Deck 11: Creating a Successful Financial Plan

Question 1

The statement of cash flows ________.

A) compares costs and expenses against a firm's net profits
B) is built on the basic accounting equation: Assets = Liabilities + Capital
C) shows what assets the business owns and what claims creditors and owners have against those assets
D) shows changes in working capital by listing sources and uses of funds

Answer 1

D

Question 2

Comparing a company's current income statement to those of prior accounting periods rarely reveals valuable information about key trends.

Answer 2

False

Question 3

According to one study, 23 percent of small business owners lack financial literacy to identify the cost that has the greatest impact on their companies.

Answer 3

True

Question 4

Which of the following associations is correct?

A) Balance sheet - cost of goods sold
B) Income statement - owner's equity
C) Current assets - inventory
D) Long-term liabilities - accounts payable

Question 5

Service companies spend the greatest percentage of their sales revenue on cost of goods sold.

Question 6

On a projected income statement, a business owner's target income is ________.

A) the sum of a reasonable salary for the time spent running the business and a normal return on the amount invested in it
B) the income at which the company's total revenues and its total expenses are equal
C) the income that will produce a 10 percent return on the owner's financial investment in the business
D) the income that the owner could earn working for someone else

Question 7

The balance sheet provides owners with an estimate of the firm's worth for a specific moment in time, while the income statement presents a "moving picture" of its profitability over a period of time.

Question 8

To determine net profit, the owner records sales revenue for the year and subtracts liabilities.

Question 9

Cost of goods sold is located on which financial statement?

A) Income statement
B) Balance sheet
C) Statement of cash flows
D) All of the above

Question 10

To reach profit objectives, entrepreneurs must be aware of their firms' ________.

A) current ratio and liabilities
B) fixed assets and owner's equity
C) assets and liabilities
D) overall financial position and any changes in the financial status

Question 11

On a company's statement of cash flows, depreciation is ________.

A) the difference between the total sources available to the owner and the total uses of those assets
B) listed as a source of funds because it is a noncash expense, already deducted as a cost of doing business
C) the owner's total investment at the company's inception plus retained earnings
D) creditors' total claims against the firm's assets

Question 12

Which of the following items would not be listed as a current asset in a company's financial reports?

A) Cash
B) Accounts receivable
C) Fixtures
D) Inventory

Question 13

On the income statement, the cost of goods sold represents the total cost, excluding shipping, of the merchandise sold during the year.

Question 14

The first section of a balance sheet lists ________.

A) assets
B) liabilities
C) claims creditors have against the firm's assets payable within one year
D) the owner's equity in terms of initial capital invested and retained earnings

Question 15

The income statement is based on the fundamental accounting equation:
Assets = Liabilities + Owner's Equity.

Question 16

The ________ shows what assets the business owns and what claims creditors and owners have against those assets, and is built on the basic accounting equation: Assets = Liabilities + Owner's Equity.

A) income statement
B) sources and uses of funds statement
C) balance sheet
D) cash budget

Question 17

________ are those items of value the business owns; ________ are those things the business owes.

A) Assets; liabilities
B) Liabilities; assets
C) Ratios; equities
D) Equities; liabilities

Question 18

Which of the following is not true regarding the components of the income statement?

A) Cost of goods sold represents the total cost, excluding shipping, of the merchandise sold during the accounting period.
B) Gross profit margin is calculated by dividing gross profit by net sales revenue.
C) Operating expenses include those costs that contribute directly to the manufacture and distribution of goods.
D) A and B above

Question 19

Assets represent what a business owns, while liabilities represent the claims creditors have against a company's assets.

Question 20

The ________ represents a "snapshot" of a business, showing an estimate of its value on a given date, while the ________ is a "moving picture" of the firm's profitability over time.

A) balance sheet; income statement
B) income statement; balance sheet
C) statement of cash flows; income statement
D) balance sheet; statement of cash flows

Question 21

Define what a pro forma financial statement is. What are the two types a small business owner uses, and how are they created?

Question 22

Explain the three basic financial reports that a small business uses in building a financial plan: the balance sheet, the income statement, and the statement of cash flows. What information is contained in each, and of what value is it to the small business owner?

