Finance Workshop 2008

8/9/2019 Finance Workshop 2008

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Bhavan Suri

Business Plan Finance Workshop

Bhavan Suri
http://www.northwestern.edu/http://www.northwestern.edu/


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Agenda

Introductions

Finance Overview (10 10:10 AM)

Financial Statements

Income Statements

Examples and Discussion Lunch and team breakout (11:30 12:00 PM)

Summary Presentations from Teams

Q & A and feedback forms
http://www.northwestern.edu/


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Introduction

What is a business plan?

A Business Plan is the document you create thatdetails your business history, current standingand future plans.

The business plan is the first document that mostinvestors will see about your company.


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Introduction

As an Entrepreneur at what stage should you

write a business plan?

How does investing generally work? Angel/Seed, Series A, Series B, etc

How does ownership work as an entrepreneur: Your idea

Investors stakes

Exit Strategy


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Finance Overview

A business plan depends on both words and numbers.

In this workshop, we go through the basics of how thenumbers come together. The single most important analysis in a business plan is a

cash flow plan, because cash is the most critical element inbusiness.

However, you can't do a cash flow plan without looking at

the income statement and balance sheets. Also need to understand sales, cost of sales, personnelexpenses and other expenses.

And you need to understand your market before doing asales forecast, so a market analysis is recommended.

And then you have the break-even as part of the initial

assessment, and tables for business ratios, generalassumptions, and other numbers. Step by step, the business plan becomes a collection of

tables and charts around the text.


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Finance Overview

Profitable companies can go broke because they

had all their money tied up in assets and couldntpay their expenses.

Working capital is critical to business health.

Unfortunately, we dont see the cash implicationsas clearly as we should, which is one of the bestreasons for proper business planning. We have to

manage cash, as well as profits.


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Finance Cash Flow

Cash flow refers to the

amounts of cash beingreceived and spent by abusiness during a definedperiod of time, sometimestied to a specific project.

This is very important fordescribing the health of thebusiness because althoughyou may have made $1000

in sales, you still may haveto wait to collect that cash(due to the terms you havewith the customer).

Transaction In Out

Incoming Loan $50.00

Sales (which were paid for in cash) $30.00

Materials ($10.00)

Labor ($10.00)

Purchased Capital ($10.00)

Loan Repayment ($5.00)

taxes ($5.00)

TOTAL Cash Flow for the Period $40.00


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Finance Income Statement

Income statements for

companies indicate howRevenue (money receivedfrom the sale of productsand services beforeexpenses are taken out,

also known as the "topline") is transformed intoNet Income (the resultafter all revenues andexpenses have beenaccounted for, also knownas the "bottom line").

Also called Profit andLoss Account (P&L).

Revenues

Net Sales $ 3,400,000

Rent revenue $ 40,000

Interest revenue $ 12,000

Total revenue $ 3,452,000

Expenses (usually sorted by amount)

Cost of goods sold $ 2,000,000

Selling expenses $ 450,000

Administrative expenses $ 350,000

Interest expense $ 45,000

Total expense $ 2,845,000

Income before taxes $ 607,000

Income taxes $ 180,600

Net income $ 426,400


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Finance Balance Sheet

A balance sheet is a

statement of the bookvalue of a business at aparticular date.

A balance sheet is oftendescribed as a "snapshot"

of the company's financialcondition on a given date.Of the basic financialstatements, the balancesheet is the only statement

which applies to a singlepoint in time, instead of aperiod of time.

Assets

Current assets

Cash

Marketable securities

Accounts receivable

Net inventory

Other current assets

Total current assets

Fixed assets (or property, plant, and equipment - PP&E)

Property

Plant & equipment

Gross PP&E

(Accumulated depreciation)

Net PP&E

Total assets


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Some Key Terms:

Income statement:

Revenue (Sales).

Cost of Goods Sold (COGS or cost of revenue).

Gross Profit (Gross Margin) = Sales COGS.

Sales and Marketing (S&M).

Research and Development (R&D). General and Administrative (GA).

