chapter 8 start-up concerns

Chapter 8Start-Up Concerns & Financial Projections

-Researching and Preparing Numbers

Learning Objectives

• Learn how to keep score with numbers.

• Determine start-up costs.• Discover ways to boot-

strap your business• Focus on pricing as part

of overall strategy.• Determine seasonality

scenarios.• Develop sales projections

and what-if scenarios.

• Develop projected income statements

• Learn the importance of cash flow.

• Understand that assets – liabilities = net worth.

• Determine profitability through break-even analysis.

• Learn how to use industry financial ratios and benchmarks.

Questions to Ask About the Financial State of Your Business

What will your start-up costs run?Which months will be strong in your particular business?Which will be weak?Can you project cash flow?How fast will your business grow?

Five areas you need to consider as you plunge into the numbers

of financial management:

Start-up CostsPricingSeasonality scenariosSales projectionsWhat-if scenarios with income and costs, cash flow, and financial ratios

Suggestions for Making Your Dollars Work Efficiently

1. Find out who you have to pay right now.

2. Find out who can wait a while.3. Keep asking what you’re getting for

your money.4. Make “conserve cash” your mantra.

How to Save Money1. Ask your customers for cash deposits when they

place orders.2. Use trade, credit, or Dating-A vendor’s extension

of the payment term into the near future.3. Lease your equipment.4. Run a lean operation; do not waste anything.5. Work out of your home as long as you can.6. Get your landlord to make on-site

improvements.7. Try to resell whatever waste or byproducts you

have in your business.

How to Save Money - Continued

8. Make mark downs quickly on dead goods.9. Use as little commercial space as you can.10. If customers do not visit your business

facility, it does not have to be highly visible or attractive.

11. When you have to borrow money, shop around.

12. Make sure your liquid cash is earning interest13. Add employees carefully.

Income Statements and Cash Flow

An income statement tells you when you’re going to make a profit on paper.A cash-flow projection tells:(1) Whether or not you can pay bills; and(2) When you’ll need cash infusions to keep goingBoth of these projections are essential to the survival of your business.

Balance SheetA picture of what your business owns and owes. Three categories make up a balance sheet:

Assets (anything of monetary value your business owns) – Liabilities (money owed to creditors) = Net Worth (owner’s equity)

Break-Even AnalysisIf you know your estimated costs (variable and fixed) and gross sales, you can use a break-even formula that will tell when you will start making money.A break-even analysis is useful at start-up time, when you have completed your income and expense projections, and when you are considering launching a new product or service.

Financial RatiosCalculating a few simple ratios will help you analyze how your venture compares with other businesses in your selected industry. Lenders use ratios as measuring devices to determine the risks associated with lending.To the entrepreneur, ratios are control tools for maintaining financial efficiency.

The Three Components of Total Cost Used in

Determining Pricing

Total CostTotal Cost

Sellingcost

Overhead costCost of

goods sold

Break-Even Chart for Pricing (a)

100

300

500

700

900

Loss

Profit

Break-Even Point

Sales (Price = $12)

Total Cost

10 30 50 70 90

Total Variable

Costs

Total FixedCosts

Production in Units

Cos

ts a

nd R

even

ue (

$)

Break-Even Chart for Pricing (b)

100

300

500

700

900

Sales(Price = $18)

Total Cost

10 30 50 70 90

Break-Even Points

Production in Units

Cos

ts a

nd R

even

ue (

$)Sales

(Price = $12)

Sales (Price = $7)

Formulas for Markup CalculationsCost + Markup = Selling priceCost = Selling price - MarkupMarkup = Selling price - Cost

x 100 = Markup expressed as a percentage of selling price

x 100 = Markup expressed as a percentage of cost

MarkupSelling price

MarkupCost

To convert markup as a percentage of selling price into a percentage of cost, or vice versa, the two formulas below are useful:

Markup as percentage of selling price100% - Markup as percentage of selling price

Markup as percentage of cost100% + Markup as percentage of cost

x 100 = Markup as percentage of cost

x 100 = Markup as percentage of selling price

Types of Pricing Strategies

Penetration pricing strategySkimming pricing strategyFollow-the-leader pricing strategyVariable pricing strategyFlexible pricing strategyPrice lining strategyWhat the traffic will bear

Benefits of Credit to Buyers and SellersBenefits of Credit to Buyers

1. The ability to satisfy immediate needs and pay for them later2. Better records of purchases on credit billing statements3. Better service and greater convenience when exchanging

purchased items4. Establishment of a credit history

Benefits of Credit to Sellers

1. Closer association with customers because of implied trust2. Easier selling through telephone- and mail-order systems3. Smoother sales peaks and valleys, since purchasing power is

always available4. Easy access to a tool with which to stay competitive

Types of Credit

Consumer Credit• Open charge accounts• Installment accounts• Revolving charge accounts

