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BA 346
Working as an EntrepreneurWeek 4-5
Accounting
“Language of Business” Measurement
What were our goals? How did we do?
Profit: The Bottom Line The “Triple Bottom Line”
Profit People Planet
Financial Statement Overview
What, Why, How for each What Pro Forma means Iterative development (AKA circular
reasoning) How good will your estimates be? When will you update them?
Three Costs to Think About
Terminology: Price vs Cost vs Investment Fixed costs
The total stays “fixed” regardless of volume e.g. Lease expense, salaries
Variable costs The total “varies” based on the volume e.g. Raw Materials, wages
Direct vs Indirect Costs Direct costs are attributable to creating & selling
the product Some fixed costs are direct costs
Investment in assets What is needed to start & run the business e.g. Equipment, working capital
Workshop Prep
What costs will your business have?
Fixed Costs Variable Costs
Ind
irect
Cost
sD
irect
Cost
s
Investment (assets needed)
The Break Even Point
What is the break even point? When will you break even? Why is it important? What sales volume is needed to be profitable? How much profit is desired? What is the targeted sales volume?
Break even is calculated as
(Fixed Costs)divided by
(Selling Price per unit - Variable Cost per unit)
Workshop Prep
Total Fixed Costs = _____________________
Variable Costs per unit = _____________________
Selling Price per Unit = _____________________
Contribution (Price – Variable) = _____________________
BREAKEVEN
(Fixed)(Contribution)
= __________ Units=
Revenue model
What product are you selling? Goods Services
What is the pricing of your product? Different tiers? Volume discount? Average price or segments?
Been to a video store lately?
The 80s video store Video chains Delivery Streaming Better streaming
1 Out Limited 4.99$ 1 Out Unlimited 8.99$ 2 Out Unlimited 13.99$ 3 Out Unlimited 16.99$ 4 Out Unlimited 23.99$
etc.
1 Out Limited 4.99$ 1 Out Unlimited 9.99$ 2 Out Unlimited 14.99$ 3 Out Unlimited 19.99$ 4 Out Unlimited 27.99$
etc.
Total Subscribers
-
2,000
4,000
6,000
8,000
10,000
12,000
14,000
2005 2006 2007 2008 2009
Netflix
Sales Vol growth 51%, 18% 26%, 31% respectively Sales Vol CAGR 31%
Avg Monthly Plan
$10
$11
$12
$13
$14
2005 2006 2007 2008 2009
Netflix
Sales Price growth… Sales Price CAGR…
Revenues (000s)
$-
$200,000
$400,000
$600,000
$800,000
$1,000,000
$1,200,000
$1,400,000
$1,600,000
$1,800,000
2005 2006 2007 2008 2009
Netflix
Sales $ growth 46%, 21%, 13%, 22% respectively Sales $ CAGR 25%
Revenue Model, cont’d
How will customers pay? Immediate payment
Cash Credit cards
Invoicing Accounts Receivable Terms Collections & aging
Building the Income Statement
Sometimes called the P&L (Profit & Loss) Statement Income – Expenses = Profit
Structure Income COGS (sometimes just Variable Costs ) Gross Profit Operating Expenses Operating Profit (sometimes EBIT) Other expenses, including Interest & Tax Net Income (Profit)
Usually easier to remember starting at the bottom…
Profit
Remember the break even point? How much profit is required?
Retained earnings for reinvestment, growth Dividends & other payouts to owners Net Income = Dividends + ΔRetained Earnings
Some industries have a Rule of Thumb for revenue, reinvestment & profit
Tax
Tax can be complicated You need a tax preparer or a CPA (or both) Depends on the structure of your business You need to strategize in advance with your tax experts
– create value form tax planning Tax rates
Effective tax rate (average) Marginal tax rate (bracket)
Rule of thumb for estimating “Typical” Effective Rate for tax Tax Expense = Taxable Income x Effective Rate Net Income = Taxable Income – Tax Expense :. Net Income = Taxable Income x (1- Effective Rate) :. Taxable Income = Net Income ÷ (1- Effective Rate) Tax Expense = Taxable Income – Net Income
Interest
Interest is the cost of financing assets Creates a tax deduction Reduces profit
Placeholder for interest Fill this in once debt and terms are
forecast
Depreciation
What is it? Creates a tax deduction from the investment in
certain types of assets (e.g. Equipment) Non-cash Expense Has nothing to do with actual condition of
equipment or possible resale value Placeholder for depreciation
Fill this in once the assets are forecast Straightline depreciation = (Purchase price –
salvage value) ÷ Years allowed for that type of asset (check with your tax expert)
Operating expenses
Variable cost x volume Raw materials (direct) Worker wages (direct) Supplies (indirect)
Fixed costs Utilities (indirect?) Rent (indirect?) Supervisor salaries (indirect)
Revenue
Price x volume Sales target
Profit needed? Net Income ÷ Contribution = Units
Needed above Breakeven
Additional revenue Remember McKay envelope? Most businesses have other items to
sell
Workshop Prep
Profit Needed = $_____________
Contribution = $_____________
Profit ÷ Contribution = _________ units
Plus Breakeven Units = _________ units
Equals Sales Target _________ units
From Revenue to Assets
What assets will be required to sell this volume?
