ITC 

4207M Fashion Entrepreneurship Management 

Module 4 : Financial Consideration 

Dr Carrie Wong
School of Fashion and Textiles 
The Hong Kong Polytechnic University 
Email: [email protected] Tel: 2766 4025 
4-1
4‐1) Creating a Successful Financial Plan 

Objectives
• How to prepare projected financial statement ? 
• How to conduct ratio analysis ? 
• How to perform break‐even analysis ? 

4-2
 The Importance of a Financial Plan

 Common mistake among business owners: Failing 
to collect and analyze basic financial data.
 Many entrepreneurs run their companies without 
any kind of financial plan.
 About 75% of business owners do not understand 
or fail to focus on the financial details of their 
companies.  
 Financial planning is essential to running a 
successful business and is not that difficult!

4-3
 Basic Financial Statements
 Balance Sheet : estimates the firm’s worth on a given date 
 Built on the accounting equation: 
Assets  =  Liabilities  +  Owner’s Equity 
 Current assets: assets such as cash and other items to converted 
into cash within one year or within the company's normal operating 
cycle
 Fixed assets: assets acquired for long‐term use in a business
 Current liabilities: those debts that must be paid within one year or 
within the normal operating cycle of a company
 Long‐term liabilities: liabilities that come due after one year
 Owner’s equity: the value of the owner’s investment in the business 

4-4
An example of Balance Sheet

Assets  =  Liabilities  +  Owner’s Equity 

4-5
 Basic Financial Statements
 Income Statement: Compares the firm’s 
expenses against its revenue  over a period of 
time to show its net income (or loss):
Net Income  =  Sales Revenue  ‐ Expenses

• Cost of goods sold: the total cost, including shipping, of the 
merchandise sold during the accounting period

4-6
An example of Income Statement 

4-7
 Discussion 
• Peter had a client with a million‐dollar account who was very 
demanding and required many hours of his working time and his 
staff’s time. For 10 years, Peter accommodated the client's whims 
because he assumed that the account was highly profitable for his 
company. 
• Only after Peter spent two months time analyzing the company’s 
accounts , he discovered that although the client’s account balance 
was sizable, it generated very little fees and was actually costing his 
company money. “I was shocked”, said Peter, who informed that 
client that he would have to charge for the additional time that 
maintaining the client's account required. The client became furious, 
and Peter suggested that he take his business elsewhere. Once the 
client left, the company’s profit increased 25%, and Peter found more 
time to recruit new clients.  
4-8
 Discussion 
• Why companies are losing money ? 
– Inadequate sales volume ??? !!!  
–  so business owners focus on pumping up the 
sales at any cost ! 
– In many cases, the root problem is inadequate 
gross profit margin 

4-9
 Basic Financial Statements
• The statement of cash flows shows the actual 
flow of cash into and out of a business for a 
certain time period. 
• The cash flow statement reflects a firm's 
liquidity

Where it came (will come ) from ?

Where it went / will go ?

4 - 10
An example of the Statement of Cash Flows 

4 - 11
 Creating Projected Financial Statements

 Helps the entrepreneur transform business goals 
into reality
 Start‐ups should focus on creating projections for 
two years
 Projected financial statements:
► Income statements

► Balance sheet

4 - 12
 Ratio Analysis

 “How is my company doing?”
 A method of expressing the relationships between 
any two elements on financial statements.
 Important barometers of a company’s health.
 Studies indicate few small business owners 
compute financial  ratios and use them to manage 
their businesses.  

4 - 13
 Twelve Key Ratios
Liquidity ratios Operating Ratios
1. Current ratio  6. Average inventory‐turnover ratio
2. Quick ratio  7. Average collection period ratio 
8. Average payable period ratio  
Leverage ratios 9. Net sales to total assets ratio
3. Debt ratio  
4. Debt‐to‐net‐worth ratio  Profitability Ratios
5. Times interest earned ratio 10. Net profit on sales ratio
11. Net‐Profit‐to‐Assets ratio
12. Net profit to equity ratio

4 - 14
 Twelve Key Ratios: Liquidity Ratios 
Liquidity Ratios - Tell whether or not a small business
will be able to meet its maturing obligations as they come
due.