Question 23

Mini-Case 11-7: Sharps and Flats
Anthony Gray has been interested in music since he was old enough to sit at the piano. He literally grew up with music, and he used his talent to earn his way through college. Anthony has grown tired of his job at a large music house in Houston and is seriously considering moving back to his hometown in Massachusetts to open his own small music shop. In researching this venture, Anthony notices that he must include a projected income statement in his loan application. Use the following statistics from Robert Morris Associates' Annual Statement Studies to answer the following question(s).
Net Sales 100.0 percent
Cost of Sales 59.9 percent
Gross Profit 40.1 percent
Operating Expenses 31.2 percent
Net Profit (Before Taxes) 8.9 percent
Gaither Mack is preparing projected financial statements to include in the business plan he is preparing for the launch of a specialty retail store. Using published financial statistics, Mack finds that the typical net profit margin for a store like his is 7.3 percent. If Mack's target income for his first year of operation is $32,000, what level of sales must he achieve to reach it?

A) $233,600
B) $438,356
C) $2,966,400
D) Cannot be determined from the information provided.

Question 24

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.

Question 25

Refer to the following information to answer the question(s) regarding Anita Lupino's toy and game shop:
Anita Lupino is planning to open her own toy and game shop. She has conducted a great deal of research at the local library, contacted the industry trade association, and has set up a meeting with a consultant at the SBDC next week. Before she goes to the SBDC, she wants to sketch out an estimated income statement. She reviews the following data from RMA's Annual Statement Studies:
Costs of Goods Sold 57.3 percent of net sales
Operating Expenses 32.9 percent of net sales
Gross Profit 42.7 percent of net sales
If Anita's net profit target is $32,000, what level of net sales must she achieve?

A) $74,941
B) $97,264
C) $326,531
D) $219,178

Question 26

The most common mistake entrepreneurs make when preparing pro forma (projected) financial statements for their companies is being overly pessimistic in their financial plans.

Question 27

A technique that allows the small business owner to perform financial analysis by understanding the relationship between two accounting elements is called ________.

A) creating the pro forma
B) budgeting
C) break-even analysis
D) ratio analysis

Question 28

Cash requirements can be determined by dividing cash expenses by ________.

A) liabilities
B) accounts receivables
C) total assets
D) the average inventory turnover

Question 29

Pro forma financial statements show a company's most recent financial position.

Question 30

Mini-Case 11-7: Sharps and Flats
Anthony Gray has been interested in music since he was old enough to sit at the piano. He literally grew up with music, and he used his talent to earn his way through college. Anthony has grown tired of his job at a large music house in Houston and is seriously considering moving back to his hometown in Massachusetts to open his own small music shop. In researching this venture, Anthony notices that he must include a projected income statement in his loan application. Use the following statistics from Robert Morris Associates' Annual Statement Studies to answer the following question(s).
Net Sales 100.0 percent
Cost of Sales 59.9 percent
Gross Profit 40.1 percent
Operating Expenses 31.2 percent
Net Profit (Before Taxes) 8.9 percent
Suppose that a market survey indicates that Anthony's proposed business is likely to generate only $190,000 in sales. What net profit should Anthony expect to earn?

Question 31

Mini-Case 11-7: Sharps and Flats
Anthony Gray has been interested in music since he was old enough to sit at the piano. He literally grew up with music, and he used his talent to earn his way through college. Anthony has grown tired of his job at a large music house in Houston and is seriously considering moving back to his hometown in Massachusetts to open his own small music shop. In researching this venture, Anthony notices that he must include a projected income statement in his loan application. Use the following statistics from Robert Morris Associates' Annual Statement Studies to answer the following question(s).
Net Sales 100.0 percent
Cost of Sales 59.9 percent
Gross Profit 40.1 percent
Operating Expenses 31.2 percent
Net Profit (Before Taxes) 8.9 percent
Michelle Becker's target income in her business for the upcoming year is $78,500. The company's gross profit margin averages 32.6 percent of sales, and its total operating expenses run 24.7 percent of sales. To achieve her target income, sales of Michelle's company should be ________.

A) $148,773
B) $993,671
C) $317,814
D) $1,271,348

Question 32

Concerning how much cash to have at startup, one rule of thumb is to have enough to cover operating expenses (less depreciation) for two inventory turnover periods.

Question 33

In start-up firms, one guideline is for the owner to draw a salary 25-30 percent below the market rate for a similar position.

