VSBDC Financial Statement Resource Guide

Financial Statement Analysis For Small Businesses
A Resource Guide
Provided By Virginia Small Business Development Center Network
Revised for the VSBDC by Henry Reeves 3/22/2011!
Copyright 2004 Florida Small Business Development Center Network

Florida SBDC Network grants permission for use and modifi ation of this manual to the !irginia SBDC "uly #$% 200&'
Contents
"opic Introduction Import nce of !in nci " St tements Co""ectin$ nd % n $in$ D t 'he Income St tement 'he B " nce Sheet Reconci"i tion of *+uity or St tement of Ch n$es in Stoc,ho"der *+uity St tement of C sh !"o-s .otes to !in nci " St tements !in nci " R tios / *0p" n tion 1ey 'erms nd Concepts !in nci " St tements s % n $ement 'oo" 'hree C se Studies !i$ure 12 Summ ry ' b"e of !in nci " R tios !i$ure 22 145 ! shions6 Inc7 !in nci " St tements !i$ure 32 Bre ,even 9n "ysis !i$ure #7 4 S mp"e C sh !"o- St tement :-ithout numbers;2 Conc"usion Sources of !in nci " 9n "ysis Inform tion
Page 3 # & ( ) 12 12 13 13 20 2# 32 33 38 #3 #( #8 #)

#ntroduction
!in nci " st tements provide sm "" business o-ners -ith the b sic too"s for determinin$ ho- -e"" their oper tions perform t "" times7 % ny entrepreneurs do not re "i<e th t fin nci " st tements h ve v "ue th t $oes beyond their use s supportin$ documents to "o n pp"ic tions nd t 0 returns7 'hese st tements re concise reports desi$ned to summ ri<e fin nci " ctivities for specific periods7 =-ners nd m n $ers c n use fin nci " st tement n "ysis to ev "u te the p st nd current fin nci " condition of their business6 di $nose ny e0istin$ fin nci " prob"ems6 nd forec st future trends in the firm>s fin nci " position7 *v "u tion pinpoints6 in fin nci " terms6 -here the firm h s been nd -here it is tod y7 Di $nosis determines the c uses of the fin nci " prob"ems th t st tement n "ysis uncovers nd su$$ests so"utions for them7 !orec sts re v "u b"e in st tement n "ysis for t-o re sons2 ?ou c n prep re forec sts th t ssume th t the b sic fin nci " f cts bout comp ny -i"" rem in the s me for specified period in the future7 'hese forec sts -i"" i""ustr te -here you@re "i,e"y to st nd if the st tus +uo is m int ined7 =r6 you c n $ in insi$hts into the imp ct of cert in business decisions by c "cu" tin$ the ns-ers to A-h t ifB +uestions7 Chen you test the conse+uences of ch n$es you>re contemp" tin$6 or th t m y occur bec use of ch n$in$ m r,et conditions or customer t stes6 for e0 mp"e6 you chieve $re ter underst ndin$ bout the fin nci " interre" tionships t -or, in business7 'he t-o ,ey reports for "" si<es nd c te$ories of business re the B " nce Sheet nd the Income St tement7 'he B " nce Sheet is n itemi<ed st tement th t "ists the tot " ssets nd the tot " "i bi"ities of business6 nd $ives its net -orth on cert in d te :such s the end of month6 +u rter6 or ye r;7 'he Income St tement records revenue versus e0penses for $iven period of time7 Re$u" r prep r tion nd n "ysis of fin nci " st tement inform tion he"ps business m n $ers nd o-ners detect the prob"ems th t e0perts continue to see s the chief c uses of sm "" business f i"ure 44 such s hi$h6 oper tin$ e0penses6 s"u$$ish s "es6 poor c sh m n $ement6 e0cessive fi0ed ssets6 nd inventory mism n $ement7 By comp rin$ st tements from different periods6 you c n more e si"y spot trends nd m ,e necess ry m n $ement decisions nd bud$et revisions before sm "" prob"ems become " r$e ones7 'his Resource Duide is intended to provide you -ith b sic underst ndin$ of the components nd purposes of fin nci " st tements7 'he B " nce Sheet nd Income St tement form ts re desi$ned s $ener " mode"s nd re not comp"ete for every business oper tion7 Comput tion of income for fin nci " ccountin$ purposes is done ccordin$ to the ru"es of Dener ""y 9ccepted 9ccountin$ Erincip"es :,no-n s D99E;7 Be - re th t income nd "osses computed usin$ D99E ru"es -i"" not necess ri"y be the s me s those c "cu" ted to comp"y -ith the Intern " Revenue Code7 In ddition to this Resource Duide6 business o-ners nd m n $ers shou"d t ,e dv nt $e of the other free or
"o- cost sources of m r,etin$ inform tion7 !ree business counse"in$ services provided by Certified Business 9n "ysts nd m ny "o-4cost semin rs nd -or,shops re offered by the Vir$ini Sm "" Business Deve"opment Centers throu$hout the st te7 !or the "oc tion of the Sm "" Business Deve"opment Center ne rest to you c "" visit ---7vir$ini sbdc7or$7 Fniversities6 community co""e$es6 nd pub"ic "ibr ries h ve other boo,s nd pub"ic tions on this topic7 9 tremendous mount of inform tion is v i" b"e on the Internet6 usin$ se rch too" such s Doo$"e7
#mportance o$ Financial Statements

% ny business e0perts nd ccount nts recommend th t you prep re fin nci " st tements month"yG +u rter"y t minimum7 Some comp nies prep re them t "e st once -ee,6 sometimes d i"y6 to st y bre st of resu"ts7 'he more fre+uent"y comp ny prep res their fin nci " st tements6 the sooner time"y decisions c n be m de7 'here re four types of fin nci " st tementsG compi"ed6 revie-ed6 udited6 nd un udited2 9 compi"ed st tement cont ins fin nci " d t from comp ny reported in fin nci " st tement form t by certified pub"ic ccount nt :CE9;G it does not inc"ude ny n "ysis of the st tement7 'he revie-ed st tement inc"udes n n "ysis of the st tement by CE9 in -hich unusu " items or trends in the fin nci " st tement re e0p" ined7 9n udited st tement : "so prep red by CE9; cont ins ny n "ysis -hich inc"udes confirm tion -ith outside p rties6 physic " inspection nd observ tion6 nd tr ns ctions tr ced to supportin$ documents7 9n udited st tement offers the hi$hest "eve" of ccur cy7 9n un udited st tement pp"ies to fin nci " st tement prep red by the comp ny -hich h s not been compi"ed6 revie-ed6 or udited by outside CE977 Sm "" business o-ners must be - re th t they m y be re+uired to submit fin nci " st tements in nine circumst nces2 17 Virtu ""y "" supp"iers of c pit "6 such s b n,s6 fin nce comp nies6 nd venture c pit "ists6 re+uire these reports -ith e ch "o n re+uest6 re$ rd"ess of previous successfu" "o n history7 B n,s m y need CE9 compi"ed or revie-ed st tements nd6 in some c ses6 udited st tements7 'hey m y not ccept comp ny or individu ""y prep red fin nci " st tements6 un"ess they re b c,ed by person " or corpor te income7 'ypic ""y6 s condition of $r ntin$ "o n6 creditor m y re+uest periodic fin nci " st tements in order to monitor the success of the business nd spot ny possib"e rep yment prob"ems7 27 Inform tion from fin nci " st tements is necess ry to prep re feder " nd st te income t 0 returns7 St tements themse"ves need not be fi"ed7

37 Erospective buyers of business -i"" s, to inspect fin nci " st tements nd the fin nci "/oper tion " trends they reve " before they -i"" ne$oti te s "e price nd commit to the purch se7 #7 In the event th t c" ims for "osses re submitted to insur nce comp nies6 ccountin$ records :p rticu" r"y the B " nce Sheet; re necess ry to subst nti te the ori$in " v "ue of fi0ed ssets7 &7 If business disputes deve"op6 fin nci " st tements m y be v "u b"e to prove the n ture nd e0tent of ny "oss7 Shou"d "iti$ tion occur6 " c, of such st tements m y h mper prep r tion of the c se7 37 Chenever n udit is re+uired44for e0 mp"e by o-ners or creditors44four st tements must be prep red2 Balance Sheet (or Statement of Financial Position) 6 Reconcilement of Equity (or Statement of Stockholders Equity for corporations) 6 Income Statement (or Statement of Earnings) 6 nd Statement of ash Flo!s" (7 9 number of st tes re+uire corpor tions to furnish sh reho"ders -ith nnu " st tements7 Cert in corpor tions6 -hose stoc, is c"ose"y he"d6 th t is6 o-ned by sm "" number of sh reho"ders6 re e0empt7 87 In inst nces -here the s "e of stoc, or other securities must be pproved by st te corpor tion or securities $ency6 the $ency usu ""y re+uires fin nci " st tements7 )7 'he Securities nd *0ch n$e Commission :S*C; re+uires most pub"ic"y he"d corpor tions :such s those -hose stoc, is tr ded on pub"ic e0ch n$es; to fi"e nnu " nd interim +u rter"y fin nci " reports7 "
Collecting and %anaging Data

'he " n$u $e nd princip"es of modern ccountin$ h ve evo"ved from the centuries4o"d need for ccur te record ,eepin$7 'od y6 the !in nci " 9ccountin$ St nd rds Bo rd :!9SB;6 the S*C6 nd the 9meric n Institute of Certified Eub"ic 9ccount nts :9ICE9; continue to refine nd revise concepts nd pr ctices7 Re$ rd"ess of ho- comp"e0 fin nci " st tement m y seem6 it is b sed on "o$ic nd pr ctic "ity7 Co""ectin$ inform tion for fin nci " st tements be$ins -ith the d i"y rithmetic of business nd fo""o-s continuin$ process c ""ed the udit tr i"7 !irst6 fi$ures from ori$in " documents such s invoices re Hourn "i<ed6 or recorded6 d i"y in the boo, of ori$in " entry6 -hich is c ""ed the Hourn "7 'od y6 these Hourn "s re m int ined in e"ectronic form t7 Items th t re not norm ""y recorded in the d i"y oper tions6 such s those for depreci tion nd morti< tion6 re c ""ed end4of4the4period dHustments nd re c "cu" ted nd Hourn "i<ed periodic ""y7 9"" of these det i"ed tr ns ctions re then posted to the $ener " "ed$er7 9mounts re b " nced :credits must e+u " debits; nd then used to prep re fin nci " st tements7
In most computeri<ed ccountin$ systems the b " ncin$ is m int ined in re "4time6 behind the scenes6 ""o-in$ fin nci " st tements to be prep red t ny time7 In number of sm "" businesses6 boo,,eepers or o-ners themse"ves prep re these reports7 !re+uent"y6 they use te0tboo, s mp"es s mode"s or st nd rd b n, forms provided by "o n officers7 But $ro-in$ number of sm "" oper tions ret in ccount nts on t "e st n occ sion " b sis7 9ccount nts typic ""y t i"or st tements to specific enterprise6 so st tement form ts v ry some-h t7 %icro businesses c n use very simp"e nd b sic system to co""ect the inform tion th t -i"" u"tim te"y be used to construct the fin nci " st tements7 'he business o-ner shou"d put "" receipts6 c nce""ed chec,s6 nd credit c rd s"ips into " r$e enve"ope7 H ve one enve"ope for e ch month7 'he o-ner c n then de"iver these receipts to his or her boo,,eeper6 -ho -i"" construct the fin nci " st tements7 'he enve"opes c n then be fi"ed - y7 !or business tr ve" usin$ your person " vehic"e6 ,eep tr c, of the odometer re din$ before the trip be$ins6 nd t the conc"usion of the trip7 Chen purch sin$ me "s for customers6 note on the receipt the n me of the customer nd the re son for the meetin$7 'he Intern " Revenue Service specifies the "en$th of time different types of business records must be ,ept7 9s the business $ro-s6 o-ners be$in to find time to become more sophistic ted nd m y dopt computer soft- re to rep" ce the boo,,eeper7 Computer techno"o$y p" ys m Hor ro"e in sm "" business tod y7 It si$nific nt"y cuts the time it t ,es to m n $e business> fin nces nd6 in turn6 mi$ht produce hi$her s "es nd better profit m r$ins bec use of improvements in n "ysis nd inform tion7 9 "ot of the time6 tedium6 nd hum n error in fin nci " ccountin$ h s dis ppe red s computers become more po-erfu" nd fford b"e to sm ""er comp nies7 Soft- re th t utom tes the ccountin$ function6 records the udit tr i"6 nd feeds fin nci " st tements nd other m n $ement reports is re di"y v i" b"e7 9ccount nts use computers nd m y h ve the ,no-"ed$e to ssist their sm "" business c"ients -ith conversion to computeri<ed ccountin$7 Some soft- re firms6 s -e"" s SBDC>s6 no- offer semin rs nd -or,shops desi$ned to he"p sm "" business o-ners "e rn "" of the functions their pro$r ms c n perform7 Eopu" r ccountin$ soft- re p c, $es inc"ude Iuic,Boo,s6 Iuic,Boo,s Ero6 Iuic,en6 nd Ee chtree6 "thou$h st nd rd office soft- re such s %icroSoft *0ce" c n be used for b sic ccountin$7 Computers simp"ify nd stre m"ine fin nci " n "ysis7 !or inst nce6 A-h t ifB forec st -ith Hust one set of simp"e v ri b"es m y t ,e n entire d y or "on$er to fi$ure m nu ""y7 'od y6 -ith n e"ectronic spre dsheet6 comp"e0 c "cu" tions -ith m ny v ri b"es c n be produced +uic,"y to test the effects of cert in decisions7 'he potenti " benefits of ccountin$ soft- re inc"ude the fo""o-in$2 Eroduce more ccur te ccountin$ inform tion f ster7 Improve time"iness nd ccur cy of fin nci " st tus reports7 Identify potenti " business or bud$et prob"ems sooner7 Imp"ement better m n $ement contro"s7 Reduce " bor costs nd outside consu"t nts> fees7
Speed co""ection of receiv b"es7 Reduce interest e0pense nd improve c sh f"o-7 Reduce "ost s "es : s resu"t of fe-er stoc, outs;7 Reduce inventory : nd inventory c rryin$ costs;7 Re "i<e hi$her return on investment7
Re$ rd"ess of -hether the entrepreneur chooses to m nu ""y m int in his or her boo,,eepin$ or imp"ements ccountin$ soft- re6 it is sti"" -ise to consu"t -ith n ccount nt for dvice on our ever ch n$in$ t 0 " -s7
"&e #ncome Statement

