FINANCIAL PLANNING: SHORT TERM AND LONG TERM 1 ENTREPRENEURIAL FINANCE

Chapter 6FINANCIAL PLANNING: SHORT TERM AND LONG TERM

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ENTREPRENEURIAL FINANCE

Venture Life Cycle: Operating And Financial Decisions

Development Stage: Screen Business Ideas Prepare Business Plan Obtain Seed Financing

Startup Stage: Choose Organizational Form Prepare Initial Financial Statements Obtain First Round Financing

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Survival Stage: Monitor Financial Performance Project Cash Needs Obtain First Round Financing Possible Actions: Liquidate v. Restructure

Rapid Growth Stage: Create and Build Value Obtain Additional Financing Examine Exit Opportunities Possible Actions: Go Public v. Sell/Merge

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Early-Maturity Stage: Manage Ongoing Operations Maintain and Add Value Obtain Seasoned Financing

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Successful Venture Life Cycle

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Financial Planning

Usually begins with forecast of sales

Short term financial planning broken down into monthly forecast

In monthly forecast, should consider the impact of seasonality

Longer term financial planning : 3 – 5 years

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Short-term Cash Planning Tools

Sales Schedule Purchase Schedule Inventory Schedule Production Schedule Wages and Commission Schedule Cash Budget

A venture’s projected cash receipts and disbursements over a forecast period

Balance Sheet, Profit and Loss9

Financial Assumptions

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FINANCIAL ASSUMPTIONS

Projected Sales ($)March 92,000 April 115,000 May 184,000 June 138,000 July 115,000 August 92,000

Buying a used delivery truck 6,900 USD Sales PolicyMiscellaneous Cash Expense 5% of the current sales Cash 60%Rent 4,600 USD per month Credit 40%Insurance Expense 460 USD per monthDepreciation Expense 1,150 USD per month Inventory PolicyTax Rate 0% Balance 80% of the sales for the monthWages Payment Policy 2 times of payment a month Inventory Cushion 46,000 USD Payment 1 50% The venture payment policy Payment 2 50% This month 50%Wages 5,750 USD per month fixed Following month 50%

15% of sales as a variable commission Cash Beginning Balance 23,000 USDWages are paid a half month after earned Interest rate of founder's loan 1.5% per monthCOGS 70% of sales Borrow and Repay at the end of every monthInventory policy 80% of the sales for the month plus a USD 46,000 Term of Loan 2 years

Minimum Cash Balance 23,000 USD

PDC – Pro Forma Balance Sheet

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Current Assets Current Liabilities Cash 23,000 Accounts Payable 38,640 Accounts Receivable 36,800 Accrued Wages 9,775 Paint Inventory 110,400 Total Current Liabilities 48,415 Prepaid Insurance 4,140Total Current Assets 174,340

Property, Plant and Equipment Gross property, plant and equipment 85,100 Accumulated depreciation -29,440 Owner's Equity 181,585Net Book Value - PPE 55,660

Total Assets 230,000 Total Liabilities and Equity 230,000

LIABILITIES AND EQUITYASSETS

PDC CompanyInitial Balance Sheet

As of March 31In USD

PDC Company Operating & Cash Budget

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PDC Company – Income Statement

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March April May June July April to JulySales 92,000 115,000 184,000 138,000 115,000 552,000 Cost of Goods Sold 64,400 80,500 128,800 96,600 80,500 386,400 Gross Margin 27,600 34,500 55,200 41,400 34,500 165,600

Operating Expenses Wages and Commissions 19,550 23,000 33,350 26,450 23,000 105,800 Rent 4,600 4,600 4,600 4,600 4,600 18,400 Miscellaneous Expenses 4,600 5,750 9,200 6,900 5,750 27,600 Insurance 460 460 460 460 460 1,840 Depreciation 1,150 1,150 1,150 1,150 1,150 4,600 Total Operating Expenses 30,360 34,960 48,760 39,560 34,960 158,240

Income From Operations (2,760) (460) 6,440 1,840 (460) 7,360

Interest Expense - - 464 421 103 988 Net Income (2,760) (460) 5,976 1,419 (563) 6,372

