A Handbook of Small Business Finance

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SMALL BUSINESS MANAGEMENT SERIES No. 15 ( Seventh Edition )

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A handbook of small bu
Stanford University Libraries
3 6105 095 870 247
A Handbook of
Small Business
FINANCE
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SMALL BUSINESS ADMINISTRATION

SBA 1.12 : 15
BU
L SI
M AL NE
SS
S
SMALL BUSINESS MANAGEMENT SERIES No. 15 ( Seventh Edition )
NO
1953 IL SBA 1.12: 15/7 C.1
E
A handbook of small bu
Stanford University Libraries
3 6105 095 870 247
A Handbook of
Small Business
FINANCE
D
R
O
UNI
F
VER
S
M
A
T
S
Y 76
MA 18
GO
VT
.
DOCUMENT

SMALL BUSINESS MANAGEMENT SERIES NO. 15 (Seventh Edition)
A Handbook of
Small Business
FINANCE
by JACK ZWICK

WASHINGTON, D.C. 1965
BU
L SI
AL NE
SS
SM
ADMINISTRATION
1953

EUGENE P. FOLEY, Administrator
OFFICE OF MANAGEMENT DEVELOPMENT
PUBLICATIONS DIVISION
For sale by the Superintendent of Documents, U.S. Government Printing Office

Washington, D.C. 20402 - Price 95 cents
Foreword
"Life can only be understood backwards, but it must be lived for-

wards." This remark was made by a Danish thinker more than a hun-
dred years ago, but it could just as well have been made yesterday by an
American small businessman. The probiem it states is exactly the one
he faces in managing the finances of his enterprise . Because of this
predicament, one of the most important requirements for good financial
management is the ability to analyze the past in such a way as to throw
light on the future. Only then can decisions be based on informed
judgment rather than on mere guesswork or intuition.
Financial management is just one of many aspects of business manage-
ment, but it is one that reaches into every other activity of the business.
It analyzes and correlates the financial aspects of all the individual
activities from the standpoint of their effect on the profitability of the
business as a whole.
Such a broad subject cannot be covered in a small booklet, but A
Handbook of Small Business Finance provides a starting point for the
small businessman who wants to improve his financial-management
skills. It points out the major areas of financial management and de-
scribes a few of the many techniques that can help the small businessman
to understand the results of his past decisions and apply this understand-
ing in making decisions for the future.
All these techniques are important, but the small businessman who
has not been using them may prefer not to take them all on at once.
In that case, he can start with the ones that seem to him to promise the
greatest usefulness . As he develops skill in using and interpreting these,
his interest in the others will grow, and his use of them will increase
with his interest .
A Handbook of Small Business Finance has been the most popular
of the booklets in the Small Business Management series. It was origi-
nally written by Dr. Ralph B. Tower, who was then professor of eco-
nomics and finance at West Virginia University. Unfortunately, Dr.
Tower did not live to see the long-continued interest in his work. The
material has been rewritten for the seventh edition by Dr. Jack Zwick,
assistant professor of finance at Columbia University's Graduate School
of Finance. This edition was edited by Jean B. MacArthur of the
Publications Division, Office of Management Development, under the
administrative direction of Robert A. Litzberg, Chief of the division.
EUGENE P. FOLEY, Administrator

Small Business Administration
DECEMBER 1964
iii
Contents
1 What Is Financial Management ? 1

Sources and Uses of Funds, 1 ; Getting the Financial Re-
sources You Need, 2 ; Making a Profit--Your Basic Obliga-
tion, 3; Managing Assets, 3; The Tools of Financial
Management, 4.
2 Financial Statements 6
The Balance Sheet, 6; Some Examples, 11 ; The Profit-and-
Loss Statement-A Retailer or Wholesaler, 13; Profit- and-
Loss Statement of a Small Manufacturer, 16; Interpreting
the Profit-and -Loss Statement, 17 ; Use With Caution, 17.
3 Ratio Analysis of Financial Statements 18

Measures of Liquidity, 19; Measures of Profitability, 26;
Common-Size Financial Statements, 29; Using the Ratios, 30.
4 Break-Even Analysis 31
Three Types of Costs, 31 ; Break-Even Analysis, 31 ; Formula
for Finding the Break-Even Point, 32 ; Break-Even Charts, 33 .
5 Managing Your Investment in Assets 37

Investment in Fixed Assets, 37; Investment in Receivables,
40; Investment in Inventories, 41 .
6 Looking Ahead 43
The Cash Budget, 43 ; Projected Financial Statements , 45;

Looking Still Further Ahead, 52.
7 The Borrower and His Banker 53

Advantages of Borrowing, 53; How Do You Rate As a
Borrower? 54; Information, Please, 55; Choosing a Bank, 56;
A Two-Way Street, 56.
8 Short and Intermediate-Term Credit 59

Short-Term Loans, 59; Intermediate-Term Loans, 60 ; Some
Types of Short- and Intermediate-Term Credit, 60.
vi
9 Long-Term Financing .
64
New Equity Or a Long-Term Loan? 64; Sources ofLong-Term
Loans, 64; The Small Business Administration, 65; State
and Local Development Companies, 67; Small Business In-
vestment Companies, 70.
10 Equity Financing 71
External Sources of Equity Capital, 71 ; Small Business In-

vestment Companies, 71 ; Venture-Capital Companies, 74;
Going Public, 75.
11 Sources of Further Information 76

Sources of Industry Ratio Data, 76; Government Publica-
tions, 77; Books, 79.
CHAPTER 1
What Is Financial
Management?
"It takes money to make money." This maxiin is a simple way of

saying that a business must have financial resources if it is to operate at
a profit. If you are in retailing or wholesaling, you must keep a stock of
goods on hand to be sold . You need to extend credit to customers. A
bank balance must be maintained for expenses such as paying suppliers
and meeting payrolls. Unless you rent your place of business, funds
are necessary for investments in land and buildings . If you are a manu-
facturer, funds are also required for equipment and machinery, for raw
materials and supplies, for stocks of goods in the process of manufacture,
for finished goods ready for sale.
But having money does not guarantee making money— that is, making
a profit. You not only have to have money ; you have to use it well .
That is why financial management is important.
Financial management includes the following functions :
Seeing that the assets of the business are used in such a way as
to bring the highest possible return on the money invested .
Evaluating the need for new assets.
• Obtaining funds to finance asset additions.
Managing both old and new assets so that each contributes its
full share toward the profitable operation of the business.
• Repaying borrowed funds from profits those funds have

generated .
Sources and Uses of Funds
As financial manager, you will find it helpful to think of assets as "uses”

or commitments of funds to your business for the purpose of making
money. For example, if you decide to take on an additional line of mer-
1
2
chandise or to expand your plant, the decision will result in more funds
being tied up in the business. Such increases in assets represent uses of
funds.
If, on the other hand, cash ( that is, bank balances ) or stocks of mer-
chandise are reduced , funds are released for other uses. A decision to
reduce assets-whether the assets are cash, accounts receivable, inventory,
or fixed investments in plant and equipment-frees funds. Hence,
reductions in assets are sources of funds.
Other sources offunds may be found in increases in debts, or liabilities.
Your business may "borrow" funds in the form of trade credit, bank
loans, and so on. Still another source is your investment, along with
profits left to accumulate in the business-together, these make up your
equity.
Increases in liabilities and equity are sources of funds because they
provide the business with additional resources ( assets ) . For example,
when your business increases its liabilities by obtaining a bank loan , it
increases its cash account ( or its privilege of withdrawing its deposits in
the form of cash ) at the same time. Or, an occasion might arise when
you would want a bank loan in order to reduce other company indebt-
edness-for instance, to pay taxes . In this case, the creation of a liability
in the form of a bank loan is a source of funds which, in turn, are used
to reduce another liability. Reduction of a liability ( in the example,
paying taxes ) is a use of funds, since funds are absorbed.
The following chart summarizes the sources and uses of funds :
/INCREASES in /INCREASES in assets

Sources liabilities Uses
DECREASES in assets DECREASES in liabilities
Getting the Financial Resources You Need
Your most important task as financial manager is to find sources of

funds to offset the company's uses of funds. When a need for funds
arises, you can accomplish this goal of balancing sources against uses
in one oftwo ways .
You can increase liabilities and/or equity to match the in-

creases in assets.
Or you can reduce the investment in some existing asset so

as to hold down the total investment in assets.
Let's assume, for example, that your business, in order to keep or

expand its sales volume, needs to extend more credit to customers for
longer periods of time. In other words, the investment in receivables
3
(an asset) must be increased . You may or may not be able to increase
your liabilities. That will depend, perhaps, on whether you can con-
vince your banker that the move is a wise one and that the company's
financial position is strong enough to warrant a loan. And you may or
may not be able to get more equity capital to finance the receivables
increase. You might decide, therefore or be forced-to squeeze down
other assets, such as bank balances or inventories, to provide the needed
funds. Your job as financial manager is to decide which of these
sources can and—even more important in many instances—which one
should be tapped for the financial resources you need.
Making a Profit- Your Basic Obligation
A primary reason for owning and operating your own business is to

make the highest possible profit for yourself. You also have responsi-
bilities to employees, to customers, to members of the community whose
lives your company influences-and these responsibilities are important.
But it is you who have taken the risk of contributing capital. Your basic
goal is to take care of this capital and use it as profitably as possible.
It is important, therefore, for you to have at your command a useful
measure of business performance that emphasizes financial returns.
There are several methods of measuring profitability, but one in par-
ticular—“ return on investment” —is especially useful. Chapter 3 ex-
plains how to use this and other profitability measures.
Managing Assets
One of your most important duties as financial manager is to keep

the assets of the business working hard and productively. It is easy for
a small business to slip into the practice of having larger inventories, bank
balances, and other investments than are really needed . " Bigger" is
often equated with "better." The sales manager wants larger inven-
tories, more lines of finished stocks, more liberal credit terms. These
added investments will improve his sales efforts . The production man-
ager wants newer and faster machines and tools, larger stocks of raw
materials and supplies. These investments enable him to cut his costs
and meet delivery dates. The financial manager wants larger cash bal-
ances to make his job easier. Office management needs new equipment .
Often it seems that the opportunities to spend money are unlimited !
The aim of asset management is to make certain that new or increased
assets pay their way. The added profits these new assets bring in should
total more than the cost of the resources involved . The return-on-in-
vestment measure mentioned above can be used to show the expected
effect on profits of an investment you may be thinking about making.
4
Thus, it is a useful tool in judging and comparing various investment

opportunities.
Often, unfortunately, opportunities that promise satisfactory returns
on investment must be put aside because of lack of capital. This is es-
pecially true in small businesses, where financing new investments can
be a real problem. When such a problem arises, good asset manage-
ment may come to the rescue in two ways. First, it may improve a small
company's chances of getting a loan by emphasizing to the lender the
financial competence and alertness of the would-be borrower. Second,
additional cash can sometimes be raised by reducing unnecessary in-
vestments in existing assets. That is, it may be possible to provide funds
for one area of the business by avoiding or reducing their use in other
areas.
The Tools of Financial Management
If your financial management is to be more than guesswork, you must

have tools to work with. At the least, you need accurate, well-organized
accounting records, regular financial reports, and some techniques for
analyzing the reports . These tools will not give you readymade answers
to your financial problems, but they will help in shaping up sound de-
cisions based on facts and tested principles of business management.
Accounting records. Good accounting records are the foundation

on which sound financial management is based. The reports with which
a financial manager works can be no more accurate nor complete than
the records they summarize.
Accounting records may be simple or complex , depending on the size
and nature of the business, but they should be well organized and con-
sistent. The small business that does not have such an accounting sys-
tem would be wise to have a public accountant set one up and explain
its use to the person who will be responsible for maintaining it. Both
time and money will be saved in the long run.
Financial reports. There are a number of financial reports that can

be helpful in financial management. The principal ones are the profit-
and-loss statement and the balance sheet. These two financial state-
ments are important to you for several reasons.
First, they are the basis for financial analysis ; and as such, they are
used by bankers and investors in making loan and investment decisions.
If you want to enlist the support of these members of the business com-
munity, you should be able to provide the statements and to explain
or defend items that appear in them.
Second, State and Federal laws pertaining to taxation and financing
require reports that can be prepared only from financial statements.
5
Third, you should be able to read and interpret these statements as

part of your management program . Only through careful financial
analysis can you find and strengthen the weak spots in your financial
policies and plan sound and vigorous programs for the future.
Chapter 2 explains the balance sheet and the profit- and -loss statement
in more detail .
Techniques for analyzing financial statements. Various percent-

ages and other measures of comparison have been found useful in in-
terpreting financial statements and highlighting relations between their
items. These comparative measures help to answer questions such as
these :
Could the company pay its bills if business conditions tightened up
temporarily? Is the money I have invested in the business bringing me
as much profit as it could? If not, where are the problem areas? What
percent profit could I promise an investor if he put some money into
the business? Are my inventories working hard enough? Does the
record show that the business is strong enough and stable enough to
qualify for a long-term loan? Such questions are of interest, not just to
the businessman himself, but to his banker, his creditors, possible inves-
tors, and others.
Some of the most useful of the techniques for analyzing financial state-
ments are explained and illustrated in chapter 3 .
CHAPTER 2
Financial Statements
The two most important financial statements are the balance sheet and
the profit-and -loss statement. The difference between the two is some-
times explained by comparing the balance sheet to a "still picture" and
the profit-and -loss statement to a "moving picture." The balance sheet
presents a financial picture of the business-its assets, liabilities, and
ownership on a given date. It is usually prepared as of the close of
the last day of a month and answers the question, "How did we stand
financially at that time?" The profit-and-loss statement ( also called
the income statement ) measures costs and expenses against sales reve-
nues over a definite period of time, such as a month or a year, to show
the net profit or loss of the business for the entire period. Notice that
the balance sheets shown in this chapter ( exhibits 1 , 2 , and 3 ) are dated
simply "December 31 , 19—, ” but the profit-and -loss statements ( ex-
hibits 4 , 5 , and 7 ) are dated "For the Year Ended December 31 , 19— .”
The Balance Sheet
The balance sheet has two main sections. The first section (the left
side if the two sections are shown side by side ) shows the assets . The
second ( or right- hand ) section shows the liabilities ( or debts ) and the
owner's equity, which together represent the claims against the assets.
The total assets always equal the combined total of the liabilities and the
owner's equity ( or capital ) —that is why this financial statement is called
a balance sheet.
Assets. Anything the business owns that has money value is an asset.
The assets of a small business commonly include cash, notes receivable,
accounts receivable, inventories, land, buildings, machinery, equipment ,
and other investments. They are usually classified as current assets , fixed
assets, or other assets .
6
7
Exhibit 1
1
The MONAR Company
Balance Sheet
December 31 , 19
Assets
Current assets :
Cash... $20,000
Accounts receivable. 40,000
Inventories …………………….. 45,000
Total current assets .. $105,000
Fixed assets :
Machinery and equipment . $20,000
Buildings. 28,000
Land.. 12,000
Total fixed assets... 60,000
Total assets.. $165,000
Liabilities and Equity
Current liabilities :
Accounts payable.. $20,000
Notes payable .. 30,000
Accrued liabilities . 6,000
Reserve for taxes... 4,000
Total current liabilities ... $60,000
Equity :
Capital stock .. $50,000
Surplus...... 55,000
Total equity. 105,000
Total liabilities and equity. $165,000
1 Not a real company.

