The document provides an overview of financial feasibility analysis, financial planning, and cashflow management for new ventures and entrepreneurship. It discusses key aspects of financial statements, including income statements, balance sheets, cashflow statements, and ratio analysis. It also covers financial forecasts, pro forma financial statements, and the importance of cash management through tools like cash budgets. The overall document provides guidance on evaluating the financial viability and planning the finances of a new business venture.

1. ABDM4233 ENTREPRENEURSHIP
Financial Feasibility,
Financial Planning,
& Cashflow Management
by
Stephen Ong
Principal Lecturer (Specialist)
Visiting Professor, Shenzhen

2. Who are the Best?
1. The way the world tells its story.
2. Whatever it takes.
3. United for a more equitable world.
4. Harnessing the past. Enriching the future.
5. From harm to home.
6. Pioneering solutions, lifesaving results.
7. Defending dignity. Fighting poverty.
8. Our doctors go to places photographers don’t.
9. It’s about saving lives.
10. Changes the way information flows in the world.
11. No good food should go to waste.

3. Competitive Analysis Grid for Element
Bars
5-3

4. The 6 Ps of Marketing for New Ventures
Product Price
Promotion Place (or
Marketing Mix distribution
channel)
Philantrophy People (or
Customer
(Do GOOD) Service)
11-4

5. Elements of a Feasibility Analysis
Industry and Product or Service
Market Feasibility
Feasibility
Financial
Feasibility

6. The 360° CUBE Pitch
Six Posters in a 6 minute Investor Pitch
SOCIAL MARKETING
PROBLEM & SALES
VISION & OPERATIONS TEAM
MISSION & KEY PARTNERS
BUSINESS FINANCIAL
MODEL MILESTONES

7. 360° Business CUBE
1. The Problem : How BIG is the problem?
2. The Solution : Our Social Enterprise’s
Vision & Mission
3. The Business Model : Getting the JOB done
for the Customer Segments
4. Marketing & Sales (and Fundraising)
5. The Team & Key Partners
6. The Financial Plan : Goals
and objectives, with a
timeline (Milestones)

8. Assessing a New
Venture’s Financial
Strength and
Viability

9. Financial Management
1 of 2
 Financial Management
 Financial management deals with two things: raising
money and managing a company’s finances in a way
that achieves the highest rate of return
 Chapter 10 focuses on raising money. This chapter
focuses primarily on:
 How a new venture tracks its financial progress through
preparing, analyzing, and maintaining past financial
statements.
 How a new venture forecasts future income and expenses by
preparing pro forma (or projected) financial statements.
8-9

10. Financial Management
2 of 2
The financial management of a firm deals with such questions on an ongoing basis:
• How are we doing? Are we making or losing money?
• How much cash do we have on hand?
• Do we have enough cash to meet our short-term obligations?
• How efficiently are we utilizing our assets?
• How do our growth and net profits compare to those of our industry
peers?
• Where will the funds we need for capital improvements come from?
• Arethere ways we can partner with other firms to share risk and
reduce the amount of cash we need?
• Overall, are we in good shape financially?
8-10

11. Financial Objectives of a Firm
1 of 3

12. Financial Objectives of a Firm
2 of 3
 Profitability
 Is the ability to earn a profit.
 Many start-ups are not profitable during their first 1 to
3 years while they are training employees and building their
brands.
 However, a firm must become profitable to remain viable
and provide a return to its owners.
 Liquidity
 Is a company’s ability to meet its short-term financial
obligations.
 Even if a firm is profitable, it is often a challenge to keep
enough money in the bank to meet its routine
obligations in a timely manner.

13. Financial Objectives of a Firm
3 of 3
 Efficiency
 Is how productively a firm utilizes its assets relative to
its revenue and its profits.
 Air Asia, for example, uses its assets very productively. Its
turnaround time, or the time its airplanes sit on the ground
while they are being unloaded and reloaded, is the lowest in
the airline industry.
 Stability
 Is the strength and vigor of the firm’s overall
financial posture.
 For a firm to be stable, it must not only earn a profit and
remain liquid but also keep its debt in check.

14. The Process of Financial Management
1 of 4
 Importance of Financial Statements
 To assess whether its financial objectives are
being met, firms rely heavily on analysis of
financial statements.
 A financial statement is a written report that
quantitatively describes a firm’s financial health.
 The income statement, the balance sheet, and the
statement of cash flows are the financial statements
entrepreneurs use most commonly.
 Forecasts
 Are an estimate of a firm’s future income and
expenses, based on past performance, its
current circumstances, and its future plans.

