Introduction to Entrepreneurial Finance.

Transcription

1 1 Intrductin t Entrepreneurial Finance. : Financial And Ecnmic Cncepts Tpic Objective: At the end f this tpic student wuld be able t: Understand the basic cncepts and imprtance f finance as it relates t individuals and business. Understand the basic ecnmic cncepts f finance. Distinguish between marginal revenue and marginal cst. Distinguish between ecnmic capital and financial capital. Determine the pprtunity cst f making decisins. Identify the relatinship that exists between savings, incme, expenditures, and taxes. Identify thse factrs that affect interest rates. Understand the relatinships that exist between supply and demand fr mney and prevailing market interest rates. Describe the rle f the Federal Reserve and thse tls used t achieve the gals f ecnmic grwth, price stability, and full emplyment. Understand the relatinship that exists between risk and return n investment. Cmpare systematic risk t unsystematic risk and their impact n business. Definitin/Overview: Finance: The field f finance refers t the cncepts f time, mney and risk and hw they are interrelated. Banks are the main facilitatrs f funding thrugh the prvisin f credit, althugh private equity, mutual funds, hedge funds, and ther rganizatins have becme imprtant. Financial assets, knwn as investments, are financially managed with careful attentin t financial risk management t cntrl financial risk

2 2 Key Pints: 1. Finance Finance is essentially any transactin where mney r a mney-like instrument is exchanged fr mney r a mney-like instrument. 2 Market A market cnsists f any rganized effrt where buyers and sellers freely exchange gds and services. Name five types f markets in which yu participate: Financial, real estate, retail, whlesale, cmmdities, stck markets, bnd markets, mney markets, and flea markets. 3. Cmpare marginal revenue, marginal cst, and marginal revenue prduct. Marginal revenue is the additinal revenue that a firm btains by selling ne mre unit. Marginal cst is the cst f hiring ne mre unit f labr r the cst f prducing ne mre unit f utput. Marginal revenue prduct is the additinal revenue we btain by hiring ne mre unit f labr. 4. Distinguish between ecnmic and financial capital. Ecnmic capital resurces include all items that man manufactures by cmbining natural and human resurces like buildings, equipment, rads, and bridges. Financial capital is a dllar value claim n ecnmic capital. Financial capital wuld include cash, deeds f trust, mrtgages, lan papers, stcks, and bnds

3 Value f the entrepreneur. The entrepreneur cmbines natural, human, and capital resurces t prduce a gd r service that we value mre than the individual cmpnents. Withut the entrepreneur, the ther resurces wuld nt nrmally be cmbined, except fr subsistence (i.e., the resurces that are just sufficient t sustain life). The entrepreneur seeks t make a prfit when using his r her ideas. When we lk at verall payments, the value f the mental talents f entrepreneurs nrmally exceeds the wages that are paid fr labr. Fr example, the wner f a prfessinal sprts team, the entrepreneur, will nrmally make mre than any player n that team. Of curse, the mre brilliant the idea and its ultimate appeal t the buyer f the gd r service, the mre prfit that will accrue t the entrepreneur. 6. Opprtunity cst An pprtunity cst is the highest value that is surrendered when a decisin is made; it is never the decisin itself. It is a quantifiable term. The highest value that is surrendered when a decisin t invest funds is made. Chices Available fr Funds Investment Opprtunity Expected Annual Return (%) Purchase stck 11 Purchase hme 9 Purchase bnds 6 Place mney in bank savings accunt 2 Purchase new car -15 [Table 1 Expected Financial Returns f Investment Opprtunity]

4 What makes up grss incme Grss incme is all f the mney received frm all surces during the year. This includes wages, tips, interest earned n savings and bnds, incme frm rental prperty, prfits t entrepreneurs, and any ther surce f incme an individual may have. Incme, Expenditures, and Taxes Grss incme is all f the mney received frm all surces during the year. Wages Tips Interest earned n savings and bnds Incme frm rental prperty Prfits t entrepreneurs Basic Incme Calculatins payments. Grss incme - taxes = Dispsable incme Fr mst f us, dispsable incme is take-hme pay. Dispsable incme - Fixed expenses = Discretinary incme Fixed expenses are cntractual bligatins like rent, utilities, insurance, and car Discretinary incme is that we can spend r save. Husehld Name Grss Incme ($) Incme, SS, & Medicare Taxes ($) Federal Taxes Paid as a % f Grss Dispsable Incme Incme ($) Fixed Expenses Discretinary ($) Incme ($) Jnes 30,000 5, % 24,773 19,673 5,100 Rberts 50,000 9, % 40,243 32,683 7,

