Measuring Financial

Performance
Chapter 4
Book: Leach, J. C., & Melicher, R. W. (2011). Entrepreneurial Finance
CHAPTER 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.
OBTAINING AND RECORDING THE RESOURCES
NECESSARY TO START AND BUILD A NEW
VENTURE
• Supporting an initial development stage usually requires minimal
asset investments such as office furniture and a computer.
• If the venture will create product prototypes, it may require
additional specific machinery and equipment.
• The initial cash on hand should be adequate to cover expenses
such as rent, utilities, and the entrepreneur’s subsistence salary.
• Access to cash beyond what is needed to pay immediate expenses
is important because there will likely be no revenues during the
development stage.
Class Discussion Qn
• Whatresources are generally needed during the
development stage of a new venture?
• Laptop

• Equipment (stationary, office supplies)

• Helper (team)
• Raw material
Figure 4.1 illustrates the relationship of gathered resources to their associated financial
footprint as a new venture moves from the development stage to the startup stage.
The primary venture footprints are recorded in its balance sheet and income statement.
BUSINESS ASSETS, LIABILITIES, AND OWNERS’
EQUITY
Suppose you are working on a venture that will produce and market a personal scanner

accessory (PSA) directly attachable to a notebook computer. To date, the venture concept

has progressed through the development stage with successful prototype production and

test marketing.

The PSA quickly scans information on business cards (with a standard

2-inch-by-3.5-inch format) to form customer lists or files. It can also be used to scan small

photographs, charts, and other written information (up to a 3-inch-by-5-inch size). The

scanner is hand sized and designed for field use by sales personnel. The venture has an

existing business plan, has been organized as the PSA Corporation, and now is preparing

to manufacture and sell the PSA.

INTERNAL OPERATING SCHEDULES

The $78,000 cost of goods sold from the income statement was determined by
multiplying the 1,200 units sold by the $65 cost to produce each scanner.
Quiz 2
• Chapter 4 – MCQs
• 19th April 2021
Table 4.3
Table 4.3 shows monthly production, cost of goods sold, and inventory schedules for

PSA Corporation during its first six months of operation. Two hundred scanners were

produced in both July and August. Beginning in September, the scanner production increased

to 300 units per month, resulting in 1,600 scanners during the first six months of

operation. The cost of goods sold schedule in the table shows that 1,200 scanners were

actually sold during the last half of the calendar year. Sales went from zero in July to a

peak of 500 units in December. The venture’s decision to produce scanners at a monthly

rate that exceeded sales (until December) was based on the expectation that sales would

continue to grow in the future. Also, at a monthly production rate of 300 scanners, the

current workforce was being fully employed. The result of production’s exceeding sales

was a finished goods inventory of 400 units at the end of December.

STATEMENT OF CASH FLOWS
Table 4.5
• The statement of cash flows makes it clear that selling on credit and increasing
inventories are a major threat to PSA’s survival. The net result of the cash inflows and
outflows from operating activities was −$54,000. That is, PSA spent $54,000 more cash
than it generated from operations.
OPERATING BREAKEVEN ANALYSES
OPERATING BREAKEVEN ANALYSES
• Toexamine whether PSA has been breaking even, we
need to compare revenues to cash operating and
financing costs. Alternatively, we can look at breakeven
by comparing revenues to cash and noncash operating
costs, omitting financing costs from the comparison.
While both methods are used in practice, the first
measure best indicates whether revenues are sufficient to
survive.
Numerical
• Suppose that a fixed costs for producing 30,000 widgets are $30,000 a year for ABC
corporation. The details are as follows:
Solution
• Breakeven calculation
• If you choose a selling price of $12.00 for each widget, then:

Formula:

Total Fixed Costs / Selling Price – Total Variable Costs = Breakeven Units

$30,000/($12-$7)=6,000 units.
• This means that selling 6,000 widgets at $12 a piece covers your costs of $30,000. Each
unit sold beyond 6,000 generates $5 worth of profit.
Class Practice Question
• Colin is the managerial accountant in charge of Company A, which sells water bottles.
He previously determined that the fixed costs of Company A consist of property taxes, a
lease, and executive salaries, which add up to $100,000. The variable cost associated
with producing one water bottle is $2 per unit. The water bottle is sold at a premium
price of $12. To determine the break even point of Company A’s premium water bottle:
Solution
• Colin is the managerial accountant in charge of Company A, which sells water bottles.
He previously determined that the fixed costs of Company A consist of property taxes, a
lease, and executive salaries, which add up to $100,000. The variable cost associated
with producing one water bottle is $2 per unit. The water bottle is sold at a premium
price of $12. To determine the break even point of Company A’s premium water bottle:
• Solution
• Break even quantity = $100,000 / ($12 – $2) = 10,000 

Therefore, given the fixed costs, variable costs, and selling price of the water bottles,
Company A would need to sell 10,000 units of water bottles to break even.
Video
• https://www.facebook.com/TheNationalNews/videos/740858546629166/
EBITDA
EBITDA (pronounced ee-bit-dah) is a firm’s earnings before interest, taxes, depreciation,
and amortization. EBITDA measures a firm’s revenues minus its variable operating
expenses (such as cost of goods sold) and its fixed operating expenses.

General and administrative costs, rental payments, insurance premiums, and possibly all
or a portion of marketing costs are generally viewed as being fixed.

