1 Ch 7 Outline 1.Introduction 2.Financial Planning - The Sales Forecast - The Profit and Loss Statement - The Cash Flow Statement - The Balance Sheet

2 FINANCIAL PLANNING In order to control the operations of a business, the entrepreneur requires a well-designed financial plan.  This can help the entrepreneur stay focused and on track despite the lack of profits during this critical phase of the venture’s life cycle.  The goal is to determine the funds needed to launch and sustain the venture as it grows.  The financing needed to launch a venture depends on many factors, including the industry, experience of the entrepreneur, location of the venture, and inventory requirements.  In addition to these expenses, the entrepreneur must obtain sufficient seed capital to sustain the venture to the point at which its revenues exceed its expenses (it becomes profitable).  Creating a financial plan helps the entrepreneur transform business goals into reality. In the start-up stage, the entrepreneur should estimate the costs for entry into an accounting system.  This estimate is achieved through pro forma financial statements; the three primary financial statements that businesses use to forecast and record operating results: oThe profit and loss statement, oThe cash flow statement, and oThe balance sheet.

3  At minimum, it is essential that the pro forma projections encompass the time periods that include: oAt minimum, it is essential that the pro forma projections encompass the periods that include: - The cash breakeven point: The point in the venture’s growth at which revenues exceed costs on a routine (monthly) basis. - The profit breakeven point: The point in the venture’s development at which the accumulated negative profits are less than the accumulated positive profits.  The challenge in developing pro forma financial statements lies in building them on a foundation of reasonable and reality-based assumptions. - These assumptions provide a set of starting numbers such as price per unit and sales volume, that are reasonable guesses. - Once the assumptions have been set, they are used to develop the pro forma spreadsheet. - Using a spreadsheet enables the entrepreneur to develop a number of what-if scenarios. - In general, investors and lenders look at four criteria when evaluating the assumptions that underlie financial statements:  Clarity of expression  Consistency with knowledge of commercial practices  Internal consistency  Comprehensiveness

4 7-2a The Sales Forecast The sales forecast, or revenue estimate, is necessary for an entrepreneur to produce the three basic financial statements. –It is easier for the entrepreneur to think in terms of unit volume than total revenue to be generated. –Once pricing has been set, the number of units sold will determine revenue, as indicated in this equation: P × V = R (price × volume = revenue) –To account for different operating results, many entrepreneurs develop more than one sales forecast, often distinguished as worst case, base case, and best case.

5 7-2b The Profit and Loss Statement The profit and loss statement (P&L) states accurately and fairly the profit or loss of the operations for a given accounting period using GAAP rules. –GAAP rules governing the P&L statement include: Revenue of any accounting period should have the appropriate costs of acquiring that revenue attributed in the same accounting period. Revenue spent on any item that has a useful life of more than one year—a so-called capital good—is considered a capital expense. –Spreading the cost of a capital good over the period of its useful life is called depreciation. Depreciation is called a non-cash expense.

6 7-2b The Profit and Loss Statement (cont.) –All the operating costs of the company must be included in one of the three cost categories: Cost of goods Selling costs General and administrative (G&A) costs –The other categories are: Gross profit Gross margin Sales and marketing expenses Profit, or net income