Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-1 The Financial Plan

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-2 Chapter Learning Objectives 1.To understand the role of budgets in preparing pro forma statements. 2.To understand why positive profits can still result in a negative cash flow. 3.To learn how to think strategically about financial management decisions 4.To learn how to prepare monthly pro forma cash flow, income, balance sheet, and sources and uses of funds statements 5.To explain the break-even point for the new venture. 6.To illustrate how ratio analysis can assist the firm 7.To illustrate the alternative software packages that can be used

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-3 Chapter Opening Profile Ted Rogers, owner of Rogers Communications, Rogers Wireless, Rogers Cable, and Rogers Media –Recently purchased Microcell (aka Fido) Pushed its debt to $8 billion (i.e. 5 times the company’s earnings before interest, taxes and depreciation) –Investing heavily in broadband and technology Wants to be the dominant communications player in Canada Entering the local phone provider marketplace Offers complete package of cable TV, Internet, local, long distance, and wireless telephone services Wants to defeat Bell Canada His challenge will be to manage his company’s cash flow and debt load

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-4 Preparing Financial Statements Entrepreneurs should be aware of a couple of points prior to engaging in this process The size of the company will dictate the extent of financial planning The “intent” of the business plan may also dictate the extent of financial planning Entrepreneurs should not estimate or assume too much in an initial plan Be careful not to overpay yourself –investors like to see an entrepreneur “sharing the pain” Do not spent too much time on these statements –Many great entrepreneurs were not necessarily great financial planners Financial planning is an ongoing process

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-5 Operating and Capital Budgets The financial plan is a key component of the business plan for several reasons: –Can be used to determine/prove feasibility of the venture –Allows planning for capital requirements –Provides confidence for investors and lenders Key statements: –Pro forma income statement –Budgets: Sales forecasts Production/manufacturing Operating costs Capital Cash flow

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-6 Operating and Capital Budgets

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-7 Reducing Expenses As an entrepreneur, the less cash spent, the more left over to pay yourself! Beware of an entrepreneur who is not careful about their spending Key tip-off: expensive vehicle lease in the business plan!

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-8 Reducing Expenses Tips to reduce expenses: –Pay in cash to take advantage of discounts offered –Shop around for the best deal –Haggle whenever possible –Barter –Grab free stuff –Form or join a co-op –Don’t buy things you don’t need –Watch where you rent

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-9 Pro Forma Income Statement Pro forma income (definition): projected net profit calculated from projected revenues minus projected costs and expenses –Monthly numbers for the first several years –Starts with sales forecast –Sales numbers should be based on market research, industry sales, or trial experience –Market share information can be key –Operating expenses can be based on industry standards, estimates, and experience

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd Pro Forma Income Statement

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd Saving Money: Changes in the Environment Experienced entrepreneurs will keep track of these expense areas Reduce inventory levels Reduce travel costs Reduce office supply costs Outsourcing Reduce bank charges Reduce shipping charges Find free help

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd Pro Forma Income Statement

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd Pro Forma Cash Flow Statement Pro forma cash flow (definition): projected cash available calculated from projected cash accumulations minus projected cash disbursements Cash flow is not the same as profitability A growing business that is profitable can very easily run out of cash Most new ventures will have negative cash flow during the start-up phase Two methods to project cash flow

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd Pro Forma Cash Flow Statement

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd Pro Forma Cash Flow Statement

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd Nontraditional Financing Lissa D’Aquanni’s chocolate business Needed to raise “owner’s equity” for her renovation project Some money came from an economic development group She also obtained a government-guaranteed loan Obtained a matching grant program Used a state program for energy-efficient upgrades

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd Pro forma balance sheet (definition): summarizes the projected assets, liabilities, and net worth of the new venture Assets (definition): represents items that are owned or available to be used in the venture operations Liabilities (definition): represents money that is owed to creditors Owner’s equity (definition): represents the amount owners have invested and/or retained from the venture operations Pro Forma Balance Sheet

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd Pro Forma Balance Sheet

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd Strategic Entrepreneurial Finance Entrepreneurs have argued that traditional financial planning does not align well with what happens “in the real world” Cash is king Entrepreneurs are more concerned about their ability to raise capital than what is expressed in textbooks Entrepreneurs are concerned about increasing the value of their company over time not so interested in short term financial results Entrepreneurs are emotionally tied to the company

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd Strategic Entrepreneurial Finance … continued Entrepreneurs have argued that traditional financial planning does not align well with what happens “in the real world” Entrepreneurs often break financial management down to a series of questions: where is the company headed what will happen in the future what can go wrong what has to happen so the company can achieve its financial goals

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd Break-even Analysis Break-even (definition): the volume of sales where the venture neither makes a profit nor incurs a loss Concept used when determining feasibility of the venture Need to determine the costs of producing one unit (variable costs) and the fixed costs of operating the business Selling price charged needs to cover the variable costs of producing the unit and the remainder (gross margin) contributes to paying the fixed costs of operating the business Formula for break-even: B/E (Q)= TFC/(SP-VC) TFC= total fixed costs SP= selling price VC= variable costs

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd Break-even Analysis

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd Key Financial Ratios Debt/equity ratio –This is a figure that banks track most vigilantly –It reveals your company’s exposure to debt (how much ya owe) Working capital ratio –Ratio of current assets to current liabilities –This reveals your ability to pay for things in the short term Wages to sales ratio –Crucial for restaurants, construction firms.. Companies that have a high portion of costs eaten up by salary Inventory to sales ratio –Expressed as the number of days to turn over a given inventory Indicates how fast you are selling stuff from the point when you obtained the materials to make it Gross profit margin –This ratio enables an entrepreneur to determine the level of sales they need to break even

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-24

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd Pro Forma Sources and Applications of Funds Proforma applications and sources of funds (definition): summarizes all the projected sources of funds available to the venture and how these funds will be discharged The purpose is to show how net income and financing were used to increase assets or to pay off debt

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd Pro Forma Sources and Applications of Funds

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd Ratio Analysis Liquidity Ratios Current Ratio Acid Test Ratio Activity Ratios Average Collection Period Inventory Turnover Leverage Ratios Debt Ratio Debt to Equity Profitability Ratios Net Profit Margin ROI - Return on investments

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd Software Packages Track financial data Generate financial statements Spreadsheet programs Accounting programs: –QuickBooksQuickBooks –PeachtreePeachtree –MYOBUSMYOBUS –Vision Point –Small Business Manager –Business Works –Turning Point

Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of Start-up Ventures Entrepreneurship & Economic Development Ethics and Social Responsibility Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd Chapter Closing Comments 1.To understand the role of budgets in preparing pro forma statements. 2.To understand why positive profits can still result in a negative cash flow. 3.To learn how to prepare monthly pro forma cash flow, income, balance sheet, and sources and uses of funds statements for the first year of operation. 4.To explain the application and calculation of the break- even point for the new venture. 5.To illustrate the alternative software packages that can be used for preparing financial statements.