VSBDC-Financial-Statement-Resource-Guide.doc

8/10/2019 VSBDC-Financial-Statement-Resource-Guide.doc

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Financial Statement AnalysisFor

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 NetworkFlorida SBDC Network grants permission for use and modifiation of this manual to the !irginia SBDC "uly #$% 200&'

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Contents

"opic Page

Introduction 3

Importnce of !innci" Sttements #

Co""ectin$ nd %n$in$ Dt &

'he Income Sttement (

'he B"nce Sheet )

Reconci"ition of *+uity or Sttement of Chn$es in Stoc,ho"der*+uity

12

Sttement of Csh !"o-s 12

.otes to !innci" Sttements 13

!innci" Rtios *p"ntion 13

ey 'erms nd Concepts 20

!innci" Sttements s %n$ement 'oo" 2#

'hree Cse Studies 32

!i$ure 1 Summry 'b"e of !innci" Rtios 3

!i$ure 2 45 !shions6 Inc7 !innci" Sttements 38

!i$ure 3 Bre,even 9n"ysis #

!i$ure #7 4 Smp"e Csh !"o- Sttement :-ithout numbers; #(

Conc"usion #8

Sources of !innci" 9n"ysis Informtion #)


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#ntroduction

!innci" sttements provide sm"" business o-ners -ith the bsic too"s for determinin$ ho- -e"" theiropertions perform t "" times7 %ny entrepreneurs do not re"ire contemp"tin$6 or tht my occur becuse of chn$in$ mr,etconditions or customer tstes6 for emp"e6 you chieve $reter understndin$ bout the finnci"interre"tionships t -or, in business7

'he t-o ,ey reports for "" si


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In ddition to this Resource uide6 business o-ners nd mn$ers shou"d t,e dvnt$e of the other free or"o- cost sources of mr,etin$ informtion7

!ree business counse"in$ services provided by Certified Business 9n"ysts nd mny "o-4cost

seminrs nd -or,shops re offered by the Vir$ini Sm"" Business Deve"opment Centersthrou$hout the stte7 !or the "oction of the Sm"" Business Deve"opment Center nerest to you c""

visit ---7vir$inisbdc7or$7

Fniversities6 community co""e$es6 nd pub"ic "ibrries hve other boo,s nd pub"ictions on this topic7

9 tremendous mount of informtion is vi"b"e on the Internet6 usin$ serch too" such s oo$"e7

#mportance o$ Financial Statements

%ny business eperts nd ccountnts recommend tht you prepre finnci" sttements month"yG

+urter"y t minimum7 Some compnies prepre them t "est once -ee,6 sometimes di"y6 to stybrest of resu"ts7 'he more fre+uent"y compny prepres their finnci" sttements6 the sooner time"ydecisions cn be mde7

'here re four types of finnci" sttementsG compi"ed6 revie-ed6 udited6 nd unudited

9 compi"edsttement contins finnci" dt from compny reported in finnci" sttement

formt by certified pub"ic ccountnt :CE9;G it does not inc"ude ny n"ysis of the sttement7

'he revie-ed sttement inc"udes n n"ysis of the sttement by CE9 in -hich unusu" items or

trends in the finnci" sttement re ep"ined7

9n udited sttement :"so prepred by CE9; contins ny n"ysis -hich inc"udes confirmtion

-ith outside prties6 physic" inspection nd observtion6 nd trnsctions trced to supportin$

documents7 9n udited sttement offers the hi$hest "eve" of ccurcy7 9n unudited sttement pp"ies to finnci" sttement prepred by the compny -hich hs not

been compi"ed6 revie-ed6 or udited by outside CE977

Sm"" business o-ners must be -re tht they my be re+uired to submit finnci" sttements in ninecircumstnces

17 Virtu""y "" supp"iers of cpit"6 such s bn,s6 finnce compnies6 nd venture cpit"ists6 re+uirethese reports -ith ech "on re+uest6 re$rd"ess of previous successfu" "on history7 Bn,s myneed CE9 compi"ed or revie-ed sttements nd6 in some cses6 udited sttements7 'hey mynot ccept compny or individu""y prepred finnci" sttements6 un"ess they re bc,ed by

person" or corporte income7 'ypic""y6 s condition of $rntin$ "on6 creditor my re+uestperiodic finnci" sttements in order to monitor the success of the business nd spot ny possib"erepyment prob"ems7


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27 Informtion from finnci" sttements is necessry to prepre feder" nd stte income t returns7Sttements themse"ves need not be fi"ed7

37 Erospective buyers of business -i"" s, to inspect finnci" sttements nd thefinnci"/opertion" trends they reve" before they -i"" ne$otite s"e price nd commit to thepurchse7

#7 In the event tht c"ims for "osses re submitted to insurnce compnies6 ccountin$ records:prticu"r"y the B"nce Sheet; re necessry to substntite the ori$in" v"ue of fied ssets7

&7 If business disputes deve"op6 finnci" sttements my be v"ub"e to prove the nture nd etentof ny "oss7 Shou"d "iti$tion occur6 "c, of such sttements my hmper preprtion of the cse7

7 henever n udit is re+uired44for emp"e by o-ners or creditors44four sttements must beprepred Balance Sheet (or Statement of Financial Position)6 Reconcilement of Equity (orStatement of Stockholders Equity for corporations)6 Income Statement (or Statement of Earnings)6nd Statement of ash Flo!s"

(7 9 number of sttes re+uire corportions to furnish shreho"ders -ith nnu" sttements7 Certincorportions6 -hose stoc, is c"ose"y he"d6 tht is6 o-ned by sm"" number of shreho"ders6 reeempt7

87 In instnces -here the s"e of stoc, or other securities must be pproved by stte corportion orsecurities $ency6 the $ency usu""y re+uires finnci" sttements7

)7 'he Securities nd *chn$e Commission :S*C; re+uires most pub"ic"y he"d corportions :such sthose -hose stoc, is trded on pub"ic echn$es; to fi"e nnu" nd interim +urter"y finnci"reports7

"

Collecting and %anaging Data

'he "n$u$e nd princip"es of modern ccountin$ hve evo"ved from the centuries4o"d need for ccurterecord ,eepin$7 'ody6 the !innci" 9ccountin$ Stndrds Bord :!9SB;6 the S*C6 nd the 9mericnInstitute of Certified Eub"ic 9ccountnts :9ICE9; continue to refine nd revise concepts nd prctices7Re$rd"ess of ho- comp"e finnci" sttement my seem6 it is bsed on "o$ic nd prctic"ity7

Co""ectin$ informtion for finnci" sttements be$ins -ith the di"y rithmetic of business nd fo""o-s continuin$ process c""ed the udit tri"7 !irst6 fi$ures from ori$in" documents such s invoices reourn"i


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those for deprecition nd morti


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Identify potenti" business or bud$et prob"ems sooner7

Imp"ement better mn$ement contro"s7

Reduce "bor costs nd outside consu"tnts> fees7

Speed co""ection of receivb"es7

Reduce interest epense nd improve csh f"o-7

Reduce "ost s"es :s resu"t of fe-er stoc, outs;7

Reduce inventory :nd inventory crryin$ costs;7

Re"is chosen fisc" yer7 !or t purposes6 theo-ner my need to prepre second Income Sttement bsed on the c"endr yer6 if the fisc" yer isdifferent7 Chec, -ith t dvisor bout Intern" Revenue Code re+uirements7

'he fo""o-in$ terms re common"y found on n income sttement

17 Hedin$'he first fcts to pper on ny sttement re the "e$" nme of the business6 the type ofsttement6 nd the period of time reported6 e7$76 month6 +urter6 or yer7

27 Co"umn Hedin$sIf you inc"ude both current month nd yer4to4dte co"umns on the Income Sttement you cnrevie- trends from ccountin$ period to ccountin$ period nd compre previous simi"r periods79"so6 it is often he"pfu" to sho- the do""r mounts s percent$es of net s"es7 'his he"ps youn"y


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&7 Cost of oods So"dCost of $oods so"d e+u"s the mount of $oods vi"b"e for s"e minus the inventory reminin$ tthe end of the ccountin$ period7 :'ot" $oods vi"b"e J be$innin$ inventory K cost of purchsin$or mnufcturin$ ne- merchndise 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 hve no cost of $oods so"d7

7 ross Erofit9"so c""ed gross margin6 this fi$ure is the difference bet-een the cost of $oods so"d nd net s"es:.et S"es 4 Cost of oods So"d J ross Erofit;7 It is the business>s profit before opertin$epenses nd tes7

(7 =pertin$ *penses'he epenses of conductin$ business opertions $ener""y f"" into t-o brod cte$ories se""in$nd $ener" dministrtive7 %nufcturers norm""y inc"ude some opertin$ epenses6 such smchinery nd "bor deprecition6 s prt of cost of s"es :Item &;7

87 'ot" :.et; =pertin$ Income'ot" opertin$ epenses re subtrcted from $ross profit to sho- -ht the business erned beforefinnci" revenue nd epenses6 tes6 nd etrordinry items7

)7 =ther Revenue nd *pensesIncome nd epenses tht re not $enerted by the usu" opertions of business nd tht renot considered etrordinry :see Item 11; re recorded here7 'ypic""y inc"uded in this cte$oryre finnci" revenue6 such s interest from investments6 nd finnci" epenses6 such s intereston borro-ed cpit"7 :5on princip" is not considered n epense7 It is "ibi"ity nd is "isted ssuch on the B"nce Sheet;7

107 Eret Income'o derive this fi$ure6 "so c""ed pret profit6 tot" finnci" revenue :minus tot" finnci"epenses; is dded to tot" opertin$ income7 'es re subtrcted from pret income if thebusiness is LC> corportion7 Eroprietorships6 "imited "ibi"ity compnies6 nd LS> corportions donot py business tes on incomeG the income is reported on the o-ners> person" returns7 :!ort p"nnin$ purposes6 ccountnts estimte the nnu" tes due6 then proect the month"yportion7;

117 *trordinry in M5ossN .et of Income ' MBenefitNithin the frme-or, of n individu" business type nd "oction6 ny occurrence tht is hi$h"yunusu" in nture6 cou"d not be foreseen6 is not epected to recur6 nd tht $enertes income orcuses "oss is considered n etrordinry item7 'he etrordinry $in or "oss is sho-n fterc"cu"tin$ t "ibi"ity :or t benefit6 s -ou"d be the cse -ith n etrordinry "oss; on theIncome Sttement7 *mp"es 9 court -rd to business not previous"y invo"ved in "-suits-ou"d be n etrordinry $inG mor csu"ty -ou"d be n etrordinry "oss7


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127 .et Income9"so c""ed net profit6 this fi$ure represents the sum of "" epenses :inc"udin$ tes6 if pp"icb"e;7.et income or profit is common"y referred to s the #ottom line7

