ST309E - OPPORTUNITY ASSESSMENT
CH7: Measuring Financial
Performance for
Entrepreneurial Ventures
Pr. Siham BIDDI
Learning objectives
• To distinguish between two kinds of performance measurement and their
importance/relevance to entrepreneurs
• To explain the principal financial statements needed for any
entrepreneurial venture – the balance sheet, income statement and cashflow statement
• To outline the process of preparing an operating budget
• To discuss the nature of cash flow and to explain how to draw up such a
document
Learning objectives
• To explain how capital budgeting can be used in the decision making
process
• To illustrate how to use break-even analysis
• To describe ratio analysis and illustrate the use of some of the important
measures and their meanings
• To understand the importance of triple bottom line accounting
• To appreciate the diversity of environmental accounting
1. INTRODUCTION
In today's competitive business environment with limited resources,
entrepreneurs prioritize safeguarding and effectively allocating
resources. Six types of resources are available:
• Tangible: financial, physical, and environmental
• Intangible: organizational, relational, and human
This chapter focuses on measuring the performance of tangible
resources such as finances and physical assets, including
consideration of the business environment.
• Economic performance, such as sales revenue and cash flow, is
traditionally measured through financial accounting.
• Governments are recognizing the need for formal metrics to
assess ecological and social risks for companies.
The chapter first examines financial performance measures and then
discusses tools such as: pro forma statements, break-even analysis,
and ratio analysis.
Finally, the chapter covers sustainability performance measures,
addressing important aspects of sustainable business practices.
2. MEASURING FINANCIAL
PERFORMANCE
• Financial information pulls together all the information presented
in the other segments of the business: marketing, distribution,
manufacturing and management.
• It quantifies all the assumptions and historical information
concerning business operations.
• Entrepreneurs must make assumptions when deriving numbers
and correlate these assumptions with other parts of their
business operations.
• Without these assumptions, the numbers derived will have little
meaning.
• Entrepreneurs should follow a clear process described in the next
section to develop the key components of a financial segment.
3. UNDERSTANDING THE KEY
FINANCIAL STATEMENTS
• Financial statements are powerful tools that entrepreneurs can
use to manage their ventures.
• The basic financial statements an entrepreneur needs to be
familiar with are:
 the balance sheet,
 the income statement
 the cash-flow statement.
Income Statement
Balance Sheet
Cash Flow Statement
Purpose
Focuses on a specific
period and summarizes
a company's revenues,
expenses, gains, and
losses.
Provides a snapshot of a
company's financial position
at a specific point in time
and highlights its assets,
liabilities, and shareholders'
equity.
Provides information
about the cash inflows
and outflows of a
company over a specific
period, categorized into
operating activities,
investing activities, and
financing activities.
Content
Sales, cost of goods
sold, operating
expenses, nonoperating income or
expenses, taxes, net
income or loss.
Assets (e.g., cash, inventory,
property, equipment),
liabilities (e.g., loans,
accounts payable),
shareholders' equity (e.g.,
retained earnings,
contributed capital).
Cash flows from
operating activities.
Cash flows from
investing activities. Cash
flows from financing
activities.
Timeframe
Income Statement
Balance Sheet
Cash Flow Statement
Specific period (e.g.,
monthly, quarterly,
annually).
Specific date (e.g., end of a
quarter, year).
Specific period (e.g.,
monthly, quarterly,
annually).
Total assets, total liabilities,
shareholders' equity,
working capital, debt-toequity ratio.
Net cash provided by
operating activities, net
cash used in investing
activities, net cash
provided by financing
activities, net increase
or decrease in cash.
Example Revenue, gross profit,
Metrics operating income, net
income, earnings per
share (EPS).
THE BALANCE SHEET
• A balance sheet is a financial statement that reports a business’s
financial position at a specific time.
• The balance sheet is divided into two parts:
 the financial resources owned by the firm
 the claims against these resources.
• The financial resources that the firm owns are called assets.
• The claims that creditors have against the company are called
liabilities.
THE BALANCE SHEET (cont’d)
• The residual interest of the firm’s owners is known as owners’ equity.
• When all three are placed on the balance sheet, the assets are typically
listed on the left, and the liabilities and owners’ equity are listed on the
right.
• A common liability is a short-term account payable in which the business
orders some merchandise, receives it, but has not yet paid for it.