Credit Cards• Bank credit cards• Entertainment credit cards• Retailer credit cards

Trade Credit

Consumer Credit• Open charge accounts• Installment accounts• Revolving charge accounts

Credit Cards• Bank credit cards• Entertainment credit cards• Retailer credit cards

Trade Credit

Commonly Used Trade Credit Terms

Credit Term Explanation

3/10, net 60Three percent discount if payment is made within the first 10 days, net (full amount) due by sixtieth day from invoice date

E.O.M. Billing at the end of the month, covering all creditpurchases during that month

C.O.D. Amount due is to be collected upon delivery of the goods

2/10, net 30,R.O.G.

Two percent discount if payment is made within 10 days;net due by thirtieth day however, both discount periodand 30 days start from the date of receipt of the goods

2/10, net 30,E.O.M.

Two percent discount if payment is made within 10 days;net due by the 30th day however, both periods startfrom the end of the month in which the sale was made

Earnings before taxes

Corporate taxes

Operating Activities

Sales revenue

Cost of producing or acquiring product or service (cost of goods sold)

Gross profit

Marketing and selling expenses and general and administrative expenses (operating expenses)

Financing Activities

Operating income

Interest expense on debt(financing costs)

The Income Statement: An Overview

Earnings before interest and taxes (operating income)

Earnings before taxesNet income available

to owners

=

= ==

Taxes

The Balance Sheet: An Overview

Assets Debt (Liabilities) and Equity (Net Worth)

+

Total Assets

Current AssetsCash

Accounts receivable

Inventories

Prepaid expenses

Fixed AssetsMachinery and equipment

Buildings

Land

+Other AssetsInvestments

Patents

Debt CapitalCurrent Debt

Accounts payableOther payables Accrued expensesShort-term notes

Long-Term DebtLong-term notesMortgages

+Owner’s Equity CapitalOwner’s net worth orPartnership equity orCommon stock equity

Total Debt and Equity

==

The Fit of the Income Statement and the Balance Sheet

Reports the profits from January 1, 2006 through December 31, 2006

Reports the profits from January 1, 2006 through December 31, 2006

Income Statement for 2006Income Statement for 2006

Balance Sheet December 31, 2005

Balance Sheet December 31, 2005

Reports the financial position as of December 31, 2005

Reports the financial position as of December 31, 2005

Balance Sheet December 31, 2006

Balance Sheet December 31, 2006

Reports the financial position as of December 31, 2006

Reports the financial position as of December 31, 2006

Time

A Firm’s Cash Flows

After-tax cash flowsfrom operations

Investments innet operating

working capital

Investmentsin fixed

assets andother assets

Firm’scashflow

=

The Purpose of Pro Forma

Financial Statements

1. How profitable can the firm be expected to be, given the projected sales levels and the expected sales expense relationships?

2. What will determine the amount and type of financing (debt or equity) to be used?

3. Will the firm have adequate cash flows? If so, how will they be used; if not, where will the additional cash come from?

The purpose of pro forma financial statements isto answer three questions:

Sales-Assets-Financing Relationships

Increases in sales

Increases in asset

requirements

Increases in asset

requirements

Increases in financing

requirements

Practical Forecasting1. Don’t stretch to reach your numbers; be factual and

conservative.2. Remember: Only the most astonishing changes in a

business or a market can justify a sudden, rocket-like performance.

3. Build projections quantitatively from clear assumptions.

4. Document the reasoning behind each projection in a written list of assumptions.

5. Use industry-specific data to guide your projections of sales and expenses.

6. Remember: Projections are immediately suspect if sales or profit margins are significantly higher or lower than the industry average.

7. Check pro forma statements against actual results at least once a month.

Chapter 9Shaking the Money Tree –

Locating Hard CashLearning Objectives

• Discover your risk tolerance.

• Determine your credit situation.

• Explore credit card usage and risks for your business.

• Understand inherent risks in borrowing from friends and family.

• Scour the lending arena for money to fund your new business.

• Introduce strategies for approaching bankers.

• Become familiar with state and local lending programs as well as those operated by the Small Business Administration and Small Business Development Centers.

• Explore vendor financing.• Locate angels.• Explore the venture

capital market.

