1. Accounting Statements and Financial Requirements
Chapter 10
Accounting Statements and Financial Requirements
In the Spotlight:
Diamond Courier
Small Business Management, 11th edition
Longenecker, Moore, and Petty
2000
South-Western College Publishing
10-1

2. Learning Objectives: Chapter 10
1. Describe the purpose and content of financial statements.
2. Explain how to forecast a new venture’s profitability.
3. Estimate the assets needed and the financing required for a new venture.
Small Business Management, 11th edition
Longenecker, Moore, and Petty
2000
South-Western College Publishing
10-2

3. The Income Statement: An Overview
Operating Activities
Sales revenue
Cost of producing or acquiring product or service (cost of goods sold)
Gross profit
Marketing and selling expenses and general and administrative expenses (operating expenses)
Earnings before taxes
Corporate taxes
Financing Activities
Operating income
Interest expense on debt (financing costs)
Taxes = = =
Net income available to owners
Earnings before taxes =
Earnings before interest and taxes (operating income)
Small Business Management, 11th edition
Longenecker, Moore, and Petty
2000
South-Western College Publishing
10-3

4. Bates & Associates’ Income Statement
Sales revenue $830,000
Cost of goods sold _540,000
Gross profit $290,000
Operating expenses:
Marketing expenses $90,000
General and administrative expenses ,000
Depreciation _28,000
Total operating expenses $190,000
Operating income $100,000 Interest expense __20,000
Earnings before taxes $ 80,000
Income tax (25%) ,000
Net income $ 60,000
Dividends paid $_15,000
Change in retained earnings $ 45,000
Small Business Management, 11th edition
Longenecker, Moore, and Petty
2000
South-Western College Publishing
10-4

5. The Balance Sheet: An Overview
Assets
Debt (Liabilities) and Equity (Net Worth)
Current Assets
Cash
Accounts receivable
Inventories
Prepaid expenses
Debt Capital
Current Debt
Accounts payable
Other payables
Accrued expenses
Short-term notes
Long-Term Debt
Long-term notes
Mortgages +
Fixed Assets
Machinery and equipment
Buildings
Land +
Owner’s Equity Capital
Owner’s net worth or
Partnership equity
Common stock equity +
Other Assets
Investments
Patents = =
Total Assets
Total Debt and Equity
Small Business Management, 11th edition
Longenecker, Moore, and Petty
2000
South-Western College Publishing
10-5

6. Bates & Associates’ Manufacturing Balance Sheets
Assets Changes
Current assets:
Cash $ 38,000 $ 43,000 $ 5,000
Accounts receivable 70,000 78, , Inventories 175, , ,000
Prepaid expenses 12,000 14, ,000
Total current assets $295,000 $345,000 $ 50,000
Fixed assets:
Gross plant and
equipment $760,000 $838,000 $ 78,000
Accumulated
depreciation 355, , ,000
Net plant and equipment $405,000 $455,000 $ 50,000
Land 70, , Total fixed assets $475,000 $525,000 $ 50,000
Goodwill and patents 30, , ,000
TOTAL ASSETS $800, $920,000 $120,000
Small Business Management, 11th edition
Longenecker, Moore, and Petty
2000
South-Western College Publishing
10-6A

7. Bates & Associates’ Manufacturing Balance Sheets
Debt (Liabilities) Changes and Equity
Current debt:
Accounts payable $ 61, $ 76,000 $ 15,000
Income tax payable 12, , ,000
Accrued wages
and salaries 4, , ,000
Interest payable 2, , , Total current debt $ 79, $100,000 $ 21,000
Long-term debt:
Long-term notes payable , , ,000
Total debt $225, $300,000 $ 75,000
Common stock $300, $300, $0
Retained earnings 275, , ,000
Total stockholders’ equity $575, $620,000 $ 45,000
TOTAL DEBT
AND EQUITY $800, $920, $120,000
Small Business Management, 11th edition
Longenecker, Moore, and Petty
2000
South-Western College Publishing
10-6B

8. The Fit of the Income Statement and the Balance Sheet
Reports the profits from January 1, 1999 through December 31, 1999
Income Statement for 1999
Balance Sheet December 31, 1998
Reports the financial position as of December 31, 1998
Balance Sheet December 31, 1999
Reports the financial position as of December 31, 1999
Time
Small Business Management, 11th edition
Longenecker, Moore, and Petty
2000
South-Western College Publishing
10-7

9. A Firm’s Cash Flows = Investments in fixed assets and other assets
net operating
working capital
Firm’s
cash
flow
After-tax cash flows
from operations =
Small Business Management, 11th edition
Longenecker, Moore, and Petty
2000
South-Western College Publishing
10-8

