Entrepreneurship: Successfully Launching

New Ventures
Seventh Edition

Chapter 8
Assessing a New
Venture’s Financial
Strength and Viability

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Learning Objectives (1 of 2)
8.1 Learn about the importance of understanding the
financial management of an entrepreneurial firm.
8.2 Identify entrepreneurial ventures’ four main financial
objectives.
8.3 Describe the financial management process
entrepreneurial firms use.
8.4 Explain the difference between historical and pro forma
financial statements.
8.5 Describe the different historical financial statements and
their purpose.

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Learning Objectives (2 of 2)
8.6 Discuss the role of forecasts in projecting a firm’s future
income and expenses.
8.7 Explain the purpose of pro forma financial statements.

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8.1 Introduction to Financial
Management (1 of 2)
• Financial Management
– Financial management deals with two things: raising
money and managing a company’s finances in a way that
achieves the highest rate of return.
– Chapter 10 focuses on raising money. This chapter
focuses primarily on:
▪ How a new venture tracks its financial progress
through preparing, analyzing, and maintaining past
financial statements.
▪ How both existing firms and new ventures forecast
future income and expenses by preparing pro forma
(or projected) financial statements.

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8.1 Introduction to Financial
Management (2 of 2)
The financial management of a firm deals with questions such as the
following on an ongoing basis:
• How are we doing? Are we making or losing money?
• How much cash do we have on hand?
• Do we have enough cash to meet our short-term obligations?
• How efficiently are we utilizing our assets?
• How do our growth and net profits compare to those of our industry
peers?
• Where will the funds we need for capital improvements come from?
• Are there ways we can partner with other firms to share risk and
reduce the amount of cash we need?
• Overall, are we in good shape financially?

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Figure 8.1 Primary Financial Objectives
of Entrepreneurial Firms
Profitability Liquidity Efficiency Stability
A company’s A company’s How The overall health
ability to make ability to meet productively a of the financial
a profit its short-term firm utilizes its structure of the
obligations assets firm, particularly
as it relates to its
debt-to-equity
ratio

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8.2 Financial Objectives of a Firm (1 of 2)

• Profitability
– Is the ability to earn a profit.
▪ Many startups are not profitable during their first one to three
years while they are training employees and building their
brands.
▪ However, a firm must become profitable to remain viable and
provide a return to its owners.
• Liquidity
– Is a company’s ability to meet its short-term financial obligations.
▪ Even if a firm is profitable, it is often a challenge to keep
enough money in the bank to meet its routine obligations in a
timely manner.

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8.2 Financial Objectives of a Firm (2 of 2)

• Efficiency
– Is how productively a firm utilizes its assets relative to its
revenue and its profits.
▪ Because planes do not earn money while sitting idle,
airplane carriers try to increase their efficiency by
reducing actual turnaround times.
• Stability
– Is the strength and vigor of the firm’s overall financial
posture.
▪ For a firm to be stable, it must not only earn a profit and
remain liquid but also keep its debt in check.

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8.3 The Process of Financial
Management (1 of 3)
• Importance of Financial Statements
– To assess whether its financial objectives are being met,
firms rely heavily on analysis of financial statements.
▪ A financial statement is a written report that
quantitatively describes a firm’s financial health.
▪ The income statement, the balance sheet, and the
statement of cash flows are the financial statements
entrepreneurs use most commonly.
• Forecasts
– Are an estimate of a firm’s future income and expenses,
based on past performance, its current circumstances,
and its future plans.

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8.3 The Process of Financial
Management (2 of 3)
• Forecasts (continued)
– New ventures typically base their forecasts on an
estimate of sales and then on industry averages or
the experiences of similar startups regarding the cost
of goods sold and other expenses.
• Budgets
– Are itemized forecasts of a company’s income,
expenses, and capital needs and are also an
important tool for financial planning and control.

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8.3 The Process of Financial
Management (3 of 3)
• Financial Ratios
– Depict relationships between items on a firm’s
financial statements.
– An analysis of its financial ratios helps a firm
determine whether it is meeting its financial
objectives and how it stacks up against industry
peers.
• Importance of Financial Management
– Many experienced entrepreneurs stress the
importance of keeping on top of the financial
management of the firm.