PDC CompanyProjected Income Statements

For The Period Of March - JulyIn USD

PDC Company – Balance Sheet

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March April May June July Mar Vs Apr Apr Vs May June Vs May July Vs JuneCurrent Assets Cash 23,000 23000 23000 23000 29487.04 0 0 0 6,487 Accounts Receivable 36,800 46000 73600 55200 46000 -9,200 -27,600 18,400 9,200 Merchandise Inventory 110,400 149040 123280 110400 97520 -38,640 25,760 12,880 12,880 Prepaid Insurance 4,140 3,680 3,220 2,760 2,300 460 460 460 460Total Current Assets 174,340 221,720 223,100 191,360 175,307 -47,380 -1,380 31,740 16,053

Plan Equipment, Fixtures and Others 85,100 92,000 92,000 92,000 92,000 -6,900 0 0 0Less : Accumulated Depreciation -29,440 -30,590 -31,740 -32,890 -34,040 1,150 1,150 1,150 1,150Net Fixed Assets - Book Value 55,660 61,410 60,260 59,110 57,960 -5,750 1,150 1,150 1,150

Total Assets 230,000 283,130 283,360 250,470 233,267 -53,130 -230 32,890 17,203

Current Liabilities Accounts Payable 38,640 59,570 51,520 41,860 33,810 20,930 -8,050 -9,660 -8,050 Accrued Wages and Commissions Payable 9,775 11500 16675 13225 11500 1,725 5,175 -3,450 -1,725 Loan 0 30935 28064.025 6864.9854 0 30,935 -2,871 -21,199 -6,865Total Current Liabilities 48,415 102,005 96,259 61,950 45,310 53,590 -5,746 -34,309 -16,640

Owner's Equity 181,585 181,125 187,101 188,520 187,957 -460 5,976 1,419 -563

Toal Liabilities and Equity 230,000 283,130 283,360 250,470 233,267 53,130 230 -32,890 -17,203

PDC CompanyProjected Balance Sheets

As Of The Periods EndedIn USD

PDC Company – Statement of Cash Flow

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April May June JulyCash Flow From Activities Net Income (460) 5,976 1,419 (563) Adjusments to Net Income for Cash Flow + Depreciation Expense 1,150 1,150 1,150 1,150 - Changes in Receivable (9,200) (27,600) 18,400 9,200 - Changes in Inventory (38,640) 25,760 12,880 12,880 - Changes in Prepaid Insurance 460 460 460 460 Changes in Accounts Payable 20,930 (8,050) (9,660) (8,050) + Change in Accrued Liablities 1,725 5,175 (3,450) (1,725) Total Adjustment (23,575) (3,105) 19,780 13,915 Net Cash Flow from Operations (24,035) 2,871 21,199 13,352

Cash Flow From Investing Capital Expenditure (CAPEX) (6,900) - - - Net Cash Used by Investments (6,900) - - -

Cash Flow From Financing Equity Issues Dividens Debt Issues 30,935 (2,871) (21,199) (6,865) Net Cash Flow From Financing 30,935 (2,871) (21,199) (6,865)

Net Change In Cash - 0 - 6,487 Beginning Cash Balance 23,000 23,000 23,000 23,000 Ending Cash Balance 23,000 23,000 23,000 29,487

PDC CompanyProjected Statement of Cash Flows

In USD

Forecasting Sales Or Revenues

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Expected Value is the weighted average of a set of scenarios or possible outcomes

Steps to validate sales forecast: Forecast future sales growth rates for several possible

scenarios and the likelihood of each scenario Corroborate the venture’s projected sales growth rates

with industry growth rates and venture’s past market share (top down or market share driven approach to sales forecasting)

Through direct contact with existing and potential customers (bottom up or customer driven approach to forecasting sales)

The likely impact of major operating changes (changes in R and D, pricing policies, credit policies, A&P)

Include the impact of inflation

Forecasting – Sensitivity Analysis

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When performing forecasting, should have more than 1 scenario: Optimistic Normal Pessimistic

