PowerPoint Presentations for Small Business Management: Launching and Growing New Ventures, Fifth Canadian Edition Adapted by Cheryl Dowell Algonquin College

Chapter 14 Financing Requirements, Pro Forma Financial Statements, and Sources of Financing

LOOKING AHEAD After studying this chapter, you should be able to: 1.Estimate the amount of financing a new or existing business will need. 2.Create pro forma (forecast) cash flows, income statements, and balance sheets. 3.Describe the types and sources of financing available. 4.Describe the appropriateness of types of financing at various stages of a venture’s life. 5.Evaluate the choice between debt financing and equity financing. 6.Discuss the most important factors in the process of obtaining start-up financing. Copyright © 2013 by Nelson Education Limited 14-3

BUSINESS NEEDS Copyright © 2013 by Nelson Education Limited Businesses need cash for three principal reasons : 1.To purchase assets such as equipment and inventory 2.To pay for other costs incurred such as payroll, advertising, taxes, etc. 3.Pre-start-up costs which include R&D and expert advice 14-4 LO 1

DETERMINING ASSET REQUIREMENTS Copyright © 2013 by Nelson Education Limited Assets that can be converted to cash within the firm’s operating cycle—cash, accounts receivable, and inventories Current assets (working capital) Relatively permanent resources intended for the use of the firm Fixed Assets Intangible assets (patents, copyrights, goodwill) Other Assets 14-5 LO 1

BUSINESS DECISIONS Copyright © 2013 by Nelson Education Limited 14-6 Buy or lease the equipment? Acquire new or used equipment? – Lease-versus-buy calculation program – Government of Canada’s website for Canadian entrepreneurs ( LO 1

WORKING CAPITAL OR OPERATING REQUIREMENTS Copyright © 2013 by Nelson Education Limited 14-7 Working capital management – The management of current assets and current liabilities Cash budget (cash flow forecast) – A planning document strictly concerned with the receipt and payment of dollars – Inflow and outflow of cash LO 1

CASH FLOW FORECAST Copyright © 2013 by Nelson Education Limited 14-8 LO 1

ESTIMATING REVENUES AND OUTFLOWS Copyright © 2013 by Nelson Education Limited 14-9 Percentage-of-Sales – Method of forecasting using a percentage of the total sales – Industry Canada LO 1

TYPES OF FINANCING Current (short-term) Debt Accounts payable Accrued expenses Short-term notes – cash amounts borrowed from a bank or another lending source and must be repaid within a short period of time Long-Term Debt Loans and mortgages from banks and other lenders with maturities greater than one year Copyright © 2013 by Nelson Education Limited Debt Capital: Financing provided by a creditor LO 1

TYPES OF FINANCING Short term debt Spontaneous financing Funds that derive initially from the owner’s investment in a firm External equity Re-investment of profit in a firm Profit retention Funds that come from retaining profits within a firm Internal equity Copyright © 2013 by Nelson Education Limited LO 1

PRO FORMA INCOME STATEMENT Copyright © 2013 by Nelson Education Limited LO 2

PRO FORMA BALANCE SHEET Copyright © 2013 by Nelson Education Limited LO 2

SOURCES OF FINANCING Copyright © 2013 by Nelson Education Limited LO 3

SOURCES OF FINANCING Copyright © 2013 by Nelson Education Limited LO 3

OTHER INDIVIDUAL INVESTORS Copyright © 2013 by Nelson Education Limited informal capital – funds provided by wealthy private individuals to high-risk ventures, such as start-ups business angel – a private investor who finances new, risky small ventures LO 3

VENTURE CAPITAL COMPANIES Copyright © 2013 by Nelson Education Limited Look for: – Distinct technology – Sustainable competitive advantage – Comprehensive business plan – Strong management team with start-up – Excellent market potential – Credible exit strategy – People: compatible skills and unusual tenacity, integrity, imagination, commitment – Products: high value-added features – Markets: large and rapidly growing – High margins: gross margins of 40 to 50 percent LO 3

BUSINESS SUPPLIERS AND ASSET-BASED LENDERS Copyright © 2013 by Nelson Education Limited Trade Credit (Accounts Payable) Equipment Loans and Leases – installment loan from a seller of machinery used by a business Bank Financing – Chartered Banks And Credit Unions LO 3

TYPES OF LOANS legal commitment by lender to lend up to a maximum amount line of credit money loaned for a 5- to 10-year term, corresponding to length of time the investment will bring in profits term loan loan for which equipment or other moveable property serve as collateral chattel mortgage Copyright © 2013 by Nelson Education Limited LO 3

TYPES OF LOANS long-term loan with real property held as collateral real estate offers business a level of convenience in making purchases, not having to establish trade credit, and still delaying when goods have to be paid for corporate credit cards Copyright © 2013 by Nelson Education Limited LO 3

UNDERSTANDING A LENDER’S PERSPECTIVE Copyright © 2013 by Nelson Education Limited The Five Cs of Credit – Character of the borrower – Capacity of the borrower to repay the loan – Capital invested in the venture by the borrower – Conditions of the industry and economy – Collateral available to secure the loan Concerns: – How much the bank will earn on the loan? – What is the likelihood that the lender will be able to repay the loan? LO 3

Copyright © 2013 by Nelson Education Limited UNDERSTANDING A LENDER’S PERSPECTIVE Lender’s Questions: – What are the strengths and qualities of the management team? – How has the firm performed financially? – How much money is needed? – What is the venture going to do with the money? – When is the money needed? – When and how will the money be paid back? – Does the borrower have qualified support people, such as a good public accountant and lawyer? LO 3

Copyright © 2013 by Nelson Education Limited UNDERSTANDING A LENDER’S PERSPECTIVE Firm’s historical statements – Balance sheets – Income statements – Statements of cash flow for 3 years LO 3

Copyright © 2013 by Nelson Education Limited UNDERSTANDING A LENDER’S PERSPECTIVE Firm’s pro forma financial statements – Timing and amounts of debt repayment included as part of the forecasts Personal financial statements – Borrower’s personal net worth (assets – debts) and estimated annual income LO 3

NEGOTIATING THE LOAN Copyright © 2013 by Nelson Education Limited Interest rate Loan maturity date Repayment schedule Loan covenants LO 3

FEDERAL ASSISTANCE TO SMALL BUSINESSES Canada Small Business Financing Program(CSBFP) Canada Small Business Financing Program Business Development Bank of Canada (BDC) Business Development Bank of Canada Industrial Research Assistance Program(IRAP) Industrial Research Assistance Program Program for Export Market Development (PEMD) Program for Export Market Development The Canadian Youth Business Foundation (CYBF) The Canadian Youth Business Foundation Copyright © 2013 by Nelson Education Limited LO 3

FINDING SOURCES OF FINANCING Copyright © 2013 by Nelson Education Limited Spontaneous financing Profit retention External financing – Comes from outside investors – First ask, “Should I use debt or equity financing?” LO 4

DEBT OR EQUITY FINANCING? Potential Profitability Borrowing increases potential for higher rates of return on owners’ equity; exposes firm to more financial risk Financial Risk Investing more owner equity limits potential return on equity; lowers financial risk for firm Copyright © 2013 by Nelson Education Limited LO 5

DEBT OR EQUITY FINANCING? Voting Control Increasing equity through borrowing requires owners to share control with external investors Copyright © 2013 by Nelson Education Limited LO 5