entrepreneurship workbook (2 ed) - legge

8/8/2019 Entrepreneurship Workbook (2 Ed) - Legge

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Contents

1 Using this workbook 1

2 The product and its market 3

3 Intellectual property 26

4 SOPA 32

5 The financial feasibility model 42

6 Spreadsheet tips 54

7 The management team 62

8 Writing the plan 68

9 Presenting the plan 75

Web support material to accompany Entrepreneurship: Context, Vision and Planning

John Legge & Kevin Hindle 2004, published by Palgrave Macmillan.

Entrepreneurship: Context, vision and planning


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1Using this workbook

This workbook is intended to guide both entrepreneurship students and people planning

their first entrepreneurial venture towards the completion of their entrepreneurial business

plan. For a student the result may be their major class project, while the novice

entrepreneur will be guided to the completion of an advanced feasibility study and a

comprehensive accountants brief. If the plan is to be used within a corporation, or as a

memorandum of understanding between joint venturers with no outside equity, little

further work will be needed. If the plan is to be used as the basis of a prospectus, or as the

basis of an approach to unrelated professional investors, a full set of pro-forma accounts willhave to be prepared by a properly qualified accountant.

Planning is not the prerogative of accountants, but money is: the entrepreneurial

business plan is intended to bring the entrepreneur and a sufficient sum of money together

to start an enterprise. Entrepreneurs need not be flamboyant, but they must have

imagination and the ability to look beyond the details while good accountants never overlook

details and can still be good accountants without ever being imaginative; creativity in an

accountant is never an unmixed blessing. An entrepreneurial venture must blend these two

opposites, and one of the rules to successful mixing is to avoid turf wars. This workbook

assumes that the planner is not a qualified accountant and the financial planning described

stops short of the point where a qualified accountant should be brought in to develop and

manage the accounts.

Chapters 2 to 6 of the workbook are intended to guide the student or entrepreneur in

the collection of essential planning data and in the completion, or at least the initiation, of

a number of essential preliminary actions. Chapters 7 and 8 discuss the writing and

presentation of an entrepreneurial business plan. The workbook has been written as a

companion to Entrepreneurship: How Innovators Create the Future and users of the

workbook who have not read Entrepreneurship will find themselves being told to do certain

things with very little explanation as to why.

Entrepreneurial business planning

Every entrepreneurial business plan shares a common emphasis on economic growth: the

entrepreneur plans to create a venture, either involving a new organisation or a new

initiative from within an established one, which will, in the first instance, represent the

most productive and socially valuable use of the resources needed by the venture, and in the

second instance create new resources that can support higher levels of consumption and

investment in the future.

The entrepreneurial business plan serves two main purposes:

it shows that a proposed initiative is commercially feasible

it is used to enlist the support of various people who currently control the resources

that the new enterprise will need.


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A plan that succeeds in enlisting the support of the necessary resource controllers can then

be used as a basis for establishing the staffing and management structures at the launch

of the new enterprise, setting up an initial Chart of Accounts for the financial control of the

enterprise, and establishing initial targets for internal costs and external revenue gener-

ation. As the new enterprise develops, problems will be encountered and opportunities dis-

covered that are almost certain to lead the enterprise in directions and to achievements thathave little if any relationship to those described in the original business plan.

This tendency of the real world to rewrite plans does not reduce the value of the entre-

preneurial business planning process: without the plan the resources the enterprise needed

could not have been put under its control and the enterprise would not have got started at

all. Planners who forget that they are describing a possible outcome, which is one of many

possible outcomes, may be surprised by reality if their venture ever gets started; more often,

their excessive confidence in their ability to control the future will so diminish the conviction

of their plan that the enterprise will never be more than a paper one.


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2The product and its market

The tables on the succeeding pages allow the users of this workbook to capture some of the

data needed to quantify the market opportunity that they are facing.

An essential step in establishing the feasibility of a concept and then in proceeding to

develop a plan to exploit it is to estimate the size of the potential market, both in numbers

and in value. The immediate outcome of this exercise will be an estimate of the available

annual gross margin (AAGM), the absolute maximum annual yield potential of the market.

This sets a long term limit to the size of a planned enterprise, and in the short term sets a

limit on the amount a rational investor or entrepreneur should be willing to spend inpursuing the opportunity.

If the AAGM is sufficient to justify the necessary investment, the entrepreneur must

prepare an entrepreneurial business plan, and one of the first steps in the preparation of

such a plan is the preparation of phased sales and revenue forecasts. The marketing data

captured while completing this part of the workbook is fundamental to the preparation of

such forecasts.

Product Details

Table 2.1 (see page 5) will look far too small if you are a committed innovator: the essence

ofyour new product cant be captured on a single page! This page is designed to let you

capture the what, how and why of new product marketing: what are our customers going to

receive; how are they going to receive it, and why will they want it.

Basic product description

Getting the basic product description into a box the size that we provide here will seem

almost impossible. You must make the effort: although the ultimate entrepreneurial

business plan will have rather more description, and the full product documentation mayrun into books rather than pages, there must be a concise way of describing the product that

captures its most important unique attributes. If you cant find a concise way of at least

introducing the product it will prove impossible to sell it in the real world: people just wont

sit still for an hour or so waiting to find out what it is that they are listening to.

Basic method of distribution

Just having a product that people want generates no sales: there must be a practical way

for them to obtain it. Distribution covers both the way an order will be placed by the final

customer or user and the way in which the actual product will be delivered. If the product

is a packaged good to be sold through supermarkets then the acts of ordering and deliveryare combined into the action of picking the goods off the shelf and putting them into a


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trolley. By contrast a sophisticated industrial service might be sold in one place by one

group of people and delivered in another by a completely different group.

Frequencies

We suggest that you put some effort into deciding how often the new product will be usedand how often it will bepurchased. This information will affect many of your subsequent

planning and operating decisions. Products that are purchased regularly can be marketed

in different ways from products that are purchased unpredictably; similarly, the expected

income variance and therefore the appropriate investment hurdle rates are affected by the

frequency and regularity of purchase.

The frequency ofuse can be used to develop an estimate of the demand for consumables

and associated services. There are many products, including the famous example of the

Gillette Safety Razor, where the initial sale of the product cannot sustain a business case

but the consumable items and related services can.

Value to user

The value to the user is close to the price at which a typical user would be indifferent

between owning this product (or any reasonably close substitute) and doing without. Taken

with some of the other data collected in subsequent tables, this sets an absolute limit on the

price that can be charged and the potential revenue that the new enterprise can earn.

Cost of acquisition and ownership

Nothing is entirely costless to own, but often the specific ownership costs are slight enough

to be ignored. Other products can involve their owners in considerable ongoing expense, inthe form of taxes, licence fees, upgrade charges, maintenance contracts, site preparation,

essential training and other costs associated with putting the new product to use. It is naive

to think that buyers are unaware of these costs, and even if they were, it could well be an

offence under the Trade Practices Act in Australia and similar laws in other jurisdictions

to take advantage of them.

The costs of purchase and ownership reduce the limit price that a supplier can charge.


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Basic product

description

Basic method of

distribution

Frequency Of use

G Regular

G Stochastic

Of purchase

G Regular

G Stochastic

Expected

annual

purchases

per user

. . . . . . .

G Often/month

G Often/year

G Annually

G . . . ./. . . .

G Often/month

G Often/year

G Annually

G . . . ./. . . .