137 *rnin$s per Shre

'ot" outstndin$ common stoc, :the number of shres current"y o-ned by stoc,ho"ders; is dividedinto net income to derive this fi$ure7 It is not pp"icb"e to proprietorships nd "imited "ibi"itycompnies6 but must be sho-n on the Income Sttements of "" pub"ic"y he"d corportions7

"&e Balance S&eet

9 B"nce Sheet records the tot" ssets6 "ibi"ities6 nd e+uity :net -orth; of business s of specificdy7 'his sttement is divided to provide t-o vie-s of the sme business -ht resources the businesso-ns6 nd the creditor nd o-ner investments tht supp"ied these resources7 'hese divisions re $ener""yset up in the t-o4co"umn ccount form6 -ith ssets on the "eft6 "ibi"ities nd e+uity on the ri$ht7 9n"terntive 44 the one co"umn sttement form or report form 44 "ists ssets on top6 "ibi"ities nd e+uity be"o-7

'he bc,bone of the B"nce Sheet is the fundment" ccountin$ e+ution 9ssets J 5ibi"ities K *+uity:trnsposed 9ssets 4 5ibi"ities J *+uity7 'his e+ution is bsed on the ccountin$ princip"e tht everybusiness trnsction6 such s se""in$ merchndise or borro-in$ cpit"6 hs dual effect7 9ny increse ordecrese on one side of the e+ution "-ys re+uires correspondin$ chn$e to the other side of thee+ution7 If the sides don>t b"nce6 fu"ty rithmetic or inccurte or incomp"ete records my be thecuse7

'he fo""o-in$ is n emp"e of the princip"e of b"nce If business o-ner purchses O26000 -orth ofne- merchndise on credit6 ssets re incresed by the v"ue of ne- inventory7 5ibi"ities re incresedO26000 t the sme time becuse the compny hs n ccounts pyb"e :"ibi"ity; ob"i$tion to the

supp"iers of the merchndise7

'o further i""ustrte the princip"e If the sme business hd O26000 csh nd used it to buy ne-merchndise6 ssets -ou"d be incresed by the inventory v"ue6 but decresed by the csh out"y7 'hus6tot" ssets -ou"d be unchn$ed6 nd "ibi"ities nd e+uity -ou"d not be ffected7

'he fo""o-in$ terms re common"y found on b"nce sheet

17 Hedin$'he "e$" nme of the business6 the type of sttement6 nd the dy6 month6 nd yer must besho-n t the top of the report7

27 9ssets9nythin$ of v"ue tht is o-ned or "e$""y due the business is inc"uded under this hedin$7 'ot"ssets inc"ude "" net re"i


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estimted ""o-nces for doubtfu" ccounts6 deprecition6 nd morti


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37 Current 9ssetsCsh nd resources tht cn be converted into csh -ithin 12 months of the dte of the B"nceSheet :or durin$ one estb"ished cyc"e of opertions; re considered current7 Besides csh:money on hnd nd demnd deposits in the bn,6 such s re$u"r svin$s ccounts nd chec,in$ccounts;6 these resources inc"ude the items "isted be"o-7 'hey re rn,ed in $ener""y

ccepted order of decresin$ "i+uidity44tht is6 the ese -ith -hich the items cou"d be converted tocsh7

9ccounts Receivb"e 'he mounts due from customers in pyment for merchndise or

services7

Inventory Inc"udes r- mteri"s on hnd6 -or, in process6 nd "" finished $oods either

mnufctured or purchsed for res"e7 Inventory v"ue is bsed on unit cost nd isc"cu"ted by ny of sever" methods :see Inventory V"ution be"o-;7

'emporry Investments Interest4 yie"din$ or dividend4yie"din$ ho"din$s epected to be

converted into csh -ithin yer7 9"so c""ed marketa#le securitiesor short$termin%estments6 they inc"ude certifictes of deposit6 stoc,s nd bonds6 nd time deposit

svin$s ccounts7 9ccordin$ to ccountin$ princip"es6 they must be "isted on the B"nceSheet t either their ori$in" cost or their mr,et v"ue6 -hichever is "ess7

Erepid *penses oods6 benefits6 or services business pys for in dvnce of use7

*mp"es re insurnce protection6 f"oor spce nd office supp"ies7

#7 5on$4'erm Investments9"so c""ed "on$4term ssets' these resources re ho"din$s tht the business intends to ,eep for yer or "on$er nd tht typic""y yie"d interest or dividends7 Inc"uded re stoc,s6 bonds nd svin$sccounts ermr,ed for speci" purposes7

&7 !ied 9ssets

!ied ssets6 fre+uent"y c""ed p"nt nd e+uipment6 re the resources business o-ns orc+uires for use in opertions nd does not intend to rese""7 Re$rd"ess of current mr,et v"ue6"nd is "isted t its ori$in" purchse price6 -ith no ""o-nce for pprecition or deprecition7=ther fied ssets re "isted t cost6 minus deprecition7 !ied ssets my be "esed rther thno-ned7 Dependin$ on the "esin$ rrn$ement6 both the v"ue nd "ibi"ity of the "esed propertymy need to be "isted on the B"nce Sheet7

7 =ther 9ssetsResources not "isted -ith ny of the bove ssets re $rouped here7 *mp"es inc"ude tn$ib"es6such s outdted e+uipment -hich cn be so"d to the scrp yrd6 nd intn$ib"es6 such s$ood-i""6 trdemr,s nd ptents7


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(7 5ibi"ities'his term covers "" monetry ob"i$tions of business nd "" c"ims creditors hve on its ssets7

87 Current 5ibi"ities

9"" debts nd ob"i$tions pyb"e -ithin 12 months or -ithin one cyc"e of opertions re deti"edhere7 'ypic""y6 they inc"ude the fo""o-in$6 -hich $ener""y re "isted in the order due7

9ccounts Eyb"e 9mounts o-ed to supp"iers for $oods nd service purchsed in

connection -ith business opertions7

Short4'erm Debt 'he b"nces of princip" due to py off short4term debt for borro-ed

funds7

Current Eortion of 5on$4'erm Debt Current mount due of tot" b"nce on notes -hose

terms eceed 12 months7

Interest Eyb"e 9ny ccrued mounts due for use of both short4nd "on$4term borro-ed

cpit" nd credit etended to the business7

'es Eyb"e 9mounts estimted by n ccountnt to hve been incurred durin$ theccountin$ period7 !or ccountin$ purposes6 this tot" my differ from the ctu" t tot"re+uired by the Intern" Revenue Codes6 since tes pyb"e re bsed on ccountin$income nd not tb"e income7 :Note( Income tes re business ob"i$tions forcorportionsG proprietorships nd prtnerships do not py income tesG the income isreported on the o-ners> person" returns7;

9ccrued Eyro"" S"ries nd -$es current"y o-ed but not yet pid7

)7 5on$ 'erm 5ibi"ities5on$4term "ibi"ities re notes6 pyments6 or mort$$e pyments due over period eceedin$ 12months or one cyc"e of opertions7 'hey re "isted by outstndin$ b"nce :minus the Current

Eortion due;7

107 *+uity9"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 "ibi"ity compny6 e+uity is ech o-ner>s ori$in" investment6 p"us nyernin$s fter -ithdr-"s7

In corportion6 the o-ners re the shreho"ders44those -ho hve invested cpit" :csh or otherssets; in echn$e for shres of stoc,7 'he corportion>s e+uity is the sum of contributions p"usernin$s retined fter pyin$ dividends7 It is deti"ed s fo""o-s

Cpit" Stoc, 'he tot" mount invested in the business in echn$e for shres of stoc,t v"ue up to the pr v"ue7 Er is the per4shre price ssi$ned to the ori$in" issue ofstoc,6 re$rd"ess of subse+uent se""in$ prices7

Cpit" Eid4In in *cess of Er 'he mount in ecess of pr v"ue tht business

receives from shres of stoc, so"d t v"ue bove pr7


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'resury Stoc, hen compny buys bc, 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 ordinri"ydoes not receive dividends7

Retined *rnin$s 'he tot" ccumu"ted net income minus the tot" ccumu"ted

dividends dec"red since the corportion>s foundin$7 'hese ernin$s re prt of the tot"e+uity for ny business7 Ho-ever6 the fi$ure is usu""y "isted seprte"y from o-ner

investments on"y on corporte B"nce Sheets -hich re done for the benefit ofshreho"ders7

117 'ot" 5ibi"ities nd *+uity'he sum of these t-o mounts must "-ys e+u" 'ot" 9ssets7

Reconciliation o$ )*uity

'his sttement reconci"es the e+uity sho-n on the current B"nce Sheet7 !or corportions this sttementis referred to s the Sttement of Retined *rnin$s or Sttement of Shreho"der *+uity7 !or "imited "ibi"itycompnies it is referred to s the Sttement of %embers *+uity6 nd for Eroprietorships s the Sttement of=-ner>s *+uity7 It records e+uity t the be$innin$ of the ccountin$ period nd deti"s dditions to6 orsubtrctions from6 this mount mde durin$ the period7 9dditions nd subtrctions typic""y re net incomeor "oss nd o-ner contributions nd/or deductions7

!i$ures used to compi"e this sttement re derived from previous nd current B"nce Sheets nd from thecurrent Income Sttement7

Statement o$ Cas& Flows

'he fourth min document of finnci" reportin$ is the Sttement of Csh !"o-s7 %ny sm"" businesso-ners nd mn$ers find tht the csh f"o- sttement is perhps the most usefu" of "" the finnci"sttements for p"nnin$ purposes7 Csh is the "ife b"ood of sm"" business if the business runs out ofcsh chnces re $ood tht the business is out of business7 'his is becuse most sm"" businesses do nothve the bi"ity to borro- money s esi"y s "r$er business cn7

'he sttement cn be prepred fre+uent"y :month"y6 +urter"y; nd is v"ub"e too" tht summri


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By understndin$ the mounts nd cuses of chn$es in csh b"nces6 the entrepreneur cn re"istic""ybud$et for continued business opertions nd $ro-th7 !or emp"e6 the Sttement of Csh !"o-s he"psns-er such +uestions s i"" present -or,in$ cpit" ""o- the business to c+uire ne- e+uipment6 or-i"" finncin$ be necessryP

%ny sm"" businesses my not need to prepre the Sttement of Csh !"o-s7 Ho-ever6 ccordin$ to99E6 it shou"d be prepred -henever n opertion>s finnci" sttements re compi"ed6 revie-ed6 orudited by CE97 In ddition6 creditors6 investors6 ne- o-ners or prtners6 nd the Intern" RevenueService my re+uire the informtion it provides7 'his sttement cn usu""y be produced by mostccountin$ soft-re pp"ictions7

Notes to Financial StatementsIf n importnt fctor does not fit into the re$u"r cte$ories of finnci" sttement6 it shou"d be inc"uded

s note7 9"so6 nythin$ tht mi$ht ffect the finnci" position of business must be documented7 'hreemor types of notes inc"ude

17 %ethodo"o$yDiscussion of the ccountin$ princip"es used by the compny7 !or emp"e6 ccru" bsis ofccountin$ vs7 csh bsis of ccountin$7

