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BA 346 Working as an Entrepreneur Week 4-5
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Accounting “Language of Business” Measurement What were our goals? How did we do? Profit: The Bottom Line The “Triple Bottom Line” Profit People Planet
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Financial Statement Overview What, Why, How for each What Pro Forma means Iterative development (AKA circular reasoning) How good will your estimates be? When will you update them?
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Three Costs to Think About Terminology: Price vs Cost vs Investment Fixed costs The total stays “fixed” regardless of volume e.g. Lease expense, salaries Variable costs The total “varies” based on the volume e.g. Raw Materials, wages Direct vs Indirect Costs Direct costs are attributable to creating & selling the product Some fixed costs are direct costs Investment in assets What is needed to start & run the business e.g. Equipment, working capital
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Workshop Prep What costs will your business have? Fixed CostsVariable Costs Indirect Costs Direct Costs Investment (assets needed)
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The Break Even Point What is the break even point? When will you break even? Why is it important? What sales volume is needed to be profitable? How much profit is desired? What is the targeted sales volume? Break even is calculated as (Fixed Costs) divided by (Selling Price per unit - Variable Cost per unit)
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Workshop Prep Total Fixed Costs = _____________________ Variable Costs per unit = _____________________ Selling Price per Unit = _____________________ Contribution (Price – Variable) = _____________________ BREAKEVEN (Fixed) (Contribution) = __________ Units =
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Revenue model What product are you selling? Goods Services What is the pricing of your product? Different tiers? Volume discount? Average price or segments?
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Been to a video store lately? The 80s video store Video chains Delivery Streaming Better streaming 1 Out Limited4.99$ 1 Out Unlimited8.99$ 2 Out Unlimited13.99$ 3 Out Unlimited16.99$ 4 Out Unlimited23.99$ etc. 1 Out Limited4.99$ 1 Out Unlimited9.99$ 2 Out Unlimited14.99$ 3 Out Unlimited19.99$ 4 Out Unlimited27.99$ etc.
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Netflix Sales Vol growth 51%, 18% 26%, 31% respectively Sales Vol CAGR 31%
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Netflix Sales Price growth… Sales Price CAGR…
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Netflix Sales $ growth 46%, 21%, 13%, 22% respectively Sales $ CAGR 25%
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Revenue Model, cont’d How will customers pay? Immediate payment Cash Credit cards Invoicing Accounts Receivable Terms Collections & aging
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Building the Income Statement Sometimes called the P&L (Profit & Loss) Statement Income – Expenses = Profit Structure Income COGS (sometimes just Variable Costs ) Gross Profit Operating Expenses Operating Profit (sometimes EBIT) Other expenses, including Interest & Tax Net Income (Profit) Usually easier to remember starting at the bottom…
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Profit Remember the break even point? How much profit is required? Retained earnings for reinvestment, growth Dividends & other payouts to owners Net Income = Dividends + ΔRetained Earnings Some industries have a Rule of Thumb for revenue, reinvestment & profit
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Tax Tax can be complicated You need a tax preparer or a CPA (or both) Depends on the structure of your business You need to strategize in advance with your tax experts – create value form tax planning Tax rates Effective tax rate (average) Marginal tax rate (bracket) Rule of thumb for estimating “Typical” Effective Rate for tax Tax Expense = Taxable Income x Effective Rate Net Income = Taxable Income – Tax Expense :. Net Income = Taxable Income x (1- Effective Rate) :. Taxable Income = Net Income ÷ (1- Effective Rate) Tax Expense = Taxable Income – Net Income
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Interest Interest is the cost of financing assets Creates a tax deduction Reduces profit Placeholder for interest Fill this in once debt and terms are forecast
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Depreciation What is it? Creates a tax deduction from the investment in certain types of assets (e.g. Equipment) Non-cash Expense Has nothing to do with actual condition of equipment or possible resale value Placeholder for depreciation Fill this in once the assets are forecast Straightline depreciation = (Purchase price – salvage value) ÷ Years allowed for that type of asset (check with your tax expert)
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Operating expenses Variable cost x volume Raw materials (direct) Worker wages (direct) Supplies (indirect) Fixed costs Utilities (indirect?) Rent (indirect?) Supervisor salaries (indirect)
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Revenue Price x volume Sales target Profit needed? Net Income ÷ Contribution = Units Needed above Breakeven Additional revenue Remember McKay envelope? Most businesses have other items to sell
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Workshop Prep Profit Needed = $_____________ Contribution = $_____________ Profit ÷ Contribution = _________ units Plus Breakeven Units = _________ units Equals Sales Target _________ units
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From Revenue to Assets What assets will be required to sell this volume? How much is the initial investment?
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Building the Balance Sheet Structure A = L + SE Assets Current Non-current Liabilities Current Non-current Equity = Assets – Liabilities Invested Capital Retained Earnings
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“Common Size” Financial Statements Sometimes it is useful to look at financials as a % of a relevant total Expenses as a % of Sales Assets & Liabilities as a % of Total Assets This is not always the best way to analyze financial structure, but it may give you a starting point
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Current Assets
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Accounts Receivable What % of customers will you be invoicing? How long will they take to pay?
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Cash How much will you need? Days sales in cash Need to cover expenses Need to not lose value
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Inventory How much will you need? Days sales in inventory Efficiency, cost, storage, issues
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Fixed assets PP&E
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Other non-current assets Depends on the business, most small businesses have none at startup Possibly patents or other intellectual property
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Final thoughts on assets Where are the assets going to come from? Where will the cash for them come from? Is debt good or bad?
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Non-current liabilities
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Accounts payable Trade credit from suppliers Other
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Notes payable Short Term Debt
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Line of credit Revolving Credit
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Connecting the IS & BS: The Statement of Cash Flows Structure Cash provided by Operations Cash provided by Investment Cash provided by Financing
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Cash from operations Start with Net Income, then add… Depreciation for the year Changes in Accounts Receivable Changes in Liabilities Changes in Inventory Changes in Other Operating Activities Cash provided (used) by Operations
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Cash from (used by) investing Negative numbers show investment Capital Expenditures Other Investments Other Cash Flows from Investing Activities Cash provided (used) by Investing Activities
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Where will the cash come from? At startup, all the investing comes from cash in the business Investment Loans
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Financing CFs, cash from financing Dividends Sales (Repurchases) of Stock Net New Debt Other Cash Flows from Financing Activities Cash provided (used) by Financing Activities
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Change in Cash Cash at Beginning of Year + Change in Cash From Operations From (used by) Investing From (used by) Financing = Cash at End of Year Cash at EOY provides the figure on the balance sheet
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Pro Forma Income Statement
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Pro Forma Balance Sheet
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Pro Forma Statement of Cash Flows
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Reality check Are the figures realistic? How will you improve them?
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Resources for real life Bookkeepers Quickbooks, et al CPA CFO
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Workshop Putting them in good form - template for workshop (printed & online)
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