15. The Process of Financial Management
2 of 4
 Forecasts (continued)
 New ventures typically base their forecasts on an
estimate of sales and then on industry averages or the
experiences of similar start-ups regarding the cost of
goods sold and other expenses.
 Budgets
 Are itemized forecasts of a company’s income,
expenses, and capital needs and are also an important
tool for financial planning and control.

16. The Process of Financial Management
3 of 4
 Financial Ratios
 Depict relationships between items on a firm’s
financial statements.
 An analysis of its financial ratios helps a firm
determine whether it is meeting its financial
objectives and how it stacks up against industry
peers.
 Importance of Financial Management
 Many experienced entrepreneurs stress the
importance of keeping on top of the financial
management of the firm.

17. The Process of Financial Management
4 of 4

18. Financial Statements
 Historical Financial Statements
 Reflect past performance and are usually
prepared on a quarterly and annual basis.
 Publicly traded firms are required by the SEC to
prepare financial statements and make them
available to the public.
 Pro Forma Financial Statements
 Are projections for future periods based on
forecasts and are typically completed for two to
three years in the future.
 Pro forma financial statements are strictly planning
tools and are not required by the SEC.

19. Importance of Keeping Good Records
The first step toward prudent
financial management is keeping
good records.

20. Example : New Venture Fitness Drinks
 New Venture Fitness Drinks
 To illustrate how financial statements are prepared,
we used New Venture Fitness Drinks, a fictitious
sports drink company.
 New Venture Fitness Drinks has been in business for five
years.
 Targeting sports enthusiasts, the company sells a line of
nutritional fitness drinks.
 The company’s strategy is to place small restaurants,
similar to smoothie restaurants, near large outdoor sports
complexes.
 The company is profitable and is growing at a rate of 25%
per year.

21. Historical Financial Statements
Three types of historical financial statements
Financial Statement Purpose
Reflects the results of the operations of a firm over a
Income specified period of time. It records all the revenues and
expenses for the given period and shows whether the firm
Statement is making a profit or is experiencing a loss.
Balance Sheet Is a snapshot of a company’s assets, liabilities, and
owner’s equity at a specific point in time.
Summarizes the changes in a firm’s cash position for
Statement of a specified period of time and details why the
changes occurred.
Cash Flows

22. Historical Income Statements

23. Historical Balance Sheets
1 of 2
Assets

24. Historical Balance Sheets
2 of 2
Liabilities and Shareholders’ Equity

25. Historical Statement of Cash Flows

26. Ratio Analysis
 Ratio Analysis
 The most practical way to interpret or make
sense of a firm’s historical financial statements
is through ratio analysis, as shown in the next
slide.
 Comparing a Firm’s Financial Results to
Industry Norms
 Comparing a firm’s financial results to industry
norms helps a firm determine how it stacks up
against its competitors and if there are any
financial “red flags” requiring attention.

27. Historical Ratio Analysis

28. Forecasts
1 of 4
 Forecasts
 The analysis of a firm’s historical financial statements
are followed by the preparation of forecasts.
 Forecasts are predictions of a firm’s future sales,
expenses, income, and capital expenditures.
 A firm’s forecasts provide the basis for its pro forma
financial statements.
 A well-developed set of pro forma financial statements
helps a firm create accurate budgets, build financial plans,
and manage its finances in a proactive rather than a
reactive manner.

29. Forecasts
2 of 4
 Sales Forecast
 A sales forecast is a projection of a firm’s sales for a
specified period (such as a year).
 It is the first forecast developed and is the basis for
most of the other forecasts.
 A sales forecast for a new firm is based on a good-faith
estimate of sales and on industry averages or the experiences of
similar start-ups.
 A sales forecast for an existing firm is based on (1) its record of
past sales, (2) its current production capacity and product
demand, and (3) any factors that will affect its future product
capacity and product demand.
8-29

