Student Business Academy Fundamentals of entrepreneurial finance

Why Most New Ventures Need Financing or Funding 10-2

The Importance of a Financial Plan Common mistake among business owners: Failing to collect and analyze basic financial data. Many entrepreneurs run their companies without any kind of financial plan. Only 11% of business owners analyze their companies’ financial statements as part of the managerial planning process. Financial planning is essential to running a successful business and is not that difficult! Ch, 11: Creating a Successful Financial Plan 11 - 3

Basic Financial Statements Balance Sheet – “Snapshot.” Estimates the firm’s worth on a given date; built on the accounting equation: Assets = Liabilities + Owner’s Equity Income Statement – “Moving picture.” Compares the firm’s expenses against its revenue over a period of time to show its net income (or loss): Net Income = Sales Revenue - Expenses Statement of Cash Flows – Shows the change in the firm's working capital over a period of time by listing the sources and uses of funds. Ch, 11: Creating a Successful Financial Plan 11 - 4

Creating Projected Financial Statements Helps the entrepreneur transform business goals into reality Challenging for a business start-up Start-ups should focus on creating projections for two years Projected financial statements: Income statements Balance sheet Ch, 11: Creating a Successful Financial Plan 11 - 5

Twelve Key Ratios Liquidity Ratios - Tell whether or not a small business will be able to meet its maturing obligations as they come due. 1. Current Ratio - Measures solvency by showing the firm's ability to pay current liabilities out of current assets. Current Ratio = Current Assets = $686,985 = 1.87:1 Current Liabilities $367,850 Ch, 11: Creating a Successful Financial Plan 11 - 6

Twelve Key Ratios Liquidity Ratios - Tell whether or not a small business will be able to meet its maturing obligations as they come due. 2. Quick Ratio - Shows the extent to which a firm’s most liquid assets cover its current liabilities. Quick Ratio = Quick Assets = 686,985 – 455,455 = .63:1 Current Liabilities $367,850 Ch, 11: Creating a Successful Financial Plan 11 - 7

Twelve Key Ratios Leverage Ratios - Measure the financing provided by a firm’s owners against that supplied by its creditors; it is a gauge of the depth of the company’s debt. Debt Ratio - Measures the percentage of total assets financed by creditors rather than owners. Debt Ratio = Total Debt = $367,850 + 212,150 = .68:1 Total Assets $847,655 Ch, 11: Creating a Successful Financial Plan 11 - 8

Twelve Key Ratios Leverage Ratios - Measure the financing provided by a firm’s owners against that supplied by its creditors; it is a gauge of the depth of the company’s debt. 4. Debt to Net Worth Ratio - Compares what a business “owes” to “what it is worth.” Debt to Net = Total Debt = $580,000 = 2.20:1 Worth Ratio Tangible Net Worth $264,155 Ch, 11: Creating a Successful Financial Plan 11 - 9

Twelve Key Ratios Leverage Ratios - Measure the financing provided by a firm’s owners against that supplied by its creditors; it is a gauge of the depth of the company’s debt. 5. Times Interest Earned - Measures the firm's ability to make the interest payments on its debt. Times Interest = EBIT* = $60,629 + 39,850 = Earned Total Interest Expense $39,850 = $100,479 = 2.52:1 $39,850 *Earnings Before Interest and Taxes Ch, 11: Creating a Successful Financial Plan 11 - 10

Twelve Key Ratios Operating Ratios - Evaluate a firm’s overall performance and show how effectively it is putting its resources to work. 6. Average Inventory Turnover Ratio - Tells the average number of times a firm's inventory is “turned over” or sold out during the accounting period. Average Inventory = Cost of Goods Sold = $1,290,117 = 2.05 times Turnover Ratio Average Inventory* $630,600 a year *Average Inventory = Beginning Inventory + Ending Inventory 2 Ch, 11: Creating a Successful Financial Plan 11 - 11

Twelve Key Ratios Operating Ratios - Evaluate a firm’s overall performance and show how effectively it is putting its resources to work. 7. Average Collection Period Ratio (days sales outstanding, DSO) - Tells the average number of days required to collect accounts receivable. Two Steps: Receivables Turnover = Credit Sales = $1,309,589 = 7.31 times Ratio Accounts Receivable $179,225 a year Average Collection = Days in Accounting Period = 365 = 50.0 Period Ratio Receivables Turnover Ratio 7.31 days Ch, 11: Creating a Successful Financial Plan 11 - 12

