Copyright 2001 November 2001 Venture 2002 – introduction to the financial planning model

1 ELEMENTS OF THE ANNUAL ACCOUNTS The financial planning model supports participants in Venture 2002 in preparing the three main elements of a company's annual accounts: the profit and loss statement, the balance sheet and the cash flow calculation. The profit and loss statement (P&L) reveals the monthly/annual profit by comparing sales against the costs incurred. For each product area, the sales and the costs associated with production are calculated (gross margin), as are the additional costs for development/engineering, marketing and sales, publicity and administration. At company level the financial result and the tax load are also calculated. The balance sheet provides information about the sources and use of company's capital. The company is financed with equity and debt, and invests this money in the fixed and liquid assets needed for its operations. The model calculates separately the investment in and depreciation of assets in all sectors (production, development/engineering, marketing, administration). The cash flow calculation is the most important planning tool in the start-up phase. It is derived from both the balance sheet and the P&L statement but, unlike the P&L statement, it provides information on the company's liquidity. Insufficient liquidity is as much a reason for bankruptcy as excessive debt: only if there is sufficient liquidity can staff, suppliers and creditors be paid at the end of the month – regardless of how profitable the company is. Unlike the P&L statement, the cash flow calculation shows actual income and expenditure: investments, for example, are shown at their full cost at the time the investment is made, and not, as in the P&L statement, factoring in depreciation over a period of time.

2 OVERVIEW OF THE FINANCIAL PLANNING MODEL InstructionsDetails Cash flow P&L statement Balance sheet Product planning Types of expenditure Investments Summary Cash flow P&L statement Balance sheet Development of sales Cash needs Diagrams /6/7 Assumptions Excel Sheets

3 STRUCTURE OF THE MODEL The model consists of seven Excel spreadsheets: Spreadsheet 1(Instructions) Contains the essential usage instructions Spreadsheet 2 (Assumptions) Contains the key assumptions of the model; these are not entry fields, but a summary of the data entered in spreadsheet 3 Spreadsheet 3 (Details [P&L, balance sheet, cash flow]) Contains the three main elements of the annual accounts in detailed form, and also the supporting calculations with the appropriate entry fields (green background); the spreadsheet has 15 pages each for 2002, 2003, and 2004–2008, i.e., a total of 45 pages. Page numbers are shown at bottom left on the print-outs and are consecutive; the contents of the first 15 pages (2002) is commented on below Spreadsheet 4 (Summary [P&L, balance sheet, cash flow]) Summarizes the three elements of the annual accounts (P&L, balance sheet, cash flow) Spreadsheets 5–7 (Development of sales, cash needs, diagrams) Overview diagrams, some of which are data-driven

4 STRUCTURE OF SPREADSHEET 3 (DETAILS) Area Page (2002) Direct cash flow calculation Indirect cash flow calculation Profit and loss statement Balance sheet Gross margin (4 products) Personnel planning/wage costs Investments/depreciation Production/stocks/inventory Rental/tax 1 2 3–4 5 6–9 10–11 12– : Pages 16– –2008: Pages 31–45

5 PROCEDURE – PROFIT AND LOSS STATEMENT Preparing the profit and lost statement (Sheet 3, pages 3–4) First, determine, for each product area, the planned sales and the related material costs, on the basis of a detailed quantity and price planning (pages 6–9). Additionally, execute an appropriate market share planning, to check that the sales development is plausible. Then, determine the types of expenditure, grouped by cost centres (production, development/engineering, marketing and sales, publicity and administration). The individual types of expenditure can be broken down into personnel costs (direct) and other (indirect) costs. Therefore, you should prepare next a detailed personnel plan, including staff numbers and personnel cost planning (pages 10–11); other costs are usually calculated per person or per sale. Production costs can be broken down into direct and indirect production costs (page 14). Allocate these to the individual product areas in proportion to a product's share of sales. When you have deducted all costs from the sales, you have the operating profit (EBIT = Earnings Before Interest and Taxes). To determine the profit for the year, next subtract the financial result and taxes. Because of country-specific tax systems, the calculation shown here is simplified by using a tax rate of 30%. We strongly recommend that a tax advisor be consulted to enable customized tax planning, especially as regards the taxation of different appropriations of profit (retention vs. payout).

6 PROCEDURE – BALANCE SHEET (1/2) Preparing the balance sheet (Sheet 3, page 5) First, prepare an investment plan for the fixed assets of the individual cost centres (page 12), to determine the individual balance sheet items on the asset side. The net investments are calculated per person. Alternatively, relating investments to sales or a unit-based investment plan could prove useful, but the model must be adjusted accordingly. Determine the depreciation period for the individual fixed asset items (page 13). This is done according to the standard operational utilization duration of the item, which for annual accounts, is fairly arbitrary. For the tax return, however, tax deduction tables, available from tax offices, must be used. Therefore, for the three groups, replace the pre-defined depreciation period in the model with the business-specific tax table guidelines. The difference between the gross capital investment (acquisition costs) and depreciation is the net investment; this corresponds to the change in the yearly fixed assets. For current assets or working capital, plan debts and liabilities from supplies and services and the inventory (page 14). The level of receivables, in particular, depends on the payment period chosen for customers; this is flexible (30–90 days) and receivables will be higher, the longer the payment period. The same applies to liabilities. The objective of a young company should be to keep the receivables as low as possible and liabilities as high as possible, so that the financing costs for working capital are kept to a minimum. For inventory, it is sufficient to determine how many months in advance the material needs to be brought in.

7 PROCEDURE – BALANCE SHEET (2/2) The liabilities side of a start-up's balance sheet can differ considerably, depending on the financing opportunities. Be sure that long-term investments are financed through the equity capital of the owners, business angels and venture capitalists, or through long-term loans; working capital, on the other hand should be financed through short-term operating credit or supplier liabilities. For monthly planning it is crucial, in the event of insufficient cash inflow, that sufficient short-term credit is available to pay the monthly bills that fall due.

8 PROCEDURE – CASH FLOW Determining cash flow (Sheet 3, pages 1–2) The cash flow calculation differs from the P&L statement in its orientation towards income and expenditure; i.e., expenditure and income that have no effect on liquidity are not included (e.g., not all income from sales has an effect on cash flow). Deduct unpaid bills and increases in receivables from the sales income determined in the P&L. The cash flows for the period can be calculated directly (page 1) or indirectly (page 2). –For the direct calculation, deduct all payments, including investments, from cash sales income –For the indirect method, based on the net profit in the P&L, add all payments that have no effect on income or deduct all income that has no effect on cash flow. Results controlling To check the consistency of the balance sheet/P&L and the cash flow calculation, add up the first three lines of the model. Doing this you check, whether the cash flow that results from the direct or indirect calculation and the liquidity in the current assets agree, and whether the totals of the asset and liability sides of the balance sheet agree.