Question 34

Refer to the following information to answer the question(s) regarding Anita Lupino's toy and game shop:
Anita Lupino is planning to open her own toy and game shop. She has conducted a great deal of research at the local library, contacted the industry trade association, and has set up a meeting with a consultant at the SBDC next week. Before she goes to the SBDC, she wants to sketch out an estimated income statement. She reviews the following data from RMA's Annual Statement Studies:
Costs of Goods Sold 57.3 percent of net sales
Operating Expenses 32.9 percent of net sales
Gross Profit 42.7 percent of net sales
If Anita's research suggests that she can expect net sales of $475,000, what net profit could she expect?

A) $202,825
B) $46,550
C) $69,350
D) $156,275

Question 35

On a projected income statement, a business owner's target income is the sum of a reasonable salary for the time spent running the business and a normal return on the amount the owner has invested in it.

Question 36

Mini-Case 11-7: Sharps and Flats
Anthony Gray has been interested in music since he was old enough to sit at the piano. He literally grew up with music, and he used his talent to earn his way through college. Anthony has grown tired of his job at a large music house in Houston and is seriously considering moving back to his hometown in Massachusetts to open his own small music shop. In researching this venture, Anthony notices that he must include a projected income statement in his loan application. Use the following statistics from Robert Morris Associates' Annual Statement Studies to answer the following question(s).
Net Sales 100.0 percent
Cost of Sales 59.9 percent
Gross Profit 40.1 percent
Operating Expenses 31.2 percent
Net Profit (Before Taxes) 8.9 percent
You are to prepare a projected income statement for a proposed business venture. Your desired income is $28,000 and you have the following published statistics: Costs of Goods Sold = 56.9 percent of net sales
Operating Expenses = 37.1 percent of net sales
Gross Profit Margin = 43.1 percent of net sales
This information indicates the net sales on your pro forma "P & L" (income statement) would be:

A) $466,667.
B) $491,228.
C) $500,000.
D) None of the above

Question 37

Mini-Case 11-7: Sharps and Flats
Anthony Gray has been interested in music since he was old enough to sit at the piano. He literally grew up with music, and he used his talent to earn his way through college. Anthony has grown tired of his job at a large music house in Houston and is seriously considering moving back to his hometown in Massachusetts to open his own small music shop. In researching this venture, Anthony notices that he must include a projected income statement in his loan application. Use the following statistics from Robert Morris Associates' Annual Statement Studies to answer the following question(s).
Net Sales 100.0 percent
Cost of Sales 59.9 percent
Gross Profit 40.1 percent
Operating Expenses 31.2 percent
Net Profit (Before Taxes) 8.9 percent
Using Anthony's target income of $23,000, construct a pro forma income statement for Anthony's proposed music shop.
Net Sales $258,427
Cost of Goods Sold 254,798
Gross Profit 103,629
Operating Expenses 80,629
Net Profit (Before Taxes) $23,000

Question 38

Which of the following is not a liquidity ratio?

A) Current ratio
B) Total asset turnover ratio
C) Quick ratio
D) None of the above

Question 39

Analyzing financial ratios could alert a business owner to which of these problems?

A) Excessive inventory
B) Overextending credit
C) Too much debt
D) All of the above

Question 40

Mini-Case 11-7: Sharps and Flats
Anthony Gray has been interested in music since he was old enough to sit at the piano. He literally grew up with music, and he used his talent to earn his way through college. Anthony has grown tired of his job at a large music house in Houston and is seriously considering moving back to his hometown in Massachusetts to open his own small music shop. In researching this venture, Anthony notices that he must include a projected income statement in his loan application. Use the following statistics from Robert Morris Associates' Annual Statement Studies to answer the following question(s).
Net Sales 100.0 percent
Cost of Sales 59.9 percent
Gross Profit 40.1 percent
Operating Expenses 31.2 percent
Net Profit (Before Taxes) 8.9 percent
Creating projected (pro forma) financial statements would allow a business owner to answer which of the following questions?

A) What profit can my business expect to achieve?
B) What sales level must my business reach if our targeted profit is X dollars?
C) What fixed and variable expenses can my business expect to incur at our targeted sales level?
D) All of the above

Question 41

Sarah's Smart Shop has an inventory turnover ratio of 3 times per year and an average inventory of $156,000. If Sarah could manage her inventory better and increase the number of turnovers to the industry average of 6 times per year, what average inventory would she need to generate the same level of sales?

