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Chapter 4
PREPARING AND USING FINANCIAL STATEMENTS
FOCUS
In this chapter, we introduce basic accounting and financial statements designed to help ventures monitor
their progress. We stress the need to understand how cash is built and burned both in terms of financial
statements and through operating breakeven analyses.
LEARNING OBJECTIVES
1. Describe the process for obtaining and recording resources needed for an early-stage venture.
2. Describe and prepare a basic balance sheet.
3. Describe and prepare a basic income statement.
4. Explain the use of internal statements as they relate to formal financial statements.
5. Briefly describe two important internal operating schedules: the cost of production schedule and the
inventories schedule.
6. Prepare a cash flow statement and explain how it helps monitor a venture’s cash position.
7. Describe operating breakeven analysis in terms of EBDAT breakeven (survival) revenues.
8. Identify major drivers on the amount of revenues needed to survive.
9. Describe operating breakeven analysis in terms of NOPAT breakeven revenues (covered in
Appendix).
CHAPTER OUTLINE
4.1 OBTAINING AND RECORDING THE RESOURCES NECESSARY TO START AND BUILD A
NEW VENTURE
4.2 BUSINESS ASSETS, LIABILITIES, AND OWNERS’ EQUITY
A. Balance Sheet Assets
B. Liabilities and Owners’ Equity
4.3 SALES, EXPENSES, AND PROFITS
4.4 INTERNAL OPERATING SCHEDULES
4.5 STATEMENT OF CASH FLOWS
4.6 OPERATING BREAKEVEN ANALYSES
A. Survival Breakeven
B. Identifying Breakeven Drivers in Revenue Projections
SUMMARY
APPENDIX A:
NOPAT Breakeven: Revenues Needed to Cover Total Operating Costs
DISCUSSION QUESTIONS AND ANSWERS
1. Describe the types of resources (assets) needed for a new product venture during its development and
startup stages. Comment on the likely revenues and expenses during these early life cycle stages.
Chapter 4: Preparing and Using Financial Statements
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Refer to: Figure 4.1 Obtaining and Recording the Resources Necessary to Start and Build a New
Venture
2. What is accrual accounting? What are generally accepted accounting principles (GAAP)?
3. What is meant by the statement that a balance sheet provides a “snapshot” of a venture’s financial
position as of a point in time? Why must a balance sheet be in “balance?”
4. Briefly describe the typical types of accounts that are found in the current assets of a new venture.
5. What is meant by the terms “depreciation” and “accumulated depreciation”?
6. What types of liabilities might show up on a venture’s balance sheet?
7. What does an income statement measure or track over time?
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A. What dollar amount would initially be recorded in the common stock account?
B. If a par value on the common stock was set at $.01 per share, show how the initial equity
investment would be recorded.
C. Now assume that 20,000 additional shares of stock are sold to an angel investor at $5 per
share six months after the initial incorporation. Show how your answer in Part A would
change if the common stock did not have a par value. Also show how your answer in
Part B would change given a par value of $.01 per share.
Assumption (no par value):
Assumption (with par value):
D. At the end of the first year of operation, the venture recorded an operating loss of
$80,000. Show the dollar amounts in the common stock account, the additional paid–in–
capital account, and the retained earnings account at the end of one year. Also indicate
the cumulative amount in stockholders’ equity at the end of one year.
2. [Internal Operating Schedules] Assume you are starting a new business involving the
manufacture and sale of a new product. Raw materials costs are $40 per product. Direct
labor costs are expected to be $30 per product. You expect to sell each product for $110.
You plan to produce 100 products next month and expect to sell 90 products.
A. Prepare cost of production, cost of goods sold, and inventories schedules for next (the
first) month.
Cost of Production Schedule:
Cost Per Unit Month 1 Month 2
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Cost of Goods Sold Schedule:
Inventories Schedule:
Month 1 Month 2
B. During the second month, you plan to produce 110 products but expect sales in the month
to be 115 products. Prepare cost of production, cost of goods sold, and inventories
schedules for the second month.
