1. PowerPoint Presentation by Charlie Cook The University of West Alabama Longenecker Moore Petty Palich © 2008 Cengage Learning. All rights reserved. CHAPTER 10 The Financial Plan: Projecting Financial Requirements Developing the New Venture Business Plan Part 3

2. © 2008 Cengage Learning. All rights reserved.10–2 Looking AHEAD 1.Describe the purpose and content of the income statement, the balance sheet, and the cash flow statement. 2.Forecast a new venture’s profitability. 3.Determine asset requirements, evaluate financial sources, and estimate cash flows for a new venture. 4.Explain the importance of using good judgment when making projections. After you have read this chapter, you should be able to:

3. © 2008 Cengage Learning. All rights reserved.10–3 Understanding Financial Statements Financial Statements (Accounting Statements)  Reports of a firm’s financial performance and resources  Helps determine a startup’s financial requirements  Assesses the financial implications of a business plan Basic Financial Statements  Income statement  Balance sheet  Cash flow statement

4. © 2008 Cengage Learning. All rights reserved.10–4 Understanding Financial Statements (cont’d) Income Statement  A report showing the profit or loss from a firm’s operations over a given period of time.  “How profitable is the business?”  Sales (revenue) – Expenses = Profits –Revenue from product or service sales –Costs of producing product/service (cost of goods sold) –Operating expenses (marketing, selling, general and administrative expenses, and depreciation) –Financing costs (interest paid) –Tax payments

5. © 2008 Cengage Learning. All rights reserved.10–5 Sections of the Income Statement (cont’d) Cost of Goods Sold  The cost of producing or acquiring goods or services to be sold by a firm Gross profit  Sales less the cost of goods sold Operating expenses  Costs related to marketing and selling a firm’s product or service, general and administrative expenses, and depreciation Operating income  Earnings before interest and taxes are paid

6. © 2008 Cengage Learning. All rights reserved.10–6 Sections of the Income Statement (cont’d) Financing Costs  The amount of interest owed to lenders on borrowed money Net Income Available To Owners (Net Income)  Income that may be distributed to the owners or reinvested in the company Depreciation Expense  Costs related to a fixed asset, such as a building or equipment, distributed over its useful life

7. © 2008 Cengage Learning. All rights reserved.10–7 The Income Statement: An Overview 10-1

8. © 2008 Cengage Learning. All rights reserved.10–8 Operating Activities Sales Revenue = = = Operating Income Earnings Before Taxes Net Income Available to Owners Cost of producing or acquiring product or service (cost of goods sold) Gross profit Marketing and selling expenses, general and administrative expenses and depreciation (operating expenses), – = – Financing Activities Operating Income Interest expense on debt (financing costs) – Taxes Earnings Before Taxes Income taxes – Sections of the Income Statement (cont’d)

9. © 2008 Cengage Learning. All rights reserved.10–9 Income Statement for Trimble & Associates Leasing, Inc., for the Year Ending December 31, 2007 10-2

10. © 2008 Cengage Learning. All rights reserved.10–10 The Balance Sheet Balance Sheet  A report showing a firm’s assets, liabilities, and owners’ equity at a specific point in time Total Assets = Debt + Owner’s equity

11. © 2008 Cengage Learning. All rights reserved.10–11 The Balance Sheet: An Overview 10-3

12. © 2008 Cengage Learning. All rights reserved.10–12 The Balance Sheet: Current Assets Current Assets (Gross Working Capital)  Assets that can be converted to cash within the firm’s operating cycle  Cash  Currency and negotiable instruments  Accounts receivable  The amount of credit extended to customers that is currently outstanding  Inventory  Raw materials and products held in anticipation of eventual sale

13. © 2008 Cengage Learning. All rights reserved.10–13 The Balance Sheet: Fixed Assets Fixed Assets  Relatively permanent resources intended for use in the business (not for resale) Depreciable Assets  Assets whose value declines (depreciates) over time Gross Fixed Assets  Original cost of depreciable assets before any depreciation expense has been taken Accumulated Depreciation  Total depreciation expense taken over the assets’ life

14. © 2008 Cengage Learning. All rights reserved.10–14 The Balance Sheet: Fixed Assets (cont’d) Net Fixed Assets  Gross fixed assets less accumulated depreciation Other Assets  Assets other than current assets and fixed assets, such as patents, copyrights, and goodwill that have an estimated value

15. © 2008 Cengage Learning. All rights reserved.10–15 The Balance Sheet: Debt Debt  Business financing provided by a creditor Current (Short-Term) Debt  Accounts payable: credit payable to suppliers  Accrued expenses: short-term liabilities incurred but not paid  Short-term notes: Cash amounts borrowed that must be repaid within a short period of time Long-Term Debt  Loans and mortgages with maturities greater than one year

