Chapter 11: Managing Financial Operations
Click on the topics below for the summary of
Each topic. Use the links below to access the
Other materials available for this chapter
PowerPoint
Chapter Case
Analytical Tools
- What is the value of the balance sheet and income statement?
- How are the current and quick ratio used in a venture?
- What is the formula for return on investment?
- List the profitability and solvency ratios to evaluate a venture?
- What is the break-even technique used to determine profit and loss?
Chapter Review
What is the value of the balance sheet and income statement?
The balance sheet provides a picture of the financial position of the business at a particular point in time, generally at the end of a financial period (e.g., month, quarter or year).
It is essentially a snapshot of a company’s resulting financial position, encompassing everything the company owns (assets) or owes (liabilities), as well as the investments into the company by its owners and the accumulated earnings or losses of the company (equity).
The statement of operations, also known as income statement, profit-and-loss statement, or P&L statement, summarizes the revenue (or income) and expenses of a company on a monthly basis for one year, or on an annual basis for several years.
How are the current and quick ratio used in a venture?
- Current Ratiois the total current asset divided by the total current liabilities. Current assets and liabilities are those items expected to generate cash or require the disbursement of cash within the next year
- The current ratio indicates the ability of the company to meet its obligations for the next year. The higher the ratio, the greater the liquidity. A low ratio indicates a lack of liquidity and potential problem meeting maturing obligations.
- Quick Ratio. also called the acid-test ratio, this is very similar to the current ratio except that it includes only those current assets—cash and accounts receivable—that can be most readily used to pay bills today.
- The quick ratio excludes inventory, which must first be sold and the cash collected before it can be used to pay liabilities. It also excludes current assets such as prepaid expenses, which are never converted to cash (they are simply assets paid for in advance.
What is the formula for return on investment?
- The return on investment compares the net profit of the business to the investment (net worth) of the business. It is calculated as net income after taxes (From the income statement) divided by total owner’s equity (from the balance sheet).
- Return on investment =
- Net Income
- Shareholders’ equity
List the profitability and solvency ratios to evaluate a venture?
- Solvency ratios can help the entrepreneur evaluate the business liabilities. Debt is associated with risk; so, the greater the debt, the higher the return rate will be. If the liabilities are large compared to equity or assets, potential lenders and investors may feel that the company is already too indebted and is not a good investment risk. Other Solvency Ratios include :Current Liabilities to Net Worth, Total Liabilities to Net Worth, Fixed Assets to Net Worth .
- . Profitability ratios can also be used to analyze the statement of operations. The more commonly used ones are as followsReturn on InvestmentandReturn on Total Assets. This measures how efficient the business in using the assets in negotiation net income.
What is the break-even technique used to determine profit and loss?
- The break-even technique is a decision-making model that helps the entrepreneur to determine whether a certain volume of output will result in a profit or loss. The point at which breaking even occurs is the volume of output at which total revenues equals total costs.
- The technique can be further used to answer the question, “What is the profit associated with a given level of output?” To use this technique, you need only three types of information: fixed costs of operation, variable costs of production, and price per unit.