Twelve Key Ratios Operating Ratios - Evaluate a firm’s overall performance and show how effectively it is putting its resources to work. 8. Average Payable Period Ratio - Tells the average number of days required to pay accounts payable. Two Steps: Payables Turnover = Purchases = $939,827 = 6.16 times Ratio Accounts Payable $152,580 a year Average Payable = Days in Accounting Period = 365 = 59.3 days Period Ratio Payables Turnover Ratio 6.16 Ch, 11: Creating a Successful Financial Plan 11 - 13

Twelve Key Ratios Operating Ratios - Evaluate a firm’s overall performance and show how effectively it is putting its resources to work. 9. Net Sales to Total Assets Ratio - Measures a firm’s ability to generate sales given its asset base. Net Sales to = Net Sales = $1,870,841 = 2.21:1 Total Assets Total Assets $847,655 Ch, 11: Creating a Successful Financial Plan 11 - 14

Twelve Key Ratios Profitability Ratios - Measure how efficiently a firm is operating; offer information about a firm’s “bottom line.” 10. Net Profit on Sales Ratio - Measures a firm’s profit per dollar of sales revenue. Net Profit on = Net Income = $60,629 = 3.24% Sales Net Sales $1,870,841 Ch, 11: Creating a Successful Financial Plan 11 - 15

Twelve Key Ratios Profitability Ratios - Measure how efficiently a firm is operating; offer information about a firm’s “bottom line.” 11. Net Profit to Assets (Return on Assets) Ratio – tells how much profit a company generates for each dollar of assets that it owns. Net Profit to = Net Income = $60,629 = 7.15% Assets Total Assets $847,655 Ch, 11: Creating a Successful Financial Plan 11 - 16

Twelve Key Ratios Profitability Ratios - Measure how efficiently a firm is operating; offer information about a firm’s “bottom line.” 12. Net Profit to Equity* Ratio - Measures an owner's rate of return on the investment (ROI) in the business. Net Profit to = Net Income = $60,629 = 22.65% Equity Owner’s Equity* $267,655 * Also called Net Worth Ch, 11: Creating a Successful Financial Plan 11 - 17

Breakeven Analysis Breakeven point - the level of operation at which a business neither earns a profit nor incurs a loss. A useful planning tool because it shows entrepreneurs minimum level of activity required to stay in business. With one change in the breakeven calculation, an entrepreneur can also determine the sales volume required to reach a particular profit target. Ch, 11: Creating a Successful Financial Plan 11 - 18

Calculating the Breakeven Point Step 1. Determine the expenses the business can expect to incur. Step 2. Categorize the expenses in step 1 into fixed expenses and variable expenses. Step 3. Calculate the ratio of variable expenses to net sales. Then compute the contribution margin: Variable Expenses 1 - Contribution Margin = Net Sales Estimate Step 4. Compute the breakeven point: Total Fixed Costs Breakeven Point ($) = Contribution Margin Ch, 11: Creating a Successful Financial Plan 11 - 19

Ch. 6: Franchising and the Entrepreneur 11 - 20

Alternatives for Raising Money for a New Venture Personal Funds Equity Capital Debt Financing Creative Sources

Preparing for Personal Financing Personal Funds The vast majority of founders contribute personal funds, along with sweat equity, to their ventures. Sweat equity represents the value of the time and effort that a founder puts into a new venture. Friends and Family Friends and family are the second source of funds for many new ventures.

Preparing to Raise Debt or Equity Financing

Preparing to Raise Debt of Equity Financing Two Most Common Alternatives Equity Funding Debt Financing Means exchanging partial ownership in a firm, usually in the form of stock, for funding. Is getting a loan.

Strategic Partners Strategic Partners Strategic partners are another source of capital for new ventures. Many partnerships are formed to share the costs of product or service development, to gain access to particular resources, or to facilitate speed to market. Older established firms benefit by partnering with young entrepreneurial firms by gaining access to their creative ideas and entrepreneurial spirit.