SUNY Empire State College CH2 Financial Management and Planning Paper Please label each chapter and exercise! Ch 2: Financial Management and Planning Exe

SUNY Empire State College CH2 Financial Management and Planning Paper Please label each chapter and exercise!
Ch 2: Financial Management and Planning

Exercise 2 from the textbook
Exercise 4 from the textbook

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Ch 3: Financial Statements

Exercise 2 from the textbook

Ch 4: Analysis of Financial Statements

Exercises 2, 4 from the textbook

Ch 5: Profit, Profitability, and Break-Even Analysis

Exercises 2, 4, 6 from the textbook EDITION
Philip J. Adelman
DeVry University
Alan M. Marks
DeVry University
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Library of Congress Cataloging-in-Publication Data
Adelman, Philip J.
Entrepreneurial finance / Philip J. Adelman, DeVry University, Alan M. Marks, DeVry University.—6 Edition.
pages cm
ISBN-13: 978-0-13-314051-4 (alk. paper)
ISBN-10: 0-13-314051-2 (alk. paper)
1. Small business—Finance. I. Marks, Alan M. II. Title.
HG4027.7.A338 2013
10 9 8 7 6 5 4 3 2 1
ISBN 10:
ISBN 13: 978-0-13-314051-4
o my wife, Hannah B. Adelman,
for her support and continued belief in my abilities;
and to my children, Eddie, Danny, and Tova; my daughters-in-law,
Connie and Cherie; my son-in-law, Jason Gilbert; and my wonderful grandchildren,
Ellie, Jed, Erin, Joey, Emily, Abby, and Naomi, for being my cheerleaders.
Philip J. Adelman
o my loving and supportive family—my wife, Cheryl; my children, Jamie and Jared;
my daughter-in-law Jessica; and my wonderful grandchildren, Kellen, Spencer, Preston, and
Beckett, who gave me the encouragement to realize that my goal is achievable.
Alan M. Marks
o DeVry University, who gave us the
opportunity to use our creative talents to teach.
In memory of Philip Pomerantz whose story gave us
the inspiration to pursue small business case studies.
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Preface ix
Chapter 1
Financial and Economic Concepts 1
Basic Financial Concepts 2 ● Importance of Finance 3 ● Economic Concepts of
Finance 3 ● Scarce Resources 4 ● Opportunity Costs 6 ● Savings, Income, Expenditures, and
Taxes 8
Policy 18

Supply of Money Saved 11
Inflation 18 ● Risk 20

Demand for Borrowed Funds 15

Federal Reserve

Conclusion 23 ● Review and Discussion
Questions 24 ● Exercises and Problems 24 ● Recommended Team Assignment 25

Case Study: Macy’s Housewares, Incorporated 25
Chapter 2
Financial Management and Planning 29
Management Functions 30 ● Planning 30 ● Organizing 31 ● Staffing 32

Directing 32
Controlling 33 ● Business Organizations and Ownership 33 ● Sole Proprietorship 34

Partnership 36 ● Corporation 38 ● Limited Liability Company 41 ● Franchise 43

Nonprofit Organizations 43 ● Starting a Business 44 ● Development of a Business
Plan 46 ● Executive Summary 46 ● General Company Description 47 ● Business Ownership
Succession Plans 52 ● Financing a Business or Raising Capital 52 ● Sources of Financing 54

Conclusion 56 ● Review and Discussion Questions 57 ● Exercises and Problems 57
Suggested Group Project 58 ● Case Study: Introduction to Entrepreneurship 59
Chapter 3
Financial Statements 63
Personal Cash Flow Statement 66 ● Income Statement 67

Statement of Financial Position 72 ● Balance Sheet 74

Chart of Accounts 67
Sole Proprietorship 78

Partnership 78 ● Public Corporations 79 ● Owner’s Equity 82 ● Statement of Cash
Flows 82 ● Problems with Financial Statements 85 ● Conclusion 87 ● Review
and Discussion Questions 88 ● Exercises and Problems 88 ● Recommended Team
Assignments 89 ● Case Study: DPSystems, LLC 90
Chapter 4
Analysis of Financial Statements 95
Vertical Analysis 97 ● Horizontal Analysis 99 ● Ratio Analysis 101 ● Types of
Business Ratios 101 ● Liquidity Ratios 101 ● Current Ratio 102 ● Quick (Acid Test) Ratio 102