Operating Margin (Earnings Before Interest and Tax).

EBIT = Gross Profit S&M R&D GA.

Other Income (Interest payments from bank loans, etc).

Taxes.

Net Income = EBIT +/- other income taxes.


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Some Key Terms:

Cash Flow Statement:

Not as important to show to investors. Need to show you understand and MANAGE cash.

Balance Sheet: Not as important to show to investors.

Assets (what you own and you can convert into hard $$). Cash, Accounts Receivable (A/R), Inventory. Property, plant, equipment (PPE).

Goodwill and intangibles.

Liabilities (what you owe). Accounts payable (A/P), Debt.

Shareholders Equity (Stockholders Equity).

NOTE:

ASSETS = LIABILITIES + EQUITY


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Lets start with $100, which well call capital. At the beginning of this exercise, your balance sheet has assets of

$100--the money--and capital of $100. Assets are equal to capital plus liabilities. A summary of the simple financial statement:


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We have a business that sells widgets.

We buy a widget for $100 and sell it for $150,and end up with $50 profit.

This is what your income statement cover - Salesminus costs are profit.

We have $150 in the bank.

The balance sheet shows the $100 in originalcapital plus $50 in earnings, which are equal tothe $150 in cash (an asset).


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Replicate the sale - buy another widget for $100

and sell it again for $150, Now there is $200 in the bank. Do it again, and

there is $250 in the bank.

The Income Statement shows sales of $450, cost

of sales of $300, and profit of $150. Income statement and balance sheet below.


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The business has sold 3 units and made $150

profit. In theory it has $250 in the bank.

Lets add Some Realism.

Most sales of products to businesses go on terms,with the money due in 30 days.

So if the widget was sold on credit you dont have$150 in the bank - you still have $50 in your

bottom line, but now you have nothing in thebank.

Instead, a customer owes you $150 this isknown as Accounts Receivable.


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Sales and profits are the same as in, but you sold

on credit, so now you have no money in thebank.


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You now get your Widget supplier to sell to you

on the same terms you sell, net 30, instead of forcash.

Now you have $100 that you owe to suppliers -called Accounts Payable.

You also have $100 worth of widget in inventory.


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Business looked good, so you borrowed the

money to buy another widget and continue. You have an extra $100 in assets (the widget in

inventory) and an extra $100 as liabilities.(Accounts Payable), so you are still in balance

And you still have no money.


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So you have the same sales and profits as in the

Sell 3 Widgets earlier example, but the balancesheet is more complex.

Now the case is more like what you have withreal business numbers.

You have to manage your cash very carefully. The amounts sitting in inventory and accounts

receivable are significant.


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Income Statement Detail

The standard Income statement in accounting subtracts

costs and expenses from sales and shows profits as thebottom line of the statement.

Expenses start with personnel and include rent, utilities,equipment, advertising, sales commissions, publicrelations, and other expenses.

The result is profits - Profits are what is left over after youstart with sales, then subtract cost of sales, expenses, andtaxes.

The Income statement is the same as the Profit and Lossstatement.

Also known as "pro forma," meaning projected, as in "proforma income" or "pro forma profit and loss.

The pro forma income is the same as a standard incomestatement except that it projects the future.


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Income Statements

COST OF GOODS SOLD (Cost of Sales or COGS): COGS are

expenses directly related to producing or buying yourproducts or services.

E.g. purchases of raw materials, wages (and payroll taxes)of employees directly involved in producing yourproducts/services. These expenses usually go up and down

along with the volume of production or sales. Control of COGS is the key to profitability for most

businesses.

For each category of product/service, analyze the elementsof COGS: labor, materials, packing, shipping, sales

commissions, etc. Underestimating COGS can lead to under pricing, which

destroys profit.

Analyze carefully and be realistic.


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Income Statements

GROSS PROFIT: Gross Profit is Total Sales minus Total

COGS. OPERATING EXPENSES (Overhead): These are necessary

expenses which are not directly related to making orbuying your products/services.