Business revenue6 e0penses6 nd the resu"tin$ profit or "oss over $iven period of time re det i"ed in the Income St tement7 It is "so c ""ed the St tement of Income nd *0pense6 St tement of * rnin$s6 or the Erofit nd 5oss St tement7 'his report ref"ects the comp ny>s chosen fisc " ye r7 !or t 0 purposes6 the o-ner m y need to prep re second Income St tement b sed on the c "end r ye r6 if the fisc " ye r is different7 Chec, -ith t 0 dvisor bout Intern " Revenue Code re+uirements7 'he fo""o-in$ terms re common"y found on n income st tement2 17 He din$ 'he first f cts to ppe r on ny st tement re the "e$ " n me of the business6 the type of st tement6 nd the period of time reported6 e7$76 month6 +u rter6 or ye r7 Co"umn He din$s If you inc"ude both current month nd ye r4to4d te co"umns on the Income St tement you c n revie- trends from ccountin$ period to ccountin$ period nd comp re previous simi" r periods7 9"so6 it is often he"pfu" to sho- the do"" r mounts s percent $es of net s "es7 'his he"ps you n "y<e perform nce nd comp re your comp ny to simi" r businesses7 Remember6 you c n choose ny period of time to n "y<e7 Revenue 9"" income f"o-in$ into business for services rendered or $oods so"d comes under this c te$ory7 In ddition to ctu " c sh tr ns ctions6 the revenue fi$ure ref"ects mounts due from customers on ccounts receiv b"e s -e"" s e+uiv "ent c sh v "ues for merch ndise or other t n$ib"e items used s p yment7 5ess S "es Returns nd 9""o- nces 'he v "ue of returned merch ndise nd ""o- nces m de for defective $oods must be subtr cted from $ross s "es to determine net s "es7 Cost of Doods So"d Cost of $oods so"d e+u "s the mount of $oods v i" b"e for s "e minus the inventory rem inin$ t the end of the ccountin$ period7 :'ot " $oods v i" b"e J be$innin$ inventory K cost of
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#7
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purch sin$ or m nuf cturin$ nemerch ndise durin$ the ccountin$ period;7 Cost of $oods so"d inc"udes "" costs direct"y re" ted to the production of the product invoiced durin$ the ccountin$ period7 Service businesses $ener ""y h ve no cost of $oods so"d7 37 Dross Erofit 9"so c ""ed gross margin6 this fi$ure is the difference bet-een the cost of $oods so"d nd net s "es :.et S "es 4 Cost of Doods So"d J Dross Erofit;7 It is the business>s profit before oper tin$ e0penses nd t 0es7 =per tin$ *0penses 'he e0penses of conductin$ business oper tions $ener ""y f "" into t-o bro d c te$ories2 se""in$ nd $ener " dministr tive7 % nuf cturers norm ""y inc"ude some oper tin$ e0penses6 such s m chinery nd " bor depreci tion6 s p rt of cost of s "es :Item &;7 'ot " :.et; =per tin$ Income 'ot " oper tin$ e0penses re subtr cted from $ross profit to sho- -h t the business e rned before fin nci " revenue nd e0penses6 t 0es6 nd e0tr ordin ry items7 =ther Revenue nd *0penses Income nd e0penses th t re not $ener ted by the usu " oper tions of business nd th t re not considered e0tr ordin ry :see Item 11; re recorded here7 'ypic ""y inc"uded in this c te$ory re fin nci " revenue6 such s interest from investments6 nd fin nci " e0penses6 such s interest on borro-ed c pit "7 :5o n princip " is not considered n e0pense7 It is "i bi"ity nd is "isted s such on the B " nce Sheet;7 Eret 0 Income 'o derive this fi$ure6 "so c ""ed pret 0 profit6 tot " fin nci " revenue :minus tot " fin nci " e0penses; is dded to tot " oper tin$ income7 ' 0es re subtr cted from pret 0 income if the business is LC> corpor tion7 Eroprietorships6 "imited "i bi"ity comp nies6 nd LS> corpor tions do not p y business t 0es on incomeG the income is reported on the o-ners> person " returns7 :!or t 0 p" nnin$ purposes6 ccount nts estim te the nnu " t 0es due6 then proHect the month"y portion7; *0tr ordin ry D in M5ossN .et of Income ' 0 MBenefitN Cithin the fr me-or, of n individu " business type nd "oc tion6 ny occurrence th t is hi$h"y unusu " in n ture6 cou"d not be foreseen6 is not e0pected to recur6 nd th t $ener tes income or c uses "oss is considered n e0tr ordin ry item7 'he e0tr ordin ry $ in or "oss is sho-n fter c "cu" tin$ t 0 "i bi"ity :or t 0 benefit6 s -ou"d be the c se -ith n e0tr ordin ry "oss; on the Income St tement7 *0 mp"es2 9 court - rd to business not previous"y invo"ved in " -suits -ou"d be n e0tr ordin ry $ inG m Hor c su "ty -ou"d be n e0tr ordin ry "oss7 .et Income 9"so c ""ed net profit6 this fi$ure represents the sum of "" e0penses :inc"udin$ t 0es6 if pp"ic b"e;7 .et income or profit is common"y referred to s the #ottom line7
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* rnin$s per Sh re 'ot " outst ndin$ common stoc, :the number of sh res current"y o-ned by stoc,ho"ders; is divided into net income to derive this fi$ure7 It is not pp"ic b"e to proprietorships nd "imited "i bi"ity comp nies6 but must be sho-n on the Income St tements of "" pub"ic"y he"d corpor tions7
"&e Balance S&eet

9 B " nce Sheet records the tot " ssets6 "i bi"ities6 nd e+uity :net -orth; of business s of specific d y7 'his st tement is divided to provide t-o vie-s of the s me business2 -h t resources the business o-ns6 nd the creditor nd o-ner investments th t supp"ied these resources7 'hese divisions re $ener ""y set up in the t-o4co"umn ccount form6 -ith ssets on the "eft6 "i bi"ities nd e+uity on the ri$ht7 9n "tern tive 44 the one co"umn st tement form or report form 44 "ists ssets on top6 "i bi"ities nd e+uity be"o-7 'he b c,bone of the B " nce Sheet is the fund ment " ccountin$ e+u tion2 9ssets J 5i bi"ities K *+uity :tr nsposed2 9ssets 4 5i bi"ities J *+uity7 'his e+u tion is b sed on the ccountin$ princip"e th t every business tr ns ction6 such s se""in$ merch ndise or borro-in$ c pit "6 h s dual effect7 9ny incre se or decre se on one side of the e+u tion "- ys re+uires correspondin$ ch n$e to the other side of the e+u tion7 If the sides don>t b " nce6 f u"ty rithmetic or in ccur te or incomp"ete records m y be the c use7 'he fo""o-in$ is n e0 mp"e of the princip"e of b " nce2 If business o-ner purch ses O26000 -orth of nemerch ndise on credit6 ssets re incre sed by the v "ue of ne- inventory7 5i bi"ities re incre sed O26000 t the s me time bec use the comp ny h s n ccounts p y b"e :"i bi"ity; ob"i$ tion to the supp"iers of the merch ndise7 'o further i""ustr te the princip"e2 If the s me business h d O26000 c sh nd used it to buy nemerch ndise6 ssets -ou"d be incre sed by the inventory v "ue6 but decre sed by the c sh out" y7 'hus6 tot " ssets -ou"d be unch n$ed6 nd "i bi"ities nd e+uity -ou"d not be ffected7 'he fo""o-in$ terms re common"y found on b " nce sheet2 17 He din$ 'he "e$ " n me of the business6 the type of st tement6 nd the d y6 month6 nd ye r must be sho-n t the top of the report7 9ssets 9nythin$ of v "ue th t is o-ned or "e$ ""y due the business is inc"uded under this he din$7 'ot " ssets inc"ude "" net re "i< b"e nd net boo, : "so c ""ed net c rryin$; v "ues7 .et re "i< b"e nd net boo, v "ues re mounts derived by subtr ctin$ from the c+uisition price of ssets ny estim ted ""o- nces for doubtfu" ccounts6 depreci tion6 nd morti< tion6 such s morti< tion of premium durin$ the term of n insur nce po"icy7 9ppreci ted v "ues re not usu ""y considered on B " nce Sheets6 e0cept6 for e0 mp"e6 -hen you re recordin$ stoc, portfo"io v "ues7
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Current 9ssets C sh nd resources th t c n be converted into c sh -ithin 12 months of the d te of the B " nce Sheet :or durin$ one est b"ished cyc"e of oper tions; re considered current7 Besides c sh :money on h nd nd dem nd deposits in the b n,6 such s re$u" r s vin$s ccounts nd chec,in$ ccounts;6 these resources inc"ude the items "isted be"o-7 'hey re r n,ed in $ener ""y ccepted order of decre sin$ "i+uidity44th t is6 the e se -ith -hich the items cou"d be converted to c sh7 9ccounts Receiv b"e2 'he mounts due from customers in p yment for merch ndise or services7 Inventory2 Inc"udes r - m teri "s on h nd6 -or, in process6 nd "" finished $oods either m nuf ctured or purch sed for res "e7 Inventory v "ue is b sed on unit cost nd is c "cu" ted by ny of sever " methods :see Inventory V "u tion be"o-;7 'empor ry Investments2 Interest4 yie"din$ or dividend4yie"din$ ho"din$s e0pected to be converted into c sh -ithin ye r7 9"so c ""ed marketa#le securities or short$term in%estments6 they inc"ude certific tes of deposit6 stoc,s nd bonds6 nd time deposit s vin$s ccounts7 9ccordin$ to ccountin$ princip"es6 they must be "isted on the B " nce Sheet t either their ori$in " cost or their m r,et v "ue6 -hichever is "ess7 Erep id *0penses2 Doods6 benefits6 or services business p ys for in dv nce of use7 *0 mp"es re insur nce protection6 f"oor sp ce nd office supp"ies7
#7
5on$4'erm Investments 9"so c ""ed "on$4term ssets' these resources re ho"din$s th t the business intends to ,eep for ye r or "on$er nd th t typic ""y yie"d interest or dividends7 Inc"uded re stoc,s6 bonds nd s vin$s ccounts e rm r,ed for speci " purposes7 !i0ed 9ssets !i0ed ssets6 fre+uent"y c ""ed p" nt nd e+uipment6 re the resources business o-ns or c+uires for use in oper tions nd does not intend to rese""7 Re$ rd"ess of current m r,et v "ue6 " nd is "isted t its ori$in " purch se price6 -ith no ""o- nce for ppreci tion or depreci tion7 =ther fi0ed ssets re "isted t cost6 minus depreci tion7 !i0ed ssets m y be "e sed r ther th n o-ned7 Dependin$ on the "e sin$ rr n$ement6 both the v "ue nd "i bi"ity of the "e sed property m y need to be "isted on the B " nce Sheet7 =ther 9ssets Resources not "isted -ith ny of the bove ssets re $rouped here7 *0 mp"es inc"ude t n$ib"es6 such s outd ted e+uipment -hich c n be so"d to the scr p y rd6 nd int n$ib"es6 such s $ood-i""6 tr dem r,s nd p tents7
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5i bi"ities 'his term covers "" monet ry ob"i$ tions of business nd "" c" ims creditors h ve on its ssets7
87
Current 5i bi"ities 9"" debts nd ob"i$ tions p y b"e -ithin 12 months or -ithin one cyc"e of oper tions re det i"ed here7 'ypic ""y6 they inc"ude the fo""o-in$6 -hich $ener ""y re "isted in the order due7 9ccounts E y b"e2 9mounts o-ed to supp"iers for $oods nd service purch sed in connection -ith business oper tions7 Short4'erm Debt2 'he b " nces of princip " due to p y off short4term debt for borro-ed funds7 Current Eortion of 5on$4'erm Debt2 Current mount due of tot " b " nce on notes -hose terms e0ceed 12 months7 Interest E y b"e2 9ny ccrued mounts due for use of both short4 nd "on$4term borro-ed c pit " nd credit e0tended to the business7 ' 0es E y b"e2 9mounts estim ted by n ccount nt to h ve been incurred durin$ the ccountin$ period7 !or ccountin$ purposes6 this tot " m y differ from the ctu " t 0 tot " re+uired by the Intern " Revenue Codes6 since t 0es p y b"e re b sed on ccountin$ income nd not t 0 b"e income7 :Note( Income t 0es re business ob"i$ tions for corpor tionsG proprietorships nd p rtnerships do not p y income t 0esG the income is reported on the o-ners> person " returns7; 9ccrued E yro""2 S " ries nd - $es current"y o-ed but not yet p id7
)7
5on$ 'erm 5i bi"ities 5on$4term "i bi"ities re notes6 p yments6 or mort$ $e p yments due over period e0ceedin$ 12 months or one cyc"e of oper tions7 'hey re "isted by outst ndin$ b " nce :minus the Current Eortion due;7 *+uity 9"so c ""ed net -orth6 e+uity is the c" im of the o-ner:s; on the ssets of the business7 In proprietorship or "imited "i bi"ity comp ny6 e+uity is e ch o-ner>s ori$in " investment6 p"us ny e rnin$s fter -ithdr - "s7 In corpor tion6 the o-ners re the sh reho"ders44those -ho h ve invested c pit " :c sh or other ssets; in e0ch n$e for sh res of stoc,7 'he corpor tion>s e+uity is the sum of contributions p"us e rnin$s ret ined fter p yin$ dividends7 It is det i"ed s fo""o-s2 C pit " Stoc,2 'he tot " mount invested in the business in e0ch n$e for sh res of stoc, t v "ue up to the p r v "ue7 E r is the per4sh re price ssi$ned to the ori$in " issue of stoc,6 re$ rd"ess of subse+uent se""in$ prices7 C pit " E id4In in *0cess of E r2 'he mount in e0cess of p r v "ue th t business receives from sh res of stoc, so"d t v "ue bove p r7
107
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're sury Stoc,2 Chen comp ny buys b c, its o-n stoc, or -hen c"ose"y he"d business buys out other o-ners7 'he v "ue of the stoc, is recorded here nd ordin ri"y does not receive dividends7 Ret ined * rnin$s2 'he tot " ccumu" ted net income minus the tot " ccumu" ted dividends dec" red since the corpor tion>s foundin$7 'hese e rnin$s re p rt of the tot " e+uity for ny business7 Ho-ever6 the fi$ure is usu ""y "isted sep r te"y from o-ner investments on"y on corpor te B " nce Sheets -hich re done for the benefit of sh reho"ders7
117
'ot " 5i bi"ities nd *+uity 'he sum of these t-o mounts must "- ys e+u " 'ot " 9ssets7
Reconciliation o$ )*uity
'his st tement reconci"es the e+uity sho-n on the current B " nce Sheet7 !or corpor tions this st tement is referred to s the St tement of Ret ined * rnin$s or St tement of Sh reho"der *+uity7 !or "imited "i bi"ity comp nies it is referred to s the St tement of %embers *+uity6 nd for Eroprietorships s the St tement of =-ner>s *+uity7 It records e+uity t the be$innin$ of the ccountin$ period nd det i"s dditions to6 or subtr ctions from6 this mount m de durin$ the period7 9dditions nd subtr ctions typic ""y re net income or "oss nd o-ner contributions nd/or deductions7 !i$ures used to compi"e this st tement re derived from previous nd current B " nce Sheets nd from the current Income St tement7
Statement o$ Cas& Flows

'he fourth m in document of fin nci " reportin$ is the St tement of C sh !"o-s7 % ny sm "" business o-ners nd m n $ers find th t the c sh f"o- st tement is perh ps the most usefu" of "" the fin nci " st tements for p" nnin$ purposes7 C sh is the "ife b"ood of sm "" business / if the business runs out of c sh ch nces re $ood th t the business is out of business7 'his is bec use most sm "" businesses do not h ve the bi"ity to borro- money s e si"y s " r$er business c n7 'he st tement c n be prep red fre+uent"y :month"y6 +u rter"y; nd is v "u b"e too" th t summ ri<es the re" tionship bet-een the B " nce Sheet nd the Income St tement nd tr ces the In fin nci " ccountin$6 c sh f"o- st tement6 "so ,no-n s statement of cash flo!s or funds flo! statement6 is fin nci " st tement th t sho-s ho- ch n$es in b " nce sheet ccounts nd income ffect c sh nd c sh e+uiv "ents6 nd bre ,s the n "ysis do-n to oper tin$6 investin$6 nd fin ncin$ ctivities7 *ssenti ""y6 the c sh f"o- st tement is concerned -ith the f"o- of c sh in nd c sh out of the business7 'he st tement c ptures both the current oper tin$ resu"ts nd the ccomp nyin$ ch n$es in the b " nce sheet7 9s n n "ytic " too"6 the st tement of c sh f"o-s is usefu" in determinin$ the short4term vi bi"ity of comp ny6 p rticu" r"y its bi"ity to p y bi""s7
#2
By underst ndin$ the mounts nd c uses of ch n$es in c sh b " nces6 the entrepreneur c n re "istic ""y bud$et for continued business oper tions nd $ro-th7 !or e0 mp"e6 the St tement of C sh !"o-s he"ps ns-er such +uestions s2 Ci"" present -or,in$ c pit " ""o- the business to c+uire ne- e+uipment6 or -i"" fin ncin$ be necess ryP % ny sm "" businesses m y not need to prep re the St tement of C sh !"o-s7 Ho-ever6 ccordin$ to D99E6 it shou"d be prep red -henever n oper tion>s fin nci " st tements re compi"ed6 revie-ed6 or udited by CE97 In ddition6 creditors6 investors6 ne- o-ners or p rtners6 nd the Intern " Revenue Service m y re+uire the inform tion it provides7 'his st tement c n usu ""y be produced by most ccountin$ soft- re pp"ic tions7
Notes to Financial Statements

