Download Chapter 12 - JonathanHeller

CHAPTER
Financial Ratios &
Break-Even Analysis
Section 12.1 Financial Ratios
Section 12.2 Break-Even
Analysis
SECTION
Financial Ratios
OBJECTIVES





Explain what a financial ratio is
Describe how income statements are used for financial
analysis
Compare operating ratios and return-on-sales ratios
Describe the ratios developed by using balance sheets
Explain the importance of return on investment
Section 12.1: Financial Ratios
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What Are Financial Ratios?
Financial ratios are relationships between important financial
data that are expressed as fractions or as percentages.
One way entrepreneurs can see relationships, patterns, and
trends is by using charts. Pie charts and bar graphs are very
helpful in illustrating financial ratios. A pie chart has “slices” that
represent portions of the whole. A bar graph uses vertical or
horizontal bars to show data.
3,500
3,000
Cost of Goods Sold
$2,000
2,500
2,000
$5,000
$3,000
Operating
Expenses
1,500
Net Income
1,000
500
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January February March
Section 12.1: Financial Ratios
April
May
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Analysis Based on
an Income Statement
Entrepreneurs use income statements to show how their
businesses are performing.


With Sales Data Analysis, an income statement is
used to review monthly sales totals in order to
determine how much the business can afford to spend.
Monthly income statements are also used to forecast
future sales.
Entrepreneurs also use income statements to measure
how cost of goods sold and operating expenses affect
profits. Same-size analysis is a comparison of total
revenue or other financial data against that same data
converted into percentages.
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Section 12.1: Financial Ratios
Income Statement Ratios
Some financial ratios provide a “snapshot” of a specific aspect
of a business and are used to monitor expenses, compare
performance with the competition, to measure profitability.

The operating ratio is the percentage of each dollar of
revenue, or sales, needed to cover expenses.
(Expenses ÷ Sales) x 100 = Operating Ratio (%)

Return on sales (ROS) is the financial ratio calculated
by dividing net income by sales.
(Net Income ÷ Sales) x 100 = Return on Sales (%)
Section 12.1: Financial Ratios
5
Ratios from Balance Sheets
Entrepreneurs create ratios from the data on the balance sheets
to monitor debt, compare debt with equity, and make sure the
business has sufficient cash to pay its debts.

The debt ratio is used to monitor the debts of a
business. This is the ratio of a business’s total debt
divided by its total assets.
(Total Debts ÷ Total Assets) x 100 = Debt Ratio (%)

The debt-to-equity ratio is the ratio of the total debts
(liabilities) of the business divided by its owner’s equity.
(Total Debts ÷ Owner’s Equity) x 100 = Debt-to-Equity Ratio (%)
Section 12.1: Financial Ratios
6
Ratios from Balance Sheets

The quick ratio is the comparison of cash to debt.
(Cash + Marketable Securities ) ÷ Current Liabilities = Quick Ratio

The current ratio is current assets divided by current
liabilities.
Current Assets ÷ Current Liabilities = Current Ratio
Section 12.1: Financial Ratios
7
Return on Investment (ROI)
Return on investment (ROI) is a financial ratio used to
determine how well the business is doing in relation to the
amount of money invested.
Return on investment (ROI) shows the profit on the
investment expressed as a percentage of the total
invested (when expressed as a percentage, it is also
referred to as the rate of return).
(Net Income ÷ Investment) x 100 = Return on Investment (%)
Section 12.1: Financial Ratios
8
SECTION
Break-Even
Analysis
OBJECTIVES


Explain the importance of the break-even point
Perform a break-even analysis
Section 12.2: Break Even Analysis
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What Is a Break-Even Point?

On an income statement, if the costs and expenses
were exactly equal to the sales, there would be neither
a profit nor a loss and net income would be zero. This
is called the break-even point, because the business
has sold exactly enough units to cover costs.

Break-even analysis examines the income statement
to identify the break-even point for a business. A breakeven analysis examines how many units of a product
(or hours of a service) a business must sell to pay all its
costs.
Section 12.2: Break Even Analysis
10
Break-Even Analysis
Use break-even analysis to determine how many units of a
product a business must sell to pay all its expenses.


The gross profit of the business (Total Sales - Total COGS)
is used to pay operating expenses.
Break-even units are the number of units of sale a
business needs to sell to arrive at the break-even point
(where the bottom line is zero).
Operating Expenses ÷ Gross Profit per Unit = Break-Even Units
Section 12.2: Break Even Analysis
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