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UNIT 3 • SHOW ME THE MONEY: FINDING, SECURING, AND MANAGING IT
USING FINANCIAL STATEMENTS
TO GUIDE A BUSINESS
8
ENTREPRENEURSHIP: Starting and Operating a Small Business, 3/e
Steve Mariotti and Caroline Glackin
Class Name
Instructor Name
Date, Semester
Performance Objectives
After this lecture, you should be able to complete the following Performance Objectives
1. Understand an income statement.
2. Examine a balance sheet to determine a business’s financing
strategy.
3. Use the balance sheet equation for analysis.
4. Perform a financial ratio analysis of an income statement.
5. Calculate return on investment.
6. Perform same-size (common-sized) analysis of an income
statement.
7. Use quick, current, and debt ratios to analyze a balance sheet.
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Scorecard for the Entrepreneur: What Do
Financial Statements Show?
Income Statement
Balance Sheet
Cash Flow Statement
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Income Statements: Showing Profit and
Loss over Time
Part of an Income Statement:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Revenue
Cost of Goods Sold (COGS)
Gross Profit
Other Variable Costs
Contribution Margin (Gross Profit)
Fixed Operating Costs (USAIIRD)
Earnings before interest and taxes (EBIT)
Pre-Tax Profit
Taxes
Net Profit/(Loss)
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Exhibit 8-1 Basic Income Statement
A Basic Income Statement:
The power of the income
statement is that it will tell you
whether you are fulfilling the
formula of buying low, selling
high, and meeting customer
needs.
The Double Bottom Line:
Ideally, you want to have a
positive double bottom line;
you are making a profit so you
can stay in business and
achieve your mission
A Basic Company Inc. Income
Statement for the Month Ended:
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A Simple Income Statement
Exhibit 8-2
Flea Market Seller Income Statement
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Income Statement for a More Complex
Business
Exhibit 8-3 Income Statement for Lola’s Custom
Draperies, Inc.,
for the Month of March 2011
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Return on Investment (ROI)
Entrepreneurs “invest” time, energy or money
into something because they expect a
“return” of money or satisfaction.
Return on investment (ROI) measures return as
a percentage of the original investment.
Net Profit/Investment X 100 = ROI%
What is made over what is paid, times 100.
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The Balance Sheet: A Snapshot of Assets,
Liabilities, and Equity at a Point in Time
Net Worth (owner’s equity) – the difference between assets and
liabilities.
1.
Assets: items a company own that have monetary value.
2.
Liabilities: debts a company has that must be paid, including
unpaid bills.
3.
Owner’s Equity (OE): also called net worth. It shows the amount
of capital in the business. It consists of common equity,
preferred equity, paid-in-capital
Fiscal Year – the 12 month financial reporting period for a company
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Short-and Long-Term Assets
Current Assets – cash or items that can be quickly
converted to cash or will be used within one year.
Long-term Assets – those that will take more than one
year to use.
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Current and Long-Term Liabilities
Liabilities – are all debts owed by the business, such
as bank loans, mortgages, lines of credit, and loans
to family or friends.
Current Liabilities- debts that are scheduled for
payment within that year.
Long-Term Liabilities – debts that are due in over one
year.
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The Balance Sheet Equation
Balance Sheet Equation – is the equation for
calculating owner’s equity.
Assets – liabilities = Net Worth (or Owner’s Equity or Capital or
Assets = liabilities + Owner’s Equity or
Liabilities = Assets - Owner’s Equity
If assets are greater that liabilities, net worth is positive.
If liabilities are greater than assets, net worth is
negative
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The Balance Sheet Shows Assets and Liabilities
Obtained through Financing
If an item was financed with debt, the loan is a liability.
If an item was purchased with the owner’s own money
(including that of shareholders), it was financed with
equity.
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Balance Sheet
Total Assets = Total Liabilities + Owner’s Equity (OE)
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The Balance Sheet Shows How a Business
Is Financed
An entrepreneur that relies too much on equity
financing from outside investors (who have thus
become owners) can lose control of the company.
An entrepreneur who takes on too much debt and is
unable to make loan payments can lose the
business, and possibly personal assets as well, to
banks or other creditors.
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Analyzing a Balance Sheet
Comparing balance sheets from two points in time
is an excellent way to see whether or not a
business has been financially successful.

Assets
- Cash
- Inventory
- Capital equipment
- Other assets
- Total assets
 Liabilities
- Short-term liabilities
- Long-term liabilities
- Owner’s equity

Depreciation – a certain portion of an asset that is subtracted
each year until the asset’s value reaches zero.
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Exhibit 8-8 Balance Sheet Variance Analysis
Restaurant Balance Sheet
Dec. 31, 2010
As of Dec. 31, 2011
As of
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Financial Ration Analysis: What Is It and
What Does It Mean to You?
Income Statement Ratios: divide sales into each line item and multiply by
a hundred.
Return on Investment
- Investment – something that a person or entity devotes resources to in
hopes of future profits or satisfaction.
- Return on Investments (ROI) - the net profit of a business divided by its
start-up investment (percentage)
- Wealth – the value of assets owned minus the value of liabilities owed.
1. Net profit.
2. Total investment in the business.
3. The period of time for which you are calculating ROI.
Net Profit
ROI = Investment x 100 = ROI
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Return on Sales
Return on sales (ROS) – net income divided by sales
for a particular time period (percentage).
Profit margin (return on sales) – net income divided by
sales (percentage).
Net Income
Return on Sales (ROS) =
Sales
Common-Sized Statement Analysis
- Operating ratio: an expression of a value versus sales
Balance-Sheet Analysis
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Current & Quick Rations
Liquidity – the ability to convert assets into cash.
Current Ratio-liquidity ration consisting of the total
sum of cash plus marketable securities divided by
current liabilities.
Marketable Securities- investments that can be
converted into cash within 24 hours.
Quick Ration-the calculation of cash in relation to
covering current debt.
Quick Ratio =
Quick Ratio =
Cash + Marketable Securities
Current Liabilities
Current Liabilities – ( Inventory + Prepayments)
Current Liabilities
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Debt Ratios: Showing the Relationship
Between Debt & Equity
Debt-to-Equity Ratio – the comparison of total debt to
total equity.
Debt-to-Equity Ratio =
Debt
Equity
Debt Ratio – the comparison of total debt to total
assets.
Debt Ratio =
Total Debt
Total Assets
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Operating-Efficiency Ratios
1. Collection-period ratio
Average Accounts Receivable (Balance Sheet)
Average Daily Sales (Income Statement)
= # of days
2. Receivable turnover ratio
Total Sales (Income Statement)
= # of times
Average Accounts Receivable (Balance Sheet)
3. Inventory turnover ratio
Cost of Goods Sold (Income Statement)
Average Inventory (Balance Sheet)
= # of times
KEY TERMS
current assets
current liabilities
current ratio
debt ratio
debt-to-equity ratio
fiscal year
investment
liquidity

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