30. Forecasts
3 of 4
Historical and Forecasted Annual Sales for New Venture Fitness Drinks
8-30

31. Forecasts
4 of 4
 Forecast of Costs of Sales and Other Items
 Once a firm has completed its sales forecast, it must
forecast its cost of sales (or cost of goods sold) and the
other items on its income statement.
 The most common way to do this is to use the
percentage-of-sales method, which is a method for
expressing each expense item as a percentage of sales.
 If a firm determines that it can use the percent-of-sales method
and it follows the procedures described in the textbook, then
the net result is that each expense item on its income statement
will grow at the same rate as sales (with the exception of items
that can be individually forecast, such as depreciation).
8-31

32. Pro Forma Financial Statements
 Pro Forma Financial Statements
 A firm’s pro forma financial statements are similar to
its historical financial statements except that they look
forward rather than track the past.
 The preparation of pro form financial statements helps
a firm rethink its strategies and make adjustments if
necessary.
 The preparation of pro forma financials is also
necessary if a firm is seeking funding or financing.
8-32

33. Types of Pro Forma Financial
Statements
Financial Statement Purpose
Pro Forma Income Shows the projected results of the operations of a
Statement firm over a specific period.
Shows a projected snapshot of a company’s
Pro Forma Balance assets, liabilities, and owner’s equity at a specific
Sheet point in time.
Pro Forma Statement Shows the projected flow of cash into and out of a
of Cash flows company for a specific period.
8-33

34. Pro Forma Income Statements
8-34

35. Pro Forma Balance Sheets
1 of 2
Assets
8-35

36. Pro Forma Balance Sheets
2 of 2
Liabilities and Shareholders’ Equity
8-36

37. Pro Forma Statement of Cash Flows
1 of 2
Operating Activities
8-37

38. Pro Forma Statement of Cash Flows
2 of 2
Investing Activities and Financing Activities
8-38

39. Ratio Analysis
 Ratio Analysis
 The same financial ratios used to evaluate a firm’s
historical financial statements should be used to
evaluate the pro forma financial statements.
 This work is completed so the firm can get a sense of
how its projected financial performance compares to its
past performance and how its projected activities will
affect its cash position and its overall financial
soundness.
8-39

40. Ratio Analysis Based on Historical and
Pro-Forma Financial Statements
8-40

41. CASH is KING
Managing Cash Flow

42. The Importance of Cash
“Everything is about cash – raising it,
conserving it, collecting it.”
Guy Kawasaki
Common cause of business failure:
Cash crisis!

43. Cash Management
 A business can be earning a profit and be
forced to close because it runs out of cash!
 American Express OPEN Small Business
Monitor study:
 59% of small business owners
experience problems with cash flow.
 Their biggest cash flow concern is
the ability to pay bills on time.

44. FIGURE 12.1 Small Business Owners’ Strategies for Improving Cash Flow
Source: American Express OPEN Small Business Monitor, 2008.

45. Cash Management
 Cash management – forecasting,
collecting, disbursing, investing, and
planning for the cash a company
needs to operate smoothly.
 Young and growing companies
are “cash sponges.”
 Know your company’s
cash flow cycle.

46. The Cash Flow Cycle
Deliver
Goods
Order Receive Pay Sell Send Customer
Goods Goods Invoice Goods* Invoice Pays**
Day 1 15 40 218 221 230 280
14 25 178 3 9 50
Cash Flow Cycle = 240 days
*Based on Average Inventory Turnover: **Based on Average Collection Period:
365 days = 178 days 365 days = 50 days
2.05 times/year 7.31 times/year
FIGURE 12.2

47. Five Cash Management
Roles of an Entrepreneur
1. Cash Finder
2. Cash Planner
3. Cash Distributor
4. Cash Collector
5. Cash Conserver

48. Cash and Profits
 Cash ≠ profits.
 Profit is the difference between a
company’s total revenue and total
expenses.
 Cash is the money that is free and
readily available to use.
 Cash flow measure a company’s
liquidity and its ability to pay it bills.

49. Cash Flow
Increase in Cash
Cash
Leakage Decrease in Cash
Accounts Receivable Accounts Payable
Cash Sales Production/Cash Purchases
Inventory
FIGURE 12.3 Leakage

50. The Cash Budget
 A “cash map” that shows the amount and
the timing of a firm's cash receipts and
cash disbursements over time.
 Predicts the amount of cash a company will
need to operate smoothly.
 Helps to visualize a company’s cash
receipts and cash disbursements and the
resulting cash balance.

51. Preparing a Cash Budget
1. Determine a Minimum Cash Balance
 Not too much...
 Not too little...
 But a cash balance that's
just right ... for you!

