Lesson Plan. Financial Ratios Financial Analysis Finance. Performance Objective Students calculate financial ratios to evaluate company performance.

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1 Financial Ratios Financial Analysis Finance Lesson Plan Performance Objective Students calculate financial ratios to evaluate company performance. Specific Objective Discuss the use of financial ratios in business finance Calculate financial ratios Identify problems and issues with financial statements Terms Ratio A comparison between two numbers showing how many times one number exceeds the other Liquidity Ratios Financial ratios that tell how well a company can pay off its short term debts and meet unexpected needs for cash. Efficiency Ratios Financial ratios that indicate how effectively a company uses its resources to generate sales. Leverage Ratios Financial ratios that show how and to what degree a company has financed its assets. Profitability Ratios Financial ratios that tell how much of each dollar of sales, assets, and owner s investments resulted in net profit. Working Capital The difference between current assets and current liabilities at a point in time. The amount of money that would be left over if all the current liabilities were paid off by current assets Current Ratio The comparison of a firm s current assets to current liabilities. The ratio indicates the amount of current assets available to pay off $1 of current debt. Acid Test/Quick Ratio Indicates a firm s ability to quickly liquidate assets to pay off current debts. Asset Turnover Ratio Incidcates the number of dollars in sales the firm generates from each dollar it has invested in assets Inventory Turnover The number of times during an operating period that the average inventory was sold Average Collection Period Indicates how quickly a firm s credit accounts are being collected and is a good measure of how efficiently a firm is managing its accounts receivable Debt to Assets Ratio Measures to what degree the assets of the firm have been financed with borrowed funds Debt to Equity Ratio Compares the total debt of the firm with the owner s equity Return on Investment The amount of profit generated by the firm in relation to the amount invested by the owners 1

2 Time When taught as written, this lesson should take approximately days to teach. Preparation TEKS Correlations: This lesson, as published, correlates to the following TEKS. Any changes/alterations to the activities may result in the elimination of any or all of the TEKS listed (c) Knowledge and Skills (5) The student calculates business ratios to evaluate company performance (A) Discuss the use of financial ratios in business finance; (4) The student manages financial resources to ensure solvency (D) Calculate financial ratios; (G) Identify problems and issues with financial statements; Interdisciplinary Correlations: English English I (B)(1). Reading/Vocabulary Development. Students understand new vocabulary and use it when reading and writing (B)(11). Reading/Comprehension of informational text/procedural texts. Students understand how to glean and use information in procedural texts and documents. Math Mathematical Models with Applications (C)(1)(A) Knowledge and Skills. compare and analyze various methods for solving a real life problem (C)(1)(C) Knowledge and Skills select a method to solve a problem, defend the method, and justify the reasonableness of the results. Occupational Correlation (O*Net Job Title: Financial Analysts O*Net Number: Reported Job Titles: Financial Quantitative Analysts, Personal Financial Advisors, Financial Examiners, Credit Analysts Tasks: Draw charts and graphs, using computer spreadsheets, to illustrate technical data Inform investment decisions by analyzing financial information to forecast business, industry, or economic conditions Interpret data on price, yield, stability, future investment risk trends, economic influences, and other factors affecting investment programs. 2