5 5 Smith 70,000 16, % 53,499 40,179 13,320 Brwn 90,000 23, % 66,569 41,369 25,200 Meeks 110,000 28, % 81,186 42,306 38,880 Adams 130,000 35, % 94,896 48,096 46,800 Charles 150,000 41, % 108,606 50,718 57,888 Surce fr taxes: Department f the Treasury, Internal Revenue Service [Table 2 Incme and Expenses f Variable Husehlds] 8. Prgressive, regressive, and prprtinal taxes. Prgressive taxes take a larger percentage f yur incme as it increases. Regressive taxes take a higher percentage f yur incme as it decreases. Prprtinal taxes are taxes where the percentage paid stays the same, regardless f incme. Examples include prgressive incme taxes, regressive sales taxes, and prprtinal prperty taxes. Taxes incme. Prgressive taxes: larger percentage f tax paid as incme increases. Regressive taxes: larger percentage f tax paid as incme decreases. Prprtinal taxes: percentage f tax paid remains the same at all levels f Example f Prgressive Tax Frmula fr tax percentage paid:

6 6 Incme tax is prgressive: Example f Regressive Tax Sales tax is regressive: Incme = $20,000; savings = 0; sales tax = 5% Sales tax paid = $20,000 x 0.05 = 1,000 Incme = $60,000; savings = $10,000; sales tax = 5% Sales tax paid = $50,000 x 0.05 = $2,500 Example f Prprtinal Tax Frmula fr tax percentage paid: Medicare tax is 1.45% Annual incme $30,000 Medicare tax = $30,000 x = $435 Annual incme $500,000 Medicare tax=$500,000 x = $7,250 Factrs Affecting Interest Rates The supply f mney saved is primarily the ttal mney that is placed in demand depsit (checking) accunts, savings accunts, and mney market mutual funds. The demand fr brrwed funds is all f the mney that is demanded in ur ecnmy at a given price

7 7 Federal Reserve Plicy The Federal Reserve is the central bank f the United States. Risk Systematic Risk: Risk assciated with ecnmic, plitical, and scilgical changes that affect all participants n an equal basis. Unsystematic Risk: Risk unique t an individual, firm, r industry. 9. Law f supply The law f supply states that as the payment r price f an item increases, ceteris paribus, we will supply mre f that item. 10. Supply Table A supply table is a listing f the quantities f sme variable, which will be supplied at varius prices in the marketplace. The supply curve is btained by hrizntally summing the quantities supplied by different suppliers at each price in the market. 11. Law Of Demand The law f demand states that if all ther factrs are cnstant, as the price fr an item decreases, peple will demand mre f that item, ceteris paribus. 12. Cncept f a surplus f mney versus a shrtage f mney. When the supply f mney saved exceeds the demand fr mney, there is a surplus f mney. At which pint institutins (banks, credit unins, savings and lans, etc.) will pay less fr savings, and interest rates will begin t fall. When the demand fr mney exceeds the supply, there is a

8 8 shrtage f mney and interest rates will be bid up in the market as institutins attempt t btain mre mney. 13. Federal Reserve (Fed) The Fed is the central bank f the United States. The three tls fr cntrlling the mney supply are the discunt rate, the reserve requirements rati, and federal pen market peratins. 14. Risk Risk invlves the prbability that the actual return n an investment will be different frm the desired return. Systematic risk is risk which is assciated with ecnmic, plitical, and scilgical changes that affect all participants n a near-equal basis. Unsystematic risk is risk that is unique t an individual, firm, r industry. : Financial Management And Planning Tpic Objective: At the end f this tpic student wuld be able t: Tpic Describe the five basic functins f a manager and hw they relate t a business. Distinguish between strategic plans and functinal plans. Understand the three factrs that must be addressed when establishing gals. Describe the financial gals fr a fr-prfit rganizatin. Trace the three-step prcess that yu must take when using cntrl

9 9 Cmpare and cntrast the basic frms f business wnership (sle prprietr, partnership, and crpratin). Distinguish between limited and unlimited liability. Cmpare and cntrast general partnership, limited partnership, and a limited liability cmpany. Understand the rle that the franchise plays when establishing a business. Understand the basic cmpnents f a SWOT analysis. Knw what basic factrs are required t cmplete a business plan. Definitin/Overview: Managerial finance : Managerial finance, the branch f finance that cncerns itself with the managerial significance f finance techniques Key Pints: 1. Planning Planning is a systematic prcess that takes us frm sme current state t sme future desired state. Strategic planning establishes the verall plan fr the business, whereas functinal planning is driven by the strategic plan. If McDnalds has a strategic plan t becme the number-ne family restaurant, then its functinal plans wuld invlve pening new restaurants in specific cmmunities arund the wrld, financing these restaurants, and develping marketing plans fr each area (Germany serves beer, America serves sda, England serves fish and chips, India serves n hamburger meat, etc.)

