PowerPoint
Presentations for
Small Business Management:
Launching and Growing New Ventures,
Fifth Canadian Edition
Adapted by
Cheryl Dowell
Algonquin College
Chapter 13
Evaluating and Managing
Financial Performance
LOOKING AHEAD
After studying this chapter, you should be able to:
1. Describe the purpose and content of financial
statements.
2. Identify the basic requirements for an accounting
system.
3. Explain two alternative accounting options.
4. Describe the purpose of and procedures related to
internal control.
5. Evaluate a firm’s operating liquidity.
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LOOKING AHEAD
6.
7.
8.
Assess a firm’s profitability.
Measure a firm’s use of debt or equity financing.
Evaluate the rate of return earned on the owner’s
investment.
9. Describe the working capital cycle of a small business.
10. Identify the important issues in managing a firm’s
cash flows.
11. Explain the key issues in managing accounts
receivable, inventory, and accounts payable.
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UNDERSTANDING FINANCIAL
STATEMENTS
• Reports of a firm’s financial performance and
resources, including an income statement, a balance
sheet and a cash flow
– Helps determine a start-up’s financial requirements
– Assesses the financial implications
of a business plan
LO 1
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INCOME STATEMENT
“How profitable is the business?”
•
•
•
•
•
Revenue from product or service sales
Costs of producing product or service
Operating expenses (marketing, selling, general and
administrative expenses, and depreciation)
Financing costs (interest paid)
Tax payments
Sales – Expenses = Profits
LO 1
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INCOME STATEMENT
LO 1
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ACCOUNTING TERMS
income statement
a financial report showing the profit or loss from a firm’s
operations over a given period of time. Also known as profit
and loss statement
gross profit
sales less the cost of goods sold
cost of goods sold
the cost of producing or acquiring goods or services to be sold
by a firm
operating expenses
costs related to general administrative expenses and selling
and marketing a firm’s product or service
LO 1
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ACCOUNTING TERMS
operating income
earnings before interest and taxes are paid
financing costs
the amount of interest owed to lenders on borrowed money
net income available
to owners
income that may be distributed to the owners or reinvested
in the company
LO 1
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THE BALANCE SHEET
• Report showing a firm’s assets, liabilities (debt),
and owners’ equity at a specific point in time
Outstanding debt + Owners’ equity = Total assets
• Snapshot of a business’s financial position at a
specific point in time
LO 1
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THE BALANCE SHEET
Types of Assets
Current Assets
(working capital)
Fixed Assets
Other Assets
LO 1
• Assets that can be converted to cash within the firm’s
operating cycle—cash, accounts receivable, and inventories
• Relatively permanent resources intended for the use of the
firm
• Intangible assets (patents, copyrights, goodwill)
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THE BALANCE SHEET
Types of Financing
Short-term
Debt Capital
(current)
•
•
•
•
Long-Term
Debt Capital
• Loans and mortgages from banks and
other lenders with maturities greater
than one year
LO 1
Accounts payable
Accrued expenses
Short-term notes
Repaid within a 12 month period
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THE BALANCE SHEET
Types of Financing
• Owners’ Equity Capital
– Money that the owners invest in the business
– Owners are “residual owners” of the firm
– Creditors have first claim on the assets of the firm
LO 1
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THE BALANCE SHEET
Types of Financing
Owners’
Equity
=
Owners’
investment +
Owners’
Equity
LO 1
=
Cumulative
profits
Owners’
investment
+
–
Owners’ cash
withdrawals
Earnings retained
within the firm
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BALANCE SHEET
ASSETS
LO 1
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THE FIT OF THE INCOME STATEMENT
AND THE BALANCE SHEET
LO 1
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BASIC REQUIREMENTS FOR
ACCOUNTING SYSTEMS
• accurate, thorough picture of operating
results
• quick comparison of current data with prior
years’ operating results and budgetary goals
• facilitate prompt filing of reports and tax
returns to regulatory and tax-collecting
government agencies
• reveal employee fraud, theft, waste, and
record-keeping errors
LO 2
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THE RECORD-KEEPING SYSTEM
• Major Types of Internal Accounting Records
– Accounts receivable records
– Accounts payable records
– Inventory records
– Payroll records
– GST/HST and PST
– Cash records
– Fixed asset records
– Other accounting records
LO 2
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ALTERNATIVE ACCOUNTING OPTIONS
Cash method
Revenues and expenses are
recognized only when
payments are received or
expenses are paid
LO 3
Accrual method
Revenue and expenses are
reported when they are incurred,
regardless of when they are
received or paid
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ALTERNATIVE ACCOUNTING OPTIONS
Single-entry system
• A chequebook system
of accounting Reflecting
only receipts and
disbursements
LO 3
Double-entry system
• A self-balancing accounting
system that uses journals
and ledgers
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INTERNAL
ACCOUNTING CONTROLS
• System of checks and balances that safeguards assets and enhances
the accuracy and reliability of financial statements
• Types of internal controls:
–
–
–
–
–
–
–
LO 4
Identifying transactions requiring owner authorization
Ensuring cheques issued have supporting documentation
Limiting access to accounting records and computers
Sending bank statements directly to the owner
Safeguarding blank cheques
Requiring employees to take vacations
Controlling access to computer facilities
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ASSESSMENT OF
FINANCIAL PERFORMANCE
Liquidity
• can it meet its short-term (one year or less) financial
commitments?
Profitability
• producing adequate operating profits on its assets
Stability
• how is the firm financing its assets?
Return to owners:
• an acceptable return on their equity investment?