A) $78,000
B) $52,000
C) $468,000
D) $312,000

Question 42

The ________ ratio is a measure of the small company's ability to pay current debts from current assets and is the liquidity ratio most commonly used as a measure of short-term solvency.

A) quick
B) debt-to-net worth
C) current
D) debt-to-assets

Question 43

The ________ ratio is a conservative measure of a firm's liquidity and shows the extent to which a firm's most liquid assets cover its current liabilities.

A) current
B) quick
C) turnover
D) net profit

Question 44

________ ratios measure the extent to which an entrepreneur relies on debt capital rather than equity capital to finance a business.

A) Liquidity
B) Leverage
C) Operating
D) Profitability

Question 45

The ________ ratio tells how many times the company's earnings cover the interest payments on the debt it is carrying.

A) debt
B) debt-to-net worth
C) times-interest-earned
D) net sales-to-working capital

Question 46

For the most meaningful interpretation, the small business owner should compare her/his firm's average collection period to ________.

A) other businesses in the same geographic area
B) a direct competitor
C) the universal standard of 25 days
D) the average for the industry and the firm's credit terms

Question 47

Financial analysts suggest that a small business should maintain a current ratio of at least ________.

A) 1:1
B) 2:1
C) 3:1
D) 4:1

Question 48

The higher the ________ ratio, the lower the degree of protection afforded creditors, and the closer creditors' interest approaches the owner's interest.

A) debt-to-net worth
B) quick
C) asset turnover
D) current

Question 49

A high debt ratio ________.

A) means that creditors provide a large percentage of the company's total financing
B) gives a small business more borrowing capacity
C) decreases the chances that creditors will lose money if the business is liquidated
D) represents a lower risk to potential lenders and creditors

Question 50

When a company is forced into liquidation, owners are most likely to incur a loss when selling ________.

A) accounts receivable
B) inventory
C) marketable securities
D) real estate

Question 51

If the accounting period is one year with credit sales totaling $2,500,000 and accounts receivable totaling $200,000, the average collection period ratio is ________.

A) 29.2 days
B) 365 days
C) 119.3 days
D) Cannot be determined from the information provided

Question 52

The average inventory turnover ratio ________.

A) measures the number of times a company's inventory is sold out during the accounting period
B) tells a business owner whether she/he is managing the company's inventory properly
C) tells a business owner how fast the merchandise is moving through the business
D) All of the above

Question 53

Which ratio would best give an owner an indication that the business is undercapitalized?

A) Debt-to-net worth
B) Net sales to total assets
C) Average inventory turnover
D) Quick

Question 54

________ ratios tell whether or not the small company will be able to meet its short-term obligations.

A) Leverage
B) Profitability
C) Liquidity
D) Operating

Question 55

________ ratios help a business owner evaluate the company's performance and indicate how effectively the business employs its resources.

A) Liquidity
B) Leverage
C) Operating
D) Profitability

Question 56

Bettina has just calculated her company's current ratio. To calculate the quick ratio, she should ________.

A) subtract current liabilities from current assets before dividing by total liabilities
B) subtract total liabilities from current assets before dividing by current liabilities
C) subtract inventory from current assets before dividing by current liabilities
D) subtract depreciation expense from current assets before dividing by current liabilities

Question 57

A business that turns over its receivables 5.9 times a year would have an average collection period of about ________.

A) 30 days
B) 2/10, net 30
C) 71 days
D) 62 days

Question 58

The ________ ratio measures the percentage of total assets financed by a small company's creditors compared to its owners.

A) debt
B) times-interest-earned
C) net sales to total assets
D) total asset turnover

Question 59

________ is one indication that a small business may be undercapitalized.

A) A current ratio below 1:1
B) A quick ratio above 2:1
C) A debt-to-net worth ratio above 1:1
D) A net sales-to-working capital ratio equal to 3:1

Question 60

Which of the following combinations of ratios would indicate that a company is financially mismanaged and is not a good credit risk?

A) High liquidity; high leverage
B) Low liquidity; high leverage
C) High liquidity; low leverage
D) Low liquidity; low leverage

Question 61

The ________ ratio shows the portion of each sales dollar remaining after deducting all expenses.

