subject module - elective ciakl ii - class 12

EUROPEAN COURSE IN ENTREPRENEURSHIP FOR THE CREATIVE INDUSTRIES

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Financial Plan


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Financial plan Sources:

Harold L. Vogel, “Entertainment Industry Economics”, Sixth Edition, John Wiley & Sons, Inc., 2001

Alan B. Albarran, “The Media Economy”, Routledge, 2010 Richard A. Brealey & Stewart C. Myers, “Principles of Corporate Finance”,

MacGrawHill, 1998

To finance a viable project Purposed objectives and review of internal resources determine needs of investment, in fixed assets and working capital. The financial plan aggregates cost/benefit calculations that fix amounts in investment needs, break-even point, profit, return on investment (return of total assets involved in the project) and return on equity (shareholders return). Decisions must be made to access project viability (enough, e.g., if it is worth taking the correspondent risk) and, if so, how will it be financed, either through equity capital, funding or both.

With the exception of rare cases of notoriety pursuit or philanthropy, the investor’s choice depends on which available project is likely to provide a higher return at a reasonable risk. Entrepreneurs need to bear in mind that they should go through with their strategic decisions only if they are profitable, or if, at the very least, there will be no unrecoverable financial losses, even when those losses are only theirs. Cost and revenue projections should be as accurate and objective as possible, and final feasibility indicators should be recalculated at risk-adjusted present value (taking into account inflation, interest, minimum required return and risk associated with the endeavour).

Basic financial concepts In its simplest form, finance refers to the funds that flow in and out of a business entity. Most businesses fail as a result of poorly managed finance. Financial management refers to the systematic process of budgeting, monitoring, and controlling the flow of funds in an organization.

Equity refers to the ownership of the firm or business Assets represent things that have value and can ultimately be converted into

cash


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Fixed assets are long-term tangible piece of property that the firm owns and uses in the production of it’s income and is not expected to be consumed or converted into cash any sooner than at least one year’s time.

Depreciation is the allocation of cost of a fixed tangible asset over its useful time

Current assets are short term tangible piece of property that are likely to be converted into cash no later than one year’s time. Examples: inventory (stock), accounts receivables (credit to clients or other entities)

Liabilities refer to debt or money that is owed Fixed costs (also known as overhead or structure costs): existing costs

independent of sales Variable costs (cost of goods sold): related to sales (usually raw materials used

in product sold or number of personnel hours in services sold) Working Capital = current assets – current liabilities

o In a project corresponds to the value of cash funds + permanent stocks + receivables (credit to clients) minus accounts payable (credit from suppliers)

Payback period or Break-even point (BEP) represents the moment where there is no loss or gain. Total revenues minus total costs = 0.

Revenues

2400

1800

.BEP 1200

600 600 1.200 1800 2400 Costs

Balance sheet A firm’s balance sheet shows its assets (what it owns) and its liabilities (what it owes) at a point in time.

Income Statement summarizes the profitability of the firm over a period of time, in this case a year. Income, profits and earnings all mean the same thing – the difference between revenues and expenses.


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Risk assessment and management

Examples of business risk

External risks

Environmental causes: areas often subject to natural disasters Regulations, taxes and subsidies: political swaps in government can

cause sudden change of legal and fiscal regulations Macro-economics: growth versus recession, inflation rates, interest

rates, exchange rates Price risk of inputs: supplies prices change unpredictably Price risk of outputs: sudden change in demand or competitors can

cause prices to fall

Internal risks Production risks: break down of machines, workers do not show up for

work, new technologies make the companies equipment obsolete Time frame in which a certain project is undertaken. Risks increases as

the project takes more time

Risk transfer

Hedging: reducing exposure to risk, for example selling future production at a fixed price (forward contract) or negotiating fixed exchange rates with banks; eliminates potential loss but give up the potential gain

Insuring: paying a premium (to the insurance) to avoid losses. For example making an insurance for a film release

Diversifying: holding many risk assets at lower price instead of concentrating in just one big investment.

