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Chapter Eight: Financial Analysis
Key Terms
Activity ratios: Ratios that measure the efficiency with which the entrepreneur is
handling the resources of the business. (LO 8.4)
Deviation analysis: An analysis of the differences between the predicted and the actual
performance. (LO 8.5)
Leverage ratios: Ratios that are used to examine the relative level of indebtedness of
the entrepreneurial business. (LO 8.4)
Liquidity ratios: Ratios that measure the short-term ability of the firm to meet its
obligations. (LO 8-4)
Profitability ratios: Ratios that examine the performance of the firm and its ability to
make economic rents over and above its costs. (LO 8-4)
Ratio analysis: A series of ratios along four areas of company performance (liquidity,
activity, leverage, profitability) that provides a picture of the health of the company. (LO
8-4)
Sensitivity analysis: A chart utilizing current cash flow statement, income statement, or
balance sheet to create a pro forma projection based upon a dramatic increase in sales,
a dramatic decrease in sales or the complication of a major change in the business.
(LO 8-6)
Suggested Text Responses
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
Opening Vignette – “Tom Szaky- Terracycle” p. 141
1. There are several reasons that women are likely to become entrepreneurs.
Sometimes women in large corporations reach the “glass ceiling” and are unable to
advance further in the corporate structure. Women may also see opportunities to
provide services or products to other women. In the opening vignette
“Vavavroomonline.com”, the founder states that there was little motorcycle gear
available in women’s sizes. This provided a niche that she entered.
Student responses will vary
Exercise 1 – p. 147
Student responses will vary.
.
Exercise 2 – p. 150
Student responses will vary.
Exercise 3 – p. 153
Student responses will vary.
Exercise 4 – p. 155
Student responses will vary.
Ethical Challenge – p. 154
Student responses will vary.
Review Questions – Responses
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
1. What are the four means to evaluate the firm, its activities, and its
2. What do liquidity ratios seek to measure? What are the major types of liquidity
3. Why are industry averages important to the interpretation of ratios? Each type
4. What do activity ratios seem to measure? What are the major types of activity
5. What do leverage ratios seek to measure? What are the major types of liquidity
6. What do performance ratios seek to measure? What are the major types of
performance ratios? Profitability ratios examine the performance of the firm and its
7. List two performance measures and explain their significance. (Any two of the
8. How is a deviation analysis used by a business? The deviation analysis shows
9. How is sensitivity analysis used to protect a business? A sensitivity analysis
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
Class Activities and Sample Assignments
1. Ask the students to discuss ratio analysis. Why are the ratios for the firm evaluated
and compared to other firms in the industry? List the four basic categories of
performance ratios. (LO 8-4)
2. Ask students to discuss deviation analysis. Then discuss why it is important and how
often a deviation analysis is performed. (LO 8-5)
3. Divide the students into groups. Assign each group one of the commonly used
ratios. Next, ask each group to prepare a presentation and describe how to calculate
the ratio, why it is important to calculate the ratio, and why that ratio is beneficial to a
business owner. The presentation can be presented as a power point presentation or
a presentation in front of the class. (LO 8-4)
4. Ask students to discuss sensitivity analysis. Then discuss why it is important to a
business owner. What data is revealed in this analysis? (LO 8-6)
5. Ask students to describe the use of nonfinancial analysis in a business. Next,
discuss the various data that is gathered as a result of the survey. Finally, ask the
students why random sampling is an effective method to survey a large pool of
customers. (LO 8-7)
6. In groups, ask the students to discuss the measurement techniques used to analyze
a business. How can they use those techniques to achieve a competitive advantage
in a particular industry? Next, ask the students to discuss how a firm gains a
competitive advantage by using the ratios for that industry. Discuss as a group or
present to the class on a flip chart or blackboard. (LO 8-3, 8-4, 8-5, 8-6, 8-7, 8-8)
7. In groups, ask students to choose an industry and prepare sample questions to
complete a survey for their customers. Next, ask the students to discuss how the
outcome of those questions can benefit a business owner. Finally discuss how the
outcome of the survey can reveal whether or not the firm has a competitive
advantage. (LO 8-7)
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
Discussion Questions for Online/Hybrid classes
1. Which of the four classic techniques used to measure a firm is the most important
to a business owner? Discuss why. (LO 8-3, 8-4, 8-5, 8-6, 8-7)
2. What is ratio analysis? How does this analysis benefit a business? (LO 8-4)
3. What does a survey reveal about competitors? What does it reveal about a
competitive advantage? (LO 8-7)
4. What are the three activity ratios? How are they calculated? What do they
measure? (LO 8-4)
5. What is deviation analysis? What does it reveal? (LO 8-5)
6. Why do small business owners compare their ratios to other firms in the same
industry? (LO 8-4)
7. What are the four classic techniques used to measure a business? Explain how
each method is an effective tool to measure the business. (LO 8-3, 8-4, 8-5, 8-6,
8-7)
8. How does sensitivity analysis benefit a business owner? What do the results of
sensitivity analysis reveal? (LO 8-6)