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Figure 8.2 The Process of Financial
Management

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8.4 Financial Statements (1 of 3)
• Historical Financial Statements
– Reflect past performance and are usually prepared on a
quarterly and annual basis.
▪ Publicly traded firms are required by the S EC to prepare
financial statements and make them available to the
public.
• Pro Forma Financial Statements
– Are projections for future periods based on forecasts and
are typically completed for two to three years in the future.
▪ Pro forma financial statements are strictly planning tools
and are not required by the S EC.

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8.4 Financial Statements (2 of 3)
• New Venture Fitness Drinks
– To illustrate how financial statements are prepared,
we used New Venture Fitness Drinks, the fictitious
sports drink company introduced in Chapter 3.
▪ New Venture Fitness Drinks has been in business
for five years.
▪ Targeting sports enthusiasts, the company sells a
line of nutritional fitness drinks.
▪ It opened a single location in 2022, added a
second location in 2024, and plans to add a third
in 2025.

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8.4 Financial Statements (3 of 3)
• New Venture Fitness Drinks (continued)
– To illustrate how financial statements are prepared, we
used New Venture Fitness Drinks, the fictitious sports
drink company introduced in Chapter 3.
▪ The company’s strategy is to place small
restaurants, similar to smoothie restaurants, near
large outdoor sports complexes.
▪ The company is profitable and is growing at a rate
of 25 percent per year.

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8.5 Historical Financial Statements
Three types of historical financial statements

Financial Statement Purpose

Income Statement Reflects the results of the operations of a firm
over a specified period of time. It records all the
revenues and expenses for the given period
and shows whether the firm is making a profit
or is experiencing a loss.
Balance Sheet Is a snapshot of a company’s assets, liabilities,
and owner’s equity at a specific point in time.
Statement of cash Summarizes the changes in a firm’s cash
flows position for a specified period of time and
details why the changes occurred.

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Table 8.1 Consolidated Income Statements
for New Venture Fitness Drinks, Inc
Blank

December 31, 2024 December 31, 2023 December 31,

2022
Net sales $586,600 $463,100 $368,900
Cost of sales 268,900 225,500 201,500
Gross profit 317,700 237,600 167,400
Operating expenses
Blank

December 31, 2024 December 31, 2023 December 31, 2022

Selling, general, and administrative expenses 117,800 104,700 90,200
Depreciation 13,500 5,900 5,100
Operating income 186,400 127,000 72,100

Other income
Blank

December 31, 2024 December 31, 2023 December 31, 2022

Interest income 1,900 800 1,100
Interest expense (15,000) (6,900) (6,400)
Other income (expense), net 10,900 (1,300) 1,200
Income before income taxes 184,200 119,600 68,000
Income tax expense 53,200 36,600 18,000
Net income 131,000 83,000 50,000
Earnings per share 1.31 0.83 0.50

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Table 8.2 Consolidated Balance Sheets for
New Venture Fitness Drinks, Inc. (1 of 2)
Assets
Current assets
Assets December 31, 2024 December 31, 2023 December 31, 2022
Cash and cash equivalents $63,800 $54,600 $56,500
Accounts receivable, less allowance for
39,600 48,900 50,200
doubtful accounts
Inventories 19,200 20,400 21,400
Total current assets 122,600 123,900 128,100

Property, plant, and equipment

Assets December 31, 2024 December 31, 2023 December 31, 2022
Land 260,000 160,000 160,000
Buildings and equipment 412,000 261,500 149,000
Total property, plant, and equipment 672,000 421,500 309,000
Less: accumulated depreciation 65,000 51,500 45,600
Net property, plant, and equipment 607,000 370,000 263,400
Total assets 729,600 493,900 391,500

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Table 8.2 Consolidated Balance Sheets for
New Venture Fitness Drinks, Inc. (2 of 2)
Liabilities and Shareholders’ Equity
Table 8.2 (continued)
Liabilities and shareholders’ equity Current liabilities
Assets December 31, 2024 December 31, 2023 December 31, 2022
Accounts payable 30,200 46,900 50,400
Accrued expenses 9,900 8,000 4,100
Total current liabilities 40,100 54,900 54,500
Long-term liabilities Long-term debt 249,500 130,000 111,000
Long-term liabilities 249,500 130,000 111,000
Total liabilities 289,600 184,900 165,500