SignificanceG

Consumer productG Sustains life

G Sustains prestige

G Enhances prestige

G Preserves property

G Enhances property

G Preserves quality of

life

G Enhances quality of

life

G Other . . . . . . . . . . . . .

GIntermediate product

G Sustains production

G Enhances throughput

G Enhances product

value

G Sustains asset value

G Enhances asset value

G Preserves reputation

G Enhances reputation

GOther . . . . . . . . . . . . . .

Estimate of value

(not price) to user

Estimate of costs of

acquisition and

ownership (other

than price)

Table 2.1 Product details


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Consumables

Many products need auxiliary or ancillary products if the user is to gain the full benefits of

ownership. Motor cars need petrol and oil, safety razors need blades, photocopiers need

blank paper. Heavy industrial equipment may need spare parts. Often, particularly for a

new product line, the supply of these products can be a useful source of profit in their own

right as well as a source of steady cash flow: economic cycles will affect the readiness of

buyers to make large purchases, but they wont, in general, change their readiness to keep

their existing equipment operating. Tables 2.2 and 2.4 are provided to capture the

anticipated revenue for the sale of the consumable supplies required by a durable product.

The cash flow from consumables and spares is not absolutely guaranteed, particularly

for successful products: competitors are likely to be attracted to any substantial after-

market and there may be no legal way to stop them entering it.

General nature of consumables

A few words in this section of the workbook should be sufficient to summarise the

consumables; a full description can be saved for the written plan or even a supporting

document. Dont waste space and effort listing consumables that you have no intention of

supplying because they are already widely available from many competing suppliers; do give

some thought to essential consumables that no one else currently supplies.

Basic method of distribution

Consumables cant, in general, be made to order: there must be stocks, a physical

distribution system, a way of placing orders and settling accounts. Spare parts may be

ordered from a price list or supplied under an inclusive warranty or ongoing maintenance

agreement. There will be associated costs and revenue opportunities.

Frequencies

Frequency data should be estimated for those consumables that the venture intends to

supply. This information will be needed to establish both the size and the stability of the

associated cash flows.


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General nature of

associated consumable

products

Basic method of

distribution

Frequency Of useG RegularG Stochastic

Of purchaseG RegularG Stochastic

Expected

annual

purchases

per user

. . . . . . .

GOften/monthG Often/year

G Annually

G . . . ./. . . .


G Annually

G . . . ./. . . .

Table 2.2 Ancillary consumables

General nature of

associated services

Basic method of

distribution



Expected annual

purchases

per user

. . . . . . .

G Often/month

G Often/yearG Annually

G . . . ./. . . .

G Often/month

G Often/yearG Annually

G . . . ./. . . .

Table 2.3 Ancillary services


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Services

Services provide a further way of generating stable cash flows after the sale of a product to

a user. Some services, such as emergency repairs and routine maintenance, preserve the

buyers investment. Others, such as training and the fitting of enhancements, increase the

value of the investment, improving the suppliers reputation and making repurchases and

recommendations more likely. Tables 2.3 and 2.5 are provided to capture service data.

Nature of services

Services can be value-preserving, as with maintenance and repair, or value-adding, such as

training and upgrading. It may be difficult to record all the service options on one sheet: we

provide two in this workbook but more may be needed. In a full operating plan for a

business, every separately priced service should be analysed, but during the early stages of

preparing an entrepreneurial business plan similar services can be grouped to keep the plan

concise.

Service delivery

Users generally place a high value on services that are delivered at their premises by highly

trained staff. In general, moving away from this level reduces the perceived value of the

service, but it also reduces the cost of delivery: part of the art of service design is in picking

the level of service where the gap between the perceived value and the actual cost is highest.

The contractual arrangements can be summarised here: some services will be charged

for as they are delivered, others will be provided under warranty at no cost, while others

may be offered as part of an extended warranty or maintenance service where the user paysa standard charge irrespective of the amount of service actually delivered. Extended

warranties can be extremely profitable if the incidence and cost of actual service delivery

has been estimated correctly.

Frequency information

Knowing the frequency and regularity of service opportunities will enable the planner to

estimate the quantity and the quality of the cash flow that each service element can

contribute. It will also be important in estimating the costs of providing warranty and

extended warranty service.


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General nature of

associated consumable

products

Basic method of

distribution



Expected

annual

purchases

per user

. . . . . . .


G Annually

G . . . ./. . . .


G Annually

G . . . ./. . . .

Table 2.4 Ancillary consumables (second box)

General nature of

associated services

Basic method of

distribution



Expected

annual

purchases

per user

. . . . . . .

G Often/monthG Often/yearG Annually

G . . . ./. . . .

G Often/monthG Often/yearG Annually

G . . . ./. . . .

Table 2.5 Ancillary services (second box)


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Competition and value

The modern business planner needs to take a very broad view of the possible competition;

competitive threats are not limited to physically similar products. Table 2.6 is provided to

help the planner consider:

What are the benefits users will expect from purchasing and using the new product?

What alternative ways are there for users to obtain similar benefits?

The alternatives are remarkably broad for industrial products, and broader still for

consumer ones: consumers may not set out their needs in a product-oriented fashion at all.

A parent with children requiring entertainment can buy them a toy, or take them to the

movies, or the zoo, or to a fast food restaurant, or the museum, or a park, or lock the study

door and ignore the sounds of breaking glass from the kitchen.

Alternatives

We have provided four lines on Table 2.6 to list probable competitors for the new product.

Planners should take a broad view of what may constitute competition: limiting their views

to physically similar products may miss the point. Competition is anything that offers users

an alternative way of obtaining a similar benefit.

The price column in this section of the table should be based on this value equivalence,

that is, how much the user would have to pay to receive the competing benefit, not simply

a price list entry. The right hand column should get the market share of the nominated

competitor for consumer products and the industry rank of the competitor for industrial

ones.

Superiority

For each of the four possible competitors we have provided space to list two reasons why the

new product should, at least some of the time, be preferred. Technical arguments should be

avoided: these are sales messages, not formal arguments.

Value premium

If the new product is better than all the probable alternatives, this should be worth money

to its users. There may be no practical way of the supplier capturing this value premium in

cash, particularly if part of it is indirect or inferred, but it does represent a buying incentive.Alternatively, if the planner cannot identify a value premium at all, there have to be

questions about the likely market take-up of the new product.

Acceptable price

There is room in this box to set out the price of the primary product and some of its major

after-market and service auxiliaries. The natural point for this price will be the average

level of the prices charged by the products established competitors, when there are close

competitors: any premium will require a strong justification and powerful sales arguments,

while a discount will cast doubt on the products quality.


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Alternatives

1 . . . . . . . . . . . . . . . . . . . . . . . . .

2 . . . . . . . . . . . . . . . . . . . . . . . . .

3 . . . . . . . . . . . . . . . . . . . . . . . . .

4 . . . . . . . . . . . . . . . . . . . . . . . . .

Price

. . . . .

. . . . .

. . . . .

. . . . .

Share

. . . . .

. . . . .

. . . . .

. . . . .

Main points of

superiority of

new product

1

(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2

(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3

(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4

(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Estimated

value premium

for new product

Estimate of

maximum

sustainable

price

Table 2.6 Competition and value

For a genuinely novel product with no close competitors, the price, for planningpurposes, can be set at about half way between the perceived value and the variable cost.

Consumer demographics

Table 2.7 is intended to be used for products marketed to final consumers as distinct from

businesses. Business-to-business product concepts will generally use Table 2.8, following.

