financial projection

Financial Management for Entrepreneurs I

Business Innovation Competition Workshops

Innovation & Entrepreneurship Institute

Business plan workshops

• Idea Creation and Opportunity Assessment– - February 2

• Matching Products and Services with Markets– February 9

• Competitive Analysis– February 16

• Strategy & Business Model– February 23

• Marketing and Sales Strategies– March 2

• Management & Ownership– March 16

• Financial Projections and Funding Strategies– March 23

• Professional Presentations– March 30

• A successful business organizes natural resources, human resources and sweat into product or service plus profit, – Thus transforming human and natural

capital into financial capital.,

• One goal of business is to generate wealth and stores it as money, as capital, which can then be rented (lent) or invested to help build more wealth…

Alchemy of wealth creation

• Cash is not always cash: There is a difference between the cash needed to run a firm and the capital needed to develop it.

• Operating cash is a lubricant that facilitates the exchange of goods and services. – Successful firms are well lubricated: They cover

operations from revenues.

• Capital is stored energy and is used to build capability. – Capital (from investments and loans) is stored profit from

past ventures. This energy from the past helps firms build more rapidly than would be possible with sweat and profit.

Capital vs cash

• Track the alchemical transformation of labor, land and capital into financial capital.

• Monitor flow of money through a business – as cash and capital.

• Support planning and measure progress.• Support judgments about the coherence of

a business plan.• Help sell business plans to others.

Financial statements & projections

• Use standard formats– With account categories and formats that fit

one’s business

• Support numbers with narrative and notes– Narrative: “After three months of losses, firm A

turns profitable; by the end of year, two, firm A should show steady profits of and settles into profits of 10% per year.”

– Notes: Assumptions, caveats, what-ifs.

• Are checked by professionals– Taxes and acceptability

Transparent financial statements

• Income Statement– Definition: Profit or loss of a business over time– Use: Project & monitor profit & so operating efficiency

• Cash Flow Statement– Definition: Tracks the inflows & outflows of cash– Use: Project & monitor the cash available for operations

& growth

• Balance Sheet– Definition: Snapshot of a firm’s wealth – and how it has

funded that wealth– Use: Project & monitor the growth or decline of a firm’s

value/capital - and so potential

Financial statements

+ Net Revenues

- Cost of Goods Sold

= Gross Profit

- Operating Expenses

= Operating Profit

+/- Other Income/Expenses

= Profit before tax

- Tax

= Profit after tax

Income statement

• Income Statement– Definition: Profit or

loss of a business over time

– Use: Project & monitor profit & so operating efficiency

Income statement

Gross Profit

OperatingProfit

Net Profit

P.A.T.COGS

Op. Exp.

OtherExp. Tax

Revenues

Other Income

Div>CF

R/E>B/S

+ Net Revenues


= Gross Profit

Income statement

• Net Revenues– Sales after discount, less

returns

• Cost of Goods Sold– Direct goods + direct labor per unit sold

• Gross Profit– Amount left to cover operations

• COGS/Sales – Constant or improving as percentage– Perils and pleasures of volume

= Gross Profit

- Operating Expense

= Operating Profit

Income statement

• Operating Expenses– Salaries (benefits, taxes)– Sales & Marketing– General Administration (supplies, IT,

insurance)– Space (rent, maintenance, utilities)– Depreciation (spreading capital

expense over use/ time)– Professional fees

• Operating Profit– Basic measure of success

= Operating Profit

+/- Other Inc or Exp

= Profit before taxes

Income statement

• Other Income– Sidelines (can be very valuable and/or

indicate new businesses or products)– Interest

• Other Expense– Cost of financing, especially interest

on loans– Other miscellaneous expenses

• Profit before Taxes– Net income

= Profit before Taxes

- Income Taxes

= Profit after Taxes

Income statement

• Income Taxes– State and local– Don’t confuse tax management

with management• Profit after Taxes

– Captured wealth– Reinvest (retained earnings) >

B/S– Distribute (dividends) > CF

Account categories that matter

• Revenues– Major lines and/or channels– Other income sources

• COGS– Direct labor, raw materials, subcontracts

• Operating Expenses– Reflect business model: Marketing/Sales, GA– Subdivide important categories; lump together

unimportant ones

• Other Expenses

+ Net Revenues


= Gross Profit

- Operating Expenses

= Operating Profit

+/- Other Income/Expenses

= Profit before tax

- Tax

= Profit after tax

Account categories exercise

• Planning: What categories should matter?

• Analysis: What categories has management chosen – and what do they tell you?

Cash flow projections

• Cash Flow Statement– Definition: Tracks the

inflows & outflows of cash

– Use: Project & monitor the cash available for operations & growth

+ Revenues- Cost of Goods- Operating Expenses (excluding

depreciation)= Cash flow from operations

+ Investment income- Acquisition of space, r&d,

equipment, etc = Cash flow from investment

+ Equity investment+ Loans- Repayments- Dividends / owner withdrawals= Cash flow from financingCash on Hand – End of Period

Three sources of cash

• Operations– Revenue less cash

expenses (ultimately, retained earnings)

• Investments • Financing

– Loans, equity






Three uses of cash

• Operations– Cash necessary to

operate

• Capacity building– Cash necessary to

build the platform

• Pay back– Cash necessary to

pay lenders, investors, owners

+ Revenues- Cost of Goods- Operating Expenses

(excluding depreciation)= Cash flow from operations




Building the cash flow statement

• Inflows– Operating: Adjust revenues for bad debt and timing– Investment: Any sales of hard assets?– Financing: Capital inflows? Loans?

