Part III – Developing the Part III – Developing the Entrepreneurial Plan Entrepreneurial Plan

Chapter 7 – Environmental Assessment: Chapter 7 – Environmental Assessment: Preparation for a New Venture Preparation for a New VentureChapter 8 – Marketing Research forChapter 8 – Marketing Research for New Ventures New VenturesChapter 9 – Financial Preparation forChapter 9 – Financial Preparation for Entrepreneurial Ventures Entrepreneurial VenturesChapter 10 – Developing an EffectiveChapter 10 – Developing an Effective Business Plan Business Plan

Copyright (c) 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Chapter 9 – Financial PreparationChapter 9 – Financial Preparation For Entrepreneurial For Entrepreneurial Ventures Ventures

The Importance of The Importance of Financial Information for Financial Information for

EntrepreneursEntrepreneurs

Significant Information for Significant Information for Financial ManagementFinancial Management

• The importance of ratio analysis in planningThe importance of ratio analysis in planning

• Techniques and uses of projected financial Techniques and uses of projected financial statementsstatements

• Techniques and approaches for designing a Techniques and approaches for designing a cash-flow schedulecash-flow schedule

• Techniques and approaches for evaluating the Techniques and approaches for evaluating the capital budgetcapital budget

The Balance SheetThe Balance Sheet

Represents the financial condition of a Represents the financial condition of a company at a certain date. It details the company at a certain date. It details the items the company owns (assets) and the items the company owns (assets) and the amount the company owes (liabilities). amount the company owes (liabilities).

It also shows the net worth of the It also shows the net worth of the company and its liquidity.company and its liquidity.

Assets = Liabilities + Owners EquityAssets = Liabilities + Owners Equity

The Income StatementThe Income StatementCommonly referred to as the P & L Commonly referred to as the P & L

(profit and loss) statement, which (profit and loss) statement, which provides the owner/manager with provides the owner/manager with

the results of operations.the results of operations.

Statement of Cash FlowStatement of Cash Flow

An analysis of the cash An analysis of the cash availability and cash needs of availability and cash needs of

the business.the business.

Preparing Financial StatementsPreparing Financial Statements

One of the most powerful tools the entrepreneur One of the most powerful tools the entrepreneur can use in planning financial operations is a can use in planning financial operations is a budget. The operating budget is a statement budget. The operating budget is a statement

of estimated income and expenses over a of estimated income and expenses over a specified period of time. The cash budget is a specified period of time. The cash budget is a

statement of estimated cash receipts and statement of estimated cash receipts and expenditures over a specified period of time. expenditures over a specified period of time.

The capital budget is used to plan The capital budget is used to plan expenditures on assets whose returns are expenditures on assets whose returns are

expected to last beyond one year.expected to last beyond one year.

The Operating BudgetThe Operating Budget• Typically, the first step in creating an operating budget is the Typically, the first step in creating an operating budget is the

preparation of the sales forecast. An entrepreneur can preparation of the sales forecast. An entrepreneur can prepare the sales forecast in several ways. One way is to prepare the sales forecast in several ways. One way is to implement a statistical forecasting technique such as simple implement a statistical forecasting technique such as simple linear regression.linear regression.

Y = a + bxY = a + bx• YY is a dependent variable (it is dependent on the values of is a dependent variable (it is dependent on the values of aa, ,

bb, and , and xx), ), xx is an independent variable (it is not dependent on is an independent variable (it is not dependent on any of the other variables), any of the other variables), aa is a constant (in regression is a constant (in regression analysis, analysis, YY is dependent on the variable is dependent on the variable xx, all other things , all other things held constant), and held constant), and bb is the slope of the line (the change in is the slope of the line (the change in YY divided by the change in divided by the change in xx).).

The Cash-Flow BudgetThe Cash-Flow Budget

The first step in the preparation of the The first step in the preparation of the cash-flow budget is the identification cash-flow budget is the identification and timing of the cash inflows. For and timing of the cash inflows. For

the typical business, cash inflows will the typical business, cash inflows will come from three sources: (1) cash come from three sources: (1) cash

sales, (2) cash payments received on sales, (2) cash payments received on account, and (3) load proceeds.account, and (3) load proceeds.

Pro Forma StatementsPro Forma Statements

Pro forma statements are projections Pro forma statements are projections of a firm’s financial position over a of a firm’s financial position over a

future period (pro forma income future period (pro forma income statement) or on a future date (pro statement) or on a future date (pro

forma balance sheet).forma balance sheet).

