Outline: Chapter 1 Introduction Importance of knowing the numbers Measuring success What is entrepreneurial financial management? What Makes Entrepreneurial Finance Similar to Traditional Finance? What Makes Entrepreneurial Finance Different from Traditional Finance? Ethics and entrepreneurial finance Copyright 2009 Cornwall, Vang & Hartman

Financial Management: The “Language” of Business Used to set clear financial goals Used to make decisions Used to forecast Used to manage cash flow Used to seek financing Used to determine an exit process for the business Copyright 2009 Cornwall, Vang & Hartman

Measuring “Success” Income for entrepreneur Wealth for entrepreneur Goals derived from personal values of the entrepreneur Copyright 2009 Cornwall, Vang & Hartman

Differences between Traditional and Entrepreneurial Finance Lack of historical data to measure risk Lack of historical data and liquidity complicate the practice of finance in early stage firms Copyright 2009 Cornwall, Vang & Hartman

Perspective of Investors Prefer less risk Diversified investors concerned with systematic risk Non-diversified investors concerned with total risk Prefer more return Prefer quick return Prefer liquidity Investors face many different opportunities No investors are immune from these expectations Copyright 2009 Cornwall, Vang & Hartman

Finance Relationships Total Risk = Diversifiable Risk + Nondiversifiable Risk Required Rate of Return = Rf + Beta(Rm - Rf) Rf = Risk-Free Rate of Return Rm = Return on Market Index like SP500 Rm-Rf =Market Risk Premium Beta is a measure of Nondiversifiable Risk Beta < 1 means asset is less volatile than market (safe asset) Beta = 1 means asset is just as volatile as market (average asset) Beta > 1 means asset is more volatile than market (risky asset) Copyright 2009 Cornwall, Vang & Hartman

Figure 1.1 Building a Financial Forecast Setting Financial Goals Revenue Forecasting Expense Forecasting Monitoring Performance Copyright 2009 Cornwall, Vang & Hartman

Table 1.1 Example of Stakeholder Analysis Ethical Principle Application Family Create balance between work demands and family time. Establish a more moderate financial growth goal to allow for time with family. Investors Deal with all investors openly and honestly. Develop a financial reporting system that provides full and accurate historical information as well as realistic forecasts. Employees Share financial success with those that helped create it. Profit sharing, stock option plans, phantom stock, ESOP, etc. while still meeting goals of entrepreneur. Copyright 2009 Cornwall, Vang & Hartman

Table 1.1 Example of Stakeholder Analysis (continued) Ethical Principle Application Customers Fair pricing Establish revenue forecasts that are realistic given this pricing principle. Suppliers Prompt payment for money owed. Establish cash forecasts that are based on an assumption of prompt payment of all invoices submitted by suppliers/vendors. Banker Honest disclosure of information Assure timely and accurate financial reporting and reasonable financial forecasting. Community Reliable employment for the community. Manage cash flow to allow for stable employment even during times of temporary slowdowns Copyright 2009 Cornwall, Vang & Hartman

Outline: Chapter 2 Setting Financial Goals Wealth vs. income Integrating non-financial goals Importance of self-assessment The self-assessment process The business plan Copyright 2009 Cornwall, Vang & Hartman

Figure 2.1 Model for Entrepreneurial Financial Management Setting Financial Goals Revenue Forecasting Expense Forecasting Monitoring Performance Copyright 2009 Cornwall, Vang & Hartman

Life Cycle of a Business Venture Figure 2.2 Pre-Launch Start-up Growth Maturity Copyright 2009 Cornwall, Vang & Hartman

“Quick and Dirty” Valuation EBITDA + extra bonuses or compensation to owners = adjusted EBITDA X earnings multiple = Valuation - Outstanding Loans = Cash proceeds to owner Copyright 2009 Cornwall, Vang & Hartman

Integrating Non-Financial Goals Ethics and values Personal definition of “success” in business Family Community Personal interests Copyright 2009 Cornwall, Vang & Hartman