8
Exhibit 2
The MONAR Company ¹
Balance Sheet
December 31 , 19—
Assets
Current assets :
Cash......... $20,000
Accounts receivable. $40,000
Less allowance
for doubtful accounts ...... 3,000 37,000
Inventories ........ $45,000
Less allowance
for inventory loss ... 5,000 40,000
Total current assets .... $97,000
Fixed assets :
Machinery.... $20,000
Less allowance
for depreciation .. 4,000 $ 16,000
Buildings ...-. $28,000
Less allowance
for depreciation .. 6,000 22,000
Land.. 12,000
Total fixed assets .. 50,000
Total assets ... $147,000

Accounts payable .. $20,000
Notes payable .. 30,000
Accrued liabilities . 6,000
Allowance for taxes. 4,000
Total current liabilities .. $60,000
Equity :
Capital stock.. $50,000
Surplus... 37.000
Total equity .. 87,000
Total liabilities and equity .... $147,000

Current assets are cash and assets that are expected to be converted
into cash during the normal operating cycle of the business ( generally,
within a year) . They include notes receivable, accounts receivable, mar-
ketable securities, and inventories, as well as cash. However, if inven-
tories are not to be used up ( that is, converted into accounts receivable
or cash ) within a year, they should be recorded as fixed assets. The same
is true of notes receivable and accounts receivable that are not expected
to be converted into cash within a year—they should be treated as fixed
assets.
The balance sheet of a small manufacturer typically shows three types
of inventories. The materials and supplies inventory consists of mate-
rials to be used in production , together with supplies used in connection
with the processing. Work in process, as the name implies, consists of
goods in the process of manufacture but not yet completed . Finished
goods are merchandise completed and ready for sale. Finished goods ( or
merchandise ) and supplies are usually the only inventory items shown
on the balance sheet by small retailers and wholesalers.
• Fixed assets are those acquired for long-term use in the business.
They include land , buildings, plant, machinery, equipment, furniture,
fixtures, and so on. These assets are typically not for resale, and they
are recorded on the balance sheet at their cost to the business , less
depreciation.
A fixed asset is treated as a long-term cost, with the cost allocated as
depreciation over the working life of the asset. Thus, the value of
a fixed asset shown on the balance sheet is not necessarily the same
as the resale value of the asset.
• "Other" assets include patents, trade investments , goodwill, and

so on. (Goodwill is recorded on the balance sheet only to the extent
that it has actually been purchased . )
Assets are also sometimes classified as tangible or intangible. Liter-
ally, tangible means "able to be physically touched ." Current and
fixed assets are normally tangible ; "other" assets, typically intangible.
Liabilities .Liabilities are the claims of creditors against the assets

of the business-in other words, debts owed by the business. They do
not include owners' claims. Among the more common liabilities are
notes payable, accounts payable, accrued liabilities, and allowance for
taxes.
Current liabilities are those due for payment within a year. Long-
term ( or fixed ) liabilities are debts, or parts of debts, that are not due
for payment within a year. The allowance for future income taxes
represents the taxes that will have to be paid on the profits of the
current year, but that are not due for payment until later. Accrued
liabilities are similar to the allowance for future income taxes in that the
expenses are charged against profits of the current year, although pay-
10
Exhibit 3
Monroe Manufacturing Company¹
Balance Sheet
December 31 , 19
Assets
Current assets :
Cash.. $40,000
Accounts receivable . $90,000
Less allowance for doubt-
ful accounts.. 10,000 80,000
Inventories :
Finished product . 75,000
Work in process. 75,000
Raw materials.. 20,000
Supplies...... 10,000 180,000
Prepaid expenses . 10,000
Total current assets .. $310,000
Fixed assets :
Furniture and fixtures .. $10,000
Less allowance for depre-
ciation.... 5,000 $5,000
Machinery and equipment .. $30,000
ciation.. 16,000 14,000
Buildings .. $45,000
ciation .. 9,000 36,000
Land..... 15,000
Total fixed assets .. 70,000
Investments .... 20,000
Total assets .. $400,000

Accounts payable. $40,000
Notes payable. 80,000
Accrued liabilities :
Wages and salaries pay-
able .. $4,000
Interest payable. 1,000 5,000
Allowance for taxes
Income tax.. $16,000
State taxes.. 4,000 20,000
Total current liabili-
ties ....... $145,000
Equity :
Capital stock. $200,000
Surplus ....... 55,000
Total equity.. 255,000
Total liabilities and equity.. $400,000
1 Not a real company .

11
ment will not be made until later. The most common example is
accrued wages, which must be accounted for whenever the last day of
the accounting period does not coincide with the last day of a pay period .
Equity. The assets of a business minus its liabilities equal the equity.
This equity is the investment of the owner or owners plus any profits
that have been left to accumulate in the business ( or minus any losses ) .
If the business is incorporated , its books will show a capital stock
account. This account represents the paid-in value of the shares
issued to the owners of the business. Undistributed profits are recorded
in an earned-surplus account. If the business is a proprietorship or a
partnership, the capital accounts appear under the name or names of
the owners . Increases in equity as a result of undistributed earnings
are also recorded there, as are decreases in equity if the business shows
a loss instead of a profit.
Valuation accounts. Depreciation and other factors reduce the

value of some assets . Because it is important to state balance-sheet
values correctly, the balance sheet is usually set up in such a way as to
show that provision has been made for such reductions in value. This
is done by using depreciation, or valuation, accounts. Some of the more
common of these accounts are the following :
Accounts receivable are analyzed according to the length of time

the money has been owed. An estimate is then made of what proportion
ofthem will turn out to be uncollectible . This "allowance for bad debts"
is usually computed for a given accounting period either as a percentage
of the average balance of receivables or as a percentage of the net credit
sales for the period. The balance sheet shows it as a deduction from the
asset "accounts receivable."
• Losses in the value of inventories may occur as a result of price

changes, style changes, physical deterioration, pilferage, and so on. If
such losses are likely to occur, an estimate of possible shrinkage should be
made. This estimate apears on the balance sheet as a deduction from
the value of the inventory.
Fixed assets, other than land, decline in value. This decline in

value may be due to wear and tear, technical obsolescence, and other
causes. A periodic charge for depreciation should be made and shown
on the balance sheet as a deduction from the value of the asset.
Some Examples
Exhibit 1 shows a simple balance sheet. It represents the financial po-

sition of the Monar Company,' a retail enterprise, on December 31 ,
¹ Not a real company.
12
19. Total assets of $ 165,000 are offset by liabilities and equity total-
ing $165,000. The balance sheet balances. The assets are grouped as
current assets and fixed assets ( Monar has no "other assets" ) . Current
liabilities are identified as such, although there are no long-term liabili-
ties.
When the valuation accounts are included in the balance sheet, the
statement becomes more accurate and therefore more useful. Exhibit
2 shows how they affect the asset figures that appeared in exhibit 1 .
Note the following changes :
1. Accounts receivable have been reduced by $3,000 to an esti-

mated $37,000, all collectible.
2. Inventory values have been reduced by $ 5,000 to $40,000 .
3. Total current assets, therefore, show a reduction of $ 8,000 from
$105,000 to $97,000 .
4. Machinery is now valued at $ 16,000 , or $4,000 less than the
original $20,000.
5. The value of the buildings has been reduced by $6,000 to
$22,000.
6. Total fixed assets have thus declined by $ 10,000 .
7. Total assets have declined by $ 18,000 .
8. Surplus is now $37,000 and total equity $87,000 , each one $ 18 ,-
000 less than in exhibit 1 .
9. Total liabilities and equity now balance total assets at $ 147,000 .
The balance sheet shown in exhibit 3 has been expanded still further
to make it even more useful. This is the relatively detailed statement of
a typical small manufacturer.
Exhibit 4
The MONAR Company ¹

Profit-and-Loss Statement
For the Year Ended December 31 , 19—
Sales $120,000
Cost of goods sold .. 70.000
Gross margin .. $50,000
Selling expenses :
Salaries.. $15,000
Commission... 5,000
Advertising .. 5,000
Total selling expenses . 25,000
Selling margin ……………... $25,000
Administrative expenses . 10,000
Net profit ... $ 15,000

13
The Profit-and-Loss Statement-A Retailer or Wholesaler
A profit-and-loss statement of the Monar Company, whose balance

sheet appears in exhibits 1 and 2 , is shown in simplified form as exhibit
4. A brief explanation of the items is given here :
Sales. The item "sales" includes all sales of merchandise or services.
The sales figure shown in exhibit 4 represents net sales. It is computed
by subtracting sales discounts and sales returns and allowances from
gross sales. (Please turn to page 16)
Exhibit 5
1
Wald Wholesale Company
Profit-and-Loss Statement
For the Year Ended December 31 , 19___
-
Net sales........ $666,720
Cost of goods sold :
Beginning inventory , Janu-
ary 1 , 19 $184,350
Merchandise purchases .. $454,920
Freight and drayage .. 30.210 485,130
Cost of goods available
for sale ....... $669,480
Less ending inventory ,
December 31 , 19. 193,710
Cost of goods sold. 475,770
Gross margin …………….. $190,950
Selling , administrative , and
general expenses :
Salaries and wages... $88,170
Rent . 24,390
Light , heat , and power.. 8,840
Other expenses ... 21,300
State and local taxes and
licenses .. 5,130
Depreciation and amortiza-
tion on leasehold im-
provements ....………….. 4,140
Repairs ...... 2.110
Total selling , adminis-
trative , and general
expenses...-. 154,080
Profit from operations .. $36,870
Other income.. $7,550
Other expense..... 1.740 5,810
Net profit before taxes .. $42,680
Provision for income tax.. 15,120
Net profit after income tax.. $27,560

Exhibit
6
14
Hayes
Manufactu
Company
1 ring
Statement
Cost
Goods
of
Manufacture d
For
the
Year
Ended
31
1
,December
9—
Work
p -n
rocess
inventory
1,J
.1 i9anuary 18,800
$
materials
:Raw
Inventory
J
1 anuary
.1, 9 1
$54,300
Purchases
.. 263,520
Freight
..
In 9,400
Cost
materials
available
for
use
.of 4
$ 27,220
inventory
D31
.1 ecember
,Less
9 163,120
materials
of
.Cost
used 2
$ 64,100
Direct
labor
. 150,650
Manufacturi
overhead
: ng
Indirect
labor
.. 23,750
$
Factory
l ight
,heat
a nd
.power 89,500
Factory
supplies
used
.. 22,100
Insurance
and
..taxes 8,100
Depreciatio
plant
of
and
.equipment n 35.300
Total
manufacturi
overhead
.. ng 178.750
Total
manufacturi
costs
. ng 593,500
Total
work
process
in
during
..period 6
$12,300
Less
work
i pn
- rocess
inventory
D 31
,1 ecember
9 42.600
Cost
of
manufacture
.goods d $
569.700
compa ot ny
ra1N. eal
7
Exhibit
Manufacturing
Hayes
Company
1
L
Statement
aoss
Profit
- nd
For
Ended
Year
the
,19—
31
December
....
sales
Net 669,100
$
goods
of
:Cost
sold
Finished
goods
inventory
J9
,1
.1 anuary 69,200
$
manufactured
goods
of
e 6 xhibit
).(Cost 569,700
goods
of
cost
Total
sale
for
available
. 638,900
$
finished
Less
inventory
goods
D
,1
31 ec.
9 66,400
goods
of
..Cost
sold 572,500
Gross
margin
.. 96,600
$
Selling
and
administrat
:expenses ive
Sellin
expens
: g
es
salaries
Sales
commissions
.and 26,700
$
Advert
expens
. ising
e 12,900
Miscel
sellin laneous
g
.expense 2,100
Total
sellin
expens
. g
es 41,700
$
Admini
expens
: strative
es
Salaries
. $ 7,400
2
Miscellaneo
administrat
.expense us
ive 4,800
Total
admini
expens
. strative
es _32,200
Total
selling
administrat
expenses
..and ive 73,900
operating
profit
.Net 22,700
$
Other
revenu
. e 15,300
.
taxes
before
profit
Net 38,000
$
Estimated
income
tax
.. 12.640
after
profit
Net
.
tax
income 2
$ 5.360
15
ot
Ncompany
r1a. eal
16
Cost of goods sold . The "cost of goods sold" is the total price paid
for the products sold during the accounting period, plus in-transporta-
tion costs. Most small retail and wholesale businesses compute cost of
goods sold by adding the value of the goods purchased during the ac-
counting period to the beginning inventory, and then subtracting the
value of the inventory on hand at the end of the accounting period.
Selling expenses. These are expenses incurred directly or indirectly

in making sales. They include salaries of the sales force , commissions ,
advertising expense , out-freight if goods are sold f.o.b. destination , and
so on. Shares of rent, heat, light, power, supplies , and other expenses
that contribute to the company's sales activities may also be charged to
selling expense . In small businesses , however , such mixed expenses are
usually charged to general expenses.
General and administrative expenses. General salaries and wages,

supplies, and other operating costs necessary to the overall administration
of the business are in this group of expenses.
Nonoperating income. Some small businesses receive additional

income from interest, dividends, miscellaneous sales, rents, royalties,
gains on sale of capital assets, and so on. In such cases, the "net profit"
shown in exhibit 4 is really a net operating profit. The nonoperating
income would be added to it and any interest paid subtracted . The
result would then be the net profit before State and Federal income taxes.
Exhibit 5 shows, in more detail than is given in exhibit 4 , a profit-and-
loss statement for a small wholesale business. The retailer's statement
of exhibit 4 would appear much the same if shown in similar detail.
Profit-and-Loss Statement of a Small Manufacturer
Because the small manufacturer converts raw materials into finished

goods, his method of accounting for cost of goods sold differs from the
method for wholesalers and retailers. As in retailing and wholesaling,
computing the cost of goods sold during the accounting period involves
beginning and ending inventories, and purchases made during the
accounting period. But in manufacturing it involves, not only finished-
goods inventories, but also raw-materials inventories, goods-in-process
inventories, direct labor, and factory-overhead costs.
To avoid a long and complicated profit-and -loss statement, the cost of
goods manufactured is usually reported separately. Exhibits 6 and 7
show a statement of cost of goods manufactured and a profit-and-loss
statement for a typical small manufacturing company. A few of the
terms used are explained below.
17
Raw materials are the materials that become a part of the finished
product.
Direct labor is labor applied directly to the actual process of convert-
ing raw materials into finished products.
Manufacturing overhead includes depreciation , light, insurance, real
estate taxes, the wages of foremen and others who do not work directly
on the product, and so on- in other words , all manufacturing costs
except raw materials and direct labor.
Interpreting the Profit-and-Loss Statement
Notice, in the profit-and-loss statements shown in exhibits 4 , 5 , and 7,

that the gross margin ( sometimes called gross profit ) is computed first,
and then the net profit. The gross margin equals sales less cost of sales.
It does not take into account the overhead expenses ( other than factory
overhead ) of being in business , the selling expenses, office expenses, and
so on. The Hayes Manufacturing Company ( exhibit 7 ) reports a
gross margin of $96,600 on net sales of $669,100 . The gross- margin
percentage, then, is about 14 percent. This indicates that the goods
sold cost the company about $86 per $ 100 of sales.
The net profit of the business is the final profit after all costs and ex-
penses for the accounting period have been deducted . The Hayes Man-
ufacturing Company made a net profit of $ 25,360, or about 4 percent
on net sales.
Use With Caution !
The balance sheet tries to present a "true and fair picture" of the
financial position of a business at the close of the accounting period . The
profit-and-loss statement tries to present a "true and fair picture" of the
results of operations during the accounting period . These reports, con-
structed according to accepted principles of accounting, are one of the
small businessman's most important tools.
But they are drawn up under conditions of uncertainty, and many of
the transactions involved are necessarily incomplete at the end of the
accounting period also, the balance sheets do not reflect resale or liquidat-
ing values ; they reflect the cost, or cost less depreciation , of the assets held
by the business as a going concern. The figures depend to some extent
on the judgment of your accountant, who has decided which accounting
techniques are best suited to your business. These facts should be kept in
mind in considering the techniques for analyzing financial statements dis-
cussed in the next chapter.
¹1 Not a real company.

