Copyright © 2016 Pearson Education, Inc. Creating a Successful Financial Plan Section 3: Launching the Business

 Describe how to prepare the basic financial statements and use them to manage a small business.  Create projected (pro forma) financial statements.  Understand the basic financial statements through ratio analysis.  Explain how to interpret financial ratios.  Conduct a break-even analysis for a small company Copyright © 2016 Pearson Education, Inc.

 Financial management:  A process that provides entrepreneurs with relevant financial information in an easy-to-read format on a timely basis.  It allows entrepreneurs to know not only how their businesses are doing financially but also why they are performing that way Copyright © 2016 Pearson Education, Inc.

 Common mistake among business owners: Failing to collect and analyze basic financial data.  Many entrepreneurs run their companies without any kind of financial plan.  About 75% of business owners do not understand or fail to focus on the financial details of their companies.  Financial planning is essential to running a successful business and is not that difficult! Copyright © 2016 Pearson Education, Inc.

 Balance Sheet:  “Snapshot”  Estimates the firm’s worth on a given date; built on the accounting equation: Assets = Liabilities + Owner’s Equity Copyright © 2016 Pearson Education, Inc.

Ch. 11: Creating a Successful Financial Plan Optional Debt Financing? Growth?

 Income Statement:  “Moving picture”  Compares the firm’s expenses against its revenue over a period of time to show its net income (or loss): Net Income = Sales Revenue - Expenses Copyright © 2016 Pearson Education, Inc. (continued)

Copyright © 2016 Pearson Education, Inc.

Ch. 11: Creating a Successful Financial Plan Really? Better shown by months till desired profitability

 Start-ups do NOT make profit initially  First year’s operations are usually at a loss  However many don’t estimate this loss  Cash flow  Burn rate  Strategies for start-up losses:  Don’t pay yourself!  Reserve capital as a buffer  Line of credit to ease uneven cash flow Ch. 11: Creating a Successful Financial Plan

Copyright © 2016 Pearson Education, Inc.

 How much will it take to get your venture going?  Assets  Operating expenses (buffer)  Pre-payments (lease deposits, insurance, etc.)  Advertising  Training of staff  Etc. Ch. 11: Creating a Successful Financial Plan

 Helps the entrepreneur transform business goals into reality  Challenging for a business start-up  They should be realistic and well-researched!  Start-ups should create two-year projections  Projected financial statements:  Income statement  Balance sheet Copyright © 2016 Pearson Education, Inc.

 Ratio analysis:  A method of expressing the relationships between any two elements on financial statements.  Important barometers of a company’s health.  Studies indicate few small business owners compute financial ratios and use them to manage their businesses Copyright © 2016 Pearson Education, Inc.

 Ratios – useful yardsticks of comparison.  Standards vary from one industry to another; the key is to watch for “red flags.”  Critical numbers: measure key financial and operational aspects of a company’s performance. Examples:  Sales per labor hour at a supermarket  Food costs as a percentage of sales at a restaurant.  Load factor (percentage of seats filled with passengers) at an airline Copyright © 2016 Pearson Education, Inc.

 When comparing critical numbers to the industry standards, ask:  Is there a significant difference in my estimated ratio and the industry average?  If so, what is the difference meaningful?  Is the difference good or bad?  What are the possible causes of this difference? What is the most likely cause? Copyright © 2016 Pearson Education, Inc.

 Breakeven point:  The level of operation at which a business neither earns a profit nor incurs a loss.  A useful planning tool because it shows entrepreneurs minimum level of activity required to stay in business.  With one change in the breakeven calculation, an entrepreneur can also determine the sales volume required to reach a particular profit target Copyright © 2016 Pearson Education, Inc.

Step 1. Determine the expenses the business can expect to incur. Step 2. Categorize the expenses in step 1 into fixed expenses and variable expenses. Step 3. Calculate the ratio of variable expenses to net sales. Step 4. Compute the breakeven point: Breakeven Point ($) = Total Fixed Costs Contribution Margin Copyright © 2016 Pearson Education, Inc.

Step 1. Net Sales estimate: $950,000 Cost of Goods Sold: $646,000 Total expenses: $236,500. Step 2. Variable Expenses: $705,125 Fixed Expenses: $177,375 Step 3. Contribution Margin = 1 - $705,125 =.26 $950,000 Step 4. Breakeven Point = $177,375 = $682, Copyright © 2016 Pearson Education, Inc. Helpful?

 Find a milestone that you can rally around (goal)…  Daily sales  Number of customers (with conversion rates)  Number of units to sell Ch. 11: Creating a Successful Financial Plan

 Financial planning is a critical step  Entrepreneurs can gain valuable insight through:  Pro forma statements  Ratio analysis  Breakeven analysis Copyright © 2016 Pearson Education, Inc.