MODULE 2 INTRODUCTION TO FORECASTING WEL Financial Intelligence

Module 2 - Forecasting Proforma Income Statement - this records sales and expenses for a given time period according to accounting standards. Balance Sheet – Financial snapshot of the venture. Shows assets, liabilities and owners equity

Anatomy of a Balance Sheet Balance Sheet shows the balance between the venture Assets and Liabilities plus the Owner’s Equity Assets = Liabilities + Owner’s Equity “Snapshot” of the venture at a particular point in time

Current Assets (Easily turned into cash) Cash & petty cash Accounts recv’ble Inventory/supplies Prepaid expenses Fixed Assets (Fairly permanent investments needed for operations) Land, buildings Prod & office equip’t. Furniture Vehicles Current Liabilities (Debts and financial obligations that need to be paid within 12 months) Accounts payable Notes payable Payroll Taxes payable Long-term Liabilities (Balances that come due after the current operating year) Mortgages Bank loans Equip’t loans Owner’s Equity (aka: “Net Worth”) (Determined by subtracting the Total Liabilities from the Total Assets) What owner has left if she liquidated all assets and paid off all debts. Total Liabilities + Owner’s Equity must always = Total Assets Assets = Liabilities + Owner’s Equity Note: This figure will differ based on legal structure Anatomy of a Balance Sheet

Current Assets Cash 1,000 Accts Rec2,000 Inventory5,000 Prepaid Insurance 250 Total 8,250 Fixed Assets Lease Improv.2,000 Equipment5,000 Vehicles 10,000 Total 17,000 Total Assets 25,250 Current Liabilities Overdraft 1,600 Credit Cards 2,500 Payroll1,325 Taxes pay. 825 Total 6,250 Long-term Liabilities Equip. Loan 1,800 Vehicle Loan 8,000 Total 9,800 Total Liabilities 16,050 Owner’s Equity (aka: “Net Worth”) Owner Capital 15,000 Retained Earnings (5,800) Total Equity 9200 Total Liabilities and Equity 25,250 Assets = Liabilities + Owner’s Equity Sample Balance Sheet

Balance Sheet Terms Assets: Things of value that the business owns. Assets are grouped into two categories: Current Assets – these include cash, inventory, prepaid expenses and accounts receivable (money that the business is owed). Fixed or Long-term Assets – items with a useful life over one year. The depreciation or decrease in value of assets is accounted for by way of depreciation expenses.

Balance Sheet Terms Liabilities: Debts or money that the business owes. They are grouped into two categories: Current Liabilities – These are financial obligations that the business must meet within a year such as accounts payable and taxes. Long-term liabilities – Any liability for which payment continues longer than one year. Examples include mortgages, bank loans, and equipment leases.

Balance Sheet Terms Equity: Equity – represents the owner’s equity, which is the “net worth” of the business. Capital – This will vary based on the legal structure however will include the “capital” of the company which is commonly cash given in exchange for shares of the company. Retained Earnings - This is the cumulative earnings (or losses) of previous years.

ProForma Income Statement Income Statement shows sales/revenue and expenses over a period of time Also known as P&L (Profit and Loss Statement) Used to Measure results Find financial problems Identify profit centers to know where to concentrate resources Figure taxes, borrow money and sell stock

Anatomy of Income Statement + Revenue (input of cash) + Gross sales ̶ Less Returns and allowances = Net sales – Cost of goods sold (“variable” expenses: Labor, Direct, Other) = Gross profit (revenue – cost of producing prod/serv) – General and administrative (“fixed” expenses) Admin., Marketing, office, utilities, equip. maintenance, etc. = Net operating income Total other income (gain (loss) on sale of assets; interest) = Net income (loss)

Sample of Income Statement Acme Store Inc. Jan. 31, 2007 (in Dollars) Gross sales$20,000 Less Returns and allowances 400 Net sales 19,600 Cost of goods sold 8,500 Gross profit 11,000 General and administrative Rent 5,000 Admin& Office Labour2,300 Utilities 1,800 Maintenance & Supplies Income (before taxes) $1,600

Income Statement Terms Income Statement - The revenue and associated expenses for the sales of goods and/ or services for a period of time. Cost of Goods Sold (COGS) - Are the costs that a business incurs as a result of producing its product or service. Gross Profit - The income earned after COGS have been deducted from revenue.

Pricing Strategies New ventures need to forecast sales and revenues as part of the planning process. A key factor that drives this is the pricing strategy. Effective pricing strategies are the result of something between an exact science based on logical factors and an intuitive insight based on instinct. The simplest method for pricing products or services is that which results in maximum net revenue.

Pricing Strategies - BEP Break Even Point (BEP) It is critical to understand a company’s BEP as part of the forecasting process. The level of operation (sales dollars or production quantity) at which a company neither earns a profit nor incurs a loss.

Fixed and Variable Expenses In order to determine BEP, expenses must be categorized as fixed and variable: Fixed expenses – expenses that do not vary with the volume of sales or production (rent, depreciation, interest rate) Variable expenses – expenses that vary directly with changes in the volume of sales or production (raw materials cost, sales commissions, etc.)

Pricing Strategies It is critical to understand at what points sales cover costs, and the venture starts to make a profit. C=$ cost a sales Variable expenses Number of units Fixed Costs profit loss $$ X=units produced or sold

Pricing Strategies Profit Planning - An example: Store buys and sells a single product Selling price is $5/unit; Purchase cost is $3/unit Fixed cost is $100/period Contribution Margin is ($5-$3)/$5 = 40% How the profit varies as volume of sales varies?

Pricing Strategies Break- Even Point : Break-even sales ($) = = Fixed costs / contribution margin (%) = $100 / 0.4 = $250 Break-even volume (units) = Fixed costs / margin per unit = $100 / ($5 - $3) = 50 units

Adding in a Profit What should be the level of sales for $100 profit? Sales ($) Fixed costs + Desired net income contribution margin = ($100 +$100)/ 0.4 = $500 Volume (units) Fixed costs + Desired net income per unit contribution margin ($100 +$100)/ 2 = 100

Markup The difference between the cost of product or service and its selling price is the Markup. Dollar markup = Retail price – Cost of merchandise % markup = Dollar markup / Cost of unit Example: If a shirt costs $15 and the manager plans to sell it for $25 Dollar markup = $25 - $15 = $10 % markup = $10 / $15 =66.67%

Summary Module 2 This section has provided an overview of key financial documents including: Balance Sheet Assets = Liabilities + Owners Equity Proforma Income Statement Sales - Pricing strategies and sales forecasts Expenses - Variable & Fixed Expenses Profit - Break Even Analysis

Assignment Create an opening balance sheet for your venture Use Excel template: “Key Financial Documents” (sheet E) Create an income statement for your venture Use Excel template: “Key Financial Documents” (sheet D)

Appendix Additional slides if required

Initial Markup Average markup required on all merchandise to cover the cost of items, all incidental expenses and a reasonable profit Initial Dollar Markup = Oper. Expenses+ Reductions + Profits Net Sales + Reductions