THE BALANCE SHEET (cont’d)
• To determine the value of an asset, the owner/manager must do the
following:
(1) identify the resource,
(2) provide a monetary measurement of that resource’s value and
(3) establish the degree of ownership in the resource.
• Liabilities are divided into two categories:
 short-term liabilities (also called current liabilities) are those that must be
paid during the coming 12 months.
 long-term liabilities are those that are not due and payable within the next
12 months, such as a mortgage on a building or a five-year bank loan.
THE BALANCE SHEET (cont’d)
• Owners’ equity is what remains after the firm’s liabilities are subtracted from
its assets.
UNDERSTANDING THE BALANCE SHEET
UNDERSTANDING THE BALANCE SHEET
UNDERSTANDING THE BALANCE SHEET (cont’d)
Current assets
• Current assets consist of cash and other assets that are reasonably
expected to be turned into cash, sold or used up during a normal operating
cycle.
• Cash refers to coins, currency and cheques on hand. It also includes money
that the business has in its cheque and savings accounts.
• Accounts receivable are claims that a company has against its customers
for unpaid balances from the sale of merchandise or the performance of
services.
• The allowance for uncollectable accounts refers to accounts receivable
judged to be uncollectable.
UNDERSTANDING THE BALANCE SHEET (cont’d)
Current assets
• Inventory is merchandise held by the company for resale to customers.
• Prepaid expenses are expenses the firm already has paid but that have not
yet been used.
UNDERSTANDING THE BALANCE SHEET (cont’d)
Fixed assets
• Fixed assets consist of land, building, equipment and other assets expected
to remain with the firm for an extended period.
UNDERSTANDING THE BALANCE SHEET (cont’d)
Non-current assets
• Non-current assets, also famous as long-term investments, are the next
resources that the companies owe. The list of non-current assets
includes intangible or fixed assets like office furniture, machinery,
buildings, and land.
• Accumulated depreciation of building refers to the amount of the building
that has been written off the books due to wear and tear.
UNDERSTANDING THE BALANCE SHEET (cont’d)
Liabilities
UNDERSTANDING THE BALANCE SHEET (cont’d)
Current liabilities
• Current liabilities are obligations that will become due and payable during
the next year or within the operating cycle.
• Accounts payable are liabilities incurred when goods or supplies are
purchased on credit.
• A note payable is a promissory note given as tangible recognition of a
supplier’s claim or a note given in connection with an acquisition of funds.
• Taxes payable are liabilities owed to the government
• A loan payable listed in current liabilities is the current instalment on a
long-term debt that must be paid this year.
UNDERSTANDING THE BALANCE SHEET (cont’d)
Long-term liabilities
• A bank loan is a long-term liability arising from a loan from a
lending institution.
Owning shares in a limited company
• Owning shares in a limited company refers to holding a portion of the
company's ownership, represented by shares, which entitles the
shareholder to certain rights and privileges, such as voting rights
and a share in the company's profits.
• Common share are the most basic form of corporate ownership.
Retained earnings
• Retained earnings are the accumulated net income kept by the
business over the life of the activity.
WHY THE BALANCE SHEET ALWAYS BALANCES ?
• If something happens that increases or decreases, one side of the
balance sheet, it is offset by something on the other side. Hence,
the balance sheet remains in balance.
• Before examining some illustrations, let us restate the balancesheet equation:
Assets = Liabilities + Owners’ equity
WHY THE BALANCE SHEET ALWAYS BALANCES ?
c
In accounting language, the terms debit and credit denote increases
and decreases in assets, liabilities and owners’ equity.
Example:
THE INCOME STATEMENT
THE INCOME STATEMENT
• The income statement is a financial statement that shows the
change that has occurred in a firm’s position as a result of its
operations over a specific period. This is in contrast to the balance
sheet, which reflects the company’s position at a particular point
in time.
• The income statement, sometimes referred to as a ‘profit and loss
statement’ or ‘P&L’, reports on the success (or failure) of the
business during the period.
– In essence, it shows whether sales revenues were greater than or less than
expenses.
UNDERSTANDING THE INCOME STATEMENT
• Revenue: the total amount of money generated from the sale of
goods or services before deducting any expenses or costs.
• Cost of goods sold: the direct costs associated with producing or
purchasing the goods that were sold during a specific period of
time.
• Operating expenses: the costs incurred by a business in its day-today operations, such as salaries, rent, utilities, marketing
expenses, and other overhead costs.