16. © 2008 Cengage Learning. All rights reserved.10–16 The Balance Sheet: Debt (cont’d) Mortgage  A long-term loan from a creditor for which real estate is pledged as collateral

17. © 2008 Cengage Learning. All rights reserved.10–17 The Balance Sheet: Types of Financing Owners’ Equity  Money that the owners invest in the business  Owners are “residual owners” of the firm.  Creditors have first claim on the assets of the firm. Retained earnings  Profits less withdrawals (dividends) over the life of the business Owners’ equity = Owners’ investment – Cumulative dividends paid to owners Cumulative profits + Owners’ equity = Owners’ investment + Earnings retained within the business

18. © 2008 Cengage Learning. All rights reserved.10–18 Balance Sheets for Trimble & Associates Leasing, Inc., for December 31, 2006 and 2007 10-4

19. © 2008 Cengage Learning. All rights reserved.10–19 The Fit of the Income Statement and Balance Sheet 10-5

20. © 2008 Cengage Learning. All rights reserved.10–20 The Cash Flow Statement Cash Flow Statement  A financial report showing a firm’s income (cash) when it is received and expenses when they are paid.  Cash flows from normal operations (operating activities)  Cash flows related to the investment in or sale of assets (investment activities)  Cash flows related to financing the firm (financing activities)

21. © 2008 Cengage Learning. All rights reserved.10–21 Profits Versus Cash Flows Accrual-Basis Accounting  Matches revenues when they are earned against the expenses associated with those revenues.  Sales reflect both cash and credit (noncash) sales  Inventory purchased on credit is a noncash expense  Depreciation is a noncash expense  Income tax is accrued and not entirely expensed Cash-Basis Accounting  Reports transactions only when cash is received or a payment is made.

22. © 2008 Cengage Learning. All rights reserved.10–22 Measuring Cash Flows Cash Flows from Operations  Net cash flows generated from operating a business  Calculated by adding back to operating income depreciation, deducting income taxes, and factoring in any changes in net working capital. Adjusted Income  After-tax cash flow Net Working Capital  Money invested in current assets less accounts payable and accruals

23. © 2008 Cengage Learning. All rights reserved.10–23 Measuring Cash Flows (cont’d) Cash Flows from Investment Activities  Cash inflows and outflows resulting from the sale or purchase of equipment or another depreciable asset Cash Flows from Financing Activities  Cash inflows and outflows resulting from:  Paying dividends and interest expense.  Increasing or decreasing short-term and long-term debt.  Issuing or repurchasing stock.

24. © 2008 Cengage Learning. All rights reserved.10–24 After-Tax Cash Flows from Operations Cash Flows from Assets Changes in Operating Working Capital Changes in Long-Term Assets Computing Cash Flows from Assets After-tax cash flows from operations Investments in operating working capital Investments in long-term assets Cash flows from assets =

25. © 2008 Cengage Learning. All rights reserved.10–25 Computing Other Cash Flows After-Tax Cash Flows From Operations Net income Depreciation expense Interest Expense After-tax cash flows from operations = + + Operating Working Capital Current assets Operating Working Capital = – Account payable and accruals

26. © 2008 Cengage Learning. All rights reserved.10–26 Cash Flow Statement for Trimble & Associates Leasing, Inc., for the Year Ending December 31, 2007 10-6

27. © 2008 Cengage Learning. All rights reserved.10–27 Cash Flows from Financing Interest and Dividends Paid to Investors Increase in Debt (firm issues new debt) Increase in Equity (firm issues new stock) Decrease in Debt (firm repays debt) Decrease in Equity (firm repurchases outstanding stock) Increases in Cash Flows from Financing Decreases in Cash Flows from Financing Cash Flows from Financing

28. © 2008 Cengage Learning. All rights reserved.10–28 Cash Flow Patterns 10-7 Pattern 1. This firm has positive cash flows from operations, negative investment cash flows, and positive cash flows from financing. It is using its cash flows from operations and new financing to expand the firm’s operations. Pattern 2. This firm is using cash flows from operations to expand the business, pay down debt, and/or pay its owners. Pattern 3. This firm is encountering negative cash flows from operations, which are being covered by selling assets and by borrowing or acquiring more equity financing. Pattern 4. This firm has negative cash flows from operations and is growing the company’s fixed assets through increased financing. This firm is a startup business that has yet to break even, is investing in assets to produce future cash flows, and is having to raise capital to make that happen.

29. © 2008 Cengage Learning. All rights reserved.10–29 Financial Forecasting Pro Forma Financial Statements  Statements that project a firm’s financial performance and condition  Purposes of pro forma statements:  How profitable can the firm be expected to be, given the projected sales levels and the expected sales expense relationships?  What will determine the amount and type of financing (debt or equity) to be used?  Will the firm have adequate cash flows? If so, how will they be used; if not, where will the additional cash come from?

