SMALL BUSINESS MANAGEMENT – CHAPTER 13 – UNDERSTANDING FINANCIAL STATEMENTS – Flashcards

... can provide a business owner with important information about a firm's expected or actual performance and in addition to that, assist with important decisions that can impact the future success or failure of a business.

An income statement answers the question "How profitable is the business?" By looking at five (5) broad areas of business activity: 1. Sales, 2. Cost of producing or acquiring goods or services, 3. Operating expenses, 4. Interest expense, and 5. Tax payments. Sales - minus expenses = profits.

Marketing expenses, selling expenses, general expenses, and administrative expenses, and depreciation.

A balance sheet provides a snapshot of a firm's financial position at a specific point in time that shows the assets a firm owns, its liabilities,and the amount of owners' equity. In its most simple form, the balance sheet is represented by the formula: total assets - minus debt = owners' equity.

Includes retained earnings. Net after paying all debts.

Contentment of customers when attending or do business with the firm or company.

Total assets include current assets, fixed assets, and other assets. Debt is financing provided by creditors. Owners' equity is the owners' investment in the business, both in terms of actual cash invested and earnings that have been retained in the business.

1. Cash flows from daily operations, operating activities, 2. Cash flows related to investment in fixed assets, investing activities, & 3. Cash flows related to financing the firm, financing activities.

Cash flows from operations are calculated by adding back the depreciation expense to the net profits and then subtracting any uncollected sales and payments for inventory. Investments in fixed assets are recorded in the statement of cash flows as a change in gross fixed assets.

Financing a business involves borrowing money, repaying debts, investing by owners, and paying dividends or selling/repurchasing stock.

A firm's ability to pay debt as it comes due is most often evaluated by looking at a firm's current ratio: current assets divided by current liabilities. A company's profitability on assets is measured by calculating a company's return on assets: total debts divided by total assets.

The return on equity, which is the rate of return earned by owners on their equity investment, is driven by a firm's return on assets and its debt ratio: net profits divided by total owners' equity.

The purpose of pro forma financial statements is to determine: 1. Future profitability based on projected sales levels and expected sales-expense relationships, 2. How much and what type of financing will be needed, and 3. Whether the firm will have adequate cash flows.

It is important for an entrepreneur to understand the drivers of a firm's profits, specially the specific ways in which each factor applies to a unique firm.

A firm's net profit is dependent on: 1. Amount of sales, 2. Cost of goods sold, 3. Operating expenses, 4. Interest expense, & 5. Taxes. In a real-world situation, an entrepreneur should project the the profits of a company for at least three (3) years into the future.

However, all firms need to understand how much working capital and fixed assets will be required. An entrepreneur should try to bootstrap as many resources as possible in order to minimize a firm's investment while simultaneously ensuring adequate resources.

Use whatever you can get for free, duct tape everything! Lift yourself as you do with your bootstraps, use your own resources as much as possible.

A direct relationship exists between sales growth and asset needs: as sales increase, more assets are required. For every dollar of assets needed, there must be a correspondent dollar of financing.

A firm's financing is determined by considering its: 1. Asset requirements, 2. Need to maintain adequate liquidity, 3. Debt ratio, 4. Sources of spontaneous debt financing, & 5. Owners' equity.

Forecasting cash flows can be accomplished in two (2) ways: 1. By preparing a pro forma statement of cash flows, &/or 2. By developing a cash budget. Ideally an entrepreneur would do both. A firm's cash flows involve three (3) activities: operating, investing, & financing activities.

A cash budget is concerned specifically with dollars both received and paid out. A cash budget should provide boundaries but should not limit creativity and flexibility.

An accounting system structures the flow of financial information to provide complete picture of financial activities. The system should be objective, follow generally accepted accounting principles, and supply information on a timely basis.

... an accounting system should provide internal records that account for accounts receivable, accounts payable, inventories, payroll, cash, and fixed assets, as well as insurance policies, leaseholds, and outside investments.