business planning - keys to success - chase morrison

Business PlanningKey to Success Workshop

Presented by Chase Morrison, PartnerB2B CFO®

Prepared ForNorth Valley Regional Chamber of Commerce

[email protected] | 818.436.0781 | www.chasemorrisoncfo.com

Workshop Objectives

• Attendees will:– Gain a better appreciation for financial information that

will help you understand your business– Be able to more proactively manage cash – Better understand the pros and cons of different funding

options– Learn how to get more value from their accounting

reports– Know how to get started on a three-year business plan– Improve decision making skills


Agenda

• Workshop objectives• Overview of financial statements– Profit & Loss (P&L)– Balance Sheet– Cash Flow Statement

• Discussion of Financial Ratios• Review how the financial statements relate to one another• Step by step plan to generate a three-year plan• Discuss how to use your plan– Make decisions about debt (or business loans)– Develop method of evaluating investments– Review options for growing your business


Financial Statements

• The Onion Analogy– Sliced into thirds – Profit & Loss, Balance Sheet and Cash Flow– Each financial statement represents a different aspect of the whole– Each third contains layers– Onion quality is dependent on all three sections– Generally, the larger the business the greater the interest in “peeling off each

layer” to better understand the business– This workshop only focuses on the top layers

Balance Sheet

Profit & Loss

Cash Flow


Valley Professional Services

• Specifics regarding the business used through the workshop:– Business is a sole proprietorship– To date, business has been funded by owner– Cash basis accounting (vs. accrual)– Been in business for three years– Owner plus two employees– No inventory– Owner is using QuickBooks to track revenue & expenses


Balance SheetYE 2012

ASSETSCurrent Assets

Cash 105,463Accounts Receivable 35,810Other Current Assets 7,647

Total Current Assets 148,920Fixed Assets 12,025

TOTAL ASSETS 160,945

LIABILITIES & EQUITYCurrent Liabilities

Accounts Payable 2,579Total Credit Cards 1,474Other Current Liabilities 6,087

Total Current Liabilities 10,140Long Term Liabilities

Loans (Debt) 29,213Total Long Term Liabilities 29,213

Total Liabilities 39,353EquityOwner's Equity 146,970Retained Earnings -25,378Total Equity 121,592TOTAL LIABILITIES & EQUITY 160,945

What can you quickly determine from the balance sheet? (Note: Assets = Liab. + Equity)

• What the company owns – Assets• Of total assets, how much is owned by

others outside the company – Liabilities• Of total assets, how much is owned by the

stakeholders – Total Equity

What are some important question you might want to immediately ask?

•Is the company solvent?• Is there sufficient liquidity (cash) to pay

near-term bills?•What do the assets consist of?


Balance Sheet -- Assets

YE 2012ASSETS

Current AssetsCash 105,463Accounts Receivable 35,810Other Current Assets 7,647

Total Current Assets 148,920Fixed Assets 12,025

TOTAL ASSETS 160,945

Understanding assets

• Assets represent things that have value extending into the future.• The value of assets represent what the

company could be liquidated for as of the statement date.• If an asset cannot be liquidated for the

recorded value, then it is considered impaired• Typically assets are listed in order of liquidity

(cash, accts receivable, inventory, etc.)

Important considerations:

• How efficiently are assets being put to use• Asset utilization will impact the level of

require profitability.

Assets Current and Long Term

Source of assets

Cash Cash is King!Accts Receivable InvoicingInventory Made or boughtFixed Assets Book valueOther LT Assets Various


Balance Sheet -- Liabilities


Accounts Payable 2,579Total Credit Cards 1,474Other Current Liabilities 6,087

Total Current Liabilities 10,140Long Term Liabilities

Loans (Debt) 29,213Total Long Term Liabilities 29,213

Total Liabilities 39,353

Liabilities Current and Long Term

Understanding liabilities

• Liabilities represent money that the company owes to others and thus represent claims on assets.• Again, categories are separated into those

that are due with 12 months—current—and those beyond 12 months—long term.• Liabilities are listed relative to when

payment is due, with nearest due toward the top of the list.• Includes loans and/or debt as component of

long term liabilities.


