1. Dr. David P. EchevarriaAll Rights Reserved1 F INANCIAL A NALYSIS OF B USINESS O PERATIONS Chapter 14 EBD-301 Accounting and Finance for Entrepreneurs

2. Dr. David P. EchevarriaAll Rights ReservedPage 2 Financial Analysis Overview A.The objective of financial analysis (FA) is to direct owner-manager attention to areas of concern in the financial performance of the business. B.Solutions will follow problem identification and analysis C.FA is a series of tools helpful in identifying problem areas D.FA helps in valuation analysis

3. Dr. David P. EchevarriaAll Rights ReservedPage 3 Financial Analysis Overview E.Comparing [current to past] performance 1.Where have we improved? 2.Where do we need to improve? 3.How do we compare to the best run business in our industry? [benchmarking] F.Key Problem Areas 1.Cost Management - key to profitability 2.Asset Management – “right-sizing”

4. Dr. David P. EchevarriaAll Rights ReservedPage 4 Liquidity Management A.Liquidity ratios measure the company's ability to pay their bills: Accounts Payable, Notes Payable, Accrued Expense 1.Current Ratio: Dollars in current assets per dollar of current liabilities. 2.Quick Ratio: Dollars in quick assets per dollar of current liabilities. (Inventory - low liquidity) 3.Cash Ratio: Cash available per dollar of current liabilities

5. Dr. David P. EchevarriaAll Rights ReservedPage 5 Asset Management A.Asset utilization ratios measure the efficiency of asset management. 1.Accounts Receivable Turnover (ARTO) 2.Days Sales Outstanding (DSO) 3.Inventory Turnover (ITO) 4.Total Assets Turnover (TATO) 5.Fixed Assets Turnover (FATO)

6. Dr. David P. EchevarriaAll Rights ReservedPage 6 Debt Management A.The extent to which assets and operating expenses are financed by borrowing money. 1.Debt Ratio (DR) 2.Times Interest Earned (TIE) 3.Fixed Charge Coverage (FCC) B.Many financial theorists favor borrowing 1.Method for increasing return on equity 2.Less expensive than equity

7. Dr. David P. EchevarriaAll Rights ReservedPage 7 Profitability Management A.Profits result when a firm’s expenses are less than its revenues. B.Profitability is a proxy measure for the firm’s ability to control costs. 1.Gross Profit Margin (GPM) – direct costs 2.Operating Profit Margin (OPM) – all operating costs 3.Net Profit Margin (NPM) – how much to bottom line

8. Investment Performance A.How well does the business produce a good return on our investment in the business: Gross investment, Equity B.Return on Assets (ROA) or Investment (ROI) C.Return of Equity (ROE) D.Basic earning Power (BEP) 1.How efficiently we generate cash from total asset investment Dr. David P. EchevarriaAll Rights ReservedPage 8

9. Dr. David P. EchevarriaAll Rights ReservedPage 9 Trend Analysis A.Trend analysis answers two very important questions: 1. How has the business done over the last x years in a particular area. 2. How does the company’s trend compare to the industry average? Industry benchmark?

10. Dr. David P. EchevarriaAll Rights ReservedPage 10 Trend Analysis Example

11. Dr. David P. EchevarriaAll Rights ReservedPage 11 DuPont System of Financial Analysis A.DuPont System: a set of interrelated financial ratios used to measure operating performance. 1.ROE = ROA x (Total Assets/ Common Equity) a.ROA = NPM * TATO b.EQTY MULT = TOTAL ASSETS / COM EQTY c.TATO = Net Sales / Total Assets 4.ROE = NPM * TATO * EQTY. MULT.

12. Dr. David P. EchevarriaAll Rights ReservedPage 12 DuPont System