1. Current Ratio - Measures solvency by showing

the firm's ability to pay current liabilities out of current
assets.

Current Ratio = Current Assets = $686,985 = 1.87:1

Current Liabilities $367,850

Think : if a company with a large number of past‐due receivables 
and stale inventory , it could have an impressive current ratio and 
still be the verge of financial collapse!!!!  4 - 15
 Twelve Key Ratios: Liquidity Ratios 
Liquidity Ratios - Tell whether or not a small business
will be able to meet its maturing obligations as they come
due.

2. Quick Ratio - Shows the extent to which a firm’s most

liquid assets cover its current liabilities.

Quick Ratio = Quick Assets = 686,985 – 455,455 = .63:1

Current Liabilities $367,850

4 - 16
 Twelve Key Ratios: Leverage ratios
Leverage Ratios: Measure the financing provided by
the firm's owners against that supplied by its creditors;
they are a gauge of the depth of the company's debt.
• Careful!  Debt is a powerful tool, but, like dynamite, 
you must handle it carefully! 

3. Debt Ratio - Measures the percentage of total assets

financed by creditors rather than owners.

Debt Ratio = Total Debt = $367,850 + 212,150 = .68:1

Total Assets $847,655
4 - 17
 Twelve Key Ratios: Leverage ratios
Leverage Ratios - Measure the financing provided by a
firm’s owners against that supplied by its creditors; it is a
gauge of the depth of the company’s debt.

4. Debt-to-Net-Worth Ratio - Compares what a business

“owes” to “what it is worth.”

Debt-to-Net- = Total Debt = $580,000 = 2.20:1

Worth Ratio Tangible Net Worth $264,155

4 - 18
 Twelve Key Ratios: Leverage ratios
Leverage Ratios - Measure the financing provided by a
firm’s owners against that supplied by its creditors;
it is a gauge of the depth of the company’s debt.

5. Times-Interest-Earned Ratio- Measures the firm's ability

to make the interest payments on its debt.

Times Interest = EBIT* = $60,629 + 39,850

Earned Total Interest Expense $39,850

= $100,479 = 2.52:1
$39,850
* Earnings Before Interest and Taxes
4 - 19
 Twelve Key Ratios: Operating Ratios
Operating Ratios - Evaluate a firm’s overall performance
and show how effectively it is putting its resources to work.
6. Average-Inventory-Turnover Ratio - Tells the average
number of times a firm's inventory is “turned over” or sold
out during the accounting period.

Average Inventory = Cost of Goods Sold = $1,290,117 = 2.05 times

Turnover Ratio Average Inventory* $630,600 a year

*Average Inventory = Beginning Inventory + Ending Inventory

2

4 - 20
 Twelve Key Ratios: Operating Ratios
Operating Ratios - Evaluate a firm’s overall performance and
show how effectively it is putting its resources to work
7. Average Collection Period Ratio (days sales outstanding,
DSO) - Tells the average number of days required to collect
accounts receivable. Two Steps:

Receivables Turnover = Credit Sales = $1,309,589 = 7.31 times

Ratio Accounts Receivable $179,225 a year

Average Collection = Days in Accounting Period = 365 = 50.0 Period

Ratio Receivables Turnover Ratio 7.31 days
One rule of thumb suggests that a company’s collection period ratio should be no more 
than one‐third greater than its credit terms
4 - 21
 Twelve Key Ratios: Operating Ratios
Operating Ratios - Evaluate a firm’s overall performance
and show how effectively it is putting its resources to work.

8. Average-Payable-Period Ratio - Tells the average number

of days required to pay accounts payable. Two Steps:

Payables Turnover = Purchases = $939,827 = 6.16 times

Ratio Accounts Payable $152,580 a year

Average Payable = Days in Accounting Period = 365 = 59.3 days

Period Ratio Payables Turnover Ratio 6.16

Float = days payables outstanding – days sales outstanding  
= 59.3 days‐50.0 days = 9.3 days 4 - 22
 Twelve Key Ratios: Operating Ratios
Operating Ratios - Evaluate a firm’s overall performance
and show how effectively it is putting its resources to
work.

