Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of...
Transcript of Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of...
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-1
The Financial Plan
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-2
Chapter Learning Objectives
1. To understand the role of budgets in preparing pro forma statements.
2. To understand why positive profits can still result in a negative cash flow.
3. To learn how to think strategically about financial management decisions
4. To learn how to prepare monthly pro forma cash flow, income, balance sheet, and sources and uses of funds statements
5. To explain the break-even point for the new venture.6. To illustrate how ratio analysis can assist the firm7. To illustrate the alternative software packages that can
be used
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-3
Chapter Opening Profile
Ted Rogers, owner of Rogers Communications, RogersWireless, Rogers Cable, and Rogers Media
– Recently purchased Microcell (aka Fido)• Pushed its debt to $8 billion (i.e. 5 times the company’s
earnings before interest, taxes and depreciation)– Investing heavily in broadband and technology
• Wants to be the dominant communications player in Canada
• Entering the local phone provider marketplace• Offers complete package of cable TV, Internet, local,
long distance, and wireless telephone services• Wants to defeat Bell Canada• His challenge will be to manage his company’s cash
flow and debt load
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-4
Preparing Financial Statements
Entrepreneurs should be aware of a couple of points prior to engaging in this process
• The size of the company will dictate the extent of financial planning
• The “intent” of the business plan may also dictate the extent of financial planning
• Entrepreneurs should not estimate or assume too much in an initial plan
• Be careful not to overpay yourself – investors like to see an entrepreneur “sharing the pain”
• Do not spent too much time on these statements– Many great entrepreneurs were not necessarily great
financial planners
• Financial planning is an ongoing process
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-5
Operating and Capital Budgets
• The financial plan is a key component of the business plan for several reasons:
– Can be used to determine/prove feasibility of the venture
– Allows planning for capital requirements
– Provides confidence for investors and lenders
• Key statements:
– Pro forma income statement
– Budgets:
• Sales forecasts
• Production/manufacturing
• Operating costs
• Capital
• Cash flow
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-6
Operating and Capital Budgets
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-7
Reducing Expenses
As an entrepreneur, the less cash spent, the more left over
to pay yourself!• Beware of an entrepreneur who is not careful about
their spending
• Key tip-off: expensive vehicle lease in the business plan!
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-8
Reducing Expenses
• Tips to reduce expenses:
– Pay in cash to take advantage of discounts offered
– Shop around for the best deal
– Haggle whenever possible
– Barter
– Grab free stuff
– Form or join a co-op
– Don’t buy things you don’t need
– Watch where you rent
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-9
Pro Forma Income Statement
• Pro forma income (definition): projected net profit calculated from projected revenues minus projected costs and expenses– Monthly numbers for the first several years
– Starts with sales forecast
– Sales numbers should be based on market research, industry sales, or trial experience
– Market share information can be key
– Operating expenses can be based on industry standards, estimates, and experience
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-10
Pro Forma Income Statement
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-11
Saving Money: Changes in the Environment
Experienced entrepreneurs will keep track of these
expense areas• Reduce inventory levels• Reduce travel costs• Reduce office supply costs• Outsourcing• Reduce bank charges• Reduce shipping charges• Find free help
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-12
Pro Forma Income Statement
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-13
Pro Forma Cash Flow Statement
Pro forma cash flow (definition): projected cash available
calculated from projected cash accumulations minus projected
cash disbursements• Cash flow is not the same as
profitability
• A growing business that is profitable can very easily run out of cash
• Most new ventures will have negative cash flow during the start-up phase
• Two methods to project cash flow
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-14
Pro Forma Cash Flow Statement
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-15
Pro Forma Cash Flow Statement
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-16
Nontraditional Financing
Lissa D’Aquanni’s chocolate business
• Needed to raise “owner’s equity” for her renovation project
• Some money came from an economic development group
• She also obtained a government-guaranteed loan
• Obtained a matching grant program
• Used a state program for energy-efficient upgrades
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-17
• Pro forma balance sheet (definition): summarizes the projected assets, liabilities, and net worth of the new venture
• Assets (definition): represents items that are owned or available to be used in the venture operations
• Liabilities (definition): represents money that is owed to creditors
• Owner’s equity (definition): represents the amount owners have invested and/or retained from the venture operations
Pro Forma Balance Sheet
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-18
Pro Forma Balance Sheet
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-19
Strategic Entrepreneurial Finance
Entrepreneurs have argued that traditional financial planning does not align well with what happens “in the real world”
• Cash is king
• Entrepreneurs are more concerned about their ability to raise capital than what is expressed in textbooks
• Entrepreneurs are concerned about increasing the value of their company over time
• not so interested in short term financial results
• Entrepreneurs are emotionally tied to the company
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-20
Strategic Entrepreneurial Finance … continued
Entrepreneurs have argued that traditional financial planning
does not align well with what happens “in the real world”
• Entrepreneurs often break financial management down to a series of questions:
• where is the company headed
• what will happen in the future
• what can go wrong
• what has to happen so the company can achieve its financial goals
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-21
Break-even Analysis
• Break-even (definition): the volume of sales where the venture neither makes a profit nor incurs a loss
• Concept used when determining feasibility of the venture• Need to determine the costs of producing one unit (variable
costs) and the fixed costs of operating the business
• Selling price charged needs to cover the variable costs of producing the unit and the remainder (gross margin) contributes to paying the fixed costs of operating the business
Formula for break-even:
B/E (Q)= TFC/(SP-VC)
TFC= total fixed costs
SP= selling price
VC= variable costs
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-22
Break-even Analysis
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-23
Key Financial Ratios
• Debt/equity ratio– This is a figure that banks track most vigilantly– It reveals your company’s exposure to debt
• (how much ya owe)
• Working capital ratio– Ratio of current assets to current liabilities– This reveals your ability to pay for things in the short term
• Wages to sales ratio– Crucial for restaurants, construction firms .. Companies that have
a high portion of costs eaten up by salary
• Inventory to sales ratio– Expressed as the number of days to turn over a given inventory
• Indicates how fast you are selling stuff from the point when you obtained the materials to make it
• Gross profit margin– This ratio enables an entrepreneur to determine the level of
sales they need to break even
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-24
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-25
Pro Forma Sources and Applications of Funds
• Proforma applications and sources of funds (definition): summarizes all the projected sources of funds available to the venture and how these funds will be discharged
• The purpose is to show how net income and financing were used to increase assets or to pay off debt
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-26
Pro Forma Sources and Applications of Funds
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-27
Ratio Analysis
Liquidity Ratios• Current Ratio• Acid Test Ratio
Activity Ratios• Average Collection Period• Inventory Turnover
Leverage Ratios• Debt Ratio• Debt to Equity
Profitability Ratios• Net Profit Margin• ROI - Return on investments
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-28
Software Packages
• Track financial data• Generate financial statements• Spreadsheet programs• Accounting programs:
– QuickBooks
– Peachtree
– MYOBUS
– Vision Point
– Small Business Manager
– Business Works
– Turning Point
Chapter 7
Concept & Development of Entrepreneurship
Entrepreneurial Decision Process
Types of Start-up Ventures
Entrepreneurship & Economic Development
Ethics and Social Responsibility
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 7-29
Chapter Closing Comments
1. To understand the role of budgets in preparing pro forma statements.
2. To understand why positive profits can still result in a negative cash flow.
3. To learn how to prepare monthly pro forma cash flow, income, balance sheet, and sources and uses of funds statements for the first year of operation.
4. To explain the application and calculation of the break-even point for the new venture.
5. To illustrate the alternative software packages that can be used for preparing financial statements.