10 Gal setting play in the planning prcess? Gal setting is a precursr t establishing a plan. In rder t begin planning, yu need gals that are measurable and can be reached in a specified time perid. 3. Five functins f a manager Planning, rganizing, staffing, directing, and cntrlling. 4. Three Steps Of Cntrlling Establish a standard f measurement, measure actual perfrmance against the standard, and take crrective actin when actual perfrmance varies frm the established standard. 5. Three frms f business wnership. The sle prprietrship, which is a business perated by the prprietr fr his r her wn prfit. A partnership is an assciatin f tw r mre persns wh carry ut a business as c-wners fr a prfit. The crpratin is a legal entity accrding t U.S. law that may accmplish all f the tasks that can be accmplished by an individual. A limited liability cmpany (LLC) is a hybrid business entity having features f bth partnerships and crpratins. 6. Unlimited liability The wner f a business is persnally liable fr any debts f the business and is legally liable fr any prblems that the business may have. This includes the payment f all judgments against the business

11 Limited Partnership Differ Frm A General Partnership A limited partnership is ne in which there is ne r mre general partners and several limited partners. A limited partner is basically an investr wh has liability limited t the amunt f the investment in the partnership. All f the partners in a general partnership are general partners. They are in charge f day-t-day peratins and are persnally liable fr the partnership. General partners have unlimited liability. 8. Sle Prprietrship Advantages f the crpratin primarily include unlimited access t financial capital (stcks and bnds) and limited liability fr the wners (can never lse mre than investment even if crpratin ceases t exist). 9. Disadvantages Of A Crpratin Disadvantages f the crpratin include numerus federal and state legal requirements, duble taxatin, and wners have little r n cntrl f hw the business is run n a daily basis. 10. Pitfalls Of Franchising Yu are nt truly yur wn bss and must cmply with the legal bligatins t the franchiser that yu agreed t in the franchise agreement. Yu must prvide the franchiser with a percentage f grss sales n a mnthly basis, and are bligated t cnduct business in a manner specified by the franchiser. 11. cmpnents f a strengths, weaknesses, pprtunities, and threats (SWOT) analysis. Strengths are areas f expertise that a business has and fr the individual are thse things that yu d well and like ding. Weaknesses are the shrtcmings f the business and fr the

12 individual are areas that yu really dislike and in which yu lack expertise. Opprtunities are items that exist in the envirnment that prvide yur business with expanded sales if taken advantage f and will help yur business grw and prsper. Threats are factrs that exist in the envirnment that may impede the grwth f yur business. 12. Majr Cmpnents Of A Business Plan. A business plan cntains a descriptin f the business which includes legal frm and name, date f frmatin, lcatin, prduct r service, brief histry, prpsed future peratins, financial data, and supprting dcuments. The answers t these last tw questins are individually determined by each student r student team. 13. Management Functins Planning is a systematic prcess that takes us frm sme current state t sme future desired state. Strategic planning invlves establishing an verall plan fr the business. Functinal planning is driven by strategic plans and is related t specific functinal areas f a business such as accunting, marketing, r human resurces. Gal setting is precursr t establishing a plan. Gals must be measurable, achievable, and have a time frame. Basic financial gals f a fr-prfit rganizatin: T maximize the wealth f the business wners (investrs) ver the life f the business T meet interest payments n debt T grw Organizing is the secnd functin f the manager and defines the structure f the business. Wh will d it? What skills d they need?

13 What is the time frame that we have set in which t have it accmplished? Where will it be accmplished? Hw d we get it accmplished? Staffing requires that the manager btain the mst capable persnnel t implement the business plans. Determine jb requirements. Develp a jb descriptin. Directing (leading). Prviding prper guidance and directin t thers t accmplish the rganizatins missin. Cntrlling is a three-step prcess: Establishing a standard f measurement Measuring actual perfrmance against the standard Taking crrective actin when actual perfrmance varies frm the established standard A sle prprietrship is perated by an individual fr prfit. A partnership is an assciatin f tw r mre persns wh carry ut a business as cwners fr a prfit. General partnership Limited partnership Limited liability cmpany The crpratin is a legal entity accrding t U.S. law. Incrprated in ne f the fifty states r territries f the United States. Public Crpratin: stck is sld t the public. Private Crpratin: Stck is nt sld t the public

14 All crpratins are frmed as C crpratins unless they meet the requirements f and request Subchapter S tax status. Subchapter S crpratin: Private crpratin with special tax status granted by Internal Revenue Service (IRS) Maximum f 100 sharehlders N duble taxatin A Limited Liability Cmpany (LLC) is a hybrid business entity having features f bth partnerships and crpratins. Taxed as a partnership Has limited liability fr its wners Flws thrugh incme and lsses t individual wners tax returns Franchise nt an actual frm f wnership. A franchise is a business in which the buyer, wh is the franchisee, purchases the right t sell the gds r services f the seller, wh is the franchiser. Starting a Business Run a SWOT analysis Strengths are the cre cmpetencies f a business. They are thse factrs that will make yur business succeed because yu perfrm in these areas better than yur cmpetitr. Weaknesses are thse areas f yur cmpany that definitely need imprvement. Opprtunities are factrs that exist utside f yur business, but that if taken advantage f, will help yur business t grw and prsper (e.g., lw interest rates fr business lans). Threats are factrs that exist in the envirnment that may impede the grwth f yur business, directly r indirectly (e.g., new cmpetitin). Develpment f a Business Plan Executive summary: Part f business plan that investrs review t determine if they want t read further. Tw pages r fewer, the executive summary shuld cntain:

