FINC 3620 exam 3
What are the three traditional pro forma statements for a for-profit business?
1. Pro forma income statement 2. Pro forma balance sheet 3. Pro forma statement of cashflows
Breakeven price
= Fixed cost per unit + Variable cost per unit where Fixed cost per unit = Fixed costs ÷ Units
Breakeven revenue
= Total fixed costs ÷ Gross margin where Gross margin = Gross profit ÷ Net sales or Gross margin = Unit contribution ÷ Price
Breakeven sales unit
= Total fixed costs ÷ Unit contribution where Unit contribution = Price - Variable cost per unit
Financial Statement Analysis
Application of analytical tools to general-purpose financial statements and related data for making business decisions.
Accounts receivable turnover ratio
The accounts receivable turnover ratio allows us to determine how fast acompany is turning its credit sales into cash. The ratio involves two formulas:Accounts receivable turnover = Credit sales ÷ Average net accounts receivablewhere
debt to total assets ratio
The debt-to-total assets ratio indicates what percentage of a business's assetsare owned by its creditors. The formula is as follows:Debt to total assets = Total liabilities ÷ Total assets
Pro Forma Financial Statements and Potential Investors and Lenders
The pro forma financial statements and schedules that should be shared with an interested investor or lender include, at minimum: the list of assumptions, the pre-revenue and post-revenue balance sheets, the income statements for all periods. list of assumptions should be shared with potential investors and lenders because it explains the research and logic behind all the number
What detail schedules typically need to be created in conjunction with the creation of pro forma financial statements?
The schedule of start-up costs
Describe what a schedule of start-up costs is and how it is created.
The schedule of start-up costs shows all the expenses a business will incur prior to their first sale This schedule is based on industry research which evaluates the size and complexity of the industry the business is trying to enter.
time-interest earned ratio
The times-interest-earned ratio illustrates the relationship between theamount of interest a company must pay its creditors on an annual basis and a com-pany's annual operating income. Here's the formula: Times interest earned = Operating income ÷ Interest
Read this article and list the top 8 reasons for the importance of ratio analysis.
The top 8 reasons for the importance of ratio analysis are Analysis of Financial Statements, Helps in understanding the Profitability of a Company, Analysis of operational efficiency of the firms, Liquidity of firms, Helps in identifying the business risks of the firm, Helps in identifying the financial risks of the company, For planning and future forecasting of the firm, and To compare the performance of the firms.
What are 3 examples of a fixed cost and 3 examples of a variable cost for this business?
Three examples of variable costs for a business are raw materials, shipping costs, and commissions. Three examples of fixed costs are rent, salaries, and utility bills.
Explain the two categories into which costs are ultimately grouped for purposes of breakeven analysis and why they're categorized in this manner
Variable and Fixed costs are the two costs that are grouped for breakeven analysis. Why?Because on both a total and per unit basis - they act opposite of each other in response tochanges in the number of units produced or sold. Cant calculate Unit contribution withoutvariable costs and you cant calculate Breakeven sales units without fixed costs
Vertical Analysis of an Income Statement
Vertical analysis is the process of using a single line item on a financial statement as a constant and determining how all the other line items relate as a percentage of that constant.
Vertical Analysis of a balance sheet
Vertical analysis of a balance sheet is carried out by using total assets as a constant and dividing every figure on the balance sheet by total assets:
Working Capital
Working capital is thecapital required to sustain operations and support business growth after a company'sstart-up phase.Working capital is calculated by subtracting a company's current liabilities fromits current assets,
Good source publications for industry-specific financial ratios are availableonline and at libraries. Here are some of the best sources:
Yahoo Industry Center (free access via the internet—a good place to start), IBISWorld, Bizminer, Almanac of Business and Industrial Financial Ratios, Industry Norms & Key Business Ratios (Dun & Bradstreet), Value Line Investment Survey, S&P Capital IQ, Mergent Online some other good sources are: annual reports of publicly held companies, trade journals relevant to your company's industry, general business and industry publications
When creating comparative balance sheets, there are a few special items to remember. List and describe those items.
