$$ entrepreneurial finance, 5th edition adelman and marks 5-1 pearson higher education ©2010 by...
TRANSCRIPT
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-1
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
Chapter 5
Profit, Profitability, and Break-Even Analysis
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-2
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
Learning Objectives Understand the difference between efficiency and
effectiveness. Distinguish between profit and profitability. Compare accounting and entrepreneurial profit. Understand the relationship of profit margin and asset
turnover on the earning power of a company.
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-3
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
Learning Objectives (continued)
Given the variable costs, revenue, and fixed costs of a business, determine the break-even point and contribution margin.
Construct and analyze a break-even chart when given variable costs, revenue, and fixed costs of a business.
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-4
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
Learning Objectives (continued)
Understand the use of leverage and its relationship to profitability and loss.
Compare and contrast the degree of operating, financial, and combined leverage and their effect on the profitability of a corporation.
Distinguish between Chapters 11, 13, and 7 bankruptcy.
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-5
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
Efficiency and Effectiveness
Efficiency is obtaining the highest possible return with the minimum use of resources.
Effectiveness, on the other hand, is accomplishing a specific task or reaching a goal.
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-6
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
Profit Versus Profitability
Profit is an absolute number that is earned on an investment. › Accounting profit, for a business, is typically shown at the
bottom of an income statement as net income. › Entrepreneurial profit is the amount that is earned above and
beyond what the entrepreneur would have earned if he or she had chosen to invest time and money in some other enterprise.
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-7
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
Profit Versus Profitability (continued)
Profitability can be measured in a business by using a ratio that is obtained by dividing net profit by total assets. Profitability, therefore, is our Return on Investment (assets).
Net profit (income)ROI
Average total assets
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-8
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
Earning Power
The earning power of a company can be defined as the product of two factors: › The company’s ability to generate income on the amount of
revenue it receives, which is also known as net profit margin; and › Its ability to maximize sales revenue from proper asset
employment, also known as total asset turnover.
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-9
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
Earning Power Formulas
Earning power is equal to net profit margin multiplied by total asset turnover which is equal to return on investment (total assets).
Earning power Net profit margin x Total asset turnover
Net profit (income) Net sales x
Net sales Average total assets
Net profit (income)Earning power
Average total assets
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-10
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
Break-Even Analysis Break-even analysis is a process of determining how
many units of production must be sold, or how much revenue must be obtained, before we begin to earn a profit.
For break-even quantity:
VC- P
FC BEQ
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-11
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
Cost Category Payment Basis Cost ($)
Rent Monthly 2000.00Salaries Monthly 5000.00Employee benefits Annually 7000.00Insurance Quarterly 1500.00Property taxes Annually 3000.00Wood Per truck 1.25Paint and finishing Per truck 0.25Labor Per truck 2.50Packing and shipping Per truck 2.00
Table 5-1 Cost Data for Carl’s Toy Trucks
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-12
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
Break-Even Analysis (continued)
Break-even dollars:
Where VC is variable cost expressed as a percentage of sales (revenue).› For retail firm: VC percentage =(Cost of Goods Sold)/(Net
Sales)› For manufacturing firm: VC percentage = (Variable cost of a
unit)/(Selling price)
P
VCFC
BE
1
$
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-13
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
Break-Even Analysis (continued)
Contribution margin is the amount of profit that will be made by a company on each unit that is sold above and beyond the break-even quantity.
Contribution margin is also the amount the company will lose for each unit of production by which it falls short of the break-even point.
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-14
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
Profit and Break-Even Desired profit with break-even analysis in quantity to
produce.
› VC is variable cost per unit Desired profit with break-even analysis in dollars.
› VC is a percentage of sales dollar (e.g., cost of goods sold as a percent).
VC - P
profit Desired FC quantity Total
dollar) sales theof percentage a (as VC-1
profit Desired $
FCBE
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-15
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
Break-Even Charts
Figure 5-1 Break-Even Chart for Carl's Toy Trucks
0
100
200
300
400
500
600
700
0 10 20 30 40 50 60 70
Units Sold in Thousand (000)
Do
llars
in T
ho
usan
ds (
000)
Total Revenue
Total Cost = FC + VC
Break-Even Point
Fixed Costs (FC)
LossArea
Profit Area
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-16
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
Leverage
Leverage uses those items that have a fixed cost to magnify the return to a company. Fixed costs can be related to company operations or related to the cost of financing.› Interest expenses paid on the amount of debt incurred is the fixed
cost of financing.› A firm is heavily financially leveraged if the fixed costs of
financing are high.
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-17
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
Leverage (continued)
Degree of operating leverage (DOL) is the percentage change in operating income divided by the percentage change in sales.
salesin change Percentage
income operatingin change Percentage DOL
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-18
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
Leverage (continued)
Degree of financial leverage (DFL) is the percentage change in earnings per share divided by the percentage change in operating income.
income operatingin change Percentage
shareper earningsin change Percentage DFL
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-19
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
Leverage (continued)
Degree of combined leverage (DCL) is the percentage change in earnings per share divided by the percentage change in sales.
sales change Percentage
shareper earningsin change Percentage DCL
income operatingin change Percentage
shareper earningsin change Percentage
salesin change Percentage
income operatingin change Percentage DCL x
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-20
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
Bankruptcy
Bankruptcy for a business occurs when the liabilities of the firm exceed the assets and the business does not have sufficient cash flow to make payments to creditors. There are essentially three types of bankruptcy, Chapter 11, Chapter 13, and Chapter 7.
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-21
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
Bankruptcy (continued)
› Chapter 11 bankruptcy occurs when a business seeks court protection while it develops a reorganization plan.
› Chapter 13 bankruptcy is reserved for individuals and sole proprietorships and is similar to, but much simpler than, Chapter 11.
› Chapter 7 bankruptcy requires liquidation of all assets of the business, and payment to the creditors.
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-22
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
Bankruptcy (continued)
Bankruptcy Abuse, Prevention, and Consumer Protection Act.› Signed into law by President Bush on April 20, 2005.› Took effect October 17, 2005.› Makes it much more difficult for individuals and business to
declare Chapter 7 bankruptcy. › Establishes a means test to determine if an individual filing
Chapter 7 is abusing the system.› Imposes federal guidelines for using the homestead exemption.
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Entrepreneurial Finance, 5th EditionAdelman and Marks
5-23
Pearson Higher Education©2010 by Pearson Education, Inc.Upper Saddle River, NJ 07458
AssetsCurrent assets Checking account 2,000$ Accounts receivable 10,000 Inventory 35,000 Total current assets 47,000$ Fixed assets Land 50,000$ Buildings 250,000$ Less: Accumulated depreciation 100,000 150,000$ Equipment 50,000 Less: Accumulated depreciation 30,000 20,000$
Total fixed assets 220,000$
Total assets 267,000$
Liabilities and owner’s equity
Current liabilities Accounts payable trade 20,000$ Notes payable bank 20,000 Taxes payable 3,000
Total current liabilities 43,000$
Long-term liabilities Building mortgage 200,000$ Equipment loan 30,000
Total long-term debt 230,000$
Total liabilities 273,000$
Owner’s equity (6,000)
Total liabilities and owner’s equity 267,000$
Table 5-3 Balance Sheet, The Tom Jones Company
The Tom Jones CompanyBalance Sheet
As of December 31, 2008