15 Business strategy fr success Brief descriptin f the market and what makes yur business unique Brief descriptin f the prduct r service Brief descriptin f management teams qualificatins Summary f revenue and expense prjectins Estimate f hw much mney is needed and hw it will be used General Cmpany Descriptin: Missin Statement: Cmpany gals Cmpany bjectives Business philsphy Frm r frms f business wnership Prducts and services Marketing plan Price Prduct Prmtin Place Operatinal plan Management and rganizatin Persnal financial statement f each wner r majr stckhlder Startup expenses and capitalizatin Financial plan; a 4-year prjectin f prfit Appendices Brchures, advertising materials, business cards Industry studies Maps and phts f lcatin

16 List f equipment wned r purchased Cpies f leases r cntracts Letters f supprt frm suppliers and future custmers Market research studies List f assets available fr a lan Financing a Business r Raising Capital Suppliers f funds include lenders and investrs Lenders increase debt and include banks and any ther lender investment: Cmpany wners Investrs increase cmpany equity and expect a psitive return n their Angel investrs prvide seed mney and mentring t start-up businesses Venture capitalist nrmally invests in cmpanies with prven track recrd : Financial Statements Tpic Objective: At the end f this tpic student wuld be able t: Understand hw financial statements are used by businesses. Understand the differences and similarities that exist between a persnal cash flw statement and a business incme statement. Distinguish between fixed and variable expenses. Understand the changes in incme statements that exist with different frms f business. Understand the differences and similarities that exist between a persnal statement f financial psitin and a business balance sheet. Analyze the cmpnents f the basic accunting equatin

17 Distinguish between assets and liabilities. Understand the relatinship between fixed assets and depreciatin. Understand the significance f the statement f cash flws. Given the basic data fr a cmpany, be able t cnstruct a financial statement. Understand the prblems that may exist with financial statements. Definitin/Overview: Financial statements : Financial statements (r financial reprts) are frmal recrds f a business' financial activities. Key Pints: 1. Financial Statements Used By Business They are used by the business fr internal cntrl f finance. Data frm statements are used t track the cmpanys recrd, present status, and future financial directin. 2. Variable and fixed expenses. Variable expenses are expenses that we have cntrl ver as individuals. Fixed expenses fr the individual are cntractual in nature such as mrtgage payments, insurance payments, and lease payments, and we have little r n cntrl ver them. Variable expenses frm the business view are related cst f gds sld. Fixed expenses fr a business are nrmally cnsidered t be perating expenses

18 Basic frmat f an incme statement The incme statement has a beginning and end date, the name f the cmpany, and prvides infrmatin frm ttal revenues subtracting all expenditures until we arrive at net incme. Its sectins include Grss Sales, Returns and Allwances, Net Sales, Cst f Gds Sld, Operating Expenses, Operating Incme, Interest Expense, Taxes (fr a crpratin), and Net Incme. 4. Primary Difference Between The Incme Statement Of A Sle Prprietrship Or Partnership And The Incme Statement Of A Crpratin The primary difference is that the incme statement fr a sle prprietrship r partnership des nt shw a line fr incme taxes as they flw thrugh t the wners individual tax return. The crprate incme statement shws an entry fr taxes, which are the crprate incme taxes paid by the crpratin. 5. Persnal Statement Of Financial Psitin It is a persnal balance sheet that lists all items that are wned (assets) by the individual and all items that are wed (liabilities) by the individual at a specific pint in time (as f date). As a result, net wrth can be determined. 7. Imprtance Of Liquidity Liquidity is a measure f hw fast an asset can be cnverted t cash. If a business des nt have sufficient liquidity it will nt be able t pay ff shrt-term creditrs n time. This affects the business credit rating and ability t brrw funds

19 Accunting equatin fr the balance sheet? Assets = Liabilities + Owners Equity 9. Difference Between A Current Asset And A Fixed Asset A current asset is an asset that has a useful life f ne year r less. A fixed asset is ne that has an expected life in excess f ne year. Fixed assets may be depreciated, current assets cannt be depreciated. 10. Owners equity in a sle prprietrship Owners equity in a sle prprietrship is the ttal value f the business that results frm subtracting ttal liabilities frm ttal assets. Owners equity in a partnership lists all f the individual partners equity. Owners equity in a crpratin includes preferred stck at par, cmmn stck at par, paid in capital in excess f par value, and accumulated retained earnings. 11. Purpse Of The Statement Of Cash Flws The purpse is t shw hw cash flwed int and ut f the business during the year. The reasn is that the incme statement and balance sheet d nt actually shw cash flw during the accunting perid. 12. Cmpnents f the statement f cash flws. The cmpnents include cash flws frm perating activities, cash flws frm investing activities, and cash flws frm financing activities; the result f these are the net increase

20 (decrease) in cash. 13. Financial Statement (Persnal Frm) Single bank lan applicatin frm which incrprates tw individual financial frms: Statement f financial psitin Cash Cash equivalents Invested assets Use assets Liabilities Net wrth Persnal cash flw statement Incme Fixed expenses Variable expenses Incme Statement Business Basic Frmat Sales, revenues, incme frm ding business Less cst f gds sld Grss prfit Less perating expenses Operating incme Less interest Net incme Persnal Incme Statement (Cash Flw Statement) IncmeInclude all surces Wages, tips, vertime Interest n savings, stck dividends, etc