52. Preparing a Cash Budget
(continued)
1. Determine a Minimum Cash Balance
2. Forecast Sales

53. Forecast Sales
 The heart of the cash budget.
 Sales are ultimately transformed
into cash receipts and cash
disbursements.
 Cash forecast is only as accurate
as the sales forecast from which
it is derived.

54. Forecast Sales
(continued)
“Lumpy” or seasonal sales patterns
are common.
 15% to 18% of wine and spirits shops’
annual sales occur between
December 15 and 31.
 40% of toy sales take place
in last 6 weeks of the year.

55. Forecast Sales
Prepare three sales forecasts:
 Pessimistic
 Optimistic
 Most Likely

56. Sales Forecast for a Start-Up
Example:
Number of cars in trading zone 84,000
x Percent of imports x 24%
= Number of imported cars in trading zone 20,160
Number of imports in trading zone 20,160
x Average expenditure on repairs x $485
= Total import repair sales potential $9,777,600
Total import repair sales potential $9,777,600
x Estimated market share x 9.9%
= Sales estimate $967,982

57. Preparing a Cash Budget
(continued)
1. Determine a Minimum Cash Balance
2. Forecast Sales
3. Forecast Cash Receipts

58. Forecast Cash Receipts
 Record all cash receipts when the
cash is actually received (i.e. the
cash method of accounting).
 Determine the collection pattern for
credit sales; then add cash sales.
 Monitor closely:
Slow and non-payers.

59. Collecting Delinquent
Accounts
1 93.80%
2 85.20%
3 73.60%
6 57.80%
9 42.80%
D
u
q
n
e
t
i
l
12 23.60%
m
M
N
h
n
o
b
u
s
e
r
t
f
24 13.60%
0.0% 20.0% 40.0% 60.0% 80.0% 100.0%
Probability of Collection

60. Preparing a Cash Budget
(continued)
1. Determine a Minimum Cash Balance
2. Forecast Sales
3. Forecast Cash Receipts
4. Forecast Cash Disbursements

61. Forecast Cash Disbursements
 Record disbursements when you expect to
make them.
 Start with those disbursements that are
fixed amounts due on certain dates.
 Review the business checkbook to ensure
accurate estimates.
 Add a cushion to the estimate to account
for “Murphy’s Law.”
 Don’t know where to begin? Try making a
daily list of the items that generate cash
and those that consume it.

62. Preparing a Cash Budget
(continued)
1. Determine a Minimum Cash Balance
2. Forecast Sales
3. Forecast Cash Receipts
4. Forecast Cash Disbursements
5. Estimate End-of-Month Cash
Balance

63. Estimate
End-of-Month Balance
 Take Beginning Cash Balance ...
 Add Cash Receipts ...
 Subtract Cash Disbursements
 Result is Cash Surplus
or Cash Shortage
(Repay or Borrow?)

64. Benefits of Cash Management
 Increase amount and speed of cash flowing
into the company
 Reduce the amount and speed of cash
flowing out
 Make the most efficient use of available cash
 Take advantage of money-saving
opportunities such as cash discounts
 Finance seasonal business needs

65. Benefits of Cash Management
(continued)
 Develop a sound borrowing and
repayment program
 Impress lenders and investors
 Provide funds for expansion
 Plan for investing surplus cash

66. The “Big Three”
of Cash Management
1. Accounts Receivable
2. Accounts Payable
3. Inventory

67. Accounts Receivable
 About 90% of industrial and wholesale
sales are on credit, and 40% of retail sales
are on account.
 Survey of small companies across a variety
of industries found that 77% extend credit
to their customers.
 Remember: “A sale is not a sale until you
collect the money.”
 Accounts receivable goal: Collect your
company’s cash as fast as you can.

68. FIGURE 12.5 Cash Flow Concerns Source: Based on American Express Corporation, 2005.

69. Beating the Cash Crisis
Accounts Receivable
 Establish a firm credit-granting policy.
 Screen credit customers carefully.
 Develop a system of collecting accounts.
 Send invoices promptly.
 When an account becomes overdue, take
action immediately.
 Add finance charges to overdue accounts
(check the law first!).

70. Accelerating
Accounts Receivable
 Ensure that invoices are accurate and
timely.
 Include a description of the goods or
services purchased.
 Ensure that invoices match purchase
orders or contracts.
 Highlight the balance dues and due date.
 Include contact information in case
customers have questions.