27 Contin$ent 5ibi"itiesCircumstnces tht hve occurred s of the sttement dte nd -hich represent potenti" finnci"ob"i$tions must be recorded by type nd estimted mount7 *mp"e 9 business o-ner cosi$ns bn, note7 If the primry borro-er shou"d defu"t6 the business o-ner -ho cosi$ned -ou"dbecome "ib"e7

37 Re+uired Disc"osuresIt is necessry tht "" si$nificnt informtion bout the compny be described in disc"osuresttement7 *mp"e If the business hs chn$ed ccountin$ procedures since the "stccountin$ period6 the chn$e must be described7

Financial Ratios

!innci" rtios re v"ub"e nd esy -y to interpret the numbers found in sttements7 Rtio n"ysis

provides the bi"ity to understnd the re"tionship bet-een fi$ures on spredsheets7 It cn he"p you tons-er critic" +uestions such s -hether the business is crryin$ ecess debt or inventory6 -hethercustomers re pyin$ ccordin$ to terms6 nd -hether the opertin$ epenses re too hi$h7


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hen computin$ finnci" re"tionships6 $ood indiction of the compny@s finnci" stren$ths nd-e,nesses becomes c"er7 *minin$ these rtios over time provides some insi$ht s to ho- effective"ythe business is bein$ operted7

%ny industries compi"e ver$e :or stndrd; industry rtios ech yer7 Stndrd or ver$e industryrtios offer the sm"" business o-ner mens of comprin$ his or her compny -ith others -ithin the sme

industry7 In this mnner they provide yet nother mesurement of n individu" compny>s stren$ths or-e,nesses7 R%9 :Ris, %n$ement 9ssocition6 former"y nmed Robert %orris Q 9ssocites; is $oodsource of comprtive finnci" rtios7 It cn be found on the Internet t http//---7rmh+7or$/

!o""o-in$ re the most critic" rtios for most businesses6 thou$h there re others tht my be computed7

17 5i+uidity%esures compny>s cpcity to py its debts s they come due7 'here re t-o rtios forev"ution "i+uidity7

urrent Ratio4 u$es ho- b"e business is to py current "ibi"ities by usin$ current ssetson"y7 9"so c""ed the !orking capital ratio+ 9 $ener" ru"e of thumb for the current rtio is 2 to 1 :or216 or 2/1;7 Ho-ever6 n industry ver$e my be better stndrd thn this ru"e of thumb7 'hectu" +u"ity nd mn$ement of ssets must "so be considered7

'he formu" is"otal Current Assets

"otal Current ,ia-ilities

&uick Ratio $ !ocuses on immedite "i+uidity :i7e76 csh6 ccounts receivb"e6 etc7; but specific""yi$nores inventory7 9"so c""ed the acid test ratio6 it indictes the etent to -hich you cou"d pycurrent "ibi"ities -ithout re"yin$ on the s"e of inventory7 &uick assets6 re hi$h"y "i+uid44thoseimmedite"y convertib"e to csh7 9 ru"e of thumb sttes tht6 $ener""y6 your rtio shou"d be 1 to 1:or 116 or 1/1;7

'he formu" isCas& . Accounts Receiva-le

. any ot&er *uick assets!Current ,ia-ilities

27 SfetyIndictes compny>s vu"nerbi"ity to ris,44tht is6 the de$ree of protection provided for thebusiness> debt7 'hree rtios he"p you ev"ute sfety

'e#t to orth $ 9"so c""ed de#t to net !orth" untifies the re"tionship bet-een the cpit"invested by o-ners nd investors nd the funds provided by creditors7 'he hi$her the rtio6 the$reter the ris, to current or future creditor7 9 "o-er rtio mens your compny is morefinnci""y stb"e nd is probb"y in better position to borro- no- nd in the future7 Ho-ever6 n


#)


16/48

etreme"y "o- rtio my indicte tht you re too conservtive nd re not "ettin$ the businessre"is bi"ity to meet interest pyments7 It "soev"utes the cpcity to t,e on more debt7 'he hi$her the rtio6 the $reter the compny>s bi"ityto m,e its interest pyments or perhps t,e on more debt7

'he formu" is)arnings Be$ore #nterest 0 "a1es

#nterest C&arges

ash Flo! to urrent *aturity of +ong$erm 'e#t $ Indictes ho- -e"" trdition" csh f"o- :netprofit p"us deprecition; covers the compny>s debt princip" pyments due in the net 12 months7

It "so indictes if the compny>s csh f"o- cn support ddition" debt7

'he formu" isNet Pro$it . Non2Cas& )1penses3

Current Portion o$ ,ong2"erm De-t

Such s deprecition6 mortis bi"ity to $enerte return on its resources7 Fse the fo""o-in$ four rtiosto he"p you ns-er the +uestion6 AIs my compny s profitb"e s it shou"d beP 9n increse in thertios is vie-ed s positive trend7

,ross Profit *argin $ Indictes ho- -e"" the compny cn $enerte return t the $ross profit"eve"7 It ddresses three res inventory contro"6 pricin$6 nd production efficiency7

'he formu" isGross Pro$it"otal Sales

-et Profit *argin $ Sho-s ho- much net profit is derived from every do""r of tot" s"es7 Itindictes ho- -e"" the business hs mn$ed its opertin$ epenses7 It "so cn indicte -hetherthe business is $enertin$ enou$h s"es vo"ume to cover minimum fied costs nd sti"" "eve ncceptb"e profit7


#$


17/48

'he formu" isNet Pro$it

"otal Sales

Return on .ssets $ *v"utes ho- effective"y the compny emp"oys its ssets to $enerte return7It mesures efficiency7

'he formu" isNet Pro$it

"otal Assets

Return on -et orth4 9"so c""ed return on in%estment (R/I)7 Determines the rte of return on theinvested cpit"7 It is used to compre investment in the compny $inst other investmentopportunities6 such s stoc,s6 re" estte6 svin$s6 etc7 'here shou"d be direct re"tionshipbet-een R=I nd ris, :i7e76 the $reter the ris,6 the hi$her the return;7

'he formu" isNet Pro$itNet /ort&

#7 *fficiency*v"utes ho- -e"" the compny mn$es its ssets7 Besides determinin$ the v"ue of thecompny>s ssets6 you shou"d "so n"y


18/48

.ccounts Paya#le urno%er $ Sho-s ho- mny times in one ccountin$ period the compny turnsover :repys; its ccounts pyb"e to creditors7 9 hi$her number indictes either tht the businesshs decided to ho"d on to its money "on$er6 or tht it is hvin$ $reter difficu"ty pyin$ creditors7

'he formu" isCost o$ Goods Sold

Average Accounts Paya-le

Paya#le Period $ Sho-s ho- mny dys it t,es to py ccounts pyb"e7 'his rtio is simi"r toccounts pyb"e turnover :bove7; 'he business my be "osin$ v"ub"e creditor discounts by notpyin$ prompt"y7

'he formu" is456 Days

Accounts Paya-le "urnover

In%entory urno%er $ Sho-s ho- mny times in one ccountin$ period the compny turns over

:se""s; its inventory7 'his rtio is v"ub"e for spottin$ understoc,in$6 overstoc,in$6 obso"escence6nd the need for merchndisin$ improvement7 !ster turnovers re $ener""y vie-ed s positivetrendG they increse csh f"o- nd reduce -rehousin$ nd other re"ted costs7 9ver$e inventorycn be c"cu"ted by ver$in$ the inventory fi$ure from the month"y B"nce Sheets7 In cyc"ic"business6 this is especi""y importnt since there cn be -ide s-in$s in sset "eve"s durin$ theyer7 !or emp"e6 mny reti"ers mi$ht hve etr stoc, in =ctober nd .ovember in preprtionfor the 'hn,s$ivin$ nd -inter ho"idy s"es7

'he formu" isCost o$ Goods SoldAverage #nventory

In%entory urno%er in 'ays $ Identifies the ver$e "en$th of time in dys it t,es the inventory toturn over7 9s -ith inventory turnover :bove;6 fe-er dys men tht inventory is bein$ so"d more+uic,"y7

'he formu" is456 Days

#nventory "urnover

Sales to -et orth $ Indictes ho- mny s"es do""rs re $enerted -ith ech do""r of investment:net -orth;7 'his is vo"ume rtio7

'he formu" is"otal Sales

Average Net /ort&


#&


19/48

Sales to otal .ssets $ Indictes ho- efficient"y the compny $enertes s"es on ech do""r ofssets7 9 vo"ume indictor6 this rtio mesures the bi"ity of the compny>s ssets to $enertes"es7

'he formu" is"otal Sales

Average "otal Assets

'e#t o%erage Ratio $ 9n indiction of the compny>s bi"ity to stisfy its debt ob"i$tions6 nd itscpcity to t,e on ddition" debt -ithout impirin$ its surviv"7

'he formu" isNet Pro$it . Any Non2Cas& )1penses

Principal on De-t

7ey "erms and Concepts

'he fo""o-in$ re brief descriptions nd ep"ntions of terms nd concepts re"ted to finnci" sttements7:Items defined e"se-here in the tet re not "isted here7;

Accrual Basis o$ AccountingBy this "on$4estb"ished nd -ide"y used princip"e6 revenue nd epenses re reco$ni


20/48

Appreciation9ny increse from the c+uisition price of fied sset or investment to current pprised mr,et v"ue7Ho-ever6 for finnci" sttement purposes6 pprecition is not considered becuse of four ccountin$concepts

(1) the o#1ecti%ity principle $-hich -ou"d necessitte n ppris" of ech sset>s mr,et v"ue perccountin$ period44 cost"y nd hi$h"y vrib"e endevor7

(2) the continuity assumption $ tht fied ssets re c+uired for continuin$ business opertions nd notfor res"e

(3) the principle of conser%atism--hich sttes tht6 $iven choice of v"ues6 n ccountnt "-yschooses the more conservtive

(4) tht finnci" sttements ref"ect the original costs.