21 Fixed expenses Cntractual, must be paid Rent, insurance, utilities, car payments, etc. Variable expenses Yu cntrl level f expenses (fd, clthing) Balance Sheet (Statement f Financial Psitin) Basic Accunting Equatin Individual Ttal assets Current assets Fixed assets Land Sle Prprietrship Partnership Crpratin Cash, accunts receivable, inventry Building & equipment (less accumulated depreciatin) Net building & equipment Ttal liabilities Current liabilities

22 Accunts payable, ntes payable, taxes payable Lng-term liabilities (debt) Ttal equity Preferred stck Cmmn stck par value Paid-in capital in excess f par (cmmn) Retained earnings Statement f Cash Flws Statement f cash flws shws hw the cmpanys wrking capital flws int and ut f the business during the year. Statement f cash flws includes: Cash flws frm perating activities is the difference between all f the cash received by the business and all f the cash paid ut by the business in cnducting its day-t-day peratins. Receipts: All cash received frm sales, changes in accunts receivable, changes in inventry. NOTE: An increase in accunts receivable r inventry represents a negative cash flw. A reductin in receivables r inventry is a psitive cash flw. Payments: All payments made by the cmpany t all accunts (suppliers, emplyees, rent, utilities, etc.). Cash Flws frm Investing Activities: Acquisitin r sale f Plant Assets Cash Flws frm Financing Activities: Prceeds frm issuance r sale f stck (preferred & cmmn), bnds. Purchase f stck r the payment f lng-term debt

23 balance, current year. Net increase (decrease) in cash plus the cash balance, previus year equals cash In Sectin 2 f this curse yu will cver these tpics: Analysis Of Financial Statements Prfit, Prfitability, And Break-Even Analysis Yu may take as much time as yu want t cmplete the tpic cverd in sectin 2. There is n time limit t finish any Sectin, Hwever yu must finish All Sectins befre semester end date. If yu want t c ntinue remaining curses later, yu may save the curse and leave. Yu can cntinue later as per yur cnvenience and this curse will be avalible in yur area t save and cntinue later. : Analysis Of Financial Statements Tpic Objective: At the end f this tpic student wuld be able t: Understand the purpse f financial statement analysis. Perfrm a vertical analysis f a cmpanys financial statements by: Cmparing thse accunts n the incme statement as a percentage f net sales and cmparing thse accunts n the balance sheet as a percentage f ttal assets fr a perid f tw r mre accunting cycles. cntrl. Determining thse areas within the cmpany that require additinal mnitring and Cmparing the percentage change f cmpnents n a cmpanys incme statement and balance sheet fr a perid f tw r mre years. cntrl. Determining thse areas within the cmpany that require additinal mnitring and

24 Perfrm rati analysis f a cmpany and cmpare thse ratis t ther cmpanies within the same industry using industry averages. Analyze the relatinships that exist between the several categries f ratis in determining the health f a business. Distinguish between liquidity, activity, leverage, prfitability, and market ratis. Knw hw t btain financial statements and financial infrmatin frm varius surces. Definitin/Overview: Financial statements : Financial statements (r financial reprts) are frmal recrds f a business' financial activities. Key Pints: 1. Financial statement analysis The purpse f financial statement analysis is t generate infrmatin which can be used internally by the business and externally by ptential creditrs and investrs. 2. Financial Statements Financial statements are used internally by managers t mnitr the business n an nging basis. The statements can be cmpared t previus time perids t determine hw effectively and efficiently the cmpanys gals are accmplished. The instructr can accept any f the financial statement analysis ratis that managers wuld nrmally use internally as lng as the student demnstrates an understanding f the actual use f the rati by a business manager

25 Three types f financial statement analysis. Vertical analysis is the prcess f using a single variable such as net sales as a cnstant and determining hw all ther variables relate t this single variable. Hrizntal analysis is the prcess f determining the percentage increase r decrease in an accunt by cmparing the base time perid t successive time perids. Rati analysis shws the relatinship between tw variables expressed as a fractin. Rati analysis is used t determine the health f a business especially as it cmpares t ther firms in the same industry r similar industries. If a cmpany had sales f $2,587,643 in 1998 and sales f $3,213,456 in 2003, by what percentage did sales change during this time perid? If the cmpany had a gal f increasing sales by 25% ver a five-year perid, did it meet its bjectives? If the cmpany in questin 4 had set a gal f increasing sales by 28% during the next five years, what shuld be the sales gal fr 2008? 4. Five categries f business ratis Liquidity ratis are used t measure the ability f the firm t meet its shrt-term creditrs claims. Activity ratis are used t determine hw well a cmpany is managing its assets and if the assets being used at the ptimum level

