Chapter 5

Chapter 5

ENTREPRENEURIAL FINANCE Leach & Melicher Chapter 6 FINANCIAL PLANNING: LONG-TERM AND SHORTTERM 2003 South-Western College Publishing 1 CHAPTER 6: LEARNING OBJECTIVES Understand the concept of a sustainable sales growth rate Understand the process of identifying when and how much additional funds will be needed to support the ventures sales forecasts Develop an understanding of the impact of varying sales growth rates on the amount and timing of additional funds needed Describe the percent of sales method for preparing long-term financial plans 2

CHAPTER 6: LEARNING OBJECTIVES Explain why projected statements of cash flows are important to the entrepreneur Describe how projected statements of cash flow relate to cash budgets 3 VENTURE LIFE CYCLE DEVELOPMENT STAGE STARTUP STAGE SURVIVAL STAGE RESTRUCTURE LIQUIDATE RAPID GROWTH STAGE SELL OR MERGE GO PUBLIC MATURITY STAGE 4

VENTURE LIFE CYCLE: OPERATING AND FINANCIAL DECISIONS Development Stage: Screen Business Ideas Prepare Business Plan Obtain Seed Financing Startup Stage: Choose Organizational Form Prepare Initial Financial Statements Obtain First Round Financing 5 VENTURE LIFE CYCLE: OPERATING AND FINANCIAL DECISIONS Survival Stage: Monitor Financial Performance Project Cash Needs Obtain First Round Financing Liquidate v. restructure

Rapid Growth Stage: Create and Build Value Obtain Additional Financing Examine Exit Opportunities Go public v. Sell or merge 6 VENTURE LIFE CYCLE: OPERATING AND FINANCIAL DECISIONS Maturity Stage: Manage Ongoing Operations Maintain and Add Value Obtain Seasoned Financing 7 FORECASTING SALES OR REVENUES Forecasting for Early Stage Ventures: Firms that are in either their development, startup, or survival stage, or just entering into their rapid growth stage of their life cycle. Industry Probability of Sales Component Sales Scenario

Occurrence Growth Rate Weight Optimistic forecast .30 X 60% = 18.0% Most likely forecast .40 X 50% = 20.0% Pessimistic forecast .30 X 40% = 12.0% 1.00 Expected Value = 50.0% 8 ESTIMATING SUSTAINABLE SALES

GROWTH RATES Internally Generated Funds: Net income or profits after taxes earned over an accounting period Sustainable Sales Growth Rate: Rate at which a firm can grow sales based on the retention of profits in the business 9 ESTIMATING SUSTAINABLE SALES GROWTH RATES EndingEquity BeginningEquity g BeginningEquity Change In Equity g Beginning Equity Equity g Beginning Equity 10 ESTIMATING SUSTAINABLE SALES

GROWTH RATES E Net Income x Retention Rate E/Ebeg (NI/Ebeg) x RR g (NI/Ebeg) x RR 11 ESTIMATING SUSTAINABLE SALES GROWTH RATES ROE Net Profit Margin x Asset Turnover x Equity Multiplier NI NI NS TA ROE X X CE NS TA CE NI NS TA g X X X RR NS TA CEbeg g Operating Performance X Financial Policies g ROA X FP

12 ESTIMATING ADDITIONAL FINANCING NEEDED TO SUPPORT GROWTH Financing Capital Needed (FCN): financial funds needed to acquire assets necessary to support a firms sales growth Spontaneously Generated Funds: increases in accounts payables and accruals (wages and taxes) that occur with a sales increase 13 ESTIMATING ADDITIONAL FINANCING NEEDED TO SUPPORT GROWTH Additional Funds Needed (AFN): financial funds still needed to finance asset growth after spontaneously generated funds and any increase in retained earnings have been used AFN = Required Increase in Assets Spontaneously Generated Funds

Increase in Retained Earnings 14 AFN EQUATION TA o APo ALo NIo AFN (NS) (NS) - (NS1) (RRo) NSo NSo NSo where : TA Total assets NS Net sales NS Change in net sales between next year and current year AP Accounts payable AL Accrued liabilitie s NI Net Income RR Retention Rate 15 AFN CALCULATIONS Sales last year = $1,600,000 Asset investment = $1,000,000

Net Income = $160,000 Current Assets = $520,000 Fixed Assets = $480,000 Accounts Payable = $48,000 Accrued Liabilities = $32,000 Projected next year sales = $2,080,000 16 AFN CALCULATIONS AFN $1,000,000 $80,000 $160,000 ($480,000) ($480,000) - ($2,080,000) (1.00) $1,600,000 $1,600,000 $1,600,000 .625($480,000) - .05($480,000) - $2,080,000(.10)(1.00) $68,000 17 PROJECTING OR FORECASTING FINANCIAL STATEMENTS Percent

of Sales Method: make projections based on the assumption that certain costs and selected balance sheet items are best expressed as a percentage of sales Constant Ratio Method: variant of the percent of sales method that projects selected cost and balance items at the same growth rate as sales 18 PROJECTING OR FORECASTING FINANCIAL STATEMENTS FINANCIAL FORECASTING PROCESS TO PROJECT FINANCIAL STATEMENTS 1. Forecast sales 2. Project income statement 3. Project balance sheet 4. Project statement of cash flows 19 GAME TOY INCOME STATEMENTS (2001 Actual, 2002 Projected) ACTUAL 2001

