course materials banking the independent business
TRANSCRIPT
Course Materials
BANKING THE INDEPENDENT BUSINESS
Steven C. LeFever Chairman
Profit MasterySeattle, Washington
August 9 - 11, 2017
© Business Resource Services Inc.
200 First Avenue West · Suite 301 · Seattle, WA 98119
Phone 206-284-5102 · Fax 206-282-4092
E-mail [email protected] · Website www.brs-seattle.com
Profit Mastery: Banking the Independent Business
Madison, WI August 9-11, 2017
Presented by Steve LeFever, Chairman
Profit Mastery Seattle, WA
Business Resource Services Inc. 200 First Avenue West Suite 301 Seattle, Washington 98119
Phone 206‐284‐5102 Fax 206‐282‐4092 E‐mail: [email protected] Website www.profitmastery.net
Steve LeFever, Chairman and Founder, Business Resource Services
© 2010 Business Resource Services
Business Resource Services • 200 First Avenue West • Suite 301 • Seattle, WA 98119800-488-3520 toll free • [email protected] • www.brs-seattle.com
Bio
Sample List of Keynotes Speeches
• BeyondSurvival:SevenStepstoFiscalFitness (60-90 minutes)
• TakingStock,TakingAction:ManagingYourBusinessInAnUncertainEconomy (60-75 minutes)
• Break-EvenAnalysis:YourPathtoGreaterProfits (75-90 minutes)
• SmallBusinessBanking:FullServiceorLipService? (60-75 minutes)
Finance = boring. For Steve LeFever, this equation doesn’t work.
With a superior command of his subject material, he makes finance compelling, interesting, and funny. Steve’s unique ability to take complex topics and translate them into plain English separates him from the crowd.
Our clients routinely tell us they never expected to take away so much new knowledge from a keynote speech. Steve has a rare skill – being able to motivate business owners and advisors to enthusiastically explore the financial workings of a business and change the areas that need changing. Steve will make you believe that finance ≠ boring; instead you’ll agree with him when he says, “Finance is fun!”
Part comedian, part financial manager, former commercial banker, current
Recent Keynote Bookings
• PearleVision, Las Vegas, NV• NationalAssociationofQuickPrinters, Austin,
TX• SylvanLearning, Phoenix, AZ• Faegre&BensonFranchiseSummit,
Minneapolis, MN• DoitBest, Indianapolis, IN• FamousDave’s, Las Vegas, NV• AssociationofSBDC, Orlando, FL• Oreck, Nashville, TN• Multi-UnitFranchiseeShow, Las Vegas, NV• ComfortKeepers, Louisville, KY• HeartsonFire, Las Vegas, NV
Compelling Subject Matter - Financial management education is repeatedly cited as the single greatest need for business owners across all industries. Steve LeFever is the acknowledged expert on the subject. Our educational programs take the mystery out of the numbers. Audience members with differing levels of expertise will gain specific tools that can be applied immediately to improve the financial health of their companies.
Industry Knowledge - Steve possesses a breadth of knowledge and experience in banking, finance, and small business management. His work with the Risk Management Association (RMA), the Association of Small Business Development Centers (ASBDC), and financial institutions around the globe help keep his insights sharp and his information relevant to business owners, operators, and managers.
entrepreneur, and 100% world-class presenter, Steve drives home his message with a no-nonsense, laugh-out-loud approach that makes him the top-rated presenter at virtually every conference he attends. For over 20 years, Steve has combined humor and practical knowledge in hard-hitting, substantive presentations. His ratings currently rank him as the highlight of our clients’ conventions in a wide spectrum of industries.
An internationally-recognized author and advocate for independent business, Steve’s book, “Profit Mastery: Knowledge-Driven Financial Performance” has sold over one million copies.
Steve has travelled widely, and the Profit Mastery program has been presented on three continents in eight languages over two decades to hundreds of thousands of business owners, managers, commercial bankers, accountants, and business coaches.
Profit Mastery: Keeping the Company in Shape
Whether you’re a manufacturer, wholesaler, retailer, service, farmer or professional — you are (or will be) a business owner. Since you became involved in business, you have undoubtedly come to the realization that you have many roles — or “hats” — to wear if you are to be successful.
Independent Business
Of the more than 26,000,000 businesses operating in today's economy, over 98% would be defined as “small”; and yet, their cumulative effect is staggering. Consider the following statistics: small business accounts for . . .
Over 50% of private employment
Creation of 75% of new jobs
Over 45% of total business output
Over 50% of the GDP (Gross Domestic Product)
In addition, small business accounts for about two-thirds of the innovation and, currently, the growth rate in employment in small business is over eight times that of employment growth in other sectors.
Entrepreneurs
In ever-increasing numbers, people are going into business for themselves. Sometimes this is planned, sometimes not: some marry it, some inherit it, some get laid off. Others have a drive to build a better mousetrap; or to build net worth; or to pursue that special American Dream of a better life. Maybe it's just the chance to be a part of something that you built; succeeding on your own merits. Maybe it's a combination of all of these. In any case, the entrepreneurial spirit is alive and well.
Your Role
What is your role in your business? Most of the time, if there are two people involved in a business, one knows how to make it and one knows how to sell it. The financial management is often left to others — with the implicit understanding that if we can make it and sell it, then we're okay.
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Financial Management
Profit Mastery addresses your role as a money manager. Of course, most business owners have not been trained professionally in accounting or finance; but given the uncertain nature of business and economic cycles combined with an increasingly rapid rate of technological change, monitoring your financial condition and making sound financial decisions has never been more important. In short, financial management is too important to leave solely to accountants and bankers — after all, it's your business that will either prosper or suffer as a result of financial decisions.
Business Failures
Of all the new businesses that are formed each year, approximately 80% fail within the first ten years. Records show over 90% of business failures are attributable to faulty management — more precisely, poor financial management. Here are the primary financial killers:
1. Failure to plan properly before start up.
2. Failure to monitor financial position.
3. Failure to understand the relationship between price, volume, and costs.
4. Failure to manage cash flow.
5. Failure to manage growth.
6. Failure to borrow properly.
7. Failure to plan for transition.
Profit Mastery: Control
Attempts to achieve physical fitness through crash diets, impulsive exercise, or superficial cosmetic and other quick-fix methods almost never work. The same is true in your business. Financial survival and health are the result of continuous management and control applied according to a plan. And the plan needs to be backed up by a sound knowledge of basic financial issues. That's how profit mastery is achieved and maintained.
The goal of this program is to provide access to all the necessary parts of the process. Your challenge is to gain control; to format the information and apply the process; to recognize symptoms and follow them back to causes — and to design corrective action steps. Financial management is not an all-or-nothing proposition. Whether this program is a first step or a review of techniques learned long ago, the journey through the process can be as rewarding as the result.
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Financial Performance Statements and Ratio Analysis
DEFINITION......Financial position refers to the economic condition of your business in comparison to its own past performance and to other companies of similar size.
REVIEW ..............Section One reviewed the basic legal and tax issues affecting all businesses. The information in this section actually provides the means for a critical analysis of management roles and business organization in relation to both tax and non-tax issues.
IMPACT ..............Determining your financial position is crucial to “fine tuning” your management decisions. It provides the level of detail a business owner needs to make sound choices.
RESULTS ............The information derived from financial position calculations lets you focus your attention on the causes of your business’ financial strengths and weaknesses. With this information you can take positive action to keep what is working and to improve what isn’t.
The Goal:
Determining your solvency, risk, and efficiency
The Tools:
Statement Spread Sheets Financial Management Ratios
Cause and Effect “Road Map”
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Key Terms
Assets ....................................................................... Everything that the business owns — including such items as cash, inventory, prepaid expenses, and vehicles.
Balance Sheet ................................................. A statement of financial position that shows the assets, liabilities and net worth of the business.
Current Assets ................................................ What the business owns that’s expected to be turned into cash within one year — such as accounts receivable and inventory.
Liabilities ............................................................. What the business owes to creditors — to the people who supply funds that must be repaid. Debt is another term for liability.
Current Liabilities ...................................... Obligations that are due to be repaid within one year.
Long-Term Debt ........................................... Obligations that are scheduled to be repaid in a period greater than one year.
Net Worth ........................................................... What the business owes to the owners — the investment that the owners have in the company. Also called owners’ equity.
Retained Earnings ....................................... The net profits (positive or negative) from the income statement that are left to accumulate in the business.
Leverage ............................................................... The increased rate of return that is made on net worth by using debt to acquire assets.
Income Statement ........................................ The summary of the revenues, costs and expenses of a company that are recognized during an accounting period.
Gross Profit ....................................................... Sales minus the Cost of Goods Sold, which is the cost of buying raw materials and producing finished goods.
Net Profit ............................................................. The amount remaining after all expenses have been met. The difference between total sales and total costs and expenses.
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The Financial Operating Cycle: You’re in the Dollars and Cents Business
As the owner of an independent business, you’re challenged by having to play multiple roles in a limited time. You put on and take off a series of management hats — and sometimes you wear them simultaneously. But the one hat you can never shed is that of financial manager and planner. You can’t take it off and you can’t give it away.
In fact, when you finally have an accounting system that produces timely and accurate financial statements, your primary ownership responsibility begins — understanding and interpreting exactly what it is you have.
The process of analyzing your statements is a glamourless nuts-and-bolts kind of task. The best way to start — indeed, the only way to start — is to roll up your sleeves and dig in. Three steps are required:
First .........understand how your statements are formulated — their structure, composition, and how they work together.
Second .....actually use your data to produce a series of financial ratios.
Third........interpret — use the ratios to analyze the causes and effects of financial events in your company.
The Right Information
We live in an age where access to information has increased exponentially. Computers now have the ability to bombard us with a magnitude of data — the sheer volume of which is enough to destroy one’s interest in analyzing and using it.
Many of us have grown to believe that computers don’t make mistakes and, therefore, computer-generated information must surely be accurate. Maybe computers don’t make errors; but people do. We’ve even coined a phrase for this process: GIGO — Garbage In, Garbage Out.
In no area of our business lives is this phenomenon more relevant than in the area of financial management. Relatively sophisticated accounting systems are capable of generating mountains of data — in fact, far in excess of what most of us need. As former commercial lenders, we analyze and use financial data regularly and never cease to be amazed at the quality of information that passes for financial statements. It seems that many business owners get the wrong data at the wrong time for the wrong reasons.
We’ve often said that for many of our clients, their primary strengths as business practitioners were knowing how to “make it” or “sell it.” Most were not CPA’s by training and many considered financial management as nothing more than a “necessary evil.”
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Most closely-held businesses did not invest in the added expense of audited statements, so financial data was often limited to a compilation of data provided by the owner — and accompanied by a solid don’t-blame-me disclaimer from the accountant. In many cases, if financial data was produced at all, it was often received months after the fact. For many businesses, financial record-keeping evolved only as a means to minimize taxes. Accountants are retained and rewarded based on their ability to make profits disappear — sort of a “watch carefully, the fingers never leave the hands” approach.
How Many Sets of Statements?
Many businesses wisely produce more than one set of statements from “the books” (the General Journal and General Ledger). How many sets? Usually, at least two — and sometimes three. One for the tax man — who uses the tax rules and regulations to produce the smallest taxable net profit possible; one for the banker — with the brightest profit picture possible; and (maybe) one for the owner — with the most realistic picture possible. Since the statements usually aren’t labeled, we sometimes wondered which set we had been given.
As an owner, the worst person to kid is yourself. You are the boss and should be the first to know when there is a problem brewing. In fact, information developed and decisions made solely for tax purposes may not be good business decisions in the long run. Put another way: a good tax decision that is a bad business decision . . . is a bad decision.
Most businesses have never given much thought to the reason they want profits. Everyone knows profits are the measure of success in a capitalistic system. But there are really three fundamental uses for profits:
1. To distribute to owners
2. To purchase new assets for growth
3. To repay debt
Certainly everyone recognizes the need for distribution to owners; that’s the name of the game. Also, most companies want to grow, and to grow you need more assets. Finally, you need profits to repay debt used to purchase existing assets (many bankers, of course, would accuse us of having our priorities reversed; repayment of debt is number one in their books).
Let’s pose a question: which one of the three uses of profits is the most important? Hopefully the answer you’d arrive at is all three. For the long-term viability of any company, the business must supply suitable profits to satisfy all three requirements.
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The Income Statement Since accurate, timely information is the key to effective decision making, let’s briefly review how the financial data is generally formatted on the income statement to arrive at a measure of profitability.
The income statement (also called a profit and loss statement or a “P & L”) simply represents the results of operations over a given time — say a quarter or a year. The primary benchmarks are gross profit and net profit. Gross profit measures what remains after direct expenses — such as direct labor and materials — are subtracted from revenue. Net profit measures what remains after general operating expenses are subtracted from the gross profit. The key financial issues relating to the income statement are pricing, margin maintenance, and expense control.