3 Skills: Complex Problem Solving, Judgment and Decision Making, Mathematics Accommodations for Learning Differences It is important that lessons accommodate the needs of every learner. These lessons may be modified to accommodate your students with learning differences by referring to the files found on the Special Populations page of this website. Preparation Review and familiarize yourself with the terminology in outlines, presentations, and handouts. Locate and evaluate various resources and websites. Prepare materials and websites prior to the start of the lesson. References Could You Start a Business? This lesson plan will teach high school students the importance of financial management for a small business. It will help students learn the concepts of business costs, positive cash flow, credit, and proper financial management in running a business. Students will learn the tools for basic financial analysis, and will investigate why the business in the video segments was not successful. As an extension activity, they can brainstorm ideas for a model new business, given what they have learned about the financial needs of a new business. Beginner s Guide to Financial Statements produced by the U.S. Securities and Exchange Commission Accounting: Real World Applications & Connections. (4 th ed.). (2000). New York City, NY: Glencoe McGraw Hill Gilbert, Claudia B. & Lehman, Mark W. (2008). Accounting: Century 21. Stamford, CT: Cengage Learning. Advanced Accounting: Century 21, Chapters 16 and 17 Brechner, Robert A. (6 th ed.). (2011). Contemporary Mathematics. Stamford, CT: CENGAGE Learning, Chapter 15. Instructional Aids 1. Websites for assignments 2. Class discussion 3. Assignment Worksheets 4. Textbooks Introduction The main purpose of this lesson is to help students understand: The use of financial ratios in business finance How to calculate financial ratios 3

4 How to identify problems and issues with financial statements Ask students if they understand the reason for using financial ratios. Ask students if they could look at a balance sheet or income statement and analyze whether the company was succeeding or not. Ask students to give examples of ways to analyze financial statements. 4

5 Outline I. Learn terminology about ratios A. Type of Ratios: Liquidity, Efficiency, Leverage, Profitability Administer Pretest Use Presentation 3.1 See Assignment 3.1 B. Meaning of each ratio II. Figure ratios A. Find missing figures in a comparative Balance Sheet and Income Statement B. Figure ratios on comparative statements Use Presentation 3.1 See Assignment 3.2 III. C. Analyze results of ratios found Complete Project A. Create a company 1. Choose name, type, and location 2. Decide on competition, advertising, plans for growth, and recommendations to make the company unique B. Set up financial statements for the company and figure ratios C. Present to class Multiple Intelligences Guide See Assignment 3.3 *Project handout *Project Rubric *Project Critique for classmates Existentialist Interpersonal Intrapersonal Kinesthetic/ Bodily Logical/ Mathematical Musical/Rhythmic Naturalist Verbal/Linguistic Visual/Spatial 5

6 Application Guided Practice Search the internet to find examples of balance sheets and income statements Figure ratios for balance sheets and income statements Analyze the meaning of ratios for each business See Assignments Independent Practice See Assignments Summary Review Explain why businesses use financial ratios Calculate financial ratios for businesses and analyze what each ratio means Create a business and complete a financial analysis of the business Informal Assessment Any and all of the following can be used as informal assessments : Check vocabulary definitions Pre test vocabulary Research online for balance sheets and income statements Analyze financial statements online Formal Assessment Evaluation The following can be considered a formal evaluation in order to keep students engaged during both the pre test(s) and post test : Evaluation of completed assignments/project Post Test Enrichment Extension Students contact local businesses and request copies of their balance sheets and income statements to analyze as a class. Figure each type of ratio. 6

7 FINANCIAL RATIOS ASSIGNMENT 3.1 MATCHING: a. Inventory Turnover f. Current Ratio b. Return on Investment g. Debt-to-Assets Ratio c. Acid Test Ratio h. Debt-to-Equity Ratio d. Working Capital i. Ratio e. Average Collection Period j. Asset Turnover Ratio A comparison between two numbers showing how many times one number exceeds the other The difference between current assets and current liabilities at a point in time. The amount of money that would be left over if all the current liabilities were paid off by current assets The comparison of a firm s current assets to current liabilities. The ratio indicates the amount of current assets available to pay off $1 of current debt Indicates a firm s ability to quickly liquidate assets to pay off current debts. Indicates how quickly a firm s credit accounts are being collected and is a good measure of how efficiently a firm is managing its accounts receivable The number of times during an operating period that the average inventory was sold Tells the number of dollars in sales the firm generates from each dollar it has invested in assets Compares the total debt of the firm with the owner s equity Measures to what degree the assets of the firm have been financed with borrowed funds The amount of profit generated by the firm in relation to the amount invested by the owners a. Efficiency Ratios b. Profitability Ratios c. Leverage Ratios d. Liquidity Ratios Financial ratios that tell how well a company can pay off its short-term debts and meet unexpected needs for cash Financial ratios that indicate how effectively a company uses its resources to generate sales Financial ratios that show how and to what degree a company has financed its assets Financial ratios that tell how much of each dollar of sales, assets, and owner s investment resulted in net profit 7

