Creating a Creating a Successful Successful

Financial PlanFinancial PlanVolume is vanity; profitability is sanity Volume is vanity; profitability is sanity

…Brad Skelton…Brad Skelton

It is better to solve problems than crises It is better to solve problems than crises …John Guinther…John Guinther

Financial ManagementFinancial Management

A process that provides A process that provides entrepreneurs with relevant entrepreneurs with relevant financial information in an financial information in an easy-to-read format on a easy-to-read format on a timely basis; it allows timely basis; it allows entrepreneurs to know not entrepreneurs to know not only how their businesses only how their businesses are doing financially, but are doing financially, but also why they are also why they are performing that way.performing that way.

Basic Financial Basic Financial StatementsStatements

The Balance SheetThe Balance Sheet

a financial statement that a financial statement that provides a snapshot of a provides a snapshot of a business’s financial business’s financial position, estimate its position, estimate its worth on a given date; it is worth on a given date; it is built on the fundamental built on the fundamental accounting equation:accounting equation:

Assets = Assets = Liabilities + Owner’s Liabilities + Owner’s

EquityEquity

Basic Financial Basic Financial Statements (cont’d)Statements (cont’d)

current assets-current assets- assets such as cash and assets such as cash and other items to be converted into cash within other items to be converted into cash within one year or within the company’s normal one year or within the company’s normal operating cycle.operating cycle.

fixed assets-fixed assets- assets acquired for long-term assets acquired for long-term use in a business.use in a business.

liabilities-liabilities- creditors’ claims against a creditors’ claims against a company’s assets.company’s assets.

current liabilities-current liabilities- those debts that must be those debts that must be paid within one year or within the normal paid within one year or within the normal operating cycle of a company.operating cycle of a company.

long-term liabilities-long-term liabilities- liabilities that come liabilities that come due after one year.due after one year.

owners equity-owners equity- the value of the owner’s the value of the owner’s investment in the business.investment in the business.

Basic Financial Basic Financial Statements (cont’d)Statements (cont’d)

The Income StatementThe Income Statement a financial statement that a financial statement that

represents a “moving represents a “moving picture” of a business, picture” of a business, comparing its expenses comparing its expenses against its revenue over a against its revenue over a period of time to show its period of time to show its net profit (or loss).net profit (or loss).

cost of goods sold-cost of goods sold- the the total cost, including total cost, including shipping of the shipping of the merchandise sold during merchandise sold during the accounting period.the accounting period.

gross profit margin-gross profit margin- gross gross profit divided bye net sales profit divided bye net sales revenue.revenue.

operating expenses-operating expenses- those those costs that contribute costs that contribute directly to the manufacture directly to the manufacture and distribution of goods.and distribution of goods.

Basic Financial Basic Financial Statements (cont’d)Statements (cont’d)

The Statement of Cash The Statement of Cash FlowsFlows

a financial a financial statement showing the statement showing the changes in a changes in a company’s working company’s working capital from the capital from the beginning of the year beginning of the year by listing both the by listing both the sources and the uses sources and the uses of those funds.of those funds.

Creating Projected Creating Projected Financial StatementsFinancial Statements

Pro Forma Statements for the Small Pro Forma Statements for the Small BusinessBusiness

Pro Forma Income StatementPro Forma Income Statement

Pro Forma Balance SheetPro Forma Balance Sheet

Pro Forma Statement of Cash FlowsPro Forma Statement of Cash Flows

Creating Projected Creating Projected Financial Statements Financial Statements

(cont’d)(cont’d)Pro Forma Income StatementPro Forma Income Statement

1. Net Sales 2 options:1. Net Sales 2 options:

a) Net Profit (Industry)=a) Net Profit (Industry)= Net Profit Wanted/Net Sales Net Profit Wanted/Net Sales oror b) Net Sales=Sales Forecast b) Net Sales=Sales Forecast

Which one is Most Likely? Optimistic? Which one is Most Likely? Optimistic? Pessimistic?Pessimistic?