9. Net-Sales-to-Total-Assets Ratio - Measures a firm’s

ability to generate sales given its asset base.

Net Sales to = Net Sales = $1,870,841 = 2.21:1

Total Assets Total Assets $847,655

4 - 23
 Twelve Key Ratios: Profitability Ratios
Profitability Ratios - Measure how efficiently a
firm is operating; offer information about a firm’s “bottom
line.”

10. Net-Profit-on-Sales Ratio (net-profit-margin ratio) to

measure a firm’s profit per dollar of sales revenue.

Net Profit on = Net Profit = $60,629 = 3.24%

Sales Net Sales $1,870,841

4 - 24
 Twelve Key Ratios: Profitability Ratios
Profitability Ratios - Measure how efficiently a
firm is operating; offer information about a firm’s
“bottom line.”

11. Net-Profit-to-Assets (Return on Assets) Ratio – tells

how much profit a company generates for each dollar
of assets that it owns.

Net Profit to = Net Profit = $60,629 = 7.15%

Assets Total Assets $847,655

4 - 25
 Twelve Key Ratios: Profitability Ratios
Profitability Ratios - Measure how efficiently a firm is
operating; offer information about a firm’s “bottom line.”

12. Net-Profit-to Equity Ratio (return-on-net-worth ratio)

Measures an owner's rate of return on the investment
(ROI) in the business.

Net Profit to = Net Income = $60,629 = 22.65%

Equity Owner’s Equity* $267,655

4 - 26
 Interpreting Ratios
 Ratios – useful yardsticks of comparison.
 Standards vary from one industry to another; the key 
is to watch for “red flags.”
 Critical numbers – measure key financial and 
operational aspects of a company’s performance.  
Examples:
► Sales per labor hour at a supermarket
► Food costs as a percentage of sales at a restaurant.
► Load factor (percentage of seats filled with passengers) at 
an airline.   

4 - 27
 Breakeven Analysis
• Breakeven point ‐ the level of operation at which 
a business neither earns a profit nor incurs a loss.  
• A useful planning tool because it shows 
entrepreneurs minimum level of activity required 
to stay in business.
• With one change in the breakeven calculation, an 
entrepreneur can also determine the sales 
volume required to reach a particular profit 
target.

4 - 28
 Calculating the Breakeven Point
Step 1.  Determine the expenses the business can expect   to incur.
Step 2.  Categorize the expenses in step 1 into fixed expenses and 
variable expenses.
Step 3. Calculate the ratio of variable expenses to net sales.   
Then compute the contribution margin:
Variable Expenses
Contribution Margin =1 -
Net Sales Estimate

Step 4. Compute the breakeven point:
Total Fixed Costs
Breakeven Point ($) =
Contribution Margin
4 - 29
 Calculating the Breakeven Point:
The Magic Shop (refer to textbook, p. 436)
Step 1. Net Sales estimate is $950,000 with Cost of Goods Sold of
$646,000 and total expenses of $236,500.

Step 2. Variable Expenses (including cost of goods sold): $705,125

Fixed Expenses: $177,375

Step 3. Contribution margin:

$705,125
Contribution Margin = 1 - = .26
$950,000
Step 4. Breakeven Point:
$177,375
Breakeven Point $ = = $682,212
.26
4 - 30
 Calculating the Breakeven Point:
The Magic Shop (refer to textbook, p. 436)
• If the shop will be opened 312 days per year, 
the average daily sales it must generate just to 
break even is:
• $682,212/312 days = $ 2187/day 

4 - 31
 Calculating the Breakeven Point:
The Magic Shop
• Adding a Profit !  
• The owner expects a reasonable profit rather than 
break‐even.
• Assumes the owner expects to gain $ 80,000, what 
level of sales must the shop achieve to generate this 
profit return? 
total fixed expenses + desired net income
Sales($) =
contribution margin expressed as a % of sales
$177,375 + $80,000
= = $989,904
0.26
4 - 32
 Calculating the Breakeven Point:
The Magic Shop (refer to textbook, p. 436)
• Convert this annual sales volume into a daily 
sales volume,
• To achieve a net profit of $80,000: 
– The store should sell $ 989904/ 312 days 
– i.e. $ 3173 per day 