9. What are the differences associated with leverage ratios and profitability ratios?
Explain how they benefit a business owner. What do they reveal? (LO 8-4)
10.What are the two liquidity ratios? How are they calculated? What do they reveal?
(LO 8-4)
11. \Discussion Questions for Online/Hybrid classes-Responses
1. Which of the four classic techniques used to measure a firm is the most
important to a business owner? Discuss why. (LO 8-3, 8-4, 8-5, 8-6, 8-7)
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
2. What is ratio analysis? How does this analysis benefit a business? (LO 8-4)
3. What does a survey reveal about competitors? What does it reveal about a
competitive advantage? (LO 8-7) A survey should show how the entrepreneurial
4. What are the three activity ratios? How are they calculated? What do they
measure? (LO 8-4) The three activity ratios are inventory turnover (which
5. What is deviation analysis? What does it reveal? (LO 8-5) A deviation
6. Why do small business owners compare their ratios to other firms in the
same industry? (LO 8-4) Different industries have variances in expected
7. What are the four classic techniques used to measure a business? Explain
how each method is an effective tool to measure the business. (LO 8-3, 8-4,
8. How does sensitivity analysis benefit a business owner? What do the
results of sensitivity analysis reveal? (LO 8-6) A sensitivity analysis helps the
9. What are the differences associated with leverage ratios and profitability
ratios? Explain how they benefit a business owner. What do they reveal?
IM 8-6
Copyright © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
Chapter Eight: Financial Analysis
10.What are the two liquidity ratios? How are they calculated? What do they
reveal? (LO 8-4) The two liquidity ratios are current ratio which is current assets
Lecture Links
Lecture Link 8.1: Entrepreneurs Create Surveys at the New Small Business
(LO 8-7)
The authors revealed that a survey is a nonfinancial method which is used to analyze a
business. The results of survey reveal pertinent data that is beneficial to a business
owner. SurveyMonkey.com is an online resource that a new small business owner can
utilize to conduct a survey. Visit the website at http://www.surveymonkey.com/i (Survey
Monkey) and consider the process required to implement a survey for the target
customers in the industry where you will compete in your new small business.Lecture
Link 8.2: Financial Ratios of American Express
(LO 8-3, 8-4, 8-5, 8-6)
The authors in the text revealed that an entrepreneurial business owner analyze the
business to reveal data about the firm. Do you keep good financial records? Visit the
website at http://wwwbloomberg.com/research/stocks/financials/ratios.asp?ticker=AXP.
This is the website for American Express. Which ratios does Bloomberg feature for this
company?
Lecture Link 8.3: Auditing Standards at the New Entrepreneurial Business
Can management complete this type of transaction? What would an auditor say about
this transaction? These are only some of the questions a new small business owner
might have about a transaction or process as it relates to the finances of the small
business. The Accounting and Auditing Policy Committee (AAPC) works in conjunction
with the Federal government to implement processes and resolve ongoing accounting
issues (FASB Accounting and Auditing Policy Committee)ii. Visit the Accounting and
Auditing Policy Committee website at http://www.fasab.gov/about/aapc and discuss
how this agency could assist a new small business owner with any accounting and
IM 8-7
Copyright © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
Chapter Eight: Financial Analysis
finance questions.Lecture Link 8.3: Auditing Standards at the New Entrepreneurial
Business - Notes
This committee helps the government improve financial reporting through discussions
and recommendation of solutions to accounting problems. The project tab lists the
current projects that are being discussed.