assuming no fixed assets have been sold or abandoned during that period, accumulated depreciation at the end of the period is calculated as (beg. Accum. Depr. + current depr.Exp.) / accum. Depr. at end of the current period in the instance of an entity that is not a corporation, owner's equity at the end of the current period is calculated as: (beg. Owner's equity + current period projected net income or( - net loss) + expected current period equity investment - expected current period distributions)/ owner's equity at the end of the current period in the instance of a corporation, retained earnings at the end of the current period is calculated as follows: (beg. RE +/- current period projected net income/loss - current period dividends)/ ending RE
The First Pro Forma Post-Revenue Balance Sheet
first pro forma post-revenue balance sheet is usually set up to be compared with the pro forma pre-revenue balance sheet. This presentation allows the financial statement reader to easily see the progress the entity is expected to make during its initial months or quarters of operations
gross margin
grossmargin is the percentage of each dollar of net sales (or sales, if there is no net salesamount) that remains after cost of goods sold has been considered. The formula isas follows:Gross margin = Gross profit ÷ Net sale
Variable cost
variable cost is a cost that changes in total with a change in the volume ofproduction or sales, but is generally fixed on a per-unit basis.
Primary market research
which is research conducted by communicating directly with current or potential customers importance of primary market research can't be stressed enough. An entrepreneur needs to remember that the information obtained directly from potential customers generally trumps the information received from all other sources. An entrepreneur who does not perform proper market research—or who does not heed the needed adjustments or actions suggested by that research—significantly increases the probability that her new venture will fail
Why does an entrepreneur need to create pro forma financial statements?
Pro forma financial statements will give an accurate view of how much capital they need to start their business, when the business will start to be profitable, and give information on the financial condition of the company for the following several years. They will also tell the entrepreneur when the business will start to run out of cash.
The reasons to postpone preparing balance sheets for years 2-5 are as follows:
As this chapter has illustrated, balance sheets are much more time consuming and difficult to create than income statements Pro forma balance sheets tend to get more and more unrealistic as we proceed further and further into the future
Breakeven Analysis
Breakeven analysis helps a business owner determine the minimum number of units that must be sold, the minimum revenue that must be brought in, and the minimum price that must be charged in order to make introducing a new product or service—or starting a new business—worthwhile. Understanding the minimum number of units that must be sold, the minimum revenue that must be brought in, and the minimum price that must be charged is obviously quite useful when trying to operate a business. It's even more useful when trying to determine if one should start a business.
Define breakeven for a product line, and explain why performing a breakeven analysis on aproposed new product line can be helpful to a business owner
Breakeven is the point at which the business's net income equals zero. For a product line, the breakeven point is where the product line net income equals zero. Performing a breakeven analysis on a new product can be helpful because it can tell the business owner how many units to sell to gain a profit or to breakeven, the minimum price that should be charged to gain revenue, and the minimum revenue that must be brought in. In all, breakeven analysis helps a business owner gain the knowledge and assurance that there is a place for the product/service in the business or that there isn't a place for it.
What is breakeven revenue, and why should every entrepreneur calculate it for any new venture she's considering starting?
Breakeven revenue is the minimum revenue a business must generate to avoid losing money. If it can't accomplish this then the business should not be started. Knowing breakeven revenue is good for when talking to investors.
Define fixed and variable costs.
Fixed costs are costs that have set costs that must be paid every month whether or not you make any sales or not. Variable costs are costs that are incurred when the product or service is produced or sold.
Refer to the business you are using as an example in this course. Give 3 start-up costs that would be an asset and 3 that would be an expense. Tell why they would be either an asset or expense.
For my business 3 start-up costs that would be considered assets are clothing inventory, store supplies, and promotional materials. Clothing inventory is an asset because you need to have inventory in a store to sell so you can actually make money. Store supplies are an asset because you will need to purchase them and they will be used in everyday business functions and their value stays consistent. Promotional materials are assets because you will use them to bring in business. And 3 start-up costs that would be considered expenses would be salary and wages, rent expenses, and what it costs to set up the business. Salary and wages are expenses because you are paying out that money to the employees. Rent expenses are an expense because you are continually paying a monthly rent bill to wherever you are leasing to house your business. And the costs to set up your business are an expense because you are paying that money to make your business legitimate and it's something that you have to annually pay.
