7/31/2019 Scarborough 10e PPT Ch07
1/36
Chapter 7 Solid Financial Plan Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall 7-1
Creating a SolidFinancial Plan
7/31/2019 Scarborough 10e PPT Ch07
2/36
Chapter 7 Solid Financial Plan Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall 7-2
Financial Planning
Research:
Significant numbers of entrepreneurs run
their companies without any kind offinancial plan!
A significant positive relationship exists
between formal planning in smallcompanies and their financialperformances
7/31/2019 Scarborough 10e PPT Ch07
3/36
Chapter 7 Solid Financial Plan Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall 7-3
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 expensesagainst its revenue over a period of time to show
its net income (or loss):
Net Income = Sales Revenue - Expenses
Statement of Cash Flows - shows the change in thefirm's working capital over a period of time by
listing the sources of funds and the uses of these
funds
7/31/2019 Scarborough 10e PPT Ch07
4/36
Foundation for Financial ForecastsMarketing analysis and forecasts Demand forproducts or servicesAssumptions
Forecasted (pro forma) Financial Elements
Cash Flow ForecastFrom operationsFrom investingFrom external sources of financing
Forecast
revenues
Projected start-upcapital
requirements
Forecast expenses
ForecastedBalance Sheet
Current assets
Fixed assets
Liabilities
Owners equity
Total liabilitiesand equity
ForecastedIncome
Statement
Sales
ExpensesDepreciation
Operatingincome
InterestTaxes
Net income
Financing Plan(Sources of Funds)
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-4
7/31/2019 Scarborough 10e PPT Ch07
5/36
Twelve Key Ratios
Liquidity Ratios - Tell whether or not a smallbusiness will be able to meet its maturingobligations as they come due
1. Current Ratio - Measures solvency by showing afirm's ability to pay current liabilities out of currentassets
Current Ratio = Current Assets = $686,985 = 1.87:1Current Liabilities $367,850
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-5
7/31/2019 Scarborough 10e PPT Ch07
6/36
Twelve Key Ratios
Liquidity Ratios - Tell whether or not a smallbusiness will be able to meet its maturingobligations as they come due
2. Quick Ratio - Shows the extent to which a firm'smost liquid assets cover its current liabilities
Quick Ratio = Quick Assets = $231,530 = .63:1Current Liabilities $367,850
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-6
7/31/2019 Scarborough 10e PPT Ch07
7/36
Twelve Key Ratios Leverage Ratios - Measure the financing provided
by a firm's owners against that supplied by itscreditors; a gauge of the depth of a company'sdebt
Careful!! Debt is a powerful tool, but you mustcontrol it
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan7-7
7/31/2019 Scarborough 10e PPT Ch07
8/36
Low HighDegree of Leverage
Optimal Zone
Be
nefits
ofLeverage
The Right Amount of Debt is a Balancing Act
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-8
7/31/2019 Scarborough 10e PPT Ch07
9/36
Twelve Key Ratios
Leverage Ratios - Measure the financing providedby a firm's owners against that supplied by itscreditors; a gauge of the depth of a company's
debt
3. Debt Ratio - Measures the percentage of totalassets financed by creditors rather than owners
Debt Ratio = Total Debt = $580,000 = .68:1Total Assets $847,655
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan7-9
7/31/2019 Scarborough 10e PPT Ch07
10/36
Twelve Key Ratios
Leverage Ratios - Measure the financing provided by afirm's owners against that supplied by its creditors; agauge of the depth of a company's debt
4. Debt to Net Worth Ratio - Compares what a business"owes" to what it is worth
Debt to Net = Total Debt = $580,000 = 2.20:1Worth Ratio Tangible Net Worth $264,155
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-10
7/31/2019 Scarborough 10e PPT Ch07
11/36
Twelve Key Ratios
Leverage Ratios - Measure the financing provided by afirm's owners against that supplied by its creditors; agauge of the depth of a company's debt
5. Times Interest Earned - Measures a firm's ability tomake 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
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-11
7/31/2019 Scarborough 10e PPT Ch07
12/36
Twelve Key Ratios
Operating Ratios - Evaluate a firm's overall performanceand show how effectively it is putting its resources towork
6. Average Inventory Turnover Ratio - Tells the averagenumber of times a firm's inventory is "turned over" or
sold out during the accounting period
Average Inventory = Cost of Goods Sold = $1,290,117 = 2.05 timesTurnover Ratio Average Inventory* $630,600 a year
*Average Inventory = Beginning Inventory + Ending Inventory2
Days Inventory (or average age of inventory) = 365 2.05 = 178 days
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-12
7/31/2019 Scarborough 10e PPT Ch07
13/36
Twelve Key Ratios
Operating Ratios - Evaluate a firm's overall performance andshow 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 daysPeriod Ratio Receivables Turnover Ratio 7.31
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-13