• Liabilities should be posted to your accounting system to assess book value.• Liabilities present opportunity to leverage

other people’s money.

Source of liabilities

Accts Payable Vendor invoicesCredit Cards CC statementsOther Current Mostly payrollLoans/Debt Borrowed cash


Balance Sheet – Owner’s Equity

LIABILITIES & EQUITYEquityOwner's Equity 146,970Retained Earnings -25,378Total Equity 121,592TOTAL LIABILITIES & EQUITY 160,945

Equity Equity and Retained Earnings (or Deficit)

Understanding equity

• Equity represents how much of the business the owner’s actually own, after creditors have been accounted for.• Equity is short hand for book value to the

owners.• Includes retained earnings or deficit (as in

our example).


• Book value does not necessarily equal what the business could be sold for.• Note that total liabilities and owner’s equity

equal total assets• Think of assets as things and liabilities and

equity as people. So the balance sheet in essence connects things to people.

Source of Equity

Owner’s Equity Owner’s investment

Retained Earnings Accumulated net income or loss


Profit & Loss Statement

Ordinary Income/Expense YE 2012

Total Income 98,610 Cost of Goods Sold 7,561

Gross Profit 91,049

Operating ExpensePayroll Expense 145,243 Automobile Expense 1,665 Other Expenses 1,053 Insurance 2,335 Job Expenses 3,850 Professional Fees 375 Other Supplies 1,143 Rent & Utilities 5,146 Repairs 120 Interest Expense 1,269

Total Operating Expense 162,199

Operating Income/(Loss) (71,150) Interest Income 854

Net Income/(Loss) (70,297)

RevenueOperating IncomeNet Income

Understanding profit and loss statement

• Determines if, after associating all invoice for services with expenses from same period, the is business making money from those services (1st half of promise to pay)• Cost of goods sold is expense activity that is

directly related to revenue activity.• Operating expenses tend to be more fixed in

nature• On accrual basis, net income does not

represent cash, more a promise of cash.


• Accrual basis accounting matches expenses to related revenue activities and is a more effective mgmt tool than cash basis acctng.• Operating or ordinary income reflects

profitability of business core activities• Other income and expense are related to

none core business activities.


Cash Flow (Cash is King!)

Understanding statement of cash flows

• Reflects actual money moving in and out business for various purposes (2nd part of promise to pay – actual payment)• Categorizes inflow and outflow of cash into 3

activities—operating, investing & financing• Operating activities – directly related to

revenue generation.• Investing activities – purchase of fixed assets,

depreciation and other activities in support of business• Financing activities – pertains to securing and

servicing debt used in the business


• Each activity reveals important aspects of company performance. • Ending cash = beginning cash + cash change

OperatingInvestingFinancial

STATEMENT OF CASH FLOWS YE 2012

Net Income/(Loss) 12,148

Operating ActivitiesChange in Accounts Receivable (114,727)Change in Prepaid (2,120)Change in Inventory (4,773)Change in Payables 2,266Change in Payroll Liabilities 5,520

Net cash provided by Operating Activities (113,834)

Investing ActivitiesChange in Accumulated Depreciation 575

Net cash provided by Investing Activities 575

Financing ActivitiesChange in Bank of Anycity Loan 19,933Change in Other Loans (3,442)Opening Equity Balance (67,601)Owner's Equity Draw (5,000)Retained Earnings 43,955

Net cash provide by Financing Activities (12,155)

Net cash increase/(decrease) for period (113,266)

Cash at beginning of period 218,839Cash at end of period 105,573


Putting it all back together

Summarizes actual

payments from customers and

made to vendors

Summarizes commitments to pay

company (revenue) and company’s commitments to pay others (expenses)