Tip: Compute for Average Daily SalesTip: Compute for Average Daily Sales

2. Estimated Monthly Expenses, see pages 393 & 2. Estimated Monthly Expenses, see pages 393 & 394394

Creating Projected Creating Projected Financial Statements Financial Statements

(cont’d)(cont’d)Pro Forma Balance SheetPro Forma Balance Sheet-Assets-Assets

Cash:Cash:Cash Requirement=Cash Expenses/AITR*Cash Requirement=Cash Expenses/AITR* *Average Inventory Turnover *Average Inventory Turnover

RatioRatio

Inventory:Inventory:AITR=Cost of Goods Sold/Inventory LevelAITR=Cost of Goods Sold/Inventory Level

Creating Projected Creating Projected Financial Statements Financial Statements

(cont’d)(cont’d)

Pro Forma Balance Sheet-Pro Forma Balance Sheet-LiabilitiesLiabilities

Accounts Payable (supplier Accounts Payable (supplier financing) financing)

Short-term Notes PayableShort-term Notes Payable

Long-term Notes PayableLong-term Notes Payable

Ratio AnalysisRatio Analysis

A method of expressing the A method of expressing the relationship between a y two relationship between a y two accounting elements that allows accounting elements that allows business owners to analyze their business owners to analyze their companies’ financial performancecompanies’ financial performance

Ratio Analysis Ratio Analysis Liquidity RatiosLiquidity Ratios: tell whether a small : tell whether a small

business will be able to meet its short-business will be able to meet its short-term obligations as they come dueterm obligations as they come due

Current RatioCurrent Ratio: measures a small firm’s : measures a small firm’s solvency by indicating its ability to pay solvency by indicating its ability to pay current liabilities out of current assetscurrent liabilities out of current assets

=Current Assets/Current Liabilities =Current Assets/Current Liabilities =$686,985/$367,850 =$686,985/$367,850

==1.87:1 Good: 2:1 Industry: 1.5:11.87:1 Good: 2:1 Industry: 1.5:1

Ratio AnalysisRatio AnalysisLiquidity Ratios (cont’d)Liquidity Ratios (cont’d) Quick RatioQuick Ratio: a conservative measure of a : a conservative measure of a

firm’s liquidity, measuring the extent to firm’s liquidity, measuring the extent to which its most liquid assets (minus which its most liquid assets (minus inventory) cover its current liabilitiesinventory) cover its current liabilities

=(Current Assets-Inventory)/Current =(Current Assets-Inventory)/Current LiabilitiesLiabilities

=($686,750-$455,555)/$367,850=($686,750-$455,555)/$367,850

==0.61:10.61:1

Good: 1:1 Industry: 0.50:1Good: 1:1 Industry: 0.50:1

Ratio Analysis Ratio Analysis

Leverage RatiosLeverage Ratios: measure the financing : measure the financing supplied by a firm’s owners against that supplied by a firm’s owners against that supplied by its creditors; they are a supplied by its creditors; they are a gauge of the depth of a company’s debtgauge of the depth of a company’s debt

Debt RatioDebt Ratio: measures the percentage of : measures the percentage of total assets financed by a company’s total assets financed by a company’s creditors compared to its ownerscreditors compared to its owners

=Total Debt (Liabilities)/Total Assets=Total Debt (Liabilities)/Total Assets =($367,850+$212,150)/$847,655=($367,850+$212,150)/$847,655 ==0.681:10.681:1 Good: 1:1 Industry: 0.64:1Good: 1:1 Industry: 0.64:1

Ratio AnalysisRatio AnalysisLeverage Ratios (cont’d)Leverage Ratios (cont’d) Debt to Net Worth RatioDebt to Net Worth Ratio: expresses the : expresses the

relationship between the capital relationship between the capital contributions from creditors and those contributions from creditors and those from owners and measures how highly from owners and measures how highly leveraged the company isleveraged the company is

=Total Debt (Liabilities)/Tangible Net =Total Debt (Liabilities)/Tangible Net WorthWorth