CHAPTER 3
Ratio Analysis of
Financial Statements
The two types of financial statement, the balance sheet and the profit-
and-loss statement, are necessary-and useful . But they are only a
start toward understanding where you stand, where you're going, and
how you're going to get there. If you are to get your money's worth out
of them ( they do take time to prepare ) , you should study various rela-
tions between some of the figures they present.
A number of indicators have been worked out for this purpose. In
many ways, these indicators or comparative measures ( usually ex-
pressed as ratios ) are more useful for analyzing your business operations
than the dollar amounts. They provide clues for spotting trends in the
direction of better or poorer performance . They also make it possible
for you to compare your company's performance with the average per-
formance of similar businesses . Some important points must be kept
in mind, however.
• Businesses are not exactly comparable . There are different ways of
computing and recording some of the items on financial statements. As
a result, the figures for your business may not correspond exactly to those
for the businesses with which you want to compare it.
Ratios are computed for specific dates. Unless the financial state-
ments on which they are based are prepared often, seasonal charac-
teristics ofyour business may be obscured .
• Financial statements show what has happened in the past. An im-

portant purpose in using ratios is to obtain clues to the future so that you
can prepare for the problems and opportunities that lie ahead. Since the
ratios are based on past performance, you must use them in the light
of your best knowledge and judgment about the future.
The ratios are not ends in themselves, but tools that can help answer
some of your financial questions. They can do this only if you interpret
them with care .
18
19
Measures of Liquidity
Liquidity may be thought of simply as ability to pay your bills. It

is the first objective of financial management. Measures of liquidity
are intended to help you answer questions such as these :
"Do we have enough cash, plus assets that can be readily turned into
cash, so that we are sure of being able to pay the debts that will fall due
during this accounting period?"
"How 'liquid' are our current assets other than cash— that is, how
quickly will they probably be turned into cash?"
The current ratio. The current ratio is one of the best known
measures of financial strength . The main question it answers is this :

"Does your business have enough current assets to meet its current
debts with a margin of safety for possible losses such as inventory
shrinkage or uncollectible accounts?"
The current ratio is computed from the balance sheet by dividing
current assets by current liabilities . For the Ajax Manufacturing Com-
pany ¹ ( exhibit 8 ) , it is computed as follows :
Current assets $ 140,000

== 2.3 ( or 2.3 to 1 ) .
current liabilities $60,000
Is this a good current ratio? Should the owner of the Ajax Company
be reasonably well satisfied with his firm's performance on this point?
These questions can't be answered with an unqualified yes or no. A
generally popular rule of thumb for the current ratio is 2 to 1 , but whether
a specific ratio is satisfactory depends on the nature of the business and
the characteristics of its current assets and liabilities.
If you decide that your current ratio is too low, you may be able to
raise it by:
Paying some debts.
Increasing your current assets from loans or other borrowing
with a maturity of more than a year.
Converting noncurrent assets into current assets .
Increasing your current assets from new equity contributions.
Plowing back profits.
Let's take some examples. Assume that a small business has the cur-
rent assets and current liabilities shown in column 1 of exhibit 9. If
this firm buys $ 15,000 worth of merchandise on account ( column 2 )
inventory will be increased to $35,000 and total current assets to
$65,000. At the same time, accounts payable will be increased to
$35,000 and total current liabilities to $40,000 . The current ratio will
drop from the present 2.0 to 1.6. (Please turn to page 23. )
¹ Not a real company.
Exhibit
8
20
Ajax
Manufactu
Company
1 ring
Combined
Balance
Sheets
December
and
January
,19
31
December
,1
319— 1,19—
January
Assets
Current
assets
:
.
Cash 30,000
$ 3
$ 0,000
Accounts
receivable
. $ 2,000
4 3
$2,000
allowance
Less
debts
bad
for
.. 2,000 40,000 2,000 30,000
Mercha
invent
.. ndise
ory 60,000 50,000
Prepai
expens
.... d
es 10.000 10.000
Total
current
assets
. 140,000
$ 1
$20,000
Fixed
asset
: s
Buildings
equipment
.and 120,000
$ 1
$ 20,000
Less
accumulated
deprecia-
.
tion 5
$ 0,000
70,000 6
$0,000
60,000
..
Land 30,000 _30,000
Total
fixed
assets
. 80,000 90,000
Other
assets
:
Goodwi
and
patent
. ll
s 10.000
Total
.assets 230,000
$ 210,000
$
Liabilities
Current
liabilities
:
Accounts
payable
.. 30,000
$ 25,000
$
Accrued
wages
and
..
taxes 10,000 10,000
Estimated
income
taxes
payable
.. 20,000 15.000
liabilities
current
.Total 60,000
$ 5
$ 0,000
Fixed
liabilities
:
Mortgage
bonds
p
.,4ercent _40,000 40,000
Total
liabilities
. 1
$00,000 90,000
$
Equity
(5,000
stock
Common
out-
shares
)standing 60,000
$ 6
$ 0,000
Retained
earnings
. 70,000 60,000
Total
owner`
.equity 130,000 120,000
Total
liabilities
equity
.and 2
$30,000 2
$10,000
eal
ot ny
ra1N.compa
21
222
9
Exhibit
Ratio
Current
on
Transactio
Various
of
Effect ns
)1
( )2
( )3
( )4
(
cur-
Original paid
MerchandiseCash New
assets
rent bought
on accoun
on ts capital
and
current account payable invested
( 5,000
liabilities )$1 7
)$
( ,000 )$
1( 0,000
:
assets
Current
1
$0,000 1
$0,000 3
$ ,000 2
$ 0,000
Cash
. 20,000 20,000 20,000 20,000
receivable
Accounts
20,000 35,000 20,000 20,000
Inventory
assets
.current 5
$0,000 65,000
$ 4
$3,000 6
$ 0,000
Total
:
liabilities
Current
2
$0,000 3
$5,000 1
$3,000 2
$ 0,000
Accounts
payable
.
5,000 5,000 5,000 5,000
Other
.
liabilities 2
$ 5,000 4
$0,000 1
$8,000 2
$ 5,000
current
Total
2
$ 5,000 2
$ 5,000 2
$ 5,000 3
$5,000
.
capital
working
Net
2.0 1.6 2.4 2.4
..
ratio
Current
23
Now, going back to the original figures, suppose that the company,
instead of buying more merchandise on account, pays bills amounting to
$7,000 with cash ( column 3 ) . Current assets will then be reduced to
$43,000 and current liabilities to $ 18,000 . The current ratio will be
increased to 2.4.
Working capital. In neither of the above two instances will there

be any change in net working capital ( the difference between current
assets and current liabilities ) . But suppose the businessman of exhibit
9, instead of taking either of these steps, invests an additional $ 10,000
in his business ( column 4 ) . This time, current liabilities will not be
affected ; but current assets will be increased to $60,000, the current
ratio will rise to 2.4 , and net working capital will be increased from
$25,000 to $35,000 .
Bankers look at net working capital over periods of time to determine
a company's ability to weather financial crises. Loans are often tied to
minimum working-capital requirements.
The acid-test ratio. This ratio, sometimes called the "quick ratio ,"
is one of the best measures of liquidity. It is computed as follows :
cash +Government securities + receivables

current liabilities
For the Ajax Manufacturing Company, which has no Government

securities, this becomes $ 70,000 divided by $ 60,000 ( see exhibit 8 ) ,
giving Ajax an acid-test ratio of 1.2 ( or 1.2 to 1 ) .
The acid-test ratio is a much more exacting measure than the current
ratio. By not including inventories, it concentrates on the really liquid
assets, whose values are fairly certain. It helps to answer this question :
"If all sales revenues should disappear, could my business meet its cur-
rent obligations with the readily convertible, ' quick' funds on hand?"
An acid-test ratio of about 1 to 1 is considered satisfactory, subject to
the following conditions :
The pattern of accounts receivable collections should not lag

much behind the schedule for paying current liabilities. In making
this comparison , you should think in terms of paying creditors early
enough to take advantage of discounts.
There should not be much danger of anything happening to

slow up the collection of accounts receivable.
Unless you feel comfortable about these two qualifications, you should
keep your acid-test ratio somewhat higher than 1 to 1 .
A general impression about the current and acid-test ratios is that the
higher the ratios the better. This may be true from your creditors' point
24
of view, because they stress prudence and safety. But it is in your interest
as owner of the business to be strong and trim, rather than fat. Idle cash
balances, and receivables and inventories out of proportion to your selling
needs should be reduced . The key to successful financial management
is to conserve the resources of your business and to make these resources
work hard for you. Two measures that are helpful in this connection
are average collection period and inventory turnover.
Average collection period . The average collection period , or num-

ber of days' sales tied up in accounts receivable, can be computed from
the balance sheet and the profit-and-loss statement as follows ( the figures
used are from exhibits 8 and 10 ) :
Step 1:
Net sales $300,000
$822, the average sales per
days in the accounting period 365
day.
Step 2:
Receivables $40,000
=
49, the number of days' sales tied up
average sales per day $822
in receivables, or average collection
period.
Knowing the average collection period helps you answer this question :
"How promptly are our accounts being collected , considering the credit
terms we extend?" It both suggests the quality of your accounts and
notes receivable and tells you how well your credit department is han-
dling the job of collecting these accounts.
Exhibit 10
Ajax Manufacturing Company¹

Condensed Profit-and-Loss Statement
For the Year Ended December 31 , 19—
Gross sales ... $303,000

Less returns and allowances. 3,000
Net sales ....... $300,000
Cost of goods sold. 180,000
Gross margin .. $120,000
Operating expenses .. 78,000
Operating profit . $42,000
Interest expense. 2,000
Income before taxes. $40,000
Estimated income tax.. 20,000
Net profit.. $20,000

25
The Ajax Manufacturing Company's ratio shows 49 days of sales on

the books. To put it another way, accounts are being collected , on the
average, in 49 days. A rule of thumb is that the average collection
period should not exceed 13 times the credit terms. If Ajax offers 30
days to pay, therefore, its average collection period should be no more
than 40 days. The management should look into the reasons for the
slower 49-day period .
The following variations in computing the average collection period
are sometimes used for greater accuracy :
• Substitute the total credit sales figure for the total sales figure.
• Use an average receivables figure . ( Add receivables figures

for the beginning and the end of the accounting period and divide
the result by 2. )
Compute the average collection period on a monthly basis .

Trends toward slower collections and serious deviations from your
normal collection pattern can then be spotted quickly and remedied .
Also, the monthly computation keeps seasonal variations in sales
and receivables from distorting the picture. For example, the aver-
age collection period of a typical retailer would be overstated if
computed on the basis of his annual end-of-the-year balance sheet.
At that time of year, his receivables balance is abnormally high be-
cause of sales around Christmas.
In figuring the average sales per day, use the number of busi-
ness days during the accounting period- say, 250 days for the year
instead of 365.
Inventory turnover. Inventory turnover shows how fast your mer-

chandise is moving. It gives you an idea of how much capital was tied
up in inventory to support the company's operations at the level of the
period covered .
Inventory turnover is found by dividing cost of goods sold by average
inventory. The Ajax Company, with an inventory of $50,000 at the
beginning of the year and an ending inventory of $ 60,000 ( exhibit 8 ) ,
computes its inventory turnover for the year as follows :
cost of goods sold $180,000

Inventory turnover = = 3.3.
average inventory 2 ( 60,000 + 50,000 )
This means that Ajax "turned" its inventories 3.3 times during the
year—that is, it used up, through operations, merchandise totaling 3.3
times its average inventory investment.
Usually, the higher the turnover, the better. A high turnover means
that your company has been able to operate with a relatively small in-
vestment in inventory. It may also suggest that your inventories are
26
current and salable ; that, since they have not been on the shelves too
long, they probably contain few unusable items. But almost anything
can be overemphasized, and inventory turnover is no exception. Too
much attention to high turnover can lead to inventory shortages and cus-
tomer dissatisfaction.
What, then, should your inventory turnover be? The desirable rate
depends on your line of business, level of business activity, and method
of valuing inventories, as well as on various trends. Astudy ofthe turn-
over rates of businesses similar to yours will help you answer the ques-
tion. Past experience will also serve as a guide.
Inventory turnover is a much better guide than the absolute size of
the inventories. Size can be misleading. An increase in inventories, for
instance, may represent the addition of stocks to support growing sales.
But it also might mean that merchandise is accumulating because sales
have slowed down. In the first case, the inventory turnover remains the
same or even increases ; in the second case, it declines. Thus, if inven-
tories begin to grow proportionately faster than sales, a declining turn-
over rate will warn the alert small businessman that trouble is brewing.
If inventories are increasing for sound reasons, the turnover will remain
the same or improve.
Like the average collection period , inventory turnover should be com-
puted monthly in order to avoid distortions caused by seasonal fluctua-
tions. Records should be cumulative and may take the form shown in
exhibit 11.
Inventory turnover records for individual items, groups of products,

and product lines are also helpful, especially for retailers and whole-
salers. They show which items are selling well and which are slow mov-
ing. Such turnovers should be prepared monthly or, for products that
are perishable or become obsolete quickly, on a perpetual or daily basis.
This enables you to reorder fast-moving items in plenty of time and to
prepare to dispose of slow-moving items before their value depreciates
too far.
Measures of Profitability
Is your business earning as much profit as it should, considering the

amount of money invested in it? This is the second major objective
(after liquidity ) of financial management, and a number of ratios have
been devised to help you measure your company's success in achieving it.
A few ofthem are explained here .
Asset earning power. The ratio of operating profit ( earnings before

interest and taxes ) to total assets is the best guide for appraising the over-
all earning power of your company's assets . This ratio takes no account
ofwhat proportion of the assets represents creditors' equity and what pro-
27
portion your own equity, nor of varying tax rates. For the Ajax Manu-
facturing Company, it is computed as follows :
Operating profit =$42,000 =

.18, or 18 percent.
total assets $230,000
Return on the owner's equity. This measure shows the return you
received on your own investment in the business . In computing the ratio
the average equity is customarily used-the average of the 12 individual
months if it is available, or the average of the figures from the beginning
and ending balance sheets. For the Ajax Company, the beginning and
ending equity figures are $ 120,000 and $ 130,000, giving an average of
$125,000. The return on the equity is then:
Net profit__ $ 20,000

.16, or 16 percent.
equity $125,000
A similar ratio uses tangible net worth instead of equity. Tangible

net worth is the equity less any intangible assets such as patents and good-
will. If there are no intangible assets, there will be no difference be-
tween the two values.
Exhibit 11
Inventory Turnover by Months, 19-
Inventory Cost of Monthly Annual

on 1st of goods sold turnover¹ turnover '
month
(1 ) (2) (3 ) (4)
January
February
2 months ' average..
March
3 months ' aver
November
11 months' average ..
December
12 months ' average...-
1 Column 2 divided by column 1.