Connections between the

company’s assets and the claims on

those assets by vendors, lenders

and owners


The big picture1

Cash 57,908 Cash Change (38,316) Cash 19,592 Accounts Receivable 34,521 Sales 181,000 Collections (OCF) 141,137 Accounts Receivable 74,384 Inventory - Cost of Goods 7,600 Inventory Paid (OCF) (7,600) Inventory - Prepayments 5,500 Prepayments (OCF) - Prepayments 5,500 Gross Fixed Assets 25,000 Fixed Asset Investment (ICF) - Gross Fixed Assets 25,000 Accumulted Depreciation 5,000 Depreciation 5,000 Accumulted Depreciation 10,000 Net Fixed Assets 20,000 Net Fixed Assets 15,000 Total Assets 117,928 Total Assets 114,475 Accounts Payable 9,250 Operating Expenses 160,112 Expenses Paid (OCF) (165,309) Accounts Payable 4,053 Debt 21,000 Borrow/(Pay Back) (FCF) (4,000) Debt 17,000 Other Operating Liabilities 9,208 Interest & Other Expenses 1,269 Interest & Other Paid (OCF) 1,606 Other Operating Liabilities 12,083 Income Tax Due - Income Tax Expense - Income Tax Paid (OCF) - Income Tax Due - Non Operating Liabilities - Non Operating Inc & Expense (850) Non Operating Exp Paid (FCF) 850 Non Operating Liabilities - Owner's Equity 180,000 Owner Paid In/(Draw) (FCF) (5,000) 175,000 Retained Earnings (101,530) Net Income 7,869 Dividend & Other (FCF) 0 Retained Earnings (93,661) Total Liabilities & Equipty 117,928 Total Liabilities & Equipty 114,475

Return on Avg Assets 6.8% Operating Cash Flow (30,166)

Beginning Balance Sheet (12/31/2011) Income Statement Cash Statement Ending Balance Sheet (12/31/2012)

• Note that all three financial statements are related• This format would help you analyze why cash is going up or down over a given period• Basic formula is beginning balance +/- P&L, +/- cash flow equals ending balance sheet• For example starting A/R + sales – collections = ending A/R balance

1 Cash flow statement format sourced from Managing by the Numbers, Chuck Kremer, Ron Rizzuto, et al.


Basic Financial Ratios and Metrics

At 32,000 feet what should our objectives be?

- Need to deliver consistent net incomeProof of a successful business modelReflects costs are being managed

- Positive operating cash flow (OCF)Shows that there is cash to pay the billsAlso demonstrates potential ability to pay the owners

- Need to have reliable return on assets (ROA)Return needs to be competitive vs. other investmentsAbility to attract investors and/or lenders


Ratios for Profitability

P&L ratios are generally a function of revenue

Gross Margin Gross Profit / Revenue(GP = Revenue - Cost of Goods)Not as useful for service businesses

Operating Margin Operating Profit / Revenue(OP = Gross Profit - Operating Exp.)Very relevant to our service business. Effectively shows the profitability of the business’ primary activities

Return on Sales Net Income / Revenue(Operating Profit - Other Inc/Exp)Final income or profit figure, typically after taxes


Trended Profit Ratios

PROFIT AND LOSS STATEMENT YE 2010 YE 2011 YE 2012

Total Income or Sales 125,000 145,000 181,000 Cost of Goods Sold 1,500 3,500 7,600

Gross Profit 123,500 141,500 173,400 Gross Margin % (Gross Profit / Sales) 98.8% 97.6% 95.8%Operating Expense

Payroll Expense 115,000 130,000 145,000 Automobile Expense 500 1,750 1,665 Other Expenses 150 500 478 Insurance 2,000 2,150 2,335 Job Expenses 800 4,000 3,850 Professional Fees - 250 375 Depreciation 5,000 5,000 5,000 Other Supplies 750 2,000 1,143 Rent & Utilities 3,500 4,500 5,146 Repairs - - 120 Interest Expense 2,000 1,680 1,269

Total Operating Expense 129,700 151,830 166,381 Operating Income/(Loss) (6,200) (10,330) 7,019 Operating Margin (Operating Income / Sales) -5.0% -7.1% 3.9%

Interest Income - 500 850 Net Income/(Loss) (6,200) (9,830) 7,869 Return on Sales (Net Income / Sales) -5.0% -6.8% 4.3%


Return on Assets (ROA)

Return on Assets = Net Income / Total Assets

Owner’sStake

(Equity)

LendersVendorsOthers

(Liabilities)

CashInventoryAccts Rec.Equipment

(Assets)

$

$

What is ROA telling us?

