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Chapter 5

ENTREPRENEURIAL FINANCE. Chapter 5. EVALUATING FINANCIAL PERFORMANCE. CHAPTER 5: LEARNING OBJECTIVES. Describe how financial ratios are used to monitor a venture’s performance

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Chapter 5

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  1. ENTREPRENEURIAL FINANCE Chapter 5 EVALUATING FINANCIAL PERFORMANCE

  2. CHAPTER 5:LEARNING OBJECTIVES • Describe how financial ratios are used to monitor a venture’s performance • Identify specific cash burn rate measures and liquidity ratios and explain how they are calculated and used by an entrepreneur • Identify and describe the use and value of conversion period ratios to the entrepreneur

  3. CHAPTER 5:LEARNING OBJECTIVES • Identify specific leverage ratios and explain their usage by lenders and creditors • Identify and describe measures of profitability and efficiency that are important to the entrepreneur and equity investors • Describe limitations when using financial ratios

  4. FINANCIAL RATIO & ANALYSIS财务比率与分析 • Financial Ratios:财务比率 show the relationship between two or more financial variables • Trend Analysis:趋势分析 used to examine a venture’s performance over time • Cross-sectional Analysis:横向比较（外部比较） used to compare a venture’s performance against another firm at the same point in time • Industry Comparables Analysis:行业比较 used to compare a venture’s performance against the average performance in the same industry

  5. MPC INCOME STATEMENT损益表举例说明

  6. MPC BALANCE SHEET资产负债表举例说明

  7. MPC BALANCE SHEET资产负债表举例说明

  8. CASH BURN现金支出 • Cash Burn:现金支出 cash a venture expends on its operating and financing expenses and its investments in assets • Cash Burn Rate:现金支出比率 cash burn for a fixed period of time, typically a month

  9. CASH BURN / BUILD / BURN RATE现金支出/现金收入/现金支出比率 • Cash Burn = Inventory-related expenses + Admin expenses + Marketing expenses + R& D expense + Interest expenses + Change in prepaid expenses – (Change in accrued liabilities + Change in payables) + Capital investment + Taxes • MPC for 2005: Cash burn = 425,000 + 65,000 + 39,000 + 27,000 + 20,000 + 0 – (1,000 + 27,000) +50,000 + 8,000 = 606,000

  10. CASH BURN / BUILD / BURN RATE现金支出/现金收入/现金支出比率 • Cash Build = Net sales – Change in receivables • MPC for 2005: Cash build = 575,000 - 30,000 = 545,000 • Cash Build Rate: Cash build for a fixed period of time, typically a month • Net Cash Burn = Cash burn – Cash build = 606,000 - 545,000 = 61,000

  11. LIQUIDITY RATIOS流动比率 • Indicate the ability to pay short-term liabilities when they come due • Current Ratio: = Average current assets/Average current liabilities = (250,000+180,000)/2 (204,000+110,000)/2 = 1.37

  12. LIQUIDITY RATIOS流动比率 • 流动资产Liquid assets: sum of a venture’s cash and marketable securities plus its receivables • Quick Ratio = Average current assets – Average inventories Average current liabilities = (250,000 +180,000)/2 – (140,000+95,000)/2 (204,000 + 110,000)/2 = .62

  13. LIQUIDITY RATIOS流动比率 • Net working capital (NWC):营运资金 current assets minus current liabilities 营运资金=流动资产-流动负债 • NWC – to – Total – Assets Ratio: = Ave. current assets – Ave. current liabilities Ave. total assets = (250,000+180,000)/2 – (204,000+110,000)/2 (446,000 + 343,000)/2 =.147 or 14.7%

  14. MPC BURN RATES & LIQUIDITY RATIOS RATIO 20042005% Change Cash burn 417,000 606,000 +45.3% Monthly cash burn 34,750 50,500 +45.3% Cash build 423,000 545,000 +28.8% Monthly cash build 35,250 45,417 +28.8% Net Cash burn -6,000 61,000 N/A Monthly net cash burn -500 5,083 N/A Year-end months of cash N/A .98 N/A Current ratio 1.56 1.37 -12.2% Quick ratio .76 .62 -18.4% NWC-total assets ratio .174 .147 -15.5%