Capital BudgetingCapital Budgeting

The first step in capital budgeting is to identify the The first step in capital budgeting is to identify the cash flows and their timing. The inflows, or returns cash flows and their timing. The inflows, or returns

as they are commonly called, are equal to net as they are commonly called, are equal to net operating income before deduction of payments to operating income before deduction of payments to

the financing sources but after the deduction of the financing sources but after the deduction of applicable taxes and with depreciation added back, applicable taxes and with depreciation added back,

as represented by the following formula:as represented by the following formula:

Expected Returns = Expected Returns = XX(1 – (1 – TT) + Depreciation) + Depreciation

Payback MethodPayback Method

In this method the length of time In this method the length of time required to “pay back” the original required to “pay back” the original

investment is the determining investment is the determining criterion.criterion.

Net Present Value (NPV method)Net Present Value (NPV method)The concept works on the premise that a The concept works on the premise that a dollar today is worth more than a dollar in dollar today is worth more than a dollar in the future. The cost of capital is the rate the future. The cost of capital is the rate

used to adjust future cash flows to used to adjust future cash flows to determine their value in present period determine their value in present period terms. This procedure is referred to as terms. This procedure is referred to as

discounting the future cash flows, and the discounting the future cash flows, and the discounted cash value is determined by the discounted cash value is determined by the

present value of the cash flow. present value of the cash flow.

Internal Rate of Return (IRR method)Internal Rate of Return (IRR method)

This method is similar to the net present This method is similar to the net present value method in that the future cash value method in that the future cash

flows are discounted. However, they are flows are discounted. However, they are discounted at a rate that makes the net discounted at a rate that makes the net

present value of the project equal present value of the project equal to zero. to zero.

Break-Even AnalysisBreak-Even Analysis

Contribution Margin ApproachContribution Margin Approach

• The difference between the selling price and the The difference between the selling price and the variable cost per unit. It is the amount per unit that variable cost per unit. It is the amount per unit that is contributed to covering all other costs.is contributed to covering all other costs.

0 = 0 = (SP –VC)S – FC or FC = (SP – VC)S(SP –VC)S – FC or FC = (SP – VC)Swherewhere SPSP = Unit selling price = Unit selling price VCVC = Variable cost per unit = Variable cost per unit SS = Sales in units = Sales in units FCFC = Fixed cost = Fixed cost

Graphic ApproachGraphic Approach

The entrepreneur needs to graph at least The entrepreneur needs to graph at least two numbers: total revenue and total two numbers: total revenue and total

costs. The intersection of these two lines costs. The intersection of these two lines (that is, where total revenues are equal to (that is, where total revenues are equal to the total costs) is the firm’s break-even the total costs) is the firm’s break-even

point. Two additional point. Two additional costs – variable costs and fixed costs – variable costs and fixed

costs – also may be plotted.costs – also may be plotted.

Goodman Industries: Graphic Break-EvenGoodman Industries: Graphic Break-Even

FixedFixed

01

2

3

4

5

6

7

8

ProjectedProjectedCosts/ProfitsCosts/Profits

$000$000

100100 200200 300300 400400 500500

VariableVariable

SalesSalesTotalTotalCostCost

Unit SalesUnit Sales

Balance Sheet RatiosBalance Sheet Ratios

CurrentCurrent Current AssetsCurrent AssetsCurrent LiabilitiesCurrent Liabilities

QuickQuickCash + AccountsCash + Accounts

ReceivableReceivable

Current LiabilitiesCurrent Liabilities

Income Statement RatiosIncome Statement Ratios

Gross MarginGross Margin Gross MarginGross MarginSalesSales

Net MarginNet MarginNet ProfitNet Profitbefore Taxbefore Tax

SalesSales

Overall Efficiency RatiosOverall Efficiency Ratios

Sales-to-AssetsSales-to-Assets SalesSalesTotal AssetsTotal Assets

Return on AssetsReturn on AssetsNet ProfitNet Profitbefore Taxbefore Tax

Total AssetsTotal Assets

Return on InvestmentReturn on InvestmentNet ProfitNet Profitbefore Taxbefore Tax

Net WorthNet Worth

Specific Efficiency RatiosSpecific Efficiency Ratios

Inventory TurnoverInventory Turnover Cost of Goods SoldCost of Goods SoldInventoryInventory

Inventory turn-daysInventory turn-days 360360Inventory TurnoverInventory Turnover

Accounts ReceivableAccounts ReceivableTurnoverTurnover

SalesSalesAccounts ReceivableAccounts Receivable

Specific Efficiency RatiosSpecific Efficiency Ratios

Average CollectionAverage CollectionPeriodPeriod

360360Accounts ReceivableAccounts Receivable

TurnoverTurnover

Accounts PayableAccounts PayableTurnoverTurnover

Cost of Goods SoldCost of Goods SoldAccounts PayableAccounts Payable

Accounts ReceivableAccounts ReceivableTurnoverTurnover

360360Accounts ReceivableAccounts Receivable

TurnoverTurnover