If n import nt f ctor does not fit into the re$u" r c te$ories of fin nci " st tement6 it shou"d be inc"uded s note7 9"so6 nythin$ th t mi$ht ffect the fin nci " position of business must be documented7 'hree m Hor types of notes inc"ude2 17 %ethodo"o$y Discussion of the ccountin$ princip"es used by the comp ny7 !or e0 mp"e6 ccru " b sis of ccountin$ vs7 c sh b sis of ccountin$7 Contin$ent 5i bi"ities Circumst nces th t h ve occurred s of the st tement d te nd -hich represent potenti " fin nci " ob"i$ tions must be recorded by type nd estim ted mount7 *0 mp"e2 9 business o-ner cosi$ns b n, note7 If the prim ry borro-er shou"d def u"t6 the business o-ner -ho cosi$ned -ou"d become "i b"e7 Re+uired Disc"osures It is necess ry th t "" si$nific nt inform tion bout the comp ny be described in disc"osure st tement7 *0 mp"e2 If the business h s ch n$ed ccountin$ procedures since the " st ccountin$ period6 the ch n$e must be described7
27
37
Financial Ratios
!in nci " r tios re v "u b"e nd e sy - y to interpret the numbers found in st tements7 R tio n "ysis provides the bi"ity to underst nd the re" tionship bet-een fi$ures on spre dsheets7 It c n he"p you to ns-er critic " +uestions such s -hether the business is c rryin$ e0cess debt or inventory6 -hether customers re p yin$ ccordin$ to terms6 nd -hether the oper tin$ e0penses re too hi$h7 Chen computin$ fin nci " re" tionships6 $ood indic tion of the comp ny@s fin nci " stren$ths nd
#(
-e ,nesses becomes c"e r7 *0 minin$ these r tios over time provides some insi$ht s to ho- effective"y the business is bein$ oper ted7 % ny industries compi"e ver $e :or st nd rd; industry r tios e ch ye r7 St nd rd or ver $e industry r tios offer the sm "" business o-ner me ns of comp rin$ his or her comp ny -ith others -ithin the s me industry7 In this m nner they provide yet nother me surement of n individu " comp ny>s stren$ths or -e ,nesses7 R%9 :Ris, % n $ement 9ssoci tion6 former"y n med Robert %orris Q 9ssoci tes; is $ood source of comp r tive fin nci " r tios7 It c n be found on the Internet t http2//---7rm h+7or$/ !o""o-in$ re the most critic " r tios for most businesses6 thou$h there re others th t m y be computed7 17 5i+uidity %e sures comp ny>s c p city to p y its debts s they come due7 'here re t-o r tios for ev "u tion "i+uidity7 urrent Ratio 4 D u$es ho- b"e business is to p y current "i bi"ities by usin$ current ssets on"y7 9"so c ""ed the !orking capital ratio+ 9 $ener " ru"e of thumb for the current r tio is 2 to 1 :or 2216 or 2/1;7 Ho-ever6 n industry ver $e m y be better st nd rd th n this ru"e of thumb7 'he ctu " +u "ity nd m n $ement of ssets must "so be considered7 'he formu" is2 "otal Current Assets "otal Current ,ia-ilities &uick Ratio $ !ocuses on immedi te "i+uidity :i7e76 c sh6 ccounts receiv b"e6 etc7; but specific ""y i$nores inventory7 9"so c ""ed the acid test ratio6 it indic tes the e0tent to -hich you cou"d p y current "i bi"ities -ithout re"yin$ on the s "e of inventory7 &uick assets6 re hi$h"y "i+uid44those immedi te"y convertib"e to c sh7 9 ru"e of thumb st tes th t6 $ener ""y6 your r tio shou"d be 1 to 1 :or 1216 or 1/1;7 'he formu" is2 Cas& . Accounts Receiva-le . any ot&er *uick assets! Current ,ia-ilities 27 S fety Indic tes comp ny>s vu"ner bi"ity to ris,44th t is6 the de$ree of protection provided for the business> debt7 'hree r tios he"p you ev "u te s fety2 'e#t to (orth $ 9"so c ""ed de#t to net !orth" Iu ntifies the re" tionship bet-een the c pit " invested by o-ners nd investors nd the funds provided by creditors7 'he hi$her the r tio6 the $re ter the ris, to current or future creditor7 9 "o-er r tio me ns your comp ny is more fin nci ""y st b"e nd is prob b"y in better position to borro- no- nd in the future7 Ho-ever6 n e0treme"y "o- r tio m y indic te th t you re too conserv tive nd re not "ettin$ the business
#4
re "i<e its potenti "7 'he formu" is2 "otal ,ia-ilities or De-t! Net /ort& or "otal )*uity! )imes Interest Earned / 9ssesses the comp ny>s bi"ity to meet interest p yments7 It "so ev "u tes the c p city to t ,e on more debt7 'he hi$her the r tio6 the $re ter the comp ny>s bi"ity to m ,e its interest p yments or perh ps t ,e on more debt7 'he formu" is2 )arnings Be$ore #nterest 0 "a1es #nterest C&arges ash Flo! to urrent *aturity of +ong$)erm 'e#t $ Indic tes ho- -e"" tr dition " c sh f"o- :net profit p"us depreci tion; covers the comp ny>s debt princip " p yments due in the ne0t 12 months7 It "so indic tes if the comp ny>s c sh f"o- c n support ddition " debt7 'he formu" is2 Net Pro$it . Non2Cas& )1penses3 Current Portion o$ ,ong2"erm De-t RSuch s depreci tion6 morti< tion6 nd dep"etion7
37
Erofit bi"ity %e sures the comp ny>s bi"ity to $ener te return on its resources7 Fse the fo""o-in$ four r tios to he"p you ns-er the +uestion6 AIs my comp ny s profit b"e s it shou"d bePB 9n incre se in the r tios is vie-ed s positive trend7 ,ross Profit *argin $ Indic tes ho- -e"" the comp ny c n $ener te return t the $ross profit "eve"7 It ddresses three re s2 inventory contro"6 pricin$6 nd production efficiency7 'he formu" is2 Gross Pro$it "otal Sales -et Profit *argin $ Sho-s ho- much net profit is derived from every do"" r of tot " s "es7 It indic tes ho- -e"" the business h s m n $ed its oper tin$ e0penses7 It "so c n indic te -hether the business is $ener tin$ enou$h s "es vo"ume to cover minimum fi0ed costs nd sti"" "e ve n ccept b"e profit7 'he formu" is2
#)
Net Pro$it "otal Sales Return on .ssets $ *v "u tes ho- effective"y the comp ny emp"oys its ssets to $ener te return7 It me sures efficiency7 'he formu" is2 Net Pro$it "otal Assets Return on -et (orth 4 9"so c ""ed return on in%estment (R/I)7 Determines the r te of return on the invested c pit "7 It is used to comp re investment in the comp ny $ inst other investment opportunities6 such s stoc,s6 re " est te6 s vin$s6 etc7 'here shou"d be direct re" tionship bet-een R=I nd ris, :i7e76 the $re ter the ris,6 the hi$her the return;7
'he formu" is2 Net Pro$it Net /ort& #7 *fficiency *v "u tes ho- -e"" the comp ny m n $es its ssets7 Besides determinin$ the v "ue of the comp ny>s ssets6 you shou"d "so n "y<e ho- effective"y the comp ny emp"oys its ssets7 ?ou c n use the fo""o-in$ r tios2 .ccounts Recei%a#le )urno%er $ Sho-s the number of times ccounts receiv b"e re p id nd reest b"ished durin$ the ccountin$ period7 'he hi$her the turnover6 the f ster the business is co""ectin$ its receiv b"es nd the more c sh the comp ny $ener ""y h s on h nd7 'he formu" is2 "otal Net Sales Average Accounts Receiva-le .ccounts Recei%a#le ollection Period 4 Reve "s ho- m ny d ys it t ,es to co""ect "" ccounts receiv b"e7 9s -ith ccounts receiv b"e turnover : bove;6 fe-er d ys me ns the comp ny is co""ectin$ more +uic,"y on its ccounts7 'he formu" is2 456 Days Accounts Receiva-le "urnover .ccounts Paya#le )urno%er $ Sho-s ho- m ny times in one ccountin$ period the comp ny turns over :rep ys; its ccounts p y b"e to creditors7 9 hi$her number indic tes either th t the business h s decided to ho"d on to its money "on$er6 or th t it is h vin$ $re ter difficu"ty p yin$ creditors7
#$
'he formu" is2 Cost o$ Goods Sold Average Accounts Paya-le Paya#le Period $ Sho-s ho- m ny d ys it t ,es to p y ccounts p y b"e7 'his r tio is simi" r to ccounts p y b"e turnover : bove7; 'he business m y be "osin$ v "u b"e creditor discounts by not p yin$ prompt"y7 'he formu" is2 456 Days Accounts Paya-le "urnover In%entory )urno%er $ Sho-s ho- m ny times in one ccountin$ period the comp ny turns over :se""s; its inventory7 'his r tio is v "u b"e for spottin$ understoc,in$6 overstoc,in$6 obso"escence6 nd the need for merch ndisin$ improvement7 ! ster turnovers re $ener ""y vie-ed s positive trendG they incre se c sh f"o- nd reduce - rehousin$ nd other re" ted costs7 9ver $e inventory c n be c "cu" ted by ver $in$ the inventory fi$ure from the month"y B " nce Sheets7 In cyc"ic " business6 this is especi ""y import nt since there c n be -ide s-in$s in sset "eve"s durin$ the ye r7 !or e0 mp"e6 m ny ret i"ers mi$ht h ve e0tr stoc, in =ctober nd .ovember in prep r tion for the 'h n,s$ivin$ nd -inter ho"id y s "es7 'he formu" is2 Cost o$ Goods Sold Average #nventory In%entory )urno%er in 'ays $ Identifies the ver $e "en$th of time in d ys it t ,es the inventory to turn over7 9s -ith inventory turnover : bove;6 fe-er d ys me n th t inventory is bein$ so"d more +uic,"y7 'he formu" is2 456 Days #nventory "urnover Sales to -et (orth $ Indic tes ho- m ny s "es do"" rs re $ener ted -ith e ch do"" r of investment :net -orth;7 'his is vo"ume r tio7 'he formu" is2 "otal Sales Average Net /ort& Sales to )otal .ssets $ Indic tes ho- efficient"y the comp ny $ener tes s "es on e ch do"" r of ssets7 9 vo"ume indic tor6 this r tio me sures the bi"ity of the comp ny>s ssets to $ener te s "es7
#*
'he formu" is2 "otal Sales Average "otal Assets 'e#t o%erage Ratio $ 9n indic tion of the comp ny>s bi"ity to s tisfy its debt ob"i$ tions6 nd its c p city to t ,e on ddition " debt -ithout imp irin$ its surviv "7 'he formu" is2 Net Pro$it . Any Non2Cas& )1penses Principal on De-t
7ey "erms and Concepts

'he fo""o-in$ re brief descriptions nd e0p" n tions of terms nd concepts re" ted to fin nci " st tements7 :Items defined e"se-here in the te0t re not "isted here7;
Accrual Basis o$ Accounting

By this "on$4est b"ished nd -ide"y used princip"e6 revenue nd e0penses re reco$ni<ed -hen service is performed or $oods re de"ivered6 re$ rd"ess of -hen p yment is received or m de7 'his method ""o-s -h t ccount nts c "" the matching of revenues nd ssoci ted e0penses7 Re%enue e0ample $ If store se""s O&00 -orth of r dios in d y6 O&00 of revenue is e rned nd entered in the boo,s even thou$h the proceeds of the s "e m y not be co""ected for month or "on$er7 E0pense e0ample $ If the store c"er, e rns O10 commission on the d y of the r dio s "e6 this e0pense to the business is recorded th t d y even thou$h it m y not ctu ""y be p id unti" the ne0t p yro"" d y7
Receiva-les Aging
'his report "ists customer>s n me6 credit "imit6 tot " b " nce6 nd ny mounts 306 306 )0 or more th n )0 d ys p st due7 By prep rin$ this report once month6 n o-ner c n spot trends nd p" n ne0t month>s co""ection efforts7
Amorti8ation
'he $r du " reduction of debt by me ns of e+u " periodic p yments sufficient to meet current interest nd "i+uid te the debt t m turityG "so6 the process of -ritin$ off $ inst e0penses the cost of prep id6 int n$ib"e sset over fi0ed period7
Appreciation
#&
9ny incre se from the c+uisition price of fi0ed sset or investment to current ppr ised m r,et v "ue7 Ho-ever6 for fin nci " st tement purposes6 ppreci tion is not considered bec use of four ccountin$ concepts2 (1) the o#2ecti%ity principle $ -hich -ou"d necessit te n ppr is " of e ch sset>s m r,et v "ue per ccountin$ period44 cost"y nd hi$h"y v ri b"e ende vor7 (3) the continuity assumption $ th t fi0ed ssets re c+uired for continuin$ business oper tions nd not for res "e (4) the principle of conser%atism - -hich st tes th t6 $iven choice of v "ues6 n ccount nt "- ys chooses the more conserv tive (5) th t fin nci " st tements ref"ect the original costs.
Cas& Basis o$ Accounting

9s its n me imp"ies6 this method reco$ni<es revenue nd e0penses on"y -hen c sh p yment is ctu ""y received or m de7 Bec use it does not proper"y m tch income nd e0penses :see 9ccru " B sis of 9ccountin$ in this section;6 the c sh b sis does not "- ys provide n ccur te picture of profit bi"ity nd is "ess common"y used th n the ccru " b sis7 'he Intern " Revenue Code p" ces cert in restrictions on the use of c sh b sis ccountin$ for computin$ income t 0 "i bi"ity7 !or further inform tion6 cont ct t 0 dvisor7
Cas& Flow
C sh f"o-s f "" into t-o c te$ories2 inflo!s nd outflo!s7 Inflo!s inc"ude revenues from s "es6 proceeds from "o ns6 nd c pit " inHections by o-ners7 /utflo!s inc"ude costs of s "es6 oper tin$ e0penses6 income t 0es6 rep yment of "o ns nd distribution to o-ners7 C sh is used to purch se m teri "s6 to p y for overhe d e0penses6 to p y " bor6 nd to m r,et merch ndise7 By studyin$ business>s individu " c sh f"o- cyc"e6 the o-ner c n determine the -or,in$ c sh needs of the comp ny7 'hese -i"" inc"ude d y4to4d y needs6 s -e"" s possib"e incre ses in the costs for m teri "s6 " bor6 nd overhe d7 By bein$ - re of these c sh needs6 the o-ner c n chieve b " nce bet-een c sh use nd profits7
Common2Si8e
9 term pp"ied to fin nci " st tements th t use 100 percent of one c te$ory s the b sis for determinin$ the proportion th t other st tement items represent7 .et s "es is used s the b sis fi$ure for Income St tements6 tot " ssets for B " nce Sheets7 Since the tot " "- ys sums to 100 percent6 the st tements prep red in this m nner re referred to s Acommon4si<e7B 'his form of comp r tive st tement en b"es the n "yst to see t $" nce the B " nce Sheet trends nd the proportion te ch n$es t ,in$ p" ce in the individu " ccounts form one st tement period to the ne0t7
Depreciation
#+
9 univers " ccountin$ ssumption ho"ds th t "" fi0ed ssets44-ith the e0ception of " nd44deterior te6 -e r out6 or become obso"ete7 'his process represents dec"ine in v "ue th t is c ""ed depreci tion7 It is c "cu" ted by pportionin$ n sset>s ori$in " c+uisition price6 minus ny e0pected s "v $e v "ue6 over the sset>s e0pected ye rs of usefu" "ife7 :!or ccountin$ purposes6 " nd is "- ys v "ued t its ori$in " purch se price7; =n the Income St tement6 depreci tion incurred durin$ the ccountin$ period is det i"ed s n e0pense7 =n the B " nce Sheet6 depreci tion is ref"ected by n sset>s "isted net boo, or net c rryin$ v "ue :cost "ess ccumu" ted depreci tion;7 'he simp"est nd most common me ns of c "cu" tin$ depreci tion is by the straight$line method7 Fsin$ it6 ccount nts divide the estim ted usefu" "ife of n sset into its purch se price minus ny pp"ic b"e s "v $e v "ue7 *0 mp"e2 9n O116000 m chine h s O16000 s "v $e v "ue nd n e0pected usefu" "ife of 10 ye rs7 9nnu " depreci tion J :O116000 4 O16000; S 10 J O160007 In five ye rs6 str i$ht4"ine accumulated depreciation -ou"d be O&60007 'here re other common c "cu" tion methods th t ""o- more cce"er ted depreci tion of fi0ed ssets7 'hese methods distribute the ori$in " c+uisition cost more he vi"y durin$ n sset>s e r"y ye rs7 9ccount nts c n sho- o-ners the v rious me ns to determine this depreci tion6 -hich is more comp"e0 th n str i$ht4"ine7 Depreci tion computed ccordin$ to the D99E ru"es is not necess ri"y the s me s th t computed to comp"y -ith the Intern " Revenue Code7 !or further inform tion6 consu"t t 0 dvisor7
#nventory Valuation
Bec use inventory units re usu ""y purch sed t v ryin$ prices6 methods h ve been est b"ished to c "cu" te the cost of $oods so"d nd the v "ue of rem inin$ inventory7 'hree -ide"y used methods re2 .%erage ost $ 'he tot " number of units of $oods v i" b"e is divided into the tot " m nuf cturin$ or c+uisition cost :inc"udin$ frei$ht ch r$es to $et the r - m teri "s to the m nuf cturer@s or supp"ier@s "oc tion7; FIF/ $ 9n cronym for Afirst in6 first out7B 'his method is b sed on the ssumption th t the inventory c+uired first is so"d first7 Conse+uent"y6 the endin$ :rem inin$; inventory consists of the most recent"y purch sed items7 9n dv nt $e of this method of v "u tion is th t it ref"ects recent costs of inventory on the B " nce Sheet7 +IF/ $ 9n cronym for A" st in6 first out7B 'his method of v "u tion ssumes th t those items of inventory most recent"y c+uired re so"d before the o"der c+uisitions7 9s resu"t6 the endin$ inventory fi$ure consists of the o"der purch ses7 Eroponents of this v "u tion method r$ue th t by representin$ current prices in the cost of $oods so"d6 m tchin$ is more ccur te"y ccomp"ished7 )1ample( 'he first item in costs O1006 the second costs O3006 nd the third costs O&007 '-o of these units re so"d7
20
C "cu" ted by a%erage cost2 O100 K O300 K O&00 J O)00 S 3 J O3007 'herefore6 the cost of $oods so"d J O300 :2 units 0 O300;G the rem inin$ inventory is v "ued t O3007 C "cu" ted by FIF/6 the cost of $oods so"d is O100 K O300 J O#00G the rem inin$ inventory is v "ued t O&007 C "cu" ted by +IF/6 the cost of $oods so"d is O&00 K O300 J O800G the rem inin$ inventory is v "ued t O1007
,everage
'he concept of borro-in$ he vi"y for fin ncin$ needs in order to minimi<e the c pit " investment nd m 0imi<e the return on investment7
,i*uidate
'o convert non4c sh ssets into c shG "so6 to c"ose the business by se""in$ "" ssets nd p yin$ "" debts7 ,i*uidity 'he e se -ith -hich items c n be converted into c sh -ithout "oss7
Negative Cas& Flow