Introducing a time frame Time units could be quarter, semester, and year, usually related to interest rate. Time frame is the shortest of the following:

Product/service life Lifespan of facilities (lease contract) or equipment Entrepreneurs decision

The excel model used in the below example of a film production will be provided to students.


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Sales forecast Sales forecast is connected with market research (number of service users expected, or quantity of product expected to be sold) and installed capacity. It should never be considered 100% capacity usage due to probable down time in equipment maintenance, malfunction or breakdown. In the case of a theatre a reasonable but not excessive percentage of total seats capacity should used. Unreasonable optimism should be avoided since it leads to overestimating sales projections. This is a recurrent error in this type of analysis which brings disastrous results. A sensitivity analysis should be made in sales projections (best case, expected case and worst case scenarios).

SALES FORECAST

Year 2013 2014 2015 2016 2017 Local distributor 600.000 TV Sales 400.000 DVD duplication 150.000 100.000 Distribution other territories 200.000 Others

TOTAL 0 0 600.000 750.000 100.000

Territory: North America, Latin America, South East Asia, Middle East, Western Europe (U.K., Germany, France, Italy, Spain), Smaller Western Europe (Benelux, Scandinavia, Greece, Portugal, Switzerland, Iceland), Eastern Europe, Africa

Cost analysis Costs should never be underestimated; either in quantity used

neither in unit price.


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VARIABLE COSTS VARIABLE OR PRODUCTION COSTS

Year 2013 2014 2015 2016 2017 Copyrights - author 10.000 Screenplay writers 2.000 2.000 Director 5.000 Producers 10.000 Actors 500.000 Director of photography 12.000 Editor 6.000 Sound-track Make-up 1.000 Assistants 3.000 Shootage costs 20.000 Location costs 10.000 Wardrobe 15.000 Travelling 10.000 30.000 Hotels, food and beverage 5.000 20.000 Others 1.000 1.000 TOTAL 43.000 620.000 0 0 0

FIXED (overhead) COSTS Year 2013 2014 2015 2016 2017

# months 13 13 13 13 13

Annual increment

2,0% 2,0% 2,0% 2,0%


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OFFICE SALARIES # Office Personnel 2013 2014 2015 2016 2017

Administration 1 1 1 1 1 Finance Human Resources Marketing Commercial I&D 1 1 1 1 1 Others 1 1 1 1 1 Total # Office Personnel 3 3 3 3 3

Average Monthly Salaries 2013 2014 2015 2016 2017 Administration 1.200 1.224 1.248 1.273 1.299 Finance 0 0 0 0 Human Resources 0 0 0 0 Marketing 0 0 0 0 Commercial 0 0 0 0 I&D 900 918 936 955 974 Others 800 816 832 849 866 Total Monthly salaries 2.900 2.958 3.017 3.078 3.139

Anual Salaries 2013 2014 2015 2016 2017 Administration 15.600 15.912 16.230 16.555 16.886 Finance 0 0 0 0 0 Human Resources 0 0 0 0 0 Marketing 0 0 0 0 0 Commercial 0 0 0 0 0 I&D 11.700 11.934 12.173 12.416 12.664 Others 10.400 10.608 10.820 11.037 11.257 Total Annual Salaries 37.700 38.454 39.223 40.008 40.808

Payroll taxes and benefits 2013 2014 2015 2016 2017 Admin 20,60% 3.214 3.278 3.343 3.410 3.479 Others 23,75% 5.249 5.354 5.461 5.570 5.681

Total Payroll taxes 8.462 8.632 8.804 8.980 9.160


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Other Costs Food allowance 1239,04 3.717 3.717 3.717 3.717 3.717 Work Insurance 1,00% 377 385 392 400 408 Training 0 0 0 0 Comissions 0 0 0 0 Health Insurance 0 0 0 0 Car and fuel 0 0 0 0 Mobile phone 0 0 0 0 Others 0 0 0 0 Total Benefits 4.094 4.102 4.109 4.117 4.125 Total Payroll Taxes+benefits 12.556 12.733 12.914 13.098 13.285 TOTAL OFFICE SALARIES 50.256 51.187 52.137 53.105 54.093