LO 4
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FINANCIAL RATIOS
SME Benchmarking Tool
LO 4
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CAN FIRM MEET ITS FINANCIAL
COMMITMENTS?
Current Ratio
Comparing cash and near-cash current assets against
the debt (current liabilities) coming due and payable
within one year.
Current ratio =
Current assets
Current liabilities
Current ratio =
$345,000
= 3.45
$100,000
Industry norm for 2011 current ratio = 1.5
LO 5
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MEASURES OF LIQUIDITY
• Acid-test ratio (quick ratio)
– measure of a company’s liquidity that excludes
inventories
Acid-test ratio =
Current assets - Inventories
Current liabilities
Acid-test ratio =
$345,000 - $210,000
= 1.35
$100,000
Industry norm for 2011 acid-test ratio = 1.35
LO 5
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MEASURES OF LIQUIDITY
• Average Collection Period
–average time it takes a firm to collect its accounts receivable
Average collection period =
Average collection period =
Accounts receivable
Daily credit sales
$78,000
 365 = 34.30 days
$830,000
Industry norm for average collection period = 26 days
LO 5
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MEASURES OF LIQUIDITY
• Inventory Turnover
–number of times inventories “roll over” during the year
Inventory turnover =
Cost of goods sold
Inventory
$540,000
Inventory turnover =
= 2.57
$210,00
Industry norm for inventory turnover = 5.48 times
LO 5
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RETURN ON
INVESTED
CAPITAL
LO 6
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CALCULATE
RETURN ON INVESTMENT (ROI)
Operating income
return on investment
(OIROI)
LO 6
Sales
Operating profits
=
×
Total assets
Sales
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CALCULATE
RETURN ON INVESTMENT (ROI)
A measure of operating profits relative to total assets
Operating income
return on investment
Operating income
return on investment
=
=
Operating income
Total Assets
$100,000
= 0.1087 or 10.87%
$920, 000
Industry norm for OIROI: 6.96%
LO 6
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MEASURING
RETURN ON INVESTMENT (ROI)
Operating Profit Margin
The ratio of operating profits to sales, showing how well a
firm manages its income statement.
Operating profit margin =
Operating profits
Sales
$100, 000
Operating profit margin =
= 12.05%
$830,000
Industry norm for operating profit margin: 3.0%
LO 6
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MEASURING
RETURN ON INVESTMENT (ROI)
Total Asset Turnover
A ratio of sales to total assets, showing the efficiency with
which the firm’s assets are used to generate sales.
Total asset turn over =
Sales
Total assets
$830,000
Total asset turn over =
= 0.90
$920,000
LO 6
Industry norm for total asset turnover = 2.3
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TURNOVER RATIOS
Industry
Norm
Accounts
receivable
turnover
Credit sales
$830,000
=
=
= 10.64
Accounts receivable
$78,000
Inventory
turnover
Cost of goods sold $540,000
=
=
= 2.57
Inventory
$210,000
5.48
Sales
$830,000
=
= 1.58
Fixed assets $525,000
10.84
Fixed asset turnover
LO 6
=
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HOW IS THE FIRM FINANCING
ITS ASSETS
Financial Leverage:
The use of debt in financing a firm’s assets
Debt-Equity Ratio
Total debt
Debt ratio =
Total assets
$300,000
=
= 0.33, or 33.0%
$920,000
Industry norm for debt ratio = 42%
LO 7
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HOW IS THE FIRM FINANCING
ITS ASSETS
Times Interest Earned Ratio:
The ratio of operating income to interest charges
Operating income
Times interest earned =
Interest Expense
$100,000
=
= 5.0
$20,000
Industry norm for time interest earned = 7.2
LO 7
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RETURN ON EQUITY
The rate of return that owners earn on their investment.
Net income
Return on equity =
Common Equity
$60,000
=
= 20%
$300,000
Industry norm for return on equity = 23.5%
LO 8
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WORKING CAPITAL
• Working Capital Management
– management of current assets and current
liabilities
• Net Working Capital
– sum of a firm’s current assets (cash, accounts
receivable, and inventories) less current liabilities
(short-term notes, accounts payable, and accruals)
LO 9
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FINANCIAL RATIO ANALYSIS
LO 9
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FINANCIAL RATIO ANALYSIS
LO 9
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WORKING -CAPITAL CYCLE
LO 9
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WORKING -CAPITAL TIME LINE
LO 9
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WORKING -CAPITAL TIME LINE
LO 9
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MANAGING CASH FLOWS
• The Nature of Cash Flows
– flow of actual cash through a firm
• Net Cash Flow
– difference between inflow and outflows
• Net Profit
– difference between revenue and expenses
• The Growth Trap
– cash shortage resulting from rapid growth
LO 10
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MANAGING CASH FLOWS
LO 10
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CASH FLOW FORECAST
LO 10
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MANAGING ACCOUNTS RECEIVABLE
Credit-Management Practices
Use the most effective methods for collecting overdue accounts
Review previous credit experiences to determine impediments to
cash flow
Minimize the time between shipping, invoicing, and sending
notices on billings
Provide incentives for prompt payment
Age accounts receivable on a monthly or even a weekly basis
Use a lock box
LO 11
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ACCOUNTS RECEIVABLE FINANCING
LO 11
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MANAGING INVENTORY
• Negotiation
– Asks creditors for adjustments or additional time
• Timing
– Creditors’ funds can supply short-term cash needs
until payment is demanded
– Accounts with cash discounts for early payment
should be examined for their savings potential
– “Buy now, pay later”—pay early enough to get cash
discounts and timely enough to avoid late-payment
fees
LO 11
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