financial management for entrepreneurs i
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Financial Management for Entrepreneurs I
Business Innovation Competition Workshops
Innovation & Entrepreneurship Institute
Business plan workshops
• Idea Creation and Opportunity Assessment– - February 2
• Matching Products and Services with Markets– February 9
• Competitive Analysis– February 16
• Strategy & Business Model– February 23
• Marketing and Sales Strategies– March 2
• Management & Ownership– March 16
• Financial Projections and Funding Strategies– March 23
• Professional Presentations– March 30
• A successful business organizes natural resources, human resources and sweat into product or service plus profit, – Thus transforming human and natural
capital into financial capital.,
• One goal of business is to generate wealth and stores it as money, as capital, which can then be rented (lent) or invested to help build more wealth…
Alchemy of wealth creation
• Cash is not always cash: There is a difference between the cash needed to run a firm and the capital needed to develop it.
• Operating cash is a lubricant that facilitates the exchange of goods and services. – Successful firms are well lubricated: They cover
operations from revenues.
• Capital is stored energy and is used to build capability. – Capital (from investments and loans) is stored profit from
past ventures. This energy from the past helps firms build more rapidly than would be possible with sweat and profit.
Capital vs cash
• Track the alchemical transformation of labor, land and capital into financial capital.
• Monitor flow of money through a business – as cash and capital.
• Support planning and measure progress.• Support judgments about the coherence of
a business plan.• Help sell business plans to others.
Financial statements & projections
• Use standard formats– With account categories and formats that fit
one’s business
• Support numbers with narrative and notes– Narrative: “After three months of losses, firm A
turns profitable; by the end of year, two, firm A should show steady profits of and settles into profits of 10% per year.”
– Notes: Assumptions, caveats, what-ifs.
• Are checked by professionals– Taxes and acceptability
Transparent financial statements
• Income Statement– Definition: Profit or loss of a business over time– Use: Project & monitor profit & so operating efficiency
• Cash Flow Statement– Definition: Tracks the inflows & outflows of cash– Use: Project & monitor the cash available for operations
& growth
• Balance Sheet– Definition: Snapshot of a firm’s wealth – and how it has
funded that wealth– Use: Project & monitor the growth or decline of a firm’s
value/capital - and so potential
Financial statements
+ Net Revenues
- Cost of Goods Sold
= Gross Profit
- Operating Expenses
= Operating Profit
+/- Other Income/Expenses
= Profit before tax
- Tax
= Profit after tax
Income statement
• Income Statement– Definition: Profit or
loss of a business over time
– Use: Project & monitor profit & so operating efficiency
Income statement
Gross Profit
OperatingProfit
Net Profit
P.A.T.COGS
Op. Exp.
OtherExp. Tax
Revenues
Other Income
Div>CF
R/E>B/S
+ Net Revenues
- Cost of Goods Sold
= Gross Profit
Income statement
• Net Revenues– Sales after discount, less
returns
• Cost of Goods Sold– Direct goods + direct labor per unit sold
• Gross Profit– Amount left to cover operations
• COGS/Sales – Constant or improving as percentage– Perils and pleasures of volume
= Gross Profit
- Operating Expense
= Operating Profit
Income statement
• Operating Expenses– Salaries (benefits, taxes)– Sales & Marketing– General Administration (supplies, IT,
insurance)– Space (rent, maintenance, utilities)– Depreciation (spreading capital
expense over use/ time)– Professional fees
• Operating Profit– Basic measure of success
= Operating Profit
+/- Other Inc or Exp
= Profit before taxes
Income statement
• Other Income– Sidelines (can be very valuable and/or
indicate new businesses or products)– Interest
• Other Expense– Cost of financing, especially interest
on loans– Other miscellaneous expenses
• Profit before Taxes– Net income
= Profit before Taxes
- Income Taxes
= Profit after Taxes
Income statement
• Income Taxes– State and local– Don’t confuse tax management
with management• Profit after Taxes
– Captured wealth– Reinvest (retained earnings) >
B/S– Distribute (dividends) > CF
Account categories that matter
• Revenues– Major lines and/or channels– Other income sources
• COGS– Direct labor, raw materials, subcontracts
• Operating Expenses– Reflect business model: Marketing/Sales, GA– Subdivide important categories; lump together
unimportant ones
• Other Expenses
+ Net Revenues
- Cost of Goods Sold
= Gross Profit
- Operating Expenses
= Operating Profit
+/- Other Income/Expenses
= Profit before tax
- Tax
= Profit after tax
Account categories exercise
• Planning: What categories should matter?