8 FINANCIAL RATIOS KEY ASSIGNMENT i 2. d 3. f 4. c 5. e 6. a 7. j 8. h 9. g 10. b 11. d 12. a 13. c 14. b 8

9 FINANCIAL RATIOS ASSIGNMENT Find the missing figures in the following Income Statement and Balance Sheet. 2. Find the results for the following ratios: Working Capital Current Ratio Acid Test/Quick Ratio Asset Turnover Ratio Debt-to-Assets Ratio Debt-to-Equity Ratio Gross Profit Margin Net Profit Margin Return on Investment 3. From your results, do the partners have the income necessary should they choose to expand? Explain your answer. 4. What does the current ratio tell you? Does Mustang, Inc. have a favorable current ratio? 5. Based on your results, which year would you say is the more productive year? Why? 6. Based on your results, would you invest in this company if given the chance? Why or why not? Mustang, Inc. Comparative Income Statement For Years Ended December 31, 2011 and Net Sales 3,100,650 3,855,000 Cost of Goods Sold 1,950,000 2,010,775 Gross Profit Operating Expenses 46,000 46,305 Net Income Mustang, Inc. Comparative Balance Sheet December 31, 2011 and 2012 Assets Cash 3,000,000 2,000,000 Petty Cash Account Receivables 895, ,000 Merchandise Inventory 6,500,000 7,250,000 Supplies 175, ,000 Equipment 235, ,045 Land 2,000,000 2,500,000 Total Assets Liabilities Current Liabilities Accounts Payable 925, ,000 Long-Term Liabilities Bonds Payable Total Liabilities 925, ,000 Owner's Equity Mustang Owner I, Capital 5,481,165 5,500,000 Mustang Owner II, Capital 4,900,000 5,296,545 Total Owner's Equity Total Liabilities & Owner's Equity 9

10 FINANCIAL RATIOS ASSIGNMENT 3.2 KEY Mustang, Inc. Comparative Income Statement For Years Ended December 31, 2011 and Net Sales 3,100,650 3,855,000 Cost of Goods Sold 1,950,000 2,010,775 Gross Profit 1,150,650 1,844,225 Operating Expenses 46,000 46,305 Net Income 1,104,650 1,797,920 Answers 3-6 will vary. Mustang, Inc. Comparative Balance Sheet December 31, 2011 and 2012 Assets Cash 1,500,000 1,000,000 Working Capital 8,145,600 8,251,500 Petty Cash Current Assets Current Liabilities Account Receivables 895, ,000 Current Ratio Merchandise Inventory 6,500,000 7,250,000 Current Assets/Current Liabilities Supplies 175, ,000 Asset Turnover Ratio 27.4% 32.1% Equipment 235, ,045 Net Sales/Total Assets Land 2,000,000 2,500,000 Net Profit Margin/Return on Sales 35.6% 46.6% Total Assets 11,306,165 11,991,545 Net Income/Net Sales Liabilities Gross Profit Margin 37.1% 47.8% Current Liabilities Gross Profit/Net Sales Accounts Payable 925, ,000 Return on Investment 12.4% 18.4% Long-Term Liabilities Net Income/Owner's Equity Bonds Payable 1,500,000 1,200,000 Debt to Equity Ratio 27.3% 22.4% Total Liabilities 2,425,000 2,195,000 Total Liabilities/Owner's Equity Owner's Equity Debt to Assets Ratio 21.4% 18.3% Mustang Owner I, Capital 4,481,165 5,000,000 Total Liabilities/Total Assets Mustang Owner II, Capital 4,400,000 4,796,545 Total Owner's Equity 8,881,165 9,796,545 Total Liabilities & Owner's Equity 11,306,165 11,991,545 10