71. Beating the Cash Crisis
Accounts Payable
 Stretch out payment times as long as
possible without damaging your credit
rating.
 Verify all invoices before paying them.
 Take advantage of cash discounts.

72. The Cost of Foregoing a Cash Discount
$1,000 invoice 2/10, net 30
$20
Amount $980 $1,000
Day 0 10 30
20 days
I $20
R = = = 37.25%
PxT $980 x 20/365
FIGURE 12.6

73. Beating the Cash Crisis
Accounts Payable
 Negotiate the best possible terms with
your suppliers.
 Be honest with creditors; avoid the “the
check is in the mail” syndrome.
 Schedule controllable cash disbursements
to come due at different times.
 Use credit cards wisely.

74. Beating the Cash Crisis
Inventory
 Monitor it closely; inventory can drain a
company’s cash.
 Avoid inventory “overbuying.”
It ties up valuable cash at
a zero rate of return.
 Arrange for inventory deliveries
at the latest possible date.
 Negotiate quantity discounts with
suppliers when possible.

75. Avoiding the Cash Crunch
 Consider bartering, exchanging goods and
services for other goods and services, to
conserve cash.
 Trim overhead costs:
 Ask for discounts and “freebies”
 Periodically evaluate expenses
 Lease rather than buy
 Avoid nonessential cash outlays
 Negotiate fixed loan payments
to coincide with your
company’s cash flow

76. Avoiding the Cash Crunch
(continued)
 Trim overhead costs:
 Buy used equipment
 Hire part-time employees and freelancers
 Outsource nonessential activities
 Control employee advances and loans
 Establish an internal security and control
system
 Develop a system to battle check fraud
 Change shipping terms

77. Avoiding the Cash Crunch
(continued)
 Start selling gift cards
 Switch to zero-based
budgeting
 Be on the lookout for
employee theft
 Keep your business plan
current
 Invest surplus cash

78. Conclusion
“Cash is King”
 Cash and profits are not the same.
 Entrepreneurial success means
operating a company “lean and mean.”
 Trim wasteful expenditures.
 Invest surplus funds.
 Plan and manage cash flow.

79. Appendix 1 :
Creating a Financial Plan

80. The Importance of a
Financial Plan
 Common mistake among business owners: Failing
to collect and analyze basic financial data.
 Many entrepreneurs run their companies without
any kind of financial plan.
 Only 11% of business owners analyze their
companies’ financial statements as part of the
managerial planning process.
 Financial planning is essential to running a
successful business and is not that difficult!

81. Basic Financial Statements
 Balance Sheet – “Snapshot.”
Estimates the firm’s worth on a given date;
built on the accounting equation:
Assets = Liabilities + Owner’s Equity
 Income Statement – “Moving picture.”
Compares the firm’s expenses against 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 the
firm's working capital over a period of time by listing
the sources and uses of funds.

82. Creating Projected
Financial Statements
 Helps the entrepreneur transform business goals
into reality
 Challenging for a business start-up
 Start-ups should focus on creating projections
for two years
 Projected financial statements:
 Income statements
 Balance sheet

83. Ratio Analysis
 “How is my company doing?”
 A method of expressing the relationships
between any two elements on financial
statements.
 Important barometers of a company’s health.
 Studies indicate few small business owners
compute financial
ratios and use them to
manage their businesses.

84. Twelve Key Ratios
Liquidity Ratios - Tell whether or not a 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

85. Twelve Key Ratios
Liquidity Ratios - Tell whether or not a small business will
be able to meet its maturing obligations as they come due.
2. Quick Ratio - Shows the extent to which a firm’s most
liquid assets cover its current liabilities.
Quick Ratio = Quick Assets = 686,985 – 455,455 = .63:1
Current Liabilities $367,850

86. 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, like dynamite, you
must handle it carefully!