10. Bates & Associates’ Measurement of Cash Flows
Step 1: Compute after-tax cash flows from operations:
Operating income (EBIT) $100,000a
Depreciation ,000a
Earnings before interest, tax, $128,000
depreciation, and amortization (EBITDA)
Tax expense $20,000a
Change in income tax payable ,000b
Cash tax payments ,000
After-tax cash flows from operation $111,000
Small Business Management, 11th edition
Longenecker, Moore, and Petty
2000
South-Western College Publishing
a Figure from income statement
b Figure from balance sheets
10-9A

11. Bates & Associates’ Measurement of Cash Flows
Step 2: Compute the change in net operating working capital:
Change in cash $ 5,000b
Change in accounts receivable 8,000b
Change in inventories 35,000b
Change in prepaid expenses 2,000b
Changes in current assets $50,000
Change in accounts payable $15,000b
Change in accrued wages ,000b
Change in non-interest-bearing current $16,000
operating liabilities
Change in net operating working capital $34,000
Small Business Management, 11th edition
Longenecker, Moore, and Petty
2000
South-Western College Publishing
a Figure from income statement
b Figure from balance sheets
10-9B

12. Bates & Associates’ Measurement of Cash Flows
Step 3: Calculate the change in fixed assets and other assets:
Gross purchase price of fixed assets $ 78,000b
Net cash used for investments in other assets ,000b
Change in long-term assets ,000
Firm’s cash flows ($ 21,000)
Small Business Management, 11th edition
Longenecker, Moore, and Petty
2000
South-Western College Publishing
a Figure from income statement
b Figure from balance sheets
10-9C

13. The Purpose of Pro Forma Financial Statements
The purpose of pro forma financial statements is
to answer three questions:
1. How profitable can the firm be expected to be, given the projected sales levels and the expected sales expense relationships?
2. What will determine the amount and type of financing (debt or equity) to be used?
3. Will the firm have adequate cash flows? If so, how will they be used; if not, where will the additional cash come from?
Small Business Management, 11th edition
Longenecker, Moore, and Petty
2000
South-Western College Publishing
10-10

14. Oakcrest Products, Inc., Projected Income Statements
Year 1 Year 2
Sales $250,000 $400, Line 1
Cost of goods sold:
Fixed costs $100,000 $100, Line 2
Variable costs (20% of sales) __50,000 _ 80, Line 3
Total cost of goods sold $150,000 $180,000 Line 4
Gross profits $100,000 $220,000 Line 5
Operating expenses:
Fixed expenses $ 50,000 $ 50,000 Line 6
Variable expenses (30% of sales) __75,000 _120,000 Line Total operating expenses $125,000 $170,000 Line 8
Operating profits ($ 25,000) $ 50,000 Line 9
Interest expense (12% interest rate) , ,000 Line 10
Earnings before taxes ($ 37,000) $ 38,000 Line 11
Taxes (25% of earnings before taxes) ,500 Line 12
Net income ($ 37,000) $ 28,500 Line 13
Small Business Management, 11th edition
Longenecker, Moore, and Petty
2000
South-Western College Publishing
10-11

15. Sales-Assets-Financing Relationships
Increases in asset requirements
Increases in financing requirements
Increases in sales
Small Business Management, 11th edition
Longenecker, Moore, and Petty
2000
South-Western College Publishing
10-12

16. Practical Forecasting
1. Don’t stretch to reach your numbers; be factual and conservative.
2. Remember: Only the most astonishing changes in a business or a market can justify a sudden, rocket-like performance.
3. Build projections quantitatively from clear assumptions.
4. Document the reasoning behind each projection in a written list of assumptions.
5. Use industry-specific data to guide your projections of sales and expenses.
6. Remember: Projections are immediately suspect if sales or profit margins are significantly higher or lower than the industry average.
7. Check pro forma statements against actual results at least once a month.
Small Business Management, 11th edition
Longenecker, Moore, and Petty
2000
South-Western College Publishing
10-13

17. BizPlanBuilder Spreadsheet Templates (p. 192)
Using your spreadsheet processor, you edit the
templates with your own financial data.
There are two ways to generate financial statements:
Integrated financials spreadsheet
Basic spreadsheets
Small Business Management, 11th edition
Longenecker, Moore, and Petty
2000
South-Western College Publishing
10-14

18. BizPlanBuilder Recommendation for Making Financial Projections (p. 207)
You may want to prepare not only one set of
projections, but three. They should include a
pessimistic (worst case) scenario and a realistic
(most likely) scenario. In this way, you will have
a true picture of your potential for gain and loss.
While the best case is what you hope for, the
worst case is what you need to be prepared for;
in the meantime, the most likely case will be the
basis for many of your decisions.
Small Business Management, 11th edition
Longenecker, Moore, and Petty
2000
South-Western College Publishing
10-15