• Analysis: What categories has management chosen – and what do they tell you?
Cash flow projections
• Cash Flow Statement– Definition: Tracks the
inflows & outflows of cash
– Use: Project & monitor the cash available for operations & growth
+ Revenues- Cost of Goods- Operating Expenses (excluding
depreciation)= Cash flow from operations
+ Investment income- Acquisition of space, r&d,
equipment, etc = Cash flow from investment
+ Equity investment+ Loans- Repayments- Dividends / owner withdrawals= Cash flow from financingCash on Hand – End of Period
Three sources of cash
• Operations– Revenue less cash
expenses (ultimately, retained earnings)
• Investments • Financing
– Loans, equity
+ Revenues- Cost of Goods- Operating Expenses (excluding
depreciation)= Cash flow from operations
+ Investment income- Acquisition of space, r&d,
equipment, etc = Cash flow from investment
+ Equity investment+ Loans- Repayments- Dividends / owner withdrawals= Cash flow from financingCash on Hand – End of Period
Three uses of cash
• Operations– Cash necessary to
operate
• Capacity building– Cash necessary to
build the platform
• Pay back– Cash necessary to
pay lenders, investors, owners
+ Revenues- Cost of Goods- Operating Expenses
(excluding depreciation)= Cash flow from operations
+ Investment income- Acquisition of space, r&d,
equipment, etc = Cash flow from investment
+ Equity investment+ Loans- Repayments- Dividends / owner withdrawals= Cash flow from financingCash on Hand – End of Period
Building the cash flow statement
• Inflows– Operating: Adjust revenues for bad debt and timing– Investment: Any sales of hard assets?– Financing: Capital inflows? Loans?
• Outflows– Operating: Inventory purchases– Operating: Operating expenses (without
depreciation), adjusted for timing– Investment: Capital purchases– Financing: Principal repayment, investor
repayment, owner withdrawals
Avoiding the cash wall
• Detailed projections– Routine and extraordinary expenses– Monthly, even weekly (once operating)
• Careful monitoring• Calculate burn rate
– Cash outflow per month
• Play with timing– Delay outflow or accelerate inflow
• Manage expectations• Negotiate
Cash flow projections exercise
• Planning: List one-time and recurring cash inflows and outflows. Juggle the timing to remain cash positive while growing.
• Analysis: Calculate the cash available for to finance investment, new initiatives, etc.