Key Factors of Your Credit Score

1. Paying all your bills on time. (35%)2. Amount of money you owe and the

amount of available credit. (30%)3. Length of credit history (15%)4. Mix of credit (10%)5. New credit applications (10%)

To Receive a Copy of Your Credit Report and Scores,

Contact:Equifax

http://www.equifax.comExperian

http://www.experian.comTrans Union Corporation http://www.transunion.com

Additional Thoughts to Consider as You Explore the Bottom Line For

Starting and Building Your Business:Income stream: What can you count on from your Business?Profit from sale of business: What is the potential profit if the business is sold?Profit life cycle: How long will it take for your business to move from start-up to a profit position?The rule: Your business should provide you with two sources of financial return: an income stream and growing equity.

Shaking the Most Fruitful Branches of the Money

TreeSelfSBABanksFamilyFederal Govt. programsFriends“Fools”

Vendor financingVenture capitalMicrolendersAngelsIPO’sState and local Govt. programs

A Few Things You Can Do to Alleviate Some of the Difficulties When Borrowing From Friends,

Family, and “Fools”

Put everything in writing.Make it a business loan, not a personal loan.A provision in the loan should be included for repayment in case of emergencies.Discuss thoroughly with your lenders the company’s goals.Discuss your fears for potential problems and encourage your lenders to discuss their issues as well.

The Five C’s of Credit:

Capacity

Collateral

Conditions

Character

Capital

SBA Program SnapshotsProgram: Basic 7(a) Loan GuarantyFunction: Serves as the SBA’s primary business loan program.Program: Certified Development Company (CDC), a 504 Loan ProgramFunction: Provides long-term, fixed-rate financing to small businesses to acquire real estate or machinery or equipment.Program: Microloan, a 7(m) Loan ProgramFunction: Provides short-term loans of up to $35,000 to small businesses.Program: Loan PrequalificationFunction: Allows business applicants to have their loan applications for $250,000 or less analyzed.

Prepare to Meet Your Lenders

List potential lenders and investors.List reasons why lenders should want to invest in your business.Think about the legal form of your business.Test your tactics by talking to a few friends.Time to go out and meet with lenders and shake another branch of the money tree.

Financial Information Required for a Bank Loan

Three years of the firm’s historical statements, if available, including balance sheets, income statements, and statements of cash flowThe firm’s pro forma financial statements, in which the timing and amounts of the debt repayment are included as part of the forecastsPersonal financial statements, showing the borrower’s personal net worth and estimated annual income

Other Sources of Financing

Community-based financial institutionsLarge corporationsVenture capital firmsStock sales

Chapter 10Legal Issues

Staying Out of Court

Learning Objectives

• Understand the importance and necessity of professional legal advice.

• Decide which legal form is best for your business.

• Explore the good, the bad, and the ugly of partnerships.

• Review the advantages of forming a limited liability company.

• Recognize the importance of documenting, organizing and saving everything.

• Understand legal escape routes.

• Protect your business with a buy-sell agreement.

• Review patent protection.• Understand copyright laws.• Take action to protect your

trademark or service mark.• Review rules for advertising

within safe, legal limits.• Explore family business

issues.

A Good Small Business Attorney Can Help

Create the right business structure for a partnership or a corporation.Review advertising and marketing materials to ensure no state or federal laws are violated.Organize your human resources department to keep you outside the courtroom.Research and protect you in regards to product liability.Review all contracts and agreements before you sign.Protect you through proper use and development of trademarks, copyrights, and patents.Handle collection and possible bankruptcy problems.Help you plan your exit strategy.Write partnership agreements and buy-sell agreements.

Alternative Legal Forms of Business

A sole proprietorship.A partnership.A limited liability company (LLC)Subchapter S corporation

Which Form of Business is Best For You?

International exposureTax implicationsLiability issuesLitigiousness of customers, employees, and businesses in your statePlans for business growthFamily structure and involvement in the businessRelationship with potential partnersCapital requirementsExit strategy

Forms of Business Organization

ProprietorshipsPartnerships

GeneralLimited

CorporationsC corporationsS (or Subchapter S) corporations

Limited Liability Companies (LLCs)

ProprietorshipsProprietorship:business venture owned by an individual who is personally liable for the venture’s liabilities

Unlimited liability:personal obligation to pay a venture’s liabilities not covered by the venture’s assets

PartnershipsPartnership:business venture owned by two or more individuals who are jointly and personally liable for the venture’s liabilities

Joint Liability:legal action treats all partners equally as a group

Partnerships (continued)Joint and Several Liability:allows subsets of partners to be the object of legal action related to the partnership

Limited Partnership:limits limited partner liabilities in a partnership to the amount of their equity capital contribution to the partnership

Questions for Partner Discussion

Management and controlDispute resolutionFinancial contributionsTime contributionsDemise of the partnershipNew partnersParticipation of family members as employees and their input into the businessEthics

CorporationsCorporation:a legal entity that separates personal assets of the owners (shareholders) from the firm’s assets

