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ENTREPRENEURSHIP: Starting and Operating a Small Business, 3/e

Steve Mariotti and Caroline Glackin

USING FINANCIAL STATEMENTS TO GUIDE A BUSINESS

UNIT 3 • SHOW ME THE MONEY: FINDING, SECURING, AND MANAGING IT

Class NameInstructor NameDate, Semester

1. Understand an income statement.2. Examine a balance sheet to determine a business’s financing strategy.3. Use the balance sheet equation for analysis.4. Perform a financial ratio analysis of an income statement.5. Calculate return on investment.6. Perform same-size (common-sized) analysis of an income statement.7. Use quick, current, and debt ratios to analyze a balance sheet.

Performance ObjectivesAfter this lecture, you should be able to complete the following Performance Objectives

8 Scorecard for the Entrepreneur: What Do Financial Statements Show?

Income Statement

Balance Sheet

Cash Flow Statement

8 Income Statements: Showing Profit and Loss over Time

Part of an Income Statement:1. Revenue

2. Cost of Goods Sold (COGS)

3. Gross Profit

4. Other Variable Costs

5. Contribution Margin (Gross Profit)

6. Fixed Operating Costs (USAIIRD)

7. Earnings before interest and taxes (EBIT)

8. Pre-Tax Profit

9. Taxes

10. Net Profit/(Loss)

8Exhibit 8-1 Basic Income Statement

A Basic Company Inc. Income Statement for the Month Ended:

A Basic Income Statement:

The power of the income statement is that it will tell you whether you are fulfilling the formula of buying low, selling high, and meeting customer needs.

The Double Bottom Line:

Ideally, you want to have a positive double bottom line; you are making a profit so you can stay in business and achieve your mission

8 A Simple Income Statement

Exhibit 8-2 Flea Market Seller Income Statement

8 Income Statement for a More Complex Business

Exhibit 8-3 Income Statement for Lola’s Custom Draperies, Inc., for the Month of March 2011

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.

8 The Balance Sheet: A Snapshot of Assets, Liabilities, and Equity at a Point in Time

Net Worth (owner’s equity) – the difference between assets and liabilities.

1. Assets: items a company own that have monetary value.

2. Liabilities: debts a company has that must be paid, including unpaid bills.

3. Owner’s Equity (OE): also called net worth. It shows the amount of capital in the business. It consists of common equity, preferred equity, paid-in-capital

Fiscal Year – the 12 month financial reporting period for a company

8 Short-and Long-Term Assets

Current Assets – cash or items that can be quickly converted to cash or will be used within one year.

Long-term Assets – those that will take more than one year to use.

8 Current and Long-Term Liabilities

Liabilities – are all debts owed by the business, such as bank loans, mortgages, lines of credit, and loans to family or friends.

Current Liabilities- debts that are scheduled for payment within that year.

Long-Term Liabilities – debts that are due in over one year.

8 The Balance Sheet Equation

Balance Sheet Equation – is the equation for calculating owner’s equity.

If assets are greater that liabilities, net worth is positive.

If liabilities are greater than assets, net worth is negative

Assets – liabilities = Net Worth (or Owner’s Equity or Capital or

Assets = liabilities + Owner’s Equity or

Liabilities = Assets - Owner’s Equity

8 The Balance Sheet Shows Assets and Liabilities Obtained through Financing

If an item was financed with debt, the loan is a liability.

If an item was purchased with the owner’s own money (including that of shareholders), it was financed with equity.

8 Balance Sheet

Total Assets = Total Liabilities + Owner’s Equity (OE)

8 The Balance Sheet Shows How a Business Is Financed

An entrepreneur that relies too much on equity financing from outside investors (who have thus become owners) can lose control of the company.

An entrepreneur who takes on too much debt and is unable to make loan payments can lose the business, and possibly personal assets as well, to banks or other creditors.

8 Analyzing a Balance Sheet

Comparing balance sheets from two points in time is an excellent way to see whether or not a business has been financially successful.

Assets- Cash- Inventory - Capital equipment- Other assets- Total assets

Liabilities- Short-term liabilities- Long-term liabilities- Owner’s equity

Depreciation – a certain portion of an asset that is subtracted each year until the asset’s value reaches zero.

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Exhibit 8-8 Balance Sheet Variance Analysis

Restaurant Balance Sheet

As of Dec. 31, 2011 As of Dec. 31, 2010

8 Financial Ration Analysis: What Is It and What Does It Mean to You?

Income Statement Ratios: divide sales into each line item and multiply by a hundred.

Return on Investment- Investment – something that a person or entity devotes resources to in

hopes of future profits or satisfaction.- Return on Investments (ROI) - the net profit of a business divided by its

start-up investment (percentage)- Wealth – the value of assets owned minus the value of liabilities owed.

1. Net profit.

2. Total investment in the business.

3. The period of time for which you are calculating ROI.

Net Profit ROI = Investment x 100 = ROI

8 Return on Sales

Return on sales (ROS) – net income divided by sales for a particular time period (percentage).

Profit margin (return on sales) – net income divided by sales (percentage).

Common-Sized Statement Analysis- Operating ratio: an expression of a value versus sales

Balance-Sheet Analysis

Net IncomeReturn on Sales (ROS) = Sales

8 Current & Quick Rations

Liquidity – the ability to convert assets into cash.

Current Ratio-liquidity ration consisting of the total sum of cash plus marketable securities divided by current liabilities.

Marketable Securities- investments that can be converted into cash within 24 hours.

Quick Ration-the calculation of cash in relation to covering current debt.

Cash + Marketable SecuritiesQuick Ratio = Current Liabilities

Current Liabilities – ( Inventory + Prepayments)Quick Ratio = Current Liabilities

8 Debt Ratios: Showing the Relationship Between Debt & Equity

Debt-to-Equity Ratio – the comparison of total debt to total equity.

Debt Ratio – the comparison of total debt to total assets.

Debt Debt-to-Equity Ratio = Equity

Total DebtDebt Ratio = Total Assets

8 Operating-Efficiency Ratios

1. Collection-period ratio

2. Receivable turnover ratio

3. Inventory turnover ratio

Average Accounts Receivable (Balance Sheet) = # of days Average Daily Sales (Income Statement)

Total Sales (Income Statement) = # of times Average Accounts Receivable (Balance Sheet)

Cost of Goods Sold (Income Statement) = # of times Average Inventory (Balance Sheet)

KEY TERMS

current assetscurrent liabilitiescurrent ratiodebt ratiodebt-to-equity ratiofiscal yearinvestmentliquidity