Year 2013 2014 2015 2016 2017

Annual increment 2,0% 2,0% 2,0% 2,0%

OFFICE SUPPLIES 2013 2014 2015 2016 2017

Stationery 1.200 1.224 1.248 1.273 1.299 Office supplies

600 612 624 637 649

Comunication

2.400 2.448 2.497 2.547 2.598 Others

300 306 312 318 325

TOTAL Office Supllies 9.090 9.272 9.457 9.646 4.871

Year 2013 2014 2015 2016 2017

Annual increment 2,0% 2,0% 2,0% 2,0%

LEGAL AND PROFESSIONAL SERVICES 2013 2014 2015 2016 2017

Layers 1.440 1.469 1.498 1.528 1.559 Accountants

1.440 1.469 1.498 1.528 1.559

Network assistance 360 367 375 382 390 Other Office equipment assistance 240 245 250 255 260 Others

0 0 0 0

TOTAL Legal and professional services 3.480 3.550 3.621 3.693 3.767


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FIXED OR OVERHEAD COSTS Year 2013 2014 2015 2016 2017

Office Salaries 37.700 38.454 39.223 40.008 40.808 Employee Benefits 4.094 4.102 4.109 4.117 4.125 Payroll Taxes 8.462 8.632 8.804 8.980 9.160 Advertising 5.000 5.000 5.000 Stationery, Office Supplies & Postage 9.090 9.272 9.457 9.646 4.871 Legal and Professional Services 3.480 3.550 3.621 3.693 3.767 Dues & Subscriptions 500 500 500 500 500 Data Processing 200 200 200 200 200 Rent or Mortgage 6.000 6.000 6.000 6.000 6.000 Building Maintenance 600 600 600 600 600 Interest on Loans or Mortgages 300 300 300 300 300 Insurances & Taxes 1.500 1.500 1.500 1.500 1.500 Depreciation 1.400 1.400 1.400 400 400 Utilities 100 100 100 100 100 TOTAL 73.426 79.609 80.814 81.044 72.331

Financial evaluation

Operating free cash flow Corresponds to earnings before depreciation and after taxes, e.g., available funds for investment and return.

OPERATING FREE CASHFLOW Year 2013 2014 2015 2016 2017 Sales + 0 0 600.000 750.000 100.000 Variable Costs - 43.000 620.000 0 0 0 Gross margin = -43.000 -620.000 600.000 750.000 100.000 Fixed costs - 73.426 79.609 80.814 81.044 72.331 Operating income = -116.426 -699.609 519.186 668.956 27.669 Income tax (25%) - 0 0 0 93.026 6.917 Operating income after tax = -116.426 -699.609 519.186 575.929 20.752

Depreciation costs of fixed assets + 1.400 1.400 1.400 400 400

OPERATING FREE CASHFLOW = -115.026 -698.209 520.586 576.329 21.152


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Investment needs o Total fixed assets purchase cost: price of property facilities, equipments

and other fixed assets. o Working capital: amount of retained cash in stocks and credit.

INVESTMENT - FIXED ASSETS

Description # Unit price Amount

Camera 2 700 1400 Mainframe 1 1000 1000 Desktop 2 600 1200 Software 1 800 800 Office furniture 1 600 600 Others 0 0 0

TOTAL 5000


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DEPRECIATION OF FIXED ASSETS

Year 2013 2014 2015 2016 2017 Cameras

Expenditure 1400 Useful life Years 5 Depreciation 20% 280 280 280 280 280

Acumulated depreciation 280 560 840 1120 1400

Hardware Expenditure 2200 Useful life Years 3 Depreciation 33% 733 733 733

Acumulated depreciation 733 1467 2200

Software Expenditure 800 Useful life Years 3 Depreciation 33% 267 267 267

Acumulated depreciation 267 533 800

Office furniture Expenditure 600 Useful life Years 5 Depreciation 20% 120 120 120 120 120


