Financials – Flashcards
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Comparing a company's current income statement to those of prior accounting periods rarely reveals valuable information about key trends.
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The most common mistake entrepreneurs make when preparing pro forma (projected) financial statements for their companies is being overly pessimistic in their financial plans.
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The net profit on sales ratio measures the owner's rate of return on the investment in the business.
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The average inventory turnover ratio measures the number of times a company's inventory is sold out during the accounting period.
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Creditors often look for a times interest earned ratio of at least 4:1 to 6:1 before pronouncing a company a good credit risk.
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Ratio analysis allows a business owner to identify potential problem areas in her business before they become business-threatening crises.
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On the income statement, the cost of goods sold represents the total cost, excluding shipping, of the merchandise sold during the year.
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Fixed expenses are those that do not vary with changes in the volume of sales, but do vary with production.
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The net profit to equity ratio reports the percentage of the owners' investment in the business that is being returned through profits annually.
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A company's average collection period ratio tells the average number of days it takes to collect its accounts receivable.
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Liquidity ratios help a business owner evaluate a small company's performance and indicate how effectively it employs its resources.
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The break-even point is the level of operation at which a business neither earns a profit nor incurs a loss, and lets the business owner know the minimum level of activity required to keep the firm in operation.
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Liquidity ratios such as the current ratio and the quick ratio, tell whether a small business will be able to meet its short-term obligations as they come due.
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Leverage ratios measure the financing supplied by the firm's owner against that supplied by his creditors.
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Taking on debt destroys a business; therefore, small business owners should avoid it at all costs.
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A current ratio of 2.4:1 means that a small company has $2.40 in current liabilities for every $1 has in current assets.
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A high current ratio guarantees that the small firm's assets are being used in the most profitable manner.
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The balance sheet provides owners with an estimate of the firm's worth for a specific moment in time, while the income statement presents a "moving picture" of its profitability over a period of time.
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On a break-even chart, the break-even point occurs at the intersection of the fixed expense line and the total revenue line.
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Service companies spend the greatest percentage of their sales revenue on cost of goods sold.
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Small businesses with high leverage ratios are more vulnerable to economic downturns, but they have greater potential for large profits.
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An inventory turnover ratio above the industry average suggests that a business is overstocked with obsolete, stale, overpriced, or unpopular merchandise.
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Almost fifty percent of small businesses become profitable within zero to twelve months.
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A high inventory turnover ratio relative to the industry average could mean that a business has too little inventory and is experiencing stockouts.
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The difference between the total sources of funds and the total uses of funds represents the increase or decrease in a firm's working capital.
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To determine net profit, the owner records sales revenue for the year and subtracts liabilities.
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Slow accounts receivable are a real danger to a small business because they often lead to cash crises.
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Most firms calculate their quick assets by subtracting the value of their inventory from their current asset total.
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As a company's debt to net worth ratio approaches 1:1, its creditors' interest in that business approaches that of the owners.
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The times-interest-earned ratio tells how many times the company's earnings cover the interest payments on the debt it is carrying.
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Ratio analysis is a useful managerial tool that can help business owners maintain financial control over their businesses, but it is of no use to a business owner trying to obtain a bank loan.
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A company with a times-interest earned ratio that is well above the industry average would likely have difficulty making the interest payments on its loans, as creditors would see that it was overextended in its debts.
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If a company's average payable period ratio is significantly lower than the credit terms vendors offer, it may be a sign that the company is not using its cash most effectively.
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The income statement is based on the fundamental accounting equation: Assets = Liabilities + Owner's Equity.
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A net sales to working capital ratio of 6.25:1 means that for every dollar in working capital $6.25 is generated in sales.
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According to one study, only 11 percent of small business owners analyzed their financial statements as part of the managerial planning process, and another study found that one-third of all entrepreneurs run their companies without any kind of financial plan.
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A quick ratio of more than 1:1 suggests that a small company is overly dependent on inventory and future sales to satisfy its short-term debt.
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Operating ratios measure the extent to which an entrepreneur relies on debt capital rather than equity capital to finance the business.
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Generally, the higher the small firm's average collection period ratio, the greater the chance of bad debt losses.
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Assets represent what a business owns, while liabilities represent the claims creditors have against a company's assets.
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The small business with a high debt to net worth ratio has more borrowing capacity than a firm with a low ratio.
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A company with a low debt to net worth ratio has less capacity to borrow than a company with a high debt to net worth ratio.
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Concerning how much cash to have at startup, one rule of thumb is to have enough to cover operating expenses (less depreciation) for two inventory turnover periods.
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Generally, the higher the current ratio, the stronger the small firm's financial position.
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Pro forma financial statements show a company's most recent financial position.
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An excessively high average payable period ratio indicates the possibility of the presence of a significant amount of past-due accounts payable.
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Ratio analysis provides an owner with a "snapshot" of the company's financial picture at a single instant; therefore, she should track these ratios over time, looking for trends that otherwise might go undetected.
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On a projected income statement, a business owner's target income is the sum of a reasonable salary for the time spent running the business and a normal return on the amount the owner has invested in it.
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In start-up firms, one guideline is for the owner to draw a salary 25-30 percent below the market rate for a similar position.
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Although sound cash management principles call for a business owner to keep her cash as long as possible, slowing accounts payable too drastically can severely damage a company's credit rating.
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