2. 10-2 The Financial Plan McGraw-Hill/Irwin Entrepreneurship, 7/e Copyright © 2008 The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10

3. 10-3 Operating and Capital Budgets (1 of 2)  Developed before the pro forma income statement.  Sales budget: estimate of the expected volume of sales by month.  Cost of sales can be determined from the sales forecasts.  In manufacturing ventures: costs of internal production or subcontracting are compared.  Includes estimated ending inventory required as a buffer.

4. 10-4 Example of a Manufacturing Budget  >

5. 10-5 Operating and Capital Budgets (2 of 2)  Operating costs:  List of fixed expenses incurred regardless of sales volume.  Variable expenses must be linked to strategy in the business plan.  Capital budgets provide a basis for evaluating expenditures that will impact the business for more than one year.

6. 10-6 Example of an Operating Budget  >

7. 10-7 Pro Forma Income Statements (1 of 2)  Pro forma income: projected net profit calculated from projected revenue minus projected costs and expenses.  Sales by month is calculated first.  Basis of the figures: marketing research, industry sales, and some trial experience.  Forecasting techniques may be used.  New ventures take time to build up sales.  Projections of all operating expenses for each of the months during the first year should be made.

8. 10-8 Pro Forma Income Statements (2 of 2)  Increasing selling expenses as sales increase should be taken into account.  Changes in expenses during the first year can necessitate month-by-month illustration.  Increase in individual expenses need to be reflected in the first year’s pro forma income statement.  Projections should be made for years 2 and 3 as well.

9. 10-9 Example of a Pro Forma Income Statement  >

10. 10-10 Pro Forma Cash Flow (1 of 2)  Projected cash available calculated from projected cash accumulations minus projected cash disbursements.  Not the same as profit.  Sales may not be regarded as cash.  Cash flow is a major problem faced by new ventures.  Use of profit as a measure of success for a new venture may be deceiving.  Two standard methods used to project cash flow:  Indirect method.  Direct method.

11. 10-11 Statement of Cash Flows: The Indirect Method  >

12. 10-12 Pro Forma Cash Flow (2 of 2)  Entrepreneurs must make monthly projections of cash.  Difficulty with projecting cash flows is determining the exact monthly receipts and disbursements.  Cash flow statement is based on best estimates.

13. 10-13 Example of a Pro Forma Cash Flow  >

14. 10-14 Pro Forma Balance Sheet  Pro forma balance sheet: summarizes the projected assets, liabilities, and net worth of the new venture.  A picture of the business at a certain moment in time.  Does not cover a period of time.  Consists of:  Assets: items that are owned or available to be used in the venture operations.  Liabilities: money that is owed to creditors.  Owner’s equity: amount owners have invested and/or retained from the venture operations.

15. 10-15 Example of a Balance Sheet  >

16. 10-16 Break-Even Analysis  Break-even: volume of sales where the venture neither makes a profit nor incurs a loss.  Break-even sales point indicates the volume of sales needed to cover total variable and fixed expenses.  The break-even formula: TFC B/E(Q) = SP – VC/Unit (Marginal Contribution)  Major weakness in calculating the breakeven lies in determining if a cost is a fixed or variable.

17. 10-17 Graphic Illustration of Breakeven  >

18. 10-18 Pro Forma Sources and Applications of Funds  Sources  Operations.  New investments.  Long-term borrowing.  Sale of assets.  Uses/ Applications:  Increase assets.  Retire long-term liabilities.  Reduce owner or stockholders’ equity.  Pay dividends.

19. 10-19 Example for Sources and Applications of Funds  >

20. 10-20 Sources of Capital McGraw-Hill/Irwin Entrepreneurship, 7/e Copyright © 2008 The McGraw-Hill Companies, Inc. All rights reserved. Chapter 11

21. 10-21 Debt or Equity Financing  Debt financing: obtaining borrowed funds for the company.  Asset-based financing; requires some asset to be used as a collateral.  Borrowed funds plus an interest rate need to be paid back.  Equity financing: obtaining funds for the company in exchange for ownership.  Does not require collateral.  Offers investor some form of ownership position.

22. 10-22 Factors Affecting Type of Financing  Availability of funds.  Assets of the venture.  Prevailing interest rates.  All financing requires some level of equity.  Amount of equity will vary by nature and size of venture.

23. 10-23 Sources for Internal Funds  Profits.  Sale of assets and little-used assets.  Working capital reduction.  Extended or discounted payment terms – suppliers.  Collecting bills (accounts receivable) more quickly.  Short-term internal source of funds:  Reducing short-term assets: inventory, cash, and other working-capital items.  Extended payment terms from suppliers.

24. 10-24 External Funds  Criteria for evaluating external sources of funds:  Length of time the funds are available.  Costs involved.  Amount of company control lost.  Sources of funds:  Self  Family and friends.  Commercial banks.  R&D limited partnerships.  Government loan programs.  Grants.  Venture capital.  Private placement.

25. 10-25 Personal Funds  Least expensive funds in terms of cost and control.  Absolutely essential in attracting outside funding.  Typical sources of personal funds:  Savings.  Life insurance.  Mortgage on a house or car.

26. 10-26 Family and Friends  Likely to invest due to relationship with entrepreneur.  Advantage: easy to obtain money; more patient than other investors.  Disadvantage: direct input into operations of venture.  A formal agreement must be written to include:  Amount of money involved.  Terms of the money.  Rights and responsibilities of the investor.  What happens if the business fails.  Entrepreneur must consider impact on personal relationship.

27. 10-27 Commercial Bank Loans  Bank loans (asset based): tangible collateral valued at more than the amount of money borrowed.  Accounts receivable.  Inventory loans.  Equipment loans.  Real-estate loans.  Cash flow financing: conventional bank loans; standard way banks lend money to companies.  Installment loans.  Straight commercial loans.  Long-term loans.  Character loans.

28. 10-28 Ratio Analysis  Serves as a measure of financial strengths and weaknesses of the venture.  Should be used with caution.  Typically used on actual financial results.  Provide a sense of where problems exist in the pro forma statements.

29. 10-29 Liquidity Ratios Current Ratio _Current assets__108, 050_ Current liabilities 40, 500 Acid-Test Ratio Current assets - Inventory__108, 050 – 10, 450_ Current liabilities 40, 500 = =2.67 times = =2.40 times

30. 10-30 Activity Ratios Average Collection Period _Accounts receivable___46, 400___ Average daily sales995, 000/ 360 Inventory Turnover Cost of goods sold__645, 000_ Inventory 10, 450 = =17 days = = 61. 7 times

31. 10-31 Leverage Ratios Debt Ratio Total liabilities_ __249, 700_ Total assets 308, 450 Debt to Equity Total liabilities__249, 700_ Stockholder’s equity 58, 750 = = 81 % = = 4.25 times

32. 10-32 Profitability Ratios Net Profit Ratio Net profit_ __8, 750_ Net sales 995,000 Return on Investment Net profit__8, 750_ Total assets 200, 400 = = 0.88 % = = 4.4 %