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Chapter Eight: Financial Analysis
Table of Contents
Brief Chapter Outline...............................................................................................2
Chapter Outline and Lecture notes..........................................................................4
Key Terms.............................................................................................................. 16
Suggested Text
Responses…………………………………………………………………………..17
Class Activities and Sample Assignments.............................................................20
Discussion Questions for Online/Hybrid classes....................................................21
Lecture Links......................................................................................................... 24
Lecture Link 8.1: Entrepreneurs Create Surveys at the New Small Business.....24
Lecture Link 8.2: Financial Ratios for American Express....................................25
Lecture Link 8.3: Auditing Standards at the New Entrepreneurial Business.......26
Bonus Internet Exercises....................................................................................... 28
Bonus Internet Exercise 8.1: Factors Impact Sales............................................28
Bonus Internet Exercise 8.2: Industry Ratio Analysis Sources............................29
Bonus Internet Exercise 8.3: Industry profit Analysis.........................................30
Critical Thinking Exercises..................................................................................... 32
Critical Thinking Exercise 8.1: Evaluating Sensitivity Analysis...........................32
Critical Thinking Exercise 8.2: Survey Questions to Assess Competitors...........34
Critical Thinking Exercise 8.3: How to Measure the Firm...................................36
Bonus Cases.......................................................................................................... 38
Bonus Case 8.1: Deviation Analysis and the Entrepreneurial Business..............38
Bonus Case 8.2: Liquidity Considerations and Solvency Issues..........................40
Bonus Case 8.3: FBI Reports Financial Crimes...................................................42
Endnotes............................................................................................................... 43
Brief Chapter Outline
I. Learning Objectives (text page 140)
.
IM 8-1
Copyright © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
Chapter Eight: Financial Analysis
Explain the use of hypothesis-driven experimentation.
Describe the importance of solid financial foundation in entrepreneurial
business.
Discuss techniques for measuring performance.
Explain ratio analysis.
Explain deviation analysis.
Explain sensitivity analysis.
Describe the use of short surveys in business.
Analyze the importance of having a measurement focus.
II. Hypothesis-Driven Analysis (text page 142 and 143)
Learning Objective 8-1: Explain the use of hypothesis-driven experimentation
III. Explain the use of hypothesis-driven experimentation (text page 142)
Learning Objective 8-2: Describe the importance of solid financial foundation in
an entrepreneurial business.
IV. Techniques for Measuring Performance (text pages 143 through 145)
Learning Objective 8-3: Discuss techniques for measuring performance.
V. Ratio Analysis (text pages 146 through 153)
Learning Objective 8-4: Explain ratio analysis.
VI. Deviation Analysis (text page 153)
Learning Objective 8-5: Explain deviation analysis.
VII. Sensitivity Analysis (text pages 154 and 155)
Learning Objective 8-6: Explain sensitivity analysis
VIII. Use of Short Surveys in Business (text pages 155 through 158)
Learning Objective 8-7: Describe the use of short surveys in business
IX. Importance of Having a Measurement Focus (text pages 158 and 159)
Learning Objective 8-8: Analyze the importance of having a measurement focus
X. For Review (text page 160)
Chapter Outline and Lecture notes
1. Learning Objectives (text page 140)
IM 8-2
Copyright © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
Chapter Eight: Financial Analysis
Explain the use of hypothesis-driven experimentation.
Describe the importance of solid financial foundation in an entrepreneurial
business.
Discuss techniques for measuring performance.
Explain ratio analysis.
Explain deviation analysis.
Explain sensitivity analysis.
Describe the use of short surveys in business.
Analyze the importance of having a measurement focus.