Sales $1,600,000 CGS 960,000 Gross Profit 640,000 Marketing Exp 160,000 G & A Exp 152,000 Deprec. Exp 48,000 EBIT 280,000 Less Interest 13,300 EBT 266,700 Less Taxes @ 40% 106,700 Net Income 160,000 -Cash Distrib. 0 \__________ Added RE $160,000

1.3 x 2001 sales .60 x 2002 sales .10 x 2002 sales Fixed costs .030 x 2002 sales Initially fixed 40% of EBT FORECAST 2002 $2,080,000 1,248,000 832,000 208,000 152,000 62,400 409,600 13,300 396,300 158,500 237,800 0 \__________ $237,800 20 GAME TOY BALANCE SHEETS (2001

Actual, 2002 Projected) Cash A/R Inventories Total C/A Net P & E Total Assets ACTUAL 2001 $16,000 184,000 320,000 520,000 480,000 1,000,000 __- A/P 48,000 Accrued Liabilities 32,000 Bank Loan 120,000 Total C/L 200,000 Common Equity 800,000

Addt'l Funds Needed 0 Total Liab & OE $1,000,000 ___ .01 x 2002 sales .115 x 2002 sales .20 x 2002 sales .325 x 2002 sales .300 x 2002 sales .625 x 2002 sales .03 x 2002 sales .02 x 2002 sales +237800 FORECAST 2002 $20,800 239,200 416,000 676,000 624,000 1,300,000 __- 62,400 41,600

120,000 224,000 1,037,800 38,200 $1,300,000 ___ 21 SHORT-TERM CASH PLANNING TOOLS Sales Schedule Purchase Schedule Wages and Commission Schedule Cash Budget 22 PDC COMPANY OPERATING & CASH BUDGET SALES SCHEDULE Schedule 1: Sales Forecast Credit sales, 40% Credit sales, 60% MARCH

APRIL MAY JUNE $92,000 36,800 55,200 $115,000 46,000 69,000 $184,000 73,600 110,400 $138,000 55,200 82,800 69,000 110,400 82,800

Schedule 2: Cash Collections Cash sales this month 100% last month's credit sales Total colections 36,800 105,800 46,000 156,400 73,600 156,400 23 PDC COMPANY OPERATING & CASH BUDGET PURCHASES SCHEDULES MARCH Schedule 3: Purchases $110,400 Ending inventory 64,400 +CGS

174,800 =Total needed 97,520 -Beginning inventory 77,280 =Purchases APRIL MAY JUNE $149,040 80,500 229,540 110,400 119,140 $123,280 128,800 252,080 149,040 103,040 $110,400 96,600 207,000

123,280 83,720 Schedule 4: Purchase Disbursements 50% last mos purch +50% this mos purch =Disbursements for purchases 38,640 59,570 59,570 51,520 51,520 41,860 98,210 111,090 93,380 24 PDC COMPANY OPERATING & CASH BUDGET

WAGES & COM M ISSIONS SCHEDULE MARCH APRIL Schedule 5: Wages & Commiss. Wages (fixed) +Commissions 15% of current sales =Total MAY JUNE $5,750 $5,750 $5,750 $5,750 13,800 19,550 17,250 23,000

27,600 33,350 20,700 26,450 11,500 16,675 28,175 16,675 13,225 29,900 Schedule 6: DisbursementsWages/Commiss. 50% last mos exp. +50% this mos exp. =Total 9,775 11,500 21,275 25 PDC COMPANY OPERATING & CASH BUDGET

CASH BUDGET APRIL MAY JUNE JULY Begin. Cash Cash receipts: $23,000 $23,000 $23,000 $23,000 Customer collections Totl cash before financing 105,800 128,800 156,400

179,400 156,400 179,400 124,200 147,200 Cash disbursements: Merchandise Wages & Comm Misc Exp Rent Truck Purchase Total Disbursements 98,210 111,090 21,275 28,175 5,750 9,200 4,600 4,600 6,900 0 136,735 153,065 93,380

29,900 6,900 4,600 0 134,780 75,670 24,725 5,750 4,600 0 110,745 26 PDC COMPANY OPERATING & CASH BUDGET APRIL Total Disbursements 136,735 Min. cash balance 23,000 Total cash needed 159,735 Excess of total cash -$30,935 Financing New borrowing $30,935

Repayments Loan balance $30,935 Interest 0 Total effects of financing $30,935 Cash balance 23,000 MAY 153,065 23,000 176,065 $3,335 JUNE JULY 134,780 23,000 157,780 $21,620 110,745 23,000 133,745 $13,455

$0 $0 2,871 21,199 $28,064 $6,865 464 421 -$3,335 -$21,620 23,000 23,000 $0 6,865 $0 103 -$6,968 29,487 27

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