Return on assets is effectively the % return on all money invested by both the stakeholders and others that the business uses as a resource to generate revenue.

As an investor, would you purchase a bond from GE for 5% or in our landscape service business?

Risk vs. Return

$

How can Von’s successfully operate with “razor thin” margins, while a pharmaceutical company requires massive profits?

Net Income

=ROA%


Trended Balance Sheet

ASSETS YE 2010 YE 2011 YE 2012Current Assets

Cash 131,239 115,992 119,968 Accounts Receivable 61,644 63,562 59,507 Prepaids 4,500 5,500 5,500 inventory - - -

Total Current Assets 197,383 185,053 184,975 Fixed Assets 25,000 20,000 15,000

TOTAL ASSETS 222,383 205,053 199,975


Accounts Payable 3,000 7,000 2,579 Total Credit Cards 1,000 2,250 1,474 Payroll Liabilities 9,583 10,833 12,083

Total Current Liabilities 13,583 20,083 16,136 Long Term Liabilities

Loans (Debt) 25,000 21,000 17,000 Total Long Term Liabilities 25,000 21,000 17,000

Total Liabilities 38,583 41,083 33,136 Equity

Starting Balance 200,000 190,000 180,000 Owner's Draw (10,000) (10,000) (5,000)

Owner's Equity 190,000 180,000 175,000 Retained Earnings (6,200) (16,030) (8,161) Total Equity 183,800 163,970 166,839 TOTAL LIABILITIES & EQUITY 222,383 205,053 199,975

Return on Assets:

2010 2011 2012Net Inc* (6,200) (9,830) 7,869Assets 222,383 203,053 199,975ROA (2.8%) (4.8%) 3.9%


Cash Flow Metrics

STATEMENT OF CASH FLOWS YE 2010 YE 2011 YE 2012

Net Income/(Loss) (6,200) (9,830) 7,869

Operating ActivitiesChange in Accounts Receivable (61,644) (1,918) 4,055 Change in Prepaid (4,500) (1,000) - Change in Inventory - - - Change in Payables 4,000 5,250 (5,197) Change in Payroll Liabilities 9,583 1,250 1,250

Net cash provided by Operating Activities (58,761) (6,248) 7,977

Investing ActivitiesChange in Fixed Assets (25,000) 5,000 5,000

Net cash provided by Investing Activities (25,000) 5,000 5,000

Financing ActivitiesChange in Bank of Anycity Loan 25,000 (4,000) (4,000) Change in Other Loans - - - Opening Equity Balance - - - Change in Owner's Equity (10,000) (10,000) (5,000) Retained Earnings - - -

Net cash provide by Financing Activities 15,000 (14,000) (9,000)

Net cash increase/(decrease) for period (68,761) (15,248) 3,977

•Should look at cash flow over time•Primary focus is operating cash flow

Four key cash flow metrics you should evaluate:

1. Is OCF positive? If not you need to quickly determine why.

2. Is OCF greater than net profit (or income)? It should be if you are depreciating fixed assets.

3. Is OCF greater than fixed asset investment? If it is, then company can self fund fixed assets.

4. If OCF trending in the same direction as net profit? If profit is going up, but OCF is going down, you may have a problem.


Summarizing our key metrics

Key Performance Measures (The Big Three)2010 2011 2012

Return on Sales (5.0%) (6.8%) 4.3%Return on Assets (2.8%) (4.8%) 3.9%Operating Cash Flow ($58,761) ($6,248) $7,977

Other Important P&L Measures

Sales $125,000 $145,000 $181,000Operating Margin (5.0%) (7.1%) 3.9%

Other Important Asset Utilization Measures

Sales/average assets 1.12 0.68 0.89Receivables days 180 160 120Net Inc/Avg Fixed Assets (49.6%) (43.7%) 45.0%

Receivables days = the number of days of receivables on balance sheet, based on Sales Receivables days = Receivables $s / (Sales / 365 days) = 59,507 / ($181,000/365) = 120 days[This means we have approximately 4 months of unpaid receivables on balance sheet]


Generating a three year plan

Where to start

• Generate summary of key performance measures for your business

• Analyze historical trends for potential issues (what are our example company’s issues?)

