Balance Sheet and Small Business

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RATIO ANALYSIS FEATURING THE DUPONT METHOD:
AN OVERLOOKED TOPIC IN THE FINANCE MODULE OF
SMALL BUSINESS MANAGEMENT AND ENTREPRENEURSHIP COURSES
Submitted by
Thomas J. Liesz
University of Idaho
(208) 885-5447 (office)
tliesz@uidaho.edu
Steven J. Maranville
University of Houston-Downtown
One Main Street
Houston, TX 77002-1001
(713) 221-8524
maranvilles@uhd.edu
Submitted to

Small Business Institute Journal
The authors wish to acknowledge the valuable comments of two SBIJ reviewers

Small Business Institute Journal, Volume 1, 2008

18
RATIO ANALYSIS FEATURING THE DUPONT METHOD:
AN OVERLOOKED TOPIC IN THE FINANCE MODULE OF
SMALL BUSINESS MANAGEMENT AND ENTREPRENEURSHIP COURSES

INTRODUCTION
Many business students, along with a lot of small business management instructors, tend to shy away from quantitative analysis.

The qualitative aspects of a business – such as

generating novel product ideas and creating marketing campaigns– are far more “fun” than record keeping and financial analysis. However, there is much evidence that a lack of financial control is often a quick path to business failure.

According to Dun & Bradstreet’s Business Failure Records (1994), “poor financial practices” is second only to “economic conditions” as a cause of business failures. Further, studies have been published as far back as 80 years ago (see Meech (1925)), as well as more recently (such as those published by Bruno, Leidecker, and Harder (1987); Gaskill, Van Auken, and Manning (1993); Lauzen (1985); and Wood (1989) that specifically cite poor financial control as a chief cause of unsuccessful businesses. Firer (1999), and more recently Kelly (2005), stress the importance of monitoring the “financial health” of a small business. Consequently, it is vital that students of small business management and entrepreneurship become skilled at performing financial analyses. Students would benefit from a relatively simple tool for not only assessing how a particular small business is faring, but also for devising strategies for bottom line improvement. Such a tool exists in the form of financial ratio analysis, and in particular, an updated version of the classic Du Pont model. The aim of this paper is to critically discuss and expand the role of ratio analysis, particularly the DuPont method,

entrepreneurial courses.

as an educational component of small business and/or

To accomplish this purpose, the authors undertake a critical and

Small Business Institute Journal, Volume 1, 2008

19
historical examination of the financial analysis literature and how ratio analysis is incorporated into small business management and entrepreneurship textbooks. Drawing the conclusion that the DuPont method is under-represented in the education of small business management students, the authors introduce the “really” modified DuPont model. The relevance of this model is, then, demonstrated through an example analysis, after which implications for the education of small business management students are discussed.

RATIO ANALYSIS
The use of financial ratios by financial analysts, lenders, academic researchers, and small business owners has been widely acknowledged in the literature for more than 40 years. (See, for example, Horrigan (1965), Edmister (1972), Osteryoung & Constand (1992), Devine & Seaton (1995), or Burson (1998). Financial ratios are used to determine a company’s strengths and weaknesses. A fundamental definition of any profit-seeking business is an entity that acquires resources in order to generate profits through the production and sale of goods and/or services. Ratios show important relationships between a firm’s resources and its financial flows. In a way, ratio analysis provides a “report card”. If the firm’s managers are doing a good job, they know it. If they are not doing a good job, not only will they know it, but they will also have a clear understanding of what they can do about it.

It would...
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