Business Plan Outline Executive Summary The Business Concept Industry Analysis Marketing Plan Operating Plan Financing Plan Copyright 2009 Cornwall, Vang & Hartman

Importance of Self-Assessment Keeps your goals front and center Financial goals change Non-financial goals change Part of on-going exit planning Copyright 2009 Cornwall, Vang & Hartman

Outline: Chapter 3 Understanding Financial Statements Accounting equation Assets = Liabilities + Owners’ Equity Basic financial statements Limitations of business financial statements Copyright 2009 Cornwall, Vang & Hartman

Basic Financial Statements Income Statement Balance Sheet Statement of Cash Flows Copyright 2009 Cornwall, Vang & Hartman

Income Statement Exhibit 3.1 The Company Month ended April 30, 2002 Sales $35,000 100.0% Cost of Goods Sold 10,000 28.6% Gross Profit 25,000 71.4% Operating Expenses Rent Expense 10,000 28.6% Utilities Expense 2,000 5.7% Wages Expense 5,000 14.3% Depreciation Expense 1,000 2.8% Total Operating Expenses 18,000 51.4% Earnings before interest and taxes (EBIT) 7,000 20.0% Interest Expense 100 .3% Earnings before taxes $ 6,900 19.7% Copyright 2009 Cornwall, Vang & Hartman

Balance Sheet Exhibit 3.2 The Company April 30, 2002 ASSETS Current Assets Cash $ 58,900 Accounts Receivable 25,000 Inventory 30,000 Total Current Assets 113,900 Fixed Assets Equipment 36,000 Less: Accumulated Depreciation (1,000) Net Fixed Assets 35,000 TOTAL ASSETS $148,900 LIABILITIES Current Liabilities Notes Payable $ 15,000 Accounts Payable 22,000 Wages Payable 5,000 Total Current Liabilities 42,000  STOCKHOLDERS’ EQUITY Common Stock 100,000 Retained Earnings 6,900 Total Stockholders’ Equity 106,900  TOTAL LIAB. & STOCKHOLDERS’ EQUITY $148,900 Copyright 2009 Cornwall, Vang & Hartman

Limitations of Financial Statements Not all assets of a company are included (e.g. employees or brand names) Intellectual property not reflected as an asset Assets are reflected at historical cost Estimates must be used for depreciation, the collectibility of accounts receivable, the salability of inventory, and the amount of warranty liability outstanding Financial statements affected by the choice of accounting methods (e.g. FIFO, LIFO or average cost) Copyright 2009 Cornwall, Vang & Hartman

Outline: Chapter 4 Revenue Forecasting Common Forecasting Mistakes The Link Between the Marketing Plan and Revenue Forecasts Creating Scenarios The Link Between the Revenue Forecast and the Cash Flow Forecast The Impact of Business Type on Revenues Quantitative Forecasting Techniques Importance of Revenue Forecasting Copyright 2009 Cornwall, Vang & Hartman

Figure 4.1 Model for Entrepreneurial Financial Management Setting Financial Goals Revenue Forecasting Expense Forecasting Monitoring Performance Copyright 2009 Cornwall, Vang & Hartman

Common Forecasting Mistakes The linear forecast mistake The hockey stick forecast mistake The 20/80 vs. 80/20 mistake Copyright 2009 Cornwall, Vang & Hartman

Marketing Plan and Forecasting Revenue Forecasts Backbone Copyright 2009 Cornwall, Vang & Hartman

Marketing Plan and Revenue Forecasting Identifying industry and market trends Market research Competitive analysis Copyright 2009 Cornwall, Vang & Hartman

