Describe the purpose of comparative financial statements.

2. Section Objectives • Describe the purpose of comparative financial statements. • Describe how different ratios are calculated. • Explain why financial statements are essential for decision making.

3. The Main Idea By maintaining and analyzing financial records and reports, business owners and other interested parties have the information necessary to make sound business decisions.

4. Content Vocabulary comparative financial statement ratio analysis current ratio working capital debt ratio net profit on sales ratio operating ratio quick ratio

5. Using Financial Statements Every business prepares two primary financial statements: • The income statement, also called a Profit and Loss (or P&L) statement, reports the revenue, expenses, and net income or loss for the period. • The balance sheet reports the assets, liabilities, and owner’s equity accounts.

6. Comparative Financial Statements A comparative financial statement can allow a business owner to compare from different accounting periods in order to evaluate the financial health of the business. comparative financial statement a financial statement with financial data from two accounting periods used as an analysis tool by a business owner

7. Ratio Analysis Owners, lenders, and creditors use ratio analysis to determine the financial strength, activity, or bill-paying ability of a business. ratio analysis the comparison of two or more amounts on a financial statement and the evaluation of the relationship between these two amounts

8. Current Ratio The current ratio indicates the ability of a business to pay its bills. current ratio the comparison of current assets (cash or other items that can be converted to cash quickly) and current liabilities (debts due within a year), used to indicate the ability of a business to pay its bills

9. Working Capital Businesses use information from the “current year” balance sheet to calculate working capital. working capital the capital available to a business to carry out its daily operations

10. Debt Ratio If a business’s debt ratio is high, a large portion of the business operation is being financed by creditors. debt ratio the measurement of the percentage of total dollars in a business that is provided by creditors

11. Net Profit on Sales Ratio Net profit on sales ratio is calculated using amounts from the “current year” income statement. net profit on sales ratio the number of cents left from each dollar of sales after expenses and income taxes are paid

12. Operating Ratio Operating ratio gives the business owner a sense of whether expenses are in line with similar businesses. operating ratio the relationship between each expense and total sales as reported on the income statement

13. Small Business and Entrepreneurship The higher the quick ratio, the better. quick ratio a measure of the relationship between short-term liquid assets, which include cash and accounts receivable, and current liabilities

14. Management Decision Making Business owners must analyze the vital information provided in financial statements, identify problem areas, and make decisions.

15. Management Decision Making Many businesses prefer to use accountants to assure their financial records are kept according to accounting standards, all reports are completed and analyzed, and taxes calculated and paid. Section 21.1 Analyzing Your Finances

16. After You Read 1. Describe the purpose of comparative financial statements. Comparative financial statements provide an analysis that shows increases and decreases in various accounts from one period to the next.

17. After You Read 2. Describe how operating ratios are calculated. Each expense is divided by total sales for the period.

18. After You Read 3. Explain why financial statements are essential for decision making. The reports provide vital financial information. This information is the basis of all financial decisions.

19. Section Objectives • Describe ways to help manage your cash flow. • Explain the importance of controlling capital expenditures. • Describe ways to control your taxes. • Describe how you can manage credit offered to customers.

20. The Main Idea Careful management of your business finances is an essential element of running a successful business.

21. Content Vocabulary variable expenses fixed expenses budget capital expenditures credit bureaus

22. Planning for Profits The main goal of a business is to make a profit. Profits do not just happen. Business owners have to plan for them.

23. Planning for Profits Forecastsales Evaluateprofit potential PlanforProfits Controlcosts Budget 23

24. Forecasting Sales You can base projections of sales on: • sales records of previous periods • the current rate of sales growth in your industry and geographic area • the rate of growth of the gross national product

25. Evaluating Profit Potential If you want to improve your profit, you can make certain changes to your profit planning, such as: • increasing sales revenue by pursuing market share • adding new products • raising prices • increasing advertising

26. Evaluating Profit Potential To understand your profit potential, you must know your fixed expenses and variable expenses. fixed expenses business expenses that do not change with number of units produced, such as insurance and rent variable expenses business expenses that change with each unit of product produced, such as supplies, wages, and production materials

27. Budgeting To be of value, your budget should be compared periodically with actual income and expenses. budget a formal, written statement of expected revenue and expenses for a future period of time

28. Managing Cash Flow For a business to be successful, a constant flow of cash is essential. If sufficient cash is not available, business owners cannot buy merchandise, pay bills, or invest funds for future growth.

29. Using a Cash Budget A cash budget helps monitor your business’s cash flow by recording estimated cash flow, actual cash flow, and the difference between the two amounts. By recording and analyzing line items each month, business owners can address any significant changes from the budgeted amounts.

30. Improving Your Cash Flow Closely monitor credit and collections. Take advantage of credit terms. Manage inventory carefully. Offer cash discounts. Set up a cash reserve. Monitor payroll expenses. Put cash surpluses to work. Reduce expenses. 30

31. Planning for Capital Expenditures Before making capital expenditures, you first should determine if you can pay for them, how much revenue they will generate, and how long they will take to pay for themselves. capital expenses long-term commitments of large sums of money to buy new equipment or replace old equipment

32. Managing Taxes These tips will help you manage your taxes. • Time income to control when it is taxed. • Time deductions. • Choose the most beneficial depreciation method. • Write off uncollectible accounts. • Claim research and development expenses. • Keep records of all expenses.

33. Managing Credit The main advantage of offering credit to customers is increased sales volume. The main disadvantage is the difficulty of collecting money owed in a timely manner.

34. Granting Credit The Five Steps of Granting Credit • Inform the customer. • Make your decision. • Evaluate credit applications. • Check credit and background. • Obtain information. 34

35. Granting Credit Credit bureaus provide important information to businesses that are considering loan or credit applications. credit bureaus agencies that collect and sell information on how promptly people and businesses pay their bills

36. Collecting Accounts A business can collect accounts internally or hire a collection agency. The most effective internal collection procedures involve progressively forceful steps.

37. After You Read 1. Describe why evaluating profit potential is a useful technique to plan for profits. Evaluating profit potential allows a business owner to decide whether to invest in a change. One way to increase profits is to venture into new markets.

38. After You Read 2. Describe ways to help manage your cash flow. Ways to manage cash flow include using a cash budget and improving cash flow by monitoring credit and collections, taking advantage of credit terms, managing inventory, offering cash discounts, setting up a cash reserve for uncollected accounts, monitoring payroll expenses, putting cash surpluses to work, and reducing expenses.

39. After You Read 3. Explain the importance of controlling capital expenditures. Capital expenditures are long-term commitments of large sums of money. A company must control capital expenditures so as not to tie up too much cash or incur too much debt.

40. After You Read 4. Describe ways to control your taxes. You can control taxes by timing income so that you control when it is taxed, timing your deductions, choosing the most beneficial method of depreciation, writing off uncollectible accounts, claiming research and development expenses, and keeping records of all expenses.

41. After You Read 5. Describe how you can manage credit offered to customers. You should gather financial information about customers, check their credit records, evaluate credit applications, make your decision, and inform the customers.

42. End of Chapter 21 Financial Management