1. The Financial Plan Part 1: Projecting Financial Requirements
Part 3 Developing the New Venture Business Plan

2. Looking Ahead After studying this chapter, you should be able to:
Describe the purpose and content of the income statement, the balance sheet, and the cash flow statement.
Forecast a new venture’s profitability.
Determine asset requirements, evaluate financial sources, and estimate cash flows for a new venture.
Explain the importance of using good judgment when making projections.
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3. Understanding Financial Statements
Financial Statements (Accounting Statements)
Reports of a firm’s financial performance and resources, including an income statement and a balance sheet
Helps determine a startup’s financial requirements
Assesses the financial implications of a business plan
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4. Understanding Financial Statements
Income Statement
A report showing the profit or loss from a firm’s operations over a given period of time.
“How profitable is the business?”
Sales – Expenses = Profits
Revenue from product or service sales
Costs of producing product or service (cost of goods sold)
Operating expenses (marketing, selling, general and administrative expenses, and depreciation)
Financing costs (interest paid)
Tax payments
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5. Sections of the Income Statement
Cost of goods sold
The cost of producing or acquiring goods or services to be sold by a firm
Gross profit
Sales less the cost of goods sold
Operating expenses
Costs related to marketing and selling a firm’s product or service, general and administrative expenses, and depreciation
Operating income
Earnings before interest and taxes are paid
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6. Sections of the Income Statement
Financing Costs
The amount of interest owed to lenders on borrowed money
Net income available to owners (Net income)
Income that may be distributed to the owners or reinvested in the company
Depreciation expense
Costs related to a fixed asset, such as a building or equipment, distributed over its useful life
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7. The Income Statement: An Overview
Operating Activities
Sales Revenue =
Operating Income
Earnings Before Taxes
Net Income Available
to Owners
Cost of producing or acquiring product or service
(cost of goods sold)
Gross profit
Marketing and selling expenses, general and administrative expenses and depreciation (operating expenses) , –
Financing Activities
Interest expense on debt (financing costs)
Taxes
Income taxes
Exhibit 10.1
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8. Income Statement for Petri & Associates Leasing, Inc
Income Statement for Petri & Associates Leasing, Inc., for the Year Ending December 31, 2005
Sales revenue $850,000
Cost of goods sold _550,000
Gross profit $300,000
Operating expenses:
Marketing expenses $90,000
General and administrative expenses ,000
Depreciation _30,000
Total operating expenses $200,000
Operating income $100,000 Interest expense __20,000
Earnings before taxes $ 80,000
Income tax (25%) ,000
Net income $ 60,000
Dividends paid $_15,000
Change in retained earnings $ 45,000
Exhibit 10.2
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9. The Balance Sheet Balance Sheet
A report showing a firm’s assets, liabilities, and owners’ equity at a specific point in time
Total Assets = Outstanding debt + Owner’s equity
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10. The Balance Sheet: An Overview
Current Assets
Cash
Accounts receivable
Inventories
Other Assets
Long-term investments, patents +
Total Assets =
Fixed Assets
Machinery and equipment
Buildings and land
Debt Capital
Accounts payable
Accrued expenses
Short-term notes
Long-term notes
Mortgages
Total Debt and Equity
Owner's Equity
Owner's net worth or
Partnership equity
Common stock equity
Assets
Debt (Liabilities) and
Equity (Net Worth)
Current Debt
Long-term Debt
The Balance Sheet: An Overview
Exhibit 10.3
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11. Balance Sheet: Current Assets
Current Assets (Working Capital)
Assets that can be converted to cash within the firm’s operating cycle
Cash: Currency and negotiable instruments
Accounts receivable: the amount of credit extended to customers that is currently outstanding
Inventory: raw materials and products held in anticipation of eventual sale
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12. Balance Sheet: Fixed Assets
Relatively permanent resources intended for use in the business (not for resale)
Depreciable assets
Assets whose value declines (depreciates) over time
Gross fixed assets
Original cost of depreciable assets before any depreciation expense has been taken
Accumulated depreciation
Total depreciation expense taken over the assets’ life