Cas& Basis o$ Accounting9s its nme imp"ies6 this method reco$ni


21/48

Depreciation9 univers" ccountin$ ssumption ho"ds tht "" fied ssets44-ith the eception of "nd44deteriorte6 -erout6 or become obso"ete7

'his process represents dec"ine in v"ue tht is c""ed deprecition7 It is c"cu"ted by pportionin$ n

sset>s ori$in" c+uisition price6 minus ny epected s"v$e v"ue6 over the sset>s epected yers ofusefu" "ife7 :!or ccountin$ purposes6 "nd is "-ys v"ued t its ori$in" purchse price7; =n the IncomeSttement6 deprecition incurred durin$ the ccountin$ period is deti"ed s n epense7 =n the B"nceSheet6 deprecition is ref"ected by n sset>s "isted net boo, or net crryin$ v"ue :cost "ess ccumu"teddeprecition;7

'he simp"est nd most common mens of c"cu"tin$ deprecition is by the straight$linemethod7 Fsin$ it6ccountnts divide the estimted usefu" "ife of n sset into its purchse price minus ny pp"icb"es"v$e v"ue7 *mp"e 9n O116000 mchine hs O16000 s"v$e v"ue nd n epected usefu" "ife of10 yers7 9nnu" deprecition J :O116000 4 O16000; 10 J O160007 In five yers6 stri$ht4"ine accumulateddepreciation-ou"d be O&60007

'here re other common c"cu"tion methods tht ""o- more cce"erted deprecition of fied ssets7'hese methods distribute the ori$in" c+uisition cost more hevi"y durin$ n sset>s er"y yers79ccountnts cn sho- o-ners the vrious mens to determine this deprecition6 -hich is more comp"ethn stri$ht4"ine7

Deprecition computed ccordin$ to the 99E ru"es is not necessri"y the sme s tht computed tocomp"y -ith the Intern" Revenue Code7 !or further informtion6 consu"t t dvisor7

#nventory Valuation

Becuse inventory units re usu""y purchsed t vryin$ prices6 methods hve been estb"ished toc"cu"te the cost of $oods so"d nd the v"ue of reminin$ inventory7 'hree -ide"y used methods re

.%erage ost $ 'he tot" number of units of $oods vi"b"e is divided into the tot" mnufcturin$ orc+uisition cost :inc"udin$ frei$ht chr$es to $et the r- mteri"s to the mnufcturer@s or supp"ier@s"oction7;

FIF/ $ 9n cronym for Afirst in6 first out7 'his method is bsed on the ssumption tht the inventoryc+uired first is so"d first7 Conse+uent"y6 the endin$ :reminin$; inventory consists of the most recent"ypurchsed items7 9n dvnt$e of this method of v"ution is tht it ref"ects recent costs of inventory onthe B"nce Sheet7

+IF/ $ 9n cronym for A"st in6 first out7 'his method of v"ution ssumes tht those items of inventorymost recent"y c+uired re so"d before the o"der c+uisitions7 9s resu"t6 the endin$ inventory fi$ureconsists of the o"der purchses7 Eroponents of this v"ution method r$ue tht by representin$ currentprices in the cost of $oods so"d6 mtchin$ is more ccurte"y ccomp"ished7


2#


22/48

)1ample( 'he first item in costs O1006 the second costs O3006 nd the third costs O&007 '-o of theseunits re so"d7

C"cu"ted by a%erage cost O100 K O300 K O&00 J O)00 3 J O3007 'herefore6 the cost of $oods so"d JO00 :2 units O300;G the reminin$ inventory is v"ued t O3007

C"cu"ted by FIF/6 the cost of $oods so"d is O100 K O300 J O#00G the reminin$ inventory is v"ued tO&007

C"cu"ted by +IF/6 the cost of $oods so"d is O&00 K O300 J O800G the reminin$ inventory is v"ued tO1007

,everage

'he concept of borro-in$ hevi"y for finncin$ needs in order to minimi


23/48

Acknowledgement( "&e $oregoing in$ormation was used wit& permission $rom Bank o$ AmericaN"0SA 9:;


24/48

4. 5o! !ell is the company doing as an in%estment64 'he Return on In%estment (R/I)M.et Income =-ners> *+uity :9ver$e;N mesures the profitbi"ity of the firm on o-ner4invested do""rs7 .et incomeis the fter4t return7 'he o-ners> e+uity :or cpit"; ccount is the investment7 It is the mount youhve contributed direct"y to the business nd mounts tht you hve reinvested vi undistributedprofits7

R=I $ives n indiction of the pst ernin$ po-er of your investment nd cn be used to compre thecompny>s performnce in this re$rd to other compnies in the industry7 It shou"d "so be compred-ith other investment opportunities open to you7 If your compny typic""y $enertes return of 10percent nd you cn invest e"se-here t 1& percent6 it doesn>t m,e sense from pure"y economicstndpoint to ,eep your funds tied up in the compny7

45 !shions> R=I for fisc" 200& -s bout 127( percent MO1#(6#30 O161&(61&0N7 9ver$e o-ners>e+uity is used s the denomintor to pproimte the mount vi"b"e for use in $enertin$ netincome over the course of the entire yer7 ',en by itse"f6 this fi$ure is neither impressive notdisturbin$7 'he medin Areturn on net -orth c"cu"ted by Dun nd Brdstreet :DQB; for ct"o$ ndmi"4order houses -s 2273 percent7 'he trend estb"ished over the "st three yers is more

importnt7 Comprin$ the 200& return -ith the t-o precedin$ yers6 there is shrp drop from #37#percent in 20036 to 2872 percent in 200#6 to 127( percent in 200&7

7" 5o! !ell has management employed the company8s assets64 'he Return on .ssets (R/.)M.etIncome 9ver$e 'ot" 9ssetsN mesures the profitbi"ity of the firm on "" invested do""rs7 'ht is6 itmesures ho- -e"" the firm>s ssets hve been emp"oyed in $enertin$ income7 'his mesure issome-ht broder thn the return on e+uity becuse it compres the returns on tot" cpit"7 'hisinc"udes the cpit" tht you nd the creditors hve provided7

ht constitutes stisfctory R=9P It depends on the type of ssets nd their end use7 =nce$in6 since compnies -ithin $iven industry tend to emp"oy simi"r ssets6 your R=9 shou"d bemesured $inst industry norms7

45 !shions> R=9 for fisc" 200& -s 87# percent MO1#(6#30 O16(160N compred -ith medinof 10 percent for the industry for the most recent period7 9$in6 45 !shions f""s short7 e "so see dec"inin$ R=9 over three yer period 2& percent for 20036 1873 percent for 200#6 nd 87# percentfor 200&7

%anagers%n$ers6 too6 re interested in mesurin$ the opertin$ performnce in terms of profitbi"ity nd return oninvested cpit"7 If they re not o-ners6 mn$ers must sti"" stisfy the o-ners> epecttions in this re$rd7 9s

mn$ers6 they re interested in mesures of opertin$ efficiency6 sset turnover6 nd "i+uidity or so"vency7'hese -i"" he"p them mn$e dy4to4dy ctivities nd ev"ute potenti" credit customers nd ,ey supp"iers7%n$er rtios serve s csh mn$ement too"s by focusin$ on the mn$ement of inventory6 receivb"es ndpyb"es7 9ccordin$"y6 these rtios tend to focus on opertin$ dt ref"ected on the profit nd "oss sttementnd on the current sections of the b"nce sheet7


24


25/48

9" .re profits high enough2 gi%en the le%el of sales6 $ In other -ords6 ho- efficient"y is mn$ementconductin$ opertionsP 'he -et Profit *arginM.et Income S"es :or Return on S"es; is mesureof the re"tive efficiency of the compny>s opertions fter deductin$ "" epenses nd income tes7 Itmesures the proportion of ech s"es do""r tht resu"ts in net income7

'he ver$e for this rtio vries -ide"y from industry to industry7 'o serve s n id in mn$ement6

the compny>s net profit mr$in shou"d be compred -ith tht of simi"r compnies in the smeindustry6 nd -ith the compny>s pst fi$ures7 'he mn$er shou"d monitor this rtio nd investi$tepotenti" prob"ems -hen the rtio be$ins to f"" be"o- the industry ver$e or hs sho-n continueddeteriortion durin$ the most recent +urter or t-o7 If both conditions eist6 mn$ement is "i,e"yfcin$ prob"em tht re+uires immedite ttention7 Incident""y6 most bn, "on officers use the returnon s"es rtio s ,ey indictor in m,in$ term "on decisions7 9 deteriortin$ rtio is often seen sn indiction of impendin$ business distress7

'he fisc" 200& net profit mr$in for 45 !shions -s 27# percent M1#(6#30/603)6(&0N7 Bycomprison6 the medin return on s"es for the industry6 s reported by DQB6 -s #70 percent6menin$ tht nother of the compny>s profitbi"ity mesures is be"o- the industry norm7 *+u""y

troub"in$ is the do-n-rd trend in the net profit mr$in since 20037 In fisc" yer 200#6 the net profitmr$in -s &73 percent6 do-n from (71 percent for 20037 =ver this period6 profits dec"ined Ipercent6 despite 327& percent increse in s"es7 If the compny -ere mintinin$ opertin$efficiency6 increses in s"es -ou"d resu"t in increses in profits :'his scenrio is $ener""y nindiction tht some opertin$ epenses re $ettin$ out of hnd7; 9n emintion of 45 !shions>income sttement su$$ests tht se""in$6 $ener" nd dministrtive epenses6 -hich $re- by &&percent over the pst t-o yers6 cou"d be the cuse of the decresed profitbi"ity7 Becuse thefinnci"s for 45 !shions on"y provide $ener" cte$ories6 it is difficu"t to ssess the cuse of theincrese in this epense cte$ory7

:" 5o! !ell are the company8s assets #eing employed to generate sales re%enue6 $ 'he.sset urno%erratioMS"es 9ver$e 'ot" 9ssetsN indictes the re"tive efficiency -ith -hich mn$ers hve usedthe firm>s ssets to $enerte output6 nd thus6 it he"ps ns-er this +uestion7 Here $in6 -ht iscceptb"e or pproprite vries from industry to industry7 Fsu""y6 ho-ever6 hi$her rtio is better7 9very hi$h turnover rte cou"d si$n" n opportunity for epnsion or the need for er"y rep"cement ofssets7 It cou"d "so men tht the compny is in hi$h4vo"ume6 "o-4mr$in industry7

45 !shions> sset turnover rtio -s 37# times MO603)6(&0 O16(160N for fisc" 200& nd6despite decrese from fisc" 200#6 remins t "eve" comprb"e -ith fisc" yer 20037 'his mens"itt"e by itse"fG but compred -ith the industry ver$e of 371 times6 -e mi$ht conc"ude tht s"esperformnce is probb"y stisfctory for the mount of resources vi"b"e7

.either the profit mr$in nor the sset turnover by itse"f provides n de+ute mesure of opertin$efficiency or profitbi"ity7 But mu"tip"yin$ the profit mr$in by the sset turnover rtio $ives us theAReturn on 9ssets rtio or ernin$s po-er on tot" ssets7 'his rtio is the sme s the R=9computed for the o-ners but is presented in form tht mn$ers often find more usefu"7 It b"ends6 inone number6 "" the mor in$redients of profitbi"ityG yet it ""o-s the mn$er to see ho- the individu"


2)


