Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ Profit, Profitability, and Break-Even Analysis Adapted from Adelman & Marks, 2007 NOTE: Use these slides in conjunction with Autoshop Pro Formas.xlsx and Carls Trucks.xlsx

Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ Efficiency and Effectiveness  Efficiency is obtaining the highest possible return with the minimum use of resources.  Effectiveness, on the other hand, is accomplishing a specific task or reaching a goal.

Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ Profit Versus Profitability (continued)  Profitability can be measured in a business by using a ratio that is obtained by dividing net profit by total assets. Profitability, therefore, is our Return on Assets.  Example: Autoshop in year 7 of operations  = $13,206,043 / 43,785,556 = 30%  In the next few slides, we see this is Earning Power

Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ Earning Power  The earning power of a company can be defined as the product of two factors: › The company’s ability to generate income on the amount of revenue it receives, which is also known as net profit margin; and › Its ability to maximize sales revenue from proper asset employment, also known as total asset turnover.

Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ Earning Power Formulas  Earning power is equal to net profit margin multiplied by total asset turnover which is equal to return on investment (total assets).

Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ Break-Even Analysis  Break-even analysis is a process of determining how many units of production must be sold, or how much revenue must be obtained, before we recover our fixed costs and begin to earn a profit.  For break-even quantity:

Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ

Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ Break-Even Analysis (continued) 

Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ Break-Even Analysis (continued)  Contribution margin is the amount of profit that will be made by a company on each unit that is sold above and beyond the break-even quantity.  Contribution margin is also the amount the company will lose for each unit of production by which it falls short of the break-even point.

Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ Profit and Break-Even  Desired profit with break-even analysis in quantity to produce. › VC is variable cost per unit  Desired profit with break-even analysis in dollars. › VC is a percentage of sales dollar (e.g., cost of goods sold as a percent).

Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ Break-Even Charts

Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ Carl’s Trucks Break-even by days of operation VC = $6 VP = $12 FC/yr = $100k Forecast = 1300/mo Does Carl reach break- even in a year of operations?

Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ Leverage  Leverage uses those items that have a fixed cost to magnify the return to a company. Fixed costs can be related to company operations or related to the cost of financing. › Interest expenses paid on the amount of debt incurred is the fixed cost of financing. › A firm is heavily financially leveraged if the fixed costs of financing are high.

Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ Leverage (continued)  Degree of operating leverage (DOL) is the percentage change in operating income divided by the percentage change in sales.

Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ Leverage (continued)  Degree of financial leverage (DFL) is the percentage change in earnings per share divided by the percentage change in operating income.

Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ Leverage (continued)  Degree of combined leverage (DCL) is the percentage change in earnings per share divided by the percentage change in sales. See Autoshop worksheet