In contrast to the balance sheet, which gives a cumulative picture of your business, the income statement shows the operating results for one period — a month, a quarter or a year. Here is a sample income statement from one of our case studies. Take a look at the format and accounting categories.
Cascade Office Systems Income Statement
For the Twelve Month Period
Sales $1,520,000
Cost Of Goods Sold 1,200,000
Gross Profit $ 320,000
Expenses
Salary ........................................................... 152,000Payroll Taxes ................................................. 16,400Advertising ...................................................... 2,000Utilities ............................................................ 4,800Office Supplies ................................................ 5,500Insurance .......................................................... 7,800Bad Debts ........................................................ 4,000Depreciation ................................................... 19,000Vehicles ........................................................... 8,600Accounting ....................................................... 5,800Travel/Entertainment ....................................... 9,500Shop Supplies .................................................. 5,500Taxes ................................................................ 4,000Other .............................................................. 2,100
Total Expenses $ 247,000
Operating Profit $ 73,000
Interest (26,600) Other Income/(Expense) 8,000
Net Profit Before Tax $ 54,400
Tax 9,500 Net Profit After Tax $ 44,900
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The Balance Sheet
Although the income statement is familiar to most business owners, the balance sheet often remains a mystery. We termed it the “forgotten statement” because some bank customers left it out of their loan proposals altogether. Since they didn’t use it much, it didn’t seem that important.
The balance sheet, however, represents the most important information to a lender: it provides an accurate reflection of the financial health of the business. Let’s review the parts of this key financial statement.
The balance sheet gives you a financial “snapshot” of your business on one particular date and time. It shows the cumulative record of business activity since the business opened — day one to the present. The two “sides” of the balance sheet are:
Assets: what the business owns.
Liabilities and Net Worth: what the business owes (to those who supplied the funds to buy the assets — the creditors and the owners).
Most people define the relationship between the three components of the balance sheet — ASSETS, LIABILITIES, and NET WORTH — in the following manner:
Assets – Liabilities = Net Worth
What you own minus what you owe is what you’re worth — at least on paper.
However, for the purposes of financial analysis, it makes a lot more sense to look at the relationship in the following manner:
Assets = Liabilities + Net Worth
This equation represents the undeniable capitalistic formula. The sides of the balance sheet must balance (assets always equal liabilities plus net worth) because for every dollar invested in assets, someone had to supply the dollar. The next page contains a sample balance sheet from the same case study we used for the income statement.
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Cascade Office Systems Balance Sheet as of Year End
Assets Liabilities and Net Worth
Cash $ 41,700 Notes Payable - Bank $ 52,800 Accounts Rec. - Trade 169,400 Current Portion - LT Debt 32,500 Inventory 212,200 Accounts Payable - Trade 99,800 Accounts Rec. - Officer 3,000 Accruals 44,100 Other 10,700 Other 26,700
Total Current Assets 437,000 Total Current Liabilities 255,900
Vehicles 25,700 Long-Term Debt 144,300 Furniture/Fixtures 24,300 Equipment 108,300 Total Liabilities 400,200 Buildings 130,000 Land 20,000 Capital Stock 60,000 Accumulated Depreciation (85,000) Retained Earnings 200,100
Fixed Assets (net) 223,300 Net Worth 260,100
Total liabilities Total Assets $660,300 And Net Worth $660,300
Stated another way, from a financing perspective, an asset is something you own; but to own it, you had to buy it. The question is: who supplied the money to buy the assets? You need to look to the right-hand side of the balance sheet for the two sources: the creditors and owners. Together they supplied all the funds to purchase the assets.
Retained Earnings — The Key Link in the Financial Cycle
From our sample balance sheet, you can see that the two primary components of the net worth section are capital stock and retained earnings.
Retained earnings are perhaps the most misunderstood area of the entire balance sheet. There are two key features of retained earnings to keep in mind:
1. They’re cumulative — since the day the company began.
2. They are generally not cash.
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This second feature is especially important. Is it possible to have retained earnings but no cash? The answer is an emphatic YES! So where have the earnings gone? The answer to this question brings us around to profits again — and establishes our concept of a dynamic financial relationship between the income statement and the balance sheet.
The fact is, both the balance sheet and the income statement together are needed for effective financial analysis — one is relatively useless without the other. Here’s a visual representation of the relationship between the balance sheet and the income statement — and of the dynamic financial cycle that needs to operate in every business.
INCOME STATEMENT BALANCE SHEET
Sales
Net Profit
Assets = Liabilities + Net
EFFICIENCY
Assets Liabilities Net Worth
3. To pay out to the owners.
2. To pay off debt
1. To pay for new assets.
Back to:Uses of Profits:
The Financial Operating Cycle
Let’s look at the cycle in detail. As we just noted above, an asset is something you own. But in order to own it, someone must supply funds to buy it. In a business there are two sources who supply funds: the creditors and the owners.
But why do you own assets? Unless you collect them, you generally have them to produce sales. And why do you produce sales? Why, to make net profit, of course. This, however is not the end of the story. At the end of the accounting period, the bookkeeper closes out all the revenue and expense accounts, and whatever is on the bottom line is transferred to retained earnings. Visually, the procedure would look something like the diagram on the following page.
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THE BALANCE SHEET / INCOME STATEMENT CONNECTION
ASSETS
LIABILITIES
Total Current Assets
Cash Accounts Receivable Inventory
Land Building Fixtures Equipment Depreciation
Total Fixed Assets (net)
Total Assets
NET WORTH
Total Current Liabilities
Notes Payable Accounts Payable Accruals
Long-Term Debt Mortgages
Total Long-Term Liabilities
Total Net Worth
Capital Stock Retained Earnings
Total Liabilities and Net Worth
Sales
- Cost of Goods Sold
Gross Profit
Operating Expenses
Salaries
Rent
Advertising
Depreciation
Taxes
Total Expenses
Operating Profit
- Interest and Other Income
Net Profit Before Tax
- Tax
Net Profit (after tax)
Efficiency — How Well the Cycle Operates After the bookkeeper closes out the net profit after tax line and transfers the amount to retained earnings, net worth is increased (that is, of course, if net profit after tax was positive). So profits increase net worth. But where did the cash go? Well, it went to one of the three uses of profits:
To pay out to the owners in the form of dividends To pay off existing liabilities To pay for new assets
And so it goes — around and around. But there is one last component that measures how well it all works: efficiency. Efficiency in converting assets to revenue, efficiency in converting revenue to profits, efficiency in structuring liabilities and net worth. Generally speaking, the key to business success lies in keeping this financial cycle working properly.
Almost everything we do in life gets measured in some form of performance analysis: baseball batting averages, grade point averages, even the likelihood of rain today. Each of these numbers is a ratio — a comparison. Using a series of financial ratios, we will outline the process of financial performance analysis — using the information from the financial statements to measure the health and progress of the business.
This means your information has to be both timely and accurate. Otherwise, GIGO. And this is one of the many places in business that you don’t want to fool yourself because, after all, you're in the dollars and cents business.
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Working Capital Cycle
Cash
Inventory Accounts Receivable
The Working Capital Cycle
For many business owners, a second cycle, the working capital cycle, operates within their balance sheet. For those of us who have inventory and/or accounts receivable in our businesses it is important to track how efficiently we manage those assets.
Here’s how the cycle works: we start out with cash and purchase some inventory. We then turn loose our crack sales force who sell the inventory, and every once in a while we hear those two dreaded words in business - “charge it” or “bill me”, and an account receivable is created. Don’t worry, our collection department efficiently collects the payments due and we are back to cash again — cash to purchase new inventory and a little left over to do some other things in the business, like pay rent, make payroll, etc. Visually the cycle looks like this:
This cycle works for every business in the world. “Aha!” you say, “my business is different. I’m a retailer and all my customers pay in cash.” In that case your cycle goes from cash to inventory and back to cash again. Or you are a service business with no inventory; in this case your cycle runs from cash to accounts receivable and back to cash again. The principles in each case are the same, how we apply them might be different. The similarities far outweigh the differences as we all are in the same business - the business of dollars and cents, how cash flows through our businesses.
As bankers we used to call this cycle “the survival cycle”. Every business owner needs to know what drives the cycle in their business, and what sucks cash out of the cycle. It is a key measure of our efficiency as business owners. Managing the cycle more efficiently (making the circle turn faster) will generate more cash for our business and reduce the level of bank loans needed to supplement our working capital.
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Profit Mastery Relationships that Show the Health of Your Business
Taken together, the balance sheet and income statement represent a complete financial picture of your company. As we mentioned, many businesses produce at least two sets of financial statements (and maybe three: one for the IRS, one for the banker, and one for the owner). But remember you can't fool all of the people all of the time and the worst possible person to kid is yourself. You need clear, concise, “decision-relevant” information.
With that in mind, let's take your financial information and develop a set of measurements that will allow us to monitor both your current position and your progress. We will do this through the development of a series of financial relationships or ratios.
Making Valid Comparisons
A ratio is nothing more than one number in relation to another. They have the very practical property of reducing a relationship to a single number no matter the size of the two numbers involved. For example, the ratio of 2:1 can be derived from the number 20 divided by 10, or 200 divided by 100, or 200,000 divided by 100,000. The ratio doesn't care about the absolute size, it only cares about the relationship. It's this relationship we will use to measure and manage your financial effectiveness.
Clearly, the question that arises is “which relationships to measure?” There are many possibilities and each financial analyst will have his or her own preference. We use the K.I.S.S. principle (Keep it Simple, Stupid!) — that is, calculate enough information to get the job done, but not so much as to become confusing. The charts on the following pages provide the ones we think are basic for almost any business.
The action steps are simple: first, you need financial statements for three years — or as many as you have. Second, you need to lay out your statements in a spread sheet format, which is nothing more than putting all the financial data on one sheet, side-by-side, by year. Third, use the same spread sheet format to calculate your financial ratios.
Take a few minutes to study the attached ratios — how they're derived and what they measure. Note that the ratios are broken down into three functional areas: balance sheet ratios, profitability ratios, and asset management ratios. We will be looking to develop financial “balance”; no one individual ratio tells the entire story. Taken together, however, they begin the process of analyzing performance and, more importantly, planning for the future.
Using Ratios as Tools
In general, there are three ways to use these ratios to analyze your business: first, to compare your current performance to your performance in prior years — your trends; second, to compare your present performance to others in your industry; and third, to compare your ratios to your plans in developing a workable operating strategy.
You operate and manage your company with limited resources, management, capital, and time. You can't fix current problems or spot developing ones unless you know where to look. This Profit Mastery® process we're describing is merely an efficient, effective method to keep your finger on the pulse of your company.
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Balance Sheet Ratios
Ratio How to Calculate What it Means In Dollars and Cents
Current Current Assets
Current Liabilities
Measures solvency: The number of dollars in Current Assets for every $1 in Current Liabilities.
For example: a Current Ratio of 1.76 means that for every $1 of Current Liabilities, the company has $1.76 in Current Assets with which to pay them.
Quick Cash + Accounts Receivable Current Liabilities
Measures liquidity: The number of dollars in Cash and Accounts Receivable for each $1 in Current Liabilities.
For example: a Quick Ratio of 1.14 means that for every $1 of Current Liabilities, the company has $1.14 in Cash and Accounts Receivable with which to pay them.
Debt-to-Worth Total Liabilities Net Worth
Measures financial risk: The number of dollars of Debt owed for every $1 in Net Worth.
For example: a Debt-to-Worth Ratio of 1.05 means that for every $1 of Net Worth that the owners have invested, the company owes $1.05 of Debt to its creditors.
Income Statement Ratios
Gross Margin Gross Profit Sales
Measures profitability at the Gross Profit level: The number of dollars of Gross Margin produced for every $1 of Sales.
For example: a Gross Margin Ratio of 34.4% means that for every $1 of Sales, the company produces 34.4 cents of Gross Profit.
Net Margin Net Profit Before Tax Sales
Measures profitability at the Net Profit level: The number of dollars of Net Profit produced for every $1 of Sales.
For example: a Net Margin Ratio of 2.9% means that for every $1 of Sales, the company produces 2.9 cents of Net Profit.
Overall Efficiency Ratios
Sales-To-Assets Sales Total Assets
Measures the efficiency of Total Assets in generating sales: The number of dollars in Sales produced for every $1 invested in Total Assets.
For example: a Sales-to-Assets ratio of 2.35 means that for every $1 dollar invested in Total Assets, the company generates $2.35 in Sales.
