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The Power of Numbers
10-1Copyright © 2011 Nelson Education Ltd.
Explore Your Financial VisionExplore Your Financial Vision
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Prepared byRon KnowlesAlgonquin College
& Jennifer Rouse BarbeauCanadore College
Chapter OverviewChapter 10 will: Describe financial statements and ratios
important to the financial health of a start-up business.
Define cash flow as a key financial statement.
Build a financial plan. Help you stay in control.
10-2Copyright © 2011 Nelson Education Ltd.
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Learning OpportunitiesFormulate a personal financial vision.Test your financial fitness.Assemble a team of financial advisers.Estimate your start-up costs.Create your own balance sheet.Project monthly sales and propose a sales
forecast.
10-3Copyright © 2011 Nelson Education Ltd.
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Learning OpportunitiesUnderstand that cash is the lifeblood of
your business.Understand that bills are paid with cash,
not profit.Create a cash flow projection and a pro
forma income statement.Use ratios to measure the financial health
of your business.
10-4Copyright © 2011 Nelson Education Ltd.
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Begin Your Financial Journey
10-5
Check out your personal financial fitness (Box 10.1)
Formulate a personal financial vision Examples are: To be financially independent. To be able to afford to travel to other countries. To be able to afford a new home and the furniture to fill it. To have the financial ability to retire and smell the roses before
turning 50.
Put your financial vision in writing Complete Action Step 45.
Copyright © 2011 Nelson Education Ltd.
Get Advice If finance is not your strength, you do not have to
do it yourself. Network to find people who can provide financial
help. Make a list of possible financial advisors (Table 10.1)
a mentor a business guru—how about a banker, real estate broker or a
retired business person a financial advisor or business broker personal financial coach
Assemble a financial team (Action Step 46).
10-6Copyright © 2011 Nelson Education Ltd.
5 Financial Tables
10-7
1. Application of Funds (start-up funding)
2. Opening Balance Sheet
3. Projected Cash Flow
4. Projected or Pro Forma Income Statement
5. End of Period or Year-End Balance Sheet
1. Application of Funds (start-up funding)
2. Opening Balance Sheet
3. Projected Cash Flow
4. Projected or Pro Forma Income Statement
5. End of Period or Year-End Balance Sheet
Copyright © 2011 Nelson Education Ltd.
Application of Funds
10-8
How much start-up money do you need? Complete an application of funds table (See
Table 10.3).
Start-up expenses or application of funds can be divided into 4 categories:
1. General Start-up Costs2. Leasehold Improvements3. Equipment Costs 4. Cash Reserve Funds
Copyright © 2011 Nelson Education Ltd.
Start-Up Expenses
10-9
1. General Start-up Costs• Organizational costs• Prepaid Expenses• Opening Inventory/Office Supplies
2. Leasehold Improvements•Carpeting, mirrors, light fixtures, etc.
3. Equipment Costs•Tables, chairs, desk, filing cabinet, etc.
4. Cash Reserve Fund•Total cash on hand immediately before the business opens (Table 10.2).
Copyright © 2011 Nelson Education Ltd.
Opening Balance SheetAn opening balance sheet is a
snapshot of the financial position of your business in the period immediately before you open your doors
See Table 10.4
10-10Copyright © 2011 Nelson Education Ltd.
Opening Balance SheetA balance sheet is normally divided into 3 major components:
1. Assets are usually divided in 3 major categories: current assets fixed assets other assets
2. Liabilities are normally divided into 2 major categories: current liabilities long-term liabilities
3. Equity The basic balance sheet equation:
• Assets = Liabilities + Equity
10-11Copyright © 2011 Nelson Education Ltd.
Balance Sheet Ratios:LiquidityLiquidity
10-12
Liquidity ratios measure the number of dollars of liquid
assets available to cover each dollar of current debt.
Two basic liquidity indicators are the current ratiocurrent ratio and
the quick ratio.quick ratio. Current ratio =
Current liabilities
Most liquid assets
Current assets
Quick ratio = Current liabilities
Copyright © 2011 Nelson Education Ltd.
10-13
Total Assets
Total Liabilities (debt)
Owner’s Investment1. Proprietorship ratio =
2. Debt-to-equity ratio =Owner’s Equity
Copyright © 2011 Nelson Education Ltd.
Solvency ratios measure the ability of a company to meet its long term obligations.