Activity Ratios 103 ● Inventory Turnover Ratio 103 ● Accounts Receivable Turnover Ratio 104
Fixed Asset Turnover Ratio 105 ● Total Asset Turnover Ratio 105 ● Leverage Ratios 106
Debt-to-Equity Ratio 106 ● Debt-to-Total-Assets Ratio 107 ● Times-Interest-Earned Ratio 107
Profitability Ratios 108 ● Gross Profit Margin Ratio 108 ● Operating Profit Margin Ratio 109
Net Profit Margin Ratio 109 ● Operating Return on Assets Ratio 110 ● Net Return on Assets
Ratio 110 ● Return on Equity Ratio 110 ● Market Ratios 111 ● Earnings per Share Ratio 111

Price Earnings Ratio 112 ● Operating Cash Flow per Share Ratio 113 ● Free Cash Flow per Share 114

Sources of Comparative Ratios 116 ● Conclusion 116 ● Review and Discussion Questions 117 ● Exercises and Problems 118 ● Recommended Team Assignment 122 ● Case
Study: Mosbacher Insurance Agency 122 ● Background 122 ● Gaining Experience 123

Mosbacher Insurance Company 124 ● Entrepreneurship at Work 124 ● The result 125
Chapter 5
Profit, Profitability, and Break-Even Analysis 127
Efficiency and Effectiveness 128 ● Profit 129 ● Profitability 129 ● Earning Power 130
Break-Even Analysis 131 ● Break-Even Quantity 132 ● Break-Even Dollars 136 ● BreakEven Charts 137 ● Leverage 138 ● Operating Leverage 139 ● Financial Leverage 140

Bankruptcy 143 ● Conclusion 146 ● Review and Discussion Questions 147
Exercises and Problems 147 ● Recommended Team Assignment 150 ● Case
Study: Mark Wheeler Craftsman, Inc. 150

Chapter 6
Forecasting and Pro Forma Financial Statements
Forecasting 154 ● Types of Forecasting Models 156 ● Mean Absolute Deviation 161 ● Practical
Sales Forecasting for Start-Up Businesses 175 ● Pro Forma Financial Statements 178

Pro Forma Income Statement 178 ● Pro Forma Cash Budget 180 ● Pro Forma Balance
Sheet 184 ● Monitoring and Controlling the Business 188 ● Start-Up Business Costs Revisited 188
Gantt Chart 189 ● Conclusion 191 ● Review and Discussion Questions 191

Exercises and Problems 192 ● Recommended Team Assignment 195 ● Case Study:
Hannah’s Donut Shop 196 ● Historical Background 197 ● Environmental Changes 198

Changes in Measurement Systems 198 ● Changes in Strategy 199 ● Implementing
the Five-Step Process and Drum Buffer Rope 202 ● Step 1 202 ● Step 2 202 ● Step 3 203
The Change Process 203 ● Step 4 204
Constraints 205 ● Summary 206

Step 5 204

Results 204

Chapter 7
Working Capital Management 207
Working Capital 208 ● Working Capital Management 208 ● Current Asset
Management 210 ● Cash Management 210 ● Marketable Securities Management 213

Accounts Receivable Management 214 ● Inventory Management 219 ● Economic Order Quantity
Formula 219 ● Types of Inventories 224 ● Current Liabilities Management 228 ● ShortTerm Debt Management 228 ● Accrued Liabilities Management 230 ● Accounts Payable Management 231 ● Conclusion 236 ● Review and Discussion Questions 237 ● Exercises
and Problems 238 ● Recommended Team Assignment 240
Steel Trading, LLC 240 ● Background 240

Case Study: Associated
Chapter 8
Time Value of Money—Part I: Future and Present Value
of Lump Sums 243
Simple Interest 245 ● Fixed Principal Commercial Loans 246 ● Bridge Loans 249 ● Bank
Discount 250 ● Compound Interest 254 ● Financial Calculators 255 ● Rounding
Errors 256 ● Effective Rate 257 ● Time-Value-of-Money Methods 259 ● Future Value
of a Lump Sum 260

Present Value of a Future Lump Sum 263

Internal Rate of Return 268
Conclusion 271 ● Review and Discussion Questions 272 ● Exercises and Problems 272 ● Recommended Team Assignment 274 ● Case Study: Blue Bonnet Café 275