=($367,850+$212,150)/($267,655-$3,500)=($367,850+$212,150)/($267,655-$3,500)==2.20:1 Industry: 1.90:12.20:1 Industry: 1.90:1

Ratio Analysis Ratio Analysis Leverage Ratios (cont’d)Leverage Ratios (cont’d) Times Interest Earned RatioTimes Interest Earned Ratio: measures : measures

a small firm’s ability to make the a small firm’s ability to make the interest payments on its debtinterest payments on its debt

Times Interest Earned RatioTimes Interest Earned Ratio =EBIT/Total Interest Expense=EBIT/Total Interest Expense =($60,629+$39,850)/$39,850=($60,629+$39,850)/$39,850 ==2.52:12.52:1 Industry: 2.0:1Industry: 2.0:1

Ratio Analysis Ratio Analysis Operating RatiosOperating Ratios: help an entrepreneur : help an entrepreneur

evaluate a small company’s overall evaluate a small company’s overall performance and indicate how effectively performance and indicate how effectively the business employs its resourcesthe business employs its resources

Average Inventory Turnover RatioAverage Inventory Turnover Ratio: : measures the number of times its average measures the number of times its average inventory is sold out, or turned over inventory is sold out, or turned over during an accounting periodduring an accounting period

=Cost of Goods Sold/Average Inventory=Cost of Goods Sold/Average Inventory

=$1,290,117/($805,745+$455,455)/2 =$1,290,117/($805,745+$455,455)/2

==2.05 times/year2.05 times/year Industry: 4.0 times/yearIndustry: 4.0 times/year

Ratio Analysis Ratio Analysis

Operating Ratios (cont’d)Operating Ratios (cont’d) Average Collection Period RatioAverage Collection Period Ratio (DSO): (DSO):

measures the number of days it takes measures the number of days it takes to collect accounts receivableto collect accounts receivable

=Days/Receivables Turnover Ratio=Days/Receivables Turnover Ratio=365/Credit Sales/Accounts Receivable=365/Credit Sales/Accounts Receivable=365/$1,309,589/$179,225=365/$1,309,589/$179,225=365/7.31=365/7.31==50 days Industry: 19.3 days50 days Industry: 19.3 days

Ratio AnalysisRatio AnalysisOperating Ratios (cont’d)Operating Ratios (cont’d) Average Payable Period RatioAverage Payable Period Ratio: :

measures the number of days it takes measures the number of days it takes a company to pay its accounts payablea company to pay its accounts payable

=365/Payables turnover ratio=365/Payables turnover ratio=365/Purchases/Accounts Payable=365/Purchases/Accounts Payable=365/$939,827/$152,580=365/$939,827/$152,580=365/6.16=365/6.16==59.3 days59.3 daysIndustry: 43 daysIndustry: 43 days

Ratio AnalysisRatio AnalysisOperating Ratios (cont’d)Operating Ratios (cont’d) Net Sales to Total Assets RatioNet Sales to Total Assets Ratio: :

measures a company’s ability to measures a company’s ability to generate sales in relation to its asset generate sales in relation to its asset basebase

=Net Sales/Net Total Assets=Net Sales/Net Total Assets

=$1,870,841/$847,655=$1,870,841/$847,655

==2.21:1 2.21:1

Industry: 2.7:1Industry: 2.7:1

Ratio Analysis Ratio Analysis Profitability RatiosProfitability Ratios: indicate how : indicate how

efficiently a small company is being efficiently a small company is being managedmanaged

Net Profit on Sales RatioNet Profit on Sales Ratio: measures a : measures a company’s profit per dollar of salescompany’s profit per dollar of sales

=Net Profit/Net Sales=Net Profit/Net Sales

=$60,629/$1,870,841=$60,629/$1,870,841

==3.24%3.24%

Industry: 7.6%Industry: 7.6%

Ratio AnalysisRatio Analysis

Profitability Ratios (cont’d)Profitability Ratios (cont’d) Net Profit to Assets RatioNet Profit to Assets Ratio: :

measures how much profit a measures how much profit a company generates for each company generates for each dollar of assets that it ownsdollar of assets that it owns

