The Power of Numbers

1. The Power of Numbers Chapter 10

2. …the cheApest money you can find is already in your business – manage assets Chapter 10

3. Financial Management System • Budgeting • The Business Plan expressed in dollars • Forecasting tool • Break-Even Point • Reporting – Income Statement, Balance Sheet, Cash Flow • Preparation • Presentation • Decision Making • Record Keeping – Accounting • Funds coming in • How money is spent • Limitations Chapter 10

4. Get Advice • If finance is not your strength, you do not have to do it yourself. • Network to find people who can provide financial help. • Make a list of possible financial advisors (Table 10.1) • a mentor • a business guru—how about a banker, real estate broker or a retired business person • a financial advisor or business broker • personal financial coach • Assemble a financial team (Action Step 46). Chapter 10

5. Record Keeping - Accounting Accounting is the central activity in economic life Collection and representation of all economic activity of the business/organization Measures Managerial effectiveness not behaviour/effort Strong bias towards results instead of inputs Principal Tool is the General Ledger – breaks financial activity into various components of income and expenses Managerial vs Financial Summaries drawn from Recording results of day-to-day accounting records Used to report to the outside Used to report within Chapter 10

6. General Leger Chapter 10

7. Chapter 10

8. Accounting – Centres of Control Assumes you can measure results – sales, Cost Centres– maximize output given a certain input (budget) OR minimize input to achieve a given output (target) What is the greatest risk? Profit Centres– maximize profits by adjusting the input mix, output quantity and price - measured by the difference between actual and budgeted profit What is the greatest risk? Investment Centres– allocate given funds to specific projects and measure ROI (profit relative to asset base) What is the greatest risk? Chapter 10

9. Reporting – Income Statement Also known as a Profit and Loss Statement Measures costs/expenses against revenues over a defined period of time: First Quarter, Period ending December 31, 2001 etc. Shows net profit or loss of the business for the entire period – a picture of the results during the accounting period Main Components: Sales– all revenue Cost of Sales– total price paid for inventory, mfg of products during that time Business Expenses– direct and indirect expenses related to running the Business Chapter 10

10. Income Statement • A projected or pro forma income statement is: • An itemized statement of sales (or revenues) and corresponding expenses over a period of time. • Normally an income statement is for a one year period (sometimes on a quarterly or even monthly basis) • Major elements of an income statement include: • sales - cost of goods sold • gross profit - operating expenses • other expenses - net profit Remember: Profit is necessarily not cash. • Action Step 49 will help you project your own income statement. Chapter 10

11. Income Statement Sales Revenue – operating revenue :- the benefits from the sales of the product or service non-operating revenue : non-operations related items (interest, sales of assets) Cost of Goods Sold (Sales) - inventory cost associated with a particular sale (raw materials, certain processing costs) beginning inventory + purchases – ending inventory = COGS Operating Expenses - costs incurred by firm in its operations (rent, payroll, utilities, sales taxes,advertising depreciation expense) Net Income (Loss) = Sales Revenue - COGS (Gross Profit) – Operating / Other Expenses (before taxes) Chapter 10

12. Income Statement Sample – Discovery Books (pg 256) – Pro-forma Table 10.8 Sales Direct (cash) Retail Internet Cost of Goods Sold Royalties Expenses Salaries Payroll Taxes Depreciation on “equipment” Workers Compensation Health Insurance Advertising Office Supplies Rent Utilities Bad debts Travel Miscellaneous Interest Taxes Gross Profit = Sales-COGS Net Profit “Bottom Line” Chapter 10

13. Key Income Statement Ratios • Income statement ratios help to determine how healthy your business is and how it compares to other businesses in your selected industry. Chapter 10

14. Key Income Statement Ratios Four key income statement ratios are: • Gross profit margin = Gross Profit / Total Sales • Profit margin = Net Profit / Total Sales • Return on Investment (ROI) = net profit / total assets • Return on owner investment = net profit / owners’ equity Chapter 10

15. The Ending Balance Sheet and Key Ratios • The closing balance sheet provides a final indicator of the financial health of your business • An example of a typical closing balance is shown in Table 10.10. Chapter 10

16. Assumptions to Financial Reports • An explanation of the figures in your “projections” • Accuracy is critical to financial projections • Based on market research, industry specific information (Robert Morris Associates Annual Statement Studies, Financial Research Associates) • Projections will only be as accurate as the information you base them upon • Some plans include best case / worst case scenarios Chapter 10

17. Break-Even Analysis • A break-even level of sales occurs when the sales (revenues) equals total expenses or costs (fixed and variable). • To calculate break-even you will have to know the value of your fixed and variable costs and your output capacity. Chapter 10

18. Break-Even Analysis • Two ways to calculate break-even are: • unit method. • revenue method. • For many businesses the projected break-even is the first step in establishing its viability. Chapter 10

19. Break-even Chart • Break-even (target profit) pricing:setting price to break even (or make a target profit) on the total costs of making and marketing a product • Break-even equals fixed cost divided by (price minus variable cost) • Used primarily when judging feasibility of a marketing action Figure 12.6 • Example (a): • B/E = $300,000/($20 - $10) • B/E = 30,000 units • Example (b): • B/E = ($300,000 + $75,000 profit)/($20 - $10) • B/E = 37,500 units Chapter 10

