Chapter 7: Using an Income Statement to Guide a

Download Report

Transcript Chapter 7: Using an Income Statement to Guide a

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 analyze a balance sheet.

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.

Income Statement

 Shows profit or loss over a particular time period  Revenues > Expenses = Positive Balance  Expenses > Revenues = Negative Balance  Prepared monthly  Serves as a scorecard; helps reveal problems Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin © 2012 Pearson Education, Upper Saddle River, NJ 07458.

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) Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin 6 © 2012 Pearson Education, Upper Saddle River, NJ 07458.

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) Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin 11 © 2012 Pearson Education, Upper Saddle River, NJ 07458.

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 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin © 2012 Pearson Education, Upper Saddle River, NJ 07458.

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 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin © 2012 Pearson Education, Upper Saddle River, NJ 07458.

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 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin 15 © 2012 Pearson Education, Upper Saddle River, NJ 07458.

The Balance Sheet Equation

Assets – Liabilities = Owner’s Equity (OE)

Assets = Liabilities + Owner’s Equity

Liabilities = Assets – Owner’s Equity

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.

Sales Less total COGS Less other var. costs Contribution margin Less fixed op. costs Profit Taxes Net profit/(loss) Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin

Amount (M)

$10 $ 4 $ 0 $ 6 $ 3 $ 3 $ 1 $ 2 19

Calculation

($10 ÷ $10) x 100 ($4 ÷ $10) X 100

% of Sales

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.

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 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin © 2012 Pearson Education, Upper Saddle River, NJ 07458.

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

Very low Low Moderate High Very high

Margin Range

2-5% 6-10% 11-20% 20-30% 30% and up

Typical Product

Very high volume OR very high price High volume OR high price Moderate volume AND moderate price Low volume OR low price Very low volume OR very low price Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin 23 © 2012 Pearson Education, Upper Saddle River, NJ 07458.

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 Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin © 2012 Pearson Education, Upper Saddle River, NJ 07458.

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 If the current ratio is greater than one, the business could sell some assets to pay off its debts.

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  Inventory turnover ratio—measures how quickly inventory is being sold Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin © 2012 Pearson Education, Upper Saddle River, NJ 07458.

Formulas for Calculating Operating Efficiency Ratios



Collection-Period Ratio:

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

Receivable Turnover Ratio:

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

Inventory Turnover Ratio:

Cost of Goods Sold (Income Statement) Average Inventory (Balance Sheet) = # of times Entrepreneurship and Small Business Management, 1/e By Steve Mariotti and Caroline Glackin 28 © 2012 Pearson Education, Upper Saddle River, NJ 07458.