• Spend significant amount of time forecasting and validating revenue

•Make decisions on entering new market, adding a new service

•Will contemplated changes require adding fixed assets, headcount, etc.?


Profit & Loss Statement

PROFIT AND LOSS STATEMENT YE 2010 YE 2011 YE 2012 YE 2013 YE 2014 YE 2014 CAGR*

Total Income or Sales 125,000 145,000 181,000 190,000 205,000 220,000 6.7%Cost of Goods Sold 1,500 3,500 7,600 7,500 7,500 8,500 3.8%

Gross Profit 123,500 141,500 173,400 182,500 197,500 211,500 6.8%Gross Margin % (Gross Profit / Sales) 98.8% 97.6% 95.8% 96.1% 96.3% 96.1%Operating Expense

Payroll Expense 115,000 130,000 145,000 148,000 155,000 165,000 4.4%Automobile Expense 500 1,750 1,665 2,000 2,500 2,500 14.5%Other Expenses 150 500 478 500 650 700 13.6%Insurance 2,000 2,150 2,335 3,000 4,000 4,500 24.4%Job Expenses 800 4,000 3,850 7,000 7,500 9,000 32.7%Professional Fees - 250 375 500 750 900 33.9%Depreciation 5,000 5,000 5,000 5,000 5,000 4,000 -7.2%Other Supplies 750 2,000 1,143 1,500 1,500 1,750 15.3%Rent & Utilities 3,500 4,500 5,146 5,500 5,500 6,500 8.1%Repairs - - 120 250 300 300 35.7%Interest Expense 2,000 1,680 1,269 1,160 960 2,480 25.0%

Total Operating Expense 129,700 151,830 166,381 174,410 183,660 197,630 5.9%Operating Income/(Loss) (6,200) (10,330) 7,019 8,090 13,840 13,870 25.5%Operating Margin (Operating Income / Sales) -5.0% -7.1% 3.9% 4.3% 6.8% 6.3%

Interest Income - 500 850 500 500 500 -16.2%Net Income/(Loss) (6,200) (9,830) 7,869 8,590 14,340 14,370 22.2%Return on Sales (Net Income / Sales) -5.0% -6.8% 4.3% 4.5% 7.0% 6.5%

* CAGR = Compound annual growth rateMaintain expense growth rate a less than or equal to revenue growth


Cash Flow

STATEMENT OF CASH FLOWS YE 2010 YE 2011 YE 2012 YE 2013 YE 2014 YE 2014

Net Income/(Loss) (6,200) (9,830) 7,869 8,590 14,340 14,370

Operating ActivitiesChange in Accounts Receivable (61,644) (1,918) 4,055 2,247 (4,521) (4,521) Change in Prepaid (4,500) (1,000) - (1,500) - (2,000) Change in Inventory - - - - - - Change in Payables 4,000 5,250 (5,197) - - - Change in Payroll Liabilities 9,583 1,250 1,250 250 583 833

Net cash provided by Operating Activities (58,761) (6,248) 7,977 9,587 10,403 8,683

Investing ActivitiesChange in Fixed Assets (25,000) 5,000 5,000 5,000 5,000 (17,000)

Net cash provided by Investing Activities (25,000) 5,000 5,000 5,000 5,000 (17,000)

Financing ActivitiesChange in Bank of Anycity Loan 25,000 (4,000) (4,000) (2,500) (2,500) 19,000 Change in Other Loans - - - - - - Opening Equity Balance - - - - - - Change in Owner's Equity (10,000) (10,000) (5,000) (5,000) (5,000) (5,000) Retained Earnings - - - - - -

