Creating a Solid

Financial Plan

Chapter 7 Solid Financial Plan Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 1
 Financial Planning
 a financial plan is a vital tool to help
entrepreneurs manage their businesses
more effectively, steering their way around
the pitfalls that cause failures.
 Entrepreneurs who ignore the financial
aspects of their businesses run the risk of
watching their companies become another
failure statistic.

Chapter 7 Solid Financial Plan Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 2
 Financial Planning

 Research:
 Significant numbers of entrepreneurs run
their companies without any kind of
financial plan!
 A significant positive relationship exists
between formal planning in small
companies and their financial
performances

Chapter 7 Solid Financial Plan Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 3
 Basic Financial
Reports
 Balance Sheet - estimates the firm's worth on a
given date; built on the accounting equation:
Assets = Liabilities + Owner's Equity
 Income Statement - compares the firm's expenses
against its revenue over a period of time to show
its net income (or loss):
Net Income = Sales Revenue - Expenses
 Statement of Cash Flows - shows the change in the
firm's working capital over a period of time by
listing the sources of funds and the uses of these
funds

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 Foundation for Financial Forecasts
•Marketing analysis and forecasts → Demand for
products or services
•Assumptions

Forecasted (pro forma) Financial Elements

Projected start-up
Forecasted capital Forecasted
Balance Sheet requirements Income
Statement
Current assets
Forecast
Sales
revenues
Fixed assets Expenses
Depreciation
Liabilities
Forecast expenses
Operating income
Owner’s equity
Interest
Total liabilities Financing Plan Taxes
and equity (Sources of Funds)
Net income

Cash Flow Forecast

• From operations
•From investing
•From external sources of financing

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

Current Ratio = Current Assets = $686,985 = 1.87:1

Current Liabilities $367,850

Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall

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

Quick Ratio = Quick Assets = $231,530 = .63:1

Current Liabilities $367,850

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 Twelve Key Ratios
 Leverage Ratios - Measure the financing provided
by a firm's owners against that supplied by its
creditors; a gauge of the depth of a company's
debt
 Careful!! Debt is a powerful tool, but you must
control it

Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall

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

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

Total Assets $847,655

Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall

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

Debt to Net = Total Debt = $580,000 = 2.20:1

Worth Ratio Tangible Net Worth $264,155

Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall

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

Times Interest = EBIT* = $100,479 = 2.52:1

Earned Total Interest Expense $39,850

*Earnings Before Interest and Taxes

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

Average Inventory = Cost of Goods Sold = $1,290,117 = 2.05 times

Turnover Ratio Average Inventory* $630,600 a year

*Average Inventory = Beginning Inventory + Ending Inventory

2

Days’ Inventory (or average age of inventory) = 365 ÷ 2.05 = 178 days

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 Twelve Key Ratios
Operating Ratios - Evaluate a firm's overall performance and
show how effectively it is putting its resources to work
7. Average Collection Period Ratio - Tells the average number
of days required to collect accounts receivable
Two Steps:

Receivables Turnover = Credit Sales = $1,309,589 = 7.31 times

Ratio Accounts Receivable $179,225 a year

Average Collection = Days in Accounting Period = 365 = 50.0 days

Period Ratio Receivables Turnover Ratio 7.31

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 Twelve Key Ratios
Operating Ratios - Evaluate a firm's overall performance
and show how effectively it is putting its resources to work
8. Average Payable Period Ratio - Tells the average number
of days required to pay accounts payable
Two Steps:

Payables Turnover= Purchases = $939,827 = 6.16 times

Ratio Accounts Payable $152,580 a year

Average Payable = Days in Accounting Period = 365 = 59.3 days

Period Ratio Payables Turnover Ratio 6.16

Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall

 Twelve Key Ratios
Operating Ratios - Evaluate a firm's overall
performance and show how effectively it is putting its
resources to work
9. Net Sales to Total Assets Ratio - Measures a firm's
ability to generate sales given its asset base

Net Sales to = Net Sales = $1,870,841 = 2.21:1

Total Assets Total Assets $847,655

Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall

 Twelve Key Ratios
Profitability Ratios - Measure how efficiently a firm is
operating; offer information about a firm's "bottom
line"
10. Net Profit on Sales Ratio - Measures a firm's profit per
dollar of sales revenue

Net Profit on = Net Income = $60,629 = 3.24%

Sales Net Sales $1,870,841

Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall

 Twelve Key Ratios
Profitability Ratios - Measure how efficiently a firm is
operating; offer information about a firm’s “bottom
line”
11. Net Profit to Assets (Return on Assets) Ratio – tells
how much profit a company generates for each dollar
of assets that it owns

Net Profit to = Net Income = $60,629 = 7.15%

Assets Total Assets $847,655

Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall

 Twelve Key Ratios
Profitability Ratios - Measure how efficiently a firm is
operating; offer information about a firm's “bottom
line”
12. Net Profit to Equity Ratio - Measures the owner's rate
of return on the investment in the business

Net Profit to = Net Income = $60,629 = 22.65%

Equity Owner’s Equity* $267,655

* Also called net worth

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

Chapter 7 Solid Financial Plan Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 19
 Calculating the
Breakeven Point
Step 1. Determine the expenses the business can
expect to incur
Step 2. Categorize the expenses in step 1 into fixed
expenses and variable expenses
Step 3. Calculate the ratio of variable expenses to
net sales. Then compute the contribution margin:
1 - Variable Expenses
Contribution Margin =
Net Sales Estimate
Step 4. Compute the breakeven point:
Total Fixed Costs
Breakeven Point = Contribution Margin
$
Chapter 7 Solid Financial Plan Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 20
 Calculating the Breakeven
Point: The Magic Shop
Step 1. Net Sales estimate is $950,000 with Cost of
Goods Sold of $646,000 and total expenses of $236,500
Step 2. Variable Expenses of $705,125; Fixed Expenses of
$177,375
Step 3. Contribution margin:

$705,125
Contribution Margin = 1 - = .26
$950,000
Step 4. Breakeven point:
$177,375
Breakeven Point = = $682,212
.26
$
Chapter 7 Solid Financial Plan Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 21
Breakeven Chart
Revenue
r ea
Line ofi
t A
Breakeven Point Pr
Sales = $682,212 Total Expense
$682,212 Line
Income and Expenses

Area
ss Fixed Expense
Lo
Line

0 $682,212 Sales Volume

Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall
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 Publishing as Prentice Hall

Chapter 7 Solid Financial Plan Copyright ©2009 Pearson Education, Inc. Publishing as Prentice Hall 23