1. part 4 PowerPoint Presentation by Charlie Cook Copyright © 2003 South-Western College Publishing. All rights reserved. All rights reserved. Projecting Financial Requirements 12 The New Venture Business Plan 12e

2. Copyright © by South-Western College Publishing. All rights reserved. 12–2 Looking Ahead After studying this chapter, you should be able to: 1. Describe the purpose and content of the income statement and the balance sheet. 2. Compute a firm’s cash flows. 3. Forecast a new venture’s profitability. 4. Estimate the assets needed and the financing required for a new venture.

3. Copyright © by South-Western College Publishing. All rights reserved. 12–3 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

4. Copyright © by South-Western College Publishing. All rights reserved. 12–4 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  Operating expenses (marketing, selling, general and administrative expenses, and depreciation)  Financing costs (interest paid)  Tax payments

5. Copyright © by South-Western College Publishing. All rights reserved. 12–5 Fig. 12.1 The Income Statement: An Overview

6. Copyright © by South-Western College Publishing. All rights reserved. 12–6 Income Statement for Bates & Associates Leasing Company for the Year Ending December 31, 2002 Sales revenue$850,000 Cost of goods sold_550,000 Gross profit$300,000 Operating expenses: Marketing expenses$90,000 General and administrative expenses 80,000 Depreciation _30,000 Total operating expenses$200,000 Operating income$100,000 Interest expense__20,000 Earnings before taxes$ 80,000 Income tax (25%) 20,000 Net income $ 60,000 Dividends paid$_15,000 Change in retained earnings$ 45,000 Fig. 12.2

7. Copyright © by South-Western College Publishing. All rights reserved. 12–7 The Balance Sheet Balance Sheet –A report showing a firm’s assets, liabilities, and owners’ equity at a specific point in time –Outstanding debt + Owner’s equity = Total assets

8. Copyright © by South-Western College Publishing. All rights reserved. 12–8 The Balance Sheet: Types of Assets Current assets (working capital) –Assets that can be converted to cash within the firm’s operating cycle—cash, accounts receivable, and inventories. Fixed Assets –Relatively permanent resources intended for the use of the firm. –Net fixed assets = gross fixed assets – accumulated depreciation Other Assets –Intangible assets (patents, copyrights, goodwill)

9. Copyright © by South-Western College Publishing. All rights reserved. 12–9 The Balance Sheet: Types of Financing Debt Capital –Financing provided by a creditor Short-term (current) Debt  Accounts payable  Accrued expenses  Short-term notes Long-Term Debt –Loans and mortgages from banks and other lenders with maturities greater than one year

10. Copyright © by South-Western College Publishing. All rights reserved. 12–10 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. Owners’ Equity = Owners’ investment – Owners’ cash withdrawals Cumulative profits + Owners’ Equity = Owners’ investment + Earnings retained within Business

11. Copyright © by South-Western College Publishing. All rights reserved. 12–11 Balance Sheets for Bates & Associates Leasing Company for December 31, 2001 and 2002 Assets Current assets: Cash$ 45,000$ 50,000$ 5,000 Accounts receivable75,00080,0008,000 Inventories180,000220,00040,000 Total current assets$300,000$350,000$ 50,000 Fixed assets: Gross plant and equipment $790,000$890,000$ 100,000 Accumulated depreciation ( 360,000)( 390,000)( 30,000) Net plant and equipment$430,000$500,000$ 70,000 Land 70,000 0 Total fixed assets$500,000$570,000$ 70,000 TOTAL ASSETS$800,000$920,000$120,000 Changes20022001 70,000

12. Copyright © by South-Western College Publishing. All rights reserved. 12–12 Balance Sheets for Bates & Associates Leasing Company for December 31, 2001 and 2002 Debt (Liabilities) and Equity Current liabilities: Accounts payable and accruals$ 15,000$ 20,000$ 5,000 Short-tern notes 60,000 80,000 20,000 Total current liabilities$ 75,000$100,000$ 25,000 Long-term notes payable 150,000 200,000 50,000 Total liabilities$225,000$300,000$ 75,000 Common stock$300,000$300,000$ 0 Retained earnings 275,000 320,000 5,000 Total stockholders’ equity$575,000$620,000$ 45,000 TOTAL DEBT AND EQUITY $800,000$920,000$120,000 Changes20022001

13. Copyright © by South-Western College Publishing. All rights reserved. 12–13 Fig. 12.3 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 or Common stock equity Assets Debt (Liabilities) and Equity (Net Worth) Current Debt Long-term Debt The Balance Sheet: An Overview

14. Copyright © by South-Western College Publishing. All rights reserved. 12–14 Determining Cash Flow: Key Terms Accrual-Basis Accounting –A method of accounting that matches revenues when they are earned against the expenses associated with those revenues. Cash-Basis Accounting –A method of accounting that reports transactions only when cash is received or a payment is made.

15. Copyright © by South-Western College Publishing. All rights reserved. 12–15 Determining Cash Flow: Key Terms Depreciation Expense –Costs related to a fixed asset, such as a building or equipment, distributed over its life. Sustainable Growth –Growth that can be financed from the cash flows generated from operating the business.

16. Copyright © by South-Western College Publishing. All rights reserved. 12–16 Fig. 12.5 Income statement reports the profits from January 1, 2002 through December 31, 2002 2002 Balance Sheet Reports a firm's financial position at end of 2002 January 1December 31 2001 Balance Sheet Reports a firm's financial position at beginning of 2002 (end of 2001) The Fit of the Income Statement and the Balance Sheet

17. Copyright © by South-Western College Publishing. All rights reserved. 12–17 Fig. 12.6 After-Tax Cash Flows from Operations Cash Flows from Assets Changes in Operating Working Capital Changes in Long-Term Assets Computing Cash Flows from Assets After-tax cash flows from operations Investments in operating working capital Investments in long-term assets Cash flows from assets =

18. Copyright © by South-Western College Publishing. All rights reserved. 12–18 Computing Other Cash Flows After-Tax Cash Flows From Operations Net income Depreciation expense Interest Expense After-tax cash flows from operations = + + Operating Work Capital Current assets Operating Working Capital = – Account payable and accruals

19. Copyright © by South-Western College Publishing. All rights reserved. 12–19 Fig. 12.7 Cash Flows from Financing

20. Copyright © by South-Western College Publishing. All rights reserved. 12–20 Financial Forecasting Pro forma Financial Statements –Reports that provide projections of a firm’s financial position –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?

21. Copyright © by South-Western College Publishing. All rights reserved. 12–21 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?”

22. Copyright © by South-Western College Publishing. All rights reserved. 12–22 Forecasting Assets and Financing Requirements Estimating Asset Requirements –Use industry ratios for assets-to-sales –Use breakeven analysis and empirical data Percentage-of-Sales Technique –Forecasting asset investment and financing requirements using a percentage of the total sales for a firm as the basis for forecasting the level of assets to be held by a firm.

23. Copyright © by South-Western College Publishing. All rights reserved. 12–23 Fig. 12.9 Increase in Sales Increase in Asset Requirements Increase in Financing Requirements Results in Assets-to-Sales-Financing Relationships

24. Copyright © by South-Western College Publishing. All rights reserved. 12–24 Ratio Analysis 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.

25. Copyright © by South-Western College Publishing. All rights reserved. 12–25 Sources of Equity Capital External Equity –Owners’ original investment Internal Equity –Profit retention (retained profits) Forecasting financial requirements (in total) Total sources of financing Spontaneous financing Profits retained within the business Total asset requirements = + = External sources of financing +