E.g.: Rent, utilities, telephone, interest, and the salaries

(and payroll taxes) of office and management employees Most operating expenses remain reasonably fixed

regardless of changes in sales volume.

Some, like sales commissions, may vary with sales. Some,like utilities, may vary with the time of year. Your

projections should reflect these fluctuations. NET PROFIT: This is Gross Profit minus Total Operating

Expenses.


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Income Statement

Subtract cost of sales

from sales.

This gives grossmargin, an importantratio for comparisons

and analysis.

A more detailed Profitand Loss is shown inthe next illustration.


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Operating expensesdivided into categories,including Sales and

Marketing expensesand General andAdministrativeexpenses (SG&A).

The sum of expensesultimately determinesthe company'sprofitability.

This is the budgetedbusiness plan.


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Balance Sheet - Assets

How will the year's operations affect assets,

debts, and equity assuming significant salesgrowth in the coming year:

ASSETS: Inventory and Accounts Receivable will have togrow. New equipment may be needed for increasedproduction. You may draw down on cash to financesome of this.


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Balance Sheet - Liabilities

The balance sheet must balance, so on the other side we have

liabilities:

LIABILITIES & EQUITY: Some of the growth may be financed byprofits retained in the business as Retained Earnings.

Your Profit & Loss Projection shows how much might be availablefrom that source.

Funds may also be contributed by the owners throughcontributions of more Invested Capital or loans to the company(Notes Payable to Stockholders).

Suppliers may provide some of the financing via increasedAccounts Payable.

The rest will have to be financed by borrowing, which can be:Short term loans (due within 12 months) such as a line of credit.Or by Long Term Debt (maturity greater than 12 months).


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Balance Sheet

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A B C D E F G H

Basic Excel: Balance SheetDec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05

Assets

Accounts Receivable 500$ 1,000$ 2,000$ 4,000$ 8,000$ 16,000$Inventory 600$ 630$ 662$ 695$ 729$ 766$Prepaid Expenses 200$ 230$ 260$ 290$ 320$ 350$Property, Plant, Equipment 11,900$ 12,810$ 13,734$ 14,676$ 15,639$ 16,628$

Total 13,200$ 14,670$ 16,656$ 19,660$ 24,689$ 33,744$

Liabilities and Equity

Accounts Payable 730$ 873$ 924$ 1,087$ 1,175$ 1,267$Debt 1,000$ 800$ 600$ 400$ 200$ -$Preferred Equity 500$ 500$ 500$ 500$ 500$ 500$Common Equity 10,970$ 12,497$ 14,632$ 17,673$ 22,814$ 31,977$

Total 13,200$ 14,670$ 16,656$ 19,660$ 24,689$ 33,744$

Capital Account

Starting PPE 11,000$ 11,900$ 12,810$ 13,734$ 14,676$ 15,639$Depreciation 1,100$ 1,190$ 1,281$ 1,373$ 1,468$ 1,564$Capital Expenditure 2,000$ 2,100$ 2,205$ 2,315$ 2,431$ 2,553$

Ending PPE 11,900$ 12,810$ 13,734$ 14,676$ 15,639$ 16,628$


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Balance Sheet

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A B C D E F G H

Basic Excel: Balance SheetDec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05

Assets

Accounts Receivable 500$ 1,000$ 2,000$ 4,000$ 8,000$ 16,000$Inventory 600$ 630$ 662$ 695$ 729$ 766$Prepaid Expenses 200$ 230$ 260$ 290$ 320$ 350$Property, Plant, Equipment 11,900$ 12,810$ 13,734$ 14,676$ 15,639$ 16,628$

Total 13,200$ 14,670$ 16,656$ 19,660$ 24,689$ 33,744$

Liabilities and Equity

Accounts Payable 730$ 873$ 924$ 1,087$ 1,175$ 1,267$Debt 1,000$ 800$ 600$ 400$ 200$ -$Preferred Equity 500$ 500$ 500$ 500$ 500$ 500$Common Equity 10,970$ 12,497$ 14,632$ 17,673$ 22,814$ 31,977$