Forecasting Sales For New Ventures

Forecasting for Early Stage Ventures (firms that are in either

their development, startup, or survival stage, or just entering

into their rapid growth stage of their life cycle)

Industry Probability of Sales Components

Sales Scenario Occurrence Growth Rate to Sum

Optimistic forecast .30 X 60% = 18.0%

Most likely forecast .40 X 50% = 20.0%

Pessimistic forecast .30 X 40% = 12.0%

1.00 Expected Value = 50.0%

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The Rationality of Growth Rate for New Venture

Growth rate for a new venture can be too optimistic as shown above which is a subject to be challenged

The new venture investors tend to adjust this optimism and forecasting difficulties by revising a venture’s sales forecast downward and expenses upward

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2011 52012 7.5 50%2013 11.25 50%2014 16.88 50%2015 25.31 50%

Average 50%

Forecast Year Sales ($ Millions)

Percentage Change (Sales Growth Rate)

Forecasting Sales for New Venture

The Rationality of Growth Rate for New Venture

There are many possible scenario-weighting combinations, some of which are valid views of new venture’s possible future

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Optimistic Forecast 0.2 60% 12%Management Forecast 0.4 50% 20%Pessimistic Forecast 0.4 10% 4%

Expected Value 36%

Industry Sales ScenarioProbability of

OccurrenceSales Growth

Rates

Forecasting Sales for New Venture - RevisionSales Growth

Rates 2011 52012 6.8 36%2013 9.25 36%2014 12.58 36%2015 17.11 36%

Average 36%

Forecast Year Sales ($ Millions)Percentage

Change (Sales

Forecasting Sales for New Venture - Revision

Management Forecast 0.5 50% 25%Pessimistic Forecast 0.5 0% 0%

Expected Value 25%

Forecasting Sales for New Venture - Revision

Industry Sales ScenarioProbability of

OccurrenceSales Growth

RatesSales Growth

Rates

Estimating Sustainable Sales Growth Rates

There are several potential impediments to a relationship between incremental sales and incremental cash flow: The incremental sales must be sold at prices that

cover all incremental costs (capacity and variable costs)

The revenue from additional unit sales must cover increases in working capital investments (inventory and accounts receivable) required to support those incremental sales

Only when sales revenues cover all of these costs are there free cash flows that give rise to an increase in venture value

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Internally Generated Funds: Net income or profits after taxes earned over an

accounting period Can be distributed to owners or reinvested to

support growth Sustainable Sales Growth Rate:

Rate at which a firm can grow sales based on the retention of profits in the business

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Equity Beginning

EquityIn Changeg

Equity Beginning

Equity BeginningEquity Ending g

Equity Beginning

Equityg


RR x )(NI/E g

RR x )(NI/EE/E

RateRetention x IncomeNet E

beg

beg beg

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Estimating Sustainable Sales Growth Rates - Example

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Assumptions Initial book value of equity $1o million No new equity injection nor withdrawal Net Income $2million Dividend $500,000 (25% of NI) and keep

$1,500,000 (75%) g = (2000,000/10,000,000) x 0.75 = 0.15 =

15%


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MultiplierEquity Turnover xAsset Margin x Profit Net ROE

FPROA x g

Policies Financial x ePerformanc Operating g

RRx CE

TAx

TA

NSx

NS

NIg

CE

TAx

TA

NSx

NS

NI

CE

NIROE

beg

Estimating Sustainable Sales Growth Rates - Example

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Assumptions Sales $1,600,000 NI $160,000 Beginning Equity $800,000 Asset $1,000,000 Retention Rate = 1 g = 160,000/1,600,000 x 1,600,000/1,000,000 x

1,000,000/800,000 = 0.2 = 20% g = Operating Performance x Financial Policy

= ROA x FP = NI / TA x TA/CE Beg x RR = 160,000/1,000,000 x

1000,000/800,000 x 1 = 0.16 x 1.25 x 1 = 20%

Estimating Additional Financing Needed To Support Growth

In the event that a growing venture’s investment in assets is not financed by profits from business operations plus spontaneous financing from suppliers, employees and governments, additional funds will be needed.