Return On Assets Net Profit Before Tax Total Assets
Measures the efficiency of Total Assets in generating Net Profit: The number of dollars in Net Profit produced for every $1 invested in Total Assets.
For example: a Return on Assets ratio of 7.1% means that for every $1 invested in Assets, the company is generating 7.1 cents in Net Profit Before Tax.
Return On Investment
Net Profit Before Tax Net Worth
Measures the efficiency of Net Worth in generating Net Profit: The number of dollars in Net Profit produced for every $1 invested in Net Worth. For example: a Return on Investment ratio of 16.1% means that for every $1 invested in Net Worth, the company is generating 16.1 cents in Net Profit Before Tax.
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Specific Efficiency Ratios
Inventory Turnover
Cost of Goods Sold Inventory
Measures the rate at which Inventory is being used on an annual basis.
For example: an Inventory Turnover ratio of 9.81 means that the average dollar volume of Inventory is used up almost ten times during the fiscal year.
Inventory Turn-Days
360 Inventory Turnover
Converts the Inventory Turnover ratio into an average “days inventory on hand” figure.
For example: a Inventory Turn-Days ratio of 37 means that the company keeps an average of thirty-seven days of Inventory on hand throughout the year.
Accounts Receivable Turnover
Sales Accounts Receivable
Measures the rate at which Accounts Receivable are being collected on an annual basis.
For example: an Accounts Receivable Turnover ratio of 8.00 means that the average dollar volume of Accounts Receivable are collected eight times during the year.
Average Collection Period
360 A/R Turnover
Converts the Accounts Receivable Turnover ratio into the average number of days the company must wait for its Accounts Receivable to be paid.
For example: an Accounts Receivable Turnover ratio of 45 means that it takes the company 45 days on average to collect its receivables.
Accounts Payable Turnover
Cost of Goods Sold Accounts Payable
Measures the rate at which Accounts Payable are being paid on an annual basis.
For example: an Accounts Payable Turnover ratio of 12.04 means that the average dollar volume of Accounts Payable are paid about twelve times during the year.
Average Payment Period
360 A/P Turnover
Converts the Accounts Payable Turnover ratio into the average number of days that a company takes to pay its Accounts Payable.
For example: an Accounts Payable Turnover ratio of 30 means that it takes the company 30 days on average to pay its bills.
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Diagnosis
The following provides possible causes for selected ratios that are either too high or too low — in relation to a company's own past performance and/or industry standards.
Balance Sheet Ratios
Current Ratio High: May indicate an imbalance in the investment in long-term assets, or an economic condition
conducive to maintaining high liquidity. Low: May indicate financing of long-term assets with short-term money.
Quick Ratio
High: May indicate an excess of cash. Normally implies under-investment in inventory. The effect normally shows up in reduced sales and reduced profits.
Low: May manifest itself in a shortage of cash, and usually indicates problems similar to current ratio and/or problems associated with over-investment in inventory.
Debt - to - Worth Ratio
High: Too much risk, leverage is too great. If economy goes bad and sales drop, interest expenses can destroy profits. Often caused by unmanaged growth.
Low: Company is too safe; not enough risk equates with not enough return. There is too much equity in the company and too much debt capacity causing low ROI.
Income Statement Ratios
Gross Margin Ratio Low: Caused by not taking discounts due to low cash, high inventory causing mark downs, poor pricing,
poor buying, or excessive shrinkage. The “low price, high volume” concept should be used with caution: the real keys to success are cash flow and profits, not sales alone.
Net Margin Ratio
Low: Indicates that the company's prices are relatively low or that its costs are relatively high — or both.
Asset Management Ratios
Sales - to - Assets Low: Indicates that the company is not generating a sufficient volume of business given the size of its
asset investment.
Inventory Turnover
High: May indicate inadequate finished goods inventory, raw materials, or W.I.P. inventory. Low: May indicate excessive finished goods inventory, raw materials, or W.I.P. inventory.
Return on Assets
Low: Indicates low profitability, or over-investment in assets — or both. Too many assets for the sales produced will normally cause low cash problems.
Return on Investment
High: May indicate too much leverage or risk. Too much debt financing causes return to appear abnormally high. Can signal trouble in times of rising interest rates, shrinking margins, and economic slow downs.
Low: Indicates low profits or over-capitalization — or both. Over-capitalization indicates too much equity and not enough risk-taking. Usually excess debt capacity causes reduced cash flow and increased bad debt expenses.
©BRS 2015 16
RX FOR SURVIVAL: Treat the Causes, Not the Symptoms
Human nature is a funny thing. We always seem to enjoy operating “on the edge.” Business and financial experts continually tell us to plan, plan, plan. But usually we don't. We wait, wait, wait. We hear a lot about preventive maintenance: you have the Fram oil filter man saying “you can pay me now - or pay me later.” But usually we wait until we're sick to go to the doctor — on the theory that “If it aint broke don't fix it!” We wait for the symptoms of problems to appear — and then respond. The problem is that sometimes it's too late.
In business, of course, we call this approach “seat-of-the-pants” management. In business and trade journals, it's been praised and romanticized: the entrepreneurial spirit . . . the go-for-broke, gut-feel attitude. Horse puckey! Now, don't get us wrong; we believe in these attitudes. But they need to be put within a structure — a framework which capitalizes on strengths and shores up weaknesses in a business.
Causes and Effects
The diagram you see on page 19 (which looks like a California road map or an engineering flow chart) presents just such a framework. Functionally, it represents the financial skeleton of your business. As you can see, it's a self-contained system; however, as with any system, it requires maintenance to function properly.
Problems — in business or anywhere else — are solved when we get to the causes. In medicine doctors only treat the symptoms of a disease when the causes are unknown. Business owners generally identify three major financial symptoms: low cash, low gross margin, and/or low net profit.
That's right: low cash, low gross margin or low net profits are not the causes of financial problems; they are the effects — or symptoms — of other hidden financial problems. And that's where the diagram becomes useful. To find causes we must trace back from the effects to examine a variety of possible causes for the symptoms.
The Road Map presents the “big picture” overview, but at the same time leads us through a process of analysis designed to pinpoint potential problem areas. This cause-and-effect analysis is an invaluable resource for business owners.
Now, in order to take positive action in any situation, you need to know three things:
Where you are. Where you want to go. How to get there.
Your own financial statements — past and present — and your own ratio calculations can show you your present position. By comparing your position with that of the industry as a whole, you can determine where you would like to be at the end of the next operating period. The “Road Map” can help you determine how to get there.
©BRS 2015 17
To read the map, start at any box and work backward against the arrows, inserting the phrase “is caused by” between the categories in the boxes. For example:
LOW GROSS MARGIN HIGH HIDDEN COSTS
* is caused by * * is caused by *
NO CASH DISCOUNTS HIGH ACCOUNTS RECEIVABLE
LOW PRODUCTIVITY TOO MUCH INVENTORY
BOOKKEEPING ERRORS
SHRINKAGE
POOR BUYING
POOR PRICING
Just a short word on “Low Gross Margin” — it's highlighted for a reason. Without an adequate margin (long-term), you may as well hang 'em up. Not maintaining margin is almost always an issue in terms of problems— direct or indirect. It's like a big star on the state map: all towns are important, but some are more important than others.
Now, let's start at “Low Cash” and take it in all directions until you've traveled through the entire system. It's a fascinating journey. Don't worry if you get strange glances as you sit there absentmindedly talking through it aloud. The key here is interdependence. When you think you've got it, try explaining it to someone else; then you'll know for sure.
Keep in mind that our financial “skeleton” is rather general: it applies to any business. Your industry may not have some of the “parts”, but don't feel cheated! Just as people come in all shapes and sizes — so do businesses. If some of these categories don't apply to you, simply leave them out. For instance, retail stores may not have accounts receivable. Just leave that part out and be glad that you have one less area to worry about managing!
Seeing the “Big Picture”
Many people visualize financial problems or issues as isolated occurrences. One of the primary benefits of our financial cause-and-effect diagram is, in fact, to highlight the interdependent nature of the financial system in your business. Remember, this diagram doesn't care how big your business is — it works for the corner deli and it works for General Motors.
Effective financial management falls somewhere between art and science. The goal is balance and control — combined with intuition and risk-taking — and luck. But we've always considered “luck” as the point at which opportunity and preparation intersect. And to achieve and maintain balance and control requires a process. This process is cause-and-effect analysis.
Our challenge for you is simple and straightforward: use this format to take a trip through your business. As with any trip, you can't reach your destination without a map and that's what this framework is — a financial road map. You may find that it generates more questions than it answers, but that's good — because you can't solve problems until you know what to ask and where to look!
©BRS 2015 18
The Steps You Take To Determine Your Course of Action
1. Gather Information
Obtain your financial statements for the last three years. Financial statements have a varietyof uses besides just showing sales and profits, but getting information out of them requiresyour active participation.
2. Package the Information
Put the data in a spread sheet format; that is, place consecutive years in side-by-side columns.
3. Calculate Your Financial Ratios
These ratios are nothing more than the relationships between sets of two numbers, but theylet us focus on those relationships rather than on the “raw” financial data. This packetcontains the ratios that we believe are essential. In addition, you may want to add others thatare specific to your type of industry.
4. Record Your Industry Composite Guidelines (if available)
Many trade associations and financial organizations produce financial data and ratio studiesfor particular industries. Robert Morris Annual Statement Studies is one of the most commonsources (your local bank should have a copy available).
5. Compare Your Results
Look for trends in the financial statement spread sheets and in the ratio spread sheet. Alsolook for changes in trends. Compare your business (1) against prior years, (2) against theindustry standards, and (3) against your future plans.
6. Analyze the Possible Causes of Problems
Ratio analysis can identify problems. The next step is to identify causes and then developsolutions. The financial cause-and-effect “Road Map” can help in finding possible causes ofproblems.
7. Take Action
Many times the worst decision is to do nothing. Usually inaction represents a “wait-and-hope” approach, indicating an inability to focus attention on the financial aspects of abusiness. Formulate a plan, implement the plan, then monitor the results. Taking action is,of course, the hard part. But if you follow the steps contained in this workbook, weguarantee that you will be better prepared to face and make those critical financial decisions.
©BRS 2015 19
Case Study Cascade Office Systems
Cascade Office Systems originally opened in ten years ago when John Thomas began manufacturing custom wood office furniture for a select clientele. (He had just taken early retirement from a major manufacturer, where he had been a successful sales rep for over 20 years.)
The new business was a gradual success on the strength of Mr. Thomas's reputation and his ability to deliver quality furniture at a reasonable price.
Mr. Thomas semi-retired from the business four years ago, turning it over to his daughter and son-in-law, Laura and Rob. Both of them perceived a growing market opportunity revolving around the production of custom office furniture for computers. While not forsaking the existing business, they implemented an impressive development campaign two years ago, including an expansion of the existing building. A year ago, they began their marketing effort with an aggressive promotion based on price and quality.
It's now the end of their most recent fiscal year and they have come to you for financial assistance. They are flushed with excitement, telling you things will be great if they can just get the funds they need to get “over the hump.” They brush off any talk of problems as “only temporary.”
What observations can you offer?
ACTION STEPS:
Step 1. Gather accurate financial information.
Step 2. Package the information so you can see relationships.
Step 3. Calculate financial ratios.
Step 4. Record your industry composites (if available).
Step 5. Compare your results.
Step 6. Analyze the possible causes of problems.
Step 7. Take action — formulate a plan, implement it, and monitor the results.
