Financial Management for Entrepreneurs

1. Financial Management for Entrepreneurs Shirley J. Daniel Professor of Accounting, Henry A. Walker Distinguished Professor of Business Enterprise University of Hawaii Business Plan Competition Help Session

2. Attribution/Sources • Peter Gardner, General Partner, Allegis Capital (from Berkeley BPC website) • Harrison and Horngren, Financial Accounting, 4e, Prentice Hall • Hanson and Mowen, Management Accounting, 5e, Southwestern • Palo Alto Software, Business Planning Software University of Hawaii Business Plan Competition Help Session

3. 2 Helpful Websites • Free: Berkeley Business Plan Competition (Workshops - 2002) http://bplan.berkeley.edu/ • Palo Alto Software Business Plan Pro www.paloalto.com University of Hawaii Business Plan Competition Help Session

4. Typical financial issues faced by entrepreneurs • Planning future initiatives • Managing the business operations • Obtaining financing (debt or equity) • Compliance with government reporting • Cash Flow • Cash Flow • Cash Flow University of Hawaii Business Plan Competition Help Session

5. The economic model of business - 4 considerations • Operating Leverage (fixed costs) • Contribution Margin • Volume • Product Mix University of Hawaii Business Plan Competition Help Session

6. The VC Perspective • Fear vs. Greed • Have seen the good, bad and ugly • Driven by percentage ownership • Limited capacity for deals • Long-term capital formation strategy • Time is limiting factor • Trust University of Hawaii Business Plan Competition Help Session

7. Investment Criteria • “Quality” seed and early-stage investments • Exceptional management teams • Defensible, proprietary technology/IP • Big, addressable markets • High margin business • Consistency with our domain expertise • Opportunities to leverage LP’s • Strong investment syndicate, min. 2 VC’s University of Hawaii Business Plan Competition Help Session

8. University of Hawaii Business Plan Competition Help Session

9. General • Focus on the variables you can control, and be conservative on the ones you can’t • Use industry standard format and labels • Monthly for first 12-24 mos., then quarterly • Proof for inconsistencies and lumpiness • Know the “levers” in the model and spend extra time on them University of Hawaii Business Plan Competition Help Session

10. Revenue Model • Addressable market size • Pricing • Customer ROI • Gross margin • Sales cycle • Channels vs. direct • Reasonable ramp • Modest penetration assumptions University of Hawaii Business Plan Competition Help Session

11. Expense Model • Control the “burn”: early keys are headcount and salary structure • Small teams are more efficient • “Center of gravity” should shift with time • Bad habits start early • Don’t build ahead of market adoption University of Hawaii Business Plan Competition Help Session

12. Cash Flow • Assume the worst, then double it • Match expenses with revenue • Balance sheet items are real • Debt vs. Equity • Think long-term • Heavy capital requirements are scary – find operational leverage University of Hawaii Business Plan Competition Help Session

13. Comparables • Who do you resemble? • How are they valued? (NI, EBITDA, etc.) • What are their multiples? • What does the Street look for? • Who invested in them? • What are their operating metrics? University of Hawaii Business Plan Competition Help Session

14. Fundraising Assumptions • Long-term capital formation strategy • Time rounds to milestones • Dilution is cumulative • Start early • Know your customer (VC, etc.) University of Hawaii Business Plan Competition Help Session

15. VC’s Financial Models • Run financial projections • Apply comparable multiples • Calc. projected future value • Apply ownership after dilution • Achieve hurdle for multiple, IRR? University of Hawaii Business Plan Competition Help Session

16. Factors in Structuring Deals • Ownership hurdles • Time before next round • Maintain incentives • Leave room for step-ups • Dry powder • Co-investors University of Hawaii Business Plan Competition Help Session

17. VC Fund Structure • Sample Early-Stage VC model: • $200M fund for 20 deals • Subtract $30M for ops. • Avg. of $8M per deal over its life • Reserves of 75-150% • Avg. 20% start, 10-12% at liquidity • Initial investment of $3-5M • Post-money capped at $25M University of Hawaii Business Plan Competition Help Session

18. Examples University of Hawaii Business Plan Competition Help Session

19. Summary • Cash is king • You’re only as good as your worst assumption • Know the economics in your market • Admit what you don’t know • Adapt • Timing is everything University of Hawaii Business Plan Competition Help Session

20. RELATIONSHIPS AMONG THE FINANCIAL STATEMENTS University of Hawaii Business Plan Competition Help Session

21. Question Answer Financial Statement 1. 2. 3. 4. University of Hawaii Business Plan Competition Help Session

22. University of Hawaii Business Plan Competition Help Session

23. THE ACCOUNTING EQUATION • The accounting equation presents the resources of the business and the claims to those resources Economic Resources = Claims to Economic Resources or Assets = Liabilities + Owners’ Equity University of Hawaii Business Plan Competition Help Session

24. ACCOUNTING FOR BUSINESS TRANSACTIONS • The table on the next slide summarizes the 11 transactions and provides the data that Air & Sea Travel used to create its financial statements • Data for the statement of cash flows are aligned under the Cash account • Income statement data appear as revenues and expenses under Retained Earnings • The balance sheet data are composed of the ending balances of the assets, liabilities, and stockholders’ equities • The statement of retained earnings, which shows net income (loss) and dividends, can be prepared from the Retained Earnings column University of Hawaii Business Plan Competition Help Session

25. ANALYSIS OF TRANSACTONS Income Statement Data Statement of Retained Earnings Data University of Hawaii Business Plan Competition Help Session