Shareholders’ equity
Assets December 31, 2024 December 31, 2023 December 31, 2022
Common stock (100,000 shares) 10,000 10,000 10,000
Retained earnings 430,000 299,000 216,000
Total shareholders’ equity 440,000 309,000 226,000
Total liabilities and shareholders’ equity 729,600 493,900 391,500

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Table 8.3 Consolidated Statement of Cash Flows
for New Venture Fitness Drinks, I nc. (1 of 2)
Blank

December 31, 2024 December 31, 2023

Blank Blank

Cash flows from operating activities

Net income $131,000 $83,000
Blank Blank

Additions (sources of cash)

Depreciation 13,500 5,900
Decreases in accounts receivable 9,300 1,300
Increase in accrued expenses 1,900 3,900
Decrease in inventory 1,200 1,000
Blank Blank

Subtractions (uses of cash)

Decrease in accounts payable (16,700) (3,500)
Total adjustments 9,200 8,600
Net cash provided by operating activities 140,200 91,600
Blank Blank

Cash flows from investing activities

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Table 8.3 Consolidated Statement of Cash Flows
for New Venture Fitness Drinks, I nc. (2 of 2)

Blank

December 31, 2024 December 31, 2023

Purchase of building and equipment (250,500) (112,500)
Net cash flows provided by investing activities (250,500) (112,500)
Blank Blank

Cash flows from financing activities

Proceeds from increase in long-term debt 119,500 19,000
Net cash flows provided by financing activities 119,500 19,000
Increase in cash 9,200 (1,900)
Cash and cash equivalents at the beginning of each 54,600 56,500
year
Cash and cash equivalents at the end of each year 63,800 54,600

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Ratio Analysis (1 of 2)
• Ratio Analysis
– The most practical way to interpret or make sense of a
firm’s historical financial statements is through ratio
analysis, as shown in the next slide.
• Comparing a Firm’s Financial Results to Industry Norms
– Comparing a firm’s financial results to industry norms
helps a firm determine how it stacks up against its
competitors and if there are any financial “red flags”
requiring attention.

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Table 8.4 Ratio Analysis for New
Venture Fitness Drinks, Inc. (1 of 2)
Ratio Formula 2024 2023 2022
Blank Blank Blank Blank

Profitability ratios: associate the

amount of income earned with the
resources used to generate it
Return on assets ROA net income / average
R O A = s tart frac tion net income over average total ass ets end fraction supers cript a
21.4% 18.7% 14.7%
total assetsa
Return on equity ROE net income / average 35.0% 31.0% 24.9%
R O E = s tart frac tion net income over average shareholders' equity end frac tion supers cript b

shareholders’ equity b
Profit margin Profit margin net income /
Profit margin = start fraction net income over net sales end fraction
22.3% 17.9% 13.6%
net sales
Blank Blank Blank Blank

Liquidity ratios: measure the

extent to which a company can
quickly liquidate assets to cover
short-term liabilities
Current start fraction current assets over current liabilities end fraction

3.06 2.26 2.35

Current assets / current liabilities
Quick start fraction quick assets over current liabilities end fraction
2.58 1.89 1.96
Quick assets / current liabilities

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Table 8.4 Ratio Analysis for New
Venture Fitness Drinks, Inc. (2 of 2)
Ratio Formula 2024 2023 2002
Blank Blank Blank Blank

Overall financial stability ratio:

measures the overall financial
stability of a firm
Debt Total debt / total assets
start fraction total debt over total assets end fraction

39.7% 37.4% 42.3%

Debt to equity Total liabilities / owners’ equity
start fraction total liabilities over owner's equity end fraction

65.8% 59.8% 73.2%

a
Average total assets beginning total assets  ending total assets 2.
b
Average shareholders’ equity beginning shareholders’ equity  ending shareholders’ equity 2.

