The Financial Plan: Projecting Financial RequirementsJul 01, 2018 · Measuring Cash Flows •Cash...

PowerPoint Presentation by Charlie Cook

The University of West Alabama

Longenecker • Moore • Petty • Palich

© 2008 Cengage Learning.

All rights reserved.

CHAPTER 10

The Financial Plan:

Projecting

Financial

Requirements

Developing the New Venture Business PlanPart 3

© 2008 Cengage Learning. All rights reserved. 10–2

Looking AHEAD

1. Describe the purpose and content of the income

statement, the balance sheet, and the cash flow

statement.

2. Forecast a new venture’s profitability.

3. Determine asset requirements, evaluate financial

sources, and estimate cash flows for a new venture.

4. Explain the importance of using good judgment when

making projections.

After you have read this chapter, you should be able to:


Understanding Financial Statements

• Financial Statements (Accounting Statements)

Reports of a firm’s financial performance and

resources

Helps determine a startup’s financial requirements

Assesses the financial implications

of a business plan

• Basic Financial Statements

Income statement

Balance sheet

Cash flow statement


Understanding Financial Statements (cont’d)

• Income Statement

A report showing the profit or loss from a firm’s

operations over a given period of time.

“How profitable is the business?”

Sales (revenue) – Expenses = Profits

– Revenue from product or service sales

– Costs of producing product/service (cost of goods sold)

– Operating expenses (marketing, selling, general and

administrative expenses, and depreciation)

– Financing costs (interest paid)

– Tax payments


Sections of the Income Statement (cont’d)

• Cost of Goods Sold

The cost of producing or acquiring goods or services

to be sold by a firm

• Gross profit

Sales less the cost of goods sold

• Operating expenses

Costs related to marketing and selling a firm’s product

or service, general and administrative expenses, and

depreciation

• Operating income

Earnings before interest and taxes are paid



• Financing Costs

The amount of interest owed to lenders on borrowed

money

• Net Income Available To Owners (Net Income)

Income that may be distributed to the owners or

reinvested in the company

• Depreciation Expense

Costs related to a fixed asset, such as a building or

equipment, distributed over its useful life


The Income Statement:

An Overview

10-1


Operating Activities

Sales Revenue

=

=

=

Operating Income

Earnings Before Taxes

Net Income Available

to Owners

Cost of producing or

acquiring product or

service

(cost of goods sold)

Gross profit

Marketing and selling

expenses, general and

administrative

expenses and

depreciation

(operating expenses)

,

–

=

–

Financing Activities

Operating Income

Interest expense

on debt

(financing costs)

–

Taxes

Earnings Before Taxes

Income taxes–



Income Statement for Trimble & Associates Leasing, Inc.,

for the Year Ending December 31, 2007

10-2


The Balance Sheet

• Balance Sheet

A report showing a firm’s assets, liabilities, and

owners’ equity at a specific point in time

Total Assets = Debt + Owner’s equity


The Balance Sheet: An Overview10-3


The Balance Sheet: Current Assets

• Current Assets (Gross Working Capital)

Assets that can be converted to cash within the firm’s

operating cycle

Cash

Currency and negotiable instruments

Accounts receivable

The amount of credit extended to customers that is

currently outstanding

Inventory

Raw materials and products held in anticipation of

eventual sale


The Balance Sheet: Fixed Assets

• Fixed Assets

Relatively permanent resources intended for use in

the business (not for resale)

• Depreciable Assets

Assets whose value declines (depreciates) over time

• Gross Fixed Assets

Original cost of depreciable assets before any

depreciation expense has been taken

• Accumulated Depreciation

Total depreciation expense taken over the assets’ life


The Balance Sheet: Fixed Assets (cont’d)

• Net Fixed Assets

Gross fixed assets less accumulated depreciation

• Other Assets

Assets other than current assets and fixed assets,

such as patents, copyrights, and goodwill that have an

estimated value


The Balance Sheet: Debt

• Debt

Business financing provided by a creditor

• Current (Short-Term) Debt

Accounts payable: credit payable to suppliers

Accrued expenses: short-term liabilities incurred

but not paid

Short-term notes: Cash amounts borrowed that

must be repaid within a short period of time

• Long-Term Debt

Loans and mortgages with maturities greater than

one year


The Balance Sheet: Debt (cont’d)

• Mortgage

A long-term loan from a creditor for which real estate

is pledged as collateral


The Balance Sheet: Types of Financing

• Owners’ Equity

Money that the owners invest in the business

Owners are “residual owners” of the firm.

