Catching Up with Running Ratios

Transcription

1 Catching Up with Running Ratios Laurie Watje, CPA University of Northern Iowa John Pappajohn Entrepreneurial Center

2 Who is Laurie? Manager Student Business Incubator at UNI CPA Former business owner The Office Stop, Carroll, IA Former office manager of a small business Party Time Fundraising, Carroll, IA Assists small business owners with Quick Books, payroll and year-end taxes

3 Review of Financial Statements Balance Sheet Assets = Liabilities + Owner s Equity Financial picture taken at a specific time Income Statement Reports success or failure of a company for a specific time period Cash Flow Tracks money coming in and going out of a business

4 Three Methods of Analyzing Financial Statements Vertical analysis Horizontal analysis Ratio analysis

5 Managing Numbers Financial Statement Analysis Vertical Analysis Items on Income Statement are expressed as a % of net sales. Items on Balance Sheet are expressed as a % of total assets. Ability to spot trends or changes. Ability to examine trends and comparing to current month s budget or historical figures.

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7 Managing Numbers Financial Statement Analysis (cont) Horizontal Analysis Current year Prior Year Prior Year This calculation allows the entrepreneur to note trends by comparing the percentage increases and/or decreases year to year to budget or historical and take appropriate action if necessary.

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9 Ratio analysis Ratio Analysis Determines the health of a business, especially as that business compares to other firms in the same industry or similar industries. Ratio a relationship between two variables, expressed as a fraction.

10 Managing Numbers Ratio Analysis Liquidity Ratios Measure company s short-term ability to pay maturing obligations Solvency and Coverage Ratios Measure degree of protection for long-term creditors and investors Operating Performance and Efficiency Measure company s long-term stability Activity Ratios Measure how effective company is at managing assets Profitability Ratios Measure degree of success or failure of a company for a given period of time

11 Working capital Liquidity Ratios Current assets Current liabilities Current Ratio Current assets / Current liabilities Quick Ratio or Acid Test Ratio (Cash + A/R + Short-term assets)/current liabilities

12 Solvency and Coverage Ratios Debt / Asset Ratio Total Liabilities / Total Assets Equity / Asset Ratio Owner s Equity / Total Assets Debt / Equity Total Liabilities / Owner s Equity Rate of Return on Equity Net Income / Owner s Equity

13 Operating Performance & Efficiency Operating Expense Ratio Total Operating Expenses / Net Sales Times Interest Earned EBIT / Interest Expense

14 Activity Ratios Accounts Receivable Turnover Sales / Average Accounts Receivable Days Sales Outstanding (DSO) 365 / Accounts Receivable Turnover Inventory Turnover Cost of Goods Sold / Average Inventory Inventory Average # of days 365 / Inventory Turnover

15 Profitability Ratios Return on Sales Net Income / Sales EBIT/Sales a better measure of return on sales Asset Turnover Sales / Average Assets Return on Assets EBIT / Average Assets ROI Return on Investment Net Profit / Investment

16 Break-Even Analysis Break-even analysis is a process of determining how many units of production must be sold, or how much revenue must be obtained, before we begin to earn a profit. For break-even quantity: BEQ P - FC VC

17 Carl s Toy Trucks Cost Category Payment Basis Cost ($) Rent Monthly Salaries Monthly Employee benefits Annually Insurance Quarterly Property taxes Annually Selling Price Per truck Wood Per truck 1.25 Paint and finishing Per truck 0.25 Labor Per truck 2.50 Packing and shipping Per truck 2.00 BEQ = FC / P VC = / = / 4.00 = 2084 trucks / month

18 Break-Even Analysis (continued) Break-even dollars: BE$ 1 FC VC P Where VC is variable cost expressed as a % of sales For retail firm: VC % =(Cost of Goods Sold)/(Net Sales) For manufacturing firm: VC % = (Variable cost of a unit)/(selling price) BE$ = $8, / 1-($6.00/$10.000) = $8, / = $8, / 0.40 = $20, monthly sales

19 Break-Even Analysis (continued) Contribution margin is the amount of profit that will be made by a business on each unit that is sold above and beyond the break-even quantity. Contribution margin is also the amount the business will lose for each unit of production by which it falls short of the break-even point. Contribution margin = P VC = $ $6.00 = $4.00

20 Profit and Break-Even Desired profit with break-even analysis in quantity to produce. Totalquantity FC Desired profit P - VC VC is variable cost per unit Desired profit with break-even analysis in dollars. FC Desired profit BE$ 1- VC (as a percentage of the sales VC is a percentage of sales dollar (cost of goods sold as a percent). dollar)

21 Financial Ratio and Break Even Calculators Using information from your business balance sheet and income statement plug in the appropriate figures and you will calculate and generate a basic ratio analysis and break even analysis for your company. Ratio Calculator Break Even Calculator

22 Limitations of Financial Statement Analysis 1. Companies may have differing year ends 2. Companies may have acquired their property, plant, and equipment in differing years 3. Companies may account for the same items using alternative accounting methods 4. Finally, industry patterns cause significant differences among companies

23 Early Warning Signs of Financial Trouble Declining profits despite increased sales Decreasing gross margin Dwindling cash flow Shrinking market share Receding sales volume Increasing interest expenses in relation to sales Swelling overhead expenses

24 Early Warning Signs of Financial Trouble (continued) Irregular, inaccurate, or untimely internally prepared financial reports Repeated failure to meet overly optimistic sales forecasts Continual stretching of accounts receivable Growing write-offs of uncollectible receivables Increasing payables in relation to revenues

25 Early Warning Signs of Financial Trouble (continued) Credit limits nearing exhaustion Increased pressure from creditors to pay A continual need to float checks as a result of bank overdraft Declining debt-to-worth ratio Lack of control over purchasing and personnel Slow-turning or out-of-balance inventories

26 Utilizing Financial Analysis in your Business Monitor financial performance Compare to previous year Compare to budget established Compare to competitors Compare within industry standards Compare to entrepreneur s expectations Identify short-term and long-term performance measures Use five to eight key measures

27 Industry Trends Bizstats Free limited service Business Valuation Market Data Purchase reports $69 - $250 / report depending on service

28 Summary Gain control of the numbers for utilization in decision making. Develop system for tracking and monitoring key assumptions. Establish clear milestones to track progress toward long-term goals. Identify specific business areas that need to be assessed and determine how information will be gathered. Determine what reports are important for you they may not be the same as what is important for your banker or accountant. You, as the entrepreneur need to understand the numbers that are needed to follow the activity of the business and ensure that those numbers can be generated through the accounting system and staff.

29 Questions? Thank you for your time!

30 Sources: Entrepreneurial Finance, 5 th ed. by Philip J. Adelman and Alan M. Marks, 2010 Pearson Education, Inc New Venture Management, by Donald F. Kuratko and Jeffrey S. Hornsby, 2009 Pearson Education, Inc Entrepreneurship, 2 nd ed. By Steve Mariotti and Caroline Glacking, 2010 Pearson Education, Inc