30. © 2008 Cengage Learning. All rights reserved.10–30 Forecasting Profitability Net Income Depends On:  Amount of sales  Cost of goods sold and operating expenses  Interest expense  Taxes “If we’re doing so well, then why am I always so broke?”

31. © 2008 Cengage Learning. All rights reserved.10–31 Pro Forma Income Statements for C&G Products, Inc. 10-8

32. © 2008 Cengage Learning. All rights reserved.10–32 Forecasting Assets and Financing Requirements and Cash Flows Bootstrapping  Minimizing a firm’s investments Determining Asset Requirements  Use industry ratios for assets-to-sales  Use breakeven analysis and empirical data Percentage-of-Sales Technique  Using a percentage of the total sales for a firm as the basis for forecasting the level of assets. accounts receivable, and inventories to be held by a firm.

33. © 2008 Cengage Learning. All rights reserved.10–33 Assets-to-Sales Financing Relationships 10-9

34. © 2008 Cengage Learning. All rights reserved.10–34 Percentage-of-Sales Technique Example

35. © 2008 Cengage Learning. All rights reserved.10–35 Determining Financing Requirements Basic Principles for Financing of Firms  The more assets a firm needs, the greater the firm’s financial requirements.  A firm should finance its growth in such a way as to maintain proper liquidity.  The amount of total debt that can be used in financing a business is limited by the amount of funds provided by the owners.  Some types of short-term debt maintain a relatively constant relationship with sales.  There are two sources of equity: external and internal.

36. © 2008 Cengage Learning. All rights reserved.10–36 Determining Financing Requirements Liquidity  The degree to which a firm has working capital available to meet maturing debt obligations. Current Ratio  The firm’s relative liquidity, determined by dividing current assets by current liabilities. Debt Ratio  Debt as a fraction of assets; total debt divided by total assets.  Spontaneous financing—debts such as accounts payable that increase as the firm grows.

37. © 2008 Cengage Learning. All rights reserved.10–37 Sources of Equity Capital External Equity  The owners’ original investment Profit Retention  The reinvestment of profits in a firm Internal Equity  Capital from retaining profits within the firm Forecasting financial requirements (in total): Total sources of financing Spontaneous financing Profits retained within the business Total asset requirements = + = External sources of financing +

38. © 2008 Cengage Learning. All rights reserved.10–38 Projected Balance Sheets for C&G Products, Inc. 10-10

39. © 2008 Cengage Learning. All rights reserved.10–39 Good Forecasting Requires Good Judgment Practical Suggestions 1. Develop realistic sales projections. 2. Build projections from clear assumptions about marketing and pricing plans. 3. Do not use unrealistic profit margins. 4. Don’t limit your projections to an income statement. 5. Provide monthly data for the upcoming year and annual data for succeeding years. 6. Avoid providing too much financial information. 7. Be certain that the numbers reconcile—and not by simply plugging in a figure. 8. Follow the plan.

40. © 2008 Cengage Learning. All rights reserved.10–40 Key TERMS financial statements (accounting statements) income statement (profit and loss statement) cost of goods sold gross profit operating expenses operating income financing costs earnings before taxes net income available to owners (net income) depreciation expense balance sheet statement of net worth current assets (gross working capital) accounts receivable inventory fixed assets depreciable assets gross fixed assets accumulated depreciation net fixed assets other assets debt current debt (short-term liabilities) accounts payable (trade credit)

41. © 2008 Cengage Learning. All rights reserved.10–41 Key TERMS accrued expenses short-term notes long-term debt mortgage ownership equity retained earnings cash flow statement accrual-basis accounting cash-basis accounting cash flows from operations adjusted income net working capital pro forma financial statements bootstrapping percentage-of-sales technique liquidity current ratio debt ratio spontaneous financing external equity profit retention internal equity

42. PowerPoint Presentation by Charlie Cook The University of West Alabama Longenecker Moore Petty Palich © 2008 Cengage Learning. All rights reserved. Appendix 10A: Computing Cash Flows for Trimble & Associates Leasing, Inc. Developing the New Venture Business Plan Part 3

43. © 2008 Cengage Learning. All rights reserved.10–43 Income Statement and Balance Sheet Changes for Trimble & Associates Leasing, Inc., for the Year Ending December 31, 2007 A10-1

44. © 2008 Cengage Learning. All rights reserved.10–44 Cash Flow Statement for Trimble & Associates Leasing, Inc., for the Year Ending December 31, 2007 A10-2

45. PowerPoint Presentation by Charlie Cook The University of West Alabama Longenecker Moore Petty Palich © 2008 Cengage Learning. All rights reserved. Appendix 10B: Computing Cash Flows for C&G Products, Inc. Developing the New Venture Business Plan Part 3

46. © 2008 Cengage Learning. All rights reserved.10–46 Cash Flow Statements for C&G Products, Inc. A10-B