• Interest expense: the costs incurred by a business for borrowing
funds or using credit, typically associated with interest payments
on loans or outstanding debt.
• Estimated income taxes: the amount of income tax expense that a
company anticipates it will owe based on its estimated taxable
income for the period.
Example: Income Statement for the Year Ended December 31
THE CASH FLOW STATEMENT
THE CASH FLOW STATEMENT
• Statement of Cash Flow: The principal purpose of the
• statement of cash flows is to provide relevant information about
the company’s cash receipts and cash payments during a
particular accounting period. It is useful for answering such
questions as:
•
•
•
•
How much cash did the firm generate from operations?
How did the firm finance fixed capital expenditures?
How much new debt did the firm add?
Was cash from operations sufficient to finance fixed asset
purchases?
– The use of a cash budget may be the best approach for an
entrepreneur starting up a venture.
Format of Statement of Cash Flows
4. PREPARING FINANCIAL BUDGETS
Preparing Financial Budgets
Preparing financial budgets involves creating a comprehensive plan for
managing the financial resources of a business or organization.
• Budget
– One of the most powerful tools the entrepreneur can use in
planning financial operations.
• Operating Budget
– A statement of estimated income and expenses over a specified
period of time.
• Cash Budget
– A statement of estimated cash receipts and expenditures over a
specified period of time.
• Capital Budget
– The plan for expenditures on assets with returns expected to
last beyond one year.
Preparing Financial Budgets
There are several common types of budgets that businesses and
organizations use to manage their finances. Some of the most
common types include:
•
•
•
•
•
•
•
Operating Budget
Capital Expenditure Budget
Cash flow Budget
Sales Budget
Production Budget
Marketing Budget
Personnel Budget
The Operating Budget
• The operating budget is a financial plan that details the
projected revenues, expenses, and costs involved in the
regular operations of a business or organization within a
defined timeframe, usually one year. Its purpose is to provide
a framework for managing day-to-day activities and aiding in
decision-making regarding resource allocation, revenue
generation, and expense management.
The Operating Budget
• The key components generally included in an operating budget
are:
–
–
–
–
–
–
Revenue Projections
Expense Budget
Cost of Goods Sold (COGS)
Operating Income or Loss
Budgeted Profit/Loss
Budget Variances
Example of a Purchase Requirements Budget
The Cash-Flow Budget
• Cash-Flow Budget
– Provides an overview of the cash inflows and outflows during
the period. By pinpointing cash problems in advance,
management can make the necessary financing arrangements.
• Preparation of the cash-flow budget
– Identification and timing of three cash inflows:
• Cash sales
• Cash payments received on account
• Loan proceeds
– Minimum cash balance
Capital Budgeting
• The Capital Budgeting Process: refers to the systematic approach of
evaluating, selecting, and managing long-term investments or
projects to allocate resources effectively and achieve the financial
goals of an organization.
• Capital Budgeting Objectives
– Which of several mutually exclusive projects should be
selected?
– How many projects, in total, should be selected?
Methods of Capital Budgeting
• There are several methods used in capital budgeting to evaluate
investment projects. Some of the commonly employed methods
include:
•
•
•
•
•
•
•
Net Present Value (NPV)
Internal Rate of Return (IRR)
Payback Period
Profitability Index (PI)
Accounting Rate of Return (ARR)
Discounted Payback Period
Risk-adjusted Discount Rate
Pro Forma Statements
• Pro Forma Statements
– Are projections of a firm’s financial position over a future period
(pro forma income statement) or on a future date (pro forma
balance sheet).
– Using beginning balance sheet balances, they depict projected
changes on the operating and cash-flow budgets which are
added to create projected balance sheet totals.
Example of a Pro Forma Statements
Break-Even Analysis
• Break-even analysis is a financial tool used in budgeting that
calculates the point at which total revenue equals total costs,
helping businesses determine the minimum level of sales or
production needed to cover all expenses and reach a neutral
financial position.
Ratio Analysis
• Ratio analysis in budgeting involves using financial ratios to assess
the financial health and performance of a company's budget. By
analyzing ratios such as liquidity ratios, profitability ratios, and
efficiency ratios, budget analysts can gain insights into the
company's ability to meet its financial obligations, generate profits,
and utilize its resources efficiently, helping inform budgeting
decisions and financial planning for the future.
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