Entrepreneurship and small business management chapter 13

 Perform a financial ratio analysis of an income statement... Balance Sheet Called a “point-in-time” financial statement because it shows the state of a business at a given moment 

Entrepreneurship and Small

Business Management

Chapter 13

Using Financial Statements to

Guide a Business

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.

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

 Together, these financial reports show the health of a business at a glance.

Income Statement

 Shows profit or loss over a particular

time period

 Prepared monthly

Serves as a scorecard; helps reveal

Parts of an Income Statement

Income Statement: Basic Format

Income Statement Calculations

A Simple Income Statement

An Income Statement for a More

Complex Business

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)

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

Balance Sheet (Horizontal Format)

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

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

The Balance Sheet Equation

Assets – Liabilities = Owner’s Equity (OE)

or

Assets = Liabilities + Owner’s Equity

or

Liabilities = Assets – Owner’s Equity

(Net worth and capital are other names for OE.)

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.

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.

Income Statement Ratios

Express each line item as a percentage of

sales to see the relationship between items.

Amount (M) Calculation % of Sales

Less other var costs $ 0

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%

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

Return on Sales (ROS)

 ROS is also called the “profit margin”

because it is an important measure of

business profitability.

 Net income ÷ sales = ROS

 To express this ratio as a percentage,

multiply it by 100.

Volume and Price Impact ROS

ROS Margin Range Typical Product

Very low 2-5% Very high volume OR very high price

Moderate 11-20% Moderate volume AND moderate price

Very high 30% and up Very low volume OR very low price

Common-Sized (“Same-Size”)

Analysis

sales amounts vary.

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

Quick and Current Ratios

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.

Current Ratio:

Current Assets ÷ Current Liabilities

Debt Ratios

Debt-to-Equity Ratio: Total Debt ÷ Equity

 Indicates how many dollars in the business

were provided by owners/investors

 Example: 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

 Example: A ratio of 0.5 means the company is

in debt for 50% of its assets.

Operating Efficiency Ratios

 Collection-period ratio—measures the

average number of days that sales are

going uncollected

 Receivable turnover ratio—measures

the efficiency of your company’s efforts to collect receivables

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)

Average Accounts Receivable (Balance Sheet)

 Inventory Turnover Ratio:

Cost of Goods Sold (Income Statement)

Average Inventory (Balance Sheet)

= # of days

= # of times

= # of times