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Lecture 7: Financial Plan

Overview

1. Basic Financial Statements 2. Ration Analysis 3. Interpreting Business Ratios 4. Breakeven Analysis

1

BEN2014 Introduction to Cyberpreneurship (by: TPL) Original Source: Zimmerer & Scarborough (Pearson)

Financial Reporting

Common mistake among business owners: Failing to collect and analyze basic financial data. One-third of entrepreneurs run their companies without any kind of financial plan. Only 11 percent of business owners analyze their companies’ financial statements as part of the managerial planning process. Financial planning is essential to running a successful business and is not that difficult!

Pg 384-421

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BEN2014 Introduction to Cyberpreneurship (by: TPL) Original Source: Zimmerer & Scarborough (Pearson)

Basic Financial Reports

Pg 384-421

Balance Sheet – “Snapshot.” Estimates the firm’s worth on a given date; built on the accounting equation: Assets = Liabilities + Owner’s Equity Income Statement – “Moving picture.” Compares the firm’s expenses against its revenue over a period of time to show its net income (or loss): Net Income = Sales Revenue - Expenses Statement of Cash Flows – shows the change in the firm's working capital over a period of time by listing the sources of funds and the uses of these funds.

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BEN2014 Introduction to Cyberpreneurship (by: TPL) Original Source: Zimmerer & Scarborough (Pearson)

Ratio Analysis

A method of expressing the relationships between any two elements on financial statements. Important barometers of a company’s financial position. Study: Only 27 percent of small business owners compute financial ratios and use them to manage their businesses.

Pg 384-421

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BEN2014 Introduction to Cyberpreneurship (by: TPL) Original Source: Zimmerer & Scarborough (Pearson)

Key Ratios

Pg 384-421

Liquidity Ratios - Tell whether or not a small business will be able to meet its maturing obligations as they come due. 1. Current Ratio - Measures solvency by showing the firm's ability to pay current liabilities out of current assets.

Current Ratio = Current Assets = $686,985 = 1.87:1 Current Liabilities $367,850

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BEN2014 Introduction to Cyberpreneurship (by: TPL) Original Source: Zimmerer & Scarborough (Pearson)

Key Ratios

Pg 384-421

Liquidity Ratios - Tell whether or not a small business will be able to meet its maturing obligations as they come due. 2. Quick Ratio - Shows the extent to which a firm’s most liquid assets cover its current liabilities.

Quick Ratio = Quick Assets = $231,530 = .63:1 Current Liabilities $367,850

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BEN2014 Introduction to Cyberpreneurship (by: TPL) Original Source: Zimmerer & Scarborough (Pearson)

Key Ratios

Pg 384-421

Leverage Ratios - Measure the financing provided by a firm’s owners against that supplied by its creditors; a gauge of the depth of the company’s debt. 3. Debt Ratio - Measures the percentage of total assets financed by creditors rather than owners.

Debt Ratio = Total Debt = $580,000 = .68:1 Total Assets $847,655

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BEN2014 Introduction to Cyberpreneurship (by: TPL) Original Source: Zimmerer & Scarborough (Pearson)

Key Ratios

Pg 384-421

Leverage Ratios - Measure the financing provided by a firm’s owners against that supplied by its creditors; a gauge of the depth of the company's debt. 4. Debt to Net Worth Ratio - Compares what a business “owes” to “what it is worth.”

Debt to Net = Worth Ratio Total Debt Tangible Net Worth = $580,000 = 2.20:1 $264,155

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BEN2014 Introduction to Cyberpreneurship (by: TPL) Original Source: Zimmerer & Scarborough (Pearson)

Key Ratios

Pg 384-421

Leverage Ratios - Measure the financing provided by a firm’s owners against that supplied by its creditors; a gauge of the depth of the company's debt. 5. Times Interest Earned - Measures the firm's ability to make the interest payments on its debt.

Times Interest = Earned EBIT* = $100,479 = 2.52:1 Total Interest Expense $39,850

***Earnings Before Interest and Taxes
**

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BEN2014 Introduction to Cyberpreneurship (by: TPL) Original Source: Zimmerer & Scarborough (Pearson)

Key Ratios

Pg 384-421

Operating Ratios - Evaluate a firm’s overall performance and show how effectively it is putting its resources to work. 6. Average Inventory Turnover Ratio - Tells the average number of times a firm's inventory is “turned over” or sold out during the accounting period.