26/48

components contribute7 'hus6 there re t-o bsic in$redients to profitbi"ityG sset turnover nd profitmr$in7 9n improvement in either 44 -ithout chn$in$ the other 44 -i"" increse the return on ssets7

ht cn mn$ers do to increse the returns on ssets nd o-ners> investmentsP 'he return onssets -i"" increse by either n increse in the sset turnover or n increse in the profit mr$in7'hree seprte items re invo"ved in the c"cu"tion s"es6 net income6 nd ssets7 Ho-ever6 since

net income is simp"y s"es minus epenses6 the three individu" items subect to mn$ement contro"re s"es6 epenses nd ssets7 *ither incresin$ s"es6 decresin$ epenses6 or decresin$ ssets6-hi"e ho"din$ the others constnt6 -i"" improve the R=9 nd -ith it the R=I7 iven 45 !shions> mostrecent finnci" sttement6 it ppers the most fruitfu" efforts -ou"d consist of contro""in$ costs toincrese both profits nd the profit mr$in7

.otice tht it doesn>t re+uire sophisticted n"ysis to come to this conc"usion7 'his i""ustrtes6ho-ever6 one ro"e of finnci" sttement n"ysis to hi$h"i$ht res tht need mn$ement ttention7=nce prob"em res re hi$h"i$hted6 so"utions cn be obvious7 'his is -hy common4sensepproch of incresin$ s"es nd "o-erin$ epenses -or,s to improve profitbi"ity7

;" .re recei%a#les coming in too slo!ly6 $ 'he.%erage ollection PeriodM:9ver$e 9/R 9nnu" CreditS"es; 3&N of receivb"es te""s ho- mny dys6 on ver$e6 customers> trde ccounts :9/R; reoutstndin$7 'he ver$e co""ection period is mesure of both "i+uidity nd performnce7 9s mesure of "i+uidity6 it te""s ho- "on$ it t,es to convert ccounts receivb"e into csh7 9s mesure ofperformnce6 it indictes ho- -e"" the compny is mn$in$ the credit etended to customers7

hether the ver$e co""ection period is too hi$h -i"" depend on -ht ,ind of credit terms thecompny etends to its customers nd ho- pproprite those terms re7 If ccounts re epected tobe pid in 30 dys6 3# dy ver$e -ou"d be considered very $ood7 %ost customers tend to-ithho"d pyment for s "on$ s the credit terms ""o-7 'his prctice6 "on$ -ith some ever4presents"o- ccounts6 cn cuse the ver$e co""ection period to eceed the stted "imit by -ee, to 10dys nd shou"d not be mtter of concern7 9n ver$e co""ection period of #8 dys in this cse6ho-ever6 cou"d be dn$er si$n"7 Customers -ho re s"o- in pyin$ their bi""s6 my never py t ""7

9s the b"nce sheet sho-s6 45 !shions> ccounts receivb"e re insi$nificnt7 'he ver$eco""ection period re"tin$ to "" s"es -s 7& dys M:O(6(8& O603)6(&0; 3&N for 200& nd "ess thnone4h"f dy for ech of the prior t-o yers7 'his rpid turnover of receivb"es is understndb"e6becuse 45 !shions> Acredit s"es re "r$e"y bn, credit crd s"es7 Csh mn$ement in thisre seems to be $ood in tht no time is -sted in $ettin$ credit crd invoices nd person" chec,scredited to the compny>s ccount7

Becuse ccounts receivb"es b"nces for 45 !shions comprise minor portion of the compny>stot" ssets6 this rtio is not prticu"r"y usefu" s csh mn$ement too" to its mn$ers7 9nd6 sstted previous"y6 common4sense pproch to finnci" sttement n"ysis must be mintined7 If6"i,e 45 !shions6 your business hs fe- receivb"es6 then n"ysis of them -ou"d not be -orth-hi"e79nother emp"e is service industries tht hve no inventory7 ith no inventory6 the net section ofn"ysis is irre"evnt7


2$


27/48

s so"vency7

'his rtio is vit" for sm""4business mn$ers -ho must m,e very effective use of the "imited cpit"vi"b"e to them7 Tust -ht is n pproprite turnover rte depends on the industry6 the inventoryitse"f6 nd $ener" economic conditions7 !or emp"e6 the Bro,- Division of usu Epers :inBro,-6 isconsin; often hs one to three yers@ -orth of r- mteri" inventory :"o$s; on hnd7Becuse the rod nd -ether conditions "imit the time -hen -ood cn be received in .orthernisconsin6 usu Epers is forced to hve very s"o- inventory turnover rte for r- mteri"s ttht prticu"r p"nt7 Ho-ever6 finished $oods :cut6 co"ored pper; turn over every 28 dys7

If inventory turnover for the firm is consistent"y much s"o-er thn the ver$e for the industry6 then

inventory stoc,s probb"y re either ecessive"y hi$h or contin "ot of obso"ete items7 *cessiveinventories simp"y tie up funds tht cou"d be used to m,e needed debt pyments or to epndopertions7 9n etreme"y hi$h turnover rte cou"d be si$n of stoc,4outs 44 not bein$ b"e to fi"" customer>s order becuse the $oods re not on hnd7 Ho-ever6 on the positive side6 if neither stoc,4outs nor co""ections re prob"em6 then hi$h rtio cn be $ood7

45 !shions> b"nce sheet "so sho-s tht6 other thn p"nt nd e+uipment6 more do""rs hve beeninvested in inventory thn ny other sset cte$ory7 iven the type of firm6 this is not unusu"7Ho-ever6 the inventory turnover rte for the compny is on"y #7& items per yer MO36&(360(0 O()(680N6 menin$ tht it t,es n ver$e of 817& dys M3& #7&N for the compny to se"" itsinventory once it is purchsed7 'his trns"tes into bout 81 dys of inventory7 Does this indicte toomuch inventory for the rte t -hich it is se""in$P =n the surfce it mi$ht seem ecessive6 considerin$tht inventory b"nces shou"d be t "o- point fter the Christms s"es rush7 9 "oo, t simi"rcompnies6 ho-ever6 reve"s tht 45 !shions> turnover is not much s"o-er thn the industry ver$eof &71 times :or (2 dys;7 *ven -ith this "eve" of inventory6 mn$ement stted in its nnu" report thtthe compny -s b"e to fi"" on"y 82 percent of orders from $oods on hnd7

S&ort2"erm CreditorsShort4term creditors6 inc"udin$ mn$ers -ho etend credit to trde customers6 re interested in the so"vencyof borro-ers or customers7 9s resu"t6 they tend to focus on the current section of the b"nce sheet7 'hesme c"cu"tions tht mn$er does on his/her o-n finnci"s sttements cn "so be done on debtor>s

finnci" sttements7 'he most -ide"y used finnci" rtios used to ns-er +uestions of short4term so"vencyre the current rationd quick ratio7

=" 'oes this customer ha%e sufficient cash or other liquid assets to co%er its short$term o#ligations6 $ 'heurrent RatioMCurrent 9ssets Current 5ibi"itiesN is one of the most fre+uent"y used mesures ofso"vency7 It sho-s the re"tionship bet-een current ssets nd current "ibi"ities7 Current "ibi"ities re


2*


28/48

ob"i$tions tht -i"" come due in the net 12 months7 Current ssets re ssets tht re epected tobe converted to csh in the sme period7 'his rtio is -ide"y used to provide one indiction of -hether prospective customer or borro-er is $ood short4term credit ris,7 9n o"d ru"e4of4thumb sys tht thecurrent rtio shou"d be t "est 270 to provide n de+ute mr$in of sfety7 hether this rtio is hi$henou$h6 ho-ever6 depends on the type of compny invo"ved nd6 to some etent6 on the time of yer7:9ir"ines often hve current rtios under 17;

ht constitutes $ood rtio "so depends on the composition of the current ssets re"tive to the duedtes for the current ob"i$tions7 If inventory m,es up si$nificnt portion of current ssets nd it ismovin$ s"o-"y6 hi$her4thn4ver$e rtio my hide potenti" "i+uidity prob"ems7 'hus6 the +uic, rtioshou"d "so be ev"uted7

'he &uick RatioMCsh K %r,etb"e Securities K 9/R Current 5ibi"itiesN :or acid test; is some-htmore ccurte $uide to short4term so"vency7 'his rtio is the sme s the current rtio ecept tht itec"udes inventory nd prepid epenses 44 the "est "i+uid of the current ssets7 It provides morepenetrtin$ mesure of so"vency thn does the current rtio7 If receivb"es turn over rpid"y6 +uic,rtio of 170 or "itt"e hi$her is probb"y de+ute7 9 $rocery store -i"" often hve +uic, rtios of 72& to 7

&0 nd current rtios tht eceed 27

Suppose -e re supp"ier to 45 !shions7 45 !shions> current rtio t the end of fisc" yer 200&-s 178 times :O160(862#0 O0(6(#0;6 do-n from 273 times the previous yer nd be"o- the industrymedin of 27& times7 Ho-ever6 even if the "test current rtio -ere 273 or better6 it "one -ou"d notprovide us much comfort becuse inventory comprises so much of the compny>s current ssets7

45 !shions> "test +uic, rtio is 7& times :O28#6(30 O((6(#0; compred -ith n industry ver$eof 170 times7 'his is more strin$ent nd v"id test of "i+uidity in this cse7 If the rtio is t "est 170times :-hich mens tht "i+uid ssets e+u" current "ibi"ities;6 -e cn usu""y ssume tht thecompny hs fe- short4term pyment prob"ems7 9t 7& times6 ho-ever6 -e -ou"d -nt to "oo, t otherindictors of future csh f"o-s7 9ny sm"" compny -ith these ,inds of numbers my be re+uired bycreditors to provide short4term proection of future csh receipts nd disbursements7

>" 5o! quickly does the prospecti%e credit customer pay its #ills6 $ Suppose tht6 on b"nce6 -e findthe compny>s short4term so"vency to be cceptb"e7 Before $reein$ to supp"y the compny on credit bsis :or estb"ishin$ credit terms for the compny;6 -e shou"d try to determine ho- +uic,"y thecompny norm""y pys its bi""s7 'he.%erage .ge of Paya#lesM:9ver$e Eyb"e .et Eurchses; 3&N he"ps ns-er this +uestion7 'ht is6 hvin$ determined tht compny hs the cpcity to pyits short4term ob"i$tions s they come due :throu$h the current or +uic, rtios;6 it is "so importnt toev"ute its pyment prctice7 In mnner simi"r to c"cu"tin$ the ver$e co""ection period forccounts receivb"e6 one cn compute the ver$e A$e of compny>s pyb"e6 -hich is thever$e number of dys it t,es to py its invoices7 'he $e of the potenti" customer>s pyb"e -i""$ive resonb"e estimte of ho- soon creditor cn epect to be pid7 'his is prticu"r"y importntfor the sm"" business tht hs ust "nded mor customer7

9 "r$e corportion is "i,e"y to use very effective :from its o-n stndpoint; csh mn$ementprocedures to ensure prompt pyment from its customers -hi"e de"yin$ pyment to its supp"iers s


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"on$ s possib"e7 Fn"ess the sm"" business is critic" supp"er of its "r$e corporte customer6 thtcorportion my not cce"erte its pyment cyc"e to meet the supp"ier>s csh f"o- needs7 'ht>s -hy itis critic""y importnt for the decision4m,in$ process of the sm""4business o-ner/mn$er to be b"eto estimte the potenti" customer>s pyment cyc"e7