Total 13,200$ 14,670$ 16,656$ 19,660$ 24,689$ 33,744$

Capital Account

Starting PPE 11,000$ 11,900$ 12,810$ 13,734$ 14,676$ 15,639$Depreciation 1,100$ 1,190$ 1,281$ 1,373$ 1,468$ 1,564$Capital Expenditure 2,000$ 2,100$ 2,205$ 2,315$ 2,431$ 2,553$

Ending PPE 11,900$ 12,810$ 13,734$ 14,676$ 15,639$ 16,628$


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Finance Overview

Steps to take when building a financial model:

Market Size and Growth:

How big is the market and how fast is it growing?

Will your company grow with the market or will it take share fromexisting competitors?

How will you price your product(s)?

Based on your growth, how many products (volume) do youneed to sell each year?

What does it cost on a cash basis to support this growth?

What assets (equipment, cash, etc.) do you need to support thisgrowth?


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Examples and Discussion

Starting from scratch:

Forecasting sales is the starting point for the financialprojection.

The sales forecast is key, so it is important to use realisticestimates.

Divide projected monthly sales into "Categories which are

divisions that make sense for your type of business. Examplecategories are: product lines, departments, branch locations,customer groups, geographical territories, or contracts.

Enter annual sales, by category, in the four "Sales History"columns on the right side of the sheet. (Startup businessescan delete this section).

Analyze past sales and note seasonal/periodic fluctuations;determine what caused them and when they are expected torecur.

Build these fluctuations into your projections for the comingyear.


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Sales Forecast (12 Months)Enter your Company Name here

Fiscal Year Begins Jun-05

12-month Sales Forecast Sales History

Jun-05 Jul-05 Aug-05 Sep-05 Oct-05 Nov-05 Dec-05 Jan-06 Feb-06 Mar-06 Apr-06 May-06

Annual

Totals

Current

Month

Ending

mm/yy 2004 2003 2002

Cat 1 units sold 0

Sale price @ unit

Cat 1 TOTAL 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

Cat 2 units sold 0

Sale price @ unit

Cat 2 TOTAL 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

Cat 3 units sold 0Sale price @ unit

Cat 3 TOTAL 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

Cat 4 units sold 0

Sale price @ unit

Cat 4 TOTAL 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

Cat 5 units sold 0

Sale price @ unit

Cat 5 TOTAL 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

Cat 6 units sold 0

Sale price @ unit

Cat 6 TOTAL 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

Cat 7 units sold 0

Sale price @ unit

Cat 7 TOTAL 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

All Categories 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0


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Cash Flow:

On the Profit & Loss Projection, check line by line whencash should come and go. This is to determine when youwill actually collect from customers.

On the expense side, predict when you will actually haveto write the check to pay those bills.

Most items will be the same as on the P&L. Rent andutility bills, for example, are paid in the month they areincurred.

Insurance, taxes, for example, may be payablequarterly or semiannually, even though you recognize

them as monthly expenses.

The payoff for an accurate cash flow is the ability tomanage and forecast working capital needs.

Cash Flow (12 months) Enter Company Name Here Fiscal Year Begins: Jan 06
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Cash Flow (12 months) Enter Company Name Here Fiscal Year Begins: Jan-06Pre-Startup

ESTJan-06 Feb-06 Mar-06 Apr-06 May-06 Jun-06 Jul-06 Aug-06 Sep-06 Oct-06 Nov-06 Dec-06

Total Item

EST

Cash on Hand(beginning of

month)0 0 0 0 0 0 0 0 0 0 0 0 0

CASH RECEIPTS

Cash Sales

Collections fm CR accounts

Loan/ other cash inj.

TOTAL CASH RECEIPTS 0 0 0 0 0 0 0 0 0 0 0 0 0 0

Total Cash Available (before

cash out)0 0 0 0 0 0 0 0 0 0 0 0 0 0

CASH PAID OUT

Purchases (merchandise)

Purchases (specify)

Purchases (specify)

Gross wages (exact withdrawal)

Payroll expenses (taxes, etc.)