However, when considering venture survival, the entrepreneur also must be able to cover
financing costs in the form of interest payments.11 Thus, to break even from a survival
viewpoint, the venture’s revenues need to cover all expenses.
When EBDAT is zero, R = VC + CFC, and the firm is at its survival breakeven.
PSA Corporation did not achieve breakeven during its first full year (due primarily to ramping up its
administrative and marketing expenses).
In Year 2, it passed breakeven to achieve a surplus EBDAT of $125,000.
Year 3 exhibited even greater success, with EBDAT reaching 19 percent of revenues. It is frequently helpful to
provide additional interpretive analysis directly relating the
EBITDA = 0

When EBDAT is zero, R = VC + CFC, and the firm is at its

survival breakeven.
EBITDA Multiple
• The EBITDA multiple is a financial ratio that compares a company’s Enterprise
Value to its annual EBITDA (which can be either a historical figure or a
forecast/estimate).  This multiple is used to determine the value of a company and
compare it to the value of other, similar businesses.
• Market capitalization
• The value of a company that is traded on the stock market, calculated by multiplying
the total number of shares by the present share price.
• Minority Interest
• A minority interest is less than 50 per cent ownership or interest in a company. This
reflects the proportion of its minority shareholders held subsidiaries.
EBITDA Multiple
• What is the Formula for the EBITDA Multiple?
• Formula:
• EBITDA Multiple = Enterprise Value / EBITDA
• To Determine the Enterprise Value and EBITDA:
• Enterprise Value = (market capitalization + value of debt + minority interest +
preferred shares) – (cash and cash equivalents)
• EBITDA = Earnings Before Tax + Interest + Depreciation + Amortization
 Numerical
• Let’s walk through an example together of how to calculate a company’s EBITDA
multiple. ABC Wholesale Corp has a Market Cap of $69.3B as of March 1, 2018, and a cash
balance of $0.3B and debt of $1.4B as of December 31, 2017.
• For the full year of 2017, its EBITDA was reported at $5.04B and the current analyst consensus
estimate for 2018 EBITDA is $5.5B. What are the resulting historical and forward-looking
multiples?
• Solution
• Calculate the Enterprise Value (Market Cap + Debt - Cash) = $69.3  + $1.4 – $ 0.3 = $70.4B
• Divide the EV by 2017 EBITDA = $70.4 / $5.04 = 14.0 (EBITDA MULTIPLE)
• Divide the EV by 2018 EBITDA = $70.4 / $5.50 = 12.8 (EBITDA MULTIPLE)
Class Practice Question
• Let’s walk through an example together of how to calculate a company’s EBITDA
multiple. ABC Wholesale Corp has a Market Cap of $80.2 B as of March 1, 2018,
and a cash balance of $0.6B and debt of $1.5B as of December 31, 2017.
• For the full year of 2017, its EBITDA was reported at $4.23B and the current
analyst consensus estimate for 2018 EBITDA is $3.52B. What are the resulting
historical and forward-looking multiples?
Solution
• Calculate the Enterprise Value (Market Cap + Debt - Cash) = $80.2  + $1.5 – $ 0.6 =
$81.1B
• Divide the EV by 2017 EBITDA = $81.1 / $4.23 = 19.17 (EBITDA MULTIPLE)
• Divide the EV by 2018 EBITDA = $70.4 / $3.52 = 23.03 (EBITDA MULTIPLE)
 Class Practice Question
• Let’s walk through an example together of how to calculate a company’s EBITDA
multiple. ABC Wholesale Corp has a Market Cap of $75.3B as of March 1, 2018, and a cash
balance of $0.2B, minority interest of $0.4 B and preferred shares of $1.2 B and debt of $1.4B
as of December 31, 2017.
• For the full year of 2020, its EBITDA was reported at $6.07B and the current analyst consensus
estimate for 2021 EBITDA is $6.09B. What are the resulting historical and forward-looking
multiples?
 Numerical
• Let’s walk through an example together of how to calculate a company’s EBITDA
multiple. ABC Wholesale Corp has a Market Cap of $75.3B as of March 1, 2018, and a cash
balance of $0.2B, minority interest of $0.4 B and preferred shares of $1.2 B and debt of $1.4B
as of December 31, 2017.
• For the full year of 2020, its EBITDA was reported at $6.07B and the current analyst consensus
estimate for 2021 EBITDA is $6.09B. What are the resulting historical and forward-looking
multiples?
• Solution
• Calculate the Enterprise Value (Market Cap + Debt + Minority Interest + Preferred Shares -
Cash) = 75.3 +0.4+1.4+1.2-0.2 = 78.01
• Divide the EV by 2020 EBITDA = $78.01 / $6.07 = 12.86 (EBITDA MULTIPLE)
• Divide the EV by 2021 EBITDA = $78.01 / $6.09 = 12.82 (EBITDA MULTIPLE)
BBC – Entrepreneurs Success Story
• https://www.youtube.com/watch?v=AOGDNYWfjrE
Class Activity – Case Study
An Angel Investor with an Agenda

1. Should the entrepreneur accept the proposal. Yes or No?

Support your answer with arguments.
2. Is Serna’s proposal reasonable? Explain.
3. How can Victor Serna’s objectives be met while allowing
Gloria (founder) the flexibility she needs?
HBR Case Study
1. Should the entrepreneur accept the proposal. Yes or No? Support your answer with
arguments.

2. Is Serna’s proposal reasonable? Explain.

3. How can Victor Serna’s objectives be met while allowing Gloria (founder) the
flexibility she needs?
• Share your answers !
Numerical Qn – Balance Sheet
• Mr. Azhar wants to prepare his balance sheet
for his online website creation business. The
details are as follows: Prepare a Balance Sheet
• Account Payables 10,000
• Accrued wages 8000 Long Term assets 50,000
• Bank loan 150,000 Owners equity 45000
Cash 2000
• Long term debts 30000 Gross equipment 19000
• Building 100,000 Receivable:49000
Accumulated depreciation 2000
Inventories 25000