Refer to your business example. What are 3 of reasons for analysis that would be most important to you? Why?
For my business the top 3 reasons for analysis would be to help understand the profitability of the company, analysis of the operational efficiency of the firm, and for planning and future forecasting of the firm. I think that the ability to get help in understanding the profitability of the company would be very important for my business because it would help me better understand which aspects of my company are more profitable than other aspects. By understanding which aspects are more profitable than others I will be able to put more funding towards those aspects and take funding away from the less profitable. The ability to perform analysis of the operational efficiency of the firm would be helpful in making it so I would have a better understanding of how to make my company more effective in how it operates. And lastly, the ability to do planning and future forecasting of the firm would be helpful in figuring out if the company is on track to accomplish any of the future goals that have been set in place and if they are behind or ahead of schedule.
Average Collection period
Mrs. Smith Prefers this way Accounts receivable turnover becomes more meaningful when it's translatedinto days. The formal name for the average number of days it takes a firm to collect its accounts receivable is the average collection period. The formula for the aver-age collection period is as follows: Average collection period = Days per year ÷ Accounts receivable turnover
What are the four basic methods of financial statement analysis? How do they differ?
Four basic methods of financial statements analysis are Vertical analysis, Horizontal analysis, Trend percentage, and Ratios. Vertical analysis - In this type of method the financial statement of a single financial year is taken. In this method every transaction is taken as a percentage of whole. This method helps in analyzing the income in a financial year. Horizontal analysis - In this method the financial statements of two successive year is taken. This method helps analyst in comparing the Income, expenses, loses of two successive years. Trend percentage - This method work as same as horizontal analysis but the major difference is that it compares financial statements of more than 2 years. This method helps analyst in getting information about several years of profit earned and losses incurred. Ratios - Ratio is a percentage method of comparing 2 or more items on a single financial statements or 2 or more items on different financial statements. This helps in calculating a number of ratios I.e. Current ratio, Liquidity ratio, Quick ratio etc
Pro forma financial statements
Help you understand how much capital you need. How your balance sheet looks. Can give you a heads-up if you are running low on cash. Pro forma financial statements indicate the amount of capital needed to start a company, tell us when the entity will become profitable, and inform us regarding the ongoing financial position of the company. Pro forma financial statements also give the entrepreneur fair warning regarding when a business is likely to be in danger of running out of cash. It's important to note that the worth of pro forma financial statements is determined by the quality of the research that underlies the lists, reconciliations, and detail schedules used to create them.
Explain the difference between historical financial statements and pro form a financial statements.
Historical financial statements are often generated on a quarterly and annual basis to represent prior performance. Pro forma financial statements are estimates for future periods based on forecasts that are usually made for a period of two to three years. Historical financial statements reflect real facts, whereas pro forma financial statements are simply planning tools
Horizontal Analysis of an Income statement
Horizontal analysis is a determination of the percentage increase or decrease in each line item on a financial statement from a base time period to a successive time period
Horizontal Analysis of a balance sheet
Horizontal analysis of a balance sheet is performed the same way as horizontal analysis of an income statement.
Why do you think it is important to understand cost behavior?
I believe it is important to understand cost behavior because the better understanding of what is causing certain expenses to increase or decrease will give you more information on how to plan accordingly. And if they were able to understand all the information they would be able to understand which expenses fluctuate the most during certain times so then they can plan accordingly for those times.
Describe the steps the first article lists on how to estimate your start-up cost.
In this article the steps to estimate your start-up costs are: List spending on assets, List spending on expenses, and determine how much money you'll need to get started
List and describe the different types of ratios typically used to perform ratio analysis.