The consumer demographics study attempts to identify every person who could reasonably

be considered a potential customer for the new product: an absolute limit on the size and

value of the market. Most products, even very successful ones, fail to reach more than afraction of their potential customers before the product is replaced or withdrawn.


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Geographic range

The starting point is a simple population count for the regions in which the product is going

to be marketed, either at launch or within one or two years of the initial launch. Many

products have wider potential than this, but so many things are likely to have changed intwo years that a new business and marketing plan should be used for these stages of market

expansion. Often the product concept will have a wide market potential, but sufficient

details will have to be changed for linguistic, cultural or regulatory reasons to make the

launchproduct unsuitable for the expanded market.

Sex

Some classes of product are much more likely to be sold to persons of one sex than to

persons of the other. Failure to take this into account, when appropriate, leads to an

erroneous doubling of the potential user population.

Household

Some products will be bought for household use, and so their ultimate success will be

limited by the number of households in the targeted region, while others will be bought for

personal use. Even with modern small families, getting the basis of purchasing wrong can

throw the market size estimate out by a factor of three or so.

Parenting

Some products, such as creche services, only appeal to people with children. Where thesefactors are significant, failure to take them into account leads to errors in estimating the

customer population and in conducting promotional campaigns.

Age and income ranges

The appeal of a new product may be highest for people in a particular age and/or income

range. Counting or targeting people outside this range can lead to expensive mistakes.

Other distinguishing features

Many products have their main appeal to people with specific interests, disabilities, singular

physical characteristics or particular occupations. This part of Table 2.7 can be used to

record this, and then to estimate the proportion of the populations that meets the particular

requirement for interest in the product. These conditions may be additive or multiplicative:

if the appeal is to tall bricklayers, short bricklayers and tall people in other trades are

excluded from the market, while if it is to tall people and to bricklayers then tall bricklayers

may, if care is not taken, be counted twice.


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Criterion % Pop. b/f

Population in

geographic range

Sex G Male G Female G N/A

Household G Household G Personal

Parenting G N/A

G No. of ch. G Ages . . . . to . . . .

Age

G From . . . . . to . . . . . . G N/A

Income (000s pa)

G From . . . . . to . . . . . . G N/A

Other (1)

Other (2)

Other (3)

Other (4)

Cohort size

Entry rate

Exit rate

Sources (1)

Sources (2)

Sources (3)

Table 2.7 Consumer demographics


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1These rates are determined by dividing the numbers entering or leaving by the

number left in the market. When a segment is defined by age range, the narrower the rangethe faster the turnover of the members of it. The population of the age 21 cohort changes

by 100 per cent every year.

14

For example:

Tall people 30%

Bricklayers 20%

minus tall bricklayers 6%

Total market 44%

Cohort size, entry and exit rates

The major result of the consumer demographic analysis will be an estimate of the number

of people, living within the targeted regions, who meet the minimum criteria for being

potential customers for the product.

The entry and exit rates allow the planner to make future year estimates of the number

of new customers entering the market and the number of established ones leaving. This, in

turn, gives the planner the ability to forecast the number of virgin customers in the market

at a future date, and therefore the likely response to sales and advertising campaigns, as

well as estimating the rate of loss of customers and their associated revenue streams and

beneficial influence.

For the Australian population as a whole, the exit rate is about 0.75 per cent (deaths

and residents departing permanently) while the entry rate is about 2 per cent (births and

inbound migration). The rate1 of passage through most markets will be substantially more

rapid than this. For many markets entry occurs at a certain age or income level; within this

level, population movements may also cause entry and exit.

Information sources

It is an excellent idea to document the sources of information relied on, and not just forstudents trying to impress their lecturer. When a plan is being reviewed by a potential

investor, the sources quoted may be referred to as a check on the planners work; also, other

sources may be used to corroborate the planners forecasts.


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Business demographics

A consumer demographic study will be about counting people: while different people might

buy at different frequencies, the unit of sale will be about the same. With business sales this

is not the case. Australian businesses vary from part time hobbies turning over $10 000 or

less to firms like BHP and Telstra, with annual sales measured in the billions. The task of

the planner is not, therefore, to count firms but to count sales opportunities. Table 2.8 is

provided to assist the planner in this task.

Customer firm size

A few products will appeal equally to firms of every size, but most wont. Even those

products that do have near universal appeal will generally have to be sold differently when

offered to firms of different sizes. These differences may be, but do not have to be, so

significant as to require a separate business plan. Planners should try to avoid glossing over

any problems in this area.

Industry type

We have provided a list of industry types, not an exhaustive one, where the business

operations are sufficiently different to make it likely that they will respond to a new product

differently.

Professional statisticians and econometricians will want to use ISIC (International

Standard Industry Classification) codes to carry out such a study, but most readers of

business plans have not memorised the significance of the many codes. A planner may have

to use the codes in order to make sense of census data, but such details may not be neededin the finished plan.

Scaling metric

In general terms the number of units of a product a firm is likely to buy will depend on some

characteristic other than its simple turnover. The demand for payroll services will, for

example, reflect the number of employees while the number of cash registers required will

tend to reflect the number of transactions rather than their total value: Woolworths have

far more people collecting money than BHP does.

Geographic segments

Very few firms can afford the expense of launching a new product everywhere. Even those

that do launch their new products in many countries at once often find that their product

must be customised to some extent for different markets for linguistic, regulatory or other

reasons, and so multiple launch and marketing plans are required.

When a segment is not going to be addressed for two or more years from the date of the

product launch, it is better to leave it out and make it the subject of a separate plan to be

produced nearer to the time when it will be implemented. Markets and technology simply

change too fast for assumptions made two years in advance to be a reliable basis for

planning and action.


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Two years after the first launch of a new product a great deal more will be known about

the way users respond to it than could possibly be known on the day of the initial launch.

If this response suggests that the product should be offered to new market segments, it will

be possible to produce a far more accurately targeted business plan closer to the time of the

extended launch. If the original plan went into too much detail about the extended markets,

and the initial launch was successful, an enterprise may be tempted to follow the initialplan too uncritically.

Aggregated financial data

Bringing together some financial numbers about the targeted segments gives the reviewer

a feel for the market: profitable, rapidly growing industries are a much softer sales target

than marginally profitable and declining ones. The aggregates also serve as a broad check

on the sales and marketing forecasts. For the plan to succeed, some part of the target

industrys added value must be diverted to the new enterprise. When this fraction starts to

get significant, reviewers are going to wonder whether firms in the target industry have the

capacity, much less the wish, to pay for the new product.

Information sources

It is an excellent idea to document the sources of information relied on, and not just for

students trying to impress their lecturer. When a plan is being reviewed by a potential

investor, the sources quoted may be referred to as a check on the planners work; also, other

sources may be used to corroborate the planners forecasts.


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Firm size G Small G Medium G Large

Industry type G Retail G Mfg G Mining

G W/H and dist G Transport G Agriculture

G Education G Public G Private

G Health G Public G Private

G Com. services G Cons. services G Bus. services

G Public admin.

G Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Scaling metric G RevenueG EmployeesG Assets

G ProfitG Transactions

G Value added

G Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Geographic

segments

1 . . . . . . . . . . . . . . . . . . . . . .

2 . . . . . . . . . . . . . . . . . . . . . .

3 . . . . . . . . . . . . . . . . . . . . . .

4 . . . . . . . . . . . . . . . . . . . . . .

