New Ventures BC May 11, 2006 Financial Data for Business Plans Otto Ehinger Ernst & Young LLP (604)

2 Financial Data for Business Plans  Historical Financial Statements –Where have you been?  Prospective Financial Statements –Where are you going?  Financial Analysis –What does it all mean?

3 Financial Data for Business Plans

4 Historical Financial Statements  Annual financial statements include the following: –Balance Sheet –Income Statement –Cash Flow Statement –Supporting Notes  Include past three to five years, if applicable

5 Historical Financial Statements  Balance Sheet –“Snapshot” of a company’s financial condition at a particular point in time –Summary of the company’s assets (what it owns), liabilities (what it owes), and shareholders’ equity (the difference) –Assets - Liabilities = Shareholders’ Equity

6 Historical Financial Statements  Balance Sheet –Generally classified as follows : Assets: current (cash, accounts receivable, inventory etc.) and fixed or long-term (property and equipment, intangibles etc.) Liabilities: current (due within one year) and long-term (due after one year) Shareholders’ equity: share capital (what has been invested in the company in the form of equity) and retained earnings (net income retained in the company since inception)

7 Historical Financial Statements  Income Statement –Commonly referred to as the “P&L” (profit and loss statement) –Summary of a company’s financial performance over a period of time, typically one year

8 Historical Financial Statements  Income Statement –Generally classified as follows: Revenues (products and/or services) Cost of revenues (products and/or services) Operating expenses (G&A, S&M, R&D) Interest income/expense and other items Income taxes Net income

9 Historical Financial Statements  Cash Flow Statement –Summary of how a company’s cash position has changed over a period of time, typically one year –It is a report of sources and uses of cash, but does not predict or forecast cash requirements in the future

10 Historical Financial Statements  Cash Flow Statement –Generally classified as follows: Cash provided by or used in operating activities Cash provided by or used in investing activities Cash provided by or used in financing activities The sum of these three categories will equal the net increase or decrease in cash year over year

11 Historical Financial Statements  Supporting Notes –Integral part of the historical financial statements –Provide additional information on significant financial statement items to help understand future cash inflows and outflows –Examples include terms and conditions of debt or equity financing arrangements, and details of commitments or contingencies

12 Historical Financial Statements  The historical financial statements summarize where you have been  The current financial condition and performance of a company is generally a good starting point to help predict the future  In the case of a start-up or early stage company, there are no historical financial statements and the future projections are inherently more uncertain

13 Prospective Financial Statements  Purpose –Formulate a credible, comprehensive set of projections reflecting the company’s anticipated financial condition and performance –More than anything else in the business plan, they address the investors bottom line interests and provide information on what kind of return to anticipate –If carefully prepared and convincingly supported, they will become one of the most critical yardsticks by which the attractiveness of the investment is measured

14 Prospective Financial Statements  Prospective financial statements include the following: –Summary of Significant Assumptions –Income Statement –Balance Sheet –Cash Flow Projections

15 Prospective Financial Statements  The number of years to project will depend on how long the company expects to take to achieve key milestones in the business plan  Typical projections include five years, if possible –Next year, projected by month or quarter –Final four years, projected by quarter or year

16 Prospective Financial Statements  Guiding Principles –Reliable data is important – Investors will do their own homework –Consider more than one financial scenario and complete sensitivity analysis Forecast – management’s best estimate Projection – “what-if” scenarios

17 Prospective Financial Statements  Guiding Principles (cont’d) –Review periodically and revise projections when appropriate – the content must always be current –The financial projections must conform to the details presented in the remainder of the business plan – a lack of consistency will indicate carelessness or an incomplete understanding

18 Prospective Financial Statements

19 Prospective Financial Statements  Summary of Significant Assumptions –The significant assumptions are the best estimates of the preparer, unlike supporting notes to the historical financial statements which are factual –A complete set of compelling and concise assumptions should be developed for all the projections in the plan –It is impossible for the investor or lender to understand the projections completely without the disclosure of the key assumptions

20 Prospective Financial Statements  Summary of Significant Assumptions –The assumptions should start with the income statement –The most important element in all of the projections is the forecasted sales volume –Remember, “what-if” and sensitivity analysis can be very useful

21 Prospective Financial Statements According to Dilbert…  “Some companies change what they’re doing to get the future they want. This is a waste of time. You can get the same result by adjusting the assumptions in your business plan. Remember, the future depends on assumptions, and the assumptions are just stuff you made up. No sense in knocking yourself out.”

22 Prospective Financial Statements  Income Statement – Consistency and credibility are critical – The numbers alone must be consistent with the rest of the business plan – Risks and uncertainties in other sections of the business plan must be addressed in the numbers – Income statement line items should be scrutinized as a % of sales or some other appropriate measure and benchmarked to industry averages, where applicable – Inflated projections will detract from the plan’s credibility

23 Prospective Financial Statements According to Dilbert…  “First assume that any positive trends will continue forever and any negative trends will turn around soon. Then run the numbers though a computer spreadsheet. The result is the future. (Later, if you turn out to be wrong, blame it on the global economy.)”

24 Prospective Financial Statements  Balance Sheet –Liquidity is critical so the prospective balance sheet should plan for adequate working capital requirements –Investors and lenders like to see a financial commitment by the entrepreneur –It is not unusual for start-up companies to experience losses in the initial stages so the prospective balance sheet should plan for future rounds of financing

25 Prospective Financial Statements  Cash Flow –The most critical of all financial projections –For early stage companies, cash is more critical than profitability (i.e. it is possible to be profitable but have negative cash flow at the same time) –Similar to historical financial statements, the cash flow projections should be classified by operating, investing and financing activities

26 Prospective Financial Statements  Cash Flow from Operating Activities – Operating cash flow is driven primarily from the income statement projections and changes in working capital balances on the balance sheet – Cash used in operations provides information on “burn rate” (i.e. if the monthly operating cash outflow is $25k, and there is $100k in the bank, then there is only 4 months of cash to burn) – It is important to understand how the components move on a monthly basis, so the company can predict when operating cash shortfalls may occur

27 Prospective Financial Statements  Cash Flow from Investing Activities –Cash used in investing activities provides information on the capital expenditure budget and how the company expects to spend some of the capital raised (i.e. purchase of property and equipment) –It is a good idea to include a detailed capital expenditure budget as a separate schedule

28 Prospective Financial Statements  Cash Flow from Financing Activities – Cash provided by financing activities provides information on when the company expects to raise additional capital and when it expects to repay any current debt it may have – It is important to anticipate when subsequent capital requirements are needed and plan for these cash infusions in advance – The worst time to seek new capital is when the company needs it the most

29 Financial Analysis  Ratios and trend analysis for both historical and prospective financial data

30 Financial Analysis  Ratio analysis includes: –Liquidity Ratios – can the company meet its near term debt obligations? –Asset Management Ratios – how efficiently and effectively is a company using the assets it has? –Debt Ratios – does the company have the right leverage and do they have capacity to raise further capital?

31 Financial Analysis  Trend analysis includes: –Revenue and profitability growth year over year –Trends in gross margin % –Trends in expenses as a % of sales and benchmarked to industry averages –Changes to break-even analysis (the level of sales needed to meet all cash obligations)

32 Concluding Remarks  Investors put the financial data under considerable scrutiny.  If the numbers don’t “add up”, the business’s credibility will suffer.  It is very important to have someone with sufficient financial expertise on your management team.

33 ? Questions