A) net profit on sales
B) net profit to equity
C) net sales to total assets
D) net sales to working capital

Question 62

An excessively high average payable period ratio ________.

A) suggests that the company is making the best use of its available cash balance
B) indicates that the company is doing a poor job of collecting its accounts receivable
C) indicates the presence of a significant amount of past-due accounts payable
D) suggests that the company is highly liquid

Question 63

Ideally, a company reaches a point where increases in operating efficiency mean that expenses as a percentage of sales revenue flatten or even decline. This is referred to as ________.

A) net profit to assets ratio
B) profitability ratio
C) net profit to equity
D) operating leverage

Question 64

________ ratios indicate how efficiently the small firm is being managed.

A) Liquidity
B) Profitability
C) Leverage
D) Operating

Question 65

Which ratio would be most helpful to a business owner to measure the profit per dollar of sales?

A) Net sales to total assets
B) Net sales to working capital
C) Net profit on sales
D) Net profit to equity

Question 66

Liquidity ratios (such as the current and the quick ratios) tell whether a small business will be able to meet its short-term obligations as they come due.

Question 67

Refer to the following information to answer the question(s) regarding Port Royal:
Net Sales $927,641
Gross Profit $301,483
Net Profit $48,457
Total Assets $203,869
Total Liabilities $74,325
Port Royal's net profit-to-equity ratio is ________ percent.

A) 23.8
B) 37.4
C) 16.1
D) 232.7

Question 68

Ratio analysis is a useful managerial tool that can help business owners maintain financial control over their businesses, but it is of no use to a business owner trying to obtain a bank loan.

Question 69

A business should provide the owner with a reasonable rate of return based upon ________.

A) the time and money invested in the business
B) industry averages
C) the capital borrowed from the bank
D) an acceptable annual salary

Question 70

Liquidity ratios help a business owner evaluate a small company's performance and indicate how effectively it employs its resources.

Question 71

For Meters, Inc., refer to the following information to answer the question(s) below:
Meters, Inc., reported net sales of $874,916 and a net profit of $74,563 on its most recent income statement. The company's balance sheet shows total assets of $342,742 and total liabilities of $88,367.
What is the net profit margin for Meters, Inc.?

A) 8.5 percent
B) 1.91:1
C) 21.8 percent
D) 29.3 percent

Question 72

The ________ ratio measures a company's ability to generate sales in relation to its assets.

A) net sales-to-working capital
B) net sales to total assets
C) average collection period
D) average inventory turnover

Question 73

A current ratio of 2.4:1 means that a small company has $2.40 in current liabilities for every $1 in current assets.

Question 74

The ________ ratio measures the owner's rate of return on the investment in the business.

A) net profit to equity
B) net profit on sales
C) quick profit
D) net sales to working capital

Question 75

The net profit to asset ratio measures ________.

A) the owner's rate of return on investment
B) how much profit a company generates for each dollar of assets that it owns
C) a company's profit per dollar of sales
D) a company's ability to generate sales in relation to its asset base

Question 76

Refer to the following information to answer the question(s) regarding Port Royal:
Net Sales $927,641
Gross Profit $301,483
Net Profit $48,457
Total Assets $203,869
Total Liabilities $74,325
Port Royal's profit margin on sales is ________ percent.

A) 5.2
B) 32.5
C) 16.1
D) 8.0

Question 77

For Meters, Inc., refer to the following information to answer the question(s) below:
Meters, Inc., reported net sales of $874,916 and a net profit of $74,563 on its most recent income statement. The company's balance sheet shows total assets of $342,742 and total liabilities of $88,367.
What is the return on net worth ratio for Meters, Inc.?

A) 8.5 percent
B) 1.91:1
C) 21.8 percent
D) 29.3 percent

Question 78

A business with a payables turnover ratio of 10.4 times a year would have an average payable period of about ________ days.

A) 3
B) 30
C) 35
D) 62

Question 79

Ratio analysis allows a business owner to identify potential problem areas in her/his business before they become business-threatening crises.

Question 80

Refer to the following information to answer the question(s) regarding Port Royal:
Net Sales $927,641
Gross Profit $301,483
Net Profit $48,457
Total Assets $203,869
Total Liabilities $74,325
Port Royal's debt-to-net worth ratio is ________.

A) 0.36:1
B) 0.08:1
C) 1.57:1
D) 0.57:1