• Outflows– Operating: Inventory purchases– Operating: Operating expenses (without

depreciation), adjusted for timing– Investment: Capital purchases– Financing: Principal repayment, investor

repayment, owner withdrawals

Avoiding the cash wall

• Detailed projections– Routine and extraordinary expenses– Monthly, even weekly (once operating)

• Careful monitoring• Calculate burn rate

– Cash outflow per month

• Play with timing– Delay outflow or accelerate inflow

• Manage expectations• Negotiate

Cash flow projections exercise

• Planning: List one-time and recurring cash inflows and outflows. Juggle the timing to remain cash positive while growing.

• Analysis: Calculate the cash available for to finance investment, new initiatives, etc.






Current AssetsLong-term Assets= Total Assets

Current LiabilitiesLong-term Liabilities= Total Liabilities

Capital InvestmentRetained Earnings= Total Equity

Balance sheet

• Balance Sheet– Definition: Snapshot

of a firm’s wealth – and how it has funded that wealth

– Use: Project & monitor the growth or decline of a firm’s value/ capital - and so potential

A = L + E

• Assets = Wealth = Use of Funds – Cash, loans to customers (A/R), buildings,

equipment, inventory, partnerships– Platform for growth

• Liabilities = LeveragedSource of Funds– Nervous claims on wealth secured by contracts &

collateral such as loans from vendors, banks, other sources, bonds

– Expand possibilities while increasing risk

• Equity = Capital = Invested Source of Funds– More patient claim on wealth secured by control,

especially owners’ capital plus retained profits

Current Assets

Long-term Assets

= Total Assets

Balance sheet

• Current Assets– Cash & similar– Accounts receivable– Inventory

• Long-term Assets– Equipment– Leasehold Improvements– Net of depreciation

Uses of cash

• Payments• Supporting customers by offering terms• Inventory• Investing in capacity: machinery, know-how,

new products, partnerships• Investing in financial instruments

Current Liabilities

Long-term Liabilities

= Total Liabilities

Balance sheet

• Current Liabilities– Accounts payable– Deposits– Line of credit– Current portion of

long-term debt

• Long-term Liabilities– Loans– Bonds


Balance sheet

• Equity– Capital Investment– Additional Paid-in

Capital– Retained Earnings

Sources of cash

• Initial equity– owners, family, friends

• Other equity: – angels, venture firms, partners, public markets

• Informal loans: – terms from suppliers, customers, landlords, partners

• Traditional loans: – credit cards, banks, leases, bonds

• Revenues• Related business income• Investment income

Matching sources & uses of funds

• Short-term sources of cash to fund short-term needs – A/P <> A/R– Deposits <> inventory

• Long-term sources of cash to fund long-term needs– Loans for hard assets with collateral

• Mortgage <> building• Lease <> equipment

– Investments for softer assets like r&d• Angel <> r&d• Strategic investor <> new product

Matching sources & uses of funds

• Farm Example– Seasonal cash flow – revolving line of credit– Equipment – leases– Buildings - mortgages

• Software Application Example– Personal & angel investment for proof of concept– Stock options (personal investment) for building core

staff– Venture capital for commercialization and marketing

roll out– Short-term loans for equipment– Mid-term loans for leasehold improvements

Current AssetsLong-term Assets= Total Assets

Current LiabilitiesLong-term Liabilities= Total Liabilities


Balance sheet exercise

• Planning: List necessary assets & timing. Brainstorm possible sources of funds and timing. Match them up.

• Analysis: Are sources and uses of funds well matched?

Tying the statements together

• Income Statement > Balance Sheet– Net income less dividends = additional

retained earnings on B/S

• Incomes Statement > Cash Flow– Direct method: All income (adjusted for timing)

- all expenses (adjusted for timing) + depreciation = operating cash flow

• (Remember other income/expense and taxes)– Interest payments provide clues about the loan

situation


• Cash Flow > Balance Sheet– New capital, new loan principal, repaid capital,

repaid loan principal, purchases or sales of equipment

– Dividends (which reduce net income’s contribution to retained earnings)

• Cash Flow > Income Statement– Changes in loans should be reflected in

changes in interest


• Balance Sheet > Income Statement– Change in retained earnings = Net income less

dividends

• Balance Sheet > Cash Flow– Indirect method: Changes in balances (eg.,

Accounts receivable, accounts payable, etc) are used to calculate changes in cash

– Similarly with changes in investing (equipment, equity) and financing categories (loans)

• Richard A Brealey and Stewart C. Myers, Principles of Corporate Finance (McGraw-Hill, 1996)

• Corporation for Enterprise Development: Financial Management for Entrepreneurs (1995)

• Craig Fleisher & Babetter E. Bensoussan, Strategic and Competitive Analysis: Methods and Techniques for Analyzing Business Competition (Prentice-Hall, 2003)

• TL Hill lectures, 2002• Nick Rowling, Commodities: How the World Was Taken to Market

(Free Association Books, 1987)• Clyde Stickney & Roman Weil, Financial Accounting: An

Introduction to Concepts, Methods and Uses (Dryden Press/Harcourt Brace College Publishers, 1994)

• G. Straughn & C. Chickadel, Building a Profitable Business (B Adams, 1994)

Bibliography

financial projection

Business

management profit

stored profit

project monitor profit

taxes income taxes

operating cash

miscellaneous expenses

taxes net income

financial capital