Sales potential

. . . . . . . . . .

. . . . . . . . . .

. . . . . . . . . .

. . . . . . . . . .

Financial data

(all segments in

plan)

Gross revenue Total VA Total profit

Revenue growth Profit growth

% pa % pa

Entry rate

% pa

Exit rate

% pa

Information sources

(1)

(2)

(3)

Table 2.8 Business demographics


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2For example, a single cash register operator in a shop, or a single skilled service

employee at a given location.

18

Uplift calculation

Planners working within corporations should ask their controllers department what uplift

to use and skip Table 2.9. We have put it here for new entrepreneurs as a reminder that

wages are only part of the cost of employing someone.

Leave and holidays

In less well regulated parts of the world, and possibly Australia too, unscrupulous employers

can avoid some or all of their paid leave obligations. People starting new enterprises should

be very cautious about such sharp employment practices, even when they are tempted to use

them: a high level of employee commitment is often critical to the success of the new

enterprise, and employees bearing grudges seldom make such commitments. Many slave

owners in Americas ante-bellum south believed that their servants were loyal and adoring,

until they saw them rushing to cheer the Unions General Sherman and help Shermans

soldiers pillage and fire the slave-owners mansions.

Incentive provision

Australian workers have a long tradition of expecting the rate for the job and a party at

Christmas, but in many cultures much larger annual bonuses are offered to the employees

of a successful business; perhaps as much as six months pay. As the Australian labour

market becomes less comprehensively regulated such arrangements will become more

common in Australia too.

Overtime provision

Very few businesses have a perfectly even flow of work, and there will be times when

employees will be asked to work longer than normal hours so as to handle peaks or to

eliminate backlogs. Workers in most countries expect to be paid at a higher rate for

overtime: in some countries such rate supplements are legally obligatory; in others they are

a matter of discretion, but employers who want a committed work force will make provision

for rewarding exceptional effort.

Idle time provision

Most businesses will experience some slack time, and in many businesses employees willinevitably be involved in non-income-generating activity for part of the time. Service

employees may have to travel between customer premises, for example, and customers will

be unwilling to pay for the travelling time, although the employees expect to be paid while

travelling. Service businesses with a single server2 must be prepared for at least 30 per cent

idle time if they are to deliver a quality response to 95 per cent of their customers;

businesses with multiple servers can plan on a higher peak period utilisation.


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19

Days Subtotal % Total %

Annual leave

Sick leave

Special leave

Long service leave

Public holidays

Incentive provision

Overtime provision

Idle time provision

Payroll tax

Insurance

Superannuation

Amenities

Supervision

Training

Other

Other

Other

Total

Table 2.9 Uplift calculations

Hours Rate Uplift Subtotal Total

Price

Labour

Materials

Distribution

Total costs

Contribution

Table 2.10 Primary product cost and margin


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20

Be careful with percentages: a 30 per cent idle time provision needs a 43 per cent

( ) uplift on wage rates.

Payroll tax and superannuationIn Australia and many other countries employers are liable to various taxes and contri-

butions. Failure to collect these may be a criminal offense: they must certainly be allowed

for in any plan.

Amenities

At the very least, employers must provide towels, soap and toilet paper; in many countries,

and even in some Australian industries, they are expected to provide considerably more

than that: subsidised canteens, subsidised housing, schools, scholarships, medical and

hospital insurance or clinics, or other necessities and comforts. As a very general rule, thelower the nominal wages, the higher may be the relative and even the absolute cost of the

amenities an employer is expected to provide.

Supervision

Military-style span of control calculations are very unfashionable, but even self directed

work teams take a certain amount of time away from revenue-generating activities to direct

themselves. Broadly speaking, the lower the wages and the less skilled the work force the

higher the level, and quite possibly the cost, of the supervision that will be required.

Do not confuse this entry with allocated overheads (overhead allocation is an obsol-

escent accounting technique used to handle fixed costs as if they were variable ones). This

covers direct costs of supervision: if one person, paid 50 per cent more than the average

worker, can supervise ten of them the direct supervision cost is 15 per cent uplifted. (If the

total uplift is 60 per cent and the basic supervision overhead is 15 per cent, the uplifted

overhead is 160 per cent of 15 per cent or 24 per cent. This raises the total uplift from 60 per

cent to 69 per cent and the supervision overhead to 25 per cent. It is pedantry to go around

the loop a second time.)

Training

Enlightened employers set aside 2 per cent or more of their payroll for employee training.Unenlightened ones spend even more in extra supervision of poorly trained employees and

in sorting out the problems that they cause. Industries where there are rapid product line

changes and a high skill level is expected of employees may spend 10 per cent or more of the

payroll on education and training of various kinds.

Other

The rows in Table 2.9 should not be regarded as a complete list of oncosts: three rows are

provided to encourage planners and entrepreneurs to make an appropriate allowance for

other direct costs of employment, such as tools, transport, cleaning of uniforms and work

clothes and, in general terms, any cost which is directly incurred when an additional worker

is employed.


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Group 1


Price

Labour

Materials

Distribution

Total costs

Contribution

Group 2


Price

Labour

Materials

Distribution

Total costs

Contribution

Group 3


Price

Labour

Materials

Distribution

Total costs

Contribution

Table 2.11 Spares and consumables


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Primary product cost and margin

Table 2.10 on page 19 is intended to help the planner capture the direct costs and contri-

bution margin from each sale of the main product.

Price

This can be the recommended retail price, in which case retailer and/or distributor margins

should be included in the distribution cost, or the shipping price, in which case only those

transport costs included in the price should be treated as distribution costs. We recommend

using the former method, as by exposing the cost of the distribution channel the

entrepreneur is in a position to evaluate alternative distribution strategies.

Labour

This line should record: the direct labour hours required to produce one unit of the product (if it is a good) or

deliver one unit (if it is a service)

the average hourly pay rate for employees directly engaged in product manufacture

and delivery

the uplift as calculated in Table 2.9.

The result is the direct labour cost.

Materials

This is the cost of materials (including average scrap and cutting allowances) required for

each unit of product manufactured and/or delivered.

Distribution

The treatment of this entry will depend on how the price is treated (see above). If the price

quoted is the final purchaser price, this line should include all the normal costs of physical

delivery, the reseller margins, and any routine incentives and reseller allowances. If the

quoted price is the wholesale or ex-factory price this should only include uncharged delivery

costs.

Spares and consumables

The detail lines in Table 2.11 on page 21 are as for the main product.

We have provided space for three separate categories. Many real products will require

a large number of different spares and types of consumable item. For planning purposes,

the different spares and consumable items can be allocated to a manageable number of

groups. One group could be warranty service, one for rarely used spares, and one for

regularly used spares and consumables.


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Group 1


Price

Labour

Materials

Distribution

Total costs

Contribution

Group 2


Price

Labour

Materials

Distribution

Total costs

Contribution

Group 3


Price

Labour

Materials

Distribution

Total costs

Contribution

Table 2.12 Ancillary services


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3Entrepreneurship: How Innovators Create the Future by John M. Legge and Kevin

Hindle, Melbourne: Macmillan, 1997. Reproduced by permission.

24

Product security Launch day value (fraction

of AAGM)

The product is an unbreakable, unavoidable and indefinite monopoly 14%

Competitive entry will not occur for at least four years from the full

launch (that is, after market testing completed)

7%

Otherwise 4%

Ancillary services

Table 2.12 on page 23 also allows for three entries, and the services might be grouped in a

similar way to that suggested for Table 2.11. One set of services might be offered once per

customer, one on a regular basis, and the third infrequently or on a warranty basis.