  15. CONVERSION PERIOD RATIOS • Conversion Period Ratio: indicates the average time it takes in days to convert certain current assets and current liability accounts into cash • Operating Cycle: time it takes to purchase, produce, and sell the venture’s products plus the time needed to collect receivables if the sales are on credit • Cash Conversion Cycle: sum of the inventory-to-sale conversion period and the sales-to-cash conversion period less the purchase-to-payment conversion period

  16. MEASURING CONVERSION TIMES • Inventory-to-Sale Conversion Period =Ave. Inventories (CGS / 365) = (140,000 + 95,000)/2 = 117,500 380,000/365 1041 = 112.9 days

  17. MEASURING CONVERSION TIMES • Given New I-to-S, Can Solve for New Average Inventories =Inventory-to-Sale Conversion Period x (COGS/365) = 105.7 X $1,041 = $110,000 (rounded)

  18. MEASURING CONVERSION TIMES • Sale-to-Cash Conversion Period: =Ave Receivables (Net Sales/365) = (105,000 + 75,000)/2 575,000/365 = 57.1 days

  19. MEASURING CONVERSION TIMES • Purchase-to-Payment Conversion Period: =Ave Payables + Ave Accrued Liabilities (COGS / 365) = (84,000+57,000)/2 + (10,000+9,000)/2 380,000/365 = 76.8 days

  20. MEASURING CONVERSION TIMES • Cash Conversion Cycle =Inventory-to-Sale Conversion Period + Sale-to-Cash Conversion Period – Purchase-to-Payment Conversion = 112.9 days + 57.1 days – 76.8 days = 93.2 days

  21. MPC CONVERSION PERIOD PERFORMANCE Conversion Ratio Impact on 20042005Conv. Cycle Inventory-to-sale 105.7 days 112.9 days +7.2 days Sale-to cash 56.3 days 57.1 days +0.8 days Purchase-to-payment 77.5 days 76.8 days +0.7 days Cash conversion cycle 84.5 days 93.2 days +8.7 days

  22. LEVERAGE RATIOS • Leverage Ratio: indicates the extent to which the venture is in debt and its ability to repay its debt obligations • Loan Principal Amount: dollar amount borrowed from a lender • Interest: dollar amount paid on the loan to a lender as compensation for making the loan

  23. MEASURING FINANCIAL LEVERAGE • Total-Debt-to-Total-Asset Ratio: = Ave total debt / Ave total assets = (204,000 +110,000)/2 + (80,000 +90,000)/2 (446,000 + 343,000)/2 = .6134 or 61.34%

  24. MEASURING FINANCIAL LEVERAGE • Equity Multiplier: = Ave total assets / Ave owners’ equity = (446,000 + 343,000)/2 (162,000 + 143,000)/2 = 2.587 times

  25. MEASURING FINANCIAL LEVERAGE • Current-Liabilities-to-Total-Debt Ratio: = Ave. current liabilities / Ave. total debt = (204,000 + 110,000)/2 (284,000 + 200,000)/2 = .6488 or 64.88%

  26. MEASURING FINANCIAL LEVERAGE • Interest Coverage Ratio: = EBITDA / Interest = 47,000 + 17,000/2 20,000 = 3.20 times

  27. MEASURING FINANCIAL LEVERAGE • Fixed Charge Coverage: = EBITDA + Lease payments … Interest + Lease payments + [Debt repayments / (1-T)] = 64,000 + 0 _ (20,000 + 0 + [10,000/(1-.30)]) = 1.87 times

  28. MPC LEVERAGE RATIO PERFORMANCE Leverage Ratio Impact on 20042005Leverage risk Total debt/total assets 59.8% 61.3% Increase Equity multiplier 2.491 2.587 Increase Current liab / total debt 52.9% 64.9% Increase Interest coverage 4.6 3.2 Increase Fixed charges coverage 2.13 1.87 Increase