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8.6 Forecasts (1 of 3)
• Forecasts
– The analysis of a firm’s historical financial statements
are followed by the preparation of forecasts.
– Forecasts are predictions of a firm’s future sales,
expenses, income, and capital expenditures.
▪ A firm’s forecasts provide the basis for its pro forma
financial statements.
▪ A well-developed set of pro forma financial
statements helps a firm create accurate budgets,
build financial plans, and manage its finances in a
proactive rather than a reactive manner.

Copyright © 2025, 2019, 2016 Pearson Education, Inc. All Rights Reserved 8 - 25
8.6 Forecasts (2 of 3)
• Sales Forecast
– A sales forecast is a projection of a firm’s sales for a
specified period (such as a year).
– It is the first forecast developed and is the basis for most of
the other forecasts.
▪ A sales forecast for a new firm is based on a good-faith
estimate of sales and on industry averages or the
experiences of similar startups.
▪ A sales forecast for an existing firm is based on (1) its
record of past sales, (2) its current production capacity
and product demand, and (3) any factors that will affect
its future production capacity and product demand.

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Figure 8.3 Historical and Forecasted Annual
Sales for New Venture Fitness Drinks

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8.6 Forecasts (3 of 3)
• Forecast of Costs of Sales and Other Items
– Once a firm has completed its sales forecast, it must
forecast its cost of sales (or cost of goods sold) and the
other items on its income statement.
– The most common way to do this is to use the percent-of-
sales method, which is a method for expressing each
expense item as a percentage of sales.
▪ If a firm determines that it can use the percent-of-sales
method and it follows the procedures described in the
textbook, then the net result is that each expense item
on its income statement will grow at the same rate as
sales (with the exception of items that can be
individually forecast, such as depreciation).

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8.7 Pro Forma Financial Statements
• Pro Forma Financial Statements
– A firm’s pro forma financial statements are similar to its
historical financial statements except that they look
forward rather than track the past.
– The preparation of pro forma financial statements
helps a firm rethink its strategies and make
adjustments if necessary.
– The preparation of pro forma financials is also
necessary if a firm is seeking funding or financing.

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Types of Pro Forma Financial
Statements

Financial Statement Purpose

Pro Forma Income Shows the projected financial results of the
Statement operations of a firm over a specific period.
Pro Forma Balance Shows a projected snapshot of a company’s
Sheet assets, liabilities, and owner’s equity at a
specific point in time.
Pro Forma Statement Shows the projected flow of cash into and out
of Cash flows of a company for a specific period.

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Table 8.6 Pro Forma Income Statement
for New Venture Fitness Drinks, Inc
blank

2024 Actual 2025 Projected 2026 Projected

Net sales $586,600 $821,200 $1,026,500
Cost of sales 268,900 390,000 487,600
Gross profit 317,700 431,200 538,900

Operating expenses
blank

2024 Actual 2025 Projected 2026 Projected

Selling, general, and 117,800 205,300 256,600
administrative expenses
Depreciation 13,500 18,500 22,500
Operating income 186,400 207,400 259,800

Other income
blank

2024 Actual 2025 Projected 2026 Projected

Interest income 1,900 2,000 2,000
Interest expense (15,000) (17,500) (17,000)
Other income (expense), net 10,900 20,000 20,000
Income before income taxes 184,200 211,900 264,800
Income tax expense 53,200 63,600 79,400
Net income 131,000 148,300 185,400
Earnings per share 1.31 1.48 1.85

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Table 8.7 Pro Forma Balance Sheets for
New Venture Fitness Drinks, Inc. (1 of 2)
Assets
Assets December 31, 2024 Projected 2025 Projected 2026
blank blank blank

Current assets
Cash and cash equivalents $63,800 $53,400 $80,200
Accounts receivable, less allowance 39,600 57,500 71,900
for doubtful accounts
Inventories 19,200 32,900 41,000
Total current assets 122,600 143,800 193,100
blank blank blank

Property, plant, and equipment

Land 260,000 260,000 360,000
Buildings and equipment 412,000 512,000 687,000
Total property, plant, and equipment 672,000 772,000 1,047,000
Less: accumulated depreciation 65,000 83,500 106,000
Net property, plant, and equipment 607,000 688,500 941,000
Total assets 729,600 832,300 1,134,100

