2. FINANCIAL MANAGEMENT FOR SMALL AND MEDIUM ENTERPRISES
CHAPTER 13
FINANCIAL MANAGEMENT FOR SMALL AND MEDIUM ENTERPRISES

3. Objectives The objectives of this chapter are to:
identify the necessary steps to be taken in order to prepare a simple project costs schedule
suggest potential sources to fund a new project
identify inputs to prepare pro forma financial statement
conduct simple financial ratio analysis for business

4. Learning Outcomes
At the end of this chapter, students should be able to:
list various types of common sources of financing for SMEs
identify important elements required in preparing a financial plan
identify necessary financial statements to be prepared in managing a small business

5. The Importance of Finance for SMEs
The need for finance in SMEs might arise on four occasions.
The first, and most common is the need for start-up capital to help in the establishment of a new business.
The requirement to finance business expansion, i.e. for purchase of new buildings, plant, or machinery; to finance working capital by holding more stocks/work in progress and trade debtors. Finance might also be needed for taking over other existing businesses as an expansion strategy.

6. The Importance of Finance for SMEs (cont.)
The need for finance in SMEs might arise on four occasions.
The third occasion is when ‘venture capital' is required, particularly to finance an innovation. This type of capital, also known as 'risk capital‘.
The last occasion is to adjust the existing financial structure of the business, e.g. changes in the proportion of equity to debt or the proportion of long to short-term debt.

7. Types of Finance for SMEs
The main types of finance for SMEs can be categorized into debt and equity finance.
Debt Finance
Debt financing is a financing method which typically involves an interest-bearing instrument, normally a term loan. This type of financing requires the entrepreneur to pay back the funds borrowed plus an interest.
Equity Finance
Equity financing offers some form of the ownership in the business to the investor. Equity finance requires the entrepreneur to give up some degree of control and ownership of the business.

8. Internal or External Funds (cont.)
Financing can also be considered from the perspective of internal versus external funds. The most frequently used funds are internally generated funds. The internal funds can come from various sources within the business, such as personal savings of the entrepreneur, profits retained in the business, sales of fixed assets, reduction of working capital, and account receivable.
The external source of finance can be generated from outside the business and the most frequently used sources of external finance are banking and developmental financial institutions (DFIs).

9. Financial Plan A financial plan is also known as a financial budget.
Determines whether or not a business proposal is viable.
The process of estimating future income, expenses and assets of the business. In business, a financial plan or a financial forecast consists of three primary pro forma (projected) financial statements, cash flow statement, income statement, and the balance sheet prepared within a business plan.

10. The Importance of Financial Plan
To Determine Total Project Implementation Cost.
To Determine Amount of Funding Required and Identify Proposed Sources of Funds.
To Ensure Sufficient Initial Investment .
To Analyse the Viability of the Project .
To Guide Project Implementation .

11. The Importance of Financial Plan (cont.)
The process of preparing a financial plan involves:
determining total project implementation costs
determining amount of funding required and identifying proposed sources of funds
calculating amount of depreciation on fixed assets
calculating amount of loan and hire purchase repayments required
estimating amount cash inflow and outflow during the planned period
estimating amount of profit generated during the planned period
estimating financial position at the end of the planned period
performing financial analysis to determine financial viability of the proposed business

12. Steps in Developing a Financial Plan
To develop a workable and meaningful financial plan, the entrepreneur has to follow these seven steps:
Gathering relevant financial inputs
Preparing project implementation cost schedule
Identifying sources of financing
Preparing pro forma cash flow statement
Preparing pro forma income statements
Preparing pro forma balance sheet
Performing financial analysis based on the above pro forma statements

13. Steps in Developing a Financial Plan (cont.)

14. Steps in Developing a Financial Plan (cont.)

15. Steps in Developing a Financial Plan (cont.)

16. Steps in Developing a Financial Plan (cont.)

17. Steps in Developing a Financial Plan (cont.)

18. Steps in Developing a Financial Plan (cont.)
Step4: Preparing the Pro Forma Cash Flow Statement
The pro forma cash flow statement is another important part of the financial plan. Pro forma cash flow statement refers to the projected statement of cash inflow and outflow throughout the planned period. The pro forma cash flow statement must be able to show the following information:
cash inflows—the projected amount of cash flowing into the company
cash outflows—the projected amount of cash flowing out of the company
cash deficit or surplus—the difference between cash inflows and cash outflows
cash position—the beginning and ending cash balances for a particular period

19. Steps in Developing a Financial Plan (cont.)
Step 4: Prepare Pro Forma Cash Flow Statement (contd.)
Elements of cash inflows:
Equity contribution (cash)
Term loan
Cash sales
Collection of receivables
Others

20. Steps in Developing a Financial Plan (cont.)
Step 4: Prepare Pro Forma Cash Flow Statement (cont.)
Elements of cash outflows:
Marketing expenditure
Operations expenditure
Administrative expenditure
Term loan repayment
Hire purchase repayment
Purchase of fixed assets
Pre-operating expenditure
Payments for deposits
Miscellaneous expenditure

21. Example: Pro Forma Cash Flow Statement

22. Steps in Developing a Financial Plan (cont.)
Step 5 Preparing the Pro Forma Income Statement [B]
The next step in developing a financial plan is to prepare the pro forma income statement which shows the expected profit or loss for the planned period, usually for three consecutive years.
Elements in the Pro Forma Income Statement
Generally, the pro forma manufacturing account consists of the following elements:
cost of goods manufactured
gross profit
net profit
For manufacturing companies, the cost of goods manufactured must be calculated first, while for trading companies; it is the gross profit. Service companies can straight away calculate the net profit.

23. Steps in Developing a Financial Plan (cont.)

24. Steps in Developing a Financial Plan (cont.)

25. Steps in Developing a Financial Plan (cont.)
Step 6 Preparing the Pro Forma Balance Sheets
Elements of the Pro Forma Balance Sheet
The general elements of the pro forma balance sheet include:
assets
owner’s equity
liabilities

26. Steps in Developing a Financial Plan (cont.)

27. Steps in Developing a Financial Plan (cont.)
Assets
Non-current assets
Fixed assets are used and depreciated by a company for more than a year, and thus, they are considered non-current assets.
Current assets
Current assets are short-term assets that can be converted into cash within a year. Examples of these assets are cash, stock (raw materials, work-in-process and/or finished goods), account receivables and other short-term investments.

28. Steps in Developing a Financial Plan (cont.)
Owners’ Equity
Owners’ equity refers to the original capital contributions from the owners or shareholders in terms of cash or assets plus the accumulated amount of net profit. However, if the company suffers a loss, the amount of loss will be deducted from the original equity contribution.
Liabilities
Liabilities are the amounts owed by the company to outsiders. They are categorized as current liabilities and non-current liabilities (long-term liabilities).The most common forms of current liabilities are accounts payable and accrued payments. Non-current liabilities or Long-term liabilities refer to the long-term obligations of the company that mature in a period of more than one year. They usually include long-term loans as well as hire purchase.

29. Steps in Developing a Financial Plan (cont.)
Analysing Financial Statements
Financial Ratio Analysis
Liquidity Ratios
Efficiency Ratios
Profitability Ratios
Solvency Ratios