Total Sales (Income Statement) = # of times
Average Accounts Receivable
(Balance Sheet)

32. Operating Efficiency Ratios
Inventory turnover ratio—measures how quickly inventory is being sold.
Cost of Goods Sold (Income Statement) = # of times
Average Inventory (Balance Sheet)