3. [Internal Operating Schedules] Assume you have developed and tested a prototype electronic
product and are about to start your new business. You purchase pre-programmed computer
chips at $70 per unit. Other component costs include: plastic casings at $15 per unit and
assembly hardware at $5 per unit. Direct labor costs are $15 per hour and three units can
be produced per hour. You intend to sell each unit at a 50 percent mark-up over the total
costs of producing each unit. The plan is to produce 500 product units per month in
January, February, and March. Sales are expected to be: 200 units in January, 400 units in
February, and 800 units in March.
A. Calculate the dollar amount of sales revenue expected in each month (i.e., January,
February, and March) and for the first quarter of the year.
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B. Prepare a cost of production schedule for January, February, and March.
Cost of Production Schedule:
Cost
Per Unit January February March
Production (units) 500 500 500
Production costs
C. Prepare a cost of goods sold schedule for each of the three months and for the first quarter
of the year. Using your cost of goods sold estimates and the sales revenues expected in Part
A, calculate the gross earnings for January, February, and March, as well as for the first
quarter of the year.
Cost of Goods Sold Schedule:
January February March Total
Gross Earnings Estimate:
D. Prepare an inventories schedule for January, February, and March.
Inventories Schedule:
January February March
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D. Prepare an inventories schedule for April, May, and June.
Inventories Schedule:
April May June
5. [Survival Revenues Breakeven] During its first year of operations, the SubRay Corporation
produced the following income statement results:
Costs of goods sold are expected to vary with sales and be a constant percentage of sales. The
general and administrative employees have been hired and are expected to remain a fixed cost.
Marketing expenses are also expected to remain fixed since the current sales staff members are
expected to remain on fixed salaries and no new hires are planned. The effective tax rate is
expected to be 30 percent for a profitable firm.
A. Estimate the survival or EBDAT breakeven amount in terms of survival revenues necessary
for the SubRay Corporation to breakeven next year.
Survival revenues (SR), when EBDAT = 0, are calculated as:
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Check:
B. Assume that the product selling price is $50 per unit. Calculate the EBDAT breakeven
point in terms of the number of units that will have to be sold next year.
6. [Statement of Cash Flows and Cash Burn or Build] Cindy and Robert (Rob) Castillo founded
the Castillo Products Company in 2015. The company manufactures components for
personal decision assistant (PDA) products and for other hand-held electronic products.
Year 2015 proved to be a test of the Castillo Products Company’s ability to survive.
However, sales increased rapidly in 2016 and the firm reported a net income after taxes of
$75,000. Depreciation expenses were $40,000 in 2016. Following are the Castillo Products
Company’s balance sheets for 2015 and 2016.
CASTILLO PRODUCTS COMPANY
2015 2016
Cash $50,000 $20,000
Accounts Receivables 200,000 280,000
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A. Calculate Castillo’s cash flow from operating activities for 2016.
See spreadsheet calculations below.
B. Calculate Castillo’s cash flow from investing activities for 2016.
See spreadsheet calculations below.
C. Calculate Castillo’s cash flow from financing activities for 2016.
See spreadsheet calculations below.
D. Prepare a formal statement of cash flows for 2016 and identify the major cash inflows
and outflows that were generated by the Castillo Company.
See spreadsheet calculations below.
E. Use your calculation results from Parts A and B above to determine whether Castillo was
building or burning cash during 2016 and indicate the dollar amount of the cash build or
burn.
See spreadsheet calculations below.
F. If Castillo had a net cash burn from operating and investing activities in 2016 divide the
amount of burn by 12 to calculate an average monthly burn amount. If the 2017 monthly
cash burn continues at the 2016 rate, indicate how long in months it will be before the
firm runs out of cash if there are no changes in financing activities.
Note: Because Retained Earnings increased by only $40,000 and Net
Income was $75,000, Cash Dividends paid must have been
$35,000.
Statement of Cash Flows ($ Thousands)
2016
75
40
–80
–100
30
20
–15