Entrepreneurship 1: Lecture 8
Projecting your Financial Status for
the first years
Avimanyu (Avi) Datta, Ph.D.
Profit Planning: Conducting CostVolume Profit Analysis

Estimate expected profit for your first year based on
your projected levels of sales.
◦ If projected levels of year1 sales = $250,000
◦ And, cost of goods sold = 50% that is 125,000
◦ Gross Margin = 50%

Break even point in sales =
𝐹𝑖𝑥𝑒𝑑 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠
𝐺𝑟𝑜𝑠𝑠 𝑀𝑎𝑟𝑔𝑖𝑛 𝑎𝑠 𝑎 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠
$125,000
=
= $250,000 in sales
.5
= break even in sales
Profit Planning: Conducting CostVolume Profit Analysis

Break even sales can be reflected in the
following simplified table
Items
Sales
Cost of Goods Sold
Gross Margin
Profit or Loss Before Taxes
Figures
Percentage
$250,000
100%
-$125,000
50%
$125,000
50%
-$125,000
50%
$0
0%
Your Business will not be making profits unless you sales exceed
$250,000
Profit Planning: Conducting CostVolume Profit Analysis
Permits you to calculate the level of sales
required to generate a certain level of
profit, e.g., $10,000
Sales to generate certain level of profit=

𝐹𝑖𝑥𝑒𝑑 𝐸𝑥𝑝𝑒𝑛𝑠𝑒+𝑃𝑟𝑜𝑓𝑖𝑡 𝐺𝑜𝑎𝑙
𝐺𝑟𝑜𝑠𝑠 𝑀𝑎𝑟𝑔𝑖𝑛 𝑎𝑠 𝑎 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠
$125,000+10,000
= $270,000 in sales
.5
=
Profit Planning: Conducting CostVolume Profit Analysis

The above estimate can be reflected in
the following income statement
Items
Sales
Cost of Goods Sold
Gross Margin
Profit or Loss Before Taxes
Figures
Percentage
$270,000
100%
-$135,000
50%
$135,000
50%
-$125,000
44.44%
$10,000
5.556%
Cash flow Projections
As good as your assumptions of reality. Some of
the assumptions are: (page 154)
 The projections in table 8-1a, 8-1b, 8-1c indicate a
high rate of profit. The level of the profit will
reduce substantially when:

◦ The business cannot generate estimated levels of
sales.
◦ The gross margin is less than 50% of sales
◦ Operating expenses are underestimated
◦ Sales of the overall market did not grow as much as
anticipated.
◦ The business did not get the anticipated market share.
Preparing your Pro
forma financial statements
A balance sheet is a financial statement
that shows the worth, or value, of a
business.
 A pro forma balance sheet projects the
growth of a business in terms of how
much capital value the business will have
at a particular date in the future

Preparing your Pro
forma financial statements

Prior to the creation of the balance sheet
you need
◦
◦
◦
◦
Your First year sales
Your Breakeven point
Your initial capital requirement
Whether you have enough money to start the
business
◦ Your cash flow statements
Preparing your Pro
forma financial statements

You still need to prepare
◦ Your opening day balance sheet
◦ Your projected income statement for the first
year
◦ The closing balance sheet for the first year
◦ The income statement for the second
through fifth year
Preparing your Pro
forma financial statements

Every Dollar assets you have must be balanced by the
dollar of liabilities of equity.
◦ Assets = liabilities + equity

The assets side shows all property and capital to
which the business claims ownership.

The liabilities side shows all the debts of the
business.

The net worth of a business is determined by adding
all the value of what is owned and subtracting from
this the total debt of the business.
Preparing your Pro
forma financial statements

Assets
◦ Current assets include cash and assets that are
easily converted into cash, such as inventory and
accounts receivable.
◦ Fixed assets are those capital purchases that
generally take a longer time to convert or liquidate
into cash, such as property, equipment, and fixtures
that require a special buyer.
Preparing your Pro
forma financial statements

Liabilities
◦ Current liabilities are debts that are to be
paid within 12 months of the date of the
balance sheet.
◦ Longterm liabilities are usually debts that
come due more than 12 months after the
date of the balance sheet.
Preparing your Pro
forma financial statements
Simplified Pro Forma Balance Sheet
Preparing your Pro
forma financial statements

Liquidity
◦ A balance sheet allows entrepreneurs,
bankers, and investors to quickly determine
the liquidity of a business operation.
◦ Liquidity is defined as a business’s ability to
meet its debt obligations as they become due.
Preparing your Pro
forma financial statements

Determining a Business’s Liquidity

Two common methods of determining a
business’s liquidity are current ratio tests
and acid-test ratios.
Preparing your Pro
forma financial statements

Current Ratio Test
◦ The current ratio test compares cash, as well as any
assets that can be converted into cash within a year,
with the debt (liabilities) that will become due and
payable within the year.
◦ The ratio is expressed as:
current ratio = current assets ÷ current liabilities
◦ A favorable current ratio would be 2:1.
◦ A minimum acceptable ratio would be 1:1.
Preparing your Pro
forma financial statements

Acid-Test Ratio
◦ The acid-test ratio is more restrictive as it
eliminates inventory, the least liquid of current
assets, from the numerator.
◦ The ratio is expressed as:
acid-test ratio = (current assets – inventory) ÷ current liabilities
Preparing your Pro
forma financial statements

Cash Flow
◦ A cash flow statement is a month-bymonth projection of financial activities.
◦ This analysis allows you to prepare for
potential cash flow problems.
◦ A cash flow statement tells you what your
business’s cash position really is
◦ A cash flow projection can be used to help
determine the initial capital reserve for a
start-up operation
Preparing your Pro
forma financial statements

Financial Records
◦ Entrepreneurs should maintain their own daily
and monthly accounting records and use
accountants for preparing tax returns and
formal financial statements.
Preparing your Pro
forma financial statements
Small business owners should have access
to
 Income and expense register
 Accounts payable ledger
 Accounts receivable ledger
 Furniture, fixture, and equipment ledger
 Notes payable ledger
 Payroll records