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13. Balance Sheet: Fixed Assets (cont’d.)
Net fixed assets
Gross fixed assets less accumulated depreciation
Other assets
Assets other than current assets and fixed assets, such as patents, copyrights, and goodwill that have an estimated value
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14. The Balance Sheet: Debt
Business financing provided by a creditor
Current (Short-term) debt
Accounts payable: outstanding credit payable to suppliers
Accrued expenses: short-term liabilities that have been incurred but not paid
Short-term notes: Cash amounts borrowed from a bank or other lending sources that 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
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15. The Balance Sheet: Debt
Long-term debt
Loans and mortgages from banks and other sources with repayment terms of more than 12 months
Mortgage
A long-term loan from a creditor for which real estate is pledged as collateral
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16. The Balance Sheet: Types of Financing
Owners’ equity
Money that the owners invest in the business
Owners are “residual owners” of the firm.
Creditors have first claim on the assets of the firm.
Retained earnings
Profits less withdrawals (dividends) over the life of the business
Owners’ equity =
Owners’ investment –
Cumulative dividends paid to owners
Cumulative profits +
Earnings retained within the business
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17. Balance Sheets for Petri & Associates Leasing, Inc
Balance Sheets for Petri & Associates Leasing, Inc., for December 31, 2004 and 2005
Exhibit 10.4
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18. Profits Versus Cash Flows
Accrual-Basis Accounting
A method of accounting that matches revenues when they are earned against the expenses associated with those revenues
Sales reflect both cash and credit (noncash) sales
Inventory purchased on credit is a noncash expense
Depreciation is a noncash expense
Income tax is accrued and may not be entirely expensed
Cash-Basis Accounting
A method of accounting that reports transactions only when cash is received or a payment is made
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19. The Fit of the Income Statement and the Balance Sheet
Exhibit 10.5
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20. The Cash Flow Statement
A financial report showing a firm’s income (cash) when it is received and expenses when they are paid.
Cash flows from normal operations (operating activities)
Cash flows related to the investment in or sale of assets (investment activities)
Cash flows related to financing the firm (financing activities)
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21. The Cash Flow Statement (cont’d.)
Cash Flows from Operations
Net cash flows generated from operating a business
Calculated by adding back to operating income depreciation, deducting income taxes, and factoring in any changes in net working capital
Adjusted Income
After-tax cash flow
Net Working Capital
Money invested in current assets less accounts payable and accruals
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22. The Cash Flow Statement (cont’d.)
Cash Flows from Investment Activities
Cash inflows and outflows resulting from the sale or purchase of equipment or another depreciable asset
Cash Flows from Financing Activities
Cash inflows and outflows resulting from:
Paying dividends and interest expense
Increasing or decreasing short-term and long-term debt
Issuing or repurchasing stock
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23. Computing Cash Flows from Assets
After-Tax Cash Flows from Operations
Cash
Flows
from Assets
Changes in Operating Working Capital
Changes in Long-Term Assets
After-tax cash flows
from operations
Investments in
operating
working capital
Investments
in long-term
assets
Cash
flows from assets =
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24. Computing Other Cash Flows
After-Tax Cash Flows From Operations
Net income
Depreciation expense
Interest Expense
After-tax cash
flows from operations = +
Operating Working Capital
Current assets
Operating Working Capital = –
Account payable and accruals
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25. Cash Flows from Financing
Interest and Dividends
Paid to Investors
Increase in Debt
(firm issues new debt)
Increase in Equity
(firm issues new stock)
Decrease in Debt
(firm repays debt)
Decrease in Equity
(firm repurchases outstanding stock)
Increases in Cash Flows from Financing
Decreases in Cash Flows from Financing
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26. Cash Flow Statement for Petri & Associates Leasing, Inc
Cash Flow Statement for Petri & Associates Leasing, Inc., for the Year Ending December 31, 2005
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Exhibit 10.6