Creditors have first claim on the assets of the firm.

• Retained earnings

Profits less withdrawals (dividends) over the life of the

business

Owners’

equity =Owners’

investment–Cumulative dividends

paid to owners

Cumulative

profits+

Owners’

equity =Owners’

investment +Earnings retained

within the business


Balance Sheets for Trimble & Associates Leasing, Inc.,

for December 31, 2006 and 2007

10-4


The Fit of the Income Statement and Balance Sheet10-5


The Cash Flow Statement

• Cash Flow Statement

A financial report showing a firm’s income (cash)

when it is received and expenses when they are paid.

Cash flows from normal operations (operating

activities)

Cash flows related to the investment in or sale of

assets (investment activities)

Cash flows related to financing the firm

(financing activities)


Profits Versus Cash Flows

• Accrual-Basis Accounting

Matches revenues when they are earned against the

expenses associated with those revenues.

Sales reflect both cash and credit (noncash) sales

Inventory purchased on credit is a noncash

expense

Depreciation is a noncash expense

Income tax is accrued and not entirely expensed

• Cash-Basis Accounting

Reports transactions only when cash is received or a

payment is made.


Measuring Cash Flows

• Cash Flows from Operations

Net cash flows generated from operating a business

Calculated by adding back to operating income

depreciation, deducting income taxes, and

factoring in any changes in net working capital.

• Adjusted Income

After-tax cash flow

• Net Working Capital

Money invested in current assets less accounts

payable and accruals


Measuring Cash Flows (cont’d)

• Cash Flows from Investment Activities

Cash inflows and outflows resulting from the sale or

purchase of equipment or another depreciable asset

• Cash Flows from Financing Activities

Cash inflows and outflows resulting from:

Paying dividends and interest expense.

Increasing or decreasing short-term and long-term

debt.

Issuing or repurchasing stock.


After-Tax Cash Flows

from Operations

Cash

Flows

from Assets

Changes in

Operating

Working Capital

Changes in

Long-Term

Assets

Computing Cash Flows from Assets

After-tax cash flows

from operations

Investments in

operating

working capital

Investments

in long-term

assets

Cash

flows from

assets=


Computing Other Cash Flows

• After-Tax Cash Flows From Operations

Net income Depreciation

expense

Interest

Expense

After-tax

cash

flows from

operations

= + +

• Operating Working Capital

Current

assets

Operating

Working

Capital= –

Account payable

and accruals


Cash Flow Statement for Trimble & Associates Leasing, Inc.,

for the Year Ending December 31, 2007

10-6


Cash Flows

from Financing

Interest and Dividends

Paid to Investors

Increase in Debt

(firm issues new debt)

Increase in Equity

(firm issues new stock)

Decrease in Debt

(firm repays debt)

Decrease in Equity

(firm repurchases

outstanding stock)

Increases in Cash Flows from Financing

Decreases in Cash Flows from Financing

Cash Flows from Financing


Cash Flow Patterns10-7

Pattern 1. This firm has positive cash flows from operations, negative investment cash

flows, and positive cash flows from financing. It is using its cash flows from

operations and new financing to expand the firm’s operations.

Pattern 2. This firm is using cash flows from operations to expand the business, pay down

debt, and/or pay its owners.

Pattern 3. This firm is encountering negative cash flows from operations, which are being

covered by selling assets and by borrowing or acquiring more equity financing.

Pattern 4. This firm has negative cash flows from operations and is growing the company’s

fixed assets through increased financing. This firm is a startup business that has

yet to break even, is investing in assets to produce future cash flows, and is

having to raise capital to make that happen.


Financial Forecasting

• Pro Forma Financial Statements

Statements that project a firm’s financial performance

and condition

Purposes of pro forma statements:

How profitable can the firm be expected to be, given

the projected sales levels and the expected sales

expense relationships?