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Table 8.7 Pro Forma Balance Sheets for
New Venture Fitness Drinks, Inc. (2 of 2)
Assets December 31, 2024 Projected 2025 Projected 2026
blank blank blank

Liabilities and shareholders’ equity

blank blank blank

Current liabilities
Accounts payable 30,200 57,500 71,900
Accrued expenses 9,900 12,000 14,000
Total current liabilities 40,100 69,500 85,900
blank blank blank

Long-term liabilities
Long-term debt 249,500 174,500 274,500
Total long-term liabilities 249,500 174,500 274,500
Total liabilities 289,600 244,000 360,400
blank blank blank

Shareholders’ equity
Common stock (100,000 shares) 10,000 10,000 10,000
Retained earnings 430,000 578,300 763,700
Total shareholders’ equity 440,000 588,300 773,700
Total liabilities and shareholders’ 729,600 832,300 1,134,100
equity

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Table 8.8 Pro Forma Statement of Cash Flows
for New Venture Fitness Drinks, Inc. (1 of 2)
Operating Activities
blank

December 31, 2024 Projected 2025 Projected 2026

blank blank blank

Cash flows from operating activities

Net income $131,000 $148,300 $185,400
blank blank blank

Changes in working capital

Depreciation 13,500 18,500 22,500
Increase (decrease) in accounts 9,300 (17,900) (14,400)
receivable
Increase (decrease) in accrued expenses 1,900 2,100 2,000
Increase (decrease) in inventory 1,200 (13,700) (8,100)
Increase (decrease) in accounts payable (16,700) 27,300 14,400
Total adjustments 9,200 16,300 16,400

Net cash provided by operating activities 140,200 164,600 201,800

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Table 8.8 Pro Forma Statement of Cash Flows
for New Venture Fitness Drinks, Inc. (2 of 2)
Investing Activities and Financing Activities
blank

December 31, 2024 Projected 2025 Projected 2026

blank blank blank

Cash flows from investing activities

Purchase of building and equipment (250,500) (100,000) (275,000)
Net cash flows provided by investing (250,500) (100,000) (275,000)
activities
blank blank blank

Cash flows from financing activities

Proceeds from increase in long-term debt 119,500 – 100,000
blank blank

Principle reduction in long-term debt (75,000)

blank blank blank

Net cash flows provided by financing

activities
Increase in cash 9,200 (10,400) 26,800
Cash and cash equivalents at the beginning 54,600 63,800 53,400
of the year
Cash and cash equivalents at the end of the 63,800 53,400 80,200
year

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Ratio Analysis (2 of 2)
• Ratio Analysis
– The same financial ratios used to evaluate a firm’s
historical financial statements should be used to
evaluate the pro forma financial statements.
– This work is completed so the firm can get a sense of
how its projected financial performance compares to
its past performance and how its projected activities
will affect its cash position and its overall financial
soundness.

Copyright © 2025, 2019, 2016 Pearson Education, Inc. All Rights Reserved 8 - 36
Table 8.9 Ratio Analysis of Historical and Pro
Forma Financial Statements for New Venture
Fitness Drinks, Inc
Profitability ratios
Historical Historical Historical Projected Projected
Ratio
2022 2023 2024 2025 2026
Return on assets 14.7% 18.7% 21.4% 19.0% 18.9%
Return on equity 24.9% 31.0% 35.0% 28.9% 27.2%
Profit margin 13.6% 17.9% 22.3% 18.1% 18.1%

Liquidity ratios
Historical Historical Historical Projected Projected
Ratio
2022 2023 2024 2025 2026
Current 2.35 2.26 3.05 2.07 2.24
Quick 1.96 1.89 2.58 1.60 1.78

Overall financial stability ratios

Historical Historical Historical Projected Projected
Ratio
2022 2023 2024 2025 2026
Debt 42.3% 37.4% 39.7% 29.3% 31.8%
Debt to equity 73.2% 59.8% 65.8% 41.5% 46.6%

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Copyright

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