Computing the AAGM

Table 2.13 has places for data on the main product, three ancillary services, three sets of

spares and consumables, and two rows for other. The frequencies are the annual frequency

of purchase, and so the total in the bottom row should be the absolute maximum amount

of revenue and gross margin that the market could produce in a year.

Most real markets do not delivery this much money, and almost never in the first year.

Table 5.1 from Entrepreneurship

3

, reproduced below, shows the maximum amount a prudententrepreneur or firm will spend on an opportunity once the AAGM is known.

This is the total amount of money that should be committed from the time the number is

calculated until the product has been on the market long enough for the user response to

be estimated with some confidence, includingthe manufacture and/or purchase of initial

trading stocks but excluding the variable costs of forecast sales and the forecast promotional

expenditure. It is possible to estimate user response after the expected repurchase interval

has elapsed by observing whether trial users are, in fact, repurchasing it, or after six to

twelve months by surveying users and asking whether they intend to repurchase and/or

recommend the new product, or by waiting two years and deducing the value of Basssq, the

recommendation rate, from the sales data.

Example

A new product is expected to appeal to an ultimate population of 10 000 users, each of whom

will spend $200, of which 50 per cent will be contribution, on it per year. The AAGM is 50%

$200 10 000 = $1 million. The budget for completing the business plan, starting the

business, purchasing initial trading stock, and paying fixed costs for a year should not

exceed $40 000.


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25

Frequency Price Margin Revenue Contrib.

Main product

Spares andconsumables (1)

Spares and

consumables (2)

Spares and

consumables (3)

Ancillary

services (1)

Ancillaryservices (2)

Ancillary

services (3)

Other (1)

Other (2)

TOTAL

Table 2.13 The AAGM

A note on interpretation

The AAGM concept was developed relatively recently by John Legge and Kevin Hindle, and

so planners should not assume that everyone that they meet will be familiar with it, or that

those who are familiar with it will agree with its use or with the suggested values in Table

5.1 from Entrepreneurship. Two aspects of the AAGM have already caused some confusion

and the following points are an attempt to clarify these: the AAGM is the total amount of gross profit that a complete monopolist with an

unlimited marketing resource could possibly extract from the fully developed market.

It is not the maximum profit a particular enterprise could generate

Table 5.1 from Entrepreneurship was developed under the assumption of a novel

product entering an untapped market, and therefore facing the maximum possible

marketing risk. When the product is a line extension or leverages an established

brand in some other way the marketing risk may be much less and the day one value

correspondingly higher.


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3Intellectual property

One of the major threats to most new ventures comes from imitators: if a well-funded fast

follower can enter a new market or match an innovative product within two or so years of

its launch the returns to the innovator may fall dramatically. When the innovation is

launched by a well funded corporation that commits adequate resources to the launch and

early marketing, it may create an early mover advantage that is sufficient to safeguard its

investment. Many innovations come from cash-strapped new ventures, carrying out what

is little more than a market trial while they try to demonstrate the viability of their

enterprise to venture and development capitalists.For such struggling entrepreneurs intellectual property protection is critical.

Patents and designs

Table 3.1 opposite may be used to record information about patents and designs, either held,

applied for or licensed. We have provided room for three entries: many enterprises will have

more.

Patent/design number

Record the actual number of the patent or registered design and note whether it is a

pending application, a patent or design registration already granted, or a patent or regis-

tered design licenced from someone else.

Description

Try, in this part of the table, to indicate what is protected. Do not simply transcribe part of

the official patent documentation. When this information eventually turns up in an

entrepreneurial business plan, the reviewer will not, in general, be an expert at interpretingpatent specifications. Be careful not to over-state the protection actually granted: a success-

ful business plan may lead to investors placing money with the entrepreneur, and care

should be taken not to deceive them, even inadvertently.

Countries

Patents are granted by countries and are not respected in countries where no patent has

been granted. Similarly, licensors of patents often limit the licensees rights to a specific list

of countries. Record any such limitations here.


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Patent/design number 9 Held

exp:9 Licensed

exp:9 Applied for

Brief description

Countries

Budget


exp:9 Licensed

exp:9 Applied for

Brief description

Countries

Budget


exp:9 Licensed

exp:9 Applied for

Brief description

Countries

Budget

Table 3.1 Patents and designs

Budget

Patents are not cheap. Unless they have already been granted and paid for there will need

to be a provision for them. Design registrations cost less than patents, but there is still a

continuing need to monitor the market for potential infringers and to persuade them to

desist.


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Copyright

Copyright exists in instruction manuals, software, drawings and the like. Entrepreneurs

who rely on subcontractors to produce any essential material of this nature need to make

sure that they have secured the right to copy it for their own purposes and have some

security against the producer selling additional copying licences to third parties.

When material subject to copyright is produced by employees in the course of their

duties, copyright normally passes to the employer, but this leaves open the possibility that

disputes could arise about the nature of the employees duties. Explicit steps to set out the

duties of creative employees and to secure copyright over their work may be advisable.

Table 3.2 lists some of the common materials potentially subject to copyright. The

author is implicitly the copyright owner: if the author is not the entrepreneur or someone

employed by the entrepreneur specifically to write the designated material there will have

to be an explicit licence or assignment executed. Where the authority column shows

assigned or licenced, the status column should indicate whether the assignment is complete,

has been agreed, or is yet to be negotiated.

Trade marks and business names

There is no point in marketing an excellent product if users cant remember who you are

when the time comes to buy more of it or to recommend it to a potential new user. The link

between the firm and its users is often a trade mark or trade name. Once a business is well

established, people who use similar names or marks may be committing an offence under

the Trade Practices Act and it may also be possible to sue them under the common law; in

both cases a successful action relies on the possibility of deception. When a business is newand has very few customers there is no one to have been deceived, and such legal actions

may fail.

The new business can protect itself by registering its business name(s) and trade marks.

Note that the definition of a registrable trade mark is broad: the Coca Cola bottle is a trade

mark, as is the McDonalds golden arches symbol and the exhaust note of the Harley-

Davidson motor bike. Table 3.3 has space to record some of the trade names and trade

marks that the business will use together with their registration dates.


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Material Author Authority Status

Staff instruction manuals

User manuals

Sales brochures

Training courses for staff

Training courses for users

Computer systems operational

Computer systems user

Other

Table 3.2 Copyright

Name or mark Date registered

Table 3.3 Business names and trade marks


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Other formal IP

Plant breeders and designers of integrated circuits and printed circuit boards have

specialised intellectual property regimes. From time to time and from country to country

new forms of statutory intellectual property may be created. Table 3.4 should be used to

make notes of any formal intellectual property, not recorded earlier, that can be used to

assist the new enterprise.

Trade and other secrets

Informal intellectual property includes development plans and status reports, market

survey reports and market intelligence summaries, customer lists, details of proposals to

key prospects and special contractual arrangements with key customers, summaries of

customer problems and their resolution, and many other items of information routinelygenerated and circulated within businesses. All of this would be useful to a rival who made

the effort to understand its significance; some of it could be critical in tight sales or

contractual situations.

People often exaggerate the benefits of good intelligence and the risks from espionage.

During the Second World War the British General Crewel commanded a tank division

defending the Egyptian frontier against the German Afrika Corps commanded by General

Rommel. The British decrypted a command from Hitler to Rommel ordering him to abandon

his advance on Egypt: this intelligence was passed to Crewel, who stood his men down.