Liquidity has Working Capital, and Current Ratio. WC = Current assets minus current liabilities. It is required to sustain operating activities. CR = CA/CL. A current ratio of less than one indicates a company faces short-term challenges to pay its bills. Both of these are important in discovering the liquidity of a company
Market Research
Market research involves the identification of one or more specific markets and the determination of their relative sizes and characteristics. The goal of the market research performed by an entrepreneur prior to the start of a business is to identify and understand all the potential customers of the business under consideration
debt to equity ratio
debt-to-equity ratio indicates what percentage of a business's assets arefinanced with debt compared to equity. The formula is as follows:Debt to equity = Total liabilities ÷ Equity
Inventory turnover ratio
inventory turnover ratio suggests how fast a firm is moving its inventory. It indicates how many times per year, on average, a company sells—and therefore must replace—all of its inventory Like accounts receivable turnover, inventory turnover becomes more meaningful when it's translated into days:365 days per year ÷ Inventory turnover of 9.25 = 39.46
Fixed Costs
ixed cost is a cost that remains the same amount in total over a specifiedperiod of time.
Ratio Analysis
liquidity ratios, activity ratios, leverage (or debt) ratios, profitability ratios
The First Pro Forma Income Statement and Market Research
list of assumptions relevant to that income statement and all the pro forma financial statements that will follow it must be developed. This list should define the hours of operation of the business, the nature and extent of the use of employees during those hours of operation, relevant details regarding the business model itself, and information that will help define the future revenues, expenses, assets, liabilities and equity of the company. In order to create this list of assumptions, the entrepreneur will consider the industry research already performed and the schedule of start-up costs already created.
Mixed costs
mixed cost is a cost that includes elements of both variable and fixed costs
The Pro Forma Pre-Revenue Balance Sheet and the Pro Forma Start-up phase Expense Statement, IncludingReconciliations of Cash and Equity
pro forma pre-revenue balance sheet (pre-revenue balance sheet), the Pro-forma start-up phase expense statement (expense statement), and their associated reconciliations of cash and equity (reconciliations) are created more or less simultaneously using the schedule of start-up costs our entrepreneurs have already created each cost associated with the start-up phase of a business represents one of two things: an asset or an expense.
profit margin
profit margin is the percentage of each dollar of net sales (or sales, if thereis no net sales amount) that remains after all expenses, including interest and taxes,have been considered. To determine profit margin, use this formula:Profit margin = Net income ÷ Net sales
Vertical, Horizontal, and Ratio Analysis—Resources and Best Practices
purpose of doing vertical, horizontal, and ratio analysis is to compare your com-pany's most recent performance against its past performance and the performanceof other companies in your industry.
Profitability ratios
ratios that help potential investors and creditors determine how much of an investment will be returned each year via the earnings of a business
Activitiy ratios
ratios that indicate how effectively a business is managing its assets
liquidity ratios
ratios that indicate how much of a firm's current assets are available to meet short-term creditors' claims
leverage (or debt) ratios
ratios that indicate the role of debt in financing the activities of a business
Startup costs related to the business
rent, utilities, business insurance, store design and decoration, clothing inventory, accessories inventory, checkout counters and furniture, clothing racks and shelving, computers and software, security system Notice further that our entrepreneurs expect to have $150,000 to start their business and start-up costs total only $120,250. It appears that seeking out lenders or additional investors (i.e., beyond the one planned angel investor) isn't necessary—at least not at this time
Industry Research
research performed to provide insight regarding the size and complexity of an industry, the number and nature of its participants, and the economic, political, market, and other factors that affect it reading industry trade journals, attending industry trade shows, talking to industry experts, reading future competitors' annual reports, talking to those who sell or service future competitors' products or services, talking to those who use future competitors' products or services, buying and using future competitors' products or services
Return on assets ratio
return-on-assets ratio (ROA) (also referred to as the return-on-investmentratio [ROI]) tells us how much profit a firm is earning on its assets. It's calculated asa percentage of those assets and involves two formulas:Return on assets = Net income ÷ Average total assets
Current Ratio
the current ratio is an indicator of a company's ability to pay its obligations in the short run. The current ratio is calculated by dividing a company's current assets by its current liabilities: if you have a current ratio of 2 or greater your company is looking good but if it is lower than 1 it is not good