C sh receipts th t re insufficient to meet on$oin$ costs nd other c sh needs6 such s necess ry investment in fi0ed ssets or e0p nded inventory7
/orking Capital
'he difference bet-een tot " current ssets nd tot " current "i bi"itiesG the resu"tin$ poo" of resources re di"y v i" b"e to m int in norm " business oper tions7

2#
Acknowledgement( "&e $oregoing in$ormation was used wit& permission $rom Bank o$ America N"0SA 9:;<' 9:;=+
Financial Statements as a %anagement "ool

7ennet& %+ %acur and ,yal Gusta$son Reprinted !ith permission from the Small Business Forum6 the 2ournal of the .ssociation of Small Business 'e%elopment enters6 !hich !as pu#lished #y the 7ni%ersity of (isconsin$E0tension Small Business 'e%elopment enter" 'his rtic"e sho-s you ho- to use your fin nci " st tements to ns-er ten import nt +uestions7 In ddition6 three c se studies provide e0 mp"es of ho- fin nci " st tement n "ysis -or,s7 !i$ure 16 Summ ry ' b"e of !in nci " R tios6 sho-s sever " r tios th t re common"y used for n "y<in$ fin nci " st tements7 1eep in mind th t the r tios sho-n in !i$ure 1 re on"y s mp"e of do<ens of -ide"y4used r tios in fin nci " st tement n "ysis7 % ny of the r tios over" p7 'o i""ustr te fin nci " st tement n "ysis6 -e -i"" use the fin nci " st tements of 145 ! shions6 Inc7 145 ! shions is direct m i" order comp ny for +u "ity Acut nd se-nB products7 'heir fin nci " st tements re presented in !i$ure 27 5i,e most sm "" businesses6 they h ve re" tive"y simp"e c pit " structure nd their income st tement ref"ects typic " revenues nd e0penses7 Inventory consists prim ri"y of merch ndise obt ined under contr ct from pproved $ rment m ,ers nd he"d for res "e7 145 ! shions uses tr de credit for purch ses6 but its s "es consist "most entire"y of credit c rd s "es7 Conse+uent"y6 -e see very "o- ccounts receiv b"e b " nce comp red -ith ccounts p y b"e7 Some of the items th t -ou"d norm ""y be seen on fin nci " st tements h ve been conso"id ted to simp"ify the present tions7 !in nci " st tement n "ysis c n be pp"ied from t-o different directions7 Vertic " n "ysis is the pp"ic tion of fin nci " st tement n "ysis to one set of fin nci " st tements7 Here6 -e "oo, Aup nd do-nB the st tements for si$ns of stren$ths nd -e ,nesses7 Hori<ont " n "ysis "oo,s t fin nci " st tements nd r tios over time7 In hori<ont " n "ysis6 -e "oo, for trends 44 -hether the numbers re incre sin$ or decre sin$G -hether p rticu" r components of the comp ny>s fin nci " position re $ettin$ better or -orse7 Ce -i"" "oo, t the fin nci "s from the perspectives of four different $roups2 o-ners6 m n $ers6 short4term creditors nd "on$4term creditors7
>wners
9"thou$h o-ners of sm "" businesses often re "so the m n $ers6 the initi " concern is -ith o-ners s investors in the business7 =-ners use fin nci " st tement d t s - y to me sure -hether their money is -or,in$ s h rd in the business s it -ou"d be in n "tern tive investment7 'he d t c n "so te"" ho- -e"" you or your m n $ers h ve m n $ed the firm>s ssets7 'hus6 the r tios th t re of $re test interest to you s o-ner/investor re those th t me sure profit bi"ity re" tive to :1; your o-n investment in the firm nd :2; the tot " mount invested in the firm from both your c pit " nd borro-ed funds7 1. 8o! !ell is the company doing as an in%estment9 4 'he Return on In%estment (R/I) M.et Income S
22
=-ners> *+uity :9ver $e;N me sures the profit bi"ity of the firm on o-ner4invested do"" rs7 .et income is the fter4t 0 return7 'he o-ners> e+uity :or c pit "; ccount is the investment7 It is the mount you h ve contributed direct"y to the business nd mounts th t you h ve reinvested vi undistributed profits7 R=I $ives n indic tion of the p st e rnin$ po-er of your investment nd c n be used to comp re the comp ny>s perform nce in this re$ rd to other comp nies in the industry7 It shou"d "so be comp red -ith other investment opportunities open to you7 If your comp ny typic ""y $ener tes return of 10 percent nd you c n invest e"se-here t 1& percent6 it doesn>t m ,e sense from pure"y economic st ndpoint to ,eep your funds tied up in the comp ny7 145 ! shions> R=I for fisc " 200& - s bout 127( percent MO1#(6#30 S O161&(61&0N7 9ver $e o-ners> e+uity is used s the denomin tor to ppro0im te the mount v i" b"e for use in $ener tin$ net income over the course of the entire ye r7 ' ,en by itse"f6 this fi$ure is neither impressive not disturbin$7 'he medi n Areturn on net -orthB c "cu" ted by Dun nd Br dstreet :DQB; for c t "o$ nd m i"4order houses - s 2273 percent7 'he trend est b"ished over the " st three ye rs is more import nt7 Comp rin$ the 200& return -ith the t-o precedin$ ye rs6 there is sh rp drop from #37# percent in 20036 to 2872 percent in 200#6 to 127( percent in 200&7 3" 8o! !ell has management employed the company:s assets9 4 'he Return on .ssets (R/.) M.et Income S 9ver $e 'ot " 9ssetsN me sures the profit bi"ity of the firm on "" invested do"" rs7 'h t is6 it me sures ho- -e"" the firm>s ssets h ve been emp"oyed in $ener tin$ income7 'his me sure is some-h t bro der th n the return on e+uity bec use it comp res the returns on tot " c pit "7 'his inc"udes the c pit " th t you nd the creditors h ve provided7 Ch t constitutes s tisf ctory R=9P It depends on the type of ssets nd their end use7 =nce $ in6 since comp nies -ithin $iven industry tend to emp"oy simi" r ssets6 your R=9 shou"d be me sured $ inst industry norms7 145 ! shions> R=9 for fisc " 200& - s 87# percent MO1#(6#30 S O16(316330N comp red -ith medi n of 10 percent for the industry for the most recent period7 9$ in6 145 ! shions f ""s short7 Ce "so see dec"inin$ R=9 over three ye r period2 2& percent for 20036 1873 percent for 200#6 nd 87# percent for 200&7
%anagers
% n $ers6 too6 re interested in me surin$ the oper tin$ perform nce in terms of profit bi"ity nd return on invested c pit "7 If they re not o-ners6 m n $ers must sti"" s tisfy the o-ners> e0pect tions in this re$ rd7 9s m n $ers6 they re interested in me sures of oper tin$ efficiency6 sset turnover6 nd "i+uidity or so"vency7 'hese -i"" he"p them m n $e d y4to4d y ctivities nd ev "u te potenti " credit customers nd ,ey supp"iers7 % n $er r tios serve s c sh m n $ement too"s by focusin$ on the m n $ement of inventory6 receiv b"es nd p y b"es7 9ccordin$"y6 these r tios tend to focus on oper tin$ d t ref"ected on the profit nd "oss st tement nd on the current sections of the b " nce sheet7 4" .re profits high enough6 gi%en the le%el of sales9 $ In other -ords6 ho- efficient"y is m n $ement
2(
conductin$ oper tionsP 'he -et Profit *argin M.et Income S S "es :or Return on S "es; is me sure of the re" tive efficiency of the comp ny>s oper tions fter deductin$ "" e0penses nd income t 0es7 It me sures the proportion of e ch s "es do"" r th t resu"ts in net income7 'he ver $e for this r tio v ries -ide"y from industry to industry7 'o serve s n id in m n $ement6 the comp ny>s net profit m r$in shou"d be comp red -ith th t of simi" r comp nies in the s me industry6 nd -ith the comp ny>s p st fi$ures7 'he m n $er shou"d monitor this r tio nd investi$ te potenti " prob"ems -hen the r tio be$ins to f "" be"o- the industry ver $e or h s sho-n continued deterior tion durin$ the most recent +u rter or t-o7 If both conditions e0ist6 m n $ement is "i,e"y f cin$ prob"em th t re+uires immedi te ttention7 Incident ""y6 most b n, "o n officers use the return on s "es r tio s ,ey indic tor in m ,in$ term "o n decisions7 9 deterior tin$ r tio is often seen s n indic tion of impendin$ business distress7 'he fisc " 200& net profit m r$in for 145 ! shions - s 27# percent M1#(6#30/3603)6(&0N7 By comp rison6 the medi n return on s "es for the industry6 s reported by DQB6 - s #70 percent6 me nin$ th t nother of the comp ny>s profit bi"ity me sures is be"o- the industry norm7 *+u ""y troub"in$ is the do-n- rd trend in the net profit m r$in since 20037 In fisc " ye r 200#6 the net profit m r$in - s &73 percent6 do-n from (71 percent for 20037 =ver this period6 profits dec"ined &#73 percent6 despite 327& percent incre se in s "es7 If the comp ny -ere m int inin$ oper tin$ efficiency6 incre ses in s "es -ou"d resu"t in incre ses in profits :'his scen rio is $ener ""y n indic tion th t some oper tin$ e0penses re $ettin$ out of h nd7; 9n e0 min tion of 145 ! shions> income st tement su$$ests th t se""in$6 $ener " nd dministr tive e0penses6 -hich $re- by && percent over the p st t-o ye rs6 cou"d be the c use of the decre sed profit bi"ity7 Bec use the fin nci "s for 145 ! shions on"y provide $ener " c te$ories6 it is difficu"t to ssess the c use of the incre se in this e0pense c te$ory7 5" 8o! !ell are the company:s assets #eing employed to generate sales re%enue9 $ 'he .sset )urno%er ratio MS "es S 9ver $e 'ot " 9ssetsN indic tes the re" tive efficiency -ith -hich m n $ers h ve used the firm>s ssets to $ener te output6 nd thus6 it he"ps ns-er this +uestion7 Here $ in6 -h t is ccept b"e or ppropri te v ries from industry to industry7 Fsu ""y6 ho-ever6 hi$her r tio is better7 9 very hi$h turnover r te cou"d si$n " n opportunity for e0p nsion or the need for e r"y rep" cement of ssets7 It cou"d "so me n th t the comp ny is in hi$h4vo"ume6 "o-4m r$in industry7 145 ! shions> sset turnover r tio - s 37# times MO3603)6(&0 S O16(316330N for fisc " 200& nd6 despite decre se from fisc " 200#6 rem ins t "eve" comp r b"e -ith fisc " ye r 20037 'his me ns "itt"e by itse"fG but comp red -ith the industry ver $e of 371 times6 -e mi$ht conc"ude th t s "es perform nce is prob b"y s tisf ctory for the mount of resources v i" b"e7 .either the profit m r$in nor the sset turnover by itse"f provides n de+u te me sure of oper tin$ efficiency or profit bi"ity7 But mu"tip"yin$ the profit m r$in by the sset turnover r tio $ives us the AReturn on 9ssetsB r tio or e rnin$s po-er on tot " ssets7 'his r tio is the s me s the R=9 computed for the o-ners but is presented in form th t m n $ers often find more usefu"7 It b"ends6 in one number6 "" the m Hor in$redients of profit bi"ityG yet it ""o-s the m n $er to see ho- the individu " components contribute7 'hus6 there re t-o b sic in$redients to profit bi"ityG sset turnover nd profit m r$in7 9n improvement in either 44 -ithout ch n$in$ the other 44 -i"" incre se the return on
24
ssets7 Ch t c n m n $ers do to incre se the returns on ssets nd o-ners> investmentsP 'he return on ssets -i"" incre se by either n incre se in the sset turnover or n incre se in the profit m r$in7 'hree sep r te items re invo"ved in the c "cu" tion2 s "es6 net income6 nd ssets7 Ho-ever6 since net income is simp"y s "es minus e0penses6 the three individu " items subHect to m n $ement contro" re s "es6 e0penses nd ssets7 *ither incre sin$ s "es6 decre sin$ e0penses6 or decre sin$ ssets6 -hi"e ho"din$ the others const nt6 -i"" improve the R=9 nd -ith it the R=I7 Diven 145 ! shions> most recent fin nci " st tement6 it ppe rs the most fruitfu" efforts -ou"d consist of contro""in$ costs to incre se both profits nd the profit m r$in7 .otice th t it doesn>t re+uire sophistic ted n "ysis to come to this conc"usion7 'his i""ustr tes6 ho-ever6 one ro"e of fin nci " st tement n "ysis2 to hi$h"i$ht re s th t need m n $ement ttention7 =nce prob"em re s re hi$h"i$hted6 so"utions c n be obvious7 'his is -hy common4sense ppro ch of incre sin$ s "es nd "o-erin$ e0penses -or,s to improve profit bi"ity7 ;" .re recei%a#les coming in too slo!ly9 $ 'he .%erage ollection Period M:9ver $e 9/R S 9nnu " Credit S "es; 0 33&N of receiv b"es te""s ho- m ny d ys6 on ver $e6 customers> tr de ccounts :9/R; re outst ndin$7 'he ver $e co""ection period is me sure of both "i+uidity nd perform nce7 9s me sure of "i+uidity6 it te""s ho- "on$ it t ,es to convert ccounts receiv b"e into c sh7 9s me sure of perform nce6 it indic tes ho- -e"" the comp ny is m n $in$ the credit e0tended to customers7 Chether the ver $e co""ection period is too hi$h -i"" depend on -h t ,ind of credit terms the comp ny e0tends to its customers nd ho- ppropri te those terms re7 If ccounts re e0pected to be p id in 30 d ys6 3# d y ver $e -ou"d be considered very $ood7 %ost customers tend to -ithho"d p yment for s "on$ s the credit terms ""o-7 'his pr ctice6 "on$ -ith some ever4present s"o- ccounts6 c n c use the ver $e co""ection period to e0ceed the st ted "imit by -ee, to 10 d ys nd shou"d not be m tter of concern7 9n ver $e co""ection period of #8 d ys in this c se6 ho-ever6 cou"d be d n$er si$n "7 Customers -ho re s"o- in p yin$ their bi""s6 m y never p y t ""7 9s the b " nce sheet sho-s6 145 ! shions> ccounts receiv b"e re insi$nific nt7 'he ver $e co""ection period re" tin$ to "" s "es - s 7& d ys M:O(6(8& S O3603)6(&0; 0 33&N for 200& nd "ess th n one4h "f d y for e ch of the prior t-o ye rs7 'his r pid turnover of receiv b"es is underst nd b"e6 bec use 145 ! shions> Acredit s "esB re " r$e"y b n, credit c rd s "es7 C sh m n $ement in this re seems to be $ood in th t no time is - sted in $ettin$ credit c rd invoices nd person " chec,s credited to the comp ny>s ccount7 Bec use ccounts receiv b"es b " nces for 145 ! shions comprise minor portion of the comp ny>s tot " ssets6 this r tio is not p rticu" r"y usefu" s c sh m n $ement too" to its m n $ers7 9nd6 s st ted previous"y6 common4sense ppro ch to fin nci " st tement n "ysis must be m int ined7 If6 "i,e 145 ! shions6 your business h s fe- receiv b"es6 then n "ysis of them -ou"d not be -orth-hi"e7 9nother e0 mp"e is service industries th t h ve no inventory7 Cith no inventory6 the ne0t section of n "ysis is irre"ev nt7 <" Is too much cash tied up in in%entories9 $ 'he In%entory )urno%er MCost of Doods So"d *0pense S
2)