Sample Competitive Grid Figure 4.3 Cleanliness of Facilities Hours of Operation Selection Price Joe’s Inc. Generally clean in public areas, but back rooms usually messy 8:00 – 6:00 Most commonly purchased products available $5 - $20 Jane’s Inc. Consistently clean and orderly throughout all facilities 8:00 – 8:00 All commonly purchased available and some specialty items in stock $12 - $30 Sally & Jim’s Shop Public areas somewhat messy and disorganized and back areas very messy 9:00 – 4:00 Many common items not in stock – usually have to special order $3 - $15 Dr. C’s Place (New Business) Plan to be spotless throughout 7:00 – 9:00 All common items plus specialty items not found at competitors’ stores $5 - $35 Copyright 2009 Cornwall, Vang & Hartman

Basic Guidelines for Revenue Forecasts Market research to assure the quality of the assumptions behind the revenue forecasts Validate assumptions with more than one source of data Plan based on more conservative assumptions Copyright 2009 Cornwall, Vang & Hartman

Creating scenarios Make Three Forecasts Best-case Worst-case Most likely case Track Key Assumptions Copyright 2009 Cornwall, Vang & Hartman

Revenue Forecast and the Cash Flow Forecast Determine if credit is to be extended to customers Estimate the percentage of the sales that will be on credit Determine how long it will take to collect credit sales Copyright 2009 Cornwall, Vang & Hartman

Importance of Revenue Forecasting Bank financing Inventory assumptions Staffing decisions Space decisions Investors Copyright 2009 Cornwall, Vang & Hartman

Outline: Chapter 5 Expense Forecasting Defining costs Cost behavior Break-even analysis The impact of business type on expenses Reducing expenses through bootstrapping Copyright 2009 Cornwall, Vang & Hartman

Figure 5.1 Model for Entrepreneurial Financial Management Setting Financial Goals Revenue Forecasting Expense Forecasting Monitoring Performance Copyright 2009 Cornwall, Vang & Hartman

Cost behavior Variable Costs Fixed Costs Mixed Costs Copyright 2009 Cornwall, Vang & Hartman

Variable Costs Type of Expense Activity Base Sales commissions Sales Materials cost Units produced Health insurance Number of employees Wages expense Number of hours worked Payroll tax expense Dollars of wages paid Copyright 2009 Cornwall, Vang & Hartman

Figure 5.1 Variable Cost Behavior $ Total Variable Cost Line Total Units Produced Copyright 2009 Cornwall, Vang & Hartman

Fixed Costs Committed fixed costs Discretionary fixed costs Copyright 2009 Cornwall, Vang & Hartman

Figure 5.2 Fixed Cost Behavior $ Total Fixed Costs Total Units Produced Copyright 2009 Cornwall, Vang & Hartman

Example – Merchandising Company Exhibit 5.1 Assumptions used Sales $100,000 100.0% COGS 65,000 65.0 65% of sales Gross profit 35,000 35.0 35% of sales Sales salaries 15,000 15.0 # of salespeople x monthly base Sales commissions 1,500 1.5 1.5% of sales Store rent 3,500 3.5 monthly rent Total selling expenses 20,000 20.0 Office rent 2,500 2.5 Office salaries 12,000 12.0 # people x monthly pay Depreciation 500 .5 cost of equip./mos. of life Total gen. & admin. EBIT Copyright 2009 Cornwall, Vang & Hartman

____________________________________ Breakeven Analysis Breakeven Quantity = Fixed Costs ____________________________________ Price per unit - Variable cost per unit Copyright 2009 Cornwall, Vang & Hartman

Outline: Chapter 6 Integrated Financial Model The entrepreneur’s aspirations reconsidered Contribution format income statement Inventory of assumptions Determining the funds needed Time out of cash Assessment of risk/sensitivity Integrating into business plan/funding document Copyright 2009 Cornwall, Vang & Hartman

Figure 6.1 Building a Financial Forecast Setting Financial Goals Revenue Forecasting Expense Forecasting Monitoring Performance Copyright 2009 Cornwall, Vang & Hartman

Time Out of Cash Time Out of Cash = Cash Operating Cash Outflow per Month Copyright 2009 Cornwall, Vang & Hartman