27. Cash Flow Patterns
Pattern 1. This firm has positive cash flows from operations, negative investment cash flows, and positive cash flows from financing. It is using its cash flows from operations and new financing to expand the firm’s operations.
Pattern 2. This firm is using cash flows from operations to expand the business, pay down debt, and/or pay its owners.
Pattern 3. This firm is encountering negative cash flows from operations, which are being covered by selling assets and by borrowing or acquiring more equity financing.
Pattern 4. This firm has negative cash flows from operations and is growing the company’s fixed assets through increased financing. This firm is a startup business that has yet to break even, is investing in assets to produce future cash flows, and is having to raise capital to make that happen.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Exhibit 10.7

28. Financial Forecasting
Pro Forma Financial Statements
Statements that project a firm’s financial performance and condition
Purposes of pro forma statements:
How profitable can the firm be expected to be, given the projected sales levels and the expected sales expense relationships?
What will determine the amount and type of financing (debt or equity) to be used?
Will the firm have adequate cash flows? If so, how will they be used; if not, where will the additional cash come from?
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.

29. Pro Forma Income Statements for Cameron Products, Inc.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Exhibit 10.8

30. Forecasting Profitability
Net Income Depends On:
Amount of sales
Cost of goods sold and operating expenses
Interest expense
Taxes
“If we’re doing so well, then why am I always so broke?”
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31. Forecasting Assets and Financing Requirements and Cash Flows
Bootstrapping
Minimizing a firm’s investments
Estimating Asset Requirements
Use industry ratios for assets-to-sales
Use breakeven analysis and empirical data
Percentage-of-Sales Technique
Using a percentage of the total sales for a firm as the basis for forecasting the level of assets, accounts receivable, and inventories to be held by a firm
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32. Assets-to-Sales-Financing Relationships
Exhibit 10.9
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33. Percentage-of-Sales Technique Example
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34. Determining Financing Requirements
Liquidity
The degree to which a firm has working capital available to meet maturing debt obligations
Current Ratio
The firm’s relative liquidity, determined by dividing current assets by current liabilities
Debt Ratio
Debt as a fraction of assets; total debt divided by total assets
Spontaneous financing—debts such as accounts payable that increase as the firm grows
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35. Sources of Equity Capital
External Equity
The owners’ original investment
Profit Retention
The reinvestment of profits in a firm
Internal Equity
Capital from retaining profits within the firm
Forecasting financial requirements (in total):
Total sources of financing
Spontaneous financing
Profits retained within the business
Total asset requirements = +
External sources of financing
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36. Projected Balance Sheets for Cameron Products, Inc.
Exhibit 10.10
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37. Good Forecasting Requires Good Judgment
Practical Suggestions
Develop realistic sales projections.
Build projections from clear assumptions about marketing and pricing plans.
Do not use unrealistic profit margins.
Don’t limit your projections to an income statement.
Provide monthly data for the upcoming year and annual data for succeeding years.
Avoid providing too much financial information.
Be certain that the numbers reconcile—and not by simply plugging in a figure.
Follow the plan.
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38. Key Terms financial statements (accounting statements)
income statement (profit and loss statement)
cost of goods sold
gross profit
operating expenses
operating income
financing costs
net income available to owners (net income)
depreciation expense
balance sheet
current assets (gross working capital)
accounts receivable
inventory
fixed assets
depreciable assets
gross fixed assets
accumulated depreciation
net fixed assets
other assets
debt
current debt (short-term liabilities)
accounts payable (trade credit)
accrued expenses
short-term notes
long-term debt
mortgage
ownership equity
retained earnings
cash flow statement
accrual-basis accounting
cash-basis accounting
cash flows from operations
net working capital
pro forma financial statements
bootstrapping
percentage-of-sales technique
liquidity
current ratio
debt ratio
spontaneous financing
external equity
profit retention
internal equity
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39. Computing Cash Flows for Petri & Associates, Inc.
Part 3 Developing the New Venture Business Plan

40. Income Statement and Balance Sheet Changes for Petri & Associates, Inc
Income Statement and Balance Sheet Changes for Petri & Associates, Inc., for the Year Ending December 31, 2005
Exhibit A10.1
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41. Cash Flow Statement for Petri & Associates, Inc
Cash Flow Statement for Petri & Associates, Inc., for the Year Ending December 31, 2005
Exhibit A10.2
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42. Computing Cash Flows for Petri & Associates, Inc.
Part 3 Developing the New Venture Business Plan

43. Cash Flow Statements For Cameron Products, Inc.
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