'o c"cu"te the ver$e $e of pyb"es for 45 !shions6 -e need to estimte purchses becuse

they re not reported direct"y in the sttements7 Cost of $oods so"d :-hich is on the incomesttement; e+u"s be$innin$ inventory6 p"us net purchses6 minus endin$ inventory7 'herefore6purchses e+u" the cost of $oods so"d :O36&(360(0; minus be$innin$ inventory O8&(60)0; p"us endin$inventory :O(38630;6 or bout O36# Fsin$ this c"cu"tion6 -e cn c"cu"te tht the ver$e$e of 45 !shions> pyb"es is M:O311600 O36# 3&N J 327) dys7 If 45 !shions -ere potenti" customer6 -e shou"d not epect it to py our invoices much sooner thn 33 dys7

,ong2"erm CreditorsBn,ers nd other "on$4term creditors -nt to be ssured of receivin$ interest nd princip" -hen echbecome due7 'hese creditors re prticu"r"y interested in the ernin$ po-er nd the present nd future

finnci" cpcity of the borro-er7

?" .s a potential or present long$term #orro!er2 is the company8s de#t load e0cessi%e6 $ If the compny>sdebt "od is too hi$h 44 it is hi$h"y "ever$ed 44 it mens tht creditors of the firm hve disproportionte"y hi$h shre6 nd o-ners hve disproportionte"y "o- shre6 of the inherent ris, ofbein$ in business7 9 simp"e mesure of the Aris, "on is the 'e#t$to$Equity ('@E)M'ot" Debt 'ot"*+uityN rtio7 'his rtio re"tes the investment provided by creditors to tht provided by o-ners7 Itindictes -ho is the mor ris,4berer in this business7 'ht is6 if the D/* rtio is 1016 it mens thtcreditors hve O10 invested in this business for every O1 tht the o-ner hs invested7 Since the o-neris m,in$ the decisions6 the creditor in this cse is in n etreme"y precrious position7 'he creditorsin this cse stnd to "ose 10 times s muchs the compny>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 rtio is 1106 it mens tht the o-ner hs more to "ose7 'he creditors for this type ofcompny -ou"d fee" sfer ,no-in$ the o-ner hs bi$$er person" st,e7 !rom creditor>sstndpoint6 "o-er D/* rtio is better7 9 "on$4term creditor tends to be s,eptic" of borro-ers> $oodintentions or ud$ment -hen the compny is hi$h"y "ever$ed or is see,in$ ne- funds tht -i"" cuse itto become hi$h"y "ever$ed7 =-ners shou"d use this rtio to vie- their compnies s "on$4termcreditor -ou"d6 nd shou"d see, to ,eep the debt4to4e+uity re"tionship -ithin industry norms7

45 !shions> D/* is 7 :O8&6(#0 O1618620;6 compred -ith medin D/* of 7 for the industry7'his -ou"d norm""y indicte re"tive finnci" stren$th7 Ho-ever6 -e shou"d note tht those "ibi"ities

tht do not need to be pid or sett"ed in the ner term6 constitute on"y bout 11 percent of tot""ibi"ities7 *cept for dvnce pyments on orders the other 8) percent re short4term ob"i$tions7Conse+uent"y6 this rtio is "ess importnt in this cse thn the short4term so"vency mesures 44 even tothe compny>s "on$4term creditors7 'his reinforces the concept tht rtio n"ysis shou"d be pp"ied-ith common sense7


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4A" .re earnings and cash flo! sufficient to co%er interest payments and pro%ide for some principalrepayment6- 'he imes Interest Earned (IE)MIncome K :Interest K 'es; Interest *penseN rtiomy be used to he"p ns-er this +uestion7 .ote tht this rtio uses income before interest nd incometes re subtrcted becuse this is the mount of income vi"b"e to cover interest7 'he "r$er thenumber6 the esier it -i"" be for the debtor compny to suffer n ernin$s depression6 nd sti"" m,e itsinterest pyments7 'he 'I* mesures the bn,>s sfety in terms of the "i,e"ihood tht it -i"" continue to

receive periodic interest pyments7 'he 'I* does not6 ho-ever6 indicte ho- -e"" totaldebt pymentsre covered7

'he ash Flo! to otal +ia#ilities M=pertin$ Csh !"o- 'ot" 5ibi"itiesN rtio is preferred by mnybn,ers s mesure of ernin$s po-er re"tive to "" debt7 'his debt cover$e rtio depicts compny>s debt repyment cpbi"ity nd is one of the more importnt indees of "on$4term so"vency7'he csh f"o- fi$ure in the numertor refers to net csh provided by opertions s reported on thesttement of csh f"o-s in !i$ure 27 !or sm"" compnies tht don>t prepre csh f"o- sttement6opertin$ csh f"o- cn be estimted by t,in$ income before interest nd tes nd ddin$ bc,deprecition nd other si$nificnt non4csh chr$es7

'he industry ver$e for this rtio is not "i,e"y to serve s prticu"r"y usefu" benchmr,7 Bn,ersre more interested in the trend of the rtio7 Incresin$ "eve"s of debt -ithout commensurteincreses in csh $enerted by profitb"e opertions is sure si$n of finnci" prob"ems hed7 'hiscou"d occur if the R=9 is "ess then the borro-in$ rte7

45 !shions> ernin$s before interest nd tes is O2&)6106 compred -ith interest epense ofO1061807 'hus6 its interest cover$e in terms of the times interest erned rtio is 2&7& times MO2&)610 O106180N7 9"thou$h this rtio hs dec"ined substnti""y over the pst three yers6 it hs not dec"ineds shrp"y s ernin$s becuse interest chr$es hve dec"ined7 !urthermore6 it is sti"" +uite "r$e6indictin$ to creditors tht interest pyments re -e"" covered7

45 !shions> csh f"o- sttement sho-s tht net csh provided by opertions durin$ fisc" yer 200&-s O&1260206 substnti" increse over both 200# nd 20037 Compred to the do-n-rd trend innet income6 the csh f"o- from opertions su$$ests the compny hs been reportin$ "r$e mountof non4csh epenses "i,e deprecition nd morti


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"&ree Case Studiesase 4 Is a critical supplier in good financial condition6

9 mn$er shou"d not over"oo, the use of finnci" sttement dt in se"ectin$ ,ey supp"iers of r- mteri"nd component prts if the informtion is vi"b"e7 !or sm"" compnies tht depend upon other compnies

for critic" r- mteri"s or merchndise6 the bi"ity to determine the vi"bi"ity of those items cou"d men thedifference bet-een success nd fi"ure7 'his is prticu"r"y importnt for the sm""er compnies tht do nothve the purchsin$ c"out of their "r$er competitors7 ?et this is one of the most over"oo,ed spects ofinventory mn$ement in most compnies7

=ne of the ,ey criteri to consider in ev"utin$ potenti" or eistin$ supp"iers is finnci" he"th7 Fn"ess supp"er hs styin$ po-er6 "" of its other fine +u"ities -on>t men much7 Here -e "oo, to the supp"ier>sfinnci" sttements for some ns-ers7 !our esi"y obtinb"e rtios re probb"y sufficient to ev"ute supp"ier>s finnci" he"th de+ute"y (4) profit margin6 (7) in%entory turno%er6 (9) quick rationd (:) de#t$to$equity7

'heprofit margin:return on s"es; shou"d be used in ev"utin$ supp"ier the sme -y it -s used toev"ute the mn$er>s o-n compny7 It shou"d be compred -ith other compnies in the industry to ev"utethe supp"ier>s re"tive opertin$ efficiency7 %ore importnt6 ho-ever6 is to "oo, t the trend of this rtio7 *ven ifthe current yer>s profit mr$in is -ithin industry norms6 dec"inin$ rtio cou"d indicte tht the supp"ier isfcin$ serious competition or even finnci" crisis7

'he in%entory turno%er ratiocn be used to determine -hether the supp"ier>s inventories re movin$6 on theone hnd6 nd -hether its inventory "eve"s my be too "o-6 on the other7 9 ,ey is to consider the industryver$e7 9 "o- turnover cou"d indicte tht inventory is not movin$6 "edin$ to future "i+uidity crisis7 9neception""y hi$h turnover cou"d indicte tht the supp"ier is mintinin$ very "o- inventory "eve"s6 -hich cou"dmen tht $oods -i"" not be vi"b"e -hen mn$er orders them7

'he observtion tht hi$h turnover cou"d be either $ood or bd reinforces the point tht rtio computtion is thestrtin$ point for finnci" sttement n"ysis 44 not the fin" point7 =ut4of4"ine rtios re Ared f"$s tht c"" forn ep"ntion7 9ny rtio tht is too hi$h or too "o- needs to be emined c"ose"y for its cuses7

'he quicknd de#t$to$equity ratiosre used etensive"y by short4term creditors nd "on$4term creditors6respective"y6 to ssess debtor>s "i+uidity nd debt structure7 9"thou$h -e re not concerned -ith bein$ pidon time by the supp"ier6 -e -nt resonb"e ssurnce tht the supp"ier cn dischr$e his finnci" ob"i$tions6both short4term s -e"" s "on$4term6 nd -i"" not be forced into bn,ruptcy7 9s noted er"ier6 the current rtioprovides on"y rou$h mesure of the supp"ier>s short4term debt pyin$ bi"ity7 'he +uic, rtio is better testnd usu""y is ust s esi"y obtinb"e from the supp"ier>s b"nce sheet7 Csh nd csh e+uiv"ents

:mr,etb"e securities;6 p"us receivb"es6 re fre+uent"y "isted seprte"y mon$ the current ssets7 !or thispurpose6 -e -ou"d be stisfied -ith +uic, rtio of 170 or hi$her6 or t "est e+u" to the industry norm7'he de#t$to$equity ratioprovides n indiction of ho- hevi"y the supp"ier is in debt6 re"tive to the mount ofcpit" provided by the o-ners7 'he hi$her the rtio6 the more concerned one shou"d be bout the "on$4term


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-e"fre of the supp"ier7 9s customer6 -e probb"y -ou"dn>t be too concerned s "on$ s the supp"ier>s D/*rtio is "ess thn 100 percent6 -hich -ou"d indicte e+u" mounts of debt nd e+uity cpit"7

Ho- -ou"d -e ssess 45 !shions if it -ere potenti" supp"ier or r- mteri"s or component prts instedof direct mi" reti"erP If -e -nt to estb"ish re"tionship -ith this compny nd re"y on it to m,e time"yde"iveries of critic" items -e -nt to be sure it is in $ood finnci" condition7 e hve su$$ested four rtios

tht shou"d be de+ute for this purpose theprofit margin6 in%entory turno%er6 quick rationd de#t$to$equityratio7 Becuse -e hve c"cu"ted these rtios "redy6 -e -i"" simp"y comment on them in the presentcontet7