4 - 33
 Conclusion
 Preparing a financial plan is a critical step 
 Entrepreneurs can gain valuable insight 
through: 
► Projected (Pro forma) statements 
► Ratio analysis
► Breakeven analysis
 Reading
• For more details, please read chapter 11 of our 
textbook 

4 - 35
 4‐2) Managing Cash Flow 
Objectives 
1.Explain the importance of cash management to a small company’s 
success.
2.Differentiate between cash and profits.
3.Understand the five steps in creating a cash budget and use them to 
create a cash budget.
4.Describe fundamental principles involved in managing the “Big Three” 
of cash management: accounts receivable, accounts payable, and 
inventory.
5.Explain the techniques for avoiding a cash crunch in a small company.
4 - 36
 The Importance of Cash

“Everything is about cash – raising it, conserving 
it, collecting it.”  
Guy  Kawasaki

Common cause of business failure:

Cash crisis!

4 - 37
 Cash Management
• A business can be earning a profit and be 
forced to close because it runs out of cash! 
• Cash management – forecasting, collecting, 
disbursing, investing, and planning for the cash 
a company needs to operate smoothly.  
• Know your company’s  cash flow cycle.

4 - 38
 The Cash Flow Cycle Account 
Account  Receivable 
payable 
Deliver
Goods
Order Receive Pay Sell Send Customer
Goods Goods Invoice Goods* Invoice Pays**

Day 1 15 40 218 221 230 280

14 25 178 3 9 50

Cash Flow Cycle = 240 days

* Based on Average Inventory Turnover: ** Based on Average Collection Period:

365 days 365 days

= 178 days = 50 days
2.05 times/year 7.31 times/year

5‐ 39
 Five Cash Management 
Roles of an Entrepreneur
1. Cash Finder
2. Cash Planner
3. Cash Distributor
4. Cash Collector
5. Cash Conserver

5 ‐ 40
 Cash and Profits
• Cash ≠ Profits !!! 
• Profit is the difference between  a company’s 
total revenue and total expenses.
• Cash is the money that is free and readily 
available to use.
• Cash flow measure a company’s liquidity and 
its ability to pay it bills.

4 - 41
 Cash Flow
Increase in Cash
Cash
Leakage Decrease in Cash

Accounts Receivable Accounts Payable

Cash Sales Production/Cash Purchases

Inventory

Leakage
5 ‐ 42
 The Cash Budget

• A “cash map” that shows the amount and the 
timing of a firm's cash receipts and cash 
disbursements over time.
• Predicts the amount of cash a company will need 
to operate smoothly.
• Helps to visualize a company’s cash receipts and 
cash disbursements and the resulting cash balance.

4 - 43
 Creating a cash budget 
• There are five basic steps: 
1) Determining an adequate minimum cash 
balance
2) Forecasting sales
3) Forecasting cash receipts
4) Forecasting cash disbursements
5) Estimating the end‐of‐month cash balance 

4 - 44
 Preparing a Cash Budget

Step 1: Determining an adequate minimum 
cash balance
– Not too much...
– Not too little...
– But a cash balance that's  just right ... for you!

4 - 45
 Preparing a Cash Budget
(continued)

Step 2: Forecast Sales
– The heart of the cash budget.
– Sales are ultimately transformed into cash 
receipts and cash disbursements.
– Cash forecast is only as accurate as the sales 
forecast from which it is derived. 
– Prepare three sales forecasts: “Pessimistic”, 
“Optimistic” , and “Most Likely”

4 - 46
 Preparing a Cash Budget
(continued)

Step 3: Forecast Cash Receipts
– Record all cash receipts when the cash is 
actually received (i.e. the cash method of 
accounting).
– Determine the collection pattern for credit 
sales; then add cash sales.
– Monitor closely:  Slow and non‐payers.

