74) To determine net profit, the owner records sales revenue for the year and subtracts liabilities.
75) Service companies spend the greatest percentage of their sales revenue on cost of goods sold.
76) Comparing a company’s current income statement to those of prior accounting periods rarely
reveals valuable information about key trends.
77) The difference between the total sources of funds and the total uses of funds represents the
increase or decrease in a firm’s working capital.
78) The most common mistake entrepreneurs make when preparing pro forma (projected)
financial statements for their companies is being overly pessimistic in their financial plans.
79) Pro forma financial statements show a company’s most recent financial position.
80) On a projected income statement, a business owner’s target income is the sum of a reasonable
salary for the time spent running the business and a normal return on the amount the owner has
invested in it.
81) In start-up firms, one guideline is for the owner to draw a salary 25-30 percent below the
market rate for a similar position.
82) Concerning how much cash to have at startup, one rule of thumb is to have enough to cover
operating expenses (less depreciation) for two inventory turnover periods.
83) Ratio analysis allows a business owner to identify potential problem areas in her business
before they become business-threatening crises.
84) Ratio analysis is a useful managerial tool that can help business owners maintain financial
control over their businesses, but it is of no use to a business owner trying to obtain a bank loan.
85) Liquidity ratios, such as the current ratio and the quick ratio, tell whether a small business
will be able to meet its short-term obligations as they come due.
86) Liquidity ratios help a business owner evaluate a small company’s performance and indicate
how effectively it employs its resources.
87) A current ratio of 2.4:1 means that a small company has $2.40 in current liabilities for every
$1 has in current assets.
88) A high current ratio guarantees that the small firm’s assets are being used in the most
profitable manner.
89) Generally, the higher the current ratio, the stronger the small firm’s financial position.
90) Most firms calculate their quick assets by subtracting the value of their inventory from their
current asset total.
91) A quick ratio of more than 1:1 suggests that a small company is overly dependent on
inventory and future sales to satisfy its short-term debt.
92) Leverage ratios measure the financing supplied by the firm’s owner against that supplied by
his creditors.
93) Small businesses with high leverage ratios are more vulnerable to economic downturns, but
they have greater potential for large profits.
94) Taking on debt destroys a business; therefore, small business owners should avoid it at all
costs.
95) The small business with a high debt-to-net worth ratio has more borrowing capacity than a
firm with a low ratio.
96) As a company’s debt-to-net worth ratio approaches 1:1, its creditors’ interest in that business
approaches that of the owners.
97) A company with a low debt-to-net worth ratio has less capacity to borrow than a company
with a high debt-to-net worth ratio.
98) The times-interest-earned ratio tells how many times the company’s earnings cover the
interest payments on the debt it is carrying.
99) A company with a times-interest-earned ratio that is well above the industry average would
likely have difficulty making the interest payments on its loans, as creditors would see that it was
overextended in its debts.
100) Creditors often look for a times-interest-earned ratio of at least 4:1 to 6:1 before
pronouncing a company a good credit risk.
101) Operating ratios measure the extent to which an entrepreneur relies on debt capital rather
than equity capital to finance the business.
102) The average inventory turnover ratio measures the number of times a company’s inventory
is sold out during the accounting period.
103) An inventory turnover ratio above the industry average suggests that a business is
overstocked with obsolete, stale, overpriced, or unpopular merchandise.
104) A high inventory turnover ratio relative to the industry average could mean that a business
has too little inventory and is experiencing stockouts.
105) A company’s average collection period ratio tells the average number of days it takes to
collect its accounts receivable.
106) Generally, the higher the small firm’s average collection period ratio, the greater the chance
of bad debt losses.
107) Slow accounts receivable are a real danger to a small business because they often lead to
cash crises.
108) If a company’s average payable period ratio is significantly lower than the credit terms
vendors offer, it may be a sign that the company is not using its cash most effectively.
109) An excessively high average payable period ratio indicates the possibility of the presence of
a significant amount of past-due accounts payable.
110) Although sound cash management principles call for a business owner to keep her cash as
long as possible, slowing accounts payable too drastically can severely damage a company’s
credit rating.
111) The net-sales-to-total assets ratio is also referred to as the total asset turnover.
112) The net-sales-to-total assets ratio measures a company’s ability to generate sales in relation
to its asset base.
113) Float is the net number of days of cash flowing into or out of a company.
114) The net profit on sales ratio measures the owner’s rate of return on the investment in the
business.
115) The net profit to equity ratio reports the percentage of the owners’ investment in the
business that is being returned through profits annually.
116) Ratio analysis provides an owner with a “snapshot” of the company’s financial picture at a
single instant; therefore, she should track these ratios over time, looking for trends that otherwise
might go undetected.
117) The break-even point is the level of operation at which a business neither earns a profit nor
incurs a loss, and lets the business owner know the minimum level of activity required to keep
the firm in operation.
118) Fixed expenses are those that do not vary with changes in the volume of sales, but do vary
with production.
119) On a break-even chart, the break-even point occurs at the intersection of the fixed expense
line and the total revenue line.
120) Explain the three basic financial reports that a small business uses in building a financial
plan: the balance sheet, the income statement, and the statement of cash flows. What information
is contained in each, and of what value is it to the small business owner?
121) Define what a pro forma financial statement is. What are the two types a small business
owner uses, and how are they created?
122) Explain what ratio analysis is. Name the four categories of ratios and describe the type of
information each group provides the small business owner.
123) List the 12 key ratios outlined in the text and explain the type of information they provide
the small business owner.
124) Why is it important for an entrepreneur, about to launch a business, to perform a break-even
analysis? Describe the steps in calculating it.
125) Explain the procedure for constructing a graph that visually portrays the firm’s break-even
point (the point where revenues equal expenses).