These additional funds will need to come from external parties

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Estimating Additional Financing Needed To Support Growth

Financing Capital Needed (FCN): financial funds needed to acquire assets

necessary to support a firm’s sales growth Some of this funding gap will be covered by

trade credit and other current liabilities the increase spontaneously with sales

Spontaneously Generated Funds:increases in accounts payables and accruals (wages and taxes) that occur with a sales increase Example: when sales increase, credit purchases

from suppliers increase, leading to increase in accounts payable

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Estimating Additional Funds Needed To Support Growth

Additional Funds Needed (AFN):gap remaining between the financial capital needed and that funded by spontaneously generated funds and retained earnings, or,

AFN = Required Increase in Assets – Spontaneously Generated Funds – Increase in Retained Earnings

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AFN Equation

RateRetention RR

IncomeNet NI

sliabilitie Accrued AL

payable Accounts AP

yearcurrent andyear next between salesnet in Change NS

salesNet NS

assets Total TA :where

)(RR NS

NI)(NS - NS)(

NS

AL AP - NS)(

NS

TAAFN o

o

o1

o

oo

o

o

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AFN Calculations

Sales last year = $1,600,000 Asset investment = $1,000,000 Net Income = $160,000 Current Assets = $520,000 Fixed Assets = $480,000 Accounts Payable = $48,000 Accrued Liabilities = $32,000 Projected growth rate = 30% Projected next year sales =

$2,080,000 (1,600,000 x 1.3)

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AFN Calculations

Implication: The venture needs $300,000 in additional capital to acquire

assets to achieve the projected 30% growth in sales $24,000 comes from spontaneously generated funds

(liabilities to suppliers, employees) $208,000 comers from retained earnings The remaining AFN $68,000 raised from external financing

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$68,000

)(.10)(1.00$2,080,000 - 00).05($480,0 -00)625($480,0.

(1.00) $1,600,000

$160,0000)($2,080,00 - ($480,000)

$1,600,000

$80,000 - ($480,000)

$1,600,000

$1,000,000

AFN

AFN Calculations – Multiple Year

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Expects to grow 30% each year for 2 years Sales in 2 year = $1,600,000 x 1.3 x 1.3 = $2,704,000 Total two year sales = $2,080,000+$2,704,000 =

$4,784,000 Two year change in sales = $2,704,000 - $1,600,000

= $1,104,000 Asset investment = $1,000,000 Net Income = $160,000 Current Assets = $520,000 Fixed Assets = $480,000 Accounts Payable = $48,000 Accrued Liabilities = $32,000 Projected growth rate = 30%AFN = $1000,000 / $1600,000 x ($1,104,000) - $80,000 / $1,600,0000 ($1,104,000)

- ($4,784,000) x $160,000 / $ 1,600,000 x 1

= 0.625 x ($1,104,000) - 0.05 x ($1,104,000) - $4,784,000 x 0.1 x 1

= $ 690,000 - $55,200 - $478,400

= $156,400

Projecting Or Forecasting Financial Statements

Percent of Sales Forecasting Method:make projections based on the assumption that certain costs and selected balance sheet items are best expressed as a percentage of sales For example: COGS ratio is 60% current year ; assumed

to be the same for next year If, for example, assets were 67% of sales last year ; will

be forecasted the same in next year If, for example, sales grow by 30%, assets also grow by

30%

Constant Ratio Method:variant of the percent of sales method that projects selected cost and balance items at the same growth rate as sales

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Projecting Or Forecasting Financial Statements

The ability to project sales forecast accurately is crucial to the venture’s financial health

Financial Forecasting Process To Project Financial Statements1. Forecast sales2. Project income statement

3. Project balance sheet 4. Project statement of cash flows

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Game Toy Income Statements(2010 Actual, 2011 Projected)

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Game Toy Balance Sheets(2010 Actual, 2011 Projected)

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Game Toy Statements of Cash Flow(Projected 2011)

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END

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Documents

FINANCIAL PLANNING: SHORT TERM AND LONG TERM 1 ENTREPRENEURIAL FINANCE