9ver $e InventoryN r tio is used to me sure the speed -ith -hich inventories re bein$ so"d nd is usefu" in m n $in$ inventory "eve"s7 Ho- much inventory shou"d the comp ny ,eep on h ndP 'he ns-er depends on m ,in$ de"ic te tr de4off bet-een nticip ted ne r4term s "es6 the costs of orderin$ nd ho"din$ inventory6 the cost of stoc,4outs6 etc7 It "so depends on the e0pected future v i" bi"ity of $oods from the comp ny>s supp"iers7 In either c se6 e0cessive c sh tied up in inventories reduces comp ny>s so"vency7 'his r tio is vit " for sm ""4business m n $ers -ho must m ,e very effective use of the "imited c pit " v i" b"e to them7 Tust -h t is n ppropri te turnover r te depends on the industry6 the inventory itse"f6 nd $ener " economic conditions7 !or e0 mp"e6 the Bro, - Division of C us u E pers :in Bro, -6 Cisconsin; often h s one to three ye rs@ -orth of r - m teri " inventory :"o$s; on h nd7 Bec use the ro d nd -e ther conditions "imit the time -hen -ood c n be received in .orthern Cisconsin6 C us u E pers is forced to h ve very s"o- inventory turnover r te for r - m teri "s t th t p rticu" r p" nt7 Ho-ever6 finished $oods :cut6 co"ored p per; turn over every 28 d ys7 If inventory turnover for the firm is consistent"y much s"o-er th n the ver $e for the industry6 then inventory stoc,s prob b"y re either e0cessive"y hi$h or cont in "ot of obso"ete items7 *0cessive inventories simp"y tie up funds th t cou"d be used to m ,e needed debt p yments or to e0p nd oper tions7 9n e0treme"y hi$h turnover r te cou"d be si$n of stoc,4outs 44 not bein$ b"e to fi"" customer>s order bec use the $oods re not on h nd7 Ho-ever6 on the positive side6 if neither stoc,4 outs nor co""ections re prob"em6 then hi$h r tio c n be $ood7 145 ! shions> b " nce sheet "so sho-s th t6 other th n p" nt nd e+uipment6 more do"" rs h ve been invested in inventory th n ny other sset c te$ory7 Diven the type of firm6 this is not unusu "7 Ho-ever6 the inventory turnover r te for the comp ny is on"y #7& items per ye r MO36&(360(0 S O()(6830N6 me nin$ th t it t ,es n ver $e of 817& d ys M33& S #7&N for the comp ny to se"" its inventory once it is purch sed7 'his tr ns" tes into bout 81 d ys of inventory7 Does this indic te too much inventory for the r te t -hich it is se""in$P =n the surf ce it mi$ht seem e0cessive6 considerin$ th t inventory b " nces shou"d be t "o- point fter the Christm s s "es rush7 9 "oo, t simi" r comp nies6 ho-ever6 reve "s th t 145 ! shions> turnover is not much s"o-er th n the industry ver $e of &71 times :or (2 d ys;7 *ven -ith this "eve" of inventory6 m n $ement st ted in its nnu " report th t the comp ny - s b"e to fi"" on"y 82 percent of orders from $oods on h nd7
S&ort2"erm Creditors
Short4term creditors6 inc"udin$ m n $ers -ho e0tend credit to tr de customers6 re interested in the so"vency of borro-ers or customers7 9s resu"t6 they tend to focus on the current section of the b " nce sheet7 'he s me c "cu" tions th t m n $er does on his/her o-n fin nci "s st tements c n "so be done on debtor>s fin nci " st tements7 'he most -ide"y used fin nci " r tios used to ns-er +uestions of short4term so"vency re the current ratio nd quick ratio7 =" 'oes this customer ha%e sufficient cash or other liquid assets to co%er its short$term o#ligations9 $ 'he urrent Ratio MCurrent 9ssets S Current 5i bi"itiesN is one of the most fre+uent"y used me sures of so"vency7 It sho-s the re" tionship bet-een current ssets nd current "i bi"ities7 Current "i bi"ities re ob"i$ tions th t -i"" come due in the ne0t 12 months7 Current ssets re ssets th t re e0pected to
2$
be converted to c sh in the s me period7 'his r tio is -ide"y used to provide one indic tion of -hether prospective customer or borro-er is $ood short4term credit ris,7 9n o"d ru"e4of4thumb s ys th t the current r tio shou"d be t "e st 270 to provide n de+u te m r$in of s fety7 Chether this r tio is hi$h enou$h6 ho-ever6 depends on the type of comp ny invo"ved nd6 to some e0tent6 on the time of ye r7 :9ir"ines often h ve current r tios under 17; Ch t constitutes $ood r tio "so depends on the composition of the current ssets re" tive to the due d tes for the current ob"i$ tions7 If inventory m ,es up si$nific nt portion of current ssets nd it is movin$ s"o-"y6 hi$her4th n4 ver $e r tio m y hide potenti " "i+uidity prob"ems7 'hus6 the +uic, r tio shou"d "so be ev "u ted7 'he &uick Ratio MC sh K % r,et b"e Securities K 9/R S Current 5i bi"itiesN :or acid test; is some-h t more ccur te $uide to short4term so"vency7 'his r tio is the s me s the current r tio e0cept th t it e0c"udes inventory nd prep id e0penses 44 the "e st "i+uid of the current ssets7 It provides more penetr tin$ me sure of so"vency th n does the current r tio7 If receiv b"es turn over r pid"y6 +uic, r tio of 170 or "itt"e hi$her is prob b"y de+u te7 9 $rocery store -i"" often h ve +uic, r tios of 72& to 7 &0 nd current r tios th t e0ceed 27 Suppose -e re supp"ier to 145 ! shions7 145 ! shions> current r tio t the end of fisc " ye r 200& - s 178 times :O160(862#0 S O30(6(#0;6 do-n from 273 times the previous ye r nd be"o- the industry medi n of 27& times7 Ho-ever6 even if the " test current r tio -ere 273 or better6 it "one -ou"d not provide us much comfort bec use inventory comprises so much of the comp ny>s current ssets7 145 ! shions> " test +uic, r tio is 7& times :O28#6(30 S O3((6(#0; comp red -ith n industry ver $e of 170 times7 'his is more strin$ent nd v "id test of "i+uidity in this c se7 If the r tio is t "e st 170 times :-hich me ns th t "i+uid ssets e+u " current "i bi"ities;6 -e c n usu ""y ssume th t the comp ny h s fe- short4term p yment prob"ems7 9t 7& times6 ho-ever6 -e -ou"d - nt to "oo, t other indic tors of future c sh f"o-s7 9ny sm "" comp ny -ith these ,inds of numbers m y be re+uired by creditors to provide short4term proHection of future c sh receipts nd disbursements7 >" 8o! quickly does the prospecti%e credit customer pay its #ills9 $ Suppose th t6 on b " nce6 -e find the comp ny>s short4term so"vency to be ccept b"e7 Before $reein$ to supp"y the comp ny on credit b sis :or est b"ishin$ credit terms for the comp ny;6 -e shou"d try to determine ho- +uic,"y the comp ny norm ""y p ys its bi""s7 'he .%erage .ge of Paya#les M:9ver $e E y b"e S .et Eurch ses; 0 33&N he"ps ns-er this +uestion7 'h t is6 h vin$ determined th t comp ny h s the c p city to p y its short4term ob"i$ tions s they come due :throu$h the current or +uic, r tios;6 it is "so import nt to ev "u te its p yment pr ctice7 In m nner simi" r to c "cu" tin$ the ver $e co""ection period for ccounts receiv b"e6 one c n compute the ver $e A $eB of comp ny>s p y b"e6 -hich is the ver $e number of d ys it t ,es to p y its invoices7 'he $e of the potenti " customer>s p y b"e -i"" $ive re son b"e estim te of ho- soon creditor c n e0pect to be p id7 'his is p rticu" r"y import nt for the sm "" business th t h s Hust " nded m Hor customer7 9 " r$e corpor tion is "i,e"y to use very effective :from its o-n st ndpoint; c sh m n $ement procedures to ensure prompt p yment from its customers -hi"e de" yin$ p yment to its supp"iers s "on$ s possib"e7 Fn"ess the sm "" business is critic " supp"er of its " r$e corpor te customer6 th t
2*
corpor tion m y not cce"er te its p yment cyc"e to meet the supp"ier>s c sh f"o- needs7 'h t>s -hy it is critic ""y import nt for the decision4m ,in$ process of the sm ""4business o-ner/m n $er to be b"e to estim te the potenti " customer>s p yment cyc"e7 'o c "cu" te the ver $e $e of p y b"es for 145 ! shions6 -e need to estim te purch ses bec use they re not reported direct"y in the st tements7 Cost of $oods so"d :-hich is on the income st tement; e+u "s be$innin$ inventory6 p"us net purch ses6 minus endin$ inventory7 'herefore6 purch ses e+u " the cost of $oods so"d :O36&(360(0; minus be$innin$ inventory O8&(60)0; p"us endin$ inventory :O(386330;6 or bout O36#&#63107 Fsin$ this c "cu" tion6 -e c n c "cu" te th t the ver $e $e of 145 ! shions> p y b"es is M:O3116030 S O36#ᢦ 0 33&N J 327) d ys7 If 145 ! shions -ere potenti " customer6 -e shou"d not e0pect it to p y our invoices much sooner th n 33 d ys7
,ong2"erm Creditors
B n,ers nd other "on$4term creditors - nt to be ssured of receivin$ interest nd princip " -hen e ch become due7 'hese creditors re p rticu" r"y interested in the e rnin$ po-er nd the present nd future fin nci " c p city of the borro-er7 ?" .s a potential or present long$term #orro!er6 is the company:s de#t load e0cessi%e9 $ If the comp ny>s debt "o d is too hi$h 44 it is hi$h"y "ever $ed 44 it me ns th t creditors of the firm h ve disproportion te"y hi$h sh re6 nd o-ners h ve disproportion te"y "o- sh re6 of the inherent ris, of bein$ in business7 9 simp"e me sure of the Aris, "o nB is the 'e#t$to$Equity ('@E) M'ot " Debt S 'ot " *+uityN r tio7 'his r tio re" tes the investment provided by creditors to th t provided by o-ners7 It indic tes -ho is the m Hor ris,4be rer in this business7 'h t is6 if the D/* r tio is 10216 it me ns th t creditors h ve O10 invested in this business for every O1 th t the o-ner h s invested7 Since the o-ner is m ,in$ the decisions6 the creditor in this c se is in n e0treme"y prec rious position7 'he creditors in this c se st nd to "ose 10 times s much s the comp ny>s o-ners7 'herefore6 the o-ner mi$ht be more -i""in$ to t ,e more specu" tive ris,s7 Converse"y6 if the r tio is 12106 it me ns th t the o-ner h s more to "ose7 'he creditors for this type of comp ny -ou"d fee" s fer ,no-in$ the o-ner h s bi$$er person " st ,e7 !rom creditor>s st ndpoint6 "o-er D/* r tio is better7 9 "on$4term creditor tends to be s,eptic " of borro-ers> $ood intentions or Hud$ment -hen the comp ny is hi$h"y "ever $ed or is see,in$ ne- funds th t -i"" c use it to become hi$h"y "ever $ed7 =-ners shou"d use this r tio to vie- their comp nies s "on$4term creditor -ou"d6 nd shou"d see, to ,eep the debt4to4e+uity re" tionship -ithin industry norms7 145 ! shions> D/* is 73 :O38&6(#0 S O161386230;6 comp red -ith medi n D/* of 73 for the industry7 'his -ou"d norm ""y indic te re" tive fin nci " stren$th7 Ho-ever6 -e shou"d note th t those "i bi"ities th t do not need to be p id or sett"ed in the ne r term6 constitute on"y bout 11 percent of tot " "i bi"ities7 *0cept for dv nce p yments on orders the other 8) percent re short4term ob"i$ tions7 Conse+uent"y6 this r tio is "ess import nt in this c se th n the short4term so"vency me sures 44 even to the comp ny>s "on$4term creditors7 'his reinforces the concept th t r tio n "ysis shou"d be pp"ied -ith common sense7 1A" .re earnings and cash flo! sufficient to co%er interest payments and pro%ide for some principal
2&
repayment9 - 'he )imes Interest Earned ()IE) MIncome K :Interest K ' 0es; S Interest *0penseN r tio m y be used to he"p ns-er this +uestion7 .ote th t this r tio uses income before interest nd income t 0es re subtr cted bec use this is the mount of income v i" b"e to cover interest7 'he " r$er the number6 the e sier it -i"" be for the debtor comp ny to suffer n e rnin$s depression6 nd sti"" m ,e its interest p yments7 'he 'I* me sures the b n,>s s fety in terms of the "i,e"ihood th t it -i"" continue to receive periodic interest p yments7 'he 'I* does not6 ho-ever6 indic te ho- -e"" total debt p yments re covered7 'he ash Flo! to )otal +ia#ilities M=per tin$ C sh !"o- S 'ot " 5i bi"itiesN r tio is preferred by m ny b n,ers s me sure of e rnin$s po-er re" tive to "" debt7 'his debt cover $e r tio depicts comp ny>s debt rep yment c p bi"ity nd is one of the more import nt inde0es of "on$4term so"vency7 'he c sh f"o- fi$ure in the numer tor refers to net c sh provided by oper tions s reported on the st tement of c sh f"o-s in !i$ure 27 !or sm "" comp nies th t don>t prep re c sh f"o- st tement6 oper tin$ c sh f"o- c n be estim ted by t ,in$ income before interest nd t 0es nd ddin$ b c, depreci tion nd other si$nific nt non4c sh ch r$es7 'he industry ver $e for this r tio is not "i,e"y to serve s p rticu" r"y usefu" benchm r,7 B n,ers re more interested in the trend of the r tio7 Incre sin$ "eve"s of debt -ithout commensur te incre ses in c sh $ener ted by profit b"e oper tions is sure si$n of fin nci " prob"ems he d7 'his cou"d occur if the R=9 is "ess then the borro-in$ r te7 145 ! shions> e rnin$s before interest nd t 0es is O2&)63106 comp red -ith interest e0pense of O1061807 'hus6 its interest cover $e in terms of the times interest e rned r tio is 2&7& times MO2&)6310 S O106180N7 9"thou$h this r tio h s dec"ined subst nti ""y over the p st three ye rs6 it h s not dec"ined s sh rp"y s e rnin$s bec use interest ch r$es h ve dec"ined7 !urthermore6 it is sti"" +uite " r$e6 indic tin$ to creditors th t interest p yments re -e"" covered7 145 ! shions> c sh f"o- st tement sho-s th t net c sh provided by oper tions durin$ fisc " ye r 200& - s O&1260206 subst nti " incre se over both 200# nd 20037 Comp red to the do-n- rd trend in net income6 the c sh f"o- from oper tions su$$ests the comp ny h s been reportin$ " r$e mount of non4c sh e0penses "i,e depreci tion nd morti< tion7 9 "i,e"y c use in the incre sed non4c sh ch r$es is the " r$e incre ses in " nd nd bui"din$s nd in fi0tures nd e+uipment7 !urthermore6 it ppe rs from the b " nce sheet th t the e0p nsion - s fin nced by intern ""y $ener ted c sh nd -ithout the ssist nce of "on$4term creditors7 9s these investments bec me productive6 the comp ny prob b"y be$ n depreci tin$ them6 resu"tin$ in the do-n- rd trend in net income7 Chen these f ctors re considered6 the dec"ine in net profit m r$ins does not "oo, so serious7 'he cash flo! to total lia#ilities ratio M=per tin$ C sh !"o- S 'ot " 5i bi"itiesN is therefore O&126020 S O38&6(#0 J (#7( percent7 St ndin$ "one6 this r tio su$$ests th t the comp ny is conserv tive"y c pit "i<ed nd $ener tes sufficient c sh to cover its future ob"i$ tions7 'he r tio is p rticu" r"y he "thy considerin$ the f ct th t more th n h "f of tot " debt is in the form of ccounts p y b"e6 used to fin nce inventory nd receiv b"es7