4 - 47
Probability of Collecting Accounts 
Receivable

5‐48
 Preparing a Cash Budget
(continued)

Step 4: Forecast Cash Disbursements
Key: Record cash disbursements when you will pay them, 
NOT when you incur the obligation to pay them
– Start with those disbursements that are fixed 
amounts due on certain dates.
– Review the business checkbook to ensure accurate 
estimates.
– Add a cushion to the estimated cash disbursements 
– Don’t know where to begin?  Try making a daily list 
of the items that generate cash and those that 
consume it.
4 - 49
Cash Flow Concerns among 
Small Business Owners

4 - 50
 Preparing a Cash Budget
(continued)

Step 5: Estimate End‐of‐Month Cash Balance
– Take Beginning Cash Balance ...
– Add Cash Receipts ...
– Subtract Cash Disbursements
– Result is Cash Surplus or Cash Shortage  (Repay 
or Borrow?)

4 - 51
 Benefits of Cash Management
• Increase amount and speed of cash flowing into the company
• Reduce the amount and speed of cash flowing out
• Make the most efficient use of available cash
• Take advantage of money‐saving opportunities such as cash 
discounts
• Finance seasonal business needs
• Develop a sound borrowing and repayment program
• Develop a sound borrowing program
• Impress lenders and investors
• Provide funds for expansion
• Plan for investing surplus cash
4 - 52
The “Big Three”  of  Cash Management

Accounts 
receivable 

Accounts
payable 

Inventory

4 - 53
 Beating the Cash Crisis
Accounts Receivable
• Establish a firm credit‐granting policy.
– Screen credit customers carefully.
– Develop a system of collecting accounts.
– Send invoices promptly.
– When an account becomes overdue, take action 
immediately.
– Add finance charges to overdue accounts (check 
the law first!).

4 - 54
 In‐class discussion: 
How to accelerate accounts receivable 
• Suggest some techniques to speed cash inflow from 
accounts receivable: 

4 - 55
 Beating the Cash Crisis
Accounts Payable

• Stretch out payment times as long as 
possible without damaging your credit 
rating
• Negotiate the best possible terms with 
your suppliers 
• Be honest with creditors
• Schedule controllable cash disbursements

4 - 56
 Beating the Cash Crisis
Inventory
• Monitor it closely; inventory can drain a company’s 
cash.
• Avoid inventory “overbuying.” 
It ties up valuable cash at a zero rate of return.
• Arrange for inventory deliveries at the latest possible 
date.
• Negotiate quantity discounts  and cash discounts 
with suppliers when possible.

4 - 57
 Beating the Cash Crisis
Inventory
• Quantity discounts: discounts that give businesses a 
price break when they order large quantities of 
merchandise and supplies  
• Cash discounts: discounts offered to customers as an 
incentive to pay for merchandise promptly  
– E.g. Cash discount terms “2/10, net 30” are common in 
many industries  
– It means total amount of the invoice is due 30 days, but if 
the bill is paid within 10 days, the buyer may deduct 2%  
from the total 
4 - 58
 Watch a video

How to free up cash in the business ? 

59
 Conclusion
• “Cash is King”
• Cash and profits are not the same.
• Entrepreneurial success means operating a 
company “lean and mean.”
– Trim wasteful expenditures.
– Invest surplus funds.
– Plan and manage cash flow.

4 - 60
 Reading
• For more details, please read chapter 12 of our
textbook

4 - 61
Here are five of the most common cash-flow problems:

1. Overestimating future sales volumes

Relentless optimism is a key trait of successful entrepreneurs. After all, what realistic person would persevere
in the face of so many obstacles, so many naysayers and so much stress? But while optimism is critical for a
new business owner, letting it compromise your objectivity can be dangerous to your cash flow.

Unfortunately, not every interested looker will actually make a purchase. While your sales volumes may
increase over the holidays, expecting them to double is a little unrealistic.

That’s why it’s so important to complete objective and realistic sales forecasting based on historical evidence
and real numbers. By applying quantitative forecasting methods, you can use actual past revenue data from
your own business or other businesses in your industry as a basis for tracking trends and predicting future
sales. This information, along with some objective intuition, will help you come up with more realistic future
sales projections.