©BRS 2015 20
Cascade Office Systems Balance Sheet Spreadsheet as of November 30
Two Years Ago
One Year Ago
Most Recent Year
Trends
ASSETS Cash 41,700 16,500 12,300 Accounts Receivable 169,400 167,000 270,000 Inventory 212,200 164,800 419,000 Other — A/R officer 3,000 Prepaid 10,700 16,700 24,800 Other
Total Current Assets 437,000 365,000 726,100 Leasehold Improvements Vehicles 25,700 30,700 30,700 Furniture/Fixtures/Office Equip 24,300 28,300 59,700 Equipment 108,300 120,300 120,300 Buildings 130,000 267,700 267,700 Land 20,000 20,000 30,000 Accumulated Depreciation (85,000) (106,000) (132,000)
Fixed Assets (net) 223,300 361,000 376,400
Other — patent acquisition 28,500
Total Assets 660,300 726,000 1,131,000
LIABILITIES & NET WORTH Notes Payable — bank 52,800 63,400 282,400 Current Portion — long-term 32,500 30,000 25,000 Accounts Payable — trade 99,800 127,800 310,100 Accruals 44,100 55,200 67,300 Other 26,700 33,400 49,600 Other
Total Current Liabilities 255,900 309,800 734,400 Long-Term Debt 144,300 114,300 89,300 Mortgages OtherTotal Long-Term Liabilities 144,300 114,300 89,300
Total Liabilities 400,200 424,100 823,700
Capital Stock 60,000 60,000 60,000 Additional Paid-In Capital Retained Earnings 200,100 241,900 247,300
Net Worth 260,100 301,900 307,300
Total Liabilities and Net Worth 660,300 726,000 1,131,000
©BRS 2015 21
Cascade Office Systems Income Statement Spreadsheet
for the 12-months ending November 30
Two Years Ago
One Year Ago
Most Recent Year
Trends
Sales 1,520,000 1,670,000 2,160,000
Cost of Goods Sold 1,200,000 1,336,000 1,760,000
Gross Profit 320,000 334,000 400,000
Expenses
Salary 152,000 158,000 219,900 Payroll Taxes 16,400 16,900 27,000 Advertising 2,000 10,500 12,200 Rent Utilities 4,800 5,200 6,100 Office Supplies 5,500 4,500 5,000 Insurance 7,800 8,200 8,800 Bad Debts 4,000 4,000 8,000 Depreciation 19,000 21,000 26,000 Vehicles 8,600 6,400 5,200 Accounting 5,800 6,200 6,800 Travel / Entertainment 9,500 4,700 1,200 Shop Supplies 5,500 5,500 7,000 Taxes 4,000 4,500 7,000 Other 2,100 700 6,000 Other
Total Expenses 247,000 256,300 346,200
Operating Profit 73,000 77,700 53,800
Other Income/(Expense) Interest (26,600) (27,600) (49,500) Other Income 8,000 2,000
Net Profit Before Taxes 54,400 50,100 6,300
Tax 9,500 8,300 900
Net Profit After Tax 44,900 41,800 5,400
©BRS 2015 22
Cascade Office Systems Ratio Analysis Spreadsheet
Two Yrs. Ago
One Yr. Ago
Most Recent Year
Industry Composite
Calculations, Trends, or
Observations
BALANCE SHEET RATIOS: Stability (or “Staying Power”)
1. Current Current Assets
Current Liabilities 1.7 1.1
2. Quick Cash + Accts. Rec.
Current Liabilities 0.8 0.5
3. Debt-to-Worth Total Liabilities
Net Worth 1.5 1.4
INCOME STATEMENT RATIOS: Profitability (or “Earning Power”)
4. Gross Margin Gross Profit
Sales 21% 20%
5. Net Margin Net Profit B4 Tax
Sales 3.5% 3.0%
ASSET MANAGEMENT RATIOS: Overall Efficiency Ratios
6. Sales-to-Assets Sales
Total Assets 2.3 2.3
7. Return on Assets Net Profit B4 Tax
Total Assets 8.2% 6.9%
8. Return on Investment
Net Profit B4 Tax
Net Worth 20.9% 16.5%
ASSET MANAGEMENT RATIOS: Working Capital Cycle Ratios
9. Inventory Turnover
Cost of Goods Sold
Inventory 5.6 8.1
10. Inventory Turn-Days
360
Inventory Turnover 64 44
11. Accounts Receivable
Turnover Sales
Accts Receivable
8.9 10
12. Accounts Receivable
Turn-Days 360
Accts Rec Turnover 40 36
13. Accounts Payable
Turnover Cost of Goods Sold
Accounts Payable 12 10.4 9.8
14. Average Payment
Period 360
Accts Pay Turnover 30 34
©BRS 2015 23
©BRS 2015 24
Simulated RMA Data Page for CASCADE OFFICE SYSTEMS
MANUFACTURERS — WOOD FURNITURE — EXCEPT UPHOLSTERED SIC #2511
Current Data Comparative Historical Data 0-1MM 1-10MM 10-50MM 50-100MM ALL ASSET SIZE
55 62 26 2 145 NUMBER OF STATEMENTS % % % % % | ASSETS |
| | | | | |
100.0 100.0 100.0 100.0 | Total |
| LIABILITIES | | | | |
| Net Worth | 100.0 100.0 100.0 100.0 | Total Liabilities & Net Worth |
| INCOME DATA | 100.0 100.0 100.0 100.0 | Net Sales |
| | . 30.1 22.2 23.0 25.8 | Gross Profit | 4
| | 2.9 3.2 4.0 3.3 | Profit Before Taxes | 5
| RATIOS | 2.2 2.8 3.6 2.9 | | 1.6 1.8 2.5 1.8 | Current | 1 1.0 1.4 2.0 1.3 | |
1.3 1.4 1.7 1.4 | | 0.7 0.8 1.2 0.8 | Quick | 2 0.4 0.5 0.7 0.5 | |
17 21.8 32 11.4 38 9.6 28 13.0 | | 41 8.9 43 8.5 50 7.3 43 8.4 | Sales / Receivables | 12 and 11 59 6.2 54 6.8 54 6.8 55 6.6 | |
41 8.8 49 7.4 70 5.2 50 7.3 | | 64 5.7 74 4.9 89 4.1 74 4.9 | Cost of Sales / Inventory | 10 and 9
101 3.6 107 3.4 122 3.0 114 3.2 | | | | | |
| | | |
| | | |
| | | |
1.0 0.5 0.6 0.6 | | 1.8 1.2 0.8 1.2 | Debt / Worth | 3 4.7 2.3 1.7 2.9 | |
40.5 29.6 29.1 31.9 | % Profit Before Taxes / Tangibles | (48) 20.8 (61) 15.8 11.8 (137) 16.6 | Net Worth | 8
0.9 4.7 5.0 4.2 | |
16.1 14.6 18.4 14.6 | % Profit Before Taxes / Total | 8.5 6.9 4.6 6.6 | Assets | 7
- 1.5 1.1 1.0 0.9 | |
| | | |
3.1 2.9 2.0 2.8 | | 2.4 2.4 1.8 2.1 | Sales / Total Assets | 6 1.9 1.7 1.5 1.7 | |
| |
©2013 BRS 25
Profit Mastery Assessment (PMA)
Summary Report Cascade Office Systems
Cash Profit (NPBT) Inventory
Hidden Costs & Interest
A/R
Hidden Costs & Interest
Gross Margin
Labor
Buying
Pricing
Cash Discounts
Refinance
Other
Other
Other
Totals
©BRS 2015 26
Low Gross Margin (Ratio #4)
Primary Impact: Profit
Poor buying and poor pricing If he can manage just a 1% improvement in each of these areas:
Buying: 1% x $1,000,000 = $10,000
Pricing: 1% x $2,160,000 ~ $22,000
Their Peers’ Margin: 22.2% Difference +/‐ 4%
Sales in Year 3: $2,000,000
X margin difference: X .04
Margin $ Left on the Table: $80,000
$500,000 Extend discounts X .02 Discounts
COGS $1,760,000 - 1,000,000 Purchases
$760,000 Labor
$10,000 in missed discounts
COGs $1,760,000 - 760,000 Labor
$1,000,000 Purchases
No Cash Discounts on Payables
Low Productivity
What’s their Low Gross Margin costing?
X .05 Low Productivity $38,000 Inefficiency
©BRS 2015 27
Too Much Inventory? (Ratio #9 & #10)
COGSInventory
= Turnover
COGS Turnover
= Inventory
COGS Targeted Turnover
= Targeted Inventory
$1,760,000 4.9
= COGS Target Inv. Turn
Actual Inventory $419,000
Excess Inventory $60,000
= $359,000
The cost of 1 Day = $60,000 / 12 days = $5,000/day
‐Targeted Inventory ‐ $359,000
Industry achieves 4.9 turns Actual COGS was $1,760,000
Primary Impact: Cash
©BRS 2015 28
Too Much A/R? (Ratios #11 and #12)
Sales
Targeted Turnover
$2,160,000
8.5 = = $254,000
Actual A/R = $270,000 Targeted A/R = $254,000
$16,000 in Excess A/R
The cost of 1 day = $16,000/2 = $8,000/day
Primary Impact : CASH
©BRS 2015 29
Hidden Costs
Proper Financing Balance Sheet Structure
Relates to upper left box on “Roadmap”
Use Cascade Balance Sheet:
Year 1 Year 2 Year 3 Total Current Assets $435,000 $365,000 ‐ Total Current Liabilities ‐$255,900 $309,800 = Working Capital $181,000 $55,000
Working Capital Decrease $126,000
How did this occur?
Buildings $130,000 $267,700 L/T Debt $144,000 $114,300 N/P Bank (S/T) $63,400 $282,400
The issue? Match the term of the loan with the life of the asset ‐‐‐‐ period.
Inventory Excess Inventory x 25% = $60,000 x .25 = $15,000 A/R Excess A/R x 25% = $16,000 x .25 = $ 4,000
Total Hidden Costs = $19,000 Primary Impact : Profit
©BRS 2015 30
Ratio Supplement: Service Businesses and Professional Practices
The process of ratio analysis that we have gone through for Cascade Office Systems applies to all businesses. But service businesses and professional practices can use the modified set of ratios to monitor their financial position more accurately.
Balance Sheet Ratios
Use the same ratios on page 14* but add:
Cash Ratio = Cash/Current Liabilities
Measures the ability of the company to pay its bills with out relying on collection of accounts receivable. Indicates how well the company could respond to a sudden crisis or opportunity.
* NOTE: For many service companies, the current and quick ratios will be nearly identicalbecause inventory is the main component that differentiates the two.
Income Statement Ratios
Use the ratios on page 14; change “Sales” to “Revenues” or “Fees” as appropriate.
Asset Management Ratios
Use the ratios on page 14 but add:
Fixed Asset Utilization Ratio = Total Revenues/Net Fixed Assets
Measures how productive the company's fixed assets (i.e. equipment) are in generating revenue. A low ratio may indicate ineffective use of fixed assets or excessive fixed assets.
Working Capital Cycle Ratios
Use the ratios on page 15, but delete “Inventory Turnover” and “Inventory Turn-Days” and add:
Accounts Receivable Aging Schedule
Accounts Receivable Turnover and Average Collection Period represent overall averages for an accounting period. A more detailed means of monitoring accounts receivable is to “age” them — that is, to list each account and identify its payment status. The following is a sample aging format:
Accounts Receivable Aging Schedule
Account 0-30 days 30-60 days 60-90 days Over 90 days Red $XXXWhite $XXXBlack $XXX $XXXBlue $XXX $XXX Total $XXX $XXX $XXX $XXX
©BRS 2015 31
Productivity Ratios
The following ratios (or modifications of them) are among those commonly used to measure efficiency in production of services:
Average Revenue Per Client = Total Revenue ÷ # Clients Served
Average Revenue Per Job = Total Revenue ÷ # Of Jobs
Average Daily Volume = Total Clients ÷ # Of Days Worked
Average Revenue Per Hour = Total Revenue ÷ # Of Hours Worked
Individual Productivity: Take any of the above ratios and calculate for individuals producing the services.
A Word on Selecting and Computing Ratios
As we said earlier, computing ratios is a relatively simple activity. The key for you is to determine which ratios are the appropriate ones to use in your company's analysis. Any time we compare two different numbers to one another, we come up with a new ratio. Therefore, you could potentially compute scores of ratios using the numbers found on your balance sheet and income statement.
But, do the ratios you come up with make sense? If so, are they meaningful to you? For instance, you could compare the dollars of Personnel Expense (from the Income Statement) to the dollars of Fixed Assets (from the Balance Sheet) and derive a ratio. What does it tell you? Probably nothing! But, if you compare Sales to Personnel Expense, the ratio may tell you how efficiently you're using your people resources to produce revenues. Now that's something you might be interested in knowing. The point is, you need to select a set of ratios which actually communicate to you about how your business is operating, and then stick with and use those ratios over time to be able to spot trends, strengths and weaknesses, and areas of opportunity.
If you're not sure which ratios may be the best to use in your business, talk with your accounting professional—they know ratios and your business. That's why you pay them good money—to be a source of information and guidance in your role as a financial manager.
You also need to know that there may be more than one way to compute a specific ratio. Depending on your particular business, one method may be more accurate and meaningful to use than another. For instance, we used balance sheet dollars as of the date of the financial statement to compute the Inventory, Accounts Receivable, and Accounts Payable turn ratios on Page 14. In your own business, that method is probably okay if you have very steady volumes of costs of goods purchases and generation of credit sales throughout the year. However, if you experience cyclical patterns during the year, the use of "as of" dollars may tend to skew your ratios, depending on when your cycles occur, compared to the date of the statement being used.
It may be more meaningful for you to use average dollars of Inventory, Accounts Receivable, and Accounts Payable — either on an annualized, quarterly, or semi-annual basis — in order to reduce the effect which your cycles may have on the ratios. These are but a few examples of how to use different methods to calculate ratios. Again, if you're not certain which method is best suited for your own business, consult with your accountant.