Outside services

Supplies (office & oper.)

Repairs & maintenance

Advertising

Car, delivery & travel

Accounting & legal

Rent

Telephone

Utilities

Insurance

Taxes (real estate, etc.)

Interest

Other expenses (specify)

Other (specify)

Other (specify)

Miscellaneous

SUBTOTAL 0 0 0 0 0 0 0 0 0 0 0 0 0 0

Loan principal payment

Capital purchase (specify)

Other startup costs

Reserve and/or Escrow

Owners' WithdrawalTOTAL CASH PAID OUT 0 0 0 0 0 0 0 0 0 0 0 0 0 0

Cash Position (end of month) 0 0 0 0 0 0 0 0 0 0 0 0 0 0
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Finances - Summary

This is where you present your company's

financial history and projections. Do not be overly creative in this section of your

plan.

You should be "vanilla-flavored Present your

finances in the standardized manner to whichaccountants and investors are accustomed.

Provide past results (if applicable), and two tothree years of projections (pro forma).

When presenting to investors create threescenarios a worst case, expected, and bestcase.


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Example Sample Market/Company

Market Size and Growth:

Total market is growing at 60% per year according to X. Enterprise software segment at 46%.

Software-as-a-Service segment at 165%.

Demand for Web Analytics solutions is high (survey).

Source: XXX

Worldwide Web Analytics Software Spend

-

500

1,000

1,500

2,000

2,500

3,000

3,500

2006 2007 2008 2009 2010 2011

TotalSpend

in$millions

Software as a Service Enterprise Software Total

l S l k /C


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Example - Sample Market/Company

Profitable in 2008.

Revenue CAGR of 150% over 6 years.

2005A 2006A 2007A 2008E 2009E 2010E 2011E

($ in thousands) Revenue 195 1,170 4,680 13,104 23,587 35,381 53,071

Cost of revenue 432 1,346 3,136 6,342 7,784 11,286 16,611

Gross profit (237) (176) 1,544 6,762 15,803 24,094 36,460Gross profit margin -121.5% -15.0% 33.0% 51.6% 67.0% 68.1% 68.7%

Operating expenses

Sales and marketing 800 1,463 2,340 3,407 6,133 9,199 13,799Research and development 1,209 1,697 1,778 1,966 3,538 5,307 7,961General and Administrative 174 257 328 655 1,179 1,769 2,654

EBIT (2,419) (3,592) (2,902) 734 4,953 7,819 12,047

Operating Margin -1240.5% -307.0% -62.0% 5.6% 21.0% 22.1% 22.7%

Net Interest and Other (0) (1) (0) 2 4 4 9Pretax income / (loss) (2,419) (3,593) (2,902) 735 4,957 7,824 12,056

Tax Provision (Reported) 0 0 0 88 1,685 2,660 4,099Net income (2,419) (3,593) (2,902) 647 3,272 5,164 7,957

W k h P j


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Workshop Project

Consulting Company Financial Summary.

Basic Revenue Assumptions:

Hours per week that you bill per consultant: 48.

Current (2006) Utilization Rate is 66%, assume this will go up to 75%.

Average Billable Rate is $150/hr, assume this goes up to $180/hr.

Currently (2006) 8 consultants, assume this will go up.

Assume you will have software products in 1 year, that will generaterevenue starting at $20,000 but will never exceed 1% of consultingrevenue.


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Consulting Company

Basic Expense Assumptions:

Fully loaded cost per consultant is 75% of revenue that the consultant brings in.

Product Development is 40% of the revenue that product sales brings in.

You have infrastructure costs that are $75,000 (2006), assume these will growdoubling for the next few years before slowing down.

You have General and Administrative costs that are $75,000 (2006), assume

these will grow doubling for the next few years before slowing down. You have R&D costs associated with product sales.

Create a Profit and Loss projection for 2008 out through 2013.

Documents

Finance Workshop 2008