ANALYZING START-UP RESOURCES CHAPTER Nine

Gathering Entrepreneurial Resources Start-up resources include: People (founding team, advisors, independent contractors) Physical assets (equipment, inventory, office or plant space) Financial (cash, equity, debt)

Bootstrapping Minimizing resources to keep low overhead Creating innovative combinations of resources to generate competitive advantage and wealth

Identifying Resource Needs Questions to answer Who does the work in this business? Where do these people work? What do they need to do the work? What information is being generated? Where does that information go?

Finding the Right Numbers- Triangulation Entrepreneur’s knowledge The Industry Venture Numbers The Market/Customer

Sales Forecast Timeline

Estimating Sales and Expenditures Develop timeline of seasonal patterns and key events that might change sales’ levels. Identify potential key events which could change sales estimates Calculate the impact of the change on the estimate Determine the probability of the occurrence

Estimating Sales and Expenditures (continued) Percentage increase in sales over 3-5 year period depends upon: Growth rates in the product/service market segment Innovations that make the product/service more attractive to the consumer Technological innovations that results in lower cost of products/services to the consumer

Estimating Sales and Expenditures (continued) Forecasting expenditures-items to consider: Cost of goods sold (COGS) Selling, general and administrative expenses (S, G, & A) Taxes

Preparing the Pro Forma Income Statement Sections of the Income Statement Section 1: revenues from all sources Section 2: operating expenses Forecasting cash needs- The Cash Flow Statement Section 1: cash receipts Section 2: cash disbursements

Preparing the Pro Forma Income Statement (continued) Assessing Risk Is the business financially feasible? Is there enough money to make the effort worthwhile?

Tools & Information NAICS ProFormas Demonstrate an understanding of entrepreneurial resource gathering Explain how to find the right numbers Estimate sales and expenditures for the new venture Prepare the pro forma income statement Forecast start-up cash needs With the use of Industry Information, The ONLY assumptiona left to defend are 1) Quanity, 2) Price, 3) Growth

Understanding Financial Statements Financial Statements (Accounting Statements) Reports of a firm’s financial performance and resources, including an income statement and a balance sheet Helps determine a startup’s financial requirements Assesses the financial implications of a business plan

Understanding Financial Statements 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 – Expenses = Profits Revenue from product or service sales Costs of producing product or service Operating expenses (marketing, selling, general and administrative expenses, and depreciation) Financing costs (interest paid) Tax payments

The Income Statement: An Overview 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 Interest expense on debt (financing costs) Taxes Income taxes

The Balance Sheet Balance Sheet A report showing a firm’s assets, liabilities, and owners’ equity at a specific point in time Outstanding debt + Owner’s equity = Total assets

The Balance Sheet: Types of Assets Current assets (working capital) Assets that can be converted to cash within the firm’s operating cycle—cash, accounts receivable, and inventories. Fixed Assets Relatively permanent resources intended for the use of the firm. Net fixed assets = gross fixed assets – accumulated depreciation Other Assets Intangible assets (patents, copyrights, goodwill)

The Balance Sheet: Types of Financing Debt Capital Financing provided by a creditor Short-term (current) Debt Accounts payable Accrued expenses Short-term notes Long-Term Debt Loans and mortgages from banks and other lenders with maturities greater than one year

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. Owners’ Equity = Owners’ investment – Owners’ cash withdrawals Cumulative profits + Earnings retained within Business

The Balance Sheet: An Overview Current Assets Cash Accounts receivable Inventories Other Assets Long-term investments, patents + Total Assets = Fixed Assets Machinery and equipment Buildings and land Debt Capital Accounts payable Accrued expenses Short-term notes Long-term notes Mortgages Total Debt and Equity Owner's Equity Owner's net worth or Partnership equity Common stock equity Assets Debt (Liabilities) and Equity (Net Worth) Current Debt Long-term Debt The Balance Sheet: An Overview

Determining Cash Flow: Key Terms Accrual-Basis Accounting A method of accounting that matches revenues when they are earned against the expenses associated with those revenues. Cash-Basis Accounting A method of accounting that reports transactions only when cash is received or a payment is made.

Determining Cash Flow: Key Terms Depreciation Expense Costs related to a fixed asset, such as a building or equipment, distributed over its life. Sustainable Growth Growth that can be financed from the cash flows generated from operating the business.

The Fit of the Income Statement and the Balance Sheet Income statement reports the profits from January 1, 2002 through December 31, 2002 2002 Balance Sheet Reports a firm's financial position at end of 2002 January 1 December 31 2001 Balance Sheet Reports a firm's financial position at beginning of 2002 (end of 2001)

Computing Cash Flows from Assets After-Tax Cash Flows from Operations Cash Flows from Assets Changes in Operating Working Capital Changes in Long-Term Assets After-tax cash flows from operations Investments in operating working capital Investments in long-term assets Cash flows from assets =

Computing Other Cash Flows After-Tax Cash Flows From Operations Net income Depreciation expense Interest Expense After-tax cash flows from operations = + Operating Work Capital Current assets Operating Working Capital = – Account payable and accruals

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

Financial Forecasting Pro forma Financial Statements Reports that provide projections of a firm’s financial position 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?

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?”

Forecasting Assets and Financing Requirements Estimating Asset Requirements Use industry ratios for assets-to-sales Use breakeven analysis and empirical data Percentage-of-Sales Technique Forecasting asset investment and financing requirements using a percentage of the total sales for a firm as the basis for forecasting the level of assets to be held by a firm.

Assets-to-Sales-Financing Relationships Increase in Sales Increase in Asset Requirements Financing Requirements Results in

Ratio Analysis Liquidity Current Ratio Debt Ratio 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.

Sources of Equity Capital External Equity Owners’ original investment Internal Equity Profit retention (retained profits) Forecasting financial requirements (in total) Total sources of financing Spontaneous financing Profits retained within the business Total asset requirements = + External sources of financing

Return on Invested Capital: An Overview Capital invested by the firm's creditors and equity investors (owners) Firm's total assets Profits and cash flows Rate of return on total capital becomes Creditors Equity investors Operating income Total assets Return on creditor's capital equity Interest rate charged on debt Net income Common equity compute equals Shared by Return on Invested Capital: An Overview