Rommel, however, ignored Hitlers order, continued to advance, and destroyed Crewels

unprepared division.

Trying to keep everything secret often means that nothing is: the most successful firmsare often very open with information in general, and the status of the few matters which

must be kept secret is known to the firms staff and information about these is kept secure

by them. The law provides strong remedies against departing staff or defaulting contractors

who publish or distribute secret information causing damage to a firm. These legal remedies

wont protect information that wasnt secret, and staff and other people who are not told

that certain information is highly sensitive may have no legal obligation to protect it.

A successful information security policy protects secrets whose release could be

genuinely damaging without disrupting normal communication inside the firm and between

the firm and its customers, suppliers and even rivals. Table 3.5 provides space to set out the

key details of the new enterprises information security policy.


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31

Other intellectual property

Table 3.4 Other formal intellectual property

Key features of information security policy

Table 3.5 Information security


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32

4SOPA

The strategy a new venture or new product marketer adopts determines the organisation

that must be built to implement it. The product, defined in Chapter 2 of this workbook, and

the organisation lead to the definition of a process. The three together imply the control of

some assets and the creation of more.

Strategy

Strategic directions (or goals)

Firms need a strategy, or at least some agreed strategic goals, to give direction to the rest

of their planning. Table 4.1 is intended to help the entrepreneur capture the key elements

of the entrepreneurs strategic objectives. A number of possibilities, not all mutually

exclusive, are included in the table. There is also space for others.

Reasonably or otherwise, some people will find it hard to publicly acknowledge some of

their objectives, but it is very important for entrepreneurs to be honest with themselves

when considering these issues. A plan to establish a new lobby group or entertainment

venue for plutocrats will differ significantly from a plan to help the underprivileged. Inevery case confusing the actual strategic directions of an enterprise with such more socially

acceptable ones as may need to be displayed in public will lead to a poorly functioning

organisation, even when calamitous failure is avoided.

Strategic targets

In Table 4.2 we set out some common business metrics and invite the entrepreneur to put

numbers in the appropriate squares. As with the previous table there is space for different

metrics to be added.

We have put columns for the launch year, the third trading year, and the tenth trading

year to let the entrepreneur paint a number picture of his or her ambitions for the firm or

the product. Once the business is operating this chart should be revisited once a year or so,

progress against ambition noted, and a new set of projections drawn up.

The strategic ambitions are recorded here as a guide to planning, not as a set of

immovable goal posts. They serve to remind the growing business that it has ambitions, and

that at every stage there is a necessary tension between resolving current problems and

laying the foundations for future growth.


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Improve the entrepreneurs lifestyle

Add excitement to the entrepreneurs life

Prove a point about the entrepreneur

Create a new growth ventureSupport the continued growth of an existing venture

Prevent or halt the decline of an existing venture

Commercialise a new technology

Commercialise a new service concept

Popularise a new idea

Improve the situation of an underprivileged group within society

Maintain the privileges of an entrenched group within society

Other

Table 4.1 Strategic directions

Targeted metric 1 year 3 years 10 years

Gross revenue from sales

Gross revenue from other activities

Gross value of assets controlledValue of net assets (shareholders equity)

Cash flow

Profit

Return on assets

Number of customers/users/clients/adopters

Annual units sold

Number of countries firm/product available in

Market share

Other

Table 4.2 Strategic targets


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Organisation

We distinguish the organisation from the process as another example of separating present

from future considerations. There are organised people involved in the process of delivering

goods and/or services for the firm, but if this was all the firm consisted of there would be no

way for it to change and adapt as its customers changed on the one hand and the tech-

nologies, services and components available to it changed on the other.

The organisation also has a current man-

agement role, in that it has the ability to

correct minor perturbations before they

degrade current operations. Both kinds of

management should be present in any

organisation that intends to be around for a

significant time. Both kinds are overheads

paid for out of fixed expenses, and the cost

only varies slowly as the revenue of the busi-ness changes. Cutting back on both the stra-

tegic and operating parts of an organisation is

a quick way to improve its current profit,

although this is often at the expense of its

future growth potential.

Table 4.3 is intended to capture some broad indications of the size, scope and cost of

the fixed part of the proposed organisation.

Three points in time are suggested: at the moment the project starts and the current plan

is put into operation; at the time the new product is first placed on the market; and after the

product has been on the market for three years. It is quite acceptable to use fractions whena function is being carried out by a part-time appointee, or when one person is covering two

or more areas, but it is not, in general, satisfactory to assume that any of the key

organisational elements in Table 4.3 can be omitted entirely.


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Organisationalfunction

Projectstart

Productl

aunch

Launchplus3years

Heads

Salary

budget

Heads

Salary

budget

Heads

Salary

budget

Exec.

Staff

Exec.

Staf

f

Exec.

Sta

ff

Chiefexecutiveandcom

pany

secretariat

Chieffinancialofficeran

dmajor

accountingfunctions

Informationsystemsmanagement

Newproductdevelopme

ntand

marketplanning

Productionanddelivery

supervision

Salesmanagementandr

eporting

Servicemanagementand

reporting

Humanresourcemanagement

(centralfunctions)

Other

Table

4.3

Planningandsupervision


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Process

The process refers to the value-adding and revenue-generating activities undertaken by a

venture. The process needs to be analysed in two dimensions at least: there is the definition

of the functions that must be carried out, and there is the definition of a scaling metric and

ratio for each of these functions. The number of sales staff, for example, may be related to

the number of new customers expected to be gained per period, while the number of service

staff may be related to the total number of customers or the aggregate value of equipment

installed or to some other measurable factor.

Table 4.4 allows the planner to define three scaling metrics which will then be used to

qualify the entries in the subsequent process design table.

Table 4.5 can be used for manufacturing or service businesses: in some cases of either

class the scaling factor on some lines will be zero. The intention is to capture the number

of heads that must be recruited for a given level of business, and to give some indication as

to how this number will vary as the business expands or contracts. The line Supervision

and management is intended to capture the direct overhead costs, such as works payroll,HR and amenities as well as foremen and supervisors.


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No Description Unit

1

2

3

Table 4.4 Process scaling metrics

Function Metric Factor Unit

budget

Transforming operations

Goods inwards and stores

Operations

Warehousing and dispatch

Supervision and management

Customer service operations

Equipment, vehicles and stores

Service to customers

Staff education and training


Sales operations

Sales personnel

Product management and merchandising

Sales training


Table 4.5 Process decomposition


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Tangible assets

A firm consists of people and things and cannot operate unless both are present. The things

dealt with in this subsection are those necessary to the operation of the business, such as

premises, equipment, work in progress, finished goods inventory, customer goodwill and

brand equity and the various core competencies implicit in a successful business. Purely

financial assets, such as the debtors ledger, are dealt with in the financial section of the

plan. The scaling metrics are those defined in Table 4.4, above.

Many of the assets listed will be leased rather than owned, but this is, again, a financial

issue to be dealt with in the financial section of the plan: who the legal owners are is less

important to practical business operations than the fact that the firm has the use of the

asset. Occasionally a firm is able to share a critical but lightly used asset: sophisticated test

equipment often falls into this category. Where guaranteed part-time access to an asset

would be as useful as full control, this should be noted.