Average Inventory = Cost of Goods Sold = $1,290,117 = 2.05 times Turnover Ratio Average Inventory* $630,600 a year

***Average Inventory = Beginning Inventory + Ending Inventory 2
**

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BEN2014 Introduction to Cyberpreneurship (by: TPL) Original Source: Zimmerer & Scarborough (Pearson)

Interpreting Ratios

Ratios – useful yardsticks of comparison. Standards vary from one industry to another; key is to watch for “red flags.” Critical numbers – measure key financial and operational aspects of a company’s performance. Examples: Sales per labor hour at a supermarket Food costs as a percentage of sales at a restaurant Load factor (percentage of seats filled with passengers) at an airline

Pg 384-421

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BEN2014 Introduction to Cyberpreneurship (by: TPL) Original Source: Zimmerer & Scarborough (Pearson)

Interpreting Ratios Sam’s Appliance Shop Current ratio = 1.87:1

Pg 384-421

Industry Median Current ratio = 1.50:1

Although Sam’s falls short of the rule of thumb of 2:1, its current ratio is above the industry median by a significant amount. Sam’s should have no problem meeting short-term debts as they come due.

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BEN2014 Introduction to Cyberpreneurship (by: TPL) Original Source: Zimmerer & Scarborough (Pearson)

Interpreting Ratios Sam’s Appliance Shop Quick ratio = 0.63:1

Pg 384-421

Industry Median Quick ratio = 0.50:1

Again, Sam is below the rule of thumb of 1:1, but the company passes this test of liquidity when measured against industry standards. Sam relies on selling inventory to satisfy short-term debt (as do most appliance shops). If sales slump, the result could be liquidity problems for Sam’s. What steps should Sam take to deal with this threat?

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BEN2014 Introduction to Cyberpreneurship (by: TPL) Original Source: Zimmerer & Scarborough (Pearson)

Interpreting Ratios Sam’s Appliance Shop Debt ratio = 0.68:1

Pg 384-421

Industry Median Debt ratio = 0.64:1

Creditors provide 68 percent of Sam’s total assets, very close to the industry median of 64 percent. Although the company does not appear to be overburdened with debt, Sam’s might have difficulty borrowing, especially from conservative lenders.

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BEN2014 Introduction to Cyberpreneurship (by: TPL) Original Source: Zimmerer & Scarborough (Pearson)

Breakeven Analysis

Pg 384-421

• The breakeven point is the level of operation at which a business neither earns a profit nor incurs a loss. • It is a useful planning tool because it shows entrepreneurs minimum level of activity required to stay in business. • With one change in the breakeven calculation, an entrepreneur can also determine the sales volume required to reach a particular profit target.

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BEN2014 Introduction to Cyberpreneurship (by: TPL) Original Source: Zimmerer & Scarborough (Pearson)

Calculating the Breakeven Point

Pg 384-421

Step 1. Determine the expenses the business can expect to incur. Step 2. Categorize the expenses in step 1 into fixed expenses and variable expenses. Step 3. Calculate the ratio of variable expenses to net sales. Then compute the contribution margin:

Contribution Margin = 1 Variable Expenses Net Sales Estimate

**Step 4. Compute the breakeven point:
**

Breakeven Point = $ Total Fixed Costs Contribution Margin

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BEN2014 Introduction to Cyberpreneurship (by: TPL) Original Source: Zimmerer & Scarborough (Pearson)

Calculating the Breakeven Point: The Magic Shop

Pg 384-421

Step 1. Net Sales estimate is $950,000 with Cost of Goods Sold of $646,000 and Total Expenses of $236,500. Step 2. Variable Expenses of $705,125; Fixed Expenses of $177,375. Step 3. Contribution margin:

Contribution Margin = 1 $705,125 $950,000 = .26

**Step 4. Breakeven point:
**

Breakeven Point = $ $177,375 .26 = $682,212

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BEN2014 Introduction to Cyberpreneurship (by: TPL) Original Source: Zimmerer & Scarborough (Pearson)

Breakeven Chart

Revenue Line

ea Ar t o fi Pr

Pg 384-421

**Breakeven Point Sales = $682,212 $682,212
**

Income and Expenses

Total Expense Line

ea Ar ss Lo

Fixed Expense Line

0

$682,212

Sales Volume

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