2+
"&ree Case Studies

ase 1B Is a critical supplier in good financial condition9 9 m n $er shou"d not over"oo, the use of fin nci " st tement d t in se"ectin$ ,ey supp"iers of r - m teri " nd component p rts if the inform tion is v i" b"e7 !or sm "" comp nies th t depend upon other comp nies for critic " r - m teri "s or merch ndise6 the bi"ity to determine the v i" bi"ity of those items cou"d me n the difference bet-een success nd f i"ure7 'his is p rticu" r"y import nt for the sm ""er comp nies th t do not h ve the purch sin$ c"out of their " r$er competitors7 ?et this is one of the most over"oo,ed spects of inventory m n $ement in most comp nies7 =ne of the ,ey criteri to consider in ev "u tin$ potenti " or e0istin$ supp"iers is fin nci " he "th7 Fn"ess supp"er h s st yin$ po-er6 "" of its other fine +u "ities -on>t me n much7 Here -e "oo, to the supp"ier>s fin nci " st tements for some ns-ers7 !our e si"y obt in b"e r tios re prob b"y sufficient to ev "u te supp"ier>s fin nci " he "th de+u te"y2 (1) profit margin6 (3) in%entory turno%er6 (4) quick ratio nd (5) de#t$to$ equity7 'he profit margin :return on s "es; shou"d be used in ev "u tin$ supp"ier the s me - y it - s used to ev "u te the m n $er>s o-n comp ny7 It shou"d be comp red -ith other comp nies in the industry to ev "u te the supp"ier>s re" tive oper tin$ efficiency7 %ore import nt6 ho-ever6 is to "oo, t the trend of this r tio7 *ven if the current ye r>s profit m r$in is -ithin industry norms6 dec"inin$ r tio cou"d indic te th t the supp"ier is f cin$ serious competition or even fin nci " crisis7 'he in%entory turno%er ratio c n be used to determine -hether the supp"ier>s inventories re movin$6 on the one h nd6 nd -hether its inventory "eve"s m y be too "o-6 on the other7 9 ,ey is to consider the industry ver $e7 9 "o- turnover cou"d indic te th t inventory is not movin$6 "e din$ to future "i+uidity crisis7 9n e0ception ""y hi$h turnover cou"d indic te th t the supp"ier is m int inin$ very "o- inventory "eve"s6 -hich cou"d me n th t $oods -i"" not be v i" b"e -hen m n $er orders them7 'he observ tion th t hi$h turnover cou"d be either $ood or b d reinforces the point th t r tio comput tion is the st rtin$ point for fin nci " st tement n "ysis 44 not the fin " point7 =ut4of4"ine r tios re Ared f" $sB th t c "" for n e0p" n tion7 9ny r tio th t is too hi$h or too "o- needs to be e0 mined c"ose"y for its c uses7 'he quick nd de#t$to$equity ratios re used e0tensive"y by short4term creditors nd "on$4term creditors6 respective"y6 to ssess debtor>s "i+uidity nd debt structure7 9"thou$h -e re not concerned -ith bein$ p id on time by the supp"ier6 -e - nt re son b"e ssur nce th t the supp"ier c n disch r$e his fin nci " ob"i$ tions6 both short4term s -e"" s "on$4term6 nd -i"" not be forced into b n,ruptcy7 9s noted e r"ier6 the current r tio provides on"y rou$h me sure of the supp"ier>s short4term debt p yin$ bi"ity7 'he +uic, r tio is better test nd usu ""y is Hust s e si"y obt in b"e from the supp"ier>s b " nce sheet7 C sh nd c sh e+uiv "ents :m r,et b"e securities;6 p"us receiv b"es6 re fre+uent"y "isted sep r te"y mon$ the current ssets7 !or this purpose6 -e -ou"d be s tisfied -ith +uic, r tio of 170 or hi$her6 or t "e st e+u " to the industry norm7 'he de#t$to$equity ratio provides n indic tion of ho- he vi"y the supp"ier is in debt6 re" tive to the mount of c pit " provided by the o-ners7 'he hi$her the r tio6 the more concerned one shou"d be bout the "on$4term -e"f re of the supp"ier7 9s customer6 -e prob b"y -ou"dn>t be too concerned s "on$ s the supp"ier>s D/* r tio is "ess th n 100 percent6 -hich -ou"d indic te e+u " mounts of debt nd e+uity c pit "7
(0
Ho- -ou"d -e ssess 145 ! shions if it -ere potenti " supp"ier or r - m teri "s or component p rts inste d of direct m i" ret i"erP If -e - nt to est b"ish re" tionship -ith this comp ny nd re"y on it to m ,e time"y de"iveries of critic " items -e - nt to be sure it is in $ood fin nci " condition7 Ce h ve su$$ested four r tios th t shou"d be de+u te for this purpose2 the profit margin6 in%entory turno%er6 quick ratio nd de#t$to$equity ratio7 Bec use -e h ve c "cu" ted these r tios "re dy6 -e -i"" simp"y comment on them in the present conte0t7 Rec "" th t the profit margin - s be"o- ver $e for the type of comp ny invo"ved nd - s dec"inin$7 5oo,in$ t this me sure "one6 one mi$ht conc"ude th t the supp"ier -i"" soon be f cin$ serious fin nci " crisis7 Ho-ever6 the in%entory turno%er ratio - s on"y s"i$ht"y be"o- the industry ver $e nd does not sho- definite trend7 Sti""6 the inventory h s been turnin$ over on"y once every 80 d ys or so7 'his re" tive"y "o- turnover r tio ppe rs to be due prim ri"y to hi$her4th n4 ver $e "eve" of inventory s percent of tot " ssets7 'his cou"d be vie-ed s f vor b"e from our st ndpoint s customer6 since hi$h inventory "eve"s shou"d resu"t in fe-er b c, orders7 Ho-ever6 hi$h "eve"s of s"o- movin$ inventories reduce the "i+uidity of comp ny>s current ssets nd -or,in$ c pit "7 'he quick ratio of 7& times is subst nti ""y be"o- the industry ver $e 44 nd the $ener " benchm r, 44 of 170 times7 Since -e re customer in this c se6 -e re not concerned bout bein$ p id by this comp nyG but -e mi$ht -onder bout the comp ny>s bi"ity to disch r$e its short4term debts s they come due7 =n the other h nd6 the de#t$to$equity ratio of 73 times indic tes th t the comp ny is not hi$h"y "ever $ed nd sti"" h s f ir mount of fin nci " f"e0ibi"ity7 'he comp ny c n prob b"y obt in ddition " "on$4term funds to m ,e up for ne r4term shortf ""s7 So6 -hi"e the first three r tios indic te th t our potenti " supp"ier m y be f cin$ "i+uidity s+uee<e6 the " st indic tes th t the comp ny>s tot " debt position is re" tive"y so"id7 =n b " nce6 if this -ere one of "imited number of potenti " supp"iers of critic " m teri "s6 -e -ou"d find "itt"e difficu"ty in est b"ishin$ "on$4term commitments7 Ce b sed our ev "u tion of 145 ! shions so"e"y upon inform tion reported in its fin nci " st tements7 9"thou$h -e ttempted to ddress the +uestions from the st ndpoint of n insider m ,in$ se"f4ev "u tion6 -e c"e r"y do not h ve "" of the specific ,no-"ed$e th t is v i" b"e to m n $ement7 'hus6 -hi"e -e mi$ht h ve e0pressed concern bout the comp ny>s "i+uidity nd profit bi"ity44p rticu" r"y recent trends in these me sures44it is possib"e th t m n $ement h s everythin$ under contro"7 'he point of the i""ustr tion is th t m n $ers c n use r tio nd trend n "ysis to uncover d n$er si$ns nd to point to re s th t need ttention7

(#
ase 3B (hen sales decline6 !hat can I do to !eather the storm9 !or this c se6 there re t-o bro d +uestions to e0 mine2 :1; :2;
an I do anything to change it around9 $
5oo,in$ b c,6 did ny of m n $ement>s decisions c use the do-nturnP 5oo,in$ for- rd6 -h t c n m n $ement do to $et throu$h the s"ump6 nd -h t c n m n $ement do to reverse the s"umpP
In the previous c se6 fin nci " st tement n "ysis - s used to ns-er +uestion nd he"p m ,e decision7 !or this c se6 -e use fin nci " st tement n "ysis to he"p m n $e the crisis6 or point to sources for possib"e intervention7 Ch t c used s "es to $o do-nP =bvious"y6 e0tern " f ctors c n c use s "es s"umps7 Ho-ever6 it shou"d be e+u ""y obvious th t m n $ement>s decisions c n "so ffect s "es7 Chere do these sho- up in fin nci " st tement n "ysisP S "es returns2 9"thou$h not discussed bove6 if s "es returns s percent $e of s "es incre ses6 it cou"d be si$n of poor product +u "ity or $ener " customer diss tisf ction7 If product +u "ity diminishes6 you cou"d be "osin$ not Hust the current s "es6 but "so s "es -e"" into the future7 If you find th t you re sendin$ more r - m teri "s or products b c, to your supp"ier6 it cou"d me n th t too m ny inferior items re s"ippin$ throu$h6 nd the +u "ity of products you m ,e or se"" is sufferin$7 5ost s "es due to poor +u "ity products c n be very h rd to turn round7 .et profit m r$in2 Chi"e it>s "- ys nice to h ve hi$h net profit m r$in6 profit m r$in th t $ro-s too +uic,"y cou"d be si$n " th t some fin nci " corners h ve been cut7 !or e0 mp"e6 continuin$ -ith the s "es return discussion6 you cou"d s ve money by buyin$ che per $oods7 'his -ou"d sho- up s "o-er cost of $oods so"d6 nd hi$her m r$in7 Ho-ever6 che per $oods cou"d then resu"t in diss tisfied customers nd "ost s "es7 ?ou cou"d "so incre se the profit m r$in by cuttin$ dvertisin$ e0pense7 'his m y "so resu"t in "o-er s "es7 !in ""y6 hi$h profit m r$in cou"d be si$n th t prices re rtifici ""y hi$h7 9ccounts receiv b"e turnover2 It>s nice to h ve f st turnover of receiv b"es7 Ho-ever6 "i,e the profit m r$in6 turnover r tio th t ch n$es too dr m tic ""y or too f st6 cou"d be si$n " for "ost s "es7 Eotenti " s "es cou"d be "ost if your s "es instrument@s credit nd co""ection po"icy is too ti$ht7 !or e0 mp"e6 9meric n *0press re+uires the tot " b " nces on its ch r$e c rds to be p id upon receipt of the invoice7 9s resu"t of this po"icy6 some customers prefer to p y -ith Vis 6 -hich ""o-s periodic rep yment6 r ther th n -ith 9meric n *0press7 In 9meric n *0press> c se6 their rep yment po"icy mi$ht improve co""ections6 but it "so m y resu"t in "ost s "es7
5oo,in$ for- rd6 -h t c n m n $ement do to correct the dec"inin$ s "es p tternP =bvious"y6 the first t c, -ou"d be to fi0 ny prob"ems identified by the previous n "ysis7 Ho-ever6 if this yie"ds "itt"e he"p6 there re other thin$s m n $ement c n do7 Inventory turnover2 'his is perh ps the most import nt r tio to monitor -hen s "es dec"ine7 By effective"y m n $in$ inventory "eve"s6 m n $er c n minimi<e the cost of "o-er s "es7 Bec use it costs money to buy nd ho"d inventory6 m int inin$ or incre sin$ inventory turnover :by buyin$ "ess nd "ettin$ the stoc,
(2
run do-n; c n s ve money nd prevent "osses7 ase 4B I can:t pay my #ills on time" (hat should I do first9 9s in C se 26 -e c n "oo, to the fin nci " st tements for c uses nd cures7 ?ou m y h ve "i+uidity prob"em if the current nd +uic, r tios re too "o-7 'he c uses of c sh f"o- prob"ems inc"ude2 dec"inin$ s "es6 poor pricin$6 poor ccounts receiv b"e turnover nd poor inventory turnover7 Eoor inventory turnover "so me ns you re buyin$ inventory6 but th t inventory isn>t se""in$ +uic,"y enou$h7 .et profit m r$in2 5oo,in$ t the net profit m r$in c n $ive you insi$hts on -hether or not the product is priced de+u te"y to cover overhe d e0penses7 In the 145 ! shions c se6 s "es -ere incre sin$6 but the profit m r$in - s decre sin$7 If the product is priced too "o-6 then s "es revenues m y not be sufficient to cover "" of the other oper tin$ e0penses6 "i,e dvertisin$6 s " ries6 etc7 Inventory turnover2 *ven sm "" ch n$es in turnover r tios c n h ve si$nific nt imp ct on the e rnin$s of comp ny7 !or e0 mp"e6 in the 145 ! shions i""ustr tion6 inventory turned over every 817& d ys7 If 145 ! shions cou"d reduce inventory nd reduce turnover to the industry ver $e of (2 d ys6 then ver $e inventory -ou"d dec"ine to O(0#682& M(2 d ys 0 O36&(370(0 :cost of $oods;/33& d ys J O(0#682&N from O()(68307 'h t mounts to O)3603& th t cou"d be invested e"se-here nd s ve O)630# in interest costs :usin$ 10 percent interest r te;7 9ccounts p y b"e turnover2 Simi" r"y6 the ccounts p y b"e turnover is present"y 33 d ys7 If 145 ! shions s"o-s p yment do-n by Hust one d y6 ver $e ccounts p y b"e -ou"d rise to O3216()) M3# d ys 0 O36#&#6310 :purch ses;/33& J O3216())N from O31160307 'he difference of O106(3) tr ns" tes into O160(# interest s vin$s7
'o improve c sh f"o- from receiv b"es -ithout dHustin$ your credit or co""ection po"icy6 consider borro-in$ $ inst the receiv b"es throu$h n ssi$nment or f ctorin$ rr n$ement7

