61) Which of the following is correct?
A) Assets – Liabilities = Equity
B) Assets – Equity = Liabilities
C) Assets = Liabilities + Equity
D) All of the above
62) In which statement are the account balances reversed to zero on a monthly basis?
A) Balance sheet
B) Cash flow statement
C) Income statement
D) All of the above
63) Proper financial management requires more than gathering financial data and organizing it
into financial statements; the small business manager must analyze those statements and use that
information to make better business decisions.
64) The balance sheet provides owners with an estimate of the firm’s worth for a specific
moment in time.
66) The small firm’s income statement presents a picture of the firm’s profitability at a particular
point in time.
67) To determine sales revenue, the owner records sales revenue for the year and subtracts
liabilities.
68) The cost of goods sold represents the total cost, including distribution, of the goods sold
during the year.
69) All costs directly related to the manufacture and distribution of goods are covered under
general expenses.
70) The statement of cash flows shows the change in a firm’s working capital.
71) 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.
72) The pro forma shows the company’s current overall financial condition.
73) The most common method of creating a projected income statement is to develop a sales
forecast and then “work down” to the bottom line.
74) An adequate profit in a small business must include a reasonable return on the owner’s total
investment in the business.
75) When determining the owner’s target income, you must consider a reasonable salary for the
time spent running the business, less the depreciation of assets.
76) The formula for calculating net profit margin is net profit/net sales (annual).
77) A new business owner must operate for at least six months in order to collect sufficient
information to calculate net sales from a profit target.
78) Most small businesses start out strong financially because of the care generally given in
determining the total asset requirements for running the business.
79) Concerning how much cash to have at start-up, a rule of thumb is to have enough to cover
operating expenses (less depreciation) for two inventory turnover periods.
80) Performing financial ratio analyses enables a business owner to identify problems early—
before they become crises.
81) Financial ratios are a common tool used by over 50% of small business owners in the daily
management of their businesses.
82) Liquidity ratios measure the financing supplied by the firm’s owners against that provided by
its creditors.
83) A quick ratio greater than 1:1 indicates that a small firm is overly dependent on inventory
and on future sales to satisfy short-term debt.
84) The higher the current ratio, the stronger the small firm’s financial position.
85) The quick ratio is the most commonly used measure for a small firm’s short-term solvency.
86) Leverage ratios are a gauge of the depth of a company’s debt.
87) Small businesses with high leverage ratios are less vulnerable to economic downturns, but
they have a lower potential for large profits.
88) The higher the debt-to-net worth ratio, the lower the degree of protection afforded creditors
should the business fail.
89) As a company’s debt-to-net worth ratio approaches 1:1, its creditors’ interest in that business
approaches that of the owners’.
90) The times-interest-earned ratio expresses the relationship between the capital contributions
of creditors and those of the owners.
91) The average inventory turnover ratio tells the owner how fast merchandise is moving through
the business.
92) There is a direct 1:1 relationship between a company’s expected average inventory turnover
ratio and the amount of cash required to launch it.
93) A low inventory turnover ratio demonstrates that the firm’s inventory is liquid and its pricing
policies are accurate.
94) The company’s average collection period ratio indicates the length of time the firm’s cash is
tied up in credit sales.
95) Generally, the higher the small firm’s average collection period ratio, the lower the chance of
bad debt losses.
96) The average payable period tells the owner the average number of days it takes to pay its
accounts payable.
97) Ideally, the average payable period should match or exceed the time it takes to convert
inventory into sales and sales into cash.
98) The small firm’s net sales to total assets ratio measures how many dollars in sales the
business makes for every dollar of working capital.
99) The net profit on sales ratio measures the owners’ rate of return on the investment in the
business.
100) When a firm’s ratios vary from the average ratios of similar firms in the industry, this
indicates that the small business is in financial jeopardy.
101) The first step in preparing a break-even analysis is to break business expenses down into
“fixed” and “variable” categories.
102) To calculate break-even sales, use the equation: break-even sales (in dollars) = total
variable costs divided by contribution margin as a percentage of sales revenue.
103) The break-even analysis provides an opportunity for integrated analysis of sales volume,
expenses, income, and other relevant factors.
104) Most small businesses prefer to express their break-even point in dollars rather than units
produced or sold, unless they are retailing.
105) On a break-even chart, the break-even point occurs at the intersection of the fixed expense
line and the total revenue line.
106) Break-even analysis is somewhat complex to use, but it is a final screening device.
107) A break-even analysis has several drawbacks including the fact that it ignores the
importance of cash flows and that its accuracy is dependent on the accuracy of revenue and
expense estimates.
108) Many business owners whose companies are losing money mistakenly believe that the
problem is inadequate sales volume; therefore, they focus on pumping sales at any cost.
109) Total profits minus total expenses gives the company’s net income.
110) Since conditions and markets change so rapidly, entrepreneurs developing financial
forecasts for start-ups should focus on creating projections for 6 months into the future.
111) To get the best results, an entrepreneur should track as many ratios as possible.
112) The quick ratio is sometimes called the working capital ratio.
113) Calculating ratios is not enough to insure proper financial control.
114) The net profit on sales ratio (also called the profit margin on sales) measures the firm’s
profit per dollar of sales.
115) The net profit to equity ratio (or the return on net worth ratio) measures the owners’ rate of
return on investment.
116) Net profit on sales ratio = Net sales / Net income.
117) A total assets turnover ratio below the industry average may indicate that the small firm is
not generating an adequate sales volume for its asset size.
118) Sales turnover ratio = Credit sales (or net sales)/Accounts receivable.
119) Typically, slow payers represent great risk to many small businesses.
120) The current ratio can sometimes be misleading, because it does not show the quality of a
company’s current assets.
121) To prepare the cash flow statement, the owner must assemble the balance sheets and the
income statements summarizing the present year’s operations.
122) The gross profit margin is calculated by dividing net income by net sales revenue.
123) The balance sheet takes a “snapshot” of a business, providing owners with an estimate of
the firm’s worth on a given date.
124) Fixed assets consist of cash and items to be converted into cash within one year or within
the normal operating cycle of the company, whichever is longer.
125) Explain the three basic financial reports that a business uses in building a financial
statement: the balance sheet, the income statement, and the statement of cash flows. What
information is contained in each, what is their value to the small business owner, and how are
they used to build financial statements?
126) Describe a pro forma statement, identifying the types of pro forma statements a small
business owner could use, and how the small business owner would create each.
127) What is the value of ratio analysis to the small business owner and what are the four
categories of ratios he/she can use?
128) What are liquidity ratios and how are they used by the small business owner? Name and
briefly explain the current and quick ratios.
129) What do leverage ratios measure? Name and explain three of them.
130) Describe what operating ratios are. Identify the five operating ratios covered in your text,
explaining how each of the five helps the small business owner manage his/her business.
131) Identify and explain the two profitability ratios a small business owner can use to measure
how effectively he/she is managing the business.
132) How can the entrepreneur interpret and use the various business ratios available to him/her?
133) What does a break-even analysis tell the small business owner?