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Asset description Metric Unit Factor Deprcn

(yrs)

Acquire

cost

Premises: administration

Premises: manufacturing

Premises: warehousing

Premises: service and repair

Premises: sales

Vehicles: benefit

Vehicles: goods transport

Vehicles: sales and service reps

Equipment: office

Equipment: manufacturing

Equipment: service and repair

Equipment: sales

Materials and components

Work in progress

Finished goods

Information technology (central)

Information technology (user)

Other

Table 4.6 Tangible assets


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1This is a quick way of valuing a 15 per cent experience curve.

40

Intangible assets

Successful companies are worth more as a going concern than the value of their physical

assets: for listed companies, the share price is usually higher than the net assets per share.

(If the share price falls below the value of the assets, the shareholders would be better off

winding up the company and selling the assets, or accepting a takeover offer from an asset

stripper, which amounts to much the same thing.)

Intangible assets should not be confused with undervalued assets: land and buildings,

and sometimes patents and other elements of intellectual property, may be recorded in a

companys accounts at their acquisition value, which may be far lower than their market

value. Asset strippers are always on the lookout for companies where the gap between the

value of the shares and the recorded value of the assets is caused by such undervaluations.

Broadly, intangible assets consist of the firms human capital, its customer goodwill

and/or brand equity, and the market value of any of its protected intellectual property such

as patents, registered designs and copyrights.

Human capital

Human capital has been used in a fairly amorphous way: obviously money that is invested

in employee training must have some lasting effect, or no one would do it. One way of

estimating it is:

capitalise training expenditure using a fairly sharp depreciation rate (such as 25 per

cent or even 33 per cent: training is forgotten, staff leave or change tasks, technology

advances)

add an amount representing the cumulative value of the staffs experience: take the

log to the base 10 (log, not ln when using a spreadsheet or calculator) of the total

number of years all current employees have been with the organisation and multiplyit by half the average annual salary.1

Goodwill and brand equity

A firms goodwill is the capital value of the future income stream that is reasonably expected

to be generated by the firms current customer base, over and above the cost of providing the

product including the rent of all the assets used in the delivery process. It should be

approximately equal to the accumulated sales and promotional expense depreciated at a

rate consistent with customer turnover.

These ways of estimating goodwill and the value of a firms core competence are

extremely tentative at the time of writing, but their relative magnitudes may serve as acheck on the realism of the planners assumptions.


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After

1 year 3 years 10 years

Number of employees

Average period of service

Total employee years

Log of total employee years

Average employee salary

Experience value

(= (salary) (log cum years) 0.5)

Cumulative employee-years of training

Depreciated value of training

Table 4.7 Human capital

After

1 year 3 years 10 years

Cumulative sales and promotional expense

Estimated annual rate of customer loss

Depreciated value of sales and promotional expense

Table 4.8 Goodwill and brand equity


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5The financial feasibility model

This chapter does not include tables for the entrepreneur or planner to fill out, since we

assume from the start that no serious planner would fail to take advantage of a modern

personal computer with a spreadsheet program. This chapter will describe how to construct

a model, which can then be used to generate pro-forma income and cash flow statements

and balance sheets.

Entrepreneurs and planners who follow these guidelines should produce a set of printed

pro-forma accounts that will be sufficient to demonstrate the financial feasibility of a

proposal. Such accounts will generally be adequate when accompanying a business caseseeking support for an internal project from the senior managers of a corporation. They

should also be sufficient, in general, for an entrepreneurial business plan prepared as an

exercise by students in entrepreneurship programs.

A limited model such as this one will not provide an adequate set of pro-forma accounts

for an entrepreneur seeking finance from an unrelated party such as a bank, a venture

capitalist or a business angel. While a conscientious lecturer might spend up to an hour

evaluating a students business plan, a venture capitalist could take two days. Chapter 14

ofEntrepreneurship: How Innovators Create the Future gives an overview of the depth of

accounting detail needed to survive such a detailed examination. Entrepreneurs who wish

to use their plan to raise capital may choose to develop this planning model into a full set

of accounts, or they may ask their accountant to do it for them. Accountants should not be

asked to develop the planning model, although their help can be very useful: the planning

model is an essential part, some say the heart, of the business plan.

Students working in teams, or students with an accounting qualification undertaking

an entrepreneurship program, should also go beyond this relatively simple financial model

and prepare a more complete one.

In general terms, the difference between a feasibility model and a full set of accounts

is the way figures are sourced, whether actual or pro-forma. A proper business accounting

system can be audited to the point that named workers and suppliers are shown to have

received money in return for specific activities, with a similar level of detail on the income

side. A feasibility model relies on ratios to generate appropriate cost and income figures,driven off a limited number of key assumptions. There should be two principal results

obtained from a feasibility model: it should be possible to show that the project is viable and

prospectively reasonable, and it should be capable of developing an investment offer which

can be used to answer the questions a potential investor might reasonably ask.

General spreadsheet structure

Modern spreadsheet packages have a multi-sheet capability, with formulae linked across

sheets but the formatting of each sheet independent from the rest. An entrepreneur or


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planner should take advantage of these facilities and make the financial feasibility model

as easy to examine and understand as possible.

The first sheet should normally be used to set out the principal assumptions and

results. Since this sheet will not normally need to be printed, full use should be made of the

spreadsheet packages colour and font facilities. The spreadsheets cell protection facilities

can be used to stop users accidentally modifying cells containing text or formulae, andannotation on this sheet should encourage prospective investors to experiment with the user

parameters. The second sheet could reasonably be used to present income statements, cash

flow projections and balance sheets. Columns near the left edge of the sheet can be used for

annual figures, with the same projections but in monthly form further to the right and the

notes to the accounts further over still. The third sheet can be used for monthly or annual

schedules projecting key financial numbers, such as investment timing and employment

levels. In a full set of working accounts, such schedules would lie behind practically every

row on the main accounts: often there will be schedules contributing to schedules, but this

level of detail is seldom appropriate for a financial feasibility forecast.

We suggest that the projections be carried forward for five years (or for the balance of

the current financial year plus five further years) except where there is a clear reason for

using a different period. A plan for a show or a major event does not need to continue past

the completion of the event or run of performances and the settling of accounts; on the other

hand, a major corporate initiative might not even start generating cash inside five years and

a longer timescale will be essential. Five years seems to be a reasonable limit for detailed

forecasts, and so even when a plan is part of a strategy that will run for a much longer

period, dealing with the problems and opportunities in five-year chunks will often prove a

satisfactory approach.

The spreadsheet calculations should be carried out on a monthly basis and summed (or

replicated, in the case of the balance sheets) to make up the annual reports. Modern

personal computers have adequate power to complete such calculations without causingperformance to suffer visibly, and an annual sweep can miss periods of strained liquidity

which monthly budgeting would have revealed. Our preference is for the marketing model

described in the previous chapter to be added after the financial projections, since it

generates the sales figures that the financial projections require. The promotional budget

projection might even be displayed on the very front sheet to allow users to experiment with

the effect of modifying it.

The last few sheets can be used for formatting reports and graphs for printing. This

allows the planner to make the screen presentation of the reports as attractive as possible

without compromises inflicted by the limitations of the available printing technology.

General spreadsheet rules

Balancing

Accountants invented the concept of balance to give warning of any arithmetic errors in a

set of accounts. A modern computer is very unlikely to make any arithmetic errors, but

human programmers, including spreadsheet users, are very prone to logical ones. Testing

for balance, by arriving at each main result by two different routes, remains extremely

important and under no circumstances should spreadsheet formulae simply assume it inorder to generate a result.


