Copyright © 2016 Pearson Education, Inc. Creating a Successful Financial Plan 11 11-2 Section 3: Launching the Business

Copyright © 2016 Pearson Education, Inc.

Creating a Successful Financial Plan

11

11-2

Section 3: Launching the Business

Describe how to prepare the basic financial statements and use them to manage a small business.

Create projected (pro forma) financial statements.

Understand the basic financial statements through ratio analysis.

Explain how to interpret financial ratios.Conduct a break-even analysis for a small

company.

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Learning Objectives


Financial management: A process that provides entrepreneurs

with relevant financial information in an easy-to-read format on a timely basis.

It allows entrepreneurs to know not only how their businesses are doing financially but also why they are performing that way.

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Financial Management


Common mistake among business owners: Failing to collect and analyze basic financial data.

Many entrepreneurs run their companies without any kind of financial plan.

About 75% of business owners do not understand or fail to focus on the financial details of their companies.

Financial planning is essential to running a successful business and is not that difficult!

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The Importance of a Financial Plan


Balance Sheet: “Snapshot” Estimates the firm’s worth on a given

date; built on the accounting equation:

Assets = Liabilities + Owner’s Equity

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Basic Financial Statements


Sample Balance Sheet

Ch. 11: Creating a Successful Financial Plan 11 - 6

Optional

Debt Financing?

Growth?

Income Statement: “Moving picture” Compares the firm’s expenses against its

revenue over a period of time to show its net income (or loss):

Net Income = Sales Revenue - Expenses

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Basic Financial Statements


(continued)

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Customer Profitability Map


Sample Income Statement


Pro-Forma Income StatementXYZ, Inc.

For 2006 through 2009(all numbers in $000)

REVENUE 2006 2007 2008 2009Gross sales $500 $650 $720 $850

Less sales returns and allowances 200 230 280 320Net Sales $300 $420 $440 $530

COST OF SALESBeginning inventory $350 $360 $420 $435

Plus goods purchased / manufactured 120 165 185 190Total Goods Available $470 $525 $605 $625

Less ending inventory 360 420 435 440Total Cost of Goods Sold $110 $105 $170 $185

Gross Profit (Loss) $190 $315 $270 $345

OPERATING EXPENSESSelling

Salaries and wages $35 $41 $46 $52Commissions 12 14 16 18Advertising 10 12 14 20Depreciation 14 15 16 16Other 5 6 6 7

Total Selling Expenses $76 $88 $98 $113

General/AdministrativeSalaries and wages $12 $14 $16 $18Employee benefits 4 5 5 6Payroll taxes 2 3 3 4Insurance 6 6 7 7Rent 8 8 9 9Utilities 2 2 2 3Depreciation & amortization 3 4 4 5Office supplies 1 1 1 1Travel & entertainment 3 3 3 4Postage 1 1 1 2Equipment maintenance & rental 0 0 1 1Interest 0 1 1 2Furniture & equipment 3 4 4 5

Total General/Administrative Expenses $45 $52 $57 $67

Total Operating Expenses $121 $140 $155 $180

Net Income Before Taxes $69 $175 $115 $165Taxes on income 22 32 26 28

Net Income After Taxes $47 $143 $89 $137

Extraordinary gain or loss $0 $0 $43 $0Income tax on extraordinary gain 0 0 12 0

NET INCOME (LOSS) $47 $143 $120 $137

Really?

Better shown by months till

desired profitability

Start-ups do NOT make profit initiallyFirst year’s operations are usually at a

lossHowever many don’t estimate this lossCash flowBurn rate

Strategies for start-up losses:Don’t pay yourself!Reserve capital as a bufferLine of credit to ease uneven cash flow

Cash Flow or burn rate


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Cash Flow


How much will it take to get your venture going?AssetsOperating expenses (buffer)Pre-payments (lease deposits,

insurance, etc.)AdvertisingTraining of staffEtc.

Start-up Capital


Helps the entrepreneur transform business goals into reality

Challenging for a business start-up They should be realistic and well-

researched! Start-ups should create two-year

projections Projected financial statements: Income statement Balance sheet 11 - 13

Creating Projected Financial Statements


Ratio analysis: A method of expressing the

relationships between any two elements on financial statements.

Important barometers of a company’s health.

Studies indicate few small business owners compute financial ratios and use them to manage their businesses.

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Ratio Analysis


Ratios – useful yardsticks of comparison.Standards vary from one industry to

another; the key is to watch for “red flags.”Critical numbers: measure key financial

and operational aspects of a company’s performance. Examples:Sales per labor hour at a supermarketFood costs as a percentage of sales at a

restaurant.Load factor (percentage of seats filled with

passengers) at an airline. 11 - 15

Interpreting Ratios


When comparing critical numbers to the industry standards, ask:Is there a significant difference in my estimated

ratio and the industry average?If so, what is the difference meaningful?Is the difference good or bad?What are the possible causes of this difference?

What is the most likely cause?

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Financial Benchmarking


Breakeven point:The level of operation at which a business

neither earns a profit nor incurs a loss. A useful planning tool because it shows

entrepreneurs minimum level of activity required to stay in business.

With one change in the breakeven calculation, an entrepreneur can also determine the sales volume required to reach a particular profit target.

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Break-Even Analysis


Step 1. Determine the expenses the business can expect to incur.

Step 2. Categorize the expenses in step 1 into fixed expenses and variable expenses.

Step 3. Calculate the ratio of variable expenses to net sales.

Step 4. Compute the breakeven point: Breakeven Point ($) = Total Fixed

Costs Contribution

Margin11 - 18

Calculating the Breakeven Point


Step 1. Net Sales estimate: $950,000 Cost of Goods Sold: $646,000

Total expenses: $236,500. Step 2. Variable Expenses: $705,125

Fixed Expenses: $177,375Step 3. Contribution Margin = 1 - $705,125

= .26

$950,000Step 4. Breakeven Point = $177,375 =

$682,212 .26

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Calculating the Breakeven Point: The Magic Shop


Helpful?

Find a milestone that you can rally around (goal)…Daily salesNumber of customers (with conversion

rates)Number of units to sell

How to use Breakeven


Financial planning is a critical step Entrepreneurs can gain valuable insight through: Pro forma statements Ratio analysisBreakeven analysis

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Conclusion


Documents

Copyright © 2016 Pearson Education, Inc. Creating a Successful Financial Plan 11 11-2 Section 3: Launching the Business