©BRS 2015 32
Mark-Up Versus Margin: Clarifying the Issue
There are many people who believe mark-up and margin are the same thing — and sometimes they are. But generally they're not. The issue is how to arrive at a target selling price when you know the cost. The important concern here is the amount of gross profit dollars contributed from sales to cover general overhead.
Here's a simple example to illustrate the point:
Item selling price: $ 1.50
Item cost: $ 1.00
Does this price-cost relationship represent 50% mark-up or 33% mark-up?
Regardless of your answer, we can safely say that this example represents a gross profit margin of 33%. The standard income statement format gives us the following:
Gross Profit Margin = Gross Profit Dollars (GPM) Total Sales
Since: Total Sales $1.50– Cost of Goods Sold 1.00
Gross Profit .50
Gross Profit Margin % = .50 = .33 = 331/3% 1.50
©BRS 2015 33
The real question is: what mark-up does this represent? Or, stated another way, how much do you have to mark up a product over cost to produce a 331/3% gross profit margin? The answer here depends on how you define mark-up. Here are the two possible definitions:
Definition A (the common definition):
Mark-Up = Selling Price – Cost Cost
= 1.50 – 1.00 1.00
= 50%
Definition B (as defined by retailers):
Mark-Up = Selling Price – Cost Selling Price
= 1.50 – 1.00 1.50
= 331/3%
It's important to note that either definition of mark-up leads to a 331/3% gross profit margin. Using the more conventional definition, it requires a 50% mark-up to produce a 331/3% gross profit margin, but retailers would say it requires a 331/3% mark-up. In other words, mark-up and margin are the same thing when using the retail definition.
We believe that confusion — and errors! — arise when you hear someone say the mark-up and the margin are the same (Definition B), then conclude that you simply multiply the cost by the mark-up (Definition A) to get the margin.
©BRS 2015 34
Here's an example: you assume that you can get a 40% margin by using a 40% mark-up (Definition A), so you do the following with an item costing $1.00:
WRONG!
$1.00 40% = $0.40 mark-up
Selling Price = $1.40
But this does not yield a 40% margin:
Sales $1.40– Cost - 1.00 Gross Profit $0.40
Gross Profit Margin = Sales – Cost Sales
= 1.40 – 1.00 1.40
= 28.6%
As you can see, marking up the cost 40% produces only a 28.6% gross profit margin. Such a mistake would produce a shortfall of 12% — or $120,000, if sales were $1,000,000.
The moral: understand how to set prices; it's the gross profit you need. Mark-up only represents a concept to produce gross profit. If you confuse these issues, it can cost you dearly in dollars and cents.
Standard (Definition A) MARK-UP/MARGIN Table
COSTMARGIN % MULTIPLIER MARK-UP %
662/3% 3.00 200%
60% 2.50 150%
50% 2.00 100%
331/3% 1.50 50%
25% 1.33 331/3%
Now try a few examples using a cost of $1.00 to verify that it works — and how it works.
©BRS 2015 35
Answer Sheet Cascade Office Systems
Ratio Analysis Spreadsheet
Two Yrs. Ago
One Yr. Ago
Most Recent Year
Industry Composite
Calculations, Trends, or
Observations
BALANCE SHEET RATIOS: Stability (or “Staying Power”)
1. Current Current Assets
Current Liabilities 1.7 1.1 0.99 1.8 726,100 734,400
2. Quick Cash + Accts. Rec.
Current Liabilities 0.8 0.5 0.38 0.8 282,300 734,400
3. Debt-to-Worth Total Liabilities
Net Worth 1.5 1.4 2.68 1.2 823,700 307,300
INCOME STATEMENT RATIOS: Profitability (or “Earning Power”)
4. Gross Margin Gross Profit
Sales 21% 20% 18.5% 22.2% 400,000
2,160,000
5. Net Margin Net Profit Before Tax
Sales 3.5% 3.0% 0.29% 3.2% 6,300
2,160,000
ASSET MANAGEMENT RATIOS: Overall Efficiency Ratios
6. Sales-to-Assets Sales
Total Assets 2.3 2.3 1.9 2.4 2,160,000 1,131,000
7. Return on Assets Net Profit Before Tax
Total Assets 8.2% 6.9% 0.56% 6.9% 6,300
1,131,000
8. Return on Investment
Net Profit Before Tax
Net Worth 20.9% 16.5% 2.0% 15.8% 6,300
307,300
ASSET MANAGEMENT RATIOS: Working Capital Cycle Ratios
9. Inventory Turnover
Cost of Goods Sold
Inventory 5.6 8.1 4.2 4.9 1,760,000 419,000
10. Inventory Turn-Days
360
Inventory Turnover 64 44 86 74 360 4.2
11. Accounts Receivable
Turnover
Sales
Accounts Receivable 8.9 10 8 8.5 2,160,000 270,000
12. Accounts Receivable
Turn-Days 360
Accts. Rec. Turnover 40 36 45 43 360
8
13. Accounts Payable
Turnover Cost of Goods Sold
Accounts Payable 12 10.4 5.7 9.8 1,760,000 310,100
14. Average Payment
Period 360
Accts. Pay. Turnover 30 34 63 37 360 5.7
©BRS 2015 36
Profit Mastery Assessment (PMA) Cascade Office Systems
Issue Cash Profit
Accts. Rec . $16,000
Inventory $60,000
Hidden Costs $19,000
Gross Margin $80,000
‐Discounts ($10,000)
‐Productivity ($38,000)
‐Buying ($10,000)
‐Pricing ($22,000)
Refinance $126,000
TOTALS $202,000 $99,000
©BRS 2015 37
$80K
(P
)
$38K
(P
)
$10K
(P
)
$10K
(P
)$2
2K (
P)
$60K
(C
)
$19K
(P
)
$126
K (
C)
$16K
(C
)
©BRS 2015 38
Income Statement Management Knowing Your Costs
DEFINITION......Managing the income statement implies managing the relationship between costs, volume and pricing. Break-even analysis is the tool that lets owners and managers gauge the results of changes in costs or pricing.
REVIEW ..............We have completed the section on financial statement analysis, which gives us a picture of the past. With break-even analysis, we have a method to analyze the present.
IMPACT ..............Break-even analysis focuses attention on two kinds of costs -- fixed costs and variable costs -- and how changes in either affect profits. The analysis answers questions such as: “Will a decrease in price produce more sales?”
RESULTS ............Using the break-even tool, we will be able to relate changes in costs and/or changes in pricing to the corresponding changes that are required in sales volume if a given level of profit is to be maintained.
The Goal:
Calculating the sales required to incur no profit, but no loss -- and to evaluate the impact of changes in costs on
the selling price-cost-volume relationship.
The Tools:
Break - Even Analysis Break - Even Proofs Expansion Analysis
©BRS 2015 39
Key Terms
Break-Even ..................................... To have no profit and no loss; the point at which revenues exactly cover expenses.
Variable Costs ................................ Expenses that vary directly with sales; those costs that are incurred only if sales are made.
Variable Cost Percentage .............. The percent of each dollar of sales that goes to cover variable costs.
Fixed Costs ..................................... Expenses that do not vary with sales; those costs that are incurred whether or not any sales are made.
Contribution Margin ..................... The amount left after variable costs are paid. The amount that is left to contribute to covering fixed costs (and profits).
Contribution Margin Percentage . The percent of each dollar of sales that is left after the variable cost percentage has been deducted; the amount from each dollar of sales that is contributed to cover fixed costs and profits.
Target Profit ................................... The amount of profit that is planned. The profit that is addedto fixed costs to determine the sales goals -- in relation to a given contribution margin.
©BRS 2015 40
The “Cup Theory” The Concept Of Contribution Margin
Sales Dollars
A useful and effective method of assessing cost-volume-profit relationships is through the application of break-even analysis. Break-even, of course, refers to the point where there is no profit and no loss - revenues exactly covering costs. But this analysis revolves around a second concept - that of contribution margin.
Contribution Margin
First, a definition. Contribution margin represents the percent of each sales dollar left after variable costs are removed. (Variable costs represent those costs that are both proportional to sales and caused by sales.)
Basically, whatever remains of each sales dollar after subtracting the variable costs represents the funds available to cover fixed costs. By definition, fixed costs represent those costs which exist independently of sales; that is, they are neither proportional to - nor caused by - sales. They're there whether or not you sell anything.
A certain percentage of each sales dollar - and it varies from business to business - remains after the proportional - or variable - costs are removed. This remaining portion of each sales dollar is contributed to the amount necessary to cover the fixed costs.
To the extent that you have just enough dollars contributed to cover all the fixed costs, financial people say you are “at break-even” - no profit, no loss. To the extent that sales produce a contribution margin greater than the fixed costs, you have a profit. Furthermore, to the extent that sales are not sufficient to produce enough dollars of contribution to cover fixed costs, you have a loss.
Net profits occur if there’s anything left after the fixed cost cup is filled.
Contribution Margin (percent of sales)
Variable Cost Cup
Fixed Cost Cup
Net Profit Cup
©BRS 2015 41
Filling the Cups
It is perhaps easiest to visualize this concept as a series of cups stacked on top of one another. The figure at the beginning of this section represents this “cup theory” graphically. The top cup represents the costs which are variable. As you can see, all the funds “left over” -- or contributed -- flow down to fill the cup labeled fixed costs on the second level. In addition, once the fixed costs have been covered (or the cup “filled”) any remaining funds flow down to the third level and become profits.
This concept becomes an extremely useful tool -- not so much to calculate the exact break-even point, but more importantly to investigate the impact on required sales volume if we change the size of the cups. That is, what happens to required sales volume if the contribution margin changes? (In other words, if the size of the variable cup changes?) And what is the impact on sales volume if the size of the fixed cost cup changes?
First, let's talk about fixed costs. If the fixed cost “cup” gets bigger, you need more dollars of contribution margin to fill it; thus, break-even sales increase as fixed costs increase. Conversely, as fixed costs decrease (the size of the cup decreases), fewer contribution dollars are required and “break-even sales” is a smaller figure.
Now, let's look at changing the variable cost percentage -- or the contribution margin. As the variable cost percentage increases, the variable cost “cup” increases and there is a decrease in the amount contributed from each sales dollar. Thus, you need more sales dollars to fill the fixed cost “cup” and break-even sales rise. Clearly, just the opposite is true when the variable cost percentage decreases and the contribution margin increases. With a decrease in the variable cost “cup”, there is an increase in the amount contributed from each sales dollar. Correspondingly, you need fewer sales dollars to fill the fixed cost “cup”, and break-even sales decrease.
So the real value in “break-even” analysis lies not just in calculating the current break-even sales, but rather in evaluating the impact on sales volume of changes in either variable costs or fixed costs -- or both. By attaching numerical formulas to the concepts we've outlined here, we can assess the required volume change, given a measurable change in the cost structure. To a measurable degree, it is possible to analyze marketing strategies in light of varying cost structures.
Knowing Your Costs
The core of this analysis, however, is rooted deeply in the importance of knowing your costs. Quite frankly, this is often the weakest area of most entrepreneurs. In the absence of any firm grip on costs, most business owners set their prices based solely on the competition. This, of course, presumes your competitors know their costs, and the rest, as they say, is history . . .
Take a few minutes, and think through the concepts we've presented here, then read on and work through our examples. Once you understand the concepts, work through your own situation. Remember, all you need is a current profit-and-loss statement to produce this analysis. You'll also find out that a complete understanding of how costs behave in your business will be your strongest ally when it gets down to “the crunch.”
©BRS 2015 42
Know Thy Costs . . . And Manage the “Creepers”
Everyone knows their costs, right? This is a concept that's as age-old as Methuselah. Well, do you know yours? Furthermore, do you know how those costs behave in your business? Finally, can you answer the question, “Why would anyone in their right mind care?”
We firmly maintain that this information ought to be “walkin'-around-in-your-head” knowledge. Not only does the behavior of these costs have a significant impact upon your profitability, but also it should impact your marketing strategy.
For the last few sections, we've talked about financial statements and ratio analysis as one way to “get your arms” around the management of your business -- and it is. But in the financial time continuum of your business, financial statements represent past history. We can't change yesterday; we can only learn from it. We can only impact today and tomorrow.
Costs are controllable today. Suppose we posed the question, “Your costs will go up $1,000; what do you have to have in increased sales just to stay even?” You guessed it; far too many times, the answer is $1,000. Bad sign.
So let's talk about costs and we'll give you a tool to manage costs and a method to analyze your cost decisions. The problem is understanding how costs behave, and the tool is break-even analysis. Break-even analysis is a financial tool that illustrates the relationships between COST-VOLUME-PRICE. By definition, break-even is the exact sales volume at which the business neither makes a profit nor incurs a loss.
