Unit 8 – Financing and Capitalizing the Business

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The ability to read and understand your company’s financial statements and the ability to forecast financial requirements are core competencies for successful small business managers. In Unit 8, we will explore two important elements of a new business: Understanding a Firm’s Financial Statements and Forecasting Financial Requirements.
New businesses incur many expenses before beginning operations! It is very easy (and dangerous) to underestimate the expenses of a new business. These expenses will to a large extent determine the amount of capitalization required to start the new business. Unit 8 will examine the processes and approaches involved in securing the necessary finances to begin the new business.

• Describe the purpose and content of an income statement.
• Name the purpose and content of a balance sheet.
• Recognize the purpose and content of a statement of cash flows.
• Define the purpose and need for financial forecasting.
• Describe how the nature of a firm affects its financing sources.
• Identify the typical sources of financing used at the outset of a new venture.

Start the Unit:
• Review the key terms
Study:
• Read Chapter 10, Chapter 11, and Chapter 12 in your text
Prepare:
• Carefully review the previously completed sections of your descriptive business plan in your MT209 Project Template.
Graded Assignments:
• Respond to the Unit 8 Discussion Board
• Complete and submit the Unit 8 Assignment
• Attend the Unit 8 Class Seminar or complete the Alternative Assignment
• Complete the Unit 8 Activity

Unit 8 Discussion:
After reading Chapter 10 and Chapter 11 in your text, and viewing “Understanding
Financial Statements Part 1” and “Understanding Financial Statements Part 2” in the
Small Business School videos, discuss the following:
1. How do a beginning balance sheet, an ending balance sheet and an income statement for the interval serve to offer a more complete picture of a firm’s financial position?
2. Discuss the three sections of a cash flow statement.
3. Discuss the role of ratios in determining a firm’s financial performance.

Using the MT209 Project Template and MT209 Project Instructions, complete the Financial Plan section, in the Descriptive Business Plan.
The Financial Plan section of the MT209 Project Template should include the following elements:
1. A discussion of what constitutes a 12-Month Profit and Loss Projection.
2. A discussion of what constitutes a 12-Month Cash Flow Projection.
3. A discussion of an opening day balance sheet showing what items of value (assets) as well as what debt (liabilities) the new business will begin with.
3. A discussion of the break-even analysis which predicts the volume of sales, at a given price, that will be required to recover total costs. This should be accompanied by an explanation of all assumptions upon which you based your break-even analysis.
4. A discussion of pro forma financial statements (income statement, balance sheet, and cash flows statement).

The Start-up Expenses sub-section of the MT209 Descriptive Business Plan should include a discussion of the following elements:
1. A discussion of the applicable expenses to start the new business. These could include some (or all) of the following: costs of sales, professional fees, technology costs, administrative costs, sales and marketing costs, wages and benefits.
2. A contingency percentage to cover any under estimation along with your rationale for this percentage.
The Capitalization sub-section of the MT209 Project Template should include a discussion of the following elements:
1. The sources of all loans (existing or proposed) including amounts, terms, and collateral.
2. The names and amounts contributed by each investor in the business including the percentage of ownership of each investor.

Three key financial statements for small businesses:
1. Balance Sheet
2. Income Statement
3. Statement of cash flows
Let’s Discuss each one briefly

The Balance Sheet is a statement of the
Accounting Equation, which is:
Assets
=
Liabilities
+
Owners’ Equity

The Accounting Equation is:
Assets
Assets are properties or items owned by a business that will provide future benefits. Examples would be cash on hand, supplies, equipment, buildings, land, marketable securities, products or inventory of merchandise available for sale, and accounts receivable from customers. --Assets: the value everything that the company owns and that can be sold, if the company goes out of business
=
Liabilities
+
Owners’ Equity

The Accounting Equation is:
Assets
Assets are properties or items owned by a business that will provide future benefits. Examples would be cash on hand, supplies, equipment, buildings, land, marketable securities, products or inventory of merchandise available for sale, and accounts receivable from customers. --Assets: the value everything that the company owns and that can be sold, if the company goes out of business
=
Liabilities
Liabilities are any claims against an asset. For example, a debt owed by the firm is a liability. It could be a loan from a bank or a line of credit from a supplier. It will include salaries and wages yet to be paid to employees, accounts payable to vendors, and interest payable on borrowed money.--- Liabilities: Money OWED by the company to other parties
+
Owners’ Equity

The Accounting Equation is:
Assets are properties or items owned by a business that will provide future benefits. Examples would be cash on hand, supplies, equipment, buildings, land, marketable securities, products or inventory of merchandise available for sale, and Assets accounts receivable from customers. --Assets: the value everything that the company owns and that can be sold, if the company goes out of business
+
=
Liabilities
Liabilities are any claims against an asset. For example, a debt owed by the firm is a liability. It could be a loan from a bank or a line of credit from a supplier. It will include salaries and wages yet to be paid to employees, accounts payable to vendors, and interest payable on borrowed money.--- Liabilities: Money OWED by the company to other parties
Owners’ Equity
The easiest way to understand Owner’s Equity is to think of it as, if we sold every asset of the company today and used the money to pay off everything that the company owed, whatever is left over afterwards goes to the owners. That is the stockholders (the owners’) equity in the firm. --Owner’s Equity: What is left for the owners after all the liabilities are paid

• It tells someone that if the company SOLD off all of its assets and paid all of its bills, how much would be left over for the owners?
A Balance Sheet provides a snapshot of what the company has (assets), what the company owes
(liabilities), and the difference between the two (equity ).
 Question: Why is the Balance Sheet important?

An Income Statement measures the success of the business’ operations.
 Question: Why is the Income Statement Important?

What the Income Statement Reflects:
It shows how much Revenue we took in (Sales)
From this amount it subtracts what it cost us in raw materials to make those sales – Cost of
Goods Sold
It also subtracts any other expenses (marketing, administration, rent, etc.,)
The result is a Net Income
Before Taxes and Interest
We could also subtract out taxes and interest to get a true Net Income

The statement of cash flows tracks the business’ cash receipts and lists the amounts and sources of all incoming and outgoing cash.
 Question: Why is the statement of cash flows important?

Analyzing numerical financial information can be complex. To simply financial analysis, these numbers can be converted into meaningful ratios that the manager can use to evaluate the financial reports.
These fall into several categories:
Liquidity Ratios (current ratio, acid test) measure a firm’s assets to its liabilities.
Asset Management Ratios (inventory turnover, fixed assets, days sales outstanding, total assets turnover) – measure how effectively the business is managing its assets.
Debt Management Ratios (total debt to total assets, times interest earned, EBITA coverage) – measures how efficiently the business used debt.
Profitability Ratios (profit margin on sales, basic earning power, return on common equity) – measure the combined effects of liquidity, asset management, and the use of debt in a business’ operations.

Market Value Ratios (price/earnings, price/cash flow, market/book) –
Measure a business’ stock price to its cash flow, its earnings, and book value of its stock.
Comparative Ratios and Benchmarking
Allows a particular business to be compared with a group of similar businesses to measure how effectively a business is performing in many areas.
 Question: Why would we want to compare our business against others?