1 Column 3 times 12.
28
Net profit on sales. This ratio measures the difference between

what your company takes in and what it spends in the process of doing
business. The ratio depends mainly on two factors-operating costs
and pricing policies. If your net profit on sales goes down, for instance,
it might be because you have lowered prices in the hope of increasing
your total sales volume. Or it might be that your costs have been
creeping up while prices remained the same.
Net profit on sales is computed as follows :
Net profit $20,000

.067 , or 6.7 percent.
net sales $300,000
This means that for every dollar of sales, the company has made a
profit of 6.7 cents.
This ratio is most useful when you compare your figures with those
of businesses comparable to yours , or when you study the trends in your
own business through several accounting periods. Comparing the net
profit on sales for individual products or product lines is also useful . Such
an analysis will help you decide which products or lines should be pushed .
Investment turnover. Investment turnover is the ratio of annual

net sales to total investment. It measures what volume of sales you
are getting for each dollar invested in assets. The Ajax Company will
compute its investment turnover as follows :
Net sales $300,000 -

= 1.3.
total assets $230,000
Return on investment ( ROI ) . The rate of return on investment

(profit divided by investment ) is probably the most useful measure of
profitability for the small business owner. Usage varies as to what
specific items from the financial statements are to be used for "profit”
and " investment. " For example, "profit" might be considered to mean
net operating profit, net profit before taxes, or net profit after taxes. "In-
vestment" could mean total assets employed or equity alone. It is im-
portant to decide which of these values you are going to use in computing
return on investment and then to be consistent . In this discussion, net
profit after taxes and total assets will be used. For the Ajax Company,
then, the return on investment is computed as follows :
Net profit $ 20,000

= .087 , or 8.7 percent.
total assets $ 230,000
Here's an illustration of the use of the return-on-investment formula :

Suppose a small businessman has a total investment of $ 250,000 in a toy-
manufacturing venture and $ 100,000 in a hotel. He wants to com-
29
pare the success of these unrelated businesses. The toy-manufacturing

venture yields annual net profits of $55,000 and the hotel earns $25,000.
The return on the toy investment is 22 percent in contrast to 25 percent
for the hotel. Other things being equal, the hotel operation is more
successful than the toy factory in terms of the return on investment.
Assume, now, that the next year, the businessman wants to increase
his toy sales from $500,000 to $600,000 , and expects the net income of
the toy business to increase from $55,000 to $66,000 as a result. In
order to do this, he will have to increase the total investment in the toy
concern from $250,000 to $350,000 .
The net profit on sales will remain the same- 11 percent. The
return on investment, however, will drop from 22 percent to 18.8 per-
cent. These changes are shown in the following summary of the toy-
manufacturing operations :
Original Expanded
Investment $250,000 $350,000
Sales $500,000 $600,000
Net profit-- $ 55,000 $ 66,000
Net profit on sales ----- 11.0 percent 11.0 percent
Return on investment . 22.0 percent 18.8 percent
Investment turnover__ 2.0 times 1.7 times
Why did the rate of return on investment drop from 22.0 to 18.8
percent, when the rate of return on sales remained at 11 percent? The
answer is found in the investment turnover. A company's net profit on
sales may be high ; but if the sales volume is low for the capital invested,
the rate of return on the investment may be low. While the toy manu-
facturer's profit on sales remained at 11 percent, his investment turn-
over was only 1.7 the second year compared to 2.0 for the first year. As
a result , the return on investment dropped from 22.0 percent to 18.8 per-
cent. On the other hand, the profit on sales can be low and still bring
a high return on investment if it is coupled with a high investment turn-
over.
The toy manufacturing illustration shows why it is important to look
at return on investment in addition to sales volume, profit on sales, and
absolute profit figures. The investment required to produce the sales
and profits are important. The entire triangle of factors-sales, profits,
and investment-must be considered in financial management.
Common-Size Financial Statements
Sometimes all values on the financial statements are reduced to per-

centages. Balance-sheet items are usually expressed as percentages of
the total assets figure ; profit-and-loss-statement items, as percentages
30
of net sales. A statement in this form is often called a "common-size"

balance sheet or profit-and-loss statement.
This type of analysis has little or no value, however, unless the per-
centages are compared with figures for other businesses in the same line
of activity or with past records of your own company.
Using the Ratios
Ratios will not provide you with any automatic solutions to your
financial problems. They are only tools-though important ones-
for measuring the performance of your business. It is the use to which
you put them that will determine their real value. Chapter 11 lists
a number of sources that publish average ratios for various types of
businesses. Compare your ratios with the averages of businesses similar
to yours. Also, compare your own ratios for several successive years,
watching especially for any unfavorable trends that may be starting.
If warning signs appear, look for the causes and for possible reme-
dies. Studying one ratio in relation to others may help here, but you
will probably also need to look into the more detailed records of your
business in the areas concerned .
Another tool for analyzing profits-break-even analysis—is discussed
in the next chapter.
CHAPTER 4
Break- Even Analysis
Operating profits are the bread and butter of your business . They
depend upon volume and selling price on the one hand, and costs on the
other. A financial manager must have some way of analyzing these
factors and their probable effect on profits. One management tool that
serves this purpose is break-even analysis.
Three Types of Costs
Costs can be classified as fixed, variable, or semivariable. Fixed costs

do not vary with the level of business activity. Examples of these costs
are indirect labor, property insurance, property taxes, depreciation al-
lowances, executive salaries, and so on. Variable costs vary directly with
the volume of business activity. They tend to double, for instance, if
production is doubled , or drop to zero if there is no production . Direct
labor and materials are examples of variable costs.
Semivariable costs change with the level of business activity, but not in
direct proportion. Office equipment might be an example, or foremen's
salaries. Up to a point, such costs are about the same regardless of the
level of output. Beyond that point, they go up . A foreman, for in-
stance, might be able to supervise a few more workmen without too much
difficulty. But suppose output is increased still more and the work force
becomes too large for him to handle. An assistant or a second foreman
will then have to be hired, and the cost will rise.
Most semivariable costs can be broken down into their fixed and var-
iable elements.
Break-Even Analysis
A good tool for analyzing the effect on profits of different costs, operat-
ing conditions, methods of pricing, and other management policies is the
break-even technique. The "break-even point" is the point of sales
volume at which sales revenues just cover costs, with no profit and no loss.
31
32
Break-even analysis can show at what approximate level of sales a new

product will pay for itself and begin to bring in a profit. It is also helpful
in analyzing the profitability of products already being sold . Suppose
you have a product that has passed its peak of popularity. It is still fairly
profitable, but the demand for it is slacking off. Break-even analysis can
show you about how far sales can drop before the item will stop making
any profit at all, and below what level it will no longer cover even its fixed
costs.
Break-even analysis can also provide guidance in management deci-
sions through series of analyses based on varying assumptions about costs
and other factors. It helps to answer questions like these ( the list is by no
means complete ) :
"How many units of the new product will have to be sold, given esti-
mates of its cost and selling price, if we are to break even?"
"The change we are planning will mean a 10-percent increase in fixed
costs. What effect will this have on profits?"
"What will be the effect of a 5-percent reduction in selling price ( or a
15-percent decline in the number of units sold ) ?"
"How much more will we have to sell to make up for a 15-cent hourly
increase in wages?"
"If we buy the new machine we are considering ( or truck, or building
improvement) , how long will it be before the investment pays for itself
and begins to return a profit?"
Formula for Finding the Break-Even Point
Once all costs have been identified and classified as fixed or variable,
the break-even point can be found by using the following formula :
total fixed costs

Break-even volume =
selling price - variable cost per unit
Suppose the Titan Manufacturing Company ' has figured the costs
for one of its products as follows : total fixed costs, $ 100,000 ; variable
costs, $50 per unit . The selling price for the item is $ 100 per unit . This
means that $50 per unit sold can be applied toward fixed costs. With
fixed costs of $ 100,000 , therefore , 2,000 units will have to be sold before
any profit will be realized . From that point on—that is, after fixed costs
are recovered the $50 per unit sold will be profit .
This break-even point of 2,000 units is obtained by using the Titan
figures in the formula given above :
$ 100,000
Break-even volume = = 2,000.
$ 100- $50
Not a real company.

33
Break-Even Charts
Figuring the break-even point by means of this formula has the ad-
vantage of simplicity. Break-even charts, however, give a broader, "mov-
ing" picture of business activity. They, too, show the specific break-
even point, but they also show the amount of profit or loss for other levels
of sales.
An example. Exhibit 12 shows a break-even chart for the Titan

Company. Sales volume, in units, has been plotted on the horizontal
axis ; costs and revenues on the vertical axis. ( For some purposes, it may
be more useful to plot time on the horizontal axis instead of sales
volume. )
Take, again, Titan's fixed costs of $ 100,000 , variable costs of $50 per
unit, and selling price of $ 100 per unit. Total operating revenues will
Exhibit 12
Volume Break- Even Chart
(Fixed costs , $ 100,000; variable costs , $ 50 per unit;

selling price, $ 100 per unit)
thousands
revenues
400
dollars
Costs
and
Total revenue line

of
in
it
of ea
300 Pr ar
Break-even point
Total cost line
200
Variable cost area
/1 ss ea
0 Lo ar
10
Fixed cost area
0
1000 2000 3000 4000
Units sold
34
equal the number of units sold times $ 100 . Total costs equal fixed costs
of $100,000 plus the number of units sold times $50.
Fixed costs appear on the chart as the horizontal line. Total cost and
total operating revenues appear as the two sloping lines ; and the point
at which they intersect is the break-even point- 2,000 units. This in-
dicates that Titan must sell 2,000 units just to offset its total operating
costs. If more than 2,000 units are sold, the business will make a profit.
If fewer than 2,000 are sold , the company will suffer losses.
This figure checks with the one resulting from use of the formula.
However, the chart gives additional information . The distance between
the two sloping lines at any point shows the amount of profit or loss that
can be expected at the sales volume represented by that point.
Changes in the break-even point. In the above illustration, profits

depend solely on sales volume. It was assumed that the selling price
Exhibit 13
Volume Break- Even Chart-Fixed Costs Reduced
(Fixed costs , $80,000 ; variable costs , $ 50 per

unit; selling price , $ 100 per unit )
thousands
400
revenues
dollars
Costs
and
of
in
Total revenue line
300 it
of ea
Pr ar
Break- even point

200 Total cost line
Variable cost area
ss rea
100 Lo a
Fixed cost area
0 1
1000 2000 3000 4000
Units sold
35
would remain at $ 100 and that the cost pattern would not change. But
suppose the company could reduce its fixed costs from $ 100,000 to
$ 80,000. Exhibit 13 shows what the effect of this change would be.
The horizontal line representing fixed costs is lowered, and the sloping
line representing total costs comes down with it. This moves the inter-
section of the two sloping lines down and to the left. The break-even
point is now seen to be 1,600 instead of 2,000 units.
Changes in variable costs would also affect the company's profit pic-
ture. If Titan could reduce its variable costs from $50 to $45 per unit,
the break-even point would drop from 2,000 units to 1,800 . This is
seen in exhibit 14. The change in variable costs shows up as a change
in the slope of the line representing total costs, which rise less rapidly
with lower variable cost per unit.
Another change that would affect the break-even volume is a raising
or lowering of the price. Increasing the price from $ 100 to $ 105 , for
Exhibit 14
Volume Break- Even Chart-Variable Costs Reduced

thousands
(Fixed costs , $ 100,000 ; variable costs , $45

revenues
dollars
400 per unit; selling price , $ 100 per unit)

Costs
and
of
in
Total revenue line it ea

of
300 Pr ar
Break-even point
Total cost line
200
Variable cost area
ss rea
Lo a
100
Fixed cost area
0
1000 2000 3000 4000
Units sold
36
Exhibit 15
Volume Break- Even Chart— Price Raised
(Fixed costs , $ 100,000; variable costs , $ 50

per unit; selling price , $ 105 per unit)
thousands
400
revenues
dollars
Costs
and
of
in
it
Total revenue line of ea
300 Pr ar
Break-even point
Total cost line
200
Variable cost area

ss ea
Lo ar
100
Fixed cost area
1000 2000 3000 4000
Units sold
instance, would reduce the break-even point to approximately 1,800

units. Exhibit 15 shows how the price increase changes the slope of
the revenue line, which, in turn, lowers the break-even point.
Application of break-even analysis. In the illustrations discussed

above, the various factors in break-even volume-sales volume, fixed
costs , variable costs, and selling price-have been analyzed one at a time.
In practice, these variables usually change simultaneously. This, of
course, makes the analysis somewhat more complicated than it appears
here.
To use break-even analysis, it is necessary to analyze carefully the
various costs of doing business . Estimates can be used, however, for cost
items that cannot be precisely identified as fixed or variable. Accuracy
is necessary only to a point that permits you to reach sound conclusions.
CHAPTER 5
Managing Your Investment
in Assets
The owner of a small business may have the best of financial rec-
ords. They may be presented to him in the right form at the right time.
But if he has not learned how to use the information, it will be of little
value. Skill in financial management-like skill in shop practice, sell-
ing, or any other business activity-comes from experience . That ex-
perience, however, must be built upon knowledge and understanding of
some fundamental principles.
Sound financial management is essentially sound asset management ;
and one of the most important aspects of asset management is close
control of your investment in three areas:
Fixed assets
Receivables
Inventories
Care should be taken that the investment in each of these assets is

no larger than you really need, considering the type of business you are
in and the requirements and goals of your company. Exhibit 16 shows
the proportions of total assets represented by these three types of assets in
incorporated businesses with assets of less than $ 1 million. These charts
give a good overall picture for major industrial groups . It is a very
general picture, however ; they represent averages, and the industrial
groups used are very broad. More specific guides are described in the
following paragraphs.
Investment in Fixed Assets
Holding down your investment in fixed assets is important for these

reasons :
1. If too much of your capital is tied up in fixed assets, you may have
too little left for working capital.
37
38
Exhibit 16
Percentage of total assets in receivables , inventories , and fixed assets
RECEIVABLES Percentages
Agriculture, forestry, and fisheries
Mining and quarrying .
Construction
Manufacturing
Public utilities *
Wholesale trade
Retail trade
Finance, insurance , and real estate
Services ..
INVENTORIES
Construction
Manufacturing
Public utilities
Wholesale trade
Retail trade
Finance, insurance , and real estate
Services ...
FIXED ASSETS
Construction ..
Manufacturing
Public utilities *
Wholesale trade
Retail trade ....
Finance, insurance, and real estate
Services .
0 10 20 30 40 50 60 70 80 90 100
Based on data for corporations with less than $ 1 million in total assets from
Statistics of Income 1960-61 : Corporation Income Tax Returns . U.S. Treasury
Department, Internal Revenue Service.
* Transportation , communication , electric, gas , and sanitary services

39
2. Investments in fixed assets typically last for a long time. They may
be difficult and costly to reconvert into cash if changed circumstances or
plans should make this necessary.
3. Fixed charges resulting from a high investment in fixed assets may
become a heavy burden during periods of low sales or falling prices.
These fixed charges include interest on long-term debt, insurance on
plant and equipment, taxes, and maintenance charges.
4. Heavy fixed costs growing out of overinvestment in fixed assets
raise the break-even point .
How much is too much? There is no specific answer to this question.

Some businesses must, because of their nature, have relatively heavy
investments in fixed assets. If these businesses are to earn a satis-
factory return on investment, they must have a high profit margin and/or
a large proportion of low-cost debt money to finance fixed assets.
One measure you can use in judging your company's asset investment
is the proportion of your total assets represented by fixed assets ( fixed
assets divided by total assets ) . Like other ratios, this one should be com-
pared with the performance of campanies similar to yours or with your
own figures for earlier periods.
Another useful measure is the turnover of fixed assets ( net sales divided
by net fixed assets ) , which tells you how many dollars' worth of goods or
services were sold for each $ 1 invested in fixed assets.
What can you do about it? There are several steps you can take to
hold down your investment in fixed assets.
• Mortgaging fixed assets makes it possible to use buildings and equip-

ment with a minimum investment. Financing is available on liberal
credit terms for most types of new machines. And while loans on build-
ing are not always as easy to get as equipment financing , you may be able
to borrow a substantial part of the purchase price if the building is
modern and of standard design . Some industrial foundations and State
and municipal financing agencies occasionally sell new buildings with no
downpayment .
Leasing is another way to avoid high investment in fixed assets.