Bonus Internet Exercises
Bonus Internet Exercise 8.1: Factors Impact Sales
It is interesting to note that there are various factors during a year that impact the sales
made by a business. Visit the website
http://www.fastlinksolutions.co.uk/calculat.htm#howto (Fast Link Solutions)iii and scroll
down to the factors that the influence sales section. Next, choose three items and
discuss how they might impact the sales at your new small business.
1. Which three factors did you choose that impact the sales made by a business?
2. How do these factors impact the sales made by the new small business? Be
specific.
3. What strategies can a business owner create to enhance the sales made by the
business? Be specific.
Bonus Internet Exercise 8.2: Industry Ratio Analysis Sources
(LO 8-4)
When a business owner evaluates the ratios for the business the owner must evaluate
those ratios compared to the industry standards in a particular industry. Visit the website
at http://guides.emich.edu/industry/ratios and discuss the following questions.
What resources did you utilize to obtain the industry data for your new small business?
How will these industry standards assist you with a ratio analysis at your new small
business?
What other data did you discover that might assist a new small business owner?
IM 8-8
Copyright © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
Chapter Eight: Financial Analysis
Bonus Internet Exercise 8.3: Industry Profit Analysis
(LO 8-4)
Business owners utilize all of the available resources to assist them with their goals and
objectives. A business owner can analyze the profit ratios of other firms in the same
industry. Visit the website http://www.bankrate.calculators/business/current-ratio.aspx
(Financial planning: Profit industry comparisons, 2017)iv and review the resources that
are available to assist a business owner.
1. What is the purpose of the small business calculator?
2. What were the other resources that you found beneficial to assist the business
owner? How would you intend to use those resourceBonus Internet Exercise
8.3: Industry profit Analysis - Notes
1. What is the purpose of the small business calculator? To follow a
non-accountant business owner to calculate the current ratio for the business.
2. What were the other resources that you found beneficial to assist the
business owner? How do you intend to use those resources? Answers will
vary.
Critical Thinking Exercises
Critical Thinking Exercise 8.1: Evaluating Sensitivity Analysis
(LO 8-5)
Sales fluctuate in a new small business. They affect the financial performance and the
cash flow of the business. The authors in the text revealed that sensitivity analysis
involves taking the current cash flow statement, the income statement, or the balance
sheet and making projections based upon a dramatic increase in sales, a dramatic
decrease in sales, or the businesses efforts to make a major change in the business
(text page 253). Sensitivity analysis can measure the cash flow impact of changes on
historical statements and existing statements.
1. Discuss the steps required to perform a sensitivity analysis on historical data.
Why is this analysis important to a business owner?
2. What does a rapid increase in sales indicate about the business? Be specific.
IM 8-9
Copyright © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
Chapter Eight: Financial Analysis
3. What does a rapid decrease in sales indicate about the business? Be specific.
4. How does a business owner know if additional funding is needed for the
business?
IM 8-10
Copyright © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
iSurvey Monkey. http://www.surveymonkey.com . Retrieved on October 30, 2009.
iiFASB Accounting and Auditing Policy Committee. Federal Accounting Standards Board
(FASB). http://www.fasab.gov/aapc/aapc.html . Federal Accounting Standards Advisory
Board. Retrieved on October 30, 2009.
iiiFast Link Solutions. http://www.fastlinksolutions.co.uk/calculat.htm#howto. Retrieved
on October 31, 2009.
iv Financial planning: profit industry comparisons. (2009). Bankrate.com.
http://www.bankrate.com/brm/news/biz/green/19990712i.asp . Retrieved on October 31,
2009.
