The New Venture
Business Plan
part
4
12
Projecting
Financial
Requirements
PowerPoint Presentation by Charlie Cook
12e
Copyright © 2003 South-Western College Publishing.
All rights reserved.
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.
Copyright © by South-Western College Publishing. All rights reserved.
12–2
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
Copyright © by South-Western College Publishing. All rights reserved.
12–3
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
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12–4
The Income Statement: An Overview
Operating Activities
Financing Activities
Taxes
Sales Revenue
Operating Income
Earnings Before Taxes
–
Cost of producing or
acquiring product or
service
(cost of goods sold)
=
Gross profit
–
Marketing and selling
expenses, general and
administrative
,expenses and
depreciation
(operating expenses)
–
Interest expense
on debt
(financing costs)
=
Earnings Before Taxes
–
Income taxes
=
Net Income Available
to Owners
=
Operating Income
Fig. 12.1
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12–5
Income Statement for Bates & Associates Leasing
Company for the Year Ending December 31, 2002
Sales revenue
Cost of goods sold
Gross profit
Operating expenses:
Marketing expenses
$90,000
General and administrative expenses
80,000
Depreciation
_30,000
Total operating expenses
Operating income
Interest expense
Earnings before taxes
Income tax (25%)
Net income
Dividends paid
Change in retained earnings
$850,000
_550,000
$300,000
$200,000
$100,000
__20,000
$ 80,000
20,000
$ 60,000
$_15,000
$ 45,000
Fig. 12.2
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12–6
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
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12–7
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)
Copyright © by South-Western College Publishing. All rights reserved.
12–8
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
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12–9
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’
Owners’
Cumulative Owners’ cash
–
=
+
Equity
investment
profits
withdrawals
Owners’
Owners’
Earnings retained
=
+
Equity
investment
within Business
Copyright © by South-Western College Publishing. All rights reserved.
12–10
Balance Sheets for Bates & Associates Leasing Company
for December 31, 2001 and 2002
2001
2002
Changes
$ 45,000
75,000
180,000
$300,000
$ 50,000
80,000
220,000
$350,000
$ 5,000
8,000
40,000
$ 50,000
$790,000
( 360,000)
$430,000
70,000
$500,000
$890,000
( 390,000)
$500,000
70,000
$570,000
$ 100,000
( 30,000)
$ 70,000
0
$ 70,000
$920,000
$120,000
Assets
Current assets:
Cash
Accounts receivable
Inventories
Total current assets
Fixed assets:
Gross plant and equipment
Accumulated depreciation
Net plant and equipment
Land
Total fixed assets
TOTAL ASSETS
$800,000
Copyright © by South-Western College Publishing. All rights reserved.
12–11
Balance Sheets for Bates & Associates Leasing Company
for December 31, 2001 and 2002
2001
2002
Changes
Debt (Liabilities) and Equity
Current liabilities:
Accounts payable and accruals
Short-tern notes
Total current liabilities
Long-term notes payable
Total liabilities
Common stock
Retained earnings
Total stockholders’ equity
TOTAL DEBT AND EQUITY
Copyright © by South-Western College Publishing. All rights reserved.
$ 15,000
60,000
$ 75,000
150,000
$225,000
$300,000
275,000
$575,000
$800,000
$ 20,000
80,000
$100,000
200,000
$300,000
$300,000
320,000
$620,000
$920,000
$
5,000
20,000
$ 25,000
50,000
$ 75,000
$
0
5,000
$ 45,000
$120,000
12–12
Assets
Current Assets
Cash
Accounts receivable
Inventories
+
Debt (Liabilities) and
Equity (Net Worth)
Debt Capital
Current Debt
Accounts payable
Accrued expenses
Short-term notes
Long-term Debt
Long-term notes
Mortgages
Fixed Assets
Machinery and
equipment
Buildings and land
+
Other Assets
Long-term
investments, patents
+
Owner's Equity
Owner's net worth
or
Partnership equity
or
Common stock equity
=
Total Assets
The Balance
Sheet: An
Overview
=
Total Debt and Equity
Fig. 12.3
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12–13
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.
Copyright © by South-Western College Publishing. All rights reserved.
12–14
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.
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12–15
The Fit of the Income Statement
and the Balance Sheet
Income statement reports the profits from
January 1, 2002 through December 31, 2002
January 1
2001 Balance Sheet Reports
a firm's financial position at
beginning of 2002 (end of
2001)
December 31
2002 Balance Sheet
Reports a firm's financial
position at end of 2002
Fig. 12.5
Copyright © by South-Western College Publishing. All rights reserved.
12–16
Computing Cash Flows from Assets
After-Tax Cash Flows
from Operations
Changes in
Operating
Working Capital
Cash
Flows
from Assets
Cash
After-tax cash flows
flows from =
from operations
assets
Investments in
operating
working capital
Changes in
Long-Term
Assets
Investments
in long-term
assets
Fig. 12.6
Copyright © by South-Western College Publishing. All rights reserved.
12–17
Computing Other Cash Flows
• After-Tax Cash Flows From Operations
After-tax
cash
= Net income
flows from
operations
+
Depreciation
expense
+
Interest
Expense
• Operating Work Capital
Operating
Working
Capital
=
Current
assets
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–
Account payable
and accruals
12–18
Cash Flows from Financing
Increase in Debt
Increase in Equity
(firm issues new debt)
(firm issues new stock)
Increases in Cash Flows from Financing
Cash Flows
from Financing
Decreases in Cash Flows from Financing
Interest and Dividends
Decrease in Debt
Paid to Investors
(firm repays debt)
Decrease in Equity
(firm repurchases
outstanding stock)
Fig. 12.7
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12–19
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?
Copyright © by South-Western College Publishing. All rights reserved.
12–20
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?”
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12–21
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.
Copyright © by South-Western College Publishing. All rights reserved.
12–22
Assets-to-Sales-Financing Relationships
Increase in Sales
Results in
Increase in
Asset Requirements
Results in
Increase in
Financing Requirements
Fig. 12.9
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12–23
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.
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12–24
Sources of Equity Capital
• External Equity
–Owners’ original investment
• Internal Equity
–Profit retention (retained profits)
• Forecasting financial requirements (in total)
Profits
Total
Spontaneous
Total asset
retained
sources
of
financing
=
=
+ within the
requirements
financing
business
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+
External
sources of
financing
12–25