26. + Common Stock + Retained Earnings - Dividends + Revenues - Expenses The accounting equation can be expanded to include revenues and expenses Liabilities Assets + = Stockholders’ Equity University of Hawaii Business Plan Competition Help Session

27. Payments to suppliers Collections from customers Operating Activities Payments to employees Receipts of interest and dividends on investments Payments of interest and income tax Other operating receipts Other operating disbursements Acquisition of plant assets Sale of plant assets Investing Activities Purchase of investments that are not cash equivalents Sale of investments that are not cash equivalents Making loans Receipts on loans receivable Payment of dividends Issuing stock Financing Activities Purchase of treasury stock Selling treasury stock Payment of principal amounts of debts Borrowing money University of Hawaii Business Plan Competition Help Session

28. Converting from the Accrual Basis to the Cash Basis for the Statement of Cash Flows Adjust Revenues to Cash Receipts Revenues Cash Flows from Operating Activities Net Income Adjust Expenses to Cash Payments Expenses Accrual-Basis Accounting Cash-Basis Accounting The direct method is easier to understand, and it provides more information for decision making University of Hawaii Business Plan Competition Help Session

29. Financial Management for Entrepreneurs Cost-Volume-Profit Analysis: A Managerial Planning Tool (Break Even) University of Hawaii Business Plan Competition Help Session

30. Sample Questions Raised and Answered by CVP Analysis 1. How many units must be sold (or how much sales revenue must be generated) in order to break even? 2. How many units must be sold to earn a before-tax profit equal to a specific dollar amount? A before-tax profit equal to 15 percent of revenues? An after-tax profit of a specific dollar amount? 3. Will total profits increase if the unit price is increased and units sold decrease? University of Hawaii Business Plan Competition Help Session

31. Sample Questions Raised and Answered by CVP Analysis (continued) 4. What is the effect on total profit if fixed costs increase and sales increase by specific amounts? 5. What is the effect on total profit if the selling price per unit is decreased and sales increase? 6. What is the effect on total profit if the sales mix is changed? University of Hawaii Business Plan Competition Help Session

32. Cost Behavior Fixed-Cost Behavior Variable-Cost Behavior $ $ Relevant Range Units Produced Units Produced University of Hawaii Business Plan Competition Help Session

33. Mixed-Cost Behavior Linearity Assumption Total Costs Cost Fixed Costs Variable Costs Number of Units Produced Total cost = Fixed cost + Total variable cost University of Hawaii Business Plan Competition Help Session

34. Cost-Volume-Profit Graph Total Revenue Revenue Profit Total Cost Y X = Break-even point in units Y = Break-even point in revenue Loss X Units sold University of Hawaii Business Plan Competition Help Session

35. Simple CVP Example Fixed costs (F) = $40,000 Selling price per unit (P) = $10 Variable cost per unit (V) = $6 Tax rate = 40% 1. What is the break-even point in units? 2. What is the break-even point in dollars? University of Hawaii Business Plan Competition Help Session

36. Simple CVP Example: BEP 1. Let X = break-even point in units Operating income = Sales revenue -Variable expenses - Fixed expenses 0 = $10X -$6X - $40,000 $10X - $6X = $40,000 $4X = $40,000 X = 10,000 units 2. Break-even point in sales dollars is: 10,000 x $10 or $100,000 This can be shown with a variable-costing income statement. University of Hawaii Business Plan Competition Help Session

37. Variable-Costing Income Statement Sales (10,000 x $10) $100,000 Less: Variable costs (10,000 x $6) 60,000 Contribution margin $ 40,000 Less: Fixed costs 40,000 Profit before taxes 0 Less: Income taxes 0 Profit after taxes $ 0 ===== University of Hawaii Business Plan Competition Help Session

38. Sales Revenue Approach Alternative approach to solving break-even point in sales dollars: Let X equal break-even sales in dollars Operating income = Sales revenue - Variable expenses - Fixed expenses 0 = X - 0.6X - $40,000 X - 0.6X = $40,000 0.4X = $40,000 X = $100,000 Note: V is the variable cost percentage which is found by: Variable Cost per Unit 6 Selling Price per Unit 10 = 0.6 University of Hawaii Business Plan Competition Help Session

39. CVP Example: Targeted Pretax Income What sales in units and dollars are needed to obtain a targeted profit before taxes of $20,000? Let X = break-even point in units Sales $ = $10X Less: Variable costs = 6X Contribution margin $60,000 = $ 4X Less: Fixed costs 40,000 Profit before taxes $20,000 ==== Therefore, $60,000 = $4X 15,000 units = X Sales in dollars is (15,000 x $10) = $150,000. Check this by completing the variable-costing income statement. University of Hawaii Business Plan Competition Help Session

40. CVP Example: Targeted Pretax Income (continued) Sales $150,000 = 15,000 x $10 Less: Variable costs 90,000 = 15,000 x $6 Contribution margin $ 60,000 Less: Fixed costs 40,000 Profit before taxes $ 20,000 ======= Therefore, it checks! University of Hawaii Business Plan Competition Help Session

41. 2 Helpful Websites • Free: Berkeley Business Plan Competition (Workshops - 2002) http://bplan.berkeley.edu/ • Palo Alto Software Business Plan Pro www.paloalto.com University of Hawaii Business Plan Competition Help Session

42. Financial Management for Entrepreneurs Q & A University of Hawaii Business Plan Competition Help Session