Almost all types of fixed assets can be leased- trucks , office furniture,
equipment, machinery, buildings, land, and so on. In fact, a business
can sometimes release capital by selling assets and leasing them back from
the purchaser.
Care should be be used, however, in entering into lease and mortgage
agreements, especially if the prospects of the business are uncertain.
Such commitments, like borrowing, bring fixed charges that must be
paid on schedule regardless of business conditions.
• Subcontracting production lessens the need for investment in fixed
assets and also the expense involved in care and maintenance.
40
Investment in Receivables
The size of your investment in accounts receivable depends on a num-

ber of factors :
1. The volume of credit sales ( the most important factor ) .
2. Your credit terms.
3. The payment practices of your customers.
4. The firmness with which you collect overdue accounts.
For instance, you may decide to offer more lenient credit terms or to
extend credit to a few somewhat "risky" customers in order to increase
sales. This will tend to increase the volume of receivables.
Or, you may wish to change your credit terms so as to shorten the col-
lection period . ( Remember, however, that this type of change may re-
duce sales revenues. ) You might, for example, substitute terms calling
for payment 30 days from the date of sale instead of 30 days after the end
of the month in which the sale was made. Discounts for early payment
might be allowed or increased . These steps will tend to decrease the
volume of receivables.
Once you have established your credit terms and collection practices,
the level of receivables can be expected to vary directly with sales volume.
If it does not, a change in the pattern of payments has taken place, and
you should inquire into the reasons for the change.
Keeping an eye on receivables. The average collection period

(explained on page 24 ) enables you to compare your collection record
with the credit terms you offer. Over time, it also shows up changes in
the pattern of payments.
Another very important technique for keeping track of your receivables
investment is the aging schedule . In an aging schedule, the accounts
receivable are classified according to date of sale and summarized as in
the following example :
Accounts Receivable Aging Schedule, Dec. 31 , 19—

Amount Percent
Receivables outstanding less than 30 days___ $ 22 , 610 70
Receivables outstanding 30 to 45 days-- 3,530 11
Receivables outstanding 45 to 60 days. 3,510 11
Receivables outstanding 60 to 90 days ‒‒‒‒‒‒ 1 , 910 6
Receivables outstanding 90 days or more.. 620 2
$32, 180 100
The aging schedule shows to what extent old accounts are piling up.
It suggests which accounts and what proportions of accounts need special
attention if sizable bad-debt losses are to be avoided . In addition to
being a valuable management tool, it is often required by bankers and
other lenders.
41
Investment in Inventories
Management of inventories in a small manufacturing plant is more

complex than in other types of businesses. For this reason, the discussion
of investment in inventories will focus on manufacturing. However,
the ideas involved apply also to small wholesalers and retailers—and to
service enterprises to some extent, since most of them sell supplies, parts,
and so on. The difference is that these businesses are concerned with
only one of the three main types of inventories-finished goods. Small
manufacturers have inventories of raw materials and goods in process,
as well as finished goods. Control of investment in inventories must be
considered separately for each of these three types.
Raw materials inventory. The size of your raw-materials inventory

should reflect the following factors :
The volume of scheduled production.

The length of time required for delivery of raw materials.
Any expected changes in prices or supplies of raw materials.
The savings that can be made by purchasing in economic lots.
The state of your financial resources.
The inventory level is usually expressed in terms of a certain number of

days' sales-for example, "60 days ' sales," or "45 days' sales." Suppose
you are manufacturing a product that requires two screws of a certain
size for each unit produced, and experience has shown that you need to
keep enough of these screws on hand for 45 days' sales. You have set
your sales goal at 1,000 units per 30-day month, which amounts to 1,500
units for 45 days' sales. With 2 screws required per unit, then, the de-
sired inventory level for the screws is 3,000.
It may or may not be necessary for you to stock enough raw materials
so that there is no possibility of your running out of them. Excessive
raw materials tie up resources without adding to profits. They also add
to warehousing and other expenses. But costs are involved , too, in run-
ning out of the materials of production . Workers and machines may
be idled, production slowed down or stopped, sales lost.
These costs vary among industries. You will have to weigh the ad-
vantages and disadvantages of hand -to-mouth purchasing against buying
for stock and then decide at what level you should keep your raw-
materials inventory.
Goods-in-process inventory. The amount of funds tied up in goods

in process depends on how long it takes to produce the finished products
and on your volume of production. Reduction of the goods-in- process
inventory, therefore, is brought about mainly by speeding up the produc-
tion process through improved scheduling or more efficient operation.
42
Finished goods inventory. The size of your finished-goods inven-

tory should be governed by production and marketing considerations.
The more your production can be geared to firm orders for completed
products, the lower your finished-goods inventory can be kept. Most
manufacturers, however, and all retailers and wholesalers find it neces-
sary to keep some stocks of finished goods on hand .
The inventory-turnover ratio described on page 25 is a useful technique
for controlling finished-goods inventories. It is an especially important
tool forthe small wholesaler or retailer.
CHAPTER 6
Looking Ahead
Keeping your asset investments as low as possible does not mean that
they should never be allowed to expand . As your business grows, there
will probably be times when you will need additional funds for invest-
ment or operations. You must be able to plan for these requirements,
and to do this you will need forecasting tools.
The techniques described in this chapter— the cash budget and pro-
jected financial statements ( sometimes called "pro forma" statements ) —
serve many purposes. They help you to keep last-minute decisions and
surprises at a minimum ; to set standards of performance for various
activities of your business ; to anticipate financial needs and the effects of
policy changes. They are a valuable aid in discussions with prospective
lenders. They help you answer such questions as these :
Will I need additional money?

When will I need it?
How long will I need it?
How much do I need?
Where can I get it?
How much will it cost?
If I borrow it, how can I repay it?
The Cash Budget
The cash budget is simply a plan for cash receipts and expenditures
during a given period . It is one of the most valuable financial tools at
your disposal . By figuring out your cash needs and cash resources ahead
of time, you put yourself in a better position to :
Take advantage of money-saving opportunities such as economic

order quantities, cash discounts, and so on.
Make the most efficient use of cash.
Finance your seasonal business needs.
43
44
Develop a sound borrowing program .

Develop a workable program of debt repayment.
Provide funds for expansion .
Plan for the investment of surplus cash .
How to do it. The length of the period to be covered by the cash

budget depends on the nature of your business, how ample your supply
of cash is, and how regularly cash flows into and out of your business.
The form shown in exhibit 17 ( pages 46 and 47 ) is for a simple cash
budget prepared monthly.
The groundwork for preparing a cash budget consists of estimating all
cash receipts and cash payments expected during the budget period .
Budgets must be carefully planned for cash sales ( including discounts
and sales returns and allowances ) , payments of accounts receivable,
and any other expected cash income. The same kind of planning must
be done for each type of expense that will go to make up the expected
cash expenditures. These budgets are based on experience and on the
goals you have set for your business.
If expected cash receipts total more than expected cash payments, the
difference is added to the expected cash balance at the beginning of the
period. If payments total more than receipts, the difference is sub-
tracted . In either case, the result is the expected cash balance at the
end of the period.
The cash balance— how much is enough? You must also decide
what size cash balance you need to maintain. This, too, is based on ex-
perience. You might, for instance, decide that cash equivalent to a cer-
tain number of days' sales is a desirable level. If the cash balance at
the end of the budgeted period is less than this amount, some short-term
borrowing or changes in plans may be necessary. The cash budget, by
bringing this to your attention early, gives you time to consider fully all
the possible courses of action.
If, on the other hand, the cash balance is larger than you need, the ex-
cess can be temporarily invested in marketable securities.
If you need funds—what kind? Cash budgets can help you decide
whether you need short-term or long-term capital. A series of 12
monthly cash budgets will show your estimated monthly cash balances
for a year. Each of these balances can then be compared with the cash
level you have established as desirable for your business . Perhaps your
cash balance is ample at the beginning and end of the 12-month period
but low at times during the year. This suggests a need for short-term
funds. The need will be self-liquidating over the 12-month period.
If, however, cash budgets are developed over longer periods of time
and the cash balance is consistently low, the business needs intermediate-
or long-term capital- intermediate if the need persists for periods lasting
45
from 12 to 30 months, and long-term or permanent capital if it persists

for a longer period .
Projected Financial Statements
The cash budget deals with only one account-cash. It is useful to

carry your plans for the future a step further by drawing up a profit-
and-loss statement and a balance sheet. These statements record your
best estimates of what the profitability of your business will be during the
period covered and the financial condition of the business at the end of
the period. They should be drawn up at least quarterly ; and if your
business is short of funds, you would be wise to prepare them more often.
They will help you avoid unforeseen peak needs that might prove em-
barrassing.
By providing a look into the future of your business, projected fi-
nancial statements enable you to judge what the financial needs of your
business will be at the end of the forecast period . You can then plan
ahead of time whatever steps may be needed to strengthen the business
or to prepare for future growth. If you wait until the need actually
arises, it will be more difficult and may even be too late.
The projected profit-and-loss statement. The value of the pro-

jected profit-and-loss statement as a guide depends largely on your esti-
mate of sales during the period for which the projection is being made.
It is therefore well worth your time to develop this estimate as ac-
curately as possible. Use the past experience of the business, figures
provided by salesmen, management projections, and any other useful
information.
Next, the cost of goods sold must be estimated. A useful first step
is to analyze operating data to find out what percentage of sales has gone
into cost of goods sold in the past . This percentage can then be adjusted
for expected variations in costs, price trends, and efficiency of operations .
(A more detailed method estimates each cost item separately and totals
the results . )
Other expenses, other income, and taxes can also be estimated on the
basis of past experience and expected changes.
A typical projected profit-and-loss statement for the Titan Manufac-
turing Company is shown in exhibit 18 ( page 48 ) .
The projected balance sheet. The projected balance sheet is a

summary of the results expected at the end of the period for which the
projection is being made. It shows the effect on each balance-sheet item
of the sources and uses of funds planned in the various budgets.
The cash figure appearing on the projected balance sheet ( see exhibit
19 on pages 50 and 51 ) is the amount decided on as the desirable cash
(Please turn to page 49.)
17
Exhibit
46
Cash
Budget
,19
31
March
Ending
Months
Three
For
January February March
Budget
Actual Actual
Budget Budget
Actual
:
receipts
cash
Expected
1.
sales
Cash
accounts
on
Collections
2.
re-
ceivable
income
Other
3.
Total
4.
cash
receipts
:
payments
cash
Expected
(or
materials
Raw
5.
merchan-
dise
)
Payroll
6.
Other
7.
direct
factory
ex-
penses
Advertising
8.
9.
Selling
expens e
10.
Admini
expens strative
e
11.
Plant
equipment
and
payments
Other
t
(12.
,iaxes
n-
terest
),and
on
so
13.
Total
cash
payments
cash
at
balance
14.
Expected
month
of
beginning
increase
Cash
15.
decrease
or
13
)item
m
4 inus
(item
at
balance
cash
Expected
16.
end
month
of
(item
14
15
)item
plus
cash
Desired
17.
balance
t
-
Short
18.
needed
loans
erm
minus
16
item
i
17
( tem
item
if
17
larger
)is
short-
for
available
Cash
19.
term
investment
(item
16
minus
16
item
if
17
item
)
larger
is
47
Exhibit
18
48
Manufactu
Titan
Company
1 ring
Statement
a
Lnd
- oss
Profit
Projected
December
31
,19—
Ending
For
Month
the
Figures
based
:
on
.
sales
from
Revenue for
month
the
Sales
budget
8
$ 0,000
..sales
of
Cost 56,000 Titan
),7
sales
of
percent
0
(for
Experience
margin
.Gross 2
$4,000
Operating
:expenses
Selling
expenses
. 10,200
$ month
the
for
Budget
Genera
expens
. l
es 4,000 fixed
2
,$ ,400
Titan
f
( or
Experience
percent
2
of
variable
plus
costs
of
sales
)
Total
operating
expenses
.. 14,200
income
Net
operations
.from 9,800
$
Other
expense
:
Intere e
.expensst debt
Outstanding
500
.
taxes
before
profit
Net 9
$,300
.taxes
Income rate
Tax
2,790
percent
30
of
taxes
.after
profit
Net 6
$,510
.
withdrawn
Earnings intention
Owner's
5,000
Retained
earnings
. 1,510
$
ot
company
ra1N. eal
4.9
balance in the cash budget. The Titan Company has established 15

days' sales as their desired cash balance. On the basis of the sales estimate
of $80,000 for December ( exhibit 18 ) , the cash account would be
$40,000 on their projected balance sheet.
The receivables and inventory accounts can be based on past experi-
ence and estimated sales. Assume that Titan's receivables have averaged
30 days' sales in the past, and that inventories have been turning roughly
one-half times monthly. If other conditions and policies do not change,
with Titan's sales estimate of $80,000, receivables should be about
$80,000 and inventory $ 160,000 at the end of the month.
Fixed assets on the estimated balance sheet are based on earlier fixed-
asset accounts. That is, the accounts on the most recent balance sheet
are adjusted for depreciation and expected additions to or reduction in
these assets.
Accrued liabilities and long-term debts can usually be assumed to re-
main unchanged . Of course, if your experience has been that accrued
liabilities tend to vary with sales volume, you should take this into
account. Any expected increase or reduction in long-term debts during
the period should also be given effect.
The accounts payable figure is based on an estimate of the number of
days' purchases that will be outstanding at the end of the month . Recent
and expected purchases and your creditors' terms of sale must be con-
sidered.
The equity account consists of the existing ownership account plus the
earnings to be retained during the period . The amount of retained
earnings to be added here comes from the projected income statement.
The remaining account, notes payable, is the last to be computed ( unless
it has already been determined in connection with the cash budget ) .
Notice that without it, the combined equity and liabilities ( $ 711,000 )
fall $69,000 short of the total assets ( $ 780,000 ) . This indicates that if
the estimates used were reasonably accurate, Titan will need roughly
$69,000 of borrowed funds to finance the activities planned.
Points to remember. Bear in mind two characteristics of projected

financial statements . First, these statements can be built up in a num-
ber of ways. The best approach is to rely on whatever information is
fairly easy to get together and enables you to make the most accurate
estimates for the various accounts. Second, remember that these state-
ments are based on estimates and assumptions. They provide only a
rough sketch of what may happen.
If actual performance differs widely from the estimates at any point,
however, the reason should be sought. Was the estimate unrealistic, or
were there weaknesses in your company's performance at that point?
Whichever proves to be the case, the trouble spot should be attended to.
(Please turn to page 52.)
50
Exhibit
19
Manufacturing
Titan
Company
1
Balance
Sheet
Projected
December
31
,19
Figures
based
:
on
Current
assets
:
.
Cash 4
$0,000 balance
Desired
'cash
days
15
to
equal
sales
Accounts
.
receivable 80,000 days
30
Average
'collection
of
period
sales
.
Inventory 160,000 season
this
during
Monthly
of
turnover
Total
.current
assets 2
$ 80,000
assets
.Fixed 500,000 month's
adjusted
for
figure
Present
depreciation
Total
.assets 7
$80,000
Liabilities
Current
:
liabilities
Notes
payable
. 69,000
$ to
needed
funds
borrowed
of
Amount
balance
assets
Accounts
.payable 76,000 on
Expectation
'purchases
days
60
of
the
books
.
liabilities
Accrued 11,000 preceding
as
Same
period
...
liabilities
current
Total 156,000
$
debt
t
.-erm
Long 70,000 Unchanged
liabilities
Total
. 2
$ 26,000
Equity
Paid
capital
-n
.i 3
$ 50,000 Unohanged
Retained
earnings
. 204,000 to
earnings
plus
amount
Present
re-
be
Dec.
in
tained
Total
equity
. 554,000
Total
liabilities
and
..equity 7
$80,000
compa ot ny
ra1N. eal
51
52
Looking Still Further Ahead
You may
find it hard to estimate capital require
ments in the more dis-
tant future by develop p r o j e cted c a s h b u d g ets and financial state-
ing
ments . Business expectat 2 m a , for instance , may be
ions 4 onths head
too uncertai for detailed schedule to be pieced together.
n s
In such cases, ask yourself this question : "Do I expect to do the same
volume of business 2 years from now, or do I expect to do x percent more
business?" When you have the answer to that question, you can make
a rough estimate of your capital requirements for the period. Here's
how.
Examine past financial statements to find the normal cash, inventory,
accounts receivable, accounts payable, and short-term borrowing per
dollar of sales. Then multiply these amounts by the dollar sales volume
you expect to be doing in 2 years. Add to existing fixed assets any addi-
tions you expect to make during the 2 years.
You are now well on your way to constructing a rough projected bal-
ance sheet for that time. A concluding step is to subtract total estimated
liabilities from total estimated assets. The difference is the projected
equity account.
Now compare this account with your existing equity account. The
difference between the two will have to be made up by retained earnings
plus new intermediate- and long-term capital.
CHAPTER 7
The Borrower and
His Banker
Commercial banks provide most of the short-term funds loaned to