  29. PROFITABILITY & EFFICIENCY RATIOS • Profitability Ratios: indicate how efficiently a venture controls its expenses • Efficiency Ratios: indicate how efficiently a venture uses its assets in producing sales

  30. MEASURING PROFITABILITY & EFFICIENCY • Gross Profit Margin: = Net Sales – COGS Net Sales = 195,000/575,000 = .3391 or 33.91%

  31. MEASURING PROFITABILITY & EFFICIENCY • Operating Profit Margin: = EBIT . Net Sales = 47,000/575,000 = .0817 or 8.17%

  32. MEASURING PROFITABILITY & EFFICIENCY • Net Profit Margin: = Net Profit Net Sales = 19,000/575,000 = .0330 or 3.30%

  33. MEASURING PROFITABILITY & EFFICIENCY • Interest Tax Shield: proportion of a venture’s interest payment paid by the government because interest is deductible before taxes are paid • NOPAT Margin: = EBIT (1 – tax rate) Net Sales = 47,000 (1 - .30) 575,000 = .0572 or 5.72%

  34. MEASURING PROFITABILITY & EFFICIENCY • Sales-to-Total-Assets Ratio: = Net Sales . Ave total assets = 575,000 . (446,000 + 343,000)/2 = 1.458 times

  35. MEASURING PROFITABILITY & EFFICIENCY • Return on Total Assets (ROA): = Net profit . Ave total assets = 19,000 _ (446,000 + 343,000)/2 = .048 or 4.8%

  36. MEASURING PROFITABILITY & EFFICIENCY • ROA Model: the decomposition of ROA into the product of the net profit margin and the sales-to-total-assets ratio ROA = (Net profit / sales) x (Net sales / Ave. total assets) = (19,000/575,000) x (575,000/ (446,000 + 343,000)/2) =.0330 x 1.458 = .048 or 4.8%

  37. MEASURING PROFITABILITY & EFFICIENCY • Return on Equity (ROE): = Net profit . Ave owners’ equity = 19,000 . (162,000 + 143,000)/2 = .1246 or 12.46% (or 12.5% rounded)

  38. MEASURING PROFITABILITY & EFFICIENCY • ROE Model: the decomposition of ROE into the product of the net profit margin, sales-to-total-assets ratio, and equity multiplier ROE = (Net profit / sales) x (Net sales / Ave. total assets) x (Ave. total assets / Ave. equity) = 3.3% x 1.46% x 2.59% = 12.5%

  39. MPC PROFITABILITY & EFFICIENCY PERFORMANCE Impact on Profitability Ratio 20042005or Efficiency Gross profit margin 34.93% 33.91% lower Operating profit margin 9.59% 8.17% lower Net profit margin 4.79% 3.30% lower Unlever. profit margin 6.71% 5.72% lower Sales to total assets 1.327 1.458 higher ROA 6.36% 4.82% lower ROE 15.85% 12.46% lower

  40. MPC INDUSTRY COMPARABLES ANALYSIS 2005 Comparison 2005Industry Ave.with industry Liquidity Ratios Current ratio 1.37 1.80 lower Quick ratio .62 .80 lower Conversion Period Ratios Inventory-to-sale 112.9 days 100 days higher Sale-to-cash 57.1 days 55.0 days higher Purchase-to-payment 76.8 days 74.1 days higher Cash conversion cycle 93.2 days 80.9 days higher

  41. MPC INDUSTRY COMPARABLES ANALYSIS 2005 Comparison Leverage Ratios2005Industry Ave.with industry Tot. debt-to-tot. assets 61.3% 60.0% higher Interest coverage 3.20 4.00 lower Profitability/Efficiency Ratios Gross profit margin 33.91% 35.0% lower Operating profit margin 8.17% 10.0% lower Net profit margin 3.30% 4.5% lower NOPAT margin 5.72% 6.00% lower Sales-to-total assets 1.458 1.5 lower Return on total assets 4.82% 6.3% lower Return on equity 12.46% 15.00% lower

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