((
Figure 9+ Summary "a-le o$ Financial Ratios Ratio >wners( Return on Investment :R=I; Formula .et Income 9ver $e =-ners> *+uity /&at it measures Return on o-ners> c pit " Chen comp red -ith return on ssets6 it me sures the e0tent to -hich fin nci " "ever $e is bein$ used for or $ inst the o-ner7 Ho- -e"" ssets h ve been emp"oyed by m n $ement7 =per tin$ efficiency7 'he bi"ity to cre te sufficient profits from oper tin$ ctivities7 Re" tive efficiency in usin$ tot " resources to product output7 * rnin$ po-er on "" ssetsG R=9 r tio bro,en into its "o$ic " p rts2 turnover nd m r$in 7 5i+uidity of receiv b"es in terms of ver $e number of d ys receiv b"es re outst ndin$7 /&at it tells you Ho- -e"" is this comp ny doin$ s n investmentP
Return on 9ssets :R=9; %anagers( .et Erofit % r$in
.et Income 9ver $e 'ot " 9ssets .et Income S "es
Ho- -e"" h s m n $ement emp"oyed comp ny ssetsP Does it p y to borro-P 9re profits hi$h enou$h6 $iven the "eve" of s "esP
9sset 'urnover
S "es 9ver $e 'ot " 9ssets .et Income 0 S "es S "es 'ot " 9ssets
Ho- -e"" re ssets bein$ used to $ener te s "es revenueP Ho- -e"" h s m n $ement emp"oyed comp ny ssetsP
Return on 9ssets
9ver $e Co""ection Eeriod
9ver $e 9/R 0 33& 9nnu " Credit S "es
9re receiv b"es comin$ in too s"o-"yP
Inventory 'urnover
Cost of Doods So"d *0pense 9ver $e Inventory
5i+uidity of inventoryG the Is too much c sh tied up number of times it turns in inventoriesP over per ye r7

(4
9ver $e 9$e of E y b"es S&ort2"erm Creditors Cor,in$ C pit "
9ver $e 9/E 0 33& .et Eurch ses
9ppro0im te "en$th of time firm t ,es to p y its bi""s for tr de purch ses7 Short4term debt4p yin$ bi"ity7
Ho- +uic,"y does prospective customer p y its bi""sP Does this customer h ve sufficient c sh or other "i+uid ssets to cover its short4term ob"i$ tionsP Does this customer h ve sufficient c sh or other "i+uid ssets to cover its short4term ob"i$ tionsP Does this customer h ve sufficient c sh or other "i+uid ssets to cover its short4term ob"i$ tionsP Is the comp ny>s debt "o d e0cessiveP
Current 9ssets / Current 5i bi"ities
Current R tio
Current 9ssets Current 5i bi"ities
Short4term debt4p yin$ bi"ity -ithout re$ rd to the "i+uidity of current ssets7 Short4term debt4p yin$ bi"ity -ithout h vin$ to re"y on s "e of inventory7 9mount of ssets provided by creditors for e ch do"" r of ssets provided by o-ner:s;
Iuic, R tio
C shK%,tb"e Sec7K9/R Current 5i bi"ities
,ong2"erm Creditors( Debt4to4*+uity R tio 'imes Interest * rned
'ot " Debt 'ot " *+uity
.et IncomeK:InterestK' 0es; 9bi"ity to p y fi0ed Interest *0pense ch r$es for interest from oper tin$ profits7
9re e rnin$s nd c sh f"o-s sufficient to cover interest p yments nd some princip " rep ymentsP 9re e rnin$s nd c sh f"o-s sufficient to cover interest p yments nd some princip " rep yments
C sh !"o- to 5i bi"ities =per tin$ C sh !"o'ot " 5i bi"ities
'ot " debt cover $e7 Dener " debt4p yin$ bi"ity7

()
Figure ?+ 72, Fas&ions' #nc+ Financial Statements #ncome Statement For t&e year ended @anuary 49( Dollars in t&ousands! .et S "es Cost of Doods Dross Erofit Se""in$6 Dener " nd 9dministr tive *0penses :inc"udin$ depreci tion; Income from =per tions =ther Income :e0penses;2 Interest nd other income Interest *0pense Income Before Income ' 0es Income ' 0 Erovision .et Income As a Percentage o$ Sales! .et S "es Cost of Doods Dross Erofit Se""in$6 Dener " nd 9dministr tive *0penses :inc"udin$ depreci tion; Income from =per tions =ther Income :e0penses;2 Interest nd other income Interest *0pense Income Before Income ' 0es Income ' 0 Erovision .et Income ?<<6 O3603)6(&0 36&(360(0 26#336380 262216&#0 2#&61#0 1#6#(0 :106180; 2#)6#30 1026000 O1#(6#30 10070U &)72 #078 3378 #70 73 :72; #71 17( 27#U ?<<A O&6#&26010 3613&6(30 263136280 168#)6100 #3(6180 1)6&10 :136))0; #(26(00 1816))0 O2)06(10 10070U &(7& #27& 337) 873 7# :73; 87( 37# &73U ?<<4 O#6&&86030 263136(10 16)#163&0 16#3#6830 &036#)0 2(62&0 :126320; &216#20 1)86300 O3226820 10070U &(7# #273 317& 1171 73 :73; 117# #73 (71U ?<<? O363326)10 16)036#80 16#&)6#30 160(36))0 3826##0 1#6#10 :136&(0; 3836280 1326080 O2216200 10070U &373 #37# 3270 117# 7# :7#; 117# #78 373U

($
Figure ?+ Cont+! 72, Fas&ions' #nc+ Financial Statements Balance S&eet @anuary 49( Dollars in t&ousands! 9ssets Current 9ssets2 C sh nd C sh *+uiv "ents Receiv b"es Inventory Erep id *0penses 'ot " Current 9ssets Eroperty6 E" nt Q *+uipment : t cost;2 5 nd nd Bui"din$s !i0tures nd e+uipment 5e seho"d improvements Construction in pro$ress 5ess 9ccumu" ted Depreci tion Eroperty6 E" nt Q *+uipment6 net 'ot " 9ssets 5i bi"ities nd Stoc,ho"ders> *+uity Current 5i bi"ities2 9ccounts E y b"e 9dv nce E yment on =rders Income ' 0es E y b"e =ther Current =b"i$ tions 'ot " Current 5i bi"ities 5on$4'erm Debt Stoc,ho"ders> *+uity2 Common Stoc,G 2071%6 2071% Q2070% Sh res6 respective"y6 t p r 9ddition " C pit "6 net Ret ined * rnin$s 5ess 're sury Stoc,6 t cost 'ot " Stoc,ho"ders> *+uity 'ot " 5i bi"ities nd *+uity ?<<6 O2(263#0 1260)0 (386330 &#6880 160(862#0 &3162(0 #(36#30 136#30 4444 :2#86#30; ((&6(30 O168&#6000 ?<<A O826&#0 36#80 8&(60)0 &#6030 ))(61#0 38363&0 #116230 1&6120 #363(0 :18368)0; 3(26180 O1633)6320 ?<<4 O32163)0 (6&&0 3386200 3)63(0 160336810 31263(0 2&16)20 1263#0 326800 :13&6020; #(#6(10 O16&116&20 ?<<? O2816(&0 26(#0 #3#6##0 336330 (826&30 1&161#0 21)6(#0 )6080 36(#0 :))6#(0; 28(6230 O1603)6()0
O3((6)(0 #6#30 (06800 1&#6&10 30(6(#0 (86000
O2##61&0 26030 &36020 13)6)&0 #3)61&0 8#6130
O2&)60#0 36&00 1036)(0 1#86()0 &1&6300 (36(#0
O2126223 #6&30 &36)#0 11(6)00 3886300 8363(0
26010 26010 3116330 30(6810 )836810 8(&6130 :1286)20; :386)#0; 161386230 161#360#0 O168&#6000 O1633)6320
26000 2)36080 32#6#00 4444 )1)6#80 O16&116&20
26000 2236080 3#16333 4444 &336(#0 O1603)6()0

(*
Figure ?+ 72, Fas&ions' #nc+ Financial Statements Statement o$ Cas& Flows %aBor component totals only! For t&e year ended @anuary 49( Dollars in t&ousands! ?<<6 .et c sh f"o-s from oper tin$ ctivities .et c sh f"o-s from investin$ ctivities .et c sh f"o-s from fin ncin$ ctivities .et incre se :decre se; In c sh nd c sh e+uiv "ents O &126020 :1(&6#10; :1#36&10; O 1)06100 ?<<A O )&6200 :2&06&30; : 836#)0; O:23868&0; ?<<4 O 2&&6300 :22363)0; 106(30 O3)63#0 ?<<9 O 21(6030 :&26310; :#362)0; O1216#30

(&
Additional Readings
'hese re din$s re intended to ccomp ny A!in nci " St tements s % n $ement 'oo"B6 n rtic"e from the Sm "" Business !orum6 nd re intended to supp"ement6 not contr dict or "ter the inform tion cont ined in the Sm "" Business !orum rtic"e7 17 Fnco""ectib"e .otes nd Receiv b"es %ost ret i" comp nies : nd some service comp nies s -e""; m ,e " r$e portion of their s "es on ccount r ther th n for c sh7 Sometimes6 -hen customer f ""s behind in the p yment of their ch r$es6 they m y s, for note to $ive them "on$er time to rep y the debt7 Chether these unp id ccounts re he"d s receiv b"es or s notes6 they need to be ccounted for nd eventu ""y discounted7 'here re t-o methods of ccountin$ for receiv b"es th t re thou$ht to be unco""ectib"e7 'he allo!ance method provides in dv nce for them6 nd the direct !rite$off (or charge$off) method reco$ni<es the e0pense on"y -hen cert in ccounts re Hud$ed unco""ectib"e7 'he oper tin$ e0pense incurred bec use of the f i"ure to co""ect is c ""ed n e0pense or "oss from uncollecti#le accounts (or notes)6 dou#tful accounts6 or #ad de#ts7 %ost " r$e businesses estim te the current unco""ectib"e portion of their tr de receiv b"es nd use the ""o- nce method7 'he provision for these future unco""ectib"es is m de by n dHustin$ entry t the end of e ch fisc " period7 '-o ccounts re c rried on the boo,s to ""o- this dHustment7 'here is debit to Fnco""ectib"e 9ccounts *0pense nd m tchin$ credit to 9""o- nce for Doubtfu" 9ccounts7 'he unco""ectib"e ccounts e0pense is then reported on the income st tement s n dministr tive e0pense6 nd t the end of the fisc " period6 the b " nce in the Fnco""ectib"e 9ccounts *0pense is c"osed to Income Summ ry7 Chen comp ny se""s most of its $oods or services on c sh b sis6 the mount of its receiv b"es is "i,e"y to represent on"y sm "" portion of its current ssets6 nd the unco""ectib"es ccounts is sm "" in re" tion to revenue7 'herefore it is ccept b"e to de" y reco$nition of the b d debt unti" the ccount is ctu ""y deemed -orth"ess7 In these c ses6 simp"e direct -rite4off is used7 'he Fnco""ectib"e 9ccounts *0pense is debited6 nd 9ccounts Receiv b"e is credited7 Since 9ccounts Receiv b"e is p rt of current ssets6 nd therefore p rt of m ny r tios used to Hud$e the he "th of the comp ny6 it is import nt to m int in c"ose supervision of unco""ectib"e ccounts7 27 C sh !"o-s 'he comp rison of c sh f"o- st tements6 over period of time6 offers more re "istic me surement too" th n ccountin$ profits7 It is on"y c sh f"o- th t the comp ny ctu ""y receives th t c n be reinvested7 9ccountin$ profits re sho-n -hen they re e rned r ther th n -hen the money is ctu ""y in h nd7 'herefore6 c sh f"o-s more correct"y ref"ect the true timin$ of benefits nd costs7 C sh f"o-s re $ener ""y divided into three m in c te$ories2 :1; c sh f"o- from oper tions6 :2; investments m de by the comp ny6 nd :3; fin ncin$ tr ns ctions6 such s stoc, issue or the c+uirin$ of debt7 'he d t needed to construct c sh f"o- st tement come from the be$innin$ nd endin$ b " nce sheets of n ccountin$ period nd the correspondin$ income st tement t the end of the s me period7 :9 s mp"e c sh f"o- st tement is inc"uded s !i$ure #7;

(+
37 C pit " Re+uirements =ne of the methods to determine the impendin$ need for c pit " is to e0 mine the C sh !"o- EroHection -ith the ssumption th t there h s been no c pit " inHection t this time7 'he proHected c sh f"o- st tements must be c refu""y comp"eted nd inc"ude 955 c sh needsG such s -or,in$ c pit "6 "" fi0ed ssets6 nd inventory incre ses7 If c pit " need e0ists6 the end of the period c sh b " nces -i"" dec"ine continuous"y unti" the bre ,4 even point is re ched nd the endin$ c sh b " nce be$ins to c"imb7 By this method6 the c pit " needed is n mount -hich e+u "s or e0ceeds the "o-est c sh b " nce in the proHections7 If this mount is invested s e+uity6 the mount st nds7 If the mount is received s debt6 the tot " must be incre sed to ref"ect the c sh re+uired for "o n interest nd princip " p yment7 If there is "re dy some c sh on h nd nd more c n be $ener ted effective"y by intern " me nsG such s inventory reduction nd cce"er tion of ccounts receiv b"e co""ection6 then the outside c pit " re+uirement m y be reduced7 #7 Sources of Industry St nd rds Dun Q Br dstreet6 Inc7 is -ide"y4,no-n nd used source of industry ver $e r tios7 DQB provides fourteen r tios c "cu" ted for " r$e number of industries7 'he comp"ete inform tion inc"udes the fourteen r tios6 -ith the inter+u rti"e r n$es6 for 12& "ines of business ctivity b sed on their fin nci " st tements7 'he 12& types of business ctivity consist of (1 m nuf cturin$ nd construction c te$ories6 30 c te$ories of -ho"es "ers6 nd 2# c te$ories of ret i"ers7 9nother $roup of usefu" r tios c n be found in the nnu " St tement Studies compi"ed nd pub"ished by Robert %orris 9ssoci tes6 -hich is the n tion " ssoci tion of b n, "o n officers7 'hese re represent tive ver $es b sed on fin nci " st tements received by b n,s in connection -ith "o ns m de7 *"even r tios re computed for 1&3 "ines of business7 'he !eder " 'r de Commission :!'C; pub"ishes +u rter"y fin nci " d t on m nuf cturin$ comp nies7 Both b " nce sheet nd income st tement d t re deve"oped from system tic s mp"e of corpor tions7 'he reports re pub"ished perh ps si0 months fter the fin nci " d t h ve been m de v i" b"e by the comp nies7 'hey inc"ude n n "ysis by industry $roups nd by sset si<e nd fin nci " st tements in r tio form :or common4si<e n "ysis; s -e""7 'he !'C reports re rich source of inform tion nd re fre+uent"y used for comp r tive purposes7 Credit dep rtments of individu " firms compi"e fin nci " r tios nd ver $es on their :1; customers in order to Hud$e their bi"ity to meet ob"i$ tions nd :2; supp"iers in order to ev "u te their fin nci " bi"ity to fu"fi"" contr cts7 'he !irst . tion " B n, of Chic $o6 for inst nce6 compi"es semi nnu " reports on the fin nci " d t for fin nce comp nies7 'he .CR6 Inc7 $ thers d t for " r$e number of business "ines7 !in nci " r tios for m ny industries re compi"ed by tr de ssoci tions nd constitute n import nt source to be chec,ed by fin nci " m n $er see,in$ comp r tive d t 7 'hese ver $es re usu ""y the best obt in b"e7 In ddition to b " nce sheet d t 6 they provide det i"ed inform tion on oper tin$ e0penses6 -hich m ,es possib"e n informed n "ysis of the efficiency of the firms7