Total Depreciation per Year 1400 1400 1400 400 400



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Calculation of working capital:

WORKING CAPITAL Year 2013 2014 2015 2016 2017

Clients (credit given to clients) + 0 0 20.000 115.000 115.000 Stocks (permanent stock) + 0 0 0 0 0

Suppliers (credit from suppliers) - 22.626 115.855 134.770 52.816 42.414 Working Capital = -22.626 -115.855 -114.770 62.184 72.586

WORKING CAPITAL VARIATION -22.626 -93.229 1.085 176.954 10.402

Working Capital Variation = WC(n+1) - WC (n) The amount to be considered is working capital variation, or the amount to be increased or decreased from the initial amount.

Project net cash flow. Total earnings at constant prices.

PROJECT NET CASFLOW Year 2013 2014 2015 2016 2017 Sales + 0 0 600.000 750.000 100.000 Variable Costs - 43.000 620.000 0 0 0 Gross margin = -43.000 -620.000 600.000 750.000 100.000

Fixed costs (OVERHEAD) - 73.426 79.609 80.814 81.044 72.331 Operating income = -116.426 -699.609 519.186 668.956 27.669 Income tax - 0 0 0 93.026 6.917

Operating income after tax = -116.426 -699.609 519.186 575.929 20.752 Depreciation + 1.400 1.400 1.400 400 400

OPERATING FREE CASHFLOW = -115.026 -698.209 520.586 576.329 21.152

Investment in fixed assets - 5.000 0 0 0 0

Investment in working capital - -22.626 -93.229 1.085 176.954 10.402

PROJECT NET CASHFLOW = -97.400 -604.980 519.501 399.375 10.750

ACCUMULATED PROJECT CASFLOW = -97.400 -702.380 -182.880 216.495 227.245


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Internal Rate of Return (IRR): measures the profitability of the project

It is the interest rate at which the net present value of all the cash flows (both positive and negative) from a project or investment equal zero

푁푃푉 = −퐶표 + 퐶푛

(1 + 푟) = 0

Co = initial investment Cn = cashflows r = IRR IRR = 19% IRR can be calculated in a scientific calculator or excel (function IRR)

Net present value (NPV) Corresponds to total earnings at market value at a certain time (current prices). It compares the value of the euro today with the value of the same euro in the future. It is determined using a discount rate. Condition for project feasibility is NPV > 0. Highly profitable projects have high NPV’s.

푁푃푉 = −퐶표 + 퐶푛

(1 + 푖)

Co = initial investment Cn = cashflows i = discount rate

Discount rate: includes inflation, interest rate (for financed projects) and risk-adjusted return rate (also called investor’s rate and should include return for investor + risk). Discount rates should differ throughout the project periods according to inflation and interest rate projections for each of those periods. Risk-adjusted return rate also differs from year to year (the longest the project the higher the risk)


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Risk-adjusted capital return rate = (1+Re) x (1+Ri) – 1

Re - return rate Ri - risk associated to the project

Discount rate = (1+I) x (1+R) – 1 I – interest rate (for financed projects) R – risk-adjusted return rate NET PRESENT VALUE

Year 2013 2014 2015 2016 2017 n 1 2 3 4 5 Discount rate 12% 12% 12% 12% 12% PROJECT CASHFLOW -97.400 -604.980 519.501 399.375 10.750 NET PRESENT VALUE -86.965 -482.286 369.770 253.810 6.100

ACCUMULATED NET PRESENT VALUE -86.965 -569.251 -199.481 54.330 60.429 NPV = 60.429 (NPV should be as high as possible) Example:

NPV4 =399375/(1+12%)^4

Payback period or Break-even point (BEP)

Corresponds to the moment (n) where revenues = costs

퐵퐸푃 = −퐶표 + 퐶푛

(1 + 푖) = 0

Co = initial investment Cn = cashflows i = discount rate The project is not viable if BEP > Project period BEP in the example = 4 – (54330/253810) = 3,79 years = 3 years, 9 months and 48 days


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Financing a project The ability/possibility of financing a project depends upon the investors trust on the project (good returns, objective analysis and projections) and on the entrepreneurs’ (their previous experience and background, their personality and behaviour. Various possibilities of funding are presented in chapter 12.