Chapter 9
Time Value of Money—Part II: Annuities 279
Future Value of an Ordinary Annuity 280 ● Future Value of an Annuity Due 286

Present Value of an Ordinary Annuity 291 ● Present Value of an Annuity Due 294

Present Value and Amortization 298 ● Amortization 300 ● Combining Lump Sum and
Annuities into the Same Problem 304 ● Conclusion 308 ● Review and Discussion
Questions 308 ● Exercises and Problems 309 ● Recommended Team Assignment 311

Case Study: Entrepreneurial Spirit 311
Chapter 10
Capital Budgeting 315
Capital Budgeting 316 ● Factors Affecting Capital Budgeting 317

Changes in Government
Research and Development 318 ● Changes in Business Strategy 318 ● Formulating a Proposal 319 ● Costs in Capital Budgeting 319 ● Benefits in Capital Budgeting 320

Evaluating the Data (Techniques of Capital Budgeting) 323 ● Payback 324 ● Net Present
Value 324 ● Profitability Index 330 ● Internal Rate of Return 331 ● Accounting Rate of Return 335

Lowest Total Cost 336 ● Making the Decision 338 ● Following Up 339 ● Taking
Regulations 317

Corrective Action 339 ● Conclusion 340 ● Review and Discussion Questions 341
Exercises and Problems 342 ● Recommended Group Activity 345 ● Case Study:
SWAN Rehabilitation Company: A Great Success Story 345

Chapter 11
Personal Finance
Risk 350 ● Identification of Risk Exposure 351 ● Risk Management 351 ● Life, Health, Disability,
Property, and Liability Insurance 353 ● Financial Planning Goals 358 ● Investments 358

Cash Equivalents 358 ● Certificates of Deposit 359 ● Bonds 360 ● Stock 364 ● Mutual
Funds 370 ● Real Estate 373 ● Precious Metals 375 ● Collectibles 375 ● Investment
Strategies 376 ● Short-Term Investment Strategies 376 ● Long-Term Investment Strategies 377

Pension Planning 377 ● Retirement Plans 378 ● Retirement Strategies 383 ● Retirement
Strategy Examples 384 ● Estate Planning 387 ● Conclusion 391 ● Review and
Discussion Questions 391 ● Exercises and Problems 392 ● Recommended Group
Activities 395 ● Case Study: The Gilberts: An Entrepreneurial Family 396
Appendix A Working with Spreadsheets
Spreadsheet Basics 399 ● Formula Entry 403
Interest or Future Value of a Lump Sum 403 ●

Future Value of an Ordinary Annuity 406 ●

Present Value of an Ordinary Annuity 409 ●

Working with Calculators 412
Appendix B
and Calculators

Simple Interest 403 ● Compound
Present Value of a Future Lump Sum 405
Future Value of an Annuity Due 408
Present Value of an Annuity Due 411
Time-Value-of-Money Tables
Appendix C Answers to Even-Numbered Exercises and Problems 425
Chapter 1 425 ● Chapter 2 425 ● Chapter 3 426 ● Chapter 4 427