26 Leverage (debt) ratis indicate hw much f the cmpanys net wrth and asset cmmitment is financed with debt (surces f funds btained frm creditrs). Prfitability ratis determine hw well the firm is using its assets and sales revenue t generate a psitive return fr its wners. Market ratis indicate what price investrs are willing t pay fr wnership in the cmpany. If a cmpany cmputes its current rati t be 3.56, what des this mean in terms f the cmpanys current assets and current liabilities? Fr every dllar f current liabilities r shrt-term creditrs claims, the cmpany has $3.56 f current assets in rder t meet these claims. Why might a cmpany have a high current rati but a lw quick rati (acid test rati)? A cmpany having a high current rati may have s much inventry that it is giving an unclear picture f its ability t meet creditrs claims. This cmpany may have s many dllars tied up in inventry that it is ver investing its wn excess funds in inventry. If a cmpany has beginning inventry f $30,000 and ending inventry f $55,000, cmpute its average inventry. If the cst f gds sld is $140,000, cmpute its inventry turnver and determine hw many days the average item is in stck. 5. Fixed Asset Turnver If fixed asset turnver falls belw ne, it indicates that fr every dllar f fixed assets cmmitted by the cmpany, it has less than ne dllar f net sales generated. In rder t cunteract this, the cmpany shuld either increase its revenue, decrease its fixed assets, r bth. In ther wrds, the cmpany is nt maximizing its fixed assets as much as initially intended

27 If a cmpany has $181,000 in ttal liabilities and $225,000 in ttal assets, what percentage f ttal assets is being financed with the use f ther peples mney? In ther wrds, fr every dllar f assets that the cmpany has a right t wn, it wes 80 cents t creditrs. 6. Grss Prfit Margin Grss Prfit Margin is used t determine hw much grss prfit is generated by each dllar in net sales. T calculate grss prfit margin we use the fllwing frmula: 7. Operating Prfit Margin Operating Prfit Margin is used t determine hw much each dllar f sales generates in perating incme. The frmula uses perating incme which is actually the Earnings f ur cmpany Befre Interest and Taxes (EBIT) and the frmula is:. 8. Net Prfit Margin Net Prfit Margin prvides us with hw much the firm earned n each dllar in sales after paying all bligatins including interest and taxes. The frmula is:

28 The distinctin ccurs in the numeratr fr all three ratis. Grss prfit margin is calculated befre perating expenses, perating prfit margin is calculated after perating expenses, and net prfit margin is calculated after interest and taxes are paid. Three Methds f Analyzing Financial Statements Vertical analysis Hrizntal analysis Rati analysis Vertical Analysis Vertical analysis is the prcess f using a single variable n a financial statement as a cnstant and determining hw all f the ther variables relate as a percentage f the single variable. Vertical Analysis f an Incme Statement The vertical analysis f the incme statement is used t determine, specifically, hw much f a cmpanys net sales cnsumed by each individual entry n the incme statement. Cnstant is net sales. The frmula is: Hrizntal Analysis Hrizntal analysis is a determinatin f the percentage increase r decrease in an accunt frm a base time perid t successive time perids. The basic frmula is: Vertical Analysis f a Balance Sheet Vertical analysis f the balance sheet is always carried ut by using ttal assets as a cnstant, r 100 percent, and dividing every figure n the balance sheet by ttal assets. The frmula is: Rati Analysis Rati analysis is used t determine the health f a business, especially as that business cmpares t ther firms in the same industry r similar industries. A rati is nthing mre than a relatinship between tw variables, expressed as a fractin

29 Types f Business Ratis Liquidity ratis determine hw much f a firms current assets are available t meet shrt-term creditrs claims. Activity ratis indicate hw efficiently a business is using its assets. Leverage (debt) ratis indicate what percentage f the business assets is financed with creditrs dllars. Prfitability ratis are used by ptential investrs and creditrs t determine hw much f an investment will be returned frm either earnings n revenues r appreciatin f assets. Market ratis are used t cmpare firms within the same industry. They are primarily used by investrs t determine if they shuld invest capital in the cmpany in exchange fr wnership. Liquidity Ratis Current Rati: The current rati is calculated by dividing ttal current assets by ttal current liabilities. The current rati is given by the fllwing: Quick, r Acid Test, Rati: This rati des nt cunt the sale f the cmpanys inventry r prepaids. It measures the ability f the firm t meet its shrt-term bligatins withut liquidating its inventry. The acid test rati is given by the fllwing: Activity Ratis Inventry turnver rati (r, simply, inventry turnver) indicates hw efficiently a firm is mving its inventry. It basically states hw many times per year the firm mves it average inventry. Inventry turnver is given as fllws:

30 Accunts receivable turnver rati allws us t determine hw fast ur cmpany is turning its credit sales int cash. Accunts receivable turnver is given by the fllwing: Average cllectin perid is the average number f days that it takes the firm t cllect its accunts receivable. Average cllectin perid is given by the fllwing: Fixed asset turnver rati indicates hw efficiently fixed assets are being used t generate revenue fr a firm Fixed asset turnver is given by the fllwing: Ttal asset turnver rati indicates hw efficiently ur firm uses its ttal assets t generate revenue fr the firm. Ttal asset turnver is given by the fllwing: Leverage Ratis Debt-t-equity rati indicates what percentage f the wners equity is debt. Debt-t-equity is given by the fllwing: Debt-t-ttal-assets rati indicates what percentage f a businesss assets is wned by creditrs. Debt-t-ttal-assets is given by the fllwing: Times-interest-earned rati shws the relatinship between perating incme and the amunt f interest in dllars the cmpany has t pay t its creditrs n an annual basis

