Presentation on theme: "Entrepreneurship and Small Business Management"— Presentation transcript:
1 Entrepreneurship and Small Business Management Chapter 13Using Financial Statements to Guide a Business
2 Ch. 13 Performance 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 of an income statement.
3 Ch. 13 Performance Objectives (continued) Calculate return on investment.Perform same-size (common-size) analysis of an income statement.Use quick, current, and debt ratios to analyze a balance sheet.
4 Financial StatementsEntrepreneurs use three basic financial statements:Income statementBalance sheetCash flow statementTogether, these financial reports show the health of a business at a glance.
5 Income Statement Shows profit or loss over a particular time period Revenues > Expenses = Positive BalanceExpenses > Revenues = Negative BalancePrepared monthlyServes as a scorecard; helps reveal problems
6 Parts of an Income Statement RevenueCOGS/COSSGross profitOther variable costsContribution marginFixed operating costsEarnings before interest and taxesPre-tax profitTaxesNet profit/(loss)
10 An Income Statement for a More Complex Business
11 Balance SheetCalled a “point-in-time” financial statement because it shows the state of a business at a given momentTypically prepared quarterly and at the end of the fiscal year (12-month accounting period chosen by the firm)
12 Parts of a Balance Sheet Assets—things the company owns that are worth moneyLiabilities—the company’s debts that must be paid (including unpaid bills)Owner’s Equity (OE)—Assets – Liabilities = OEAlso called “net worth”The amount of capital in the company
14 Types/Examples of Assets Current assets—cash, items easily turned into cash, and items used within one yearAccounts receivableInventorySuppliesLong-term assets—items that would take the business more than one year to useEquipmentFurnitureMachineryReal estate
15 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 yearExamples of liabilities:Accounts payable (bills)Loans from banks, family, or friendsMortgagesLines of credit
16 The Balance Sheet Equation Assets – Liabilities = Owner’s Equity (OE)orAssets = Liabilities + Owner’s EquityLiabilities = Assets – Owner’s Equity(Net worth and capital are other names for OE.)
17 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.
18 Analyzing Balance Sheet Data Compare balance sheets from two different points in time to see progress.Calculate the percentage of change between the reports for each line item.An increase in owner’s equity is one way to measure success.
19 Income Statement Ratios Express each line item as a percentage of sales to see the relationship between items.Amount (M)Calculation% of SalesSales$10($10 ÷ $10) x 100100%Less total COGS$ 4($4 ÷ $10) X 10040%Less other var. costs$ 0Contribution margin$ 6($6 ÷ $10) X 10060%Less fixed op. costs$ 3($3 ÷ $10) x 10030%ProfitTaxes$ 1($1 ÷ $10) x 10010%Net profit/(loss)$ 2($2 ÷ $10) x 10020%
20 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%
21 Things Needed to Calculate ROI Net profit—amount the firm has earned beyond what it has spent to cover costsTotal investment—start-up investment plus any additional money invested laterPeriod of time for which you are calculating ROI—typically one month or one year
22 Return on Sales (ROS)ROS is also called the “profit margin” because it is an important measure of business profitability.Net income ÷ sales = ROSTo express this ratio as a percentage, multiply it by 100.
23 Volume and Price Impact ROS Margin RangeTypical ProductVery low2-5%Very high volume OR very high priceLow6-10%High volume OR high priceModerate11-20%Moderate volume AND moderate priceHigh20-30%Low volume OR low priceVery high30% and upVery low volume OR very low price
24 Common-Sized (“Same-Size”) 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
25 Quick and Current Ratios Quick Ratio:(Cash + Marketable Securities) ÷ Current LiabilitiesMarketable securities—investments such as certificates of deposit or Treasury billsIf the quick ratio is greater than one, there is enough cash to cover all bills (but not loans) within 24 hours.Current Ratio:Current Assets ÷ Current LiabilitiesIf the current ratio is greater than one, the business could sell some assets to pay off its debts.
26 Debt Ratios Debt-to-Equity Ratio: Total Debt ÷ Equity Indicates how many dollars in the business were provided by owners/investorsExample: A ratio of 1-to-1 means for every $1 of debt, the company owns $1 of assets.Debt Ratio: Total Debt ÷ Total AssetsIndicates how many dollars in the business were provided by creditorsExample: A ratio of 0.5 means the company is in debt for 50% of its assets.
27 Operating Efficiency Ratios Collection-period ratio—measures the average number of days that sales are going uncollectedReceivable turnover ratio—measures the efficiency of your company’s efforts to collect receivablesInventory turnover ratio—measures how quickly inventory is being sold
28 Formulas for Calculating Operating Efficiency Ratios Collection-Period Ratio:Average Accounts Receivable (Balance Sheet)Average Daily Sales (Income Statement)Receivable Turnover Ratio:Total Sales (Income Statement)Inventory Turnover Ratio:Cost of Goods Sold (Income Statement)Average Inventory (Balance Sheet)= # of days= # of times= # of times