FINANCIAL PLANNING: SHORT TERM AND LONG TERM 1 ENTREPRENEURIAL FINANCE

 Development Stage:  Screen Business Ideas  Prepare Business Plan  Obtain Seed Financing  Startup Stage:  Choose Organizational Form  Prepare Initial Financial Statements  Obtain First Round Financing 2

 Survival Stage:  Monitor Financial Performance  Project Cash Needs  Obtain First Round Financing  Possible Actions: Liquidate v. Restructure  Rapid Growth Stage:  Create and Build Value  Obtain Additional Financing  Examine Exit Opportunities  Possible Actions: Go Public v. Sell/Merge 3

 Early-Maturity Stage:  Manage Ongoing Operations  Maintain and Add Value  Obtain Seasoned Financing 4

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 Usually begins with forecast of sales  Short term financial planning broken down into monthly forecast  In monthly forecast, should consider the impact of seasonality  Longer term financial planning : 3 – 5 years 8

 Sales Schedule  Purchase Schedule  Inventory Schedule  Production Schedule  Wages and Commission Schedule  Cash Budget  A venture’s projected cash receipts and disbursements over a forecast period  Balance Sheet, Profit and Loss 9

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19  Expected Value is the weighted average of a set of scenarios or possible outcomes  Steps to validate sales forecast:  Forecast future sales growth rates for several possible scenarios and the likelihood of each scenario  Corroborate the venture’s projected sales growth rates with industry growth rates and venture’s past market share (top down or market share driven approach to sales forecasting)  Through direct contact with existing and potential customers (bottom up or customer driven approach to forecasting sales)  The likely impact of major operating changes (changes in R and D, pricing policies, credit policies, A&P)  Include the impact of inflation

20  When performing forecasting, should have more than 1 scenario:  Optimistic  Normal  Pessimistic

Forecasting for Early Stage Ventures (firms that are in either their development, startup, or survival stage, or just entering into their rapid growth stage of their life cycle) Industry Probability of Sales Components Sales Scenario Occurrence Growth Rate to Sum Optimistic forecast.30 X 60% = 18.0% Most likely forecast.40 X 50% = 20.0% Pessimistic forecast.30 X 40% = 12.0% 1.00Expected Value = 50.0% 21

 Growth rate for a new venture can be too optimistic as shown above which is a subject to be challenged  The new venture investors tend to adjust this optimism and forecasting difficulties by revising a venture’s sales forecast downward and expenses upward 22

 There are many possible scenario-weighting combinations, some of which are valid views of new venture’s possible future 23

 There are several potential impediments to a relationship between incremental sales and incremental cash flow:  The incremental sales must be sold at prices that cover all incremental costs (capacity and variable costs)  The revenue from additional unit sales must cover increases in working capital investments (inventory and accounts receivable) required to support those incremental sales  Only when sales revenues cover all of these costs are there free cash flows that give rise to an increase in venture value 24

 Internally Generated Funds:  Net income or profits after taxes earned over an accounting period  Can be distributed to owners or reinvested to support growth  Sustainable Sales Growth Rate: Rate at which a firm can grow sales based on the retention of profits in the business 25

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28  Assumptions  Initial book value of equity $1o million  No new equity injection nor withdrawal  Net Income $2million  Dividend $500,000 (25% of NI) and keep $1,500,000 (75%)  g = (2000,000/10,000,000) x 0.75 = 0.15 = 15%

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30  Assumptions  Sales $1,600,000  NI $160,000  Beginning Equity $800,000  Asset $1,000,000  Retention Rate = 1  g = 160,000/1,600,000 x 1,600,000/1,000,000 x 1,000,000/800,000 = 0.2 = 20%  g = Operating Performance x Financial Policy = ROA x FP = NI / TA x TA/CE Beg x RR = 160,000/1,000,000 x 1000,000/800,000 x 1 = 0.16 x 1.25 x 1 = 20%

 In the event that a growing venture’s investment in assets is not financed by profits from business operations plus spontaneous financing from suppliers, employees and governments, additional funds will be needed.  These additional funds will need to come from external parties 31

 Financing Capital Needed (FCN):  financial funds needed to acquire assets necessary to support a firm’s sales growth  Some of this funding gap will be covered by trade credit and other current liabilities the increase spontaneously with sales  Spontaneously Generated Funds: increases in accounts payables and accruals (wages and taxes) that occur with a sales increase  Example: when sales increase, credit purchases from suppliers increase, leading to increase in accounts payable 32

 Additional Funds Needed (AFN): gap remaining between the financial capital needed and that funded by spontaneously generated funds and retained earnings, or,  AFN = Required Increase in Assets – Spontaneously Generated Funds – Increase in Retained Earnings 33

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 Sales last year = $1,600,000  Asset investment = $1,000,000  Net Income = $160,000  Current Assets = $520,000  Fixed Assets = $480,000  Accounts Payable = $48,000  Accrued Liabilities = $32,000  Projected growth rate = 30%  Projected next year sales = $2,080,000 (1,600,000 x 1.3) 35

 Implication:  The venture needs $300,000 in additional capital to acquire assets to achieve the projected 30% growth in sales  $24,000 comes from spontaneously generated funds (liabilities to suppliers, employees)  $208,000 comers from retained earnings  The remaining AFN $68,000 raised from external financing 36

37  Expects to grow 30% each year for 2 years  Sales in 2 year = $1,600,000 x 1.3 x 1.3 = $2,704,000  Total two year sales = $2,080,000+$2,704,000 = $4,784,000  Two year change in sales = $2,704,000 - $1,600,000 = $1,104,000  Asset investment = $1,000,000  Net Income = $160,000  Current Assets = $520,000  Fixed Assets = $480,000  Accounts Payable = $48,000  Accrued Liabilities = $32,000  Projected growth rate = 30%

 Percent of Sales Forecasting Method: make projections based on the assumption that certain costs and selected balance sheet items are best expressed as a percentage of sales  For example: COGS ratio is 60% current year ; assumed to be the same for next year  If, for example, assets were 67% of sales last year ; will be forecasted the same in next year  If, for example, sales grow by 30%, assets also grow by 30%  Constant Ratio Method: variant of the percent of sales method that projects selected cost and balance items at the same growth rate as sales 38

 The ability to project sales forecast accurately is crucial to the venture’s financial health  Financial Forecasting Process To Project Financial Statements 1. Forecast sales 2. Project income statement 3. Project balance sheet 4. Project statement of cash flows 39

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