31 Times-interest-earned is given by the fllwing: Prfitability Ratis Grss prfit margin rati is used t determine hw much grss prfit is generated by each dllar in net sales. Grss prfit margin is given by the fllwing: Operating prfit margin rati is used t determine hw much each dllar f sales generates in perating incme. Operating prfit margin is given by the fllwing: Net prfit margin rati tells us hw much a firm earned n each dllar in sales after paying all bligatins including interest and taxes. Net prfit margin is given by the fllwing: Operating return n assets rati is als referred t as perating return n investment and allws us t determine hw much we are actually earning n each dllar in assets prir t paying interest and taxes. Operating return n assets is given by the fllwing: Net return n assets (ROA) rati is als referred t as net return n investment and tells us hw much a firm earns n each dllar in assets after paying bth interest and taxes. Net return n assets is given by the fllwing: Return n equity (ROE) rati tells the stckhlder, r individual wner, what each dllar f his r her investment is generating in net incme

32 Return n equity (ROE) is given by the fllwing: Return n equity (ROE) can als use the relatinship between the return n assets and the amunt f debt t assets. It can be expressed with the fllwing frmula: Market Ratis Earnings per share rati is nthing mre than the net prfit r net incme f the firm, less preferred dividends (if the cmpany has preferred stck), divided by the number f shares f cmmn stck utstanding (issued). Earnings per share is given by the fllwing: Price earnings rati is a magnificatin f earnings per share in terms f market price f stck. Price earnings rati is given by the fllwing: Operating cash flw per-share rati cmpares the perating cash flw n the statement f cash flws t the number f shares f cmmn stck utstanding. Prfit, Prfitability, And Break-Even Analysis Tpic Objective: At the end f this tpic student wuld be able t:

33 Understand the difference between efficiency and effectiveness. Distinguish between prfit and prfitability. Cmpare accunting and entrepreneurial prfit. Understand the relatinship f prfit margin and asset turnver n the earning pwer f a cmpany. Given the variable csts, revenue, and fixed csts f a business, determine the break-even pint and cntributin margin. Cnstruct and analyze a break-even chart when given variable csts, revenue, and fixed csts f a business. Understand the use f leverage and its relatinship t prfitability and lss. Cmpare and cntrast the degree f perating, financial, and cmbined leverage and their effect n the prfitability f a crpratin. Definitin/Overview: Efficiency And Effectiveness: Since efficiency is btaining the highest pssible return with the minimum use f resurces and effectiveness is accmplishing a specific task r gal, then ne can be effective withut being efficient and vice versa. Entrepreneurial Prfit: Accunting prfit is simply the bttm line f a business incme statement and is an abslute number, whereas an entrepreneurial prfit uses the ecnmic cncept f pprtunity cst. It is the prfit that the entrepreneur wuld have earned if he r she had invested bth time and mney in sme ther enterprise. Earning pwer :Earning pwer is the prduct f tw factrs: net prfit margin and ttal asset turnver. Net prfit margin is net incme divided by sales, and ttal asset turnver is sales divided by ttal assets. This prduct gives rise t return n assets r investment, which is net incme divided by ttal assets

34 Key Pints: 1. Efficiency and Effectiveness Efficiency is btaining the highest pssible return with the minimum use f resurces. Effectiveness, n the ther hand, is accmplishing a specific task r reaching a gal. 2. Prfit versus Prfitability Prfit is an abslute number that is earned n an investment. Accunting prfit, fr a business, is typically shwn at the bttm f an incme statement as net incme. Entrepreneurial prfit is the amunt that is earned abve and beynd what the entrepreneur wuld have earned if he r she had chsen t invest time and mney in sme ther enterprise. Prfitability can be measured in a business by using a rati that is btained by dividing net prfit by ttal assets. Prfitability, therefre, is ur Return n Investment (assets). 3. Earning Pwer The earning pwer f a cmpany can be defined as the prduct f tw factrs: The cmpanys ability t generate incme n the amunt f revenue it receives, which is als knwn as net prfit margin; and Its ability t maximize sales revenue frm prper asset emplyment, als knwn as ttal asset turnver. Earning Pwer Frmulas Earning pwer is equal t net prfit margin multiplied by ttal asset turnver which is equal t return n investment (ttal assets)