What will determine the amount and type of

financing (debt or equity) to be used?

Will the firm have adequate cash flows? If so, how

will they be used; if not, where will the additional

cash come from?


Forecasting Profitability

• Net Income Depends On:

Amount of sales

Cost of goods sold and operating expenses

Interest expense

Taxes

“If we’re doing so well, then why am I always so broke?”


Pro Forma Income

Statements for

C&G Products, Inc.

10-8


Forecasting Assets and Financing Requirements and Cash Flows

• Bootstrapping

Minimizing a firm’s investments

• Determining Asset Requirements

Use industry ratios for assets-to-sales

Use breakeven analysis and empirical data

• Percentage-of-Sales Technique

Using a percentage of the total sales for a firm as the

basis for forecasting the level of assets. accounts

receivable, and inventories to be held by a firm.


Assets-to-Sales Financing Relationships10-9


Percentage-of-Sales Technique Example


Determining Financing Requirements

• Basic Principles for Financing of Firms

The more assets a firm needs, the greater the firm’s

financial requirements.

A firm should finance its growth in such a way as to

maintain proper liquidity.

The amount of total debt that can be used in financing

a business is limited by the amount of funds provided

by the owners.

Some types of short-term debt maintain a relatively

constant relationship with sales.

There are two sources of equity: external and internal.


Determining Financing Requirements

• Liquidity

The degree to which a firm has working capital

available to meet maturing debt obligations.

• Current Ratio

The firm’s relative liquidity, determined by dividing

current assets by current liabilities.

• Debt Ratio

Debt as a fraction of assets; total debt divided by total

assets.

Spontaneous financing—debts such as accounts

payable that increase as the firm grows.


Sources of Equity Capital

• External Equity

The owners’ original investment

• Profit Retention

The reinvestment of profits in a firm

• Internal Equity

Capital from retaining profits within the firm

• Forecasting financial requirements (in total):

Total

sources of

financing

Spontaneous

financing

Profits

retained

within the

business

Total asset

requirements= +=External

sources of

financing+


Projected Balance Sheets

for C&G Products, Inc.

10-10


Good Forecasting RequiresGood Judgment

• Practical Suggestions

1. Develop realistic sales projections.

2. Build projections from clear assumptions

about marketing and pricing plans.

3. Do not use unrealistic profit margins.

4. Don’t limit your projections to an income statement.

5. Provide monthly data for the upcoming year and annual data

for succeeding years.

6. Avoid providing too much financial information.

7. Be certain that the numbers reconcile—and not by simply

plugging in a figure.

8. Follow the plan.


Key TERMS

• financial statements

(accounting statements)

• income statement

(profit and loss statement)

• cost of goods sold

• gross profit

• operating expenses

• operating income

• financing costs

• earnings before taxes

• net income available to owners

(net income)

• depreciation expense

• balance sheet

• statement of net worth

• current assets

(gross working capital)

• accounts receivable

• inventory

• fixed assets

• depreciable assets

• gross fixed assets

• accumulated depreciation

• net fixed assets

• other assets

• debt

• current debt

(short-term liabilities)

• accounts payable

(trade credit)


Key TERMS

• accrued expenses

• short-term notes

• long-term debt

• mortgage

• ownership equity

• retained earnings

• cash flow statement

• accrual-basis accounting

• cash-basis accounting

• cash flows from operations

• adjusted income

• net working capital

• pro forma financial statements

• bootstrapping

• percentage-of-sales technique

• liquidity

• current ratio

• debt ratio

• spontaneous financing

• external equity

• profit retention

• internal equity






Appendix 10A:

Computing Cash

Flows for Trimble

& Associates

Leasing, Inc.



Income Statement and

Balance Sheet Changes for

Trimble & Associates

Leasing, Inc., for the Year

Ending December 31, 2007

A10-1


Cash Flow Statement for Trimble & Associates Leasing, Inc., for the Year

Ending December 31, 2007

A10-2






Appendix 10B:

Computing Cash

Flows for C&G

Products, Inc.



Cash Flow Statements for C&G Products, Inc.A10-B

The Financial Plan: Projecting Financial RequirementsJul 01, 2018 · Measuring Cash Flows •Cash...

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