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Unformatted text preview: Creating a Solid Financial Plan Chapter 8 Financial Plan
Chapter 8 Financial Plan Financial Planning
Onethird of entrepreneurs run their companies without any kind of financial plan! Only 11 percent of small business owners analyze their companies’ financial statements. Chapter 8 Financial Plan
Chapter 8 Financial Plan 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):
its
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
sources
uses
funds.
funds. Chapter 8 Financial Plan
Chapter 8 Financial Plan Twelve Key Ratios
Twelve Key Ratios
Liquidity Ratios Tell whether or not the small business will be able to meet its maturing obligations as they come due.
1. Current Ratio Measures solvency by showing the firm's ability to pay current liabilities out of current assets.
Current Ratio = Current Assets = $686,985 = 1.87:1 Current Liabilities $367,850 Twelve Key Ratios
Twelve Key Ratios
Liquidity Ratios Tell whether or not the small business will be able to meet its maturing obligations as they come due.
2. Quick Ratio Shows the extent to which the firm's most liquid assets cover its current liabilities.
Quick Ratio = Quick Assets = $231,530 = .63:1 Current Liabilities $367,850 Twelve Key Ratios
Twelve Key Ratios Leverage Ratios Measure the financing provided by the firm's owners against that supplied by its creditors; a gauge of the depth of the company's debt.
Careful!! Debt is a powerful tool, but you must control it. The Right Amount of Debt is a Balancing Act. Benefits of Leverage Optimal Zone Low Degree of Leverage High Twelve Key Ratios
Twelve Key Ratios
Leverage Ratios Measure the financing provided by the firm's owners against that supplied by its creditors; a gauge of the depth of the company's debt.
3. Debt Ratio Measures the percentage of total assets financed by creditors rather than owners.
Debt Ratio = Total Debt = $580,000 = .68:1 Total Assets $847,655 Twelve Key Ratios
Twelve Key Ratios
Leverage Ratios Measure the financing provided by the firm's owners against that supplied by its creditors; a gauge of the depth of the company's debt.
4. Debt to Net Worth Ratio Compares what the business "owes" to “what it is worth.”
Debt to Net = Total Debt = $580,000 = 2.20:1
Worth Ratio Tangible Net Worth $264,155 Twelve Key Ratios
Twelve Key Ratios
Leverage Ratios Measure the financing provided by the firm's owners against that supplied by its creditors; a gauge of the depth of the company's debt.
5. Times Interest Earned Measures the firm's ability to make the interest payments on its debt.
Times Interest = EBIT* = $100,479 = 2.52:1
Earned Total Interest Expense $39,850 *Earnings Before Interest and Taxes Twelve Key Ratios
Twelve Key Ratios
Operating Ratios Evaluate the 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 the 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 Twelve Key Ratios
Twelve Key Ratios
Operating Ratios Evaluate the 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 Twelve Key Ratios
Twelve Key Ratios
Operating Ratios Evaluate the 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 Twelve Key Ratios
Twelve Key Ratios
Operating Ratios Evaluate the firm's overall performance and show how effectively it is putting its resources to work.
9. Net Sales to Total Assets Ratio Measures the 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 Twelve Key Ratios
Twelve Key Ratios
Operating Ratios Evaluate the firm's overall performance and show how effectively it is putting its resources to work.
10. Net Sales to Working Capital Ratio Measures how many dollars in sales the company generates for every dollar of working capital.
Net Sales to = Net Sales = $1,870,841 = 5.86:1 Working Capital Working Capital* $319,135
*Working Capital = current assets current liabilities = $686,985 $367,850 Twelve Key Ratios
Twelve Key Ratios
Profitability Ratios Measure how efficiently the firm is operating; offer information about the firm's "bottom line."