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Figure 5.1 Spreadsheet structure

Rounding and conditioning

Digital computers are finite automata (amaze your friends with that one) and under certaincircumstances will, while working correctly, produce results that do not seem to be those

prescribed by the laws of arithmetic. In financial applications this can become apparent by

a failure to achieve balance or when columns of numbers which appear to sum to a different

number than the computer-generated total.

The correct way to make sure that this does not happen is for the spreadsheet writer

to take positive control of rounding and truncation. ROUND and TRUNC functions or their

equivalents are provided in spreadsheet packages to facilitate this. All spreadsheet

expressions involving division, or multiplication by a number with a fractional component

(like a percentage) should be protected by a ROUND or TRUNC function, ensuring that the

answer is an exact number of dollars.Figure 5.2 shows the use of the ROUND function, both to define the precision of the

monthly percentage rate and to ensure that the interest due is always an exact number of

dollars.

Zeros

By accounting convention, zero quantities are presented as a blank field in the accounts of

a business. An option (in Microsoft Excel, for example, Tools, Options,View, zero values)

allows users to select this option and make the screen and printed output from the model

more accountant-friendly. If blanked zeros are selected and a zero appears in a money field

this generally means that the rounding and conditioning controls have failed and the cell

contains a small value other than zero.


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Interest rate 9.70% (Annual)

0.81% (Monthly)

Principal $105,131

Interest due $849

Interest rate 0.097 (Annual)

=ROUND(B1/12,5) (Monthly)

Principal 105131

Interest due =ROUND(B4*B2,0)

Figure 5.2 The ROUND functionThe same spreadsheet fragment is shown in normal and in formula view.

Annotation

Modern spreadsheet packages allow their users a rich variety of annotation devices. In

Microsoft Excel, for example, each cell can have a note stored in it; in addition, drawings,

arrows, and text boxes can be added to the spreadsheet. These facilities should be used

freely, both to help subsequent users who may inherit the model and to help the initial user

if it becomes necessary to amend or review it after it has been set aside for a period.

Cells can be named and the name used in formulae instead of the simple reference: this

can also make a spreadsheet easier to follow.

The printed presentation of the accounts should normally have a note for practically

every line, explaining how the figures were derived and including, or referencing, any

relevant auxiliary tables.

The income statement

The Income Statement (or P&L in American-speak) should be the primary reference pointfor someone examining a plan. We strongly urge planners to keep the number of lines in the

statement low enough to fit on a printed page in a reasonable font size; where (as will

usually be the case) more information is required it can be developed in an auxiliary

schedule and the fact noted by a note in Notes to the accounts for the printed version and

drawn on the spreadsheet for the screen version. The value-adding format outlined here

works, but it is not intrinsically superior to the various alternative layouts. Planners

working for a corporation with an established standard for the presentation of accounts

should follow their employers instructions wherever they differ from the suggestions below.

Guides to planners preparing accounts (including this one) will suggest rows that, in

some cases, will not be needed. It is usually better to omit them altogether rather than

waste a precious line on a row of blanks.

Revenue

This may be a single line, but often a few more add clarity. Even when only a single product

is covered by a plan, as with a new line of packaged consumer goods, it is often useful to

have a second line for co-promotion allowances and incentives, distinguishing revenue

booked from amounts actually received.

When there is a manufactured product with associated spare parts and service sales,

it is a good idea to show primary sales revenue separately from service and spare parts

revenue, since the former is much more volatile than the latter. An other revenue line can


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be helpful as a place to put income such as grants and licence and franchising fees which

may significantly improve the viability of a proposal.

By convention, sales taxes are recorded as negative amounts under the revenue heading

rather than an expense. The firm receives the money, but only as trustee for the tax

authorities, and the sales tax is not treated as an operating expense but rather as a

correction to the nominal revenue.

Direct costs

Direct costs are costs that vary directly with the level of business. They always include

purchased materials and components and transport contractors charges. By convention,

they include the wage costs of the staff directly involved in producing and delivering the

goods and services which make up the product offering. This is reasonable for casual staff,

outworkers and employees on piece rates, but it is a very dubious assumption when salaried

professionals or highly skilled blue collar workers are involved.

Compass Airlines (mk I) performed a competitive evaluation of Australian and Ansett

airlines, assuming that flight and cabin crew were direct costs, and that Compasss

competitors would not be able to lower their prices below these levels: on this basis,

Compass forecast fabulous profits for its operation. Ansett and Australian, on the other

hand, observed that their pilots and cabin crew drew the same salary on the ground and in

the air, and aircraft leases had to be paid whether the aircraft was flying or not, and their

direct costs, and therefore their minimum prices, were much lower than Compass had

assumed. Compass went broke in approximately a year.

In general, staff whose wages are not closely related to the level of output, and who have

skills, knowledge or experience that would be difficult or costly to replace, should be

accounted below the gross margin line under general expenses and not treated as a direct

cost, no matter how directly they are involved in the value-adding activities of the business.Sales commissions, but not sales salaries, can be included as a direct cost if they are

likely to be a significant amount.

Gross margin

The difference between the revenue after allowances and the direct costs is the gross

margin: this should always be reported as a percentage as well as a dollar figure. The

reciprocal of the gross margin is, implicitly, the price elasticity of demand which in turn is

an indication of the expected sensitivity of the market to price cutting.

General expenses

General expenses should be broken down into at least the following elements:

sales and marketing staff and related costs

manufacturing staff and related costs (where relevant)

promotion

administration

new product development

depreciation.


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Each of these lines will normally need to be supported by an auxiliary schedule. Additional

lines may be needed if there are major expenses expected that are not easily assigned to one

of these headings.

Earnings before interest and tax (EBIT)

The EBIT is the difference between the gross margin and the total of the general expenses.

It should be presented both as a dollar figure and as a percentage of sales: prospective

buyers of an established business are keenly interested in the EBIT, and so a strong value

will be an indication that the entrepreneur and/or the venture investors will find it

relatively easy to make a profitable exit by way of a trade sale in due course.

Interest

Interest income and expense should be shown below the EBIT line. Separate lines for

interest earned, and short and long term interest obligations are generally considered

desirable.

Taxable income and tax

Taxable income should be stated after deducting the net interest expense from the EBIT.

Tax should be shown at the appropriate rate, remembering that the Tax Office does not pay

money to companies that have trading losses, and that profits are sheltered from tax until

all past losses have been exhausted. A little care is needed in programming the appropriate

calculations. Novices sometimes show negative tax being received while a firm is making

losses: such errors rob a plan of any credibility.

Tax is an annual matter, and so while most of the calculations should be done on amonthly basis and aggregated to form the annual data, company tax should be calculated

from the annual data and shown as being due in the last month of each financial year. In

Australia, companies over a certain size are required to make progressive company income

tax payments during each year based on the previous years tax assessment. Unless these

payments are properly planned for, they may place stress on a growing companys cash

reserves.

Profit and distributions

Profit, like company tax, is an annual matter: earnings before tax can be calculatedmonthly, or even more frequently, but since a firms income tax liability is based on its

whole-year business, so is its after tax profit. It is often convenient to describe the

disposition of the profit, basically the split between dividends and retained profits, on the

Income Statement.

Cash flow statement

There are many possible formats for a cash flow statement: the functional area format

presented here is adequate; but an alternative format may be used if necessary.


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Trading (or operations)

Three lines can

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