7/31/2019 Scarborough 10e PPT Ch07
14/36
Lowering Your Average CollectionPeriod Can Save You $$
Improving your companys average collection period
ratio translates into dollar savings:
Savings = Credit Sales x Annual Interest Rate x # of days avg. collection pd. Lowered365
Example:
Savings = $1,309,589 x 8.75% x 8 days = $2,512365 days
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-14
7/31/2019 Scarborough 10e PPT Ch07
15/36
Twelve Key Ratios
Operating Ratios - Evaluate a firm's overall performanceand show how effectively it is putting its resources towork
8. Average Payable Period Ratio - Tells the averagenumber of days required to pay accounts payable
Two Steps:
Payables Turnover = Purchases = $939,827 = 6.16 timesRatio Accounts Payable $152,580 a year
Average Payable = Days in Accounting Period = 365 = 59.3 daysPeriod Ratio Payables Turnover Ratio 6.16
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-15
7/31/2019 Scarborough 10e PPT Ch07
16/36
Twelve Key Ratios
Operating Ratios - Evaluate a firm's overallperformance and show how effectively it is putting itsresources to work
9. Net Sales to Total Assets Ratio - Measures a firm's
ability to generate sales given its asset base
Net Sales to = Net Sales = $1,870,841 = 2.21:1Total Assets Total Assets $847,655
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-16
7/31/2019 Scarborough 10e PPT Ch07
17/36
Twelve Key Ratios
Profitability Ratios - Measure how efficiently a firm isoperating; offer information about a firm's "bottomline"
10. Net Profit on Sales Ratio - Measures a firm's profit perdollar of sales revenue
Net Profit on = Net Income = $60,629 = 3.24%
Sales Net Sales $1,870,841
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-17
7/31/2019 Scarborough 10e PPT Ch07
18/36
Twelve Key Ratios
Profitability Ratios - Measure how efficiently a firm isoperating; offer information about a firms bottomline
11. Net Profit to Assets (Return on Assets) Ratio tellshow much profit a company generates for each dollarof assets that it owns
Net Profit to = Net Income = $60,629 = 7.15%Assets Total Assets $847,655
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-18
7/31/2019 Scarborough 10e PPT Ch07
19/36
Twelve Key Ratios
Profitability Ratios - Measure how efficiently a firm isoperating; offer information about a firm's bottomline
12. Net Profit to Equity Ratio - Measures the owner's rateof return on the investment in the business
Net Profit to = Net Income = $60,629 = 22.65%
Equity Owners Equity* $267,655
* Also called net worth
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-19
7/31/2019 Scarborough 10e PPT Ch07
20/36
Interpreting Ratios
Sams Appliance Shop
Current ratio = 1.87:1
Industry Median
Current ratio = 1.60:1
Although Sams falls short of the rule ofthumb of 2:1, its current ratio is above theindustry median by a significant amount.
Sams should have no problem meetingshort-term debts as they come due
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-20
7/31/2019 Scarborough 10e PPT Ch07
21/36
Interpreting Ratios
Sams Appliance Shop
Quick ratio = 0.63:1
Industry Median
Quick ratio = 0.50:1
Again, Sams is below the rule of thumbof 1:1, but the company passes this testof liquidity when measured againstindustry standards. Sams relies on selling
inventory to satisfy short-term debt (asdo most appliance shops). If sales slump,the result could be liquidity problems forSams
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-21
7/31/2019 Scarborough 10e PPT Ch07
22/36
Interpreting Ratios
Sams Appliance Shop
Debt ratio = 0.68:1
Industry Median
Debt ratio = 0.62:1
Creditors provide 68% of Sams totalassets, very close to the industry median of62%. Although the company does notappear to be overburdened with debt,
Sams might have difficulty borrowing,especially from conservative lenders
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-22
7/31/2019 Scarborough 10e PPT Ch07
23/36
Interpreting Ratios
Sams Appliance Shop
Debt to net worthratio = 2.20:1
Industry Median
Debt to net worthratio =2.30:1
Sams owes $2.20 to creditors for every
$1.00 the owner has invested in thebusiness (compared to $2.30 to every$1.00 in equity for the typical business.)Many lenders will see Sams as borrowedup, having reached its borrowingcapacity. Creditors claims are more thantwice those of the owners
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-23
7/31/2019 Scarborough 10e PPT Ch07
24/36
Interpreting Ratios
Sams Appliance Shop
Times interest earnedratio = 2.52:1
Industry Median
Times interest earnedratio =2.10:1
Sams earnings are high enough tocover the interest payments on its debtby a factor of 2.52:1, better than thetypical firm in the industry. Sams has acushion (although a small one) inmeeting its interest payments
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-24
7/31/2019 Scarborough 10e PPT Ch07
25/36
Interpreting Ratios
Sams Appliance Shop
Average inventoryturnover ratio = 2.05times per year
Industry Median
Average inventoryturnover ratio = 4.40times per year
Inventory is moving through Sams at avery slow pace. What could be causingsuch a low turnover in the business?