20. Impact on Reporting • What if…… • In the beginning of January the business purchased two new desk top computers and printers (capital) for $10,000 plus $700 GST. • How would this be shown in the January General Ledger? • How would this be shown on the January Income Statement? • How would this be represented on the January Balance Sheet? Chapter 10

21. Impact on Reporting • What if…… • In the beginning of January the business borrowed $6,000 for three months (1.5% / month) to bridge finance the computer purchase. • How would this be shown in the January General Ledger? • How would this be shown on the January Income Statement? • How would this be represented on the January Balance Sheet? Chapter 10

22. Plotting Your Future Checklist • Do you have a financial vision? • What are your estimated start-up costs? • Validate your sales forecast. • Identify all your cost and pricing assumptions. • Prepare an opening balance sheet. • Prepare a monthly cash flow. • What is your fallback position if your sales forecast and cash flow do not reach expectations? • Prepare a projected income statement and closing balance sheet. • What concerns might a banker have? What would be your response? • Is your break-even within range of your minimum sales forecast? • How do your financial ratios compare to industry averages? Chapter 10

23. Financing A Business Case Studies Case Study 1: Your Business • If you are ready with the financial information for your business, prepare: • An opening balance sheet. • A projected monthly cash flow for the first year of operation. • A projected income statement for the first year. • An ending balance sheet after the first year of operation. Chapter 10

24. Show me the money…… Chapter 10

25. Arranging Finances • Personal Funds 66% of Start-ups • Savings, cash investments, RRSP • Car • Credit cards, mortgaging property • “Love Money”12% of new business start-up • Family, friends, other people • If you decide to borrow from family and friends: • Do not accept more money than your lender can afford to lose • Put everything in writing • Make it a business loan • Include in the loan a provision for repayment • Discuss you company’s goals and any potential problems • Get independent advice Probably your most important and only source Chapter 10

26. Banks(most popular external source) • Term Loan (time bound) • Operating loan – Line of Credit • Government • Federal (Business Improvement, Small Business Loan Act) • Provincial (Ministry of Economic Development and Trade) • Venture Capital • Funds (4 or 5 out of 100 proposals) • “Angels” (less than $50,000) • Communities (matching investors with entrepreneurs) • Province (supported venture capital programs) • Institutions (York University Alumni Club) Chapter 10

27. Arranging Finances • Find Money in Start-up • Suppliers – Inventory Buying Plan • Leasing vs. Buying • Leasehold Improvements • Advance Payment of Customers Chapter 10

28. Financing by Stage of Business Development Table 11.1 Chapter 10

29. Strategies for Seeking Finances Pick the right lending agency Research applications beforehand Don’t go “unannounced” Come prepared Show them you know your field Know exactly how much you want Don’t beg Think before you sign Chapter 10

30. Formal FinancingPrepare to Meet Your Banker • Some strategies • Make your banker part of your team • Try not to surprise your banker • Invite your banker to your business • Respect the banker’s rules • Have an up-to-date plan • Get ready for collateral, personal and spousal guarantees • Understand the banker's discretionary limits Chapter 10

31. Your Credit History • Credit refers to the money loaned or the ability to borrow money. • A lender will need to review your credit history and will probably request a credit report. • Key factors for making a decision about your credit are—in order of importance: • How you pay your bills. • Amount of money you owe and the amount of available credit. • Length of credit history. • Mix of credit. • New credit applications. • What is your credit history? • You’ll need a copy of your credit report—it’s free from three credit • reporting agencies. (See Action Step 50.) Chapter 10

32. Unsecured Credit • Unsecured credit is credit extended to a borrower on the promise to repay the debt with no collateral or guarantee. Chapter 10

33. Unsecured Credit • Before you start your business you are encouraged to determine you how much unsecured credit you have and: • Check out your health and medical insurance needs. • Apply for additional credit cards or increased limits. • Apply for a personal line of credit—which will depend on the four Cs (capital, character, capacity and collateral). • Explore the possibility of a home-equity loan or home-equity line of credit. Chapter 10

34. “Will that be: Debit Or Equity” Chapter 10

35. Will that be Debt or Equity? Equity financing • If you or others invest money in a business and expect, in return, a portion of ownership, this is called equity financing or ownership investment. Debt financing • If you or others lend money to a business and expect to be repaid the full amount plus interest, this is called debt financing. Chapter 10

36. Will that be Debt or Equity? How should you finance the business: debt or equity or some combination? • The trick is to find the right balance between debt and equity—one that will satisfy the needs of • You the owner • The business • The market Chapter 10

37. Major types of debt financing are: Shareholders loans Canada Small Business Financing (CSBF) loans Operating loans (Line of Credit) Term loans Major types of equity financing are: Sole proprietorship or partnership Owner’s personal investment Incorporated business Common shares Preferred shares Convertible debentures Types of Debt and Equity? Chapter 10

38. Plotting Your Future Checklist • What is the total amount of equity you need to establish and operate your business for the first year? Identify all the sources of funds. • Identify your funding shortfall each month from the cash flow, and the funding sources and expected rate of interest. • Are there any government, agency, or foundation funding sources for your venture? • How much, if anything, do you expect from a venture capitalist or angel investor, and what ownership are you prepared to forego? • Who are your prime vendors? What type of purchase agreement do you have with them? • What is your debt-to-equity ratio, and how does that compare to industry ratios? Chapter 10