11 FINANCIAL RATIOS STUDENT PROJECT 3.3 From the following case, prepare a slideshow and oral presentation with solutions to the questions that follow. Two other mid-level managers and you have recently been laid off from your positions at a major gas company due to downsizing. The three of you have decided to branch out on your own and open a small company together. You each have $20,000 in severance monies and savings that you plan to use as well. Your presentation is to be given to the class. Your job is to convince the class to loan you money, so you will need to show them that you have a sound business plan that will produce profits. You are asked to provide the needed information that will assist the class during your presentation to decide whether to loan you money for your new company: 1. Business: Name, type, and location. 2. Need for business chosen and reason for location choice. 3. Specific competition which will be encountered and a comparison to your company. 4. Needs of the business: How many employees, types of supplies, equipment, inventory, etc. 5. Anticipated Budget. This should be specific numbers, including items such as salaries, rent, supplies, advertising, cost of computers, inventory, and Internet access, etc. Set up in a spreadsheet. 6. Breakdown of salaries to be paid. Make sure that you pay the three owners a realistic salary. 6. Anticipated Balance Sheet for first year of business. Use correct format. 7. Anticipated Income Statement for first year of business. Use correct format. Include a breakdown of your expected revenue. 8. Two charts (different types) reflecting data that you have generated that will help convince the class to loan you money. Label appropriately. 10. Ratios. From your income statement and balance sheet, figure working capital, current ratio, debt-to-assets ratio, and debt-to-equity ratio. 9. Specific plans for growth in the next five years. 10. Recommendations to make the business unique. 11. Advertising plans. List specific methods of advertising planned. Be creative with this. 12. Convince the class and instructor to loan you money for your new business. ASK FOR LOAN. 11

12 Be creative and provide details. This will count as two test grades. Your slideshow will be graded based on details provided and creativity in your presentation. Your presentation to the class will be graded based on your knowledge and professionalism. Day 1: Day 2: Days 3, 4, 5: Day 6: Brainstorm name of company. Research locations for your business. Submit name, type of company, and location of company. Research dollar amounts for rent, salaries, equipment, etc. Submit numbers. Figure the amount of savings each owner will use, and the amount of loan you will request. Prepare slideshow. Last day to work on slideshow. Print and submit it. 12

13 FINANCIAL RATIOS STUDENT PROJECT 3.3 RUBRIC (5) Organization (logical sequence of slides) (5) Visuals/Graphics (relevant, appropriate size) (5) Mechanics (grammar, spelling, capitalization) (5) Backgrounds (relevant, don t distract from writing) (5) Name, type, and location of business (5) Need for the business and reason for location choice (5) Competition (be specific, show comparison) (5) Needs (number of employees, types of supplies and equipment, etc.) (5) Anticipated Budget (in budget format) (3) Breakdown of salaries (10) Anticipated Balance Sheet for the year (in correct format) (10) Anticipated Income Statement for the year (in correct format) (10) Two charts reflecting data that you have generated (5) Ratios (working capital, current ratio, debt-to-assets, debt-to-equity) (3) Plans for growth in the next five years (3) Recommendations to make the business unique (3) Advertising plans (3) Conclusion: ask for loan (5) Creativity Slideshow Test Grade (100) Presentation Test Grade 13

14 FINANCIAL RATIOS STUDENT PROJECT 3.3 CRITIQUE SHEET FOR STUDENTS Presenter Business Name Strengths of Business Plan Weaknesses of Business Plan Would you invest in the business? Why or why not? Presenter Business Name Strengths of Business Plan Weaknesses of Business Plan Would you invest in the business? Why or why not? Presenter Business Name Strengths of Business Plan Weaknesses of Business Plan Would you invest in the business? Why or why not? Presenter Business Name Strengths of Business Plan Weaknesses of Business Plan Would you invest in the business? Why or why not? 14