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan7-25
7/31/2019 Scarborough 10e PPT Ch07
26/36
Interpreting Ratios
Sams Appliance Shop
Average collectionperiod ratio = 50.0days
Industry Median
Average collectionperiod ratio = 10.5days
Sams collects the average accountreceivable after 50 days compared tothe industry median of 11 days nearly
5 times longer. What is a moremeaningful comparison for this ratio?
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-26
7/31/2019 Scarborough 10e PPT Ch07
27/36
Interpreting Ratios
Sams Appliance Shop
Average payable periodratio = 59.3 days
Industry Median
Average payableperiod ratio = 23 days
Sams payables are nearly 40 percentslower than those of the typical firm inthe industry. Stretching payables too far
could seriously damage the companyscredit rating. What are the possiblecauses of this discrepancy?
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-27
7/31/2019 Scarborough 10e PPT Ch07
28/36
Interpreting Ratios
Sams Appliance Shop
Net sales to totalassets ratio = 2.21:1
Industry Median
Net Sales to totalassets ratio = 3.4:1
Sams Appliance Shop is not generatingenough sales given the size of its assetbase. What could cause this?
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-28
7/31/2019 Scarborough 10e PPT Ch07
29/36
Interpreting Ratios
Sams Appliance Shop
Net profit on salesratio = 3.24%
Industry Median
Net profit on salesratio = 4.3%
After deducting all expenses, Sams hasjust 3.24 cents of every sales dollar leftas profit nearly 25% below the
industry median. Sam may discover thatsome of his operating expenses are outof balance
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-29
7/31/2019 Scarborough 10e PPT Ch07
30/36
Interpreting Ratios
Sams Appliance Shop
Net profit to assetsratio = 7.15%
Industry Median
Net sales to workingcapital ratio = 4.0%
Sams generates a return of 7.15% for every$1 in assets, which is nearly 79% above theindustry average. Given his asset base, Sam issqueezing an above-average return out of his
company. Is this likely to be the result ofexceptional profitability or is there anotherexplanation?
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-30
7/31/2019 Scarborough 10e PPT Ch07
31/36
Interpreting Ratios
Sams Appliance Shop
Net profit on equityratio = 22.65%
Industry Median
Net profit on equityratio = 16.0%
Sams return on his investment in thebusiness is an impressive 22.65%,compared to an industry median of just
16%. Is this the result of highprofitability or is there anotherexplanation?
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan 7-31
7/31/2019 Scarborough 10e PPT Ch07
32/36
Chapter 7 Solid Financial Plan Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall 7-32
Breakeven Analysis
The breakeven point is the level of operationat which a business neither earns a profit norincurs a loss
It is a useful planning tool because it showsentrepreneurs the minimum level of activityrequired to stay in business
With one change in the breakevencalculation, an entrepreneur can alsodetermine the sales volume required to reacha particular profit target
7/31/2019 Scarborough 10e PPT Ch07
33/36
Chapter 7 Solid Financial Plan Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall 7-33
Calculating theBreakeven Point
Step 1. Determine the expenses the business canexpect to incur
Step 2. Categorize the expenses in step 1 into fixed
expenses and variable expensesStep 3. Calculate the ratio of variable expenses to
net sales. Then compute the contribution margin:
Contribution Margin = 1 -Variable Expenses
Net Sales EstimateStep 4. Compute the breakeven point:
Breakeven Point$
=Total Fixed Costs
Contribution Margin
7/31/2019 Scarborough 10e PPT Ch07
34/36
Chapter 7 Solid Financial Plan Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall 7-34
Calculating the BreakevenPoint: The Magic Shop
Step 1. Net Sales estimate is $950,000 with Cost ofGoods Sold of $646,000 and total expenses of$236,500
Step 2. Variable Expenses of $705,125; FixedExpenses of $177,375
Step 3. Contribution margin:
Contribution Margin = 1 -$705,125
$950,000
Step 4. Breakeven point:
Breakeven Point
$
=$177,375
.26
= .26
= $682,212
7/31/2019 Scarborough 10e PPT Ch07
35/36
Breakeven Chart
Sales Volume
Total Expense
Line
Revenue
Line
Fixed Expense
Line
Breakeven Point
Sales = $682,212
$682,212
$682,212
0
Copyright 2012 Pearson Education, Inc. publishing as Prentice HallChapter 7 Solid Financial Plan7-35
7/31/2019 Scarborough 10e PPT Ch07
36/36
All rights reserved. No part of this publication may bereproduced, stored in a retrieval system, or transmitted,in any form or by any means, electronic, mechanical,photocopying, recording, or otherwise, without the priorwritten permission of the publisher. Printed in theUnited States of America.
Copyright 2012 Pearson Education,Inc. Publishing as Prentice Hall