2. Hypothesis-Driven Analysis (text pages 142 and 143)
Learning Objective 8-1: Explain the use of hypothesis-driven experimentation
A. Core element of the lean start-up approach
i. Use many small experiments with customers
ii. Refine the product/services offered
iii. Effectively experiment with customers throughout the life of the
business
B. Customers’ reaction to a crafted-up solution
i. Best reaction is decision to purchase
ii. Product/service the same for some customers and changed for
others
iii. Track results for a short period of time
C. Done in a retail space, service operation or manufacturing
D. Split analysis sheet
i. Tests as many different aspects as possible
ii. Observe differences in sales, engagement time spent, other
metric of interest
E. Credibility for funding, operational improvement, relations with suppliers
3. Importance of a Solid Financial Foundation in an Entrepreneurial Business
Learning Objective 8-2: Describe the importance of solid financial foundation in
entrepreneurial business
A. Recap evaluation of a firm (text page 143)
i. Start with the mission of the organization
IM 8-3
Copyright © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
Chapter Eight: Financial Analysis
ii. Mission is related to a specific industry where the firm
competes
iii. Firm hopes to build its competitive advantage
B. Outcomes of the firm are measured at intervals relevant to the business
C. Evaluate cost savings frequently
D. Examine the development of various metrics that should be used to
evaluate the business
4. Techniques for Measuring Performance (text pages 143 through 146)
Learning Objective 8-3: Discuss techniques for measuring performance
A. Company analysis proceeds from the general to the specific
B. Four analysis techniques to design and monitor the core metrics of the firm
i. Ratio analysis
ii. Deviation analysis
iii. Sensitivity analysis
iv. Short surveys
C. Recall the study of the balance sheet and income statements to prepare
for section 8.4, the Ratio Analysis
5. Ratio Analysis (text pages 146 through 153)
Learning objective 8-4: Explain ratio analysis
A. Ratio analysis
i. A series of ratios along four areas of company performance
(liquidity, activity, leverage, profitability) that provides a picture
of the health of the company
ii. A tool to examine the overall health of the organization
iii. Small business owners use a combination of the ratios to
evaluate the firm
iv. Compare ratios
1. To similar organizations
2. To Industry averages
3. To previous performance of the firm
1. Annual
2. Monthly
v. Four categories of ratios
1. Liquidity
2. Activity
3. Leverage
4. Profitability
IM 8-4
Copyright © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
Chapter Eight: Financial Analysis
B. Liquidity ratios
i. Ratios that measure the short-term ability of the firm to meet its
obligations
1. Obligations include debt or accounts payable due in the
near term
2. Financial industry standards require that liquidity ratios be
within certain ranges to be considered healthy
3 If ratio falls below the lower bounds of its liquidity level, the
bank may limit the line of credit to the firm or require a
higher interest rate on the debt
a. Indicates the firm is operating at a risk, or the bank
considers the ratio to be at a risk level not
appropriate to meet the obligations of the note
4. Two ratios used to evaluate whether the business can meet
its short-term obligations:
a. Current Ratio
i. Current assets divided by current liabilities.
ii. Measures assets that can be turned into cash
quickly to pay immediate liabilities.
iii. The cash balance of the firm plus inventory
divided by all short-term liabilities
b. Quick (Acid) Ratio
i. Current assets minus inventory divided by
current liabilities
ii. Removes the ability to sell inventory and
examines the pure cash position relative to the
current liabilities.
iii. Quick ratio is also known as the acid test
5. Calculating liquidity ratios
a. For this illustration, use the example in figure 8.1
provided on page 145 of the text or provide an
example for the class
C. Activity Ratios
i. Ratios that measure the efficiency with which the entrepreneur
is handling the resources of the business
ii. A helpful resource to use as the business develops
iii. Used to evaluate the firm on a monthly basis
1. Inventory turnover
a. Cost of goods sold divided by inventory
b. Cost of goods sold is the direct costs involved with
the product
IM 8-5
Copyright © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
Chapter Eight: Financial Analysis
c. As the inventory turnover rises, the firm is closer to a
just-in-time system
d. Inventory turnover ratio is better than the industry
average
e. An improvement in this ratio on a monthly basis
indicates that the firm is operating at a higher level of
efficiency
2. Accounts receivable turnover
a. Credit sales divided by accounts receivable
b. Examines how fast the company turns credit sales
into cash
c. Faster turnover indicates the business turns credit
sales into cash
i. Indicates a good cash flow
d. Credit sales are aged into categories based on how
long it has been since the sale
e. The older the debt is, the less likely the payment will
be paid
f. Debt less than 30 days will likely be paid to the firm
g. Debt that is 90 days past due may not be recovered
3. Total/Fixed Asset Turnover
a. Net sales divided by fixed assets or net sales divided
by total assets
b. Popular evaluation tool
c. Difference depends on whether or not the business
has large amounts of fixed assets.
d. Examine the ability to generate sales from the assets
employed by the organization
e. As the number increases, the firm is being more
efficient
f. New business owners try to minimize the amount of
both fixed and total assets in order to conserve cash
4. Calculating activity ratios
a. Calculation requires data from the balance sheet and
the income statement
b. From the balance sheet, use the inventory figure, or
the denominator in the calculation
c. From the income statement, use the cost of goods
sold number, or the numerator in the calculation
IM 8-6
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written consent of McGraw-Hill Education.
Chapter Eight: Financial Analysis
d. To demonstrate this calculation, use the numbers and
criteria provided in Figure 8.1 and 8.2 in the text.
i. Focus on the relative change in the
numbers
ii. An increase in the inventory turnover rate
indicates that the firm is operating at a
greater rate of efficiency
iii. If the firm is new, an increase in this
calculation might reveal that the new firm
is gaining experience
iv. The firm may have gained a competitive
advantage
v. Identify the competitive advantage
vi. Obtain industry data relative to the
industry turnover rates
IM 8-7
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written consent of McGraw-Hill Education.