35 Break-Even Analysis Break-even analysis is a prcess f determining hw many units f prductin must be sld, r hw much revenue must be btained, befre we begin t earn a prfit. Fr break-even quantity: Where VC is variable cst expressed as a percentage f sales (revenue). Fr retail firm: VC percentage =(Cst f Gds Sld)/(Net Sales) Fr manufacturing firm: VC percentage = (Variable cst f a unit)/(selling price) Cntributin margin is the amunt f prfit that will be made by a cmpany n each unit that is sld abve and beynd the break-even quantity. Cntributin margin is als the amunt the cmpany will lse fr each unit f prductin by which it falls shrt f the break-even pint. 5. Prfit and Break-Even 6. Leverage Desired prfit with break-even analysis in quantity t prduce. VC is variable cst per unit Desired prfit with break-even analysis in dllars. VC is a percentage f sales dllar (e.g., cst f gds sld as a percent). Leverage uses thse items that have a fixed cst t magnify the return t a cmpany. Fixed csts can be related t cmpany peratins r related t the cst f financing. Interest expenses paid n the amunt f debt incurred is the fixed cst f financing. A firm is heavily financially leveraged if the fixed csts f financing are high. Degree f perating leverage (DOL) is the percentage change in perating incme divided by the percentage change in sales. Degree f financial leverage (DFL) is the percentage change in earnings per share divided by the percentage change in perating incme. Degree f cmbined leverage (DCL) is the percentage change in earnings per share divided by the percentage change in sales

36 Bankruptcy Bankruptcy fr a business ccurs when the liabilities f the firm exceed the assets and the business des nt have sufficient cash flw t make payments t creditrs. There are essentially three types f bankruptcy Bankruptcy ccurs when a business seeks curt prtectin while it develps a rerganizatin plan. Bankruptcy is reserved fr individuals and sle prprietrships and is similar t, but much simpler than. Bankruptcy requires liquidatin f all assets f the business, and payment t the creditrs. 8. Bankruptcy Abuse, Preventin, and Cnsumer Prtectin Act. Signed int law by President Bush n April 20, Tk effect Octber 17, Makes it much mre difficult fr individuals and business t declare Chapter 7 bankruptcy. Establishes a means test t determine if an individual filing Chapter 7 is abusing the system. Impses federal guidelines fr using the hmestead exemptin

37 In Sectin 3 f this curse yu will cver these tpics: Frecasting And Pr Frma Financial Statements Wrking Capital Management Yu may take as much time as yu want t cmplete the tpic cverd in sectin 3. There is n time limit t finish any Sectin, Hwever yu must finish All Sectins befre semester end date. If yu want t c ntinue remaining curses later, yu may save the curse and leave. Yu can cntinue later as per yur cnvenience and this curse will be avalible in yur area t save and cntinue later. : Frecasting And Pr Frma Financial Statements Tpic Objective: At the end f this tpic student wuld be able t: Understand the basic steps used in selecting a frecasting mdel. Knw hw t evaluate a frecasting mdel. Given a business situatin, chse the prper frecasting mdel. Calculate a frecast using time series data. Explain the rle that the Mean Abslute Deviatin (MAD) plays in selecting a frecasting mdel. Understand the relatinship amng a businesss revenue base, sales frecast, assets, and need fr financing. Cnstruct pr frma financial statements frm available data n a prpsed r existing business. Definitin/Overview: Frecasting : Frecasting is the prcess f estimatin in unknwn situatins. Predictin is a similar, but mre general term. Bth can refer t estimatin f time series, crss-sectinal r

38 lngitudinal data. Usage can differ between areas f applicatin: fr example in hydrlgy, the terms "frecast" and "frecasting" are smetimes reserved fr estimates f values at certain specific future times, while the term "predictin" is used fr mre general estimates, such as the number f times flds will ccur ver a lng perid. Risk and uncertainty are central t frecasting and predictin. Key Pints: 1. Frecasting A frecast is a quantifiable estimate f future demand. Frecasting in business is the prcess f estimating the future demand fr ur prducts and services. Frecasting fr the financial manager als requires estimates f future interest rates. 2. Frecasting Prcess Determine the type f mdel t be used. Determine the frecast hrizn. Select ne r mre frecasting mdels. Evaluate the mdels. Apply the chsen mdel. Mnitr and cntrl the mdel. 3 Determine the Type f Mdel t be Used Wh will be using the frecast and what infrmatin d they require? Hw relevant is histrical data, and what is its availability? Hw accurate des the frecast have t be? What is the time perid f the frecast? Hw much time d we have t develp the frecast? What is the cst r benefit (value) f this frecast t ur cmpany?

39 Determine the Frecast Hrizn Inverse relatinship between frecast accuracy and time hrizn. The lnger the time hrizn the mre inaccurate the frecast will be. Time hrizn shuld be at least as lng as time perid f strategic plan. Prduct life cycles influence length f frecasts. Technlgical prduct sales wuld have a shrt frecast. Milk sales wuld have a lng frecast. Select One r Mre Frecasting Mdels 5. Evaluate the Mdels Cmpare the accuracy f frecasting mdels by use f Mean Abslute Deviatin (MAD) Remember the mdel assists the frecaster, it des nt make the decisin. Changing market and ecnmic cnditins require us t cnstantly evaluate ur frecasting mdels. 6. Apply the Chsen Mdel Applicatin in business is used t determine future requirement. Applicatin f the mdel and specific units f measurement used depends n the area f the business that uses the mdel: Marketing wants demand f prduct. Prductin requires units. Finance requires dllars. Persnnel requires human resurces. 7. Mnitr and Cntrl the Mdel Mdel shuld allw us t develp cntrls in a three-step prcess: Determine standard fr measuring prgress tward frecast. Measure actual perfrmance against this standard. Take crrective actin