of $1.20. Markup on selling price equals 33 and one-third percent. Markup on cost equals 50 percent. These lead to Consumer selling price of $1.80.
Chart 3: Two channel members. Firm cost equals $1.00. Markup on cost equals 20 percent, which leads to first Channel member selling price of $1.20. Markup on selling price equals 10 percent. Markup on cost equals 11 percent. These lead to second Channel member selling price of $1.32. Markup on selling price equals 33 and one-third percent. Markup on cost equals 50 percent. These finally lead to Consumer selling price of $1.98.
Chapter 3 Understanding Financial Documents
Learning Objectives
To foster an understanding of how financial documents are used in entrepreneurial ventures
To analyze the components of the basic accounting equation
To understand the logic of an income statement
To understand the relevance of the statement of cash flow
Case: Hostess Brands LLC
Little did the founders of the Continental Baking Company know in the 1920s that the company would go through two bankruptcy proceedings by 2013. Through a series of mergers, the company at one time was the largest commercial bakery in the United States, with its Wonder Bread and Hostess cake products becoming Hostess Brands LLC in 1930.
Despite having multiple owners, including International Telephone and Telegraph, Interstate Bakeries Corporation, Ralston Purina, Ripplewood Holdings, Silver Point Capital, Monarch Alternative Capital, and today Apollo Global Management LLC and Metropoulos & Co., the famous Twinkies brand has not had any significant change since invented by James Alexander Dewar in the Depression era of the United States.
Over the years, even though millions of Hostess products were being sold, the company was not keeping a close watch on the numbers, and the income statement of the company was in bad shape due mostly to the company's high fixed-cost structure. The labor unions had negotiated generous pensions and health care benefits not in line with the market. When sales declined in the 1980s and 1990s with people consuming fewer carbohydrates and no successful new product introductions, Hostess Brands LLC had $450 million in debt in 2004 when it filed for its first bankruptcy in September of that year.
During the years in bankruptcy, Hostess Brands LLC attempted to restructure its debt and its unfunded pension funds and had several purchase offers, including one for $580 million in 2007 from its biggest competitor, a part of the giant Mexican bakery firm Bimbo Bakeries USA, Grupo Bimbo. The company stayed intact and emerged from bankruptcy in 2009 by (1) obtaining a $130 million equity infusion for controlling interest by Ripplewood Holdings, a private equity firm; (2) debt providers, including Silver Point Capital and Monarch Alternative Capital, two hedge funds having about 30% of the debt, keeping their loans; and (3) the labor unions agreeing to reduce the number of jobs and salaries by $110 million.
Again, the numbers were not watched carefully; the company had 12 different unions with 15,000 members, 40 different pension plans, and $2 billion in pension liability, and again it was forced to file for bankruptcy in January 2012. As a result of not being able to reach an agreement with the unions and creditors, mismanagement, and not watching the numbers, the company stopped producing its brands of Twinkies, CupCakes, Ding Dongs, and Ho Hos in November 2012. The company sold its Wonder Bread brand to Flowers Foods and Hostess Brands LLC to Apollo Global Management LLC and Metropoulos & Co. Twinkies and Hostess CupCakes were back on the shelves for purchase on July 15, 2013. It is hoped that the numbers will be carefully watched this time to avoid a third bankruptcy.
Financial statements are extremely important for any business, regardless of size or industry, as they provide information on the operating, financing, and investment activities of the venture and help keep a company from filing for bankruptcy protection as occurred twice in the case of Hostess Brands LLC. They are a fundamental tool for raising capital and assessing the financial health of the venture. They allow projections, comparisons, and the evaluation of past performance and future cash flow. In a nutshell, financial statements are a necessary tool for assessing a venture's current and future earnings and associated cash flow. In this chapter, we will cover three basic financial documents: the balance sheet, the income statement, and the statement of cash flow. Chart 3.1 presents a schematic representation of the material covered in this chapter.
Chart 3.1 Schematic of Chapter 3
The Balance Sheet
The balance sheet allows venture owners to assess how healthy the business is in comparison with other past periods. It records what the company has in the form of assets, debt, and equity at the end of a month, fiscal quarter, or year. It is a “snapshot” of the firm's financial status at an instant in time. Table 3.1 provides an example of a balance sheet.
Assets are defined as the resources of the venture. Such assets were financed through liabilities or equity. Liabilities represent obligations the venture has to pay in the future, while equity defines the ownership interest of the venture. The relation between those three elements is the core of the balance sheet and is known as the accounting identity:
Table 3.1
Assets
Assets represent the tangible and intangible property that the venture owns and has accounting value. It is important to note that assets can be both physical assets and intangible assets. Examples of physical assets are inventory, company cars, and real estate. Examples of intangible assets are patents, copyrights, trademarks, and goodwill. Assets are usually ordered in the balance sheet in order of their liquidity. The most liquid assets appear first on the balance sheet followed by the least liquid ones. Current assets represent the most liquid assets of a venture, meaning they can more easily be turned into cash. Examples of current assets are cash, marketable securities, and accounts receivable.
A venture's requirement for current assets is dependent on its operating cycle. The operating cycle is measured based on the time it takes to convert an investment in cash into inventory and then back into cash proceeds from its sale to customers. As a general rule, the longer the operating cycle, the larger the venture's need for liquidity (i.e., cash).
Noncurrent assets may not be readily converted into cash and are usually subject to wide swings in value. These assets are composed of buildings, land, mineral interests, and equipment (ranging from computers to furniture). Assets in this category are “depreciated” over time. Depreciation is the “expensing” or “writing off” of an asset over its economic life. Depreciation affects the value of such items on the firm's books. The value of the asset is and lowered by a certain amount each year. The annual amount of depreciation depends on the type of item. The depreciation amount appears on the income statement (which we will