Limited Liability:creditors can seize the corporation’s assets but have no recourse against the shareholders’ personal assets

Corporate Charter:legal document that establishes the corporation

S Corporation:provides limited liability for shareholders plus corporate income is taxed like personal income to the shareholders

Consider the Following Reasons for Incorporation:

1. You limit your liability2. To change your tax picture3. To Upgrade your image4. To have the opportunity to

channel some heavy expenses5. To guarantee continuity6. To offer internal incentives

Limited Liability Companies (LLCs)

Limited Liability Company (LLC):a business organization owned by “members” (shareholders) with limited liability

Major Incentive for Organizing as an LLC

earnings can be taxed at the personal income tax rates of the members

Subchapter S Corporation

Definition: Legal entity that may

provide positive tax treatment for

small business.

Bases for Comparing Various Business

Organizational Forms

Number of Owners & Ease of StartupInvestor LiabilityEquity Capital SourcesFirm Life & Liquidity of OwnershipTaxation

Number of Owners & Ease of Startup

Proprietorshipone; low time & legal costs

Partnership (general)two or more; moderate time & legal costs

Limited Partnershipone or more general & one or more limited partners; moderate time & legal costs

Number of Owners & Ease of Startup (continued)

Corporation (C)one or more, with no limit; high time & legal costs

S (Subchapter S) Corporationless than 75 owners; high time & legal costs

Limited Liability Company (LLC)one or more, with no limit; high time & legal costs

Investor LiabilityProprietorshipunlimited

Partnership (general)unlimited (joint & several liability)

Limited Partnershiplimited partners’ liability limited to their

investments

Investor Liability (continued)

Corporation (C)limited to shareholders’ investments

S (Subchapter S) Corporationlimited to shareholders’ investments

Limited Liability Company (LLC)limited to owners’ investments

Equity Capital SourcesProprietorshipowner

Partnership (general)partners, families, & friends

Limited Partnershipgeneral and limited partners

Equity Capital Sources (continued)

Corporation (C)venture investors & common shareholders

S (Subchapter S) Corporationventure investors & Subchapter S

investors

Limited Liability Company (LLC)venture investors & equity offerings to

owners

Firm Life & Liquidity of Ownership

Partnershiplife determined by owner; often difficult to transfer ownership

Partnership (general) life determined by partners; often difficult to transfer ownership

Limited Partnershiplife determined by general partner; often difficult to transfer ownership

Firm Life & Liquidity of Ownership (continued)

Corporation (C) unlimited life; usually easy to transfer ownership

S (Subchapter S) Corporationunlimited life; often difficult to transfer ownership

Limited Liability Company (LLC)life set by owners; often difficult to transfer ownership

TaxationProprietorshippersonal tax rate

Partnership (general)personal tax rates

Limited Partnershippersonal tax rates

Taxation (continued)Corporation (C)corporate taxation; dividends subject to personal tax rates

S (Subchapter S) Corporationincome flows to shareholders; taxed at personal tax rates

Limited Liability Company (LLC)income flows to owners; taxed at personal tax rates

Taxes and the Form of Organization

Sole Proprietorship: Business income reported on owners’ individual federal income tax returnsPartnership: Income allocated to partners, who individually report it on their personal tax returnsC Corporation: Income is reported by the business, which pays any taxes owed on its profits

Intellectual Property

Your Most valuable Asset

Patents

Ten Things You Should Know to Protect Your

Inventions

1. What is patent?2. What is the text

for getting a patent?

3. What is a patentability search?

4. What is a patent notice?

5. When must I apply for a patent?

6. What is a worldwide patent?

7. Does a patent guarantee my right to sell my product?

8. What is an infringement study?

9. Are patents worth the costs?

10.Where can I get more information on patents?

Copyrights

Ten Things You Should Know to Protect Your Artwork, Ads,

Writings, and Software1. What is a copyright?2. What protection

does a copyright give?

3. Are Websites Copyrightable?

4. How long does a copyright last?

5. If I use only 10 percent, can I use copyrighted works?

6. Must copyrights be registered?

7. Do I need a copyright notice?

8. Do I own copyrights I pay others to create?

9. Do foreign countries protect copyrights?

10.Where can I get more information on copyrights?

Trademarks

Ten Things You Should Know to Protect Your Product and

Business Names1. What is a trademark?2. How should a mark

be used?3. What is a trade

name?4. Does my

incorporation or fictitious business name statement give me the right to use my name?

5. Must trademarks be registered?

6. What is a trademark search?

7. Is my product’s shape or packaging protectable?

8. Can I register my trade dress?

9. What about protection in foreign countries?

10.Where may I get information on protecting product and business names?