+ Revenues- Cost of Goods- Operating Expenses (excluding
depreciation)= Cash flow from operations
+ Investment income- Acquisition of space, r&d,
equipment, etc = Cash flow from investment
+ Equity investment+ Loans- Repayments- Dividends / owner withdrawals= Cash flow from financingCash on Hand – End of Period
Current AssetsLong-term Assets= Total Assets
Current LiabilitiesLong-term Liabilities= Total Liabilities
Capital InvestmentRetained Earnings= Total Equity
Balance sheet
• Balance Sheet– Definition: Snapshot
of a firm’s wealth – and how it has funded that wealth
– Use: Project & monitor the growth or decline of a firm’s value/ capital - and so potential
A = L + E
• Assets = Wealth = Use of Funds – Cash, loans to customers (A/R), buildings,
equipment, inventory, partnerships– Platform for growth
• Liabilities = LeveragedSource of Funds– Nervous claims on wealth secured by contracts &
collateral such as loans from vendors, banks, other sources, bonds
– Expand possibilities while increasing risk
• Equity = Capital = Invested Source of Funds– More patient claim on wealth secured by control,
especially owners’ capital plus retained profits
Current Assets
Long-term Assets
= Total Assets
Balance sheet
• Current Assets– Cash & similar– Accounts receivable– Inventory
• Long-term Assets– Equipment– Leasehold Improvements– Net of depreciation
Uses of cash
• Payments• Supporting customers by offering terms• Inventory• Investing in capacity: machinery, know-how,
new products, partnerships• Investing in financial instruments
Current Liabilities
Long-term Liabilities
= Total Liabilities
Balance sheet
• Current Liabilities– Accounts payable– Deposits– Line of credit– Current portion of
long-term debt
• Long-term Liabilities– Loans– Bonds
Capital InvestmentRetained Earnings= Total Equity
Balance sheet
• Equity– Capital Investment– Additional Paid-in
Capital– Retained Earnings
Sources of cash
• Initial equity– owners, family, friends
• Other equity: – angels, venture firms, partners, public markets
• Informal loans: – terms from suppliers, customers, landlords, partners
• Traditional loans: – credit cards, banks, leases, bonds
• Revenues• Related business income• Investment income
Matching sources & uses of funds
• Short-term sources of cash to fund short-term needs – A/P <> A/R– Deposits <> inventory
• Long-term sources of cash to fund long-term needs– Loans for hard assets with collateral
• Mortgage <> building• Lease <> equipment
– Investments for softer assets like r&d• Angel <> r&d• Strategic investor <> new product
Matching sources & uses of funds
• Farm Example– Seasonal cash flow – revolving line of credit– Equipment – leases– Buildings - mortgages
• Software Application Example– Personal & angel investment for proof of concept– Stock options (personal investment) for building core
staff– Venture capital for commercialization and marketing
roll out– Short-term loans for equipment– Mid-term loans for leasehold improvements
Current AssetsLong-term Assets= Total Assets
Current LiabilitiesLong-term Liabilities= Total Liabilities
Capital InvestmentRetained Earnings= Total Equity
Balance sheet exercise
• Planning: List necessary assets & timing. Brainstorm possible sources of funds and timing. Match them up.
• Analysis: Are sources and uses of funds well matched?
Tying the statements together
• Income Statement > Balance Sheet– Net income less dividends = additional
retained earnings on B/S
• Incomes Statement > Cash Flow– Direct method: All income (adjusted for timing)
- all expenses (adjusted for timing) + depreciation = operating cash flow
• (Remember other income/expense and taxes)– Interest payments provide clues about the loan
situation
Tying the statements together
• Cash Flow > Balance Sheet– New capital, new loan principal, repaid capital,
repaid loan principal, purchases or sales of equipment
– Dividends (which reduce net income’s contribution to retained earnings)
• Cash Flow > Income Statement– Changes in loans should be reflected in
changes in interest
Tying the statements together
• Balance Sheet > Income Statement– Change in retained earnings = Net income less
dividends
• Balance Sheet > Cash Flow– Indirect method: Changes in balances (eg.,
Accounts receivable, accounts payable, etc) are used to calculate changes in cash
– Similarly with changes in investing (equipment, equity) and financing categories (loans)
• Richard A Brealey and Stewart C. Myers, Principles of Corporate Finance (McGraw-Hill, 1996)
• Corporation for Enterprise Development: Financial Management for Entrepreneurs (1995)
• Craig Fleisher & Babetter E. Bensoussan, Strategic and Competitive Analysis: Methods and Techniques for Analyzing Business Competition (Prentice-Hall, 2003)
• TL Hill lectures, 2002• Nick Rowling, Commodities: How the World Was Taken to Market
(Free Association Books, 1987)• Clyde Stickney & Roman Weil, Financial Accounting: An
Introduction to Concepts, Methods and Uses (Dryden Press/Harcourt Brace College Publishers, 1994)
• G. Straughn & C. Chickadel, Building a Profitable Business (B Adams, 1994)
Bibliography
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