New Venture Development Chapters 1-3 Review New Venture Development

ENTREPRENEURIAL FINANCE Fourth Edition Chapter 1 Financial and Economic Concepts

Choices Available for Funds Expected financial returns of investment opportunity Investment opportunity Expected annual rate of return (%) Purchase stock 11 Purchase home 9 Purchase bonds 6 Place cash in saving account 2 Buy a new car -15

Opportunity Costs The highest value that is surrendered when a decision to invest funds is made. Given the previous table with choices for funds: If you decide to purchase a car (-15%), your opportunity cost is buying shares of stock (11%) If you decide to buy shares of stock (11%), your opportunity cost is buying a home (9%)

Income, Expenditures, and Taxes Gross income is all of the money received from all sources during the year. Wages Tips Interest earned on savings and bonds Income from rental property Profits to entrepreneurs

Basic Income Calculations Gross income - taxes = Disposable income For most of us, disposable income is take-home pay. Disposable income - Fixed expenses = Discretionary income Fixed expenses are contractual obligations like rent, utilities, insurance, and car payments. Discretionary income is cash that we can spend or save.

Taxes Progressive taxes: larger percentage of tax paid as income increases. Regressive taxes: smaller percentage of tax paid as income increases. Proportional taxes: percentage of tax paid remains the same at all levels of income.

Example of Progressive Tax Formula for tax percentage paid: Income tax is progressive:

Example of Regressive Tax Sales tax is regressive – it’s higher for those who consume more as a percentage of their incomes: Income = $20,000; savings = 0; sales tax = 5% Sales tax paid = $20,000 x 0.05 = 1,000 Income = $60,000; savings = $10,000; sales tax = 5% Sales tax paid = $50,000 x 0.05 = $2,500

Example of Proportional Tax The tax we pay into Medicare is a proportional tax (percentage of tax paid remains the same at all levels of income) Formula for tax percentage paid: Medicare tax is 1.45% Annual income $30,000 Medicare tax = $30,000 x 0.0145 = $435 Annual income $500,000 Medicare tax=$500,000 x 0.0145 = $7,250

Factors Affecting Interest Rates The supply of money saved is primarily the total money that is placed in demand deposit (checking) accounts, savings accounts, and money market mutual funds. Appear in a bank’s liabilities on balance sheet The demand for borrowed funds is all of the money that is demanded in our economy at a given price. Appear in a bank’s assets on balance sheet Assets Liabilities Equity Pay rates of 0 % to 3% Charge rates of 6% to 20%

Factors Affecting Interest Rates (continued) Federal Reserve Policy The Federal Reserve is the central bank of the United States. The Fed tries to control interest rates – and therefore the rate of inflation or deflation – by purchases and sales of bonds And by setting the overnight lending fee between banks (i.e., the “federal fund rate”)

Managing: You will know… 5 basic functions of a manager Difference between strategic plans and functional plans 3 factors that must be addressed when establishing goals Financial goals of a for-profit company 3-step process to take when using control How to compare and contrast different forms of business ownership The basic components of SWOT analysis What goes into a business plan

5 functions of managing Planning Organizing Staffing Directing Controlling operations

Planning A systematic process that takes from a current state to some future desired state Strategic planning is development of long-term (> 1 year) plans for the business Functional planning relates to the different functional areas that are driven by the strategic plan Financial planning is determining monetary requirements Goal setting forces you to identify measurable objectives that are achievable and have timelines

Organizing Defining structures, responsibilities, and lines of communication This comes from the functional plan: Who will do what? What skills they need? When do we have to accomplish specific tasks? How do we accomplish them?

Staffing Obtaining the most capable personnel to implement the business plans Each functional plan involves people assigned to specific jobs – you will have to write the job requirements (education, personal skills, training) and the job description

Directing Providing proper guidance and direction to others who will accomplish the organizational mission Good managers and employers have good long-term, loyal employees Directing in the financial arena is done through the budgeting process

Controlling A three-step process that involves: Establishing a standard of measurement Measuring actual performance against the standard Taking corrective action when actual performance deviates from established standard

Business organizations and ownership You are responsible for understanding the differences between the forms small businesses can take – follow the link above.