Rec"" tht theprofit margin-s be"o- ver$e for the type of compny invo"ved nd -s dec"inin$7 5oo,in$t this mesure "one6 one mi$ht conc"ude tht the supp"ier -i"" soon be fcin$ serious finnci" crisis7Ho-ever6 the in%entory turno%er ratio-s on"y s"i$ht"y be"o- the industry ver$e nd does not sho- definitetrend7 Sti""6 the inventory hs been turnin$ over on"y once every 80 dys or so7 'his re"tive"y "o- turnoverrtio ppers to be due primri"y to hi$her4thn4ver$e "eve" of inventory s percent of tot" ssets7 'hiscou"d be vie-ed s fvorb"e from our stndpoint s customer6 since hi$h inventory "eve"s shou"d resu"t infe-er bc, orders7 Ho-ever6 hi$h "eve"s of s"o- movin$ inventories reduce the "i+uidity of compny>s current

ssets nd -or,in$ cpit"7

'he quick ratioof 7& times is substnti""y be"o- the industry ver$e 44 nd the $ener" benchmr, 44 of 170times7 Since -e re customer in this cse6 -e re not concerned bout bein$ pid by this compnyG but -emi$ht -onder bout the compny>s bi"ity to dischr$e its short4term debts s they come due7 =n the otherhnd6 the de#t$to$equity ratioof 7 times indictes tht the compny is not hi$h"y "ever$ed nd sti"" hs firmount of finnci" f"eibi"ity7 'he compny cn probb"y obtin ddition" "on$4term funds to m,e up forner4term shortf""s7 So6 -hi"e the first three rtios indicte tht our potenti" supp"ier my be fcin$ "i+uiditys+uees "i+uidity nd profitbi"ity44prticu"r"y recent trends in these mesures44it ispossib"e tht mn$ement hs everythin$ under contro"7 'he point of the i""ustrtion is tht mn$ers cn usertio nd trend n"ysis to uncover dn$er si$ns nd to point to res tht need ttention7


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ase 7 hen sales decline2 !hat can I do to !eather the storm6 an I do anything to change it around6 $!or this cse6 there re t-o brod +uestions to emine

:1; 5oo,in$ bc,6 did ny of mn$ement>s decisions cuse the do-nturnP:2; 5oo,in$ for-rd6 -ht cn mn$ement do to $et throu$h the s"ump6 nd -ht cn mn$ement do

to reverse the s"umpP

In the previous cse6 finnci" sttement n"ysis -s used to ns-er +uestion nd he"p m,e decision7!or this cse6 -e use finnci" sttement n"ysis to he"p mn$e the crisis6 or point to sources for possib"eintervention7

ht cused s"es to $o do-nP =bvious"y6 etern" fctors cn cuse s"es s"umps7 Ho-ever6 it shou"d bee+u""y obvious tht mn$ement>s decisions cn "so ffect s"es7 here do these sho- up in finnci"sttement n"ysisP

S"es returns 9"thou$h not discussed bove6 if s"es returns s percent$e of s"es increses6 it cou"d

be si$n of poor product +u"ity or $ener" customer disstisfction7 If product +u"ity diminishes6 you

cou"d be "osin$ not ust the current s"es6 but "so s"es -e"" into the future7 If you find tht you re sendin$more r- mteri"s or products bc, to your supp"ier6 it cou"d men tht too mny inferior items res"ippin$ throu$h6 nd the +u"ity of products you m,e or se"" is sufferin$7 5ost s"es due to poor +u"ityproducts cn be very hrd to turn round7

.et profit mr$in hi"e it>s "-ys nice to hve hi$h net profit mr$in6 profit mr$in tht $ro-s too

+uic,"y cou"d be si$n" tht some finnci" corners hve been cut7 !or emp"e6 continuin$ -ith thes"es return discussion6 you cou"d sve money by buyin$ cheper $oods7 'his -ou"d sho- up s "o-ercost of $oods so"d6 nd hi$her mr$in7 Ho-ever6 cheper $oods cou"d then resu"t in disstisfiedcustomers nd "ost s"es7 ?ou cou"d "so increse the profit mr$in by cuttin$ dvertisin$ epense7 'hismy "so resu"t in "o-er s"es7 !in""y6 hi$h profit mr$in cou"d be si$n tht prices re rtifici""y hi$h7

9ccounts receivb"e turnover It>s nice to hve fst turnover of receivb"es7 Ho-ever6 "i,e the profit

mr$in6 turnover rtio tht chn$es too drmtic""y or too fst6 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 emp"e6 9mericn*press re+uires the tot" b"nces on its chr$e crds to be pid upon receipt of the invoice7 9s resu"tof this po"icy6 some customers prefer to py -ith Vis6 -hich ""o-s periodic repyment6 rther thn -ith9mericn *press7 In 9mericn *press> cse6 their repyment po"icy mi$ht improve co""ections6 but it"so my resu"t in "ost s"es7

5oo,in$ for-rd6 -ht cn mn$ement do to correct the dec"inin$ s"es ptternP =bvious"y6 the first tc,-ou"d be to fi ny prob"ems identified by the previous n"ysis7 Ho-ever6 if this yie"ds "itt"e he"p6 there re

other thin$s mn$ement cn do7

Inventory turnover 'his is perhps the most importnt rtio to monitor -hen s"es dec"ine7 By effective"y

mn$in$ inventory "eve"s6 mn$er cn minimi


34/48

buy nd ho"d inventory6 mintinin$ or incresin$ inventory turnover :by buyin$ "ess nd "ettin$ the stoc,run do-n; cn sve money nd prevent "osses7

ase 9 I can8t pay my #ills on time" hat should I do first6

9s in Cse 26 -e cn "oo, to the finnci" sttements for cuses nd cures7 ?ou my hve "i+uidity prob"em if

the current nd +uic, rtios re too "o-7 'he cuses of csh f"o- prob"ems inc"ude dec"inin$ s"es6 poorpricin$6 poor ccounts receivb"e turnover nd poor inventory turnover7 Eoor inventory turnover "so mensyou re buyin$ inventory6 but tht inventory isn>t se""in$ +uic,"y enou$h7

.et profit mr$in 5oo,in$ t the net profit mr$in cn $ive you insi$hts on -hether or not the product is

priced de+ute"y to cover overhed epenses7 In the 45 !shions cse6 s"es -ere incresin$6 but theprofit mr$in -s decresin$7 If the product is priced too "o-6 then s"es revenues my not be sufficient tocover "" of the other opertin$ epenses6 "i,e dvertisin$6 s"ries6 etc7

Inventory turnover *ven sm"" chn$es in turnover rtios cn hve si$nificnt impct on the ernin$s of

compny7 !or emp"e6 in the 45 !shions i""ustrtion6 inventory turned over every 817& dys7 If 45

!shions cou"d reduce inventory nd reduce turnover to the industry ver$e of (2 dys6 then ver$einventory -ou"d dec"ine to O(0#682& M(2 dys O36&(370(0 :cost of $oods;/3& dys J O(0#682&N fromO()(6807 'ht mounts to O)3603& tht cou"d be invested e"se-here nd sve O)630# in interest costs:usin$ 10 percent interest rte;7

9ccounts pyb"e turnover Simi"r"y6 the ccounts pyb"e turnover is present"y 33 dys7 If 45 !shions

s"o-s pyment do-n by ust one dy6 ver$e ccounts pyb"e -ou"d rise to O3216()) M3# dys O36# :purchses;/3& J O3216())N from O3116007 'he difference of O106(3) trns"tes into O160(# interest svin$s7

'o improve csh f"o- from receivb"es -ithout dustin$ your credit or co""ection po"icy6 consider borro-in$

$inst the receivb"es throu$h n ssi$nment or fctorin$ rrn$ement7


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35/48

Figure 9+ Summary "a-le o$ Financial Ratios

Ratio Formula /&at it measures /&at it tells you

>wners(Return on Investment

:R=I;

.et Income9ver$e =-ners> *+uity Return on o-ners>

cpit"hen compred -ithreturn on ssets6 itmesures the etent to-hich finnci" "ever$eis bein$ used for or$inst the o-ner7

Ho- -e"" is this compny

doin$ s n investmentP

Return on 9ssets:R=9;

.et Income9ver$e 'ot" 9ssets

Ho- -e"" ssets hvebeen emp"oyed bymn$ement7

Ho- -e"" hsmn$ement emp"oyedcompny ssetsP Does it

py to borro-P%anagers(.et Erofit %r$in

.et IncomeS"es =pertin$ efficiency7

'he bi"ity to cretesufficient profits fromopertin$ ctivities7

9re profits hi$h enou$h6$iven the "eve" of s"esP

9sset 'urnover S"es9ver$e 'ot" 9ssets

Re"tive efficiency inusin$ tot" resources toproduct output7

Ho- -e"" re ssetsbein$ used to $enertes"es revenueP

Return on 9ssets .et Income S"es S"es 'ot" 9ssets

*rnin$ po-er on ""ssetsG R=9 rtio bro,eninto its "o$ic" prtsturnover nd mr$in7

Ho- -e"" hsmn$ement emp"oyedcompny ssetsP

9ver$e Co""ectionEeriod

9ver$e 9/R 3&9nnu" Credit S"es

5i+uidity of receivb"es interms of ver$enumber of dysreceivb"es reoutstndin$7

9re receivb"es comin$ intoo s"o-"yP

Inventory 'urnover Cost of oods So"d *pense 9ver$e Inventory

5i+uidity of inventoryG thenumber of times it turnsover per yer7

Is too much csh tied upin inventoriesP

9ver$e 9$e of 9ver$e 9/E 3& 9pproimte "en$th of Ho- +uic,"y does


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Eyb"es .et Eurchses time firm t,es to pyits bi""s for trdepurchses7

prospective customer pyits bi""sP

S&ort2"erm Creditorsor,in$ Cpit" Current 9ssets

Current 5ibi"itiesShort4term debt4pyin$bi"ity7

Does this customer hvesufficient csh or other

"i+uid ssets to cover itsshort4term ob"i$tionsP

Current Rtio Current 9ssetsCurrent 5ibi"ities

Short4term debt4pyin$bi"ity -ithout re$rd tothe "i+uidity of currentssets7

Does this customer hvesufficient csh or other"i+uid ssets to cover itsshort4term ob"i$tionsP

uic, Rtio CshK%,tb"e Sec7K9/R Current 5ibi"ities

Short4term debt4pyin$bi"ity -ithout hvin$ tore"y on s"e of inventory7

Does this customer hvesufficient csh or other"i+uid ssets to cover its

short4term ob"i$tionsP

,ong2"erm Creditors(Debt4to4*+uity Rtio

'ot" Debt'ot" *+uity

9mount of ssetsprovided by creditors forech do""r of ssetsprovided by o-ner:s;

Is the compny>s debt"od ecessiveP

'imes Interest *rned .et IncomeK:InterestK'es; Interest *pense

9bi"ity to py fiedchr$es for interest fromopertin$ profits7

9re ernin$s nd cshf"o-s sufficient to coverinterest pyments ndsome princip"repymentsP

Csh !"o- to 5ibi"ities =pertin$ Csh !"o- 'ot" 5ibi"ities

'ot" debt cover$e7ener" debt4pyin$bi"ity7

9re ernin$s nd cshf"o-s sufficient to coverinterest pyments ndsome princip"repyments


($


37/48

Figure ?+ 72, Fas&ions' #nc+ Financial Statements#ncome Statement

For t&e year ended @anuary 49(

Dollars in t&ousands! ?