small companies except for trade credit. In addition, they provide more
than 80 percent of the intermediate- and long-term funds borrowed by
small business for expansion. The chances are that at some time, if
not repeatedly, you will want to borrow from a bank.
Advantages of Borrowing
You should avoid excessive borrowing ; but at the same time, you
should be aware of the possible benefits of borrowing.
Borrowed funds can earn more than they cost. The rate of inter-
est that lenders charge is generally lower than the rate of return you
expect your investment to earn. As a result, borrowed funds, if they
are used successfully, increase the return on your investment over what
it would have been without the borrowing.
Interest payments on borrowed funds are tax deductible. Dividend

payments or other returns to investors or not. These facts should be
taken into account, along with other considerations, in deciding on
borrowing policies.
Some credit is a matter of convenience. Buying merchandise on

open account and services on an accrual basis are examples of the use of
credit for convenience. Wages are a specific example. Even a very
small businessman would find it difficult to make daily wage settlements.
• Borrowing is more flexible than ownership. When a business

owner supplies the entire investment, he may find that part of his capital
is idle during off seasons. As a result, he may receive a lower average
return than if he had invested some of his money elsewhere and used
short-term borrowed funds during his own company's periods of peak
53
54
needs. The small businessman can usually increase or decrease the

amount of borrowed funds to correspond fairly well with his business.
capital requirements.
• Loan funds are easier to find than equity funds. The prospects of
profits are often too uncertain to satisfy a potential owner-investor.
Since lenders, as creditors, have prior claims to income and assets, loan
funds are usually more plentiful than equity capital.
How Do You Rate as a Borrower?
The lender— who more often than not is a banker-needs certain

information on which to base a loan decision . Part of it will be fur-
nished by the borrower, and the rest will come from the banker's own
credit files and from outside sources. This information is related to
what credit men call the "Cs" of credit- Character, Capacity, Capital,
Collateral, Circumstances, and Coverage ( insurance ) .
Character. To the banker, "character" means two things in par-

ticular :
1. The borrower will do everything in his power to conserve his busi-

ness assets and so ensure repayment of his loan . He will manage his
business to the best of his ability. He will not squander his own or
other funds.
2. The borrower is a man of his word. When he says that he will

repay his borrowings promptly, he means it . If he does not keep his
promise, he at least will have made every possible effort to do so.
Capacity. The management skill shown by the small businessman

in using his investment and enlarging it is another important business
asset. For those just embarking on a business career or entering a new
field, however, past experience may carry little weight. For example,
experience as a machinist, salesman, or bookkeeper alone- however
successful—does not qualify a person to direct all the activities involved
in operating a machine shop.
Capital. The small businessman's investment in his own business is

evidence of his faith in its future. He himself must furnish the manage-
ment and most of the capital until others have enough confidence in his
business to be willing to invest in it.
Collateral. Businessmen who have a high credit standing do much

of their borrowing on an unsecured basis. Others are often obliged to
back up their credit standing with collateral . This is especially likely to
be true of a new small businessman . If he owns a home or other im-
proved real estate, life-insurance policies with a cash surrender value, or
55
marketable securities, he may be able to use such assets as collateral for

business loans.
Before borrowing on these terms, however, he should consider the con-
sequences to himself and his family if he should be forced to withdraw
from the business before it becomes firmly established. A small business-
man who retires from business prematurely usually does so at a loss.
Circumstances. Some factors over which the small businessman has

no control may have a bearing on the granting of a bank loan and its
repayment. These include :
Seasonal character of the business.

Long-run business changes.
The level of community business activity.
The competitive position of the firm.
The nature of the product.
Coverage. Proper insurance coverage is extremely important. Small

businessmen are subject to possible business losses from many causes, such
as these:
The death of an owner, partner, or principal stockholder.

Physical damage or interruption of operations as the result of fire,
explosion, flood, tornado, or other violent causes.
Theft, embezzlement, or other acts of dishonesty by owners, offi-
cers, employees, and others.
Public liability not covered by workmen's compensation insur-
ance.
A new small businessman may not be able to insure his company as

fully as the owner of an established business, but he should recognize the
need. A going concern has little excuse for neglecting to establish and
maintain adequate insurance protection against basic risks. (See your
insurance broker, agent, or company representative ! )
Information, Please
If you apply for a loan, you will have to provide, besides the loan ap-
plication, copies of recent balance sheets and profit-and-loss statements.
Check in advance to see whether your bank requires that you use special
statement forms, and get copies of whatever forms you will need . This
will give you a better idea of the types of information the banker will
want. If you do not understand how to prepare the forms, you can
get help from the banker, a public accountant, or others familiar with
loan-application procedures.
In addition to the standard financial-statement data, the bank will
probably want details about your liabilities, contingent liabilities (for
56
example, notes you have endorsed for others ) , property owned, insur-
ance, other business connections, and so on. It is a good idea, too, to
prepare a cash budget and projected financial statements for the period
to be covered by the loan. These statements can be used to support
your explanation of how the money is to be used and how the loan will
be repaid. The more financial data you provide, the more favorably
the bank is likely to look upon your application— if the data are thought-
fully and accurately prepared.
Exhibit 20 shows a loan-application form used for single proprietor-
ships by a medium-sized national bank in a city of 30,000 population.
Most smaller banks use forms much like this one except for minor details.
Choosing a Bank
What should you look for in choosing a bank? There are five main
points to consider.
• Is the banker progressive? Has he kept pace with changing condi-

tions, and is he alert to the developing requirements of the community?
Does the management of the bank combine integrity, experience,

ability, and initiative?
• How does the banker approach your problems? Does he appear in-
terested and helpful?
• Can you get the kind of credit you need? Be sure the banker under-
stands your particular needs and is prepared to service them.
• How big is the bank? Generally speaking, size should probably not
be the deciding factor in choosing a bank. It may make a difference,
however, in the types and amount of credit available, the services of-
fered, prestige, and so on.
A Two-Way Street
A banking relation is a two-way street. The banker has a right to

expect something from you , too. For instance, it is logical for a banker
to be interested not only in your borrowing business but also in your ac-
count as a depositor . Also, you will find that it doesn't pay to move fre-
quently from one bank to another .
An alert banker will want a great deal of confidential information
from you. Good banking practice demands that he protect himself,
his depositors, and you . Therefore , you should expect him to look care-
fully into your records, needs, and plans. Don't think of the prepara-
tion of detailed financial statements as a nuisance imposed upon you
by the banker's unreasonable love for statistics. He can judge your
57
Exhibit 20
APPLICATION FOR LOAN
Individual
Borrower :
Name
Street address
City and State

Amount of loan :
Endorsers or collateral offered :.
Borrower's principal source of income and approxi-

mate amount of same per annum :.
On collateral
Amounts already owing this bank : Unsecured $
As endorser
Purpose of loan :.
Will loan be handled on demand , 30-day , 60-day , or

90-day basis ?.
If loan is not to be paid in full at first maturity ,

state what arrangements are agreed upon as to re-
ductions at first and successive maturities .
(Care should be exercised to see that the borrower
understands fully the arrangements as to liquida-
tion of loan . )
From what source does the borrower expect to obtain

the necessary funds to meet the liquidation as out-
lined above ?.
This day of
Signature of applicant
58
financial position and progress only through the information and figures
you give him.
Once you have started a satisfactory banking relation, continue to con-
sult your banker. Keep him informed about new developments in your
business, discuss your financial problems with him, and supply him regu-
larly with complete and current financial statements, even at times when
you have no need for bank credit.
CHAPTER 8
Short and Intermediate
Term Credit
Commercial banks, as stated in the last chapter, provide a large part

of the funds borrowed by small businesses ( except for trade credit ) .
There are a number of other sources, however. These include com-
mercial finance companies, factors, insurance companies, suppliers, indus-
trial foundations, small business investment companies, and some Gov-
ernment sources.
Whichever of these sources you plan to approach, when you set out to
borrow money or secure any type of credit financing, you should know
how long you will need the credit. Short-term credit is generally con-
sidered to be credit extended for 1 year or less ; intermediate-term credit,
for more than 1 year but not more than 5 years ; and long-term credit, for
more than 5 years. ( Some authorities distinguish between intermediate-
and long-term loans at 10 years instead of 5. ) Funds contributed as
equity financing, on the other hand , are not repaid, but become part of
the permanent capital of the business.
Short- and intermediate-term loans are discussed in this chapter, long-
term loans in chapter 9, and equity financing in chapter 10.
Short-Term Loans
Short-term loans are usually sought for working-capital purposes to

pay for merchandise in time to take advantage of the discount, to cover
payrolls, to build up inventories for a seasonal increase in sales, and so on.
It is expected that the loan will be paid out of ordinary operating income
as the temporary need passes.
Short-term loans are easier to get than intermediate- and long-term
loans, especially for small businessmen. They are often unsecured and
may be less expensive than longer loans.
59
60
Intermediate-Term Loans
An intermediate-term loan ( also called simply a term loan ) provides

the small businessman with capital for other than temporary needs with-
out requiring him to yield business control. In this way, it gives him a
chance to build up his equity over a period of years.
Suppose, for example, that you need new equipment to increase your
output, but don't have the cash to pay for it. With an intermediate-
term loan, you will be able to acquire title to the machine right away.
During the life of the loan , the equipment will be helping to produce
income from which you can pay the installments and interest.
Intermediate-term loans are also used to purchase existing businesses,
to help establish new ones, to provide additional working capital , and to
replace long-term indebtedness that carries a higher rate of interest.
They may be either secured or unsecured . Payment may be made
monthly, quarterly, semiannually, or annually, often with small early
payments and a large final payment called a balloon payment.
While a term loan is in force. you will be subject to certain restrictions
as to how you manage your business. The loan agreement is usually de-
signed to protect the lender against drastic reductions in the value of col-
lateral or in business income available for repayment of the loan. Also,
term borrowers are required to submit periodic financial statements. On
the other hand, term lenders often give their borrowers expert advice on
business matters affecting the loan.
Some Types of Short- and Intermediate-Term Credit
Loans may also be described on the basis of factors others than the
time allowed for repayment-for example, type of security required,
common
method of repayment, source, and so on. Some of the most
kinds are described here.
Simple commercial loans. Most of these loans are made for periods
ranging from 30 to 90 days. They are usually based on financial state-
ments. Often, they are unsecured, and signed by the maker without
other endorsement. In most cases, it is expected that they will be paid
from the funds produced by normal business activity. This type of loan
is used particularly for seasonal financing and for building up inventories .
Character loans. Character loans are usually made as individual

rather than business credit. They are sometimes used for business pur-
poses, however.
Installment loans. Loans of this type are made for many business
purposes, usually by larger banks. They may be extended for almost
61
any period the bank sees fit to offer, with payments generally on a
monthly basis.
As the loan is reduced, it is often possible to obtain refinancing at
better rates. Also, these loans may be tailored to the seasonal require-
ments of the business, with heavier payments in peak months and smaller
payments during off-season periods.
Lines of credit. A line of credit is an informal understanding be-

tween a businessman and his bank. The bank agrees to grant loans as
the businessman requests them so long as they do not exceed at any one
time a maximum established in the agreement. The loans are usually
unsecured, and are often granted almost automatically during the period
of the agreement ( usually a year ) and up to the total specified . Credit
lines are used most commonly by businessmen with a seasonal need for
short-term funds.
Accounts-receivable loans. Accounts and notes receivable can be

used as a basis for short- or intermediate-term loans from your bank, a
finance company, or a factor. (A factor specializes in lending money
on accounts receivable and/or purchasing them outright . ) If your
working capital is limited or your sales volume fluctuates, you will find
type of financing particularly useful.
this type
When you obtain an accounts-receivable loan, you pledge or assign

all or part of your accounts receivable as security for the loan. The
agreement for the loan specifies what percentage of the volume of receiv-
ables you assign will be loaned to you . In the case of a bank loan, this
will usually be from 75 to 80 percent of sound receivables ; for factor
loans, it may be somewhat higher. The agreement also sets forth your
rights and liabilities, those of the lender, the conditions under which each
assignment is to operate, and the charges, which may include both inter-
est and service charges.
You assign accounts receivable to the lender as you need funds. Each
time, you prepare a schedule of assigned accounts and, if a loan is made,
you sign a note for the amount. Usually, the lender stamps the assigned
accounts in your accounts-receivable ledger.
Factoring accounts receivable. In more and more lines of business,

factoring companies are being used to convert accounts receivable into
cash. This procedure, called "factoring," is not the same as assigning
accounts receivable as security for a loan, though most factoring com-
panies handle both types of financing . In factoring, you enter into an
agreement under which the factor buys all your accounts receivable as
they arise. The accounts sold are no longer among your assets, nor does
the amount received increase your liabilities, since it will not have to be
repaid. If you borrow on your accounts receivable, on the other hand,
they remain as an asset, and the amount of the loan becomes a liability.
62
With a loan on receivables, you are still responsible for collection, but
when you sell the accounts, the factor takes over that function. He
assumes all the risk and has no recourse if an account proves uncollecti-
ble. Because of this, the factor will pass on the credit standing of your
customers. If he does not approve an account, you may still make the
sale, but at your own risk. The factor will not buy that account.
The factor typically makes a service charge of 1 or 2 percent on the
face amount of the accounts purchased . In addition, he charges interest
at the rate of about 6 percent per year for the perio ! Letween the time
you receive funds from him and the average maturity date of the receiv-
ables he purchases from you.
Factoring is an expensive method of raising funds, but it does away
with the need for a credit and collection department . Also , it is often
the quickest way for a small business to obtain cash.
Warehouse-receipt loans. Often, a small businessman needs extra

cash when he is accumulating inventories for seasonal or other peak de-
mands. When this happens, he may be able to obtain a warehouse-
receipt loan. Under such an arrangement, the inventory is delivered
to a professional warehouseman and stored in a special " field ware-
house " established on the premises of the borrower. The receipts is-
sued to him by the warehouseman are then turned over to the bank as
collateral for a loan.
When orders are received , the borrower will " buy back" from the bank
enough warehouse receipts to fill the orders. As more sales are made,
he will be able to buy back all his warehouse receipts and so complete
the repayment of his loan .
Costs of warehouse-receipt loans vary widely. The field warehouse-
man's bill is based on the value of the inventory, the work involved in
checking the inventory in and out, and the duration of the agreement .
Bank charges run 6 percent or more ; combined charges, 6 to 12 percent.
Since the initial costs are high, this type of financing should not be
undertaken unless the arrangement is expected to continue for some
time. Even so, it is rather expensive financing. It may, however, be
the only source open to a borrower who has exhausted his unsecured
credit, and it does have several advantages for the small businessman.
He can build up his inventories when he finds it most profitable

to do so .
He can maintain a more stable production schedule .
He can take advantage of cash or quantity discounts .
He can get additional working capital at times when operating
costs are high and working capital is low.
Floor planning. Floor planning is used mostly to finance the inven-

tories of automobile and appliance dealers- merchants whose product
units are easily identifiable and have considerable unit value . In floor
63
planning, the dealer has possession of the merchandise ( in exchange