How much is the initial investment?
Building the Balance Sheet
Structure A = L + SE
Assets Current Non-current
Liabilities Current Non-current
Equity = Assets – Liabilities Invested Capital Retained Earnings
“Common Size” Financial Statements
Sometimes it is useful to look at financials as a % of a relevant total Expenses as a % of Sales Assets & Liabilities as a % of Total Assets
This is not always the best way to analyze financial structure, but it may give you a starting point
Current Assets
Accounts Receivable
What % of customers will you be invoicing?
How long will they take to pay?
Cash
How much will you need? Days sales in cash Need to cover expenses Need to not lose value
Inventory
How much will you need? Days sales in inventory Efficiency, cost, storage, issues
Fixed assets
PP&E
Other non-current assets
Depends on the business, most small businesses have none at startup Possibly patents or other intellectual
property
Final thoughts on assets
Where are the assets going to come from?
Where will the cash for them come from?
Is debt good or bad?
Non-current liabilities
Accounts payable
Trade credit from suppliers Other
Notes payable
Short Term Debt
Line of credit
Revolving Credit
Connecting the IS & BS: The Statement of Cash Flows
Structure Cash provided by Operations Cash provided by Investment Cash provided by Financing
Cash from operations
Start with Net Income, then add… Depreciation for the year Changes in Accounts Receivable Changes in Liabilities Changes in Inventory Changes in Other Operating Activities Cash provided (used) by Operations
Cash from (used by) investing
Negative numbers show investment
Capital Expenditures Other Investments Other Cash Flows from Investing Activities Cash provided (used) by Investing
Activities
Where will the cash come from?
At startup, all the investing comes from cash in the business Investment Loans
Financing CFs, cash from financing
Dividends Sales (Repurchases) of Stock Net New Debt Other Cash Flows from Financing Activities Cash provided (used) by Financing Activities
Change in Cash
Cash at Beginning of Year + Change in Cash
From Operations From (used by) Investing From (used by) Financing
= Cash at End of Year
Cash at EOY provides the figure on the balance sheet
Pro Forma Income Statement
Income Statement
Revenue
Variable Costs
Gross Profit
Fixed Costs
EBIT
Depreciation
Interest
EBT
Tax Expense
Net Income
Pro Forma Balance SheetBalance Sheet
Assets
Current Assets
Cash
Accounts Receivable
Inventory
Other Current Assets
Total Current Assets
Property, Plant & Equipment (net)
Other Non-current Assets
Total Assets
Liabilities
Current Liabilities
Accounts Payable
Notes Payable
Current Portion of Long Term Debt
Other Current Liabilities
Total Current Liabilities
Long Term Debt
Other Non-current Liabilities
Total Liabilities
Owners' Equity
Common Stock (at par value)
Additional Paid-in Capital
Retained Earnings
Total Equity
Total Liabilities & Owners' Equity
Balance Sheet
Assets
Current Assets
Cash
Accounts Receivable
Inventory
Other Current Assets
Total Current Assets
Property, Plant & Equipment (net)
Other Non-current Assets
Total Assets
Liabilities
Current Liabilities
Accounts Payable
Notes Payable
Current Portion of Long Term Debt
Other Current Liabilities
Total Current Liabilities
Long Term Debt
Other Non-current Liabilities
Total Liabilities
Owners' Equity
Common Stock (at par value)
Additional Paid-in Capital
Retained Earnings
Total Equity
Total Liabilities & Owners' Equity
Pro Forma Statement of Cash FlowsOperations
Net Income
Depreciation
Changes in Accounts Receivable
Changes in Liabilities
Changes in Inventory
Changes in Other Operating Activities
Cash provided (used) by Operations
Investing
Capital Expenditures
Other Investments
Other Cash Flows from Investing Activities
Cash provided (used) by Investing Activities
Financing
Dividends
Sales (Repurchases) of Stock
Net New Debt
Other Cash Flows from Financing Activities
Cash provided (used) by Financing Activities
Cash at Beginning of Year
Change in Cash
Cash at End of Year
Operations
Net Income
Depreciation
Changes in Accounts Receivable
Changes in Liabilities
Changes in Inventory
Changes in Other Operating Activities
Cash provided (used) by Operations
Investing
Capital Expenditures
Other Investments
Other Cash Flows from Investing Activities
Cash provided (used) by Investing Activities
Financing
Dividends
Sales (Repurchases) of Stock
Net New Debt
Other Cash Flows from Financing Activities
Cash provided (used) by Financing Activities
Cash at Beginning of Year
Change in Cash
Cash at End of Year
Reality check
Are the figures realistic? How will you improve them?
Resources for real life
Bookkeepers Quickbooks, et al CPA CFO
Workshop
Putting them in good form - template for workshop (printed & online)
