Section 12.1 Financial Ratios

Section 12.2 Break-EvenAnalysis

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

2Section 12.1: Financial Ratios

What Are Financial Ratios?

3Section 12.1: Financial Ratios

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.

Analysis Based onan Income Statement

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.

4Section 12.1: Financial Ratios

Income Statement Ratios

The operating ratio is the percentage of each dollar of revenue, or sales, needed to cover expenses.

Return on sales (ROS) is the financial ratio calculated by dividing net income by sales.

5Section 12.1: Financial Ratios

Ratios from Balance Sheets

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.

The debt-to-equity ratio is the ratio of the total debts (liabilities) of the business divided by its owner’s equity.

6Section 12.1: Financial Ratios

Ratios from Balance Sheets

The quick ratio is the comparison of cash to debt.

The current ratio is current assets divided by current liabilities.

7Section 12.1: Financial Ratios

Return on Investment (ROI)

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).

8Section 12.1: Financial Ratios

OBJECTIVES

Explain the importance of the break-even point Perform a break-even analysis

Break-EvenAnalysis

9Section 12.2: Break Even Analysis

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 break-even analysis examines how many units of a product (or hours of a service) a business must sell to pay all its costs.

10Section 12.2: Break Even Analysis

Break-Even Analysis

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).

11Section 12.2: Break Even Analysis