=Net Profit/Total Assets=Net Profit/Total Assets=$60,629/$847,655=$60,629/$847,655==7.15%7.15%Industry: 5.5%Industry: 5.5%

Ratio AnalysisRatio Analysis

Profitability Ratios (cont’d)Profitability Ratios (cont’d) Net Profit to Equity RatioNet Profit to Equity Ratio: :

measures the owner’s rate of measures the owner’s rate of return on investmentreturn on investment

=Net Profit/Owner’s Equity=Net Profit/Owner’s Equity=$60,629/$267,655=$60,629/$267,655==22.65%22.65%Industry:12.6% Industry:12.6%

Interpreting Business Interpreting Business RatiosRatiosCritical numbersCritical numbers: :

indicators that indicators that measure key financial measure key financial and operational and operational aspects of a company’s aspects of a company’s performance; when performance; when these numbers are these numbers are moving in the right moving in the right direction, a business is direction, a business is on track to reach its on track to reach its objectivesobjectives

Break-even AnalysisBreak-even Analysis Break-even pointBreak-even point: the level of : the level of

operation (sales dollars or production operation (sales dollars or production quantity) at which a company neither quantity) at which a company neither earns a profit or incurs a lossearns a profit or incurs a loss

Fixed expensesFixed expenses: expenses that do not : expenses that do not vary with changes in the volume of vary with changes in the volume of sales or production sales or production

Variable expensesVariable expenses: expenses that : expenses that vary directly with changes in the vary directly with changes in the volume of sales or productionvolume of sales or production

Break-Even AnalysisBreak-Even AnalysisCalculating the Break-Even PointCalculating the Break-Even Point Step 1Step 1: Determine Expenses expected to be : Determine Expenses expected to be

incurred (646,000+$236,500)incurred (646,000+$236,500) Step 2Step 2: Categorize the expenses into fixed and : Categorize the expenses into fixed and

variable ($177,375+$705,125)variable ($177,375+$705,125) Step 3Step 3: Calculate ratio of variable expenses to : Calculate ratio of variable expenses to

net sales ($705,125/$950,000)=74%, net sales ($705,125/$950,000)=74%, Contribution margin is 26%= Contribution margin is 26%=

Step 4Step 4: Compute Break-even Sales:: Compute Break-even Sales:=Total Fixed Cost/Contribution Margin as % of =Total Fixed Cost/Contribution Margin as % of

salessales=$177,375/0.26=$177,375/0.26==$686,212$686,212

Break-even AnalysisBreak-even Analysis

Better than Break-even SalesBetter than Break-even Sales

=(Total Fixed Expenses + Desired =(Total Fixed Expenses + Desired Profit)/Contribution Margin as % Profit)/Contribution Margin as % of salesof sales

=($177,375+$80,000)/0.26=($177,375+$80,000)/0.26

==$989,904$989,904

Break-even AnalysisBreak-even Analysis

Break-even point in unitsBreak-even point in units

=Total Fixed Costs/(Sale Price/unit-=Total Fixed Costs/(Sale Price/unit-Variable cost/unit)Variable cost/unit)

=$390,000/($17.50-$12.10)=$390,000/($17.50-$12.10)

=$390,000/$5.40=$390,000/$5.40

==72,22272,222

Break-even AnalysisBreak-even AnalysisConstructing a Break-even ChartConstructing a Break-even Chart Step 1Step 1: Horizontal axis, mark a scale : Horizontal axis, mark a scale

to plot sales volumeto plot sales volume Step 2Step 2: Vertical axis, mark a scale to : Vertical axis, mark a scale to

plot income and expense in dollarsplot income and expense in dollars Step 3Step 3: Draw fixed expense line : Draw fixed expense line Step 4Step 4: Draw a total expense line: Draw a total expense line Step 5Step 5: Draw the revenue line: Draw the revenue line Step 6Step 6: Locate break-even point: : Locate break-even point:

intersection of revenue line and total intersection of revenue line and total expense line expense line