Part III – Developing the Entrepreneurial Plan Chapter 7 – Environmental Assessment: Preparation for a New Venture Chapter 8 – Marketing Research for New Ventures Chapter 9 – Financial Preparation for Entrepreneurial Ventures Chapter 10 – Developing an Effective Business Plan Copyright (c) 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Chapter 9 – Financial Preparation For Entrepreneurial Ventures

The Importance of Financial Information for Entrepreneurs

Significant Information for Financial Management The importance of ratio analysis in planningThe importance of ratio analysis in planning Techniques and uses of projected financial statementsTechniques and uses of projected financial statements Techniques and approaches for designing a cash-flow scheduleTechniques and approaches for designing a cash-flow schedule Techniques and approaches for evaluating the capital budgetTechniques and approaches for evaluating the capital budget

The Balance Sheet Represents the financial condition of a company at a certain date. It details the items the company owns (assets) and the amount the company owes (liabilities). It also shows the net worth of the company and its liquidity. Assets = Liabilities + Owners Equity

The Income Statement Commonly referred to as the P & L (profit and loss) statement, which provides the owner/manager with the results of operations.

Statement of Cash Flow An analysis of the cash availability and cash needs of the business.

Preparing Financial Statements One of the most powerful tools the entrepreneur can use in planning financial operations is a budget. The operating budget is a statement of estimated income and expenses over a specified period of time. The cash budget is a statement of estimated cash receipts and expenditures over a specified period of time. The capital budget is used to plan expenditures on assets whose returns are expected to last beyond one year.

The Operating Budget Typically, the first step in creating an operating budget is the preparation of the sales forecast. An entrepreneur can prepare the sales forecast in several ways. One way is to implement a statistical forecasting technique such as simple linear regression.Typically, the first step in creating an operating budget is the preparation of the sales forecast. An entrepreneur can prepare the sales forecast in several ways. One way is to implement a statistical forecasting technique such as simple linear regression. Y = a + bx Y is a dependent variable (it is dependent on the values of a, b, and x ), x is an independent variable (it is not dependent on any of the other variables), a is a constant (in regression analysis, Y is dependent on the variable x, all other things held constant), and b is the slope of the line (the change in Y divided by the change in x ).Y is a dependent variable (it is dependent on the values of a, b, and x ), x is an independent variable (it is not dependent on any of the other variables), a is a constant (in regression analysis, Y is dependent on the variable x, all other things held constant), and b is the slope of the line (the change in Y divided by the change in x ).

The Cash-Flow Budget The first step in the preparation of the cash-flow budget is the identification and timing of the cash inflows. For the typical business, cash inflows will come from three sources: (1) cash sales, (2) cash payments received on account, and (3) load proceeds.

Pro Forma Statements Pro forma statements are projections of a firm’s financial position over a future period (pro forma income statement) or on a future date (pro forma balance sheet).

Capital Budgeting The first step in capital budgeting is to identify the cash flows and their timing. The inflows, or returns as they are commonly called, are equal to net operating income before deduction of payments to the financing sources but after the deduction of applicable taxes and with depreciation added back, as represented by the following formula: Expected Returns = X(1 – T) + Depreciation

Payback Method In this method the length of time required to “pay back” the original investment is the determining criterion.

Net Present Value (NPV method) The concept works on the premise that a dollar today is worth more than a dollar in the future. The cost of capital is the rate used to adjust future cash flows to determine their value in present period terms. This procedure is referred to as discounting the future cash flows, and the discounted cash value is determined by the present value of the cash flow.

Internal Rate of Return (IRR method) This method is similar to the net present value method in that the future cash flows are discounted. However, they are discounted at a rate that makes the net present value of the project equal to zero.

Break-Even Analysis

Contribution Margin Approach The difference between the selling price and the variable cost per unit. It is the amount per unit that is contributed to covering all other costs. 0 = (SP –VC)S – FC or FC = (SP – VC)S where SP = Unit selling price VC = Variable cost per unit S = Sales in units FC = Fixed costThe difference between the selling price and the variable cost per unit. It is the amount per unit that is contributed to covering all other costs. 0 = (SP –VC)S – FC or FC = (SP – VC)S where SP = Unit selling price VC = Variable cost per unit S = Sales in units FC = Fixed cost

Graphic Approach The entrepreneur needs to graph at least two numbers: total revenue and total costs. The intersection of these two lines (that is, where total revenues are equal to the total costs) is the firm’s break-even point. Two additional costs – variable costs and fixed costs – also may be plotted.

Goodman Industries: Graphic Break-Even Fixed Projected Costs/Profits $ Variable Sales Total Cost Unit Sales

Balance Sheet Ratios Current Current Assets Current Liabilities Quick Cash + Accounts Receivable Current Liabilities

Income Statement Ratios Gross Margin Sales Net Margin Net Profit before Tax Sales

Overall Efficiency Ratios Sales-to-Assets Sales Total Assets Return on Assets Net Profit before Tax Total Assets Return on Investment Net Profit before Tax Net Worth

Specific Efficiency Ratios Inventory Turnover Cost of Goods Sold Inventory Inventory turn-days 360 Inventory Turnover Accounts Receivable Turnover Sales Accounts Receivable

Specific Efficiency Ratios Average Collection Period 360 Accounts Receivable Turnover Accounts Payable Turnover Cost of Goods Sold Accounts Payable Accounts Receivable Turnover 360