87. Twelve Key Ratios
Leverage Ratios - Measure the financing provided by a
firm’s owners against that supplied by its creditors; it is a
gauge of the depth of the company’s debt.
2. Debt Ratio - Measures the percentage of total assets
financed by creditors rather than owners.
Debt Ratio = Total Debt = $367,850 + 212,150 = .68:1
Total Assets $847,655

88. Twelve Key Ratios
Leverage Ratios - Measure the financing provided by a
firm’s owners against that supplied by its creditors; it is a
gauge of the depth of the 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 = 2.20:1
Worth Ratio Tangible Net Worth $264,155

89. Twelve Key Ratios
Leverage Ratios - Measure the financing provided by a
firm’s owners against that supplied by its creditors;
it is 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* = $60,629 + 39,850 =
Earned Total Interest Expense $39,850
= $100,479 = 2.52:1
$39,850
*Earnings Before Interest and Taxes

90. The Right Amount of Debt
is a Balancing Act
Optimal
Zone
Benefits of Leverage
Degree of Leverage
Low FIGURE 11.6 High

91. Table 11.1 How Lenders View Liquidity and Leverage
Liquidity Leverage
If chronic, this is often evidence of This is a very conservative position. With
mismanagement. It is a sign that the owner this kind of leverage, lenders are likely to
Low has not planned for the company's working
capital needs. In most businesses
lend money to satisfy a company's capital
needs. Owners in this position should
characterized by low liquidity, there is have no trouble borrowing money.
usually no financial plan. This situation is
often associated with last minute or "Friday
night" financing.
This is an indication of good management. If a company's leverage is comparable to
The company is using its current assets that of other businesses of similar size in
Average wisely and productively. Although they may
not be impressed, lenders feel comfortable
the same industry, lenders are comfortable
making loans. The company is not
making loans to companies with adequate overburdened with debt and is
liquidity. demonstrating its ability to use its
resources to grow.
Some lenders look for this because it Businesses that carry excessive levels of
indicates a most conservative company. debt scare most lenders off. Companies in
High However, companies that constantly
operate this way usually are forgoing
this position normally will have a difficult
time borrowing money unless they can
growth opportunities because they are not show lenders good reasons for making
making the most of their assets. loans. Owners of these companies must
be prepared to sell lenders on their ability
to repay.
Ch, 11: Creating a Successful Financial Plan
Source: Adapted from David H. Bangs, Jr., Financial Troubleshooting, Upstart Publishing Company, (Dover, New Hampshire, 1992), p. 124.
11- 91
11- 91

92. Twelve Key Ratios
Operating Ratios - Evaluate a 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 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 times
Turnover Ratio Average Inventory* $630,600 a year
*Average Inventory = Beginning Inventory + Ending Inventory
2

93. Twelve Key Ratios
Operating Ratios - Evaluate a firm’s overall performance and
show how effectively it is putting
its resources to work.
7. Average Collection Period Ratio (days sales outstanding, DSO)
- 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 Period Ratio
Receivables Turnover Ratio 7.31 days

94. Twelve Key Ratios
Operating Ratios - Evaluate a 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

95. Twelve Key Ratios
Operating Ratios - Evaluate a firm’s overall performance
and show how effectively it is putting
its resources 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 = 2.21:1
Total Assets Total Assets $847,655

96. Twelve Key Ratios
Profitability Ratios - Measure how efficiently a
firm is operating; offer information about a firm’s
“bottom line.”
10. Net Profit on Sales Ratio - Measures a firm’s profit per
dollar of sales revenue.
Net Profit on = Net Income = $60,629 = 3.24%
Sales Net Sales $1,870,841

97. Twelve Key Ratios
Profitability Ratios - Measure how efficiently a
firm is operating; offer information about a firm’s
“bottom line.”
11. Net Profit to Assets (Return on Assets) Ratio – tells how
much profit a company generates for each dollar of
assets that it owns.
Net Profit to = Net Income = $60,629 = 7.15%
Assets Total Assets $847,655

98. Twelve Key Ratios
Profitability Ratios - Measure how efficiently a
firm is operating; offer information about a firm’s
“bottom line.”
12. Net Profit to Equity* Ratio - Measures an
owner's rate of return on the investment (ROI)
in the business.
Net Profit to = Net Income = $60,629 = 22.65%
Equity Owner’s Equity* $267,655
* Also called Net Worth

99. Interpreting Ratios
 Ratios – useful yardsticks of comparison.
 Standards vary from one industry to another; the
key is to watch for “red flags.”
 Critical numbers – measure key financial and
operational aspects of a company’s performance.
Examples:
 Sales per labor hour at a supermarket
 Food costs as a percentage of sales at a restaurant.
 Load factor (percentage of seats filled with
passengers) at an airline.