40
&7 5imit tion to R tio 9n "ysis 9"thou$h r tios re e0ception ""y usefu" too"s6 they do h ve "imit tions nd must be used -ith c ution7 R tios re constructed from ccountin$ d t 6 nd ccountin$ d t re subHect to different interpret tions nd even to m nipu" tion7 !or e0 mp"e6 t-o firms m y use different depreci tion methods or inventory v "u tion methods6 nd dependin$ on the procedures fo""o-ed6 reported profits c n be r ised or "o-ered7 Simi" r differences c n be encountered in the tre tment of rese rch nd deve"opment e0penditures6 pension p" n costs6 mer$ers6 product - rr nties6 nd b d4debt reserves7 !urther6 if firms use different fisc " ye rs6 nd if se son " f ctors re import nt6 this c n inf"uence the comp r tive r tios7 'hus6 if the r tios of t-o firms re to be comp red6 it is import nt to n "y<e the b sic ccountin$ d t upon -hich the r tios -ere b sed nd to reconci"e ny m Hor differences7 9 fin nci " m n $er must "so be c utious -hen Hud$in$ -hether p rticu" r r tio is A$oodB or Ab dB nd in formin$ composite Hud$ment bout firm on the b sis of set of r tios7 !or e0 mp"e6 hi$h inventory turnover r tio cou"d indic te efficient inventory m n $ement6 but it cou"d "so indic te serious short $e of inventories nd su$$est the "i,e"ihood of stoc,4outs7 !urther6 there is nothin$ s cred bout the industry ver $e fi$ures44 fter ""6 ny m n $ement -orth its s "t -i"" try to be better th n ver $e7 R tios6 then6 re e0treme"y usefu" too"s7 But s -ith other n "ytic " methods6 they must be used -ith Hud$ment nd c ution6 not in n unthin,in$6 mech nic " m nner7 37 Bre ,4*ven 9n "ysis4Do"" r S "es C "cu" tin$ bre ,4even points on the b sis of do"" r s "es inste d of on units of output is fre+uent"y usefu"7 'he m in dv nt $e of this method6 is th t it en b"es one to determine $ener " bre ,4even point for firm th t se""s m ny products t v ryin$ prices7 !urthermore6 the procedure re+uires minimum of d t 7 =n"y three v "ues re needed2 s "es6 fi0ed costs6 nd v ri b"e costs7 S "es nd tot "4cost d t re re di"y v i" b"e from nnu " reports of corpor tions nd from investment m nu "s7 'ot " costs must then be se$re$ ted into fi0ed nd v ri b"e components7 'he m Hor fi0ed ch r$es :rent6 interest6 depreci tion6 nd $ener " nd dministr tive e0penses; m y be t ,en from the income st tement7 !in ""y6 v ri b"e costs re c "cu" ted by deductin$ fi0ed costs from tot " costs7 Bre ,4even occurs -hen the contribution m r$in e+u "s fi0ed costs7 Contribution m r$in is c "cu" ted by subtr ctin$ v ri b"e costs from tot " s "es7 M9 formu" for the bre ,4even point in terms of s "es do"" rs needed is2 s C $c D 9 2 vc D s! or $c D gp 44 st ted s percent of s "esG -here sJs "es6 $cJfi0ed costs6 vcJv ri b"e costs6 nd gpJ$ross profitN In business termino"o$y6 hi$h de$ree of "ever $e imp"ies th t re" tive"y sm "" ch n$e in s "es resu"ts in " r$e ch n$e in profits7 Ce c n divide "ever $e into t-o c te$ories2 fin nci " "ever $e nd oper tin$ "ever $e7 'he si$nific nce of the de$ree of oper tin$ "ever $e is c"e r"y i""ustr ted by !i$ure 37 'hree firms6 96 B6 nd C6 -ith differin$ de$rees of "ever $e6 re contr sted7 !irm 9 h s re" tive"y sm "" mount of fi0ed ch r$es44it does not h ve much utom ted e+uipment6 so its depreci tion cost is "o-7 .ote6 ho-ever6 th t 9>s v ri b"e cost "ine h s re" tive"y steep s"ope6 denotin$ th t its v ri b"e costs per unit re hi$her th n those of the other firms7 !irm B is considered to h ve norm " mount of fi0ed costs in its oper tions7 It uses utom ted e+uipment :-ith -hich one oper tor c n turn out fe- or m ny units t the s me " bor cost; to bout the s me e0tent s the ver $e firm in the industry7 !irm B bre ,s even t hi$her "eve" of oper tions th n does firm 97 9t production "eve" of #06000 units6 B is "osin$ O86000 but 9 bre ,s even7 =n the other h nd6 firm C h s the hi$hest fi0ed costs7 It is hi$h"y utom ted6 usin$ e0pensive6 hi$h4speed
4#
m chines th t re+uire very "itt"e " bor per unit produced7 Cith such n oper tion6 its v ri b"e costs rise s"o-"y7 Bec use of the hi$h overhe d resu"tin$ from ch r$es ssoci ted -ith the e0pensive m chinery6 firm C>s bre ,4 even point is hi$her th n th t for either firm 9 or firm B7 =nce firm C re ches its bre ,4even point6 ho-ever6 its profits rise f ster th n do those of the other firms7 (7 5imit tion of Bre ,4even 9n "ysis Bre ,4even n "ysis is usefu" in studyin$ the re" tions mon$ vo"ume6 prices6 nd costsG it is thus he"pfu" in pricin$6 cost contro"6 nd decisions bout "tern tive e0p nsion pro$r ms7 It h s "imit tions6 ho-ever6 s $uide to m n $eri " ctions7 5ine r bre ,4even n "ysis is especi ""y -e , in -h t it imp"ies bout the s "es possibi"ities for the firm7 9ny "ine r bre ,4even ch rt is b sed on const nt s "es price7 'herefore6 in order to study profit possibi"ities under different prices6 -ho"e series of ch rts is necess ry6 one ch rt for e ch price7 Cith re$ rd to costs6 bre ,4even n "ysis is "so deficient44the re" tions indic ted by the ch rt do not ho"d t "" outputs7 9s s "es incre se6 e0istin$ p" nt nd e+uipment re -or,ed to c p cityG both this situ tion nd the use of ddition " -or,ers nd overtime p y c use v ri b"e costs to rise sh rp"y7 9ddition " e+uipment nd p" nt sp ce re re+uired6 thus incre sin$ fi0ed costs7 !in ""y6 over period 6the products so"d by the firm ch n$e in +u "ity nd +u ntity7 Such ch n$es in product mi0 inf"uence the "eve" nd s"ope of the cost function7 5ine r bre ,4even n "ysis is usefu" s first step in deve"opin$ the b sic d t re+uired for pricin$ nd for fin nci " decisions7 But more det i"ed n "ysis is re+uired before fin " Hud$ments c n be m de7

42
2#0 200 130 120 80 #0 0 30 80 Fnits :&; Income nd Costs 2#0 200 130 120 80 #0 0 20 2#0 200 130 120 80 Income #0 30 80 Income 20 #0 Income
!irm 9 Se""in$ Erice J O2700 !i0ed Costs J O206000 V ri b"e Costs JO17&0 & Fnits so"d:I; 'ot " costs Bre ,4even point !i0ed costs 100 120 206000 #06000 306000 806000 1006000 1206000 O #06000 806000 1206000 1306000 2006000 2#06000 S "es
F#GER) 4+
Costs O &06000 806000 1106000 1#06000 1(06000 2006000
Erofit 4O106000 0 106000 206000 306000 #06000
!irm B Se""in$ Erice J O2700 !i0ed Costs J O#06000 V ri b"e Costs JO1720 & Fnits so"d:I; S "es O #06000 806000 1206000 1306000 2006000 2#06000 Costs O 3#6000 886000 1126000 1336000 1306000 18#6000 Erofit 4O2#6000 4 86000 86000 2#6000 #06000 &36000
'ot " costs Bre ,4even point !i0ed costs 100 120 Se""in$ Erice J O2700 !i0ed Costs J O306000 V ri b"e Costs JO1700 & Fnits so"d:I; 'ot " costs Bre ,4even point !i0ed costs 206000 S "es Costs Erofit 206000 0 206000 #06000 306000 206000 #06000 306000 806000 1006000 1206000
!irm C
#0 0 20 #0 30 80 100 120
O #06000 O 806000 4O#06000 #06000 806000 1006000 4 306000 1206000 1206000 806000 1306000 1#06000 1006000 2006000 1306000 1206000 2#06000 1806000

4(
Figure A+ 2 Sample Cas& Flow Statement wit&out num-ers!( Cas& $lows $rom operations C sh inf"o-s received from customers .et s "es 5ess ch n$e in ccounts receiv b"e C sh inf"o-s received from customers C sh p id to supp"iers Cost of $oods so"d E"us ch n$e in inventory 5ess ch n$e in ccounts p y b"e C sh p id to supp"iers =ther oper tin$ c sh outf"o-s nd interest p yments % r,etin$ e0penses Dener " nd dministr tive e0penses 5ess ch n$e in ccrued e0penses Interest e0pense 5ess ch n$e in interest p y b"e =ther oper tin$ c sh outf"o-s nd interest p yments C sh t 0 p yments Erovision for t 0es in the income st tement 5ess ch n$e in ccrued t 0es C sh t 0 p yments "otal cas& $lows $rom operations Cas& $lows 222 investment activities O 006000 Eurch se of fi0ed ssets Eurch se of other current ssets Eurch se of p tents Net cas& used $or investments Cas& $lows 222 $inancing activities O 006000 Eroceeds from "on$4term debt Common stoc, dividends Net cas& provided used! -y $inancing activities "otal cas& $lows c&ange in cas& in -alance s&eets! 4 006000 O 006000 O 06000 V00 V06000 O0006000 O0006000 4 06000 O0006000 O0006000 V06000 4 006000 O0006000 O 006000 V06000 4 000 V06000 4 000 O0006000 O 006000 4 06000 O 006000 O 006000

44
Conclusion
Compi"in$6 n "y<in$6 nd underst ndin$ fin nci " st tements provides business o-ners one of the most import nt too"s for reducin$ the consider b"e ris, invo"ved in st rtin$ nd $ro-in$ business7 'he comp rison of fin nci " r tios to industry st nd rds is6 perh ps6 one of the best uses of fin nci " inform tion6 s it ""o-s the business o-ner to comp re the perform nce of his or her business -ith other "i,e businesses7 In ddition to providin$ inform tion to o-ners critic " for their o-n decision m ,in$6 the ccur cy of fin nci " st tements -i"" imp ct the business> t 0 ob"i$ tions nd opportunities to obt in e+uity nd/or debt fin ncin$7 C refu" record ,eepin$ "e ds to ccur te fin nci " st tements6 thereby reducin$ the business> t 0 burden7 Business o-ners h ve the opportunity to comp re their fin nci " r tios -ith industry st nd rds before pp"yin$ for "o ns6 thereby $ivin$ them the opportunity to correct ny prob"ems th t cou"d "e d to the reHection of their business "o n pp"ic tion or e+uity offerin$7

4)
Sources o$ Financial Analysis #n$ormation

Inform tion from SB9 on underst ndin$ fin nci " st tements7 Inc"udes SB9>s temp" tes7 http2//---7sb 7$ov/m n $in$/fin ncin$/st tement7htm" )he Interpretation of Financial Statements6 BenH min =7 Dr h m6 Spencer B7 %eredith7 )he .nalysis and 7se of Financial Statements6 Der "d I7 Chite6 9sh-inp u" C7 Sondhi6 H im D7 !ried7 Securities nd *0ch n$e Commission2 sec7$ov/ed$ r7htm" !in nci " nd =per tin$ Resu"ts of Dep rtment nd Speci "ty Stores6 pub"ished by the . tion " Ret i" %erch nts 9ssoci tion7 'his is n nnu " "ist of det i"ed fin nci " inform tion7 St nd rd nd Eoor>s industry reports for fee2 st nd rd ndpoors7com is7 Some co""e$es nd universities m y h ve subscription7 . tion " Venture C pit " 9ssoci tion nvc 7or$ Securitiesd t 7com Ero+uest Direct V "ue 5ine Investment Survey =ffici " Duide to 9meric n Incomes Consumer *0penditure Survey !eder " Reserve Bu""etin Intern tion " !in nci " St tistics B"oomber$ D t b se *conomy7com h s "in,s to ne r"y mi""ion sources of economic nd fin nci " d t on industries6 consumers6 nd $overnment st tistics7 economy7com/free"unch/ 9ctive %oney6 provided by the Co"umbus *nterprise Deve"opment Corpor tion7 9ctive %oney t ,es one throu$h the process of bui"din$ fin nci " proHections in c"e r nd simp"e - y7cedcorp7com/ ctivemoney/st rtWcd7htm entre-or"d is the 1 uffm n Center for *ntrepreneuri " 5e dership6 -hich provides v riety of resources6 inc"udin$ the fin nci " benchm r,in$ system t 7businesse,$7com
4$
Er tt>s Duide to Venture C pit " Sources is pub"ished by Venture *conomics7 'his is "ist of venture c pit " comp nies6 "on$ -ith their investment criteri nd re s of focus7 b n,r te7com provides inform tion on b n, "endin$6 current r tes nd credit c rds7 too",it7cch7com is the Commerce C"e rin$ House6 -hich provides mode" spre dsheets6 s mp"e business p" ns6 reports6 nd "e$ " nd t 0 inform tion7 moneyhunter7com Dun Q Br dstreet2 http2//---7dnb7com/us/ nd http2//sm ""business7dnb7com/ R%9 :Ris, % n $ement 9ssoci tion; 9nnu " St tement Studies http2//---7rm h+7or$/ Studyfin nce7com provides free6 se"f4p ced tutori " on b sic fin nci " st tements7 It introduces b sic fin nci " st tements nd fin nci " st tement concepts7 Comen>s Business Deve"opment Center tutori "6 Fnderst ndin$ B sic !in nci " St tements http2//---7on"ine-bc7$ov/docs/fin nce/fsWintro7htm" 9meric n *0press2 http2//home37 meric ne0press7com/sm ""business/5 ndin$/informyourdecisions7 spP openWhomeJinformbhe dQopenWpthomeJ rtdiscW$button Intern " Revenue Service2 Inc"udes n on"ine c" ssroom for their Sm "" Business ' 0 Cor,shop http2//---7irs7$ov/businesses/sm ""/inde07htm" IRS Sm "" Business ' 0 Cor,shop "oc tions in !"orid 2 http2//---7irs7$ov/businesses/sm ""/ rtic"e/066idJ))&#(6007htm"

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Financial Statement Analysis For Small Businesses

Copyright 2004 Florida Small Business Development Center Network

Copyright 2004 Florida Small Business Development Center Network

#mportance o$ Financial Statements

Copyright 2004 Florida Small Business Development Center Network

Collecting and %anaging Data

"&e #ncome Statement

"&e Balance S&eet

Copyright 2004 Florida Small Business Development Center Network

Copyright 2004 Florida Small Business Development Center Network

Statement o$ Cas& Flows

Notes to Financial Statements

7ey "erms and Concepts

Accrual Basis o$ Accounting

Cas& Basis o$ Accounting

Negative Cas& Flow

Copyright 2004 Florida Small Business Development Center Network

Financial Statements as a %anagement "ool

Copyright 2004 Florida Small Business Development Center Network

"&ree Case Studies

Copyright 2004 Florida Small Business Development Center Network

an I do anything to change it around9 $

Copyright 2004 Florida Small Business Development Center Network

Return on 9ssets :R=9; %anagers( .et Erofit % r$in

.et Income 9ver $e 'ot " 9ssets .et Income S "es

9ver $e Co""ection Eeriod

9ver $e 9/R 0 33& 9nnu " Credit S "es

9re receiv b"es comin$ in too s"o-"yP

Cost of Doods So"d *0pense 9ver $e Inventory

Copyright 2004 Florida Small Business Development Center Network

9ver $e 9$e of E y b"es S&ort2"erm Creditors Cor,in$ C pit "

9ver $e 9/E 0 33& .et Eurch ses

Current 9ssets / Current 5i bi"ities

Current 9ssets Current 5i bi"ities

C shK%,tb"e Sec7K9/R Current 5i bi"ities

,ong2"erm Creditors( Debt4to4*+uity R tio 'imes Interest * rned

'ot " Debt 'ot " *+uity

C sh !"o- to 5i bi"ities =per tin$ C sh !"o'ot " 5i bi"ities

Copyright 2004 Florida Small Business Development Center Network

Copyright 2004 Florida Small Business Development Center Network

O3((6)(0 #6#30 (06800 1&#6&10 30(6(#0 (86000

O2##61&0 26030 &36020 13)6)&0 #3)61&0 8#6130

O2&)60#0 36&00 1036)(0 1#86()0 &1&6300 (36(#0

O2126223 #6&30 &36)#0 11(6)00 3886300 8363(0

26000 2)36080 32#6#00 4444 )1)6#80 O16&116&20

26000 2236080 3#16333 4444 &336(#0 O1603)6()0

Copyright 2004 Florida Small Business Development Center Network

Copyright 2004 Florida Small Business Development Center Network

Copyright 2004 Florida Small Business Development Center Network

Copyright 2004 Florida Small Business Development Center Network

Copyright 2004 Florida Small Business Development Center Network

Costs O &06000 806000 1106000 1#06000 1(06000 2006000

Erofit 4O106000 0 106000 206000 306000 #06000

Copyright 2004 Florida Small Business Development Center Network

Copyright 2004 Florida Small Business Development Center Network

Copyright 2004 Florida Small Business Development Center Network

Sources o$ Financial Analysis #n$ormation

Copyright 2004 Florida Small Business Development Center Network

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,ong2"erm Creditors( Debt4to4+uity R tio 'imes Interest rned