for a note) , but title to it remains with a bank or other lender who has
paid the manufacturer. When the dealer sells a unit, he must pay the
lender the amount due on that unit. The agreement contains various
provisions for the protection of the lender.
Trade credit. Trade credit is the credit extended by a supplier to

a buyer for goods purchased. It is the most commonly used form of
short-term credit, especially among small businesses.
If the goods purchased are paid for in time to take advantage of the
cash discounts, trade credit costs the buyer nothing. If not, it can be
one of the most expensive types of financing.
Suppose you have an invoice for $ 1,000 with terms of 2/10, net/30.
If you pay the invoice within the 10 days, you will pay $980. But sup-
pose you do not have enough cash to pay the invoice within 10 days,
although you will be able to pay it within the 30-day period . You will
then have to pay the full $ 1,000. In other words, the extra 20 days'
credit will cost 2 percent of $ 1,000, or $20.
On the other hand, if you borrowed $ 1,000 from the bank on a 30-day
note and paid the invoice within the 10 days, you would pay the bank
only $5 interest, a saving of $ 15 .
It pays to use the full cash-discount period or, if no cash discount is
offered, the full credit period . Delaying payment beyond the credit
period, however, injures your credit rating and may be costly in the long
run.
1
Except that the cost to the supplier of extending credit is hidden in the price.
This cost, however, cannot be avoided unless the supplier offers a discount for imme-
diate cash payment .
CHAPTER 9
Long-Term Financing
When long-term rather than short- or intermediate-term funds are

needed, one or more of the following sources may be used :
1. Internal sources such as retained earnings, asset reductions, or the
sale of assets not essential to the business ( for example, security holdings ) .
2. Long-term borrowings.
3. The investment of new permanent capital.
Which kind of financing you use may depend upon what you can get,
since sources of long-term loans or new capital for small businesses are
not plentiful. But before you begin your search, you should know which
type is best for your needs.
New Equity Or a Long-Term Loan?
A small businessman is sometimes reluctant to accept new equity from

outside the business because he wants to keep ownership of the business
entirely in his own hands. Sometimes, however, more equity capital is
what the business needs, rather than a loan.
Furthermore, equity capital may have some real advantages over long-
term borrowed funds. It is true that an investor of equity capital often
expects to have a voice in the management of the company in which he
risks his money. But that prospect is not necessarily a grim one. He
may bring new skills or a fresh viewpoint that will add strength and
vitality to the business .
On the other hand, loans, too, have some advantages. These advan-
tages were pointed out at the beginning of chapter 7. The important
point is that all types of funds should be considered carefully in relation
to the needs and existing resources of your business.
Sources of Long-Term Loans
If you decide that your need for long-term funds cannot be filled from
within the company, you should first of all talk the problem over with
64
65
your banker. Even if he is unable or unwilling to provide the funds you

need, discussing your situation with him will sharpen your own under-
standing of it, and he may be able to suggest other sources.
A correspondent bank, another local bank, or a small business invest-
ment company (see page 70 ) may be able to help you . Perhaps your
bank will agree to share a loan with one or more other financing agen-
cies. In many communities, there are individuals, local credit pools,
State or community development companies, or other lending agencies
that may be able to supply funds on terms that will suit your needs.
Some Federal agencies make or guarantee loans for certain types of
businesses or purposes.¹ And of special interest to small businesses gen-
erally is the lending program of the Small Business Adminitration.
The Small Business Administration
The Small Business Administration ( SBA ) is an independent agency

of the Federal Government, established by Congress to advise and help
the Nation's small businesses. Its four major areas of activity are :
• Helping small companies find adequate capital and credit.
• Providing management, financial, and production counsel .
Licensing and regulating small business investment companies.

Helping small business get a fair share of Government procurement
contracts and surplus sales.
Financial counseling. If you need counseling in connection with
financing your business , you may get help from financial specialists as-
signed to SBA's field offices, which are listed on the inside back cover of
this booklet. These specialists are prepared to advise you on a wide
range of financial problems. They may be able to help you get a loan
on reasonable terms from a bank or other private source. Or they may
be able to show you how to solve your problem without borrowing-by
making some changes in your management or financial policies or
methods.
SBA loans. If borrowing does appear to be necessary or advisable,

and no private source can be found , SBA will consider making the loan.
However, by law, SBA cannot consider a loan application unless there
is evidence that the loan could not be obtained elsewhere on reasonable
terms. This usually means a letter from one or two banks notifying you
that your application for a loan has been rejected .
The basic information about the most important of these lending programs is
presented in Management Aids for Small Manufacturers, No. 52 , "Loan Sources in
the Federal Government," which is available free from your nearest SBA field office
or from the Small Business Administration, Washington, D.C. 20416.
66
It is the policy of SBA to encourage loans by banks and other private

institutions. Therefore, if the bank is willing to supply part but not all
of the funds needed , SBA will consider participating with it in a loan
to the businessman or guaranteeing part of a loan made to him by the
bank. SBA may either provide or guarantee up to 90 percent of a bank
loan.
If the bank cannot extend credit even in participation with SBA,
the borrower may apply for a "direct" SBA loan- that is, a loan for
which SBA supplies all the funds. Under the law, SBA cannot enter
into a direct-loan agreement if a participation loan is available, nor into
an immediate participation agreement if a loan is available on the guar-
anty basis.
The key features of SBA's principal business-loan programs are shown
in exhibit 21. Lower interest rates, longer maximum maturities, and
lower collateral requirements than those shown are granted when sub-
stantial economic injury has been suffered through ( 1 ) a major natural
disaster as determined by the President or the Secretary of Agriculture ;
(2 ) a small firm's inability to process or market a product for human con-
sumption because of disease or toxicity of the product ; or ( 3 ) relocation
of a small firm as a result of its displacement by a Federally aided urban-
renewal, highway, or other construction program.
Are you eligible for an SBA loan ? To be eligible for consideration

for a business loan from the Small Business Administration, a company
must qualify as a small business and must meet SBA's credit require-
ments.
For business-loan purposes , SBA defines a small business as one that
(1 ) is independently owned and operated, ( 2 ) is not dominant in its
field, and ( 3 ) meets certain standards of size in terms of employment or
annual receipts. These standards vary for different types of businesses.
Call or write the nearest SBA field office for the specific standards for
your industry.
In addition to qualifying as a small business, a loan applicant must
meet the following general credit requirements :
• The applicant must be of good character.

• There must be evidence that he has the ability to operate his business
successfully.
• He must have enough capital in the business so that, with loan as-
sistance from SBA, he will be able to operate on a sound financial basis.
The past record and future prospects of the business must indicate
ability to repay the loan out of income from the business.
Since the Small Business Administration is a public agency using tax-
payers' funds, it has an unusual responsibility as a lender. Therefore,
it will not make loans to a few types of businesses nor for certain purposes.
67
For example, loans will not be made to gambling enterprises ; to firms in

which 50 percent or more of the net sales is derived from the sale of alco-
holic beverages ; nor for the purpose of speculation in real or personal
property.
What to do. If you have been unable to obtain funds elsewhere and
intend to apply for an SBA loan, you should first visit the nearest SBA
field office ( see inside back cover ) and discuss your situation with an SBA
financial specialist. This is not a rigid requirement, but it will be well
worth your while. You will find his advice most valuable in the prep-
aration of your loan application , and probably even beyond that.
Take with you the business records you prepared in connection with
your application for a bank loan and any other information that might
help the financial specialist understand your problems. No charge is
made for information and counsel furnished by SBA either in connection
with the preparation and filing of an application or as part of its general
counseling program.
Your banker can probably supply the application forms you need. If
not, you can get them from the SBA field office.
State and Local Development Companies
The Small Business Administration is also authorized to lend funds to

State and local development companies for use in financing specific small
businesses. An increasing number of States and local communities are
organizing development corporations, or industrial foundations, to pro-
mote the establishment or expansion of businesses in their areas. Serv-
ices offered by these organizations may include the following :
• Buying, developing, and selling industrial sites. This usually results

in less delay and more reasonable prices for the small manufacturer seek-
ing a site than negotiations through regular business channels.
Buying and building plants for lease or sale. Here, too, a purchase
price may be lower than would have to be paid otherwise. If the plant is
leased, less investment in fixed assets will be necessary, with more money
available for working capital.
• Providing funds by direct intermediate- or long-term loans or by

purchase of stock in the business. In some cases, development companies
will lend larger amounts in proportion to the value of the security and for
longer periods than is customary for banks.
Giving management, engineering, and other counseling services to
By pooling the knowledge of the businessmen of the
small businesses.
community, an industrial foundation is often able to provide expert
advice.
Exhibit
21
Features
Key
SBA's
of
Small
Business
Programs
Loan
68
information
(F or
loans
about
and
State
to
development
local
companies
business
loans
investment
,asmall
nd
loans
disaster
nearest
field
SBA
write
or ontact
office
Small
the
to
WAdministration
ashington
,cDBusiness
.C.
20416.
)
BANK
SIMPLIFIED SIMPLIFIED
EARLY
BUSINESS
REGULAR PROGRAM
LOAN
SMALL PARTICIPATION MATURITY
PALN
PLAN
businesses
Most
in-
are
that that
business
Any that
business
Any Regular
under
as
Same
dependently
op-
and
owned meets
criteria meets
criteria Business
Plan
.Loan
dominant
not
and
erated
in stated
under
Regular Regular
for Major
distinction
fields
their
cannot
;that .
Plan
Loan
Business Business
Loans between
this
plan
obtain
private
financing
on Small
Loan
Plan
is will
bank
if Bank
Simplified
and
WHO
IS reasonable
and
terms
not
are design-
specifically greater
provide Participation
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?
ELIGIBLE financing
for
eligible
from the
meet
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ed
needs %o:25f
of total that
is
bank
pro-
other
Government
agencies
, of
firms
small
very loan
,oanr vides
least
at
50
%
as
qualify
that
mall
s"and unable
obtain
to equal
amount
to loan
of
and
is
re-
SBA's
under
standards
,size financing
other
be- be
to
loan
bank paid
.
SBA
before
generally
which
based
are
on cause
lack
of .
refinanced
dollar
volume
business
of
or .
collateral
adequate
number
of
employees
.
Business
cconstruction
, on- Regular
under
as
Same Same
under
as Same
under
as
Regular
version
or
expansion
; Business
Loan
.
Plan Business
Regular Business
Loan
.
Plan
LOAN purchase
equipment
of
, Loan
Plan
.
PURPOSES facilities
achinery
sm, up-
materials
or
plies
;and
.
capital
working
borrower
any
$3
to50,000
.one 5,000
any
$to
1one $350,000
to
any Same
as
under
Simpli-
maximum
is
This
of
share
SBA borrowe
SBA
,as r borrowe
one
,as r Partici-
Bank
fied
participation
"-
loan
one share
of
participa- of
share
SBA Plan
.
pation
MAXIMUM and
SBA
by
jointly
made loan
tion
SBA
or loan
.
AMOUNT private
institu-
lending direct
.
loan
maximum
and
--
tion
SBA
loan
-"" irect
one
dmade
Agency
by
.entirely
Maximum
51
%pofer
on
annum Regular
under
as
Same under
as
Same
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Regular
under
as
"iSBA
of
share
mmediate .Business
Plan
Loan ular
Business Business
,
Plan
Loan
wloan
"( here
participation Loan
.
Plan immediate
but
on
private
and
SBA
in-
lending basis
participation
stitution
each
put
part
up only
.
funds
loan
of
)immediately
and
loan.1
direct
SBA
on
INTEREST Where
SBA
apguarantees
or-
RATE in-
of
,ltion
a oan ending
set
may
stitution
"reason-
legal
and
r"able
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,i
Hentire
. owever
loan f
share
its
provides
later
SBA
of loan
share
SBA
on
,rate
maximum
is
5+%.then
1of
10
of
aule
as
years
r.Maximum Maximum
yof
6, ears Reg-
under
as
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under
as
However
working
capital plus
for
needed
time Business
ular Business
.
Plan
Loan
limited
are
generally
loans loan
if .Loan
construction Plan
construc-
wto
,6yhile
ears buildin
for
is
used g
MATURITY maximum
have
may
loans
tion constru
. ction
estimated
of
plus
years
10
construc-
for
required
time
tion
.
mort-
chattel
or
estate
Real Whatever
worthwhile under
as
Same
Reg- Same
Regular
under
as
gage
;assignment
ware-
of avail-
is
collateral ular
Business ,Business
Plan
Loan
marketable
for
house
receipts , ncluding
able
iany .
Plan
Loan col-
that
except
of
;assignment
merchandise fixed
assets
pur- lateral
of
be
must
,
contracts
of
types
certain the
with
ohased subject
not
type
a
TYPE
OF en-
personal
or
guarantees loan
. deprecia-
rapid
to
COLLATERAL ;in
dorsements
in-
some tion
obsoles-
or
ourrent
stances
of
assignment oenoe
.
receivables
,and
inventories
otherwise
or
bonded
in
stored
.
warehouse
acceptable
AUGUST
1964 Government
Interest
%
14
Federal
by
classified
certain
in
.charged
areas
redevelopment
or
unemployment
as
69
70
The primary purpose of development companies is to promote the eco-

nomic welfare of their communities. Therefore, the small businessman
who seeks their cooperation needs to be able to show that substantial
benefit to the community will result.
Small Business Investment Companies
Small business investment companies ( SBIC's ) may make long-term

loans to incorporated and unincorporated small businesses to provide
funds for sound financing, growth, modernization, and expansion . Ex-
cept under special circumstances , these loans must have final maturities of
not less than 5 years and not more than 20 years. Since a major function
of SBIC's is to provide equity financing for small businesses, they are dis-
cussed more fully in the next chapter.
CHAPTER 10
Equity Financing
Suppose you decide that you need more equity capital rather than
a long-term loan.Where will you get that kind of money? The first
place to look is within the company. Has your financial planning pro-
vided for retained earnings that can be plowed back into the business?
Is your expectation of future profits firm enough so that with sound
planning and management you can count on plowing back substantial
amounts in the next few years? Do you have personal funds that you
can invest in the business, or securities that can be sold?
External Sources of Equity Capital
If internal sources do not produce the amount of new equity capital

you need, the next step is to look for someone outside the company who
will invest money in the business- in other words, who will buy a share
of it. The most likely place for most very small, unincorporated busi-
nesses to find this kind of capital is among or through friends and rela-
tives, business associates, and perhaps employees. There are a few
other sources available under certain circumstances, however.
Small Business Investment Companies
A new source of equity financing for small businesses, as well as long-

term loans ( see chapter 9 ) , was opened up by the Small Business In-
vestment Act of 1958. This act authorized the establishment of small
business investment companies ( SBIC's ) . Responsibility for licensing,
regulating, and in some cases helping to finance these organizations was
delegated to the Small Business Administration. SBIC's, in turn, were
to help finance small businesses by providing long-term loans and equity
capital.
Although SBIC's are licensed by SBA, they are privately owned ( that
is, non-Governmental ) and privately operated, profit-motivated corpo-
rations. (Their activities are restricted , however, to providing financing
71
72
and advisory services to small businesses. Other activities may be en-

gaged in only if they are incidental and appropriate to these primary
functions . ) SBA sets down broad guidelines for the operation of
SBIC's, but it does not supervise the negotiations between you and the
investment company. Any agreement you reach is a strictly private
business arrangement between you and the SBIC.
Types of SBIC financing. If your company is incorporated, an