To calculate break-even, we first need to define two broad classes of costs based on how they behave in the business. First, fixed costs. Within a reasonable sales range, fixed costs do not vary with sales or production volume. Examples would include administrative salaries, rent, interest, insurance, utilities, and depreciation. Next, variable costs. Variable costs are those which are directly proportional to the sales volume i.e., no sales, no variable costs. Examples would include direct materials (i.e., cost of goods sold), commissions, and bad debts. Think of variable costs this way: sales cause variable costs. If sales don't cause them, consider them fixed.
Okay, so now how do you calculate break-even? As outlined in the “Steps To Calculate Break-Even” on pages 39 and 40, from your existing profit/loss statement, total all your current fixed costs. Let's say your total comes to $100,000. Next, calculate your total variable costs as a percent of your total sales. Let's say your “variable cost percent” turns out to be 75%.
What does this mean in terms of $1.00? Well, for every $1.00 of sales, 75 cents goes to variable costs. What's left? Yes, 25 cents. To cover what? Right, fixed costs. So now we have to answer the question, “How many 25-cents in $100,000 of fixed costs?” The answer, of course, is 400,000. This means that you will have to do $400,000 to break-even. This is diagrammed on the next page using the term “contribution margin” to replace the term “what's left?”
©BRS 2015 43
Break-Even Calculation Break-Even Proof
Fixed Costs: $100,000 Sales: 400,000 Sales: $400,000
Variable Cost %: 75% Less: 75% variable cost – 300,000Contribution Margin $100,000
Formula: $100,000 Less: fixed costs – 100,000(100% - 75%) Net Profit $ 0
Break-Even Sales: $400,000
The key issue is not so much how to calculate break-even, as it is how to use it. For example, we once discovered that our company had contracted for a coffee service and our annual costs went up $1,000. How much in additional sales did we need to cover this increase?
Fixed Cost Increment = 1,000 = $4,000 100% - 75% .25
Sales had to increase $4,000 just to pay for the coffee. It's these “creepers” you must watch every day because for every $1.00 increase in “fixed costs” (as they “creep” on you), you have to achieve a $4.00 sales increase just to stay even.
There was another experience some years ago that has stuck with us to this very day. We stopped by a client's shop one day, only to discover him fuming around mad as hell. Seems an employee had just destroyed a $6,000 cement mixer. We said, “We sure understand.” He replied, “No, fellas, you don't understand at all ― that's not the problem.” So we said, “Guess we don't understand.”
He stormed over to the trash bin and pulled out three discarded C-clamps. “See this,” he fumed. “They'll only break one cement mixer in their life ― and it's insured. But they'll throw away three C-clamps every day forever. Add it up!” We did. And if you add it up for your business, you may find a few surprises and some new ways to “manage the creepers.”
©BRS 2015 44
Break-Even Analysis
Break-even analysis identifies that point where revenues exactly cover costs -- so that no profit is generated, but no loss is incurred. As a management tool, it extends to a much broader application. Using it, you can answer questions such as:
What additional sales will I need to cover the rent increase my landlord isproposing?
If I raise prices, how much can my sales drop before my profits are affected?
If sales drop (in a recession, for example), how much do I need to cut fixed coststo maintain my current level of profit?
If I cut my price, what additional sales will I have to make in order to maintainmy current profit level?
Steps to Calculate Break-Even
Step 1
Classify expenses from your current income statement into two cost categories: fixed or variable. Then add up the total for each category.
Fixed Costs are those that remain constant over a reasonable range of sales, or do not vary appreciably with sales volume. For example:
Rent Office Supplies Advertising
Salaries Payroll Taxes Utilities
Depreciation Interest Expense Insurance
When these do change, they tend to jump in increments ― such as rent increases for additional space, depreciation on new equipment purchases, or salaries for additional staff. When this type of increase occurs, break-even needs to be recalculated.
Variable Costs are those that vary directly ― or proportionally ― to sales. An easy way to evaluate whether a cost is fixed or variable is to ask: do sales cause this cost? If sales cause the cost, it's variable. For example:
Direct Labor Commissions
Direct Materials Bad Debts
If you can't decide what to call an expense, be conservative and call it fixed ― thus making your break-even point higher.
©BRS 2015 45
Step 2
Determine the variable expense percentage -- that is, the total variable expense as a percentage of sales:
VARIABLE COSTS = VARIABLE COST PERCENTAGE SALES
Step 3
Determine the contribution margin -- that is, the amount from each sales dollar which is left after deducting variable costs -- to cover fixed costs:
SALES % – VARIABLE COST % = CONTRIBUTION MARGIN %
Which is the same thing as:
100% – VARIABLE COST % = CONTRIBUTION MARGIN %
Step 4
Calculate break-even using one of the two following formulas:
To calculate break-even in dollars:
BREAK–EVEN = FIXED COSTS CONTRIBUTION MARGIN%
NOTE: Express contribution margin as a decimal -- not a percentage.
To calculate break-even in units (if your product can be measured in just one type of unit -- such as yards, gallons, cases, or hours):
BREAK–EVEN = FIXED COSTS SELLING VARIABLE
PRICE — COST PER UNIT PER UNIT
©BRS 2015 46
Steve’s Pen Company
The Cup Theory The Concept of Contribution Margin
Sales Dollars
Contribution Margin (percent of sales)
Variable Cost Cup
Fixed Cost Cup
Net Profit Cup
©BRS 2015 47
Case Study Olympic Flooring - Practice Example
Two years ago Bob Nelson wanted to figure his break-even sales volume, so he went through his income statement and classified his costs and totaled each category. Here's what he got:
Variable Costs: ....................$496,000
Fixed Costs: ........................$109,200
In that year, his Sales were:
Sales ....................................$620,000
What were break-even sales for Olympic Flooring that year? Use your break-even worksheet to do the calculations.
©BRS 2015 48
Case Study Olympic Flooring
Once again you have been called in to provide some assistance to Bob Nelson. He has already gone through his most recent income statement and classified his costs into fixed and variable. Here is what he came up with:
Variable Costs: ....................$904,680
Fixed Costs: ........................$151,820
Bob's sales in the most recent year were:
Sales .................................$1,077,000
Your job now is to calculate his variable cost percentage, his contribution margin, and his break-even sales point; then answer the questions below. (Remember: Bob made a profit this year - he was not at break-even sales last year.)
1. What are break-even sales for Olympic Flooring?
2. What additional annual sales are needed if rent increases by $2,000 per month?
3. What total sales will be necessary to generate a $50,000 profit -- assuming thatthere is no rent increase?
©BRS 2015 49
Case Study Olympic Flooring
Olympic has a homogeneous unit -- yards -- that can be used to measure all product sold. What Bob needs to know now is how many yards he needs to sell. Here is the cost breakdown per yard:
Sales Price (per yard) ................................. $5.00/yard
Variable Cost (per yard) ............................ $4.20/yard
Fixed Cost .................................................. $151,820
1. How many yards must be sold to break-even?
2. How many yards must be sold by a new salesperson (who will get an annual salaryof $20,000) to cover their cost?
3. How many yards must be sold if the selling price is raised to $5.10 -- assuming there isno new salesperson and no change in variable cost?
©BRS 2015 50
Break-Even Analysis Worksheets For Calculating Cost - Volume - Profit Relationships
The following pages contain two sets of break-even analysis worksheets:
one for calculating break-even using a DOLLAR BASIS
and
one for calculating break-even using a UNIT BASIS
BE SURE YOU ARE USING THE RIGHT ONE FOR THE ANALYSIS YOU ARE DOING!
©BRS 2015 51
Cost - Volume - Profit Relationships Break-Even Analysis: Dollar Basis
Step 1. Classify Your Costs
Using your most recent income statements, classify all costs as either fixed or variable, then total each category. Actual Total Sales = $_______________
Total Variable Costs = $_______________
Total Fixed Costs = $_______________
Step 2. Calculate Variable Cost Percent “For every $1.00 of sales, what percent goes away to variable costs.” Variable Cost Percentage = Total Variable Costs = $_______________ = _____%
Actual Total Sales $ Step 3. Calculate Contribution Margin
“For every $1.00 of sales (after paying for variable costs), what percent is left to cover fixed costs . . . plus any targeted profit?” 100% – Variable Cost Percentage = 100% – _____% = _____%
Step 4. Calculate Break-Even Sales
“How many ‘cents-es’ does it take to cover your fixed costs?” Break-Even Sales = Total Fixed Costs = $_______________ = $_______________ Contribution Margin % NOTE: To calculate the sales needed to generate a target profit, just add that target profit
amount to your total fixed costs, then divide that amount by your contribution margin.
Step 5. Check Your Calculations “Does the sales level you figured actually ‘break-even’ ― or give you the profits you target?” Break-Even Sales _______________ minus Variable Costs * – _______________ equals Contribution Dollars = _______________ minus Fixed Costs – _______________ equals Net Profit = _______________ *Compute this figure by multiplying Break-Even (above) by the Variable Cost Percent in Step 2.
©BRS 2015 52
Cost - Volume - Profit Relationships Break-Even Analysis: Unit Basis
Step 1. Classify Your Costs
Using your most recent income statements, classify all costs as either fixed or variable, then total each category. Record the actual number of units sold and actual sales volume.
Actual Total Sales = $_______________
Total Variable Costs = $_______________
Total Fixed Costs = $_______________
Total Units Sold = ________________
Step 2. Calculate Your Price Per unit
Price Per Unit = Total Sales =$_______________ per unit
Number of Units Sold
Step 3. Calculate Your Variable Cost Per Unit
Variable Cost Per Unit = Total Variable Costs = $_______________ per unit
Total Units Sold
Step 4. Calculate Your Contribution Dollars Per Unit
Price per Unit – Variable Cost per Unit
= $_____________ per unit – $_____________ per unit = $_____________ per unit
Step 5. Calculate Your Break-Even Sales in Units
Break-Even Sales = Total Fixed CostsContribution Dollars per Unit
= $_______________ =__________ units needed in sales to “break-even” $ per unit
NOTE: To calculate the sales needed to generate a target profit, just add that target profit amount to your total fixed costs, then divide that amount by your contribution margin.
©BRS 2015 53
Expansion Analysis Using Break-Even as a Decision Tool
SITUATION: Many times clients have come to us with plans for expansion -- or plans to purchase or start a new venture. The outline below represents a “quick and dirty” method of evaluating the sales volume necessary to cover costs -- including target (or required) profits. We've also included both an example and a blank form to use when you need to analyze expansion possibilities.
EXAMPLE: You have three stores, and you plan to open a fourth. By doing a little financial analysis, you find that your cost structure is as follows:
Fixed Costs.........................................$250,000
Variable Cost % .................................60% (as a percent of sales)
Your Planned Investment ...................$1,000,000
Your Target ROI ................................20%
Target Profit .......................................$200,000 (20% of $1,000,000)
Here are the calculations:
Formula = Fixed Costs + Target Profit 100% – Variable Cost %
= 250,000 + 200,000 .4
= 450,000 .4
= $1,125,000
So you need sales of $1,125,000 to cover your fixed costs and provide your target profit of $200,000.
NOTE: No expansion analysis is complete without a market analysis focusing on the sales you'll most likely get. You then can compare what you'll get -- which the market analysis will tell you -- with what you need -- from your financial analysis.
If what you'll get is greater than what you need -- it's a go. If what you'll get is less than what you need -- it's back to the drawing board.
©BRS 2015 54
Expansion Analysis Worksheet
Estimate:
1. Fixed Costs (in dollars) ........................................................................._______________
2. Variable Costs (as a % of sales) ............................................................_______________
3. Total Investment Planned (in dollars) ..................................................._______________
4. Desired Return On Investment (ROI - expressed as a decimal) ..........._______________
Calculate:
A. Multiply investment required by desired return to determine “target net profit in dollars”:
Item 3 Item 4 = A
B. Add fixed cost (dollars) plus “target net profit” to yield “the nut you've got to crack”:
Item 1 + Item A = B
C. Subtract variable cost % (% of sales) from 100% to yield “contribution margin percent”:
100% – Item 2 = C %
D. Divide the “nut to crack” (Item B above) by the contribution margin decimal (Item C above) to determine “sales necessary to cover costs and provide target ROI”:
Item B = D Item C
NOTE: This analysis gives you the financial parameters of the issue. You will still need to acquire market data to make a realistic assessment of feasibility -- and also take into account numerous non-financial issues.