38/48


39/48

Figure ?+ 72, Fas&ions' #nc+ Financial Statements

Statement o$ Cas& Flows%aor component totals only!For t&e year ended @anuary 49(

Dollars in t&ousands!

?


40/48

Additional Readings

'hese redin$s re intended to ccompny A!innci" Sttements s %n$ement 'oo"6 n rtic"e from theSm"" Business !orum6 nd re intended to supp"ement6 not contrdict or "ter the informtion contined in theSm"" Business !orum rtic"e7

17 Fnco""ectib"e .otes nd Receivb"es%ost reti" compnies :nd some service compnies s -e""; m,e "r$e portion of their s"es on ccountrther thn for csh7 Sometimes6 -hen customer f""s behind in the pyment of their chr$es6 they my s,for note to $ive them "on$er time to repy the debt7 hether these unpid ccounts re he"d sreceivb"es or s notes6 they need to be ccounted for nd eventu""y discounted7 'here re t-o methods ofccountin$ for receivb"es tht re thou$ht to be unco""ectib"e7 'he allo!ance methodprovides in dvnce forthem6 nd the direct !rite$off (or charge$off) methodreco$ni


41/48


42/48


43/48

=n the other hnd6 firm C hs the hi$hest fied costs7 It is hi$h"y utomted6 usin$ epensive6 hi$h4speedmchines tht re+uire very "itt"e "bor per unit produced7 ith such n opertion6 its vrib"e costs rise s"o-"y7Becuse of the hi$h overhed resu"tin$ from chr$es ssocited -ith the epensive mchinery6 firm C>s bre,4even point is hi$her thn tht for either firm 9 or firm B7 =nce firm C reches its bre,4even point6 ho-ever6 itsprofits rise fster thn do those of the other firms7

(7 5imittion of Bre,4even 9n"ysisBre,4even n"ysis is usefu" in studyin$ the re"tions mon$ vo"ume6 prices6 nd costsG it is thus he"pfu" inpricin$6 cost contro"6 nd decisions bout "terntive epnsion pro$rms7 It hs "imittions6 ho-ever6 s $uide to mn$eri" ctions7

5iner bre,4even n"ysis is especi""y -e, in -ht it imp"ies bout the s"es possibi"ities for the firm7 9ny"iner bre,4even chrt is bsed on constnt s"es price7 'herefore6 in order to study profit possibi"ities underdifferent prices6 -ho"e series of chrts is necessry6 one chrt for ech price7

ith re$rd to costs6 bre,4even n"ysis is "so deficient44the re"tions indicted by the chrt do not ho"d t ""outputs7 9s s"es increse6 eistin$ p"nt nd e+uipment re -or,ed to cpcityG both this sitution nd the

use of ddition" -or,ers nd overtime py cuse vrib"e costs to rise shrp"y7 9ddition" e+uipment ndp"nt spce re re+uired6 thus incresin$ fied costs7 !in""y6 over period 6the products so"d by the firmchn$e in +u"ity nd +untity7 Such chn$es in product mi inf"uence the "eve" nd s"ope of the cost function75iner bre,4even n"ysis is usefu" s first step in deve"opin$ the bsic dt re+uired for pricin$ nd forfinnci" decisions7 But more deti"ed n"ysis is re+uired before fin" ud$ments cn be mde7


4(


44/48

2#0 !irm 9 F#GER) 4+Se""in$ Erice J O2700

200 !ied Costs J O206000Vrib"e Costs JO17&0 &

10 Income Fnits so"d:; S"es Costs Erofit

120 'ot" costs 206000 O #06000 O &06000 4O106000 80 #06000 806000 806000 0

Bre,4even point 06000 1206000 1106000 106000 #0 !ied costs 806000 106000 1#06000 206000

1006000 2006000 1(06000 306000 0 1206000 2#06000 2006000 #06000 20 #0 0 80 100 120

Fnits :&;Income nd Costs2#0 !irm B

Se""in$ Erice J O2700200 !ied Costs J O#06000Vrib"e Costs JO1720 &


120 'ot" costs206000 O #06000 O #6000 4O2#6000

80 Bre,4even point #06000 806000 886000 4 8600006000 1206000 1126000 86000

#0 !ied costs 806000 106000 136000 2#6000 1006000 2006000 106000 #06000

0 1206000 2#06000 18#6000 &6000 20 #0 0 80 100 120

2#0 !irm CSe""in$ Erice J O2700

200 !ied Costs J O06000Vrib"e Costs JO1700 &


120 'ot" costs Bre,4even point 206000 O #06000 O 806000 4O#06000

80 #06000 806000 1006000 4 206000!ied costs 06000 1206000 1206000 0

#0 806000 106000 1#06000 206000 1006000 2006000 106000 #06000

0 1206000 2#06000 1806000 06000 20 #0 0 80 100 120


44


45/48

Figure + 2 Sample Cas& Flow Statement wit&out num-ers!(

Cas& $lows $rom operations

Csh inf"o-s received from customers.et s"es O6

5ess chn$e in ccounts receivb"e 4 6Csh inf"o-s received from customers O6Csh pid to supp"iersCost of $oods so"d O6

E"us chn$e in inventory 6 5ess chn$e in ccounts pyb"e 4 6

Csh pid to supp"iers O6=ther opertin$ csh outf"o-s nd interest pyments%r,etin$ epenses O 6

ener" nd dministrtive epenses 6 5ess chn$e in ccrued epenses 4

Interest epense 6 5ess chn$e in interest pyb"e 4 =ther opertin$ csh outf"o-s nd interest pyments O6

Csh t pymentsErovision for tes in the income sttement O 6

5ess chn$e in ccrued tes 4 6Csh t pyments O 6

"otal cas& $lows $rom operations O 6

Cas& $lows 222 investment activities

Eurchse of fied ssetsO 6

Eurchse of other current ssets Eurchse of ptents 6

Net cas& used $or investments O6

Cas& $lows 222 $inancing activities

Eroceeds from "on$4term debtO 6

Common stoc, dividends 4 6Net cas& provided used! -y $inancing activities O 6

"otal cas& $lows c&ange in cas& in -alance s&eets! O 6


4)


46/48

Conclusion

Compi"in$6 n"y


47/48

Sources o$ Financial Analysis #n$ormation

Informtion from SB9 on understndin$ finnci" sttements7 Inc"udes SB9>s temp"tes7http//---7sb7$ov/mn$in$/finncin$/sttement7htm"

he Interpretation of Financial Statements6 Benmin =7 rhm6 Spencer B7 %eredith7

he .nalysis and 3se of Financial Statements6 er"d I7 hite6 9sh-inpu" C7 Sondhi6 Him D7 !ried7

Securities nd *chn$e Commission sec7$ov/ed$r7htm"

!innci" nd =pertin$ Resu"ts of Deprtment nd Speci"ty Stores6 pub"ished by the .tion" Reti"%erchnts 9ssocition7 'his is n nnu" "ist of deti"ed finnci" informtion7

Stndrd nd Eoor>s industry reports for fee stndrdndpoors7comis7 Some co""e$es nd universities myhve subscription7

.tion" Venture Cpit" 9ssocition nvc7or$

Securitiesdt7com

Ero+uest Direct

V"ue 5ine Investment Survey

=ffici" uide to 9mericn Incomes

Consumer *penditure Survey

!eder" Reserve Bu""etin

Interntion" !innci" Sttistics

B"oomber$ Dtbse

*conomy7com hs "in,s to ner"y mi""ion sources of economic nd finnci" dt on industries6 consumers6nd $overnment sttistics7economy7com/free"unch/

9ctive %oney6 provided by the Co"umbus *nterprise Deve"opment Corportion7 9ctive %oney t,es one

throu$h the process of bui"din$ finnci" proections in c"er nd simp"e-y7cedcorp7com/ctivemoney/strtWcd7htm

entre-or"dis the uffmn Center for *ntrepreneuri" 5edership6 -hich provides vriety of resources6inc"udin$ the finnci" benchmr,in$ system t7businesse,$7com


4*
http://www.sba.gov/managing/financing/statement.htmlhttp://www.sec.gov/edgar.htmlhttp://www.standardandpoors.com/http://www.nvca.org/http://www.economy.com/freelunch/http://www.economy.com/freelunch/http://www.cedcorp.com/activemoney/start_cd.htmhttp://www.entreworld/http://www.businessekg.com/http://www.businessekg.com/http://www.sba.gov/managing/financing/statement.htmlhttp://www.sec.gov/edgar.htmlhttp://www.standardandpoors.com/http://www.nvca.org/http://www.economy.com/freelunch/http://www.cedcorp.com/activemoney/start_cd.htmhttp://www.entreworld/http://www.businessekg.com/


48/48

Ertt>s uide to Venture Cpit" Sources is pub"ished by Venture *conomics7 'his is "ist of venture cpit"compnies6 "on$ -ith their investment criteri nd res of focus7

bn,rte7comprovides informtion on bn, "endin$6 current rtes nd credit crds7

too",it7cch7comis the Commerce C"erin$ House6 -hich provides mode" spredsheets6 smp"e business p"ns6

reports6 nd "e$" nd t informtion7

moneyhunter7com

Dun Q Brdstreet http//---7dnb7com/us/nd http//sm""business7dnb7com/

R%9 :Ris, %n$ement 9ssocition; 9nnu" Sttement Studies http//---7rmh+7or$/

Studyfinnce7com provides free6 se"f4pced tutori" on bsic finnci" sttements7 It introduces bsicfinnci" sttements nd finnci" sttement concepts7

omen>s Business Deve"opment Center tutori"6 Fnderstndin$ Bsic !innci" Sttementshttp//---7on"ine-bc7$ov/docs/finnce/fsWintro7htm"

9mericn *press http//home37mericnepress7com/sm""business/5ndin$/informyourdecisions7spPopenWhomeJinformbhedQopenWpthomeJrtdiscW$button

Intern" Revenue Service Inc"udes n on"ine c"ssroom for their Sm"" Business ' or,shophttp//---7irs7$ov/businesses/sm""/inde7htm"

IRS Sm"" Business ' or,shop "octions in !"oridhttp//---7irs7$ov/businesses/sm""/rtic"e/066idJ))(6007htm"
http://www.bankrate.com/http://www.toolkit.cch.com/http://www.moneyhunter.com/http://www.dnb.com/us/http://www.bankrate.com/http://www.toolkit.cch.com/http://www.moneyhunter.com/http://www.dnb.com/us/

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