100. FIGURE 11.7 Trend Analysis of Ratios

101. Putting Your Ratios to the Test
When comparing your company’s ratios to your industry’s standards,
ask the following questions:
1. Is there a significant difference in my company’s ratio
and the industry average?
2. If so, is this a meaningful difference?
3. Is the difference good or bad?
4. What are the possible causes of this difference?
What is the most likely cause?
5. Does this cause require that I take action?
6. If so, what action should I take to correct the problem?
Source: Adapted from George M. Dawson, “Divided We Stand,” Business Start-Ups, May 2000, p. 34.

102. Interpreting Ratios
Sam’s Appliance Shop Industry Median
Current ratio = 1.87:1 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 short-term debts as
they come due.

103. Interpreting Ratios
Sam’s Appliance Shop Industry Median
Quick ratio = 0.63:1 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 short-term debt (as
do most appliance shops). If sales slump, the result
could be liquidity problems for Sam’s. What steps
should Sam take to deal with this threat?

104. Interpreting Ratios
Sam’s Appliance Shop Industry Median
Debt ratio = 0.68:1 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.

105. Interpreting Ratios
Sam’s Appliance Shop Industry Median
Debt to net worth Debt to net worth
ratio = 2.20:1 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.

106. Interpreting Ratios
Sam’s Appliance Shop Industry Median
Times interest earned Times interest
ratio = 2.52:1 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.

107. Interpreting Ratios
Sam’s Appliance Shop Industry Median
Average inventory Average inventory
turnover ratio = 2.05 turnover ratio = 4.0
times per year times per year
Inventory is moving through Sam’s at a
very slow pace. What could be causing
this low inventory turnover in Sam’s
business?

108. Interpreting Ratios
Sam’s Appliance Shop Industry Median
Average collection Average collection
period ratio = 50.0 days 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?
What steps can Sam take to improve this ratio?

109. Interpreting Ratios
Sam’s Appliance Shop Industry Median
Average payable period Average payable
ratio = 59.3 days 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?

110. Interpreting Ratios
Sam’s Appliance Shop Industry Median
Net sales to total Net Sales to total
assets ratio = 2.21:1 assets ratio = 2.7:1
Sam’s Appliance Shop is not generating
enough sales, given the size of its asset
base. What factors could cause this?

111. Interpreting Ratios
Sam’s Appliance Shop Industry Median
Net profit on sales Net profit on sale
ratio = 3.24% 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.

112. Interpreting Ratios
Sam’s Appliance Shop Industry Median
Net profit to assets Net Sales to working
ratio = 7.15% capital ratio = 5.5%
Sam’s generates a return of 7.15% for every $1 in
assets, which is 30% above the industry average.
Given his asset base, Sam is squeezing an above-
average return out of his company. Is this likely to
be the result of exceptional profitability, or is there
another explanation?

113. Interpreting Ratios
Sam’s Appliance Shop Industry Median
Net profit on equity Net profit on equity
ratio = 22.65% 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?

114. Breakeven Analysis
 Breakeven point - the level of operation
at which a business neither earns a
profit nor incurs a loss.
 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.

115. 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:
1 - Variable Expenses
Contribution Margin =
Net Sales Estimate
Step 4. Compute the breakeven point:
Total Fixed Costs
Breakeven Point ($) = Contribution Margin

116. 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: $705,125
Fixed Expenses: $177,375
Step 3. Contribution margin:
$705,125
Contribution Margin = 1 - = .26
$950,000
Step 4. Breakeven Point:
$177,375
Breakeven Point = = $682,212
.26
$

117. FIGURE 11.8 Break-Even Chart for the Magic Shop

118. Conclusion
 Preparing a financial plan is a critical step
 Entrepreneurs can gain valuable insight
through:
 Pro forma statements
 Ratio analysis
 Breakeven analysis

119. Further Reading
 Scarborough, Norman, M. 2011. Essentials of
Entrepreneurship and Small Business
Management. 6th edition. Pearson.
 Brooks, Arthur C. (2006) Social Entrepreneurship :
A Modern Approach to Social Value Creation.
Pearson
 Barringer, Bruce R. & Ireland, R. Duane, 2011
Entrepreneurship – Successfully launching new
ventures 4th edition, Pearson.
 Schaper, M., Volery, T., Weber, P. & Lewis, K. 2011.
Entrepreneurship and Small Business. 3rd Asia
Pacific edition. John Wiley.