©BRS 2015 55
Answer Sheet Olympic Flooring Break-Even
Page 46:
Step 2: Compute the Variable Cost Percentage
Variable Costs = 496,000 divided by Sales = 620,000=Variable Cost % (V.C.%) = 80%
Step 3: Compute the Contribution Margin Percentage
Sales Percentage = 100% less Variable Cost Percentage = -80%=Contribution Margin % (C.M.%) = 20% (or, .2, when stated as a decimal)
Step 4: Compute Break Even in Dollars
Fixed Costs = 109,200 divided by Contribution Margin % = .2=Break Even (B.E.) = $546,000
Page 47
1. Step 2: V.C. = 904,680 Sales = 1,077,000=V.C. % = 84%
Step 3: Sales% = 100% - V.C.% = -84%=C.M.% = 16% (.16)
Step 4: F.C. = 151,820 C.M. % = .16=B.E. = $948,875
2. Step 4: F.C. = $24,000 C.M. % = .16=B.E. = $150,000
(or, $2,000/.16 = $12,500 x 12 = $150,000)
©BRS 2015 56
Answer Sheet Olympic Flooring Break-Even
Page 47 (continued)
3. Existing Fixed Costs = $151,820+ Profit Goal* = + 50,000= Total Fixed Costs = $201,820
(*Profit dollars “behave” like a fixed cost)
Step 4: F.C. = $201,820 C.M. % = .16=B.E. = $1,261,375
Page 48:
1. Step 4: Fixed Costs = 151,820 = 151,820 C.M. per unit = (5.00 – 4.20) = .80
=B.E. = 189,775 square yards (units)
2. Step 4: Fixed Costs = 20,000 C.M. per unit = .80
=B.E. = 25,000 square yards (units)
3. Step 4: Fixed Costs = 151,820 = 151,820Raise price 2% to $5.10
C.M. per unit = (5.10 – 4.20) = .90
=B.E. = 168,689 square yards (units)
3.Extra Credit Fixed Costs = 151,820 = 151,820Lower price 2% to $4.90
C.M. per unit = (4.90 – 4.20) = .70
=B.E. = 216,886 square yards (units)
If Olympic raises its price by 2%, sales can drop 11%, and still make the same profit.
If Olympic lowers its price by 2%, sales must increase by 14% to make the same profit
©BRS 2015 57
Balance Sheet Management Controlling Your Growth
DEFINITION......Managing your balance sheet implies taking positive control of growth. With a tool called "Financial Gap," we will project what funds will be necessary to support projected growth -- and where those funds will come from.
REVIEW ..............The income statement shows the rewards of growth -- in increased sales and increased profits. Cash flow analysis shows the funds required to support seasonal growth.
IMPACT ..............Permanent, long-term growth imposes other requirements on the company. As sales increase, many types of assets -- especially inventory and accounts receivable -- increase proportionally. The balance sheet shows the cost of growth in terms of decreased solvency, liquidity, and increased risk to the company.
RESULTS ............By projecting the funds needed for sales growth and examining alternative sources for the funds, we can manage growth. Using Financial Gap as a tool, we can help to insure that increased sales produce increased benefit -- and guard against the company "growing itself out of business."
THE GOAL:
Project a balance sheet, evaluate the need for funds, evaluate financial management effectiveness, and manage growth.
THE TOOLS:
Financial Gap a technique which uses the "percent of sales" calculation.
©BRS 2015 58
KEY TERMS
Financial Gap ................................. The difference between the funds needed to buy new assetsand the funds available. The amount of new debt and/or equity thatthe company will have to borrow in order to support increasedsales.
Percent of Sales ............................. A method for measuring the variable assets and liabilities that acompany needs to support a given level of sales. Each category ofvariable assets and variable liabilities for a completed year is dividedby sales for that year. The resulting percentage can then be applied toprojected sales for future years to determine the new investmentneeded for each category.
Variable Asset ................................ An asset that increases (or decreases) as sales rise or fall. Forexample, more sales would mean more accounts receivable - eventhough the company was collecting them just as efficiently as beforethe sales increase (In other words, the pie would be cut the same, butit would be a larger pie).
Variable Liability ........................ A liability that increases to support payment of the variable assets,which increase as a result of a sales increase. For example, more saleswould require that more inventory be kept on hand (to avoid stock-outs). This, in turn, would mean carrying more accounts payable -- ifthe company maintained its accounts payable turnover at the same rateas before the increase.
Sustainable Growth .................. The rate at which a company can grow while still maintaining itstargeted debt-to-worth ratio. In other words, how fast a company cangrow if it is to maintain a specified level of financial risk.
©BRS 2015 59
Net Profits Don't Guarantee Cash Flow
Many years ago, we were involved with a partner in the jewelry supply industry. The wholesale distribution company grew from $17,000 in sales the first year to a little over $2 million in sales our fourth year. At this point, something very strange happened. While we were celebrating our remarkable growth in sales and profits, we ran out of cash -- constantly. We looked at each other and asked a question I've heard many times since: "If we're profitable, how come we don't have any money?"
The answer, of course, revolves around the basic tendency of most of us to measure financial success with our eyes firmly riveted only on sales -- ignoring exactly where the money is going.
To get a handle on the issue, we'll need to review the basic financial relationships and to focus on that "forgotten" financial statement -- the balance sheet. As we've mentioned before, the fundamental, undeniable, capitalistic formula is:
Assets = Liabilities + Net Worth
An asset is something you own; but to own it, you have to buy it. To buy it, someone has to supply the money. And, as you know, the money is supplied by either the creditors (liabilities) or the owners (net worth).
Now, why would you own assets in the first place? Unless your hobby is collecting them, most businesses use them to generate sales and hopefully sales will generate profits.
In our section on financial position, we looked at the relationship between the balance sheet and the income statement with this "efficiency" diagram:
©BRS 2015 60
Net Profit EFFICIENCY
Assets Liabilities Net Worth
3. To pay out to the owners.
2. To pay off
1. To pay for new assets.
Back to: Uses of Profits:
THE FINANCIAL OPERATING CYCLE
Increased Sales "cause" increased Assets
Increased Assets "cause" increased Liabilities + Net
Sales = Assets Liabilities + Net Worth
When looking at financial position, we said that we need assets to make sales. Now, to see the effects of growth, we have reversed the asset-sales arrow. This change illustrates a new way of looking at the relationship. At any given level of sales, you need a certain amount of assets -- and if you make more sales, you'll need more assets.
What we're saying is that to make profits, you need sales -- and to make sales, you need assets -- and to acquire assets, you need a supply of funds. In a nutshell, this simple framework outlines all the issues and variables involved in the financial management process.
What's the glue that supports this framework? Right back to efficiency. First, in converting assets to sales and second, in converting sales to profits. The efficient company will need fewer assets to produce the same sales; thus, since they need to acquire fewer assets, they will need less capital.
Our opening paragraph asked where the money goes. Perhaps a better, and certainly more practical issue is: Where does the money come from to buy assets?
In fact, there are really only four sources of funds to acquire new assets, and we've listed them below:
1. New equity.
2. Net profits -- in the form of retained earnings.
3. Trade credit -- or, as we call them, free liabilities.
4. Bank debt.
©BRS 2015 61
Most business owners don't want to put in new equity; they usually are looking for legal ways to take out more money. Net profits are generally a rather small percentage of the total funds needed. There are definite limits to credit suppliers are willing to extend; therefore, in many situations, bank debt becomes the only available source. Although we don't usually think of them in this way, the bank becomes the "source of last resort," which is called in to fill the Financial Gap. Financial Gap is defined as the difference between the value of new assets required to support a given level of sales and the total funds supplied by new equity, net profits, and trade credit.
Of course, you've probably never gone to the bank for a loan and said, "Hi, there. You're my last resort because I've used up all of my other sources of funds!" -- but that's the economic reality behind needing the bank and the bankers know it -- they didn't fall off the turnip truck yesterday (Last week, perhaps -- but not yesterday).
Actually, during the last twenty years or so the banks have come a long way in terms of recognizing a number of economic realities in relation to their business customers. For one thing, they've learned that net profits don't guarantee cash flow: profitable growing companies can have just as much trouble paying back loans as unprofitable ones. What the banks needed to do (and did) was to change their outmoded definition of cash flow.
The traditional banking definition of cash flow was Net Profits plus Depreciation. As you can see, such a definition only focused on sources, not uses of funds -- and it ignored completely any changes taking place on the balance sheet.
Funds provided by operation can easily be channeled into assets other than cash -- inventories, receivables, and/or fixed assets. When this happens, there is no "cash flow" to pay back the bank. Consequently, since the mid-eighties, the banking industry has made increasing use of this concept we've called Financial Gap. Our next step, then, is to examine how the financial community uses this Financial Gap concept to evaluate your need for funds and your need for management skills.
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The Sponge Technique: Squeeze the Balance Sheet to Improve Cash Flow
Everyone knows the value of a sponge: it absorbs water. This is a pretty good deal. Well, your company's balance sheet is just like a sponge -- except that it soaks up cash, rather than water. This is not necessarily a good financial deal. As the sponge nears its capacity to absorb additional water, it becomes increasingly less efficient. The same thing occurs with your balance sheet and the phenomenon has two basic causes. Increasing sales -- or growth -- creates a need for additional money to finance an increased level of assets. As we noted in the last section, the main source for most companies is from creditors -- in other words, debt. Risk (in the form of increased debt) increases accordingly, and increasing interest expense may even put downward pressure on profits. Furthermore, growth in sales is often accompanied by a decrease in the efficiency of operation. This inefficiency really surfaces on the balance sheet as proportionally more assets are required to support new sales levels. In other words, the rate of asset growth increases faster than sales; you make the same percent of profit -- but you make it less efficiently. So, what do you do? From our perspective, the clear message in a growth situations is straight forward: Manage better. We've listed below a few of the ways that can be done:
_____ Manage current assets (inventory, A/R) more efficiently
_____ Restructure debt (long-term, not short term)
_____ Make more profit
_____ Sell existing unproductive assets
_____ Curtail expansion
_____ Lease fixed assets
_____ Implement sale-leaseback of existing fixed assets
_____ Accept more risk (i.e., more debt)
_____ Don't grow (use pricing, etc. to limit growth)
_____ Get new equity -- a passive investor or active partner
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This checklist represents the action steps necessary to manage growth effectively; you need to arrive at the particular combination of components which will work for you (Remember, when it comes to the balance sheet, doing "nothing" is usually the worst possible decision).
By earning the same level of profits more efficiently, sufficient cash is "squeezed out" of the balance sheet to significantly reduce the borrowing requirements.
Consequently, this concept that we've labeled "Financial Gap" can be applied two ways. First, it's effective as a tool to estimate borrowing needs in a growth situation -- at an existing level of asset management efficiency. More importantly, it's an indispensable management planning tool for developing goals and standards of performance for efficient management.
Keep in mind, then, that there are three fundamental parameters in evaluating the growth capabilities of expanding companies:
1. How efficient is the company now?
2. The financial requirements of a particular company; that is, what new assets willbe needed?
3. The owner's abilities as an "asset manager" -- strong or weak?
Growth is reflected on the profit and loss statement as increases in sales and (hopefully) profits. The "cost of growth" is generally reflected on the balance sheet in the form of increased debt to offset decreased efficiency.
These are controllable issues. If you choose not to control them, then your banker may choose to "help." This help will come in the form of restrictive covenants regarding asset management -- that is, turnover requirements for inventory and/or accounts receivable (Listen for the comment: "I'm doing this for your own good!")
What they're really saying is that borrowing implies a partnership; you supply efficient management and your banker will supply sufficient funds. Banks are in business to finance efficient growth - not to subsidize your inefficiency.
The sponge analogy? Well, efficiency translates to squeezing your balance sheet to free up the funds you need to grow; otherwise, you'll find it squeezing you.
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Steps to Calculate Financial Gap
First .........Evaluate which assets and liabilities vary with sales.
Normally Variable: cash, accounts receivable, inventory, accounts payable, and accrued expenses.
And note payable; this is our "plug" figure -- the FINANCIAL GAP we need to fill.
Second .....Evaluate projected levels of assets which do not vary with sales.
Assets Not Normally Variable: land, buildings, equipment, and furniture/fixtures. (These assets are normally projected based on company "capacity." They do not vary constantly as a percentage of sales but rather, when an increase is made, they "jump" to a new level in a "stair-step" fashion).
Third........Project a new net worth by taking existing net worth and adding projected net profit after tax.
Fourth......Calculate each "variable" asset as a percent of sales.
Example:
Sales = $600,000
Accounts Receivable = $108,000
The "percent of sales" for Accounts Receivable is simply:
Accounts Receivable = 108,000
Sales 600,000
= .18
= 18%
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Fifth .........Apply the percentages derived in Step Four to the new projected sales level.