Chapter 5 430 ● Chapter 6 431 ● Chapter 7 435 ● Chapter 8 435

Chapter 9 438 ● Chapter 10 442 ● Chapter 11 444
Case Studies 447
Glossary 463
Index 477
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In this edition, we include short case studies of small businesses at the end of each
chapter. We have also added some additional case studies at the end of the textbook.
Chapter 2 has updated material on the Small Business Administration (SBA), with
a discussion of new programs including loans and grants that have been developed
to assist veterans and severely disabled veterans. We also added updated sources
of financing, the requirements for obtaining federal contracts, and the need for
businesses to develop succession plans. Chapter 4 has updated financial ratios that
include averaging information from two balance sheets when data for the ratio is
taken from both the income statement and balance sheet (statement of financial
position). Chapter 8 introduces fixed interest loans to include both fixed principal
commercial loans and bridge loans. New to this edition are examples of Time Value
of Money problems using both Microsoft Excel and the TI (Texas Instruments)
BA II Plus calculator. We include step-by-step diagrams for the solution to TVM
problems. Chapter 9 includes a discussion of adjustable rate mortgages (ARMs)
and illustrates the problem with an upside-down mortgage when real estate values
decline. We also include step-by-step diagrams for the solution to TVM annuity
problems using the TI BA II Plus calculator. Chapter 11 is updated to show changes
in retirement programs and now includes a discussion of Medicare insurance and an
explanation of the new Medicare Prescription Drug Plan and income replacement
insurance policies. Chapter 11 also includes the requirements for an annual financial tuneup. Appendix A has been updated to show solutions to typical financial
problems using both Microsoft Excel and the TI BA II plus calculator. We include
screenshots of Microsoft Excel spreadsheets. We also include screenshots of how to
enter time-value-of-money formulas using the function wizard fx. Appendix A also
includes step-by-step solutions to sample problems using the TI BA II Plus financial
We have written this textbook for the more than 99 percent of business owners
and managers in the United States who manage sole proprietorships, partnerships,
limited liability companies, or small non-public corporations. We are targeting
those individuals and students who wish to learn more about the financial aspects
of business entrepreneurship. We make complex theory easy to understand and
discuss vital issues with a direct and clear delivery of material. We apply many of
the techniques that are found in traditional corporate finance texts to businesses at
an understandable level.
Most people who want to start a business come from all types of occupations
(e.g., blue collar, trade, professional, technical, engineering). Their formal education may be in something other than business. This book is written primarily as
a textbook for the education institution that caters to the concerns of individuals
wishing to enhance their abilities in those areas of business that lead to successful
entrepreneurship. This text can also be used by universities, community colleges,
and technical colleges offering programs in finance and entrepreneurship. Of the
more than 31 million businesses in the United States, approximately 72 percent are
sole proprietorships, 10 percent are partnerships, 6 percent are C corporations, and
13 percent are Subchapter S corporations; less than 1 percent are publicly traded
corporations. However, almost all financial textbooks are written for the large corporation and do not address the needs of more than 99 percent of all business. In
addition, the majority of these business establishments have fewer than 20 employees.1 For these businesses, the owner is pretty much the chief financial officer, the
chief executive officer, and the chief operating officer. Such a business owner needs
a working knowledge of finance, because he or she has no staff support on a fulltime basis to assist in planning.
Our textbook differs from the typical financial textbook. Traditional financial
texts are written for college juniors, seniors, or graduate students with the assumption that the student has had several courses in accounting and that this student will
be working for a major corporation. This is not usually the case. Our textbook
provides the critical financial information required for the majority of students and
entrepreneurs entering the business world today. The resources used in writing a
business plan often omit many of the financial aspects that the owner may need
to determine the financial health of an existing or future business. Because many
students may come from a non-business background rather than having a prior
formal business education, we begin our text by outlining the basic economic factors affecting finance. We then discuss the advantages and disadvantages of various
forms of business ownership. The text provides examples of financial statements for
each type of business ownership. We devote more time than most financial texts
discussing working capital and inventory management, because even though the
sales may increase, a new business may fail because of poor working capital and
inventory management techniques.
Internal Revenue Service, Statistics of Income Bulletin, Historical Table, Winter 2011. U.S. Securities
and Exchange Commission filings. Retrieved July 25, 2012, from
Most business managers have been trained to judge the profitability of a project in terms of payback and break-even analysis. We have taken corporate capital
budgeting techniques and adapted them by showing the weighted average cost of
capital as it exists for most business owners. We also demonstrate the importance of
the time value of money as a tool in both business planning and personal financial
planning, and we simplify the use of this tool. We provide the reader with specific
examples in which each of the six time-value-of-money formulas is actually used
by individuals and businesses.
All individuals, regardless of whether they work for the traditional publicly
traded corporation, must make decisions about their retirement plans. Traditional
financial textbooks do not cover personal financial planning. Because of this, we
devote all of Chapter 11 to this vital topic, which includes an in-depth discussion of
risk management as well as those investment vehicles that enable the entrepreneur
to plan for personal financial goals. We believe that it is imperative for business
managers not only to run their business successfully on a day-to-day basis, but to
have those skills that enable them to plan for their personal and family’s future as
Thanks to Timothy Ackley and Joyce Barden at DeVry University, Phoenix,
Arizona, for their expert assistance and advice. Special thanks to the reviewers of
this text: Craig Armstrong, University of Alabama Tuscaloosa; Thomas Bilyeu,
Southwestern Illinois College; Josh Detre, Louisiana State University.
Philip J. Adelman
Alan M. Marks
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Financial and Economic
Learning Objectives
When you have completed this chapter, you should be able to:
♦ Understand the basic concept and importance of finance as it relates to
individuals and business.
♦ Unders…
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