Revenue forecasting can be especially difficult in your first few years of business because you don’t have past
sales figures or as much experience to draw from. This is where working with a mentor from within your own
industry may be extremely useful. A good business mentor can offer his or her own experience to help you
project future sales, and even offer historical sales figures from personal experience to help you predict
upcoming sales volumes.

No matter which method you select, make sure to base your future sales expectations on objective facts and
sound judgment. This will save you from overspending based on pipe dreams that may never come true.

2. Engaging in impulse spending during the startup phase

“It takes money to make money”: We hear this saying so often in business, and in many ways it is true. But,
unfortunately, this common belief can make many a rookie entrepreneur fall prey to gross overspending -
- especially in the first few months of business.

The reality is that while, yes, it does take money to make money, not all startup expenses are created equal.
Starting a business involves plenty of clearly beneficial expenses -- costs that will benefit your company’s
profitability in measurable ways. But there are also plenty of consultants, advisors and B2B service providers
who would be happy to take your startup’s capital for things you don’t actually need.

If you want your business to make money, then, keep your eye on the bottom line, considering the cost-
benefit of every single expense. After all, every dollar you spend on your business is a dollar that is ultimately
taken away from your profit margin.

Along with your revenue forecast, create a realistic budget, and stick to it. Calculate when you plan for your
business to break even -- and as unexpected expenses or opportunities for impulse spending come up, go back
to your projections and calculate how those purchases will delay your break-even point. You may decide that
your employees don’t need that ping pong table after all.
3. Being passive about past-due receivables
One of the fastest cash-flow killers – particularly for small B2B business -- results from unpaid invoices from
clients. If you aren’t being proactive about collecting payments from your clients, you could be on your way to
a dangerous cash-flow situation.

Sadly, small businesses that don’t have solid late-payment penalties and collections policies in place are often
taken advantage of. If your clients don’t know for sure that they’ll hear from you the moment a payment is
late, you’re sure to be the last of their vendors to get paid.

If you haven’t already, set clear policies with your customers for penalties and consequences when payments
are late. Good policies include a 5 percent late penalty after five days, and work stoppage after 30 days past
due (for service-based companies).

Create an internal time line of procedures for when you’ll send the initial invoice, when payment reminders
will go out and when you’ll make collections phone calls or cut off services if past invoices aren’t paid.

Some companies have even benefited from incentivizing customers through discounts for early payments.

4. Not using a cash-flow budget

So, say you’ve set realistic expectations for future sales. You’ve reined in spending, and you’re doing
everything possible to make your clients pay up. These three changes alone will do wonders for your
company’s long-term cash flow. But without tracking your day-to-day cash flow, you may still find your
business in a tight spot.

For retail companies, the months just before the holidays are a time when cash flow can be particularly tight.
You need more inventory from your suppliers to prepare for an influx of sales, but if those supplier payments
come due before your sales actually happen, you may have trouble paying bills on time.

Using a cash-flow statement will help you track your inflow of revenue and outflow of expenses during a
specific time period. This will help you anticipate when you’ll have more money going out than coming in, so
you can plan ahead for those difficult periods. Without one, you’re just guessing at whether you’ll have the
money you need when you need it, and you'll increase your chances of facing late payments and other
penalties on past due invoices.

5. Not keeping a cushion of cash on hand

No matter how many safeguards you have in place to protect your company’s cash, hiccups in cash flow are a
business reality. This may be no big deal if you have a cushion of savings on hand. But if your company is
working from a zero account balance, one slow sales month could mean instant disaster.

To safeguard your business from cash-flow issues, maintain an account balance equivalent to at least two
months of operating expenses. That way, even if you experience unexpected stalls to cash flow, you have
reserves in place to protect yourself.

Cash-flow issues are one of the greatest challenges of business ownership. But if you stay objective about your
business, rein in unnecessary spending and stay alert to potential pitfalls, you’ll be head and shoulders above
your business peers in your potential for long-term business success.