Financial leverage Total earnings of the project can be increased using financial leverage. Financial leverage in financed endeavours is savings in income taxes due to financing costs (interest paid for financed amounts). In effect financial costs reduce operating earnings thus reducing income tax amount. In previous analysis income tax was calculated over operating income, disregarding the way the project would be financed. Total project earnings are then NPV + AV.

Adjusted value (AV) is the amount of savings in income tax at market value at a

certain time.

LONG TERM LOAN 5% 25%

Discount rate n Loan debt Loan

amortization Interest

Savings in income tax Interest x

Inc.Tax

Adjusted value

12% 1 50.000 0 2.500 625 558 12% 2 50.000 10.000 2.500 625 498 12% 3 40.000 10.000 2.000 500 356 12% 4 30.000 10.000 1.500 375 238 12% 5 20.000 10.000 1.000 250 142

Total adjusted value AV1 1.650

SHORT TERM LOAN

4% 25%

Discount rate n Loan debt Loan

amortization Interest

Savings in income tax Interest x

Inc.Tax

Adjusted value

12% 1 0 0 0 0 0 12% 2 650.000 500.000 32.500 8.125 6.477 12% 3 150.000 150.000 7.500 1.875 1.335 12% 4 0 0 0 0 0 12% 5 0 0 0 0 0

Total adjusted value AV2 7.812


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TOTAL ADJUSTED VALUE AV1+AV2 9462

NPV

AV

NET PRESENT VALUE: 60.429 + 9462 = 69.892

Financial Statements

INCOME STATEMENT 2013 2014 2015 2016 2017 Sales revenue 0 0 600.000 750.000 100.000 Cost of goods sold 43.000 620.000 0 0 0 Gross margin -43.000 -620.000 600.000 750.000 100.000 General, selling ,administrative expenses 72.026 78.209 79.414 80.644 71.931 Depreciation costs 1.400 1.400 1.400 400 400 Operating Income -116.426 -699.609 519.186 668.956 27.669 Interest expense 2.500 35.000 9.500 1.500 1.000 Taxable Income -118.926 -734.609 509.686 667.456 26.669 Income tax - 25% 0 0 0 80.901 6.667 Net Income -118.926 -734.609 509.686 586.554 20.002

Allocation of net income: Dividends 0 0 0 250.000 0

Retained earnings -118.926 -734.609 509.686 336.554 20.002 (1)

Accumulated income -118.926 -853.535 -343.850 323.606 N/A Income tax 0 0 0 80.901 Per Portuguese law one is allowed to recover previous losses (up to 4 years) for income tax purposes


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BALANCE SHEET Assets 2013 2014 2015 2016 2017 Property, plant and equipment (PP&E) 5.000 5.000 5.000 5.000 5.000 Accumulated depreciation 1.400 2.800 4.200 4.600 5.000 Net PP&E 3.600 2.200 800 400 0

Current assets Inventories 0 0 0 0 0

Receivables 0 0 20.000 115.000 115.000 Cash and marketable securities 100 120 120 120 120 Total current assets 100 120 20.120 115.120 115.120

Total Assets 3.700 2.320 20.920 115.520 115.120

Liabilities and Stokholders' Equity 2013 2014 2015 2016 2017 Paid-in capital 50.000 50.000 50.000 50.000 50.000 Retained earnings -118.926 -853.535 -343.850 -7.296 12.706 Stockholders' equity -68.926 -803.535 -293.850 42.704 62.706

Long term debt 50.000 40.000 30.000 20.000 10.000

Current liabilities Short-term debt 0 650.000 150.000 0 0

Accounts payable 22.626 115.855 134.770 52.816 42.414 Total current liabilities 22.626 765.855 284.770 52.816 42.414

Total liabilities and stockholders' equity 3.700 2.320 20.920 115.520 115.120

subject module - elective ciakl ii - class 12

Business