11. Net Profit on Sales Ratio Measures the firm's profit per dollar of sales revenue.
Net Profit on = Net Income = $60,629 = 3.24% Sales Net Sales $1,870,841 Twelve Key Ratios
Twelve Key Ratios
Profitability Ratios Measure how efficiently the firm is operating; offer information about the 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 Interpreting Ratios
Interpreting Ratios
Sam’s Appliance Shop
Current ratio = 1.87:1 Industry Median
Current ratio = 1.50:1 Although Sam’s falls short of the rule of thumb of 2:1, its current ratio is above the industry median by a significant amount. Sam’s should have no problem meeting shortterm debts as they come due. Interpreting Ratios
Interpreting Ratios
Sam’s Appliance Shop
Quick ratio = 0.63:1 Industry Median
Quick ratio = 0.50:1 Again, Sam is below the rule of thumb of 1:1, but the company passes this test of liquidity when measured against industry standards. Sam relies on selling inventory to satisfy shortterm debt (as do most appliance shops). If sales slump, the result could be liquidity problems for Sam’s. Interpreting Ratios
Interpreting Ratios
Sam’s Appliance Shop
Debt ratio = 0.68:1 Industry Median
Debt ratio = 0.64:1 Creditors provide 68% of Sam’s total assets. very close to the industry median of 64%. Although the company does not appear to be overburdened with debt, Sam’s might have difficulty borrowing , especially from conservative lenders. Interpreting Ratios
Interpreting Ratios
Sam’s Appliance Shop
Debt to net worth
ratio = 2.20:1 Industry Median
Debt to net worth ratio =1.90:1 Sam’s owes $2.20 to creditors for every $1.00 the owner has invested in the business (compared to $1.90 to every $1.00 in equity for the typical business. Many lenders will see Sam’s as “borrowed up,” having reached its borrowing capacity. Creditor’s claims are more than twice those of the owners. Interpreting Ratios
Interpreting Ratios
Sam’s Appliance Shop
Times interest earned ratio = 2.52:1 Industry Median
Times interest earned ratio =2.0:1 Sam’s earnings are high enough to cover the interest payments on its debt by a factor of 2.52:1, slightly better than the typical firm in the industry. Sam’s has a cushion (although a small one) in meeting its interest payments. Interpreting Ratios
Interpreting Ratios
Sam’s Appliance Shop
Average inventory turnover ratio = 2.05 times per year Industry Median
Average inventory turnover ratio = 4.0 times per year Inventory is moving through Sam’s at a very slow pace. What could be causing such a low turnover in the business? Interpreting Ratios
Interpreting Ratios
Sam’s Appliance Shop
Average collection period ratio = 50.0 days Industry Median
Average collection period ratio = 19.3 days Sam’s collects the average account receivable after 50 days compared to the industry median of 19 days more than 2.5 times longer. What is a more meaningful comparison for this ratio? Interpreting Ratios
Interpreting Ratios
Sam’s Appliance Shop
Average payable period ratio = 59.3 days Industry Median
Average payable period ratio = 43 days Sam’s payables are nearly 40 percent slower than those of the typical firm in the industry. Stretching payables too far could seriously damage the company’s credit rating. What are the possible causes of this discrepancy? Interpreting Ratios
Interpreting Ratios
Sam’s Appliance Shop
Net sales to total assets ratio = 2.21:1 Industry Median
Net Sales to total assets ratio = 2.7:1 Sam’s Appliance Shop is not generating enough sales, given the size of its asset base. What could cause this? Interpreting Ratios
Interpreting Ratios
Sam’s Appliance Shop
Net sales to working capital ratio = 5.86:1 Industry Median
Net Sales to working capital ratio = 10.8:1 Sam’s generates just $5.86 in sales for every $1 of working capital, just over half of what the typical firm in the industry does. The message is clear: Sam’s is not producing an adequate volume of sales. Possible causes . . . ? Interpreting Ratios
Interpreting Ratios
Sam’s Appliance Shop
Net profit on sales ratio = 3.24% Industry Median
Net profit on sale ratio = 7.6% After deducting all expenses, Sam’s has just 3.24 cents of every sales dollar left as profit less than half the industry average. Sam may discover that some of his operating expenses are out of balance. Interpreting Ratios
Interpreting Ratios
Sam’s Appliance Shop
Net profit on equity ratio = 22.65% Industry Median
Net profit on equity ratio = 12.6% Sam’s return on his investment in the business is an impressive 22.65%, compared to an industry median of just 12.6% Is this the result of high profitability or is there another explanation? 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 8 Financial Plan
Chapter 8 Financial Plan 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:
Contribution Margin = 1 Variable Expenses
Net Sales Estimate Step 4. Compute the breakeven point:
Breakeven Point = $
Chapter 8 Financial Plan
Chapter 8 Financial Plan Total Fixed Costs Contribution Margin 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:
Contribution Margin = 1 $705,125
$950,000 = .26 Step 4. Breakeven point:
Breakeven Point
$
Chapter 8 Financial Plan
Chapter 8 Financial Plan $177,375
= .26 = $682,212 ...
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 Spring '11
 DuWeane

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