SBIC may supply your business needs through a long-term loan ( not
less than 5 years ) , by supplying equity capital , or by combinations of
these two. The equity capital may be supplied through straight pur-
chase of stock in your company, through loans with stock-purchase war-
rants attached, or through the purchase of notes or bonds that can be ex-
changed for stock ( convertible debentures ) . In order to sell stock or
issue convertible debentures, your firm must be a corporation . There-
fore, if it is a partnership or a proprietorship, and you do not wish to
incorporate, a long-term loan is the only type of financing you can get
from SBIC's.
Other services. A great advantage in doing business with an SBIC

is that you may have access to added management skills. These skills
can be very important to your concern as it grows, enters new markets
and areas, and comes up against new competitors. The SBIC may wish
to put a representative on your board of directors, both to help you and
to keep the SBIC management informed of your progress.
How to start. If you are considering applying to an SBIC for

financing , first talk the problem over with your lawyer, your account-
ant, and your banker . Clarify in your mind whether you really want
equity financing, or just a loan. Be sure that you know how much
financing you need and why, and that you understand clearly the vari-
ous types of financing SBIC's may offer-what you get and what you
must promise in each case. Send for the free SBA pamphlet on SBIC
financing, and study it.
Choosing an SBIC. Once you have decided to seek SBIC financing,

you immediately face another important decision-the choice of an
SBIC. The best way to start is to get a complete list of licensed small
business investment companies from the nearest SBA office . Then talk
with your advisers and with other business associates who may have had
dealings with SBIC's or who might be able to direct you to someone who
has.
Points to consider. Here are some factors that should be kept in

mind in choosing an SBIC :
Size . The amount an SBIC can invest in a single small business
is limited to 20 percent of its paid-in capital and surplus , and some of
73
them prefer to stay below this maximum. However, an SBIC may team
up with other sources of financing, including other SBIC's, to provide a
larger amount than it could provide alone.
In considering size, be sure to keep in mind your company's long-term
financing needs—at least up to the time you are ready for a public of-
fering of stock, if you are thinking in those terms. Will this SBIC
financing do the job, or will you need another injection of capital later?
Is it possible that you will need more funds as the result of an emergency?
Will the SBIC you choose be able to provide more money if you need it?
Geographic location . Generally speaking, if other factors are

equal , you are better off dealing with an SBIC that has other investments
in your area. This is especially true if you plan to rely on the SBIC for
management assistance.
• Specialized interests. A number of SBIC's specialize in certain

industries or services . When this is the case, the investment company's
officers or directors are likely to be especially competent to help small
businesses in that field.
• Types of investment. Many SBIC's will make only equity-type

investments ; others, only straight loans. Be sure the SBIC's you ap
proach make the type of investment you want.
Management. Most expanding small businesses that are looking

for equity financing need management assistance. SBIC's vary in their
ability to provide this help and in the ways in which it is provided. A
fee may or may not be charged.
How to apply. Once you decide which SBIC's you would prefer to
deal with, and in what order, select one or two to talk to first. If neither
of them can help you , then try numbers three and four on your list. But
before you enter into any negotiations, be sure that you know your own
company its conditions, needs, and expected future development. Un-
derstand why you need this financing and what you will do with it.
Also, prepare a written prospectus for the SBIC outlining your com-
pany's background, present status, and future outlook. Include financial
statements and projections for the next several years. Relate your need
for equity capital to these projections, and include a realistic appraisal
of your company's growth and profit potential.
SBIC's and venture-capital companies. Many SBIC's, including

a number of the large ones, operate in a manner similar to that of the
venture-capital companies described in the next section. A major dif-
ference is that SBIC's all operate under the same ground rules, just as
banks and savings and loan associations do . These ground rules, which
are spelled out in the Small Business Investment Act and regulations,
are designed primarily to protect the small businessman.
74
Venture-Capital Companies
If your company is pioneering in a new field, one of the organizations

known as venture- or risk-capital companies may be a source of equity
capital. These companies invest in relatively undeveloped industries
that show good growth prospects . Their interests include new services,
processes, and products in almost every commercial, industrial, and scien-
tific industry .
Venture-capital companies finance their projects in a number of ways.
The most common is a straight exchange of stock for the funds. In most
cases, these companies demand voting stock for the risks they take.
The venture company usually agrees to invest a certain maximum
amount of capital . For the protection of both parties, the capital is
usually not given all at once, but by preset periods, as the new company
meets its projections .
Whether or not the venture-capital company buys a controlling inter-
est, it prefers that the manager of the small company continue to run
his own business. Confidence in the manager is one of the criteria for
investment. The investing company, however, usually acts as adviser,
providing background support in such areas as financial management,
administration, and marketing. It may also help the small company
select a board of directors whose members can be helpful in the various
aspects of the business and can provide valuable contacts .
How to apply. Some venture- capital companies prefer to seek out

their own prospects. Others welcome solicitation . If you do not know
of any of these companies, a banker, attorney, corporation director, in-
vestment banking company, or SBA field office can probably put you
in touch with one. Venture companies use these sources in their search
for prospects.
Venture companies are experienced in judging the merits of original
ideas. They can usually express interest or disinterest quickly, giving
concrete reasons for their reaction. So , to present the broadest and most
accurate case for your idea, you should be ready to answer these ques-
tions and the answer should be yes, with supporting evidence :
Have you surveyed the market for your product, process, or

service? Is there a need for it? Does it have a broad potential market?
With little or no competition ?
Does it open a genuinely new place in the market?
• Are there good growth possibilities for the idea? Does it lead to
the production of related products , processes, or services?
• Are the potential profits good?
Do you have enough business, management , production , or tech-
nical background to see your idea through ?
75
You should also be prepared to furnish the following more specific

information :
The amount of money needed.

The purpose for which it is to be used.
A brief financial history of the company.
A biography of the principals.
A balance sheet and a profit-and-loss statement.
If you are just getting started. Most venture companies now prefer
to invest in small companies that have been established for 2 or 3 years.
If, however, you intend to ask for help in starting your business, you
should be able to answer yes to the following questions :
Have you developed a model, or in some other way checked out the
technical soundness of your idea?
Have you worked out the probable costs of your idea in terms of pro-
duction, overhead, and marketing?
Going Public
Selling stock to the public is another way of getting equity capital. To

do this, you must incorporate, if you haven't already done so. The stock
is usually sold through an investment house, and extreme care should be
taken to find one that is competent, reliable, and experienced in handling
small issues. First of all, discuss the idea with your advisers—your
banker, your lawyer, your accountant- and with a consultant who
specializes in the field of public financing for small companies.
At best, though, "going public" is likely to be an expensive, involved,
and uncertain way for a small business to raise funds. It is not for most
small businesses.
CHAPTER 11
Sources of Further
Information
This booklet has described several concepts and tools of financial

analysis that can help the small businessman interpret financial data and
manage the operations of his business. But it is important to remember
that understanding and applying these tools successfully requires more
than a knowledge of how the tools work. It is also essential to under-
stand when the tools should be used and, more important, what their
strengths and limitations are.
Financial analysis cannot be carried out in a routine, standardized
way. You must be able to tailor the concepts and tools to the specific
requirements of your business. You must ask yourself, "What questions
need to be asked about my business ?" and then, "What approach shall
I use to get practical answers to these questions?"
Before analyzing a financial problem , ask yourself these questions :
"What factors, trends, relations, and time periods have a bearing on
the problem ?"
"What tool or method of analysis will be most useful?"
"How much detail work is justified?"
The amount of literature in the field of business finance is vast. Some
of the information is not applicable to the finance problems of small
businesses. Much of it is, however, and some of it is designed especially
for small businessmen.
The following lists may be useful to small business owner-managers
who wish to study the subject of business finance further. The lists are
necessarily brief. No slight is intended toward authors and sources not
included .
Sources of Industry Ratio Data
Among the best known sources of industry ratio data with which to
compare your own ratios are the following :
76
77
Quarterly Financial Report for Manufacturing Corporations. Published

jointly by the Federal Trade Commission and the Securities Exchange
Commission. For sale by the Superintendent of Documents, U.S.
Government Printing Office, Washington, D.C. 20402. Annual sub-
scription : domestic, $ 1.25 ; foreign, $ 1.75.
Covers, in broadly defined industry groups, all manufacturing cor-
porations except newspapers and related subgroups.
Fourteen Important Ratios. Published annually by Dun and Bradstreet,
Inc., 99 Church St. , New York, N.Y. Free.
Covers 72 lines of business activity, including manufacturing, whole-
saling, and retailing industries.
Statement Studies. Published annually by Robert Morris Associates , Na-
tional Association of Bank Loan Officers and Credit Men, Philadel-
phia National Bank Bldg., Philadelphia, Pa. $ 10.
Based on data collected from member banks of the association.
Covers 175 lines of business.
Mail-Me-Monday Barometer of Small Business . Published semiannually

by the Accounting Corporation of America, 1929 First Ave., San Diego,
Calif. $ 12.50.
The businesses covered here are mostly retail and commercial service
groups.
Specialized Industry Reports. There are many sources of ratio data special-
izing in single industries or industry groups . These sources include trade
associations, specialized accounting firms, trade magazines, universities,
some large industrial corporations, and several Government agencies.
A number of them are listed in the booklet Ratio Analysis for Small
Business (see below, under "U.S. Government Publications" ) . This
booklet also has more detailed information about the publications
whose specific titles are mentioned above.
U.S. Government Publications
• The following publications may be purchased from the Superin-

tendent of Documents, Washington, D.C. 20402 .
Cost Accounting for Small Manufacturers, by R. Lee Brummet ( Small Busi-
ness Management Series No. 9) . 1953. Small Business Administra-
tion. $ 1.60.
Ratio Analysis for Small Business, by Richard Sanzo ( Small Business Man-
agement Series No. 20 ) . 3d ed . 1970. Small Business Administration .
70 cents .
Guides for Profit Planning, by B. LaSalle Woelfel ( Small Business Man-

agement Series No. 25 ) . 1960. Small Business Administration. 70
cents.
Management Audit for Small Manufacturers, by Philip M. Faucett ( Small

Business Management Series No. 29) . 1963. Small Business Ad-
ministration . 65 cents.
78
Insurance and Risk Management for Small Business, by Mark R. Greene

(Small Business Management Series No. 30 ) . 1963. Small Business
Administration . 80 cents.
Management Audit for Small Retailers, by John W. Wingate ( Small Busi-

ness Management Series No. 31 ) . 1964. Small Business Adminis-
tration. 65 cents.
The First Two years : Problems of Small Firm Growth and Survival, by
Kurt B. Mayer and Sidney Goldstein ( Small Business Research Series
No. 2. ) 1961. Small Business Administration. $2.40 .
Interbusiness Financing: Economic Implications for Small Business, by Rob-

ert P. Hungate ( Small Business Research Series No. 3 ) . 1962. Small
Business Administration . $ 1.50.
Guides for Business Analysis and Profit Evaluation . 1959. Business and
Defense Services Administration , U.S. Department of Commerce. 30
cents.
• Write to your nearest SBA field office for SBA 115A, Free Manage-
ment Assistance Publications.
Books
Basic Business Finance, by Pearson Hunt, Charles M. Williams, and Gordon

Donaldson. Rev. ed. 1961. $ 11.35 . Richard D. Irwin, Inc., 1818
Ridge Rd., Homewood, Ill.
Financial Management, by Robert W. Johnson . Rev. ed . 1962. $ 11.35 .

Allyn & Bacon, Inc. , Rockleigh , N.J.
Inventories and Business Health, by Roy A. Foulke. 1960. $1 . Dun &
Bradstreet, Inc. , 99 Church St. , New York, N.Y.
Practical Financial Statement Analysis, by Roy A. Foulke . 5th ed. 1961 .
$ 12.50 . McGraw- Hill Book Co. , Inc. , 330 West 42d St. , New York,
N.Y.
Managerial Finance, by J. Fred Weston. 1962. $ 11.35 . Holt, Rinehart,

and Winston, Inc. , 383 Madison Ave. , New York , N.Y.
Accounting in Business Decisions, by H. A. Black and J. E. Champion.

1961. $ 11.95 . Prentice-Hall, Inc. , Englewood Cliffs , N.J.
Financial Controls for Management, by R. B. Lewis. 1961. $ 19.50 .
Prentice -Hall, Inc. , Englewood Cliffs, N.J.
Techniques of Financial Analysis. E. A. Helfert, editor. 1963. $5.25.

Richard D. Irwin, Inc., Homewood , Ill .
Management Accounting, by R. N. Anthony. Rev. ed . 1960. $ 10.65 .
Richard D. Irwin, Inc. , Homewood, Ill.
How to Control Accounts Receivable for Greater Profits. 1959. $1.

Dun & Bradstreet. Inc. , 99 Church St., New York, N.Y.
Equity Financing for Small Business, by Salomon J. Flink. 1962. $ 7.50.
Simmons-Boardman Books , 30 Church St., New York, N.Y.
79
Financing Business Firms, by Charles L. Prather. 1961. $ 10 . Richard

D. Irwin, Inc., Homewood, Ill.
The Flow of Funds in Small Business and in Large Business, 1963. $2.50.
Brown University, Providence, R.I.
Financing and Initial Operations of New Firms, by George W. Summers.
1962. $4.50. Prentice-Hall, Englewood Cliffs, N.J.
✩U.S. GOVERNMENT PRINTING OFFICE : 1974 O-557-603

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SMALL BUSINESS MANAGEMENT SERIES No. 15 ( Seventh Edition )

SBA 1.12:15/7 C.1

3 6105 095 870 247

SMALL BUSINESS ADMINISTRATION

SMALL BUSINESS MANAGEMENT SERIES No. 15 ( Seventh Edition )

3 6105 095 870 247

SMALL BUSINESS ADMINISTRATION

SMALL BUSINESS ADMINISTRATION

SMALL BUSINESS ADMINISTRATION

OFFICE OF MANAGEMENT DEVELOPMENT

For sale by the Superintendent of Documents, U.S. Government Printing Office

"Life can only be understood backwards, but it must be lived for-

EUGENE P. FOLEY, Administrator

1 What Is Financial Management ? 1

3 Ratio Analysis of Financial Statements 18

5 Managing Your Investment in Assets 37

The Cash Budget, 43 ; Projected Financial Statements , 45;

7 The Borrower and His Banker 53

8 Short and Intermediate-Term Credit 59

External Sources of Equity Capital, 71 ; Small Business In-

11 Sources of Further Information 76

"It takes money to make money." This maxiin is a simple way of

• Repaying borrowed funds from profits those funds have

Sources and Uses of Funds

As financial manager, you will find it helpful to think of assets as "uses”

/INCREASES in /INCREASES in assets

Getting the Financial Resources You Need

Your most important task as financial manager is to find sources of

You can increase liabilities and/or equity to match the in-

Or you can reduce the investment in some existing asset so

Let's assume, for example, that your business, in order to keep or

Making a Profit- Your Basic Obligation

A primary reason for owning and operating your own business is to

One of your most important duties as financial manager is to keep

Thus, it is a useful tool in judging and comparing various investment

The Tools of Financial Management

If your financial management is to be more than guesswork, you must

Accounting records. Good accounting records are the foundation

Financial reports. There are a number of financial reports that can

Third, you should be able to read and interpret these statements as

Techniques for analyzing financial statements. Various percent-

The Balance Sheet

Total assets.. $165,000

Liabilities and Equity

Total liabilities and equity. $165,000

1 Not a real company.

The MONAR Company ¹

Total assets ... $147,000

Liabilities and Equity

Total liabilities and equity .... $147,000

1 Not a real company.

• "Other" assets include patents, trade investments , goodwill, and

Liabilities .Liabilities are the claims of creditors against the assets

Monroe Manufacturing Company¹

Liabilities and Equity

1 Not a real company .

Valuation accounts. Depreciation and other factors reduce the

Accounts receivable are analyzed according to the length of time

• Losses in the value of inventories may occur as a result of price

Fixed assets, other than land, decline in value. This decline in

Exhibit 1 shows a simple balance sheet. It represents the financial po-

1. Accounts receivable have been reduced by $3,000 to an esti-