Project new sales level = $900,000
Accounts Receivable % = 18%
New level of Accounts Receivable is:
18% $900,000 = $162,000
Sixth .........Project the new balance sheet.
Begin at Cash and move DOWN the assets side to Total Assets. As you move down the Asset side, you will be adding projected asset elements together to arrive at Total Assets.
Then, move ACROSS to Total Liabilities + Net Worth.
Finally, move UP the liabilities side. As you move up the Liabilities side, you will be subtracting projected liability and net worth elements to arrive at the projected final figure.
The final figure filled in is Notes Payable -- this is your FINANCIAL GAP.
Seventh ....Calculate the new balance sheet ratios -- the current ratio, the quick ratio, and debt-to-worth. Compare these to your existing ratios.
Eighth ......Analyze. Is this where you want to be? If not, consider any or all of the following options:
_____ Manage current assets.
_____ Restructure debt.
_____ Make more profit.
_____ Sell existing unproductive assets.
_____ Curtail expansion.
_____ Lease fixed assets.
_____ Implement sale-leaseback of existing fixed assets.
_____ Accept more risk.
_____ Don't grow (use pricing, etc. to limit growth).
_____ Get new equity.
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Case Study Evergreen Distributing
Evergreen Distributing is a small, local supplier of Olympic Flooring. Recently, however, their sales have begun to increase rapidly. In the year just completed, sales reached $600,000, and now they have a real opportunity -- and a decision to make:
If they continue on their present course, they expect sales to rise to $900,000.
If they "go for it" they figure they can reach $1,600,000 in sales next year.
In either case, they expect profits to remain the same as they were this year:
Net Profit After Tax: 3% of Sales
For the year just completed -- sales of $600,000 -- the balance sheet looked like this:
PERCENT PERCENTOF SALES* OF SALES*
Cash .............................. $ 24,000 4% Note Payable .................. $ 0
Accounts Receivable ..... 108,000 18% Accounts Payable ............ 90,000 15%
Inventory ........................ 156,000 26% Accruals ........................... 42,000 7%
Total Total Current Assets ...... $ 288,000 Current Liabilities .. $ 132,000
Equipment ...................... 150,000 25% Long-Term Liabilities ..... 140,000
Land/Building ........... 120,000 Total Liabilities ......... 272,000
Total Fixed Assets .... 270,000 Net Worth ...................... 286,000
Total LiabilitiesTotal Assets ................ $ 558,000 and Net Worth ...... $ 558,000
* Assets and liabilities that vary with sales are indicated by an entry in the percent-of-sales column. Variable assets (as a percent of sales) are: 4% + 18% + 26% + 25% =73%. This, in turn, is equal to Total Variable Assets/Total Sales = 438,000/600,000 = .73
Financial Gap
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Evergreen Distributing Balance Sheet
TO DO: Calculate the balance sheet that Evergreen will have if they achieve their projections of $900,000 in sales, then evaluate the financial health of the company using your balance sheet ratios.
Projected Sales .....................$ 900,000 Projected NPAT .........................$ 27,000
PERCENT PERCENTOF SALES* OF SALES*
Cash ..................... $ __________ 4% Note Payable ....... $ __________
Accts. Receivable ... __________ 18% Accounts Payable ... __________ 15%
Inventory ................. __________ 26% Accruals .................. __________ 7%
Total Total Current Assets ... $ ========= Current Liabilities .. $ ========
Equipment ............... __________ 25% Long-Term Liabilities 140,000
Land/Building ........ 120,000 Total Liabilities ..... __________
Total Fixed Assets __________ Net Worth ............... __________
(old Net Worth* = 286,000)Total Liabilities
Total Assets .......... $ ========= and Net Worth . $ =========
* Reminder: to determine what net worth will be after reaching the projected sales level,take the old net worth (from the actual year just completed) and add the net profit aftertax from the projected year.
BALANCE SHEET RATIOS
At $600,000 At $900,000
Current _______________ _______________
Quick _______________ _______________
Debt-To-Worth _______________ _______________
Financial Gap
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FOR REFERENCE:
BALANCE SHEET RATIO REVIEW
HOW DERIVED DEFINITION
SOLVENCY:
Current Ratio Current Assets Measures solvency: Current Liabilities the company's ability to pay its bills.
LIQUIDITY:
Quick Ratio Cash + Accts Rec. Measures liquidity: (or acid test ratio) Current Liabilities the company's ability to generate
cash; to pay bills without relying on sale of inventories.
LEVERAGE:
Debt-to-Net Worth Total Liabilities Measures the company's ability Net Worth to withstand adversity:
shows the riskiness of the company.
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Evergreen Distributing Balance Sheet
TO DO: Calculate the balance sheet that Evergreen will have if they achieve their projections of $1,600,000 in sales -- then evaluate the financial health of the company, both in relation to their present situation and the alternative of going to $900,000 in sales.
Projected Sales .....................$ 1,600,000 Projected NPAT .........................$ 48,000
PERCENT PERCENTOF SALES* OF SALES*
Cash ..................... $ __________ 4% Note Payable ....... $ __________
Accts. Receivable ... __________ 18% Accounts Payable ... __________ 15%
Inventory ................. __________ 26% Accruals .................. __________ 7%
Total Total Current Assets ... $ ========= Current Liabilities .. $ ========
Equipment ............... __________ 25% Long-Term Liabilities 140,000
Land/Building ........ 120,000 Total Liabilities ..... __________
Total Fixed Assets __________ Net Worth ............... __________
(old Net Worth* = 286,000)Total Liabilities
Total Assets .......... $ ========= and Net Worth . $ =========
* Reminder: to determine what net worth will be after reaching the projected sales level,take the old net worth (from the actual year just completed) and add the net profit aftertax from the projected year.
BALANCE SHEET RATIOS
At $600,000 At $900,000 At $1,600,000
Current _______________ _______________ _______________
Quick _______________ _______________ _______________
Debt-To-Worth _______________ _______________ _______________
Financial Gap
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FOR REFERENCE:
BALANCE SHEET RATIO REVIEW
HOW DERIVED DEFINITION
SOLVENCY:
Current Ratio Current Assets Measures solvency: Current Liabilities the company's ability to pay its bills.
LIQUIDITY:
Quick Ratio Cash + Accts Rec. Measures liquidity: (or acid test ratio) Current Liabilities the company's ability to generate
cash; to pay bills without relying on sale of inventories.
LEVERAGE:
Debt-to-Net Worth Total Liabilities Measures the company's ability Net Worth to withstand adversity:
shows the riskiness of the company.
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Managing Evergreen Distributing Selected Options from Page 61
Here are three options that we selected to target improvement in Evergreen's efficiency. If Evergreen can attain these goals, the company can have the benefits of growth without the cost of growth that usually show up on the balance sheet.
MANAGE INVENTORY TURNOVER
Evergreen's Cost of Goods Sold is 70% of sales: $900,000 70% = $630,000
Inventory Turnover = Cost of Goods Sold Inventory
= $630,000 $234,000
= 2.7 turns per year
Inventory Turn-Days = 360 days Inventory Turnover
= 360 2.7
= 133 days
In other words, the inventory turns once every 133 days. But . . . if Evergreen could turn the inventory more efficiently (that is, faster), they would produce an inventory savings. At four turns per year, for example:
4 turns = 90 days
Inventory = Cost of Goods Sold Inventory Turnover
= $630,000 4
= $157,500
Inventory at 2.7 turns: $234,000
minus Inventory at 4.0 turns: – $157,500
equals Inventory Savings $ 76,500
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MANAGE ACCOUNTS RECEIVABLE TURNOVER
The same principle applies to Accounts Receivable management.
Accounts Receivable Turnover = Credit Sales A/R
= $900,000 $162,000
= 5.6
Average Collection Period = 360 days A/R Turnover
Accounts Receivable Turn Days = 360 5.6
= 64 days
If Evergreen can improve its A/R collection to 45 days, then:
Accounts Receivable Turnover = 360 days Avg Coll Period
= 360 45
= 8
Accounts Receivable = Credit Sales A/R Turnover
= $900,000 8
= $112,500
A/R at 5.6 turns: $162,000 minus A/R at 8.0 turns: – $112,500equals A/R Savings $ 49,500
RESTRUCTURE DEBT
During the projected year, Evergreen will purchase $75,000 of equipment:
Ending Equipment: $225,000
minus Beginning Equipment: – $150,000
equals Equipment Purchase: $ 75,000
In the Financial Gap projection, the funds needed to pay for this purchase were classified as a Current Liability (payable within one year). If this equipment purchase is financed with 80% long-term debt, then $60,000 will be in a long-term note, thereby "freeing up" that amount of cash flow in the coming year which otherwise would have had to be used to repay short-term debt:
$75,000 80% = $60,000
Old Long-Term Debt: $140,000plus Added Long-Term Debt: + $ 60,000
equals New Long-Term Debt $200,000
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Evergreen Distributing "Managed" Balance Sheet
If Evergreen was able to implement the efficiency improvements listed above -- and achieved its target sales level of $900,000, with a net profit after tax of $27,000 -- it's balance sheet would look like this:
PERCENT PERCENTOF SALES OF SALES
Cash .............................. $ 36,000 Note Payable ......................... $ 0
Accounts Receivable ..... 112,500 Accounts Payable ............ 75,000
Inventory ....................... 157,000 Accruals .......................... 63,000
Total Total Current Assets ...... $ 306,000 Current Liabilities .. $ 138,000
Equipment ...................... 225,000 Long-Term Liabilities .... 200,000
Land/Building .......... 120,000 Total Liabilities ......... 338,000
Total Fixed Assets .... 345,000 Net Worth ...................... 313,000 Total Liabilities
Total Assets ................ $ 651,000 and Net Worth ...... $ 651,000
BALANCE SHEET RATIOS At $900,000
At $600,000 At $900,000 "Managed"
Current Current Assets 2.18 1.33 2.22 Current Liabilities
Quick Cash + A/R 1.00 0.61 1.08 Current Liabilities
Debt-to-Worth Total Liabilities 0.95 1.48 1.08 Net Worth
Financial Gap
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Answer Sheet Evergreen Distributing
Balance Sheet
TO DO: Calculate the balance sheet that Evergreen will have if they achieve their projections of $900,000 in sales, then evaluate the financial health of the company using your balance sheet ratios.
Projected Sales .....................$ 900,000 Projected NPAT .........................$ 27,000
PERCENT PERCENTOF SALES* OF SALES*
Cash................................$ 36,000 4% Note Payable .................$126,000
Accts. Receivable ............162,000 18% Accounts Payable ............135,000 15%
Inventory .........................234,000 26% Accruals ............................63,000 7%
Total Total Current Assets ...........$ 432,000 Current Liabilities .....$ 324,000
Equipment .......................225,000 25% Long-Term Liabilities . 140,000
Land/Building .......... 120,000 Total Liabilities ............464,000
Total Fixed Assets........345,000 Net Worth........................313,000 (old Net Worth* = 286,000)
Total LiabilitiesTotal Assets ...................$777,000 and Net Worth ........$ 777,000
* Reminder: to determine what net worth will be after reaching the projected sales level, takethe old net worth (from the actual year just completed) and add the net profit after tax fromthe projected year.
BALANCE SHEET RATIOS
At $600,000 At $900,000
Current 2.18 1.33
Quick 1.0 .61
Debt-To-Worth .95 1.48
Financial Gap
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Answer Sheet Evergreen Distributing
Balance Sheet
TO DO: Calculate the balance sheet that Evergreen will have if they achieve their projections of $1,600,000 in sales ―then evaluate the financial health of the company, both in relation to their present situation and the alternative of going to $900,000 in sales.
Projected Sales .....................$ 1,600,000 Projected NPAT .........................$ 48,000
PERCENT PERCENTOF SALES* OF SALES*
Cash................................$ 64,000 4% Note Payable .................$462,000
Accts. Receivable ............288,000 18% Accounts Payable ............240,000 15%
Inventory .........................416,000 26% Accruals ..........................112,000 7%
Total Total Current Assets ............$768,000 Current Liabilities ......$814,000
Equipment .......................400,000 25% Long-Term Liabilities . 140,000
Land/Building .......... 120,000 Total Liabilities ............954,000
Total Fixed Assets........520,000 Net Worth........................334,000 (old Net Worth* = 286,000)
Total LiabilitiesTotal Assets ................$1,288,000 and Net Worth ......$1,288,000
* Reminder: to determine what net worth will be after reaching the projected sales level, takethe old net worth (from the actual year just completed) and add the net profit after tax fromthe projected year.
BALANCE SHEET RATIOS
At $600,000 At $900,000 At $1,600,000
Current 2.18 1.33 .94
Quick 1.0 .61 .43
Debt-To-Worth .95 1.48 2.86
Financial Gap
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