Net cash provide by Financing Activities 15,000 (14,000) (9,000) (7,500) (7,500) 14,000

Net cash increase/(decrease) for period (68,761) (15,248) 3,977 7,087 7,903 5,683

Cash at beginning of period 200,000 131,239 115,992 119,968 127,055 134,958 Cash at end of period 131,239 115,992 119,968 127,055 134,958 140,640


Balance Sheet

ASSETS YE 2010 YE 2011 YE 2012 YE 2013 YE 2014 YE 2014Current Assets

Cash 131,239 115,992 119,968 127,055 134,958 140,640 Accounts Receivable 61,644 63,562 59,507 57,260 61,781 66,301 Prepaids 4,500 5,500 5,500 7,000 7,000 9,000 inventory - - - - - -

Total Current Assets 197,383 185,053 184,975 191,315 203,738 215,942 Fixed Assets 25,000 20,000 15,000 10,000 5,000 22,000

TOTAL ASSETS 222,383 205,053 199,975 201,315 208,738 237,942


Accounts Payable 3,000 7,000 2,579 2,579 2,579 2,579 Total Credit Cards 1,000 2,250 1,474 1,474 1,474 1,474 Payroll Liabilities 9,583 10,833 12,083 12,333 12,917 13,750

Total Current Liabilities 13,583 20,083 16,136 16,386 16,969 17,803 Long Term Liabilities

Loans (Debt) 25,000 21,000 17,000 14,500 12,000 31,000 Total Long Term Liabilities 25,000 21,000 17,000 14,500 12,000 31,000

Total Liabilities 38,583 41,083 33,136 30,886 28,969 48,803 Equity

Starting Balance 200,000 190,000 180,000 175,000 170,000 165,000 Owner's Draw (10,000) (10,000) (5,000) (5,000) (5,000) (5,000)

Owner's Equity 190,000 180,000 175,000 170,000 165,000 160,000 Retained Earnings (6,200) (16,030) (8,161) 429 14,769 29,139 Total Equity 183,800 163,970 166,839 170,429 179,769 189,139 TOTAL LIABILITIES & EQUITY 222,383 205,053 199,975 201,315 208,738 237,942


Key Performance Measures Trending

YE 2010 YE 2011 YE 2012 YE 2013 YE 2014 YE 2015 CAGRKey Performance Measures (The Big ThreeReturn on Sales -5.0% -6.8% 4.3% 4.5% 7.0% 6.5% 14.5%Return on Assets -2.8% -4.8% 3.9% 4.3% 6.9% 6.0% 15.3%Operating Cash Flow ($58,761) ($6,248) $7,977 $9,587 $10,403 $8,683 2.9%

Other Important P&L MeasuresTotal Sales $125,000 $145,000 $181,000 $190,000 $205,000 $220,000 6.7%Operating Margin -5.0% -7.1% 3.9% 4.3% 6.8% 6.3% 17.6%

Other Important Asset UtilizationSales/average assets 1.12 0.68 0.89 0.95 1.00 0.99 3.3%Receivable days 180 160 120 110 110 110 -2.9%Net Income/Average Fixed Assets -49.6% -43.7% 45.0% 68.7% 191.2% 106.4% 33.3%

-10.0%-8.0%-6.0%-4.0%-2.0%0.0%2.0%4.0%6.0%8.0%10.0%

$0

$50,000

$100,000

$150,000

$200,000

$250,000

2010 2011 2012 2013 2014 2015

Sales Return on Sales

020406080100120140160180200

($70,000)

($60,000)

($50,000)

($40,000)

($30,000)

($20,000)

($10,000)

$0

$10,000

$20,000

2010 2011 2012 2013 2014 2015

Operating Cash Flow Receivable Days

-10.0%-8.0%-6.0%-4.0%-2.0%0.0%2.0%4.0%6.0%8.0%10.0%

180,000

190,000

200,000

210,000

220,000

230,000

240,000

250,000

2010 2011 2012 2013 2014 2015

Assets ROA

business planning - keys to success - chase morrison

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