Starting a business One of the first decisions is legal formation (no “business” until owners establish it) Owner must determine how much money is needed to start the business (owner’s equity, outside financing) SWOT analysis

SWOT analysis Strengths, weaknesses, opportunities, and threats Strengths: the core competencies of your business – succeed because you do these better than competitors Weaknesses: areas where your business needs improvement (old equipment, untrained workers, no $)

SWOT analysis Strengths, weaknesses, opportunities, and threats Opportunities: factors that exist in the business environment that will help the business grow Threats: factors…that will impede the business

SWOT analysis Note: opportunities and threats are also shaped by your own strengths and weaknesses “Given my superior ability to write apps for iPhones, I can take advantage of the growing base of iPhone owners who use apps”

The business plan Tend to cover a common format to make it easier for investors to read The executive summary is everything. It is the first thing readers will see, but you should write it last You must convince your audience in two pages or less that they need to read the rest of your plan Autoshop example on wiki space

Stages of business growth Seed/start-up: the initial stage; the company has a concept and is normally < 18 months old Early: less than 3 years old, product or service is commercially available Expansion: older than 3 years old and has high revenue growth, but may not show a profit Later: product or service is widely available; generates revenue and has positive cash flow

Chapter 3 Financial Statements

Financial Statement (Personal Form) Single bank loan application form which incorporates two individual financial forms: Statement of financial position Cash Cash equivalents Invested assets Use assets Liabilities Net worth Personal cash flow statement Income Fixed expenses Variable expenses

Personal Income Statement (Cash Flow Statement) Income—Include all sources Wages, tips, overtime Interest on savings, stock dividends, etc. Fixed expenses Contractual, must be paid Rent, insurance, utilities, car payments, etc. Variable expenses You control level of expenses (food, clothing)

Sources of financing Personal assets: savings, investments, credit cards, home-equity loans Equity financing: company-retained earnings and fixed assets of company as collateral Bank loans Angel investors: provide seed money for start-up and early-stage companies Venture capitalists: provide financing at expansion and later stages of business development

Differentiating types of costs Variable costs are directly related to the volume of product flow – the cost you incur for each sale of a unit of product Variable costs X # units sold = total revenues Fixed costs are the operating costs associated with running the business but not directly related to revenues

Income Statement Business Basic Format Sales, revenues, income from doing business Less cost of goods sold Gross profit Less operating expenses Operating income Less interest Net income (explain)

Statement of Cash Flows Statement of cash flows shows how the company’s working capital flows into and out of the business during the year. Statement of cash flows includes: Cash flows from operating activities is the difference between all of the cash received by the business and all of the cash paid out by the business in conducting its day-to-day operations. Cash Flows from Investing Activities: Acquisition or sale of Plant Assets Cash Flows from Financing Activities: Proceeds from issuance or sale of stock (preferred & common), bonds. Purchase of stock or the payment of long-term debt.

Statement of Cash Flows (continued) Examples of operating cash flow Receipts: All cash received from sales, changes in accounts receivable, changes in inventory. NOTE: An increase in accounts receivable or inventory represents a negative cash flow. A reduction in receivables or inventory is a positive cash flow. Payments: All payments made by the company to all accounts (suppliers, employees, rent, utilities, etc.). Net increase (decrease) in cash plus the cash balance, previous year equals cash balance, current year.

Types of activities Operating Investing Financing Corporation

Balance Sheet (Statement of Financial Position) Total assets Current assets Cash, accounts receivable, inventory, treasuries Anything in your possession that can be reasonably be expected to turn into cash in 90 days Fixed assets Land Building & equipment (less accumulated depreciation) Net building & equipment

Balance Sheet (Statement of Financial Position) Total liabilities Current liabilities Accounts payable, notes payable, taxes payable Long-term liabilities (debt) Total equity Preferred stock Common stock par value Paid-in capital in excess of par (common) Retained earnings

Balance Sheet Basic Accounting Equation Individual Sole Proprietorship Partnership Corporation

Family

Balance sheet – “Partners’ equity”

Corporation Assets Current assets Fixed assets Liabilities and SE Equity Current liabilities Long-term liabilities Shareholders’ equity Preferred stock Common stock Retained earnings Corporation

What’s accumulated depreciation? Corporation

Depreciation The wearing out of a business asset during its useful life The IRS establishes schedules that businesses use to determine the appropriate method of depreciation Land never depreciates, but equipment does, usually over 10-year period Break down depreciation schedules for each piece of equipment When a fixed asset is sold or disposed of, both its cost and accumulated depreciation go off the balance sheet

Accumulated depreciation on the balance sheet