The two standard solvency ratios solvency ratios are:
Balance Sheet Ratios:SolvencySolvency
Projected Cash FlowA projected or pro forma cash flow pro forma cash flow is:
A financial statement which helps you control the money that comes into your business and the money that is spent.
Why is a cash flow so important? Shows you can pay for day-to-day operations. Shows the lender you have the cash to make loan
payments. Provides a format for planning the most effective use of
cash. Provides a schedule of receipts and payments of accounts. Helps plan for of unexpected changes in circumstances.
10-14Copyright © 2011 Nelson Education Ltd.
Creating a Cash Flow
Five steps to creating a cash flow:Five steps to creating a cash flow:1. Calculate your opening balance sheet2. Calculate projected sales for each
month3. Forecast receipts4. Forecast disbursements5. Summary of cash flow
10-15Copyright © 2011 Nelson Education Ltd.
Income StatementA projected or pro forma income statement pro forma income statement is:
An itemized statement of sales (or revenues) and corresponding expenses over a period of time.
Normally for a 1 year period (sometimes on a quarterly basis)
Major elements of an income statement include: - sales - cost of goods sold- gross profit - operating expenses - other expenses - net profit
Remember: Profit is not Remember: Profit is not cash.cash.
Action Step 49 will help you project Action Step 49 will help you project your own income statement.your own income statement.
10-16Copyright © 2011 Nelson Education Ltd.
Key Income Statement Ratios
Income statement ratios Income statement ratios help to: determine how healthy your
business is and how it compares to other
businesses in your selected industry.
10-17Copyright © 2011 Nelson Education Ltd.
4 key income statement ratios:4 key income statement ratios:
1.1. Gross profit margin Gross profit margin = Gross Profit / Total Sales
2.2. Profit margin Profit margin
= Net Profit / Total Sales
Inventory turnover Inventory turnover = Cost of Goods Sold / Average Inventory
4.4. Gross margin return on inventory Gross margin return on inventory investment (GMROI) investment (GMROI) = Gross Profit Margin (%) x Sales to Stock Ratio
10-18Copyright © 2011 Nelson Education Ltd.
Key Income Statement Ratios
Ending Balance Sheet & Key Ratios The closing balance sheet provides a final
indicator of the financial health of your business.
A closing balance is shown in Table 10.10. Two key ratios based on the ending balance
sheet and income statement are:1. Return on Investment (ROI) = net profit / total
assets2. Return on owner investment = net profit / owners’
equity
10-19Copyright © 2011 Nelson Education Ltd.
What is a Break-Even AnalysisA break-even level of salesbreak-even level of sales occurs when
the sales (revenues) equals total expenses or costs (fixed and variable).
To calculate break-even you will have to know the value of your fixed and variable costs and your output capacity.
10-20
Copyright © 2011 Nelson Education Ltd.
Break-Even Analysis Two ways to calculate break-even are:
unit method. unit method. revenue method.revenue method.
For many businesses the projected break-even is the first step in establishing its viability.
10-21
Copyright © 2011 Nelson Education Ltd.
Chapter 10 helps you prepare Parts H, I & J of your business plan:
Financial SectionFinancial Section Financial statements Financial ratios Cash Flow
10-22Copyright © 2011 Nelson Education Ltd.
Business Plan Business Plan Building Block
Do you have a financial vision? What are your estimated start-up costs? Validate your sales forecast. Identify all your cost and pricing
assumptions. Prepare an opening balance sheet. Prepare a monthly cash flow.
10-23Copyright © 2011 Nelson Education Ltd.
Checklist for Your Business PlanYour Business Plan
What is your fallback position if your sales forecast and cash flow do not reach expectations?
Prepare a projected income statement and closing balance sheet.
What concerns might a banker have? What would be your response?
Is your break-even within range of your minimum sales forecast?
How do your financial ratios compare to industry averages?
10-24Copyright © 2011 Nelson Education Ltd.
Checklist for Your Business PlanYour Business Plan
Financing A Business Case Study 1: Your Business
If you are ready with the financial information for your business, prepare:An opening balance sheet.A projected monthly cash flow for the first year
of operation.A projected income statement for the first year. An ending balance sheet after the first year of
operation.
10-25Copyright © 2011 Nelson Education Ltd.
CaseStudy
Case Study 2: DISCovery Books and Magazines Inc.
If you’re not ready to do a financial plan: complete the financial statements for
DISCovery Books and Magazines Inc.
10-26Copyright © 2011 Nelson Education Ltd.
Financing A Business CaseStudy