planning to succeed - the definitive eguide for building company financial forecasts mark ostryn...

8/14/2019 Planning to Succeed - The Definitive eGuide for Building Company Financial Forecasts Mark Ostryn DRAFT 180708

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FORECASTING, FINANCING & FAST TRACKING YOUR BUSINESS GROWTH

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© 2008. Knowledge 2020 Pty Ltd. Please do not reproduce without prior permission, which will usually begranted. Contact Mark Ostryn 02 8005 1240 http://www.knowledge2020.com The above text containsgeneric financial information that does not constitute financial advice

TABLE OF CONTENTS

1 INTRODUCTION ......................................................................................................................................... 5

2 STRATEGIC VISION ..................................................................................................................................... 7

2.1 WHYFORECAST................................................................................................................................................ 8 2.2 PROFILE OF SUCCESS........................................................................................................................................... 9 2.3 MAKING FORECASTING EFFECTIVE....................................................................................................................... 11 2.4 UNDERSTANDING CUSTOMERS .................................................................................................................. 12

2.4.1 MARKET SEGMENTATION ...................................................................................................................... 13 2.5 REALISTIC ASSUMPTIONS ........................................................................................................................... 14 2.6 GETTING STARTED WITH YOUR FORECAST.............................................................................................................. 15

3. REVENUES ................................................................................................................................................ 19

3.1 PRODUCTSALES.............................................................................................................................................. 20 3.2 PRICING........................................................................................................................................................ 22 3.3 GEOGRAPHICALEXPANSION ........................................................................................................................... 25 3.4 NEW PRODUCTREVENUES ............................................................................................................................. 26 3.5 BUSINESSSEGMENTS....................................................................................................................................... 27 3.6 ALLIANCES, PARTNERSHIPS, LICENSING AND DISTRIBUTION AGREEMENTS .............................................. 27

3.6.1 Licensing ................................................................................................................................................ 28 3.6.2 STRATEGIC ALLIANCES ........................................................................................................................... 30 3.6.3 DISTRIBUTION CHANNELS ...................................................................................................................... 30

3.7 FRANCHISING ............................................................................................................................................. 31 3.7.1 Being a Franchisor ................................................................................................................................. 31 3.7.2 Being a Franchisee ................................................................................................................................. 33

3.8 PROJECT MANAGEMENT ............................................................................................................................ 33 3.9 CONSULTANCY ........................................................................................................................................... 34 3.10 OTHERINCOME.............................................................................................................................................. 34

3.10.1 Grants & financial Assistance ........................................................................................................... 34 3.10.2 Intellectual Property Income ............................................................................................................ 35

4. COSTS ....................................................................................................................................................... 37

4.1 COST OF SALE................................................................................................................................................. 38 4.1.1 Refunds, Warranties and Guarantees .................................................................................................... 38 4.1.2 Loyalty & Awards Programmes ............................................................................................................. 39

4.2 OPERATING EXPENSES/ OVERHEADS ................................................................................................................ 40 4.2.1 Marketing .............................................................................................................................................. 41



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4.2.2 Information Technology ......................................................................................................................... 46 4.2.3 Employee / Personnel Costs ................................................................................................................... 49 4.2.4 Administrative Costs .............................................................................................................................. 53 4.2.5 Legal Costs ............................................................................................................................................. 54 4.2.6 TAXes ..................................................................................................................................................... 55

5. BALANCE SHEET, WORKING CAPITAL & CAPITAL EXPENDITURE ................................................................. 59

5.1 BUSINESSCHALLENGES – MANAGING YOURCASHFLOW ....................................................................................... 60 5.1.1 Managing Working Capital ........................................................................................................................ 61

5.2 BUSINESS GROWTH – INVESTING INTHEFUTURE ....................................................................................... 66 5.2.1 Manufacturing challenges .................................................................................................................... 67 5.2.2 Research & DeveloPment challenges .................................................................................................... 68

5.3 LIMITS TO GROWTH – CAN YOU GROW TOO QUICKLY? ............................................................................. 69 5.4 DEPRECIATION& AMORTISATION....................................................................................................................... 69

5.4.1 INTANGIBLE ASSETS & AMORTISATION ................................................................................................ 70

6 FINANCING .............................................................................................................................................. 71

6.1 DEBT ........................................................................................................................................................... 72 6.2 EQUITY ....................................................................................................................................................... 73

6.2.1 RETAINED PROFITS ................................................................................................................................. 74 6.2.2 Share capital issued ............................................................................................................................... 74 6.2.3 Dividends declared & paid ..................................................................................................................... 75 6.2.4 Reserves ................................................................................................................................................. 75

7 REPORTING & ANALYSIS ................................................................................................................................. 76 7.1 CASH FLOW & CASH MANAGEMENT FORECASTING.............................................................................................. 76

7.1.1 CASH FLOW AND INVESTORS ................................................................................................................. 79 7.2 RATIOANALYSIS ........................................................................................................................................... 80 7.3 VARIANCE ................................................................................................................................................... 81 7.4 SCENARIO ANALYSIS ......................................................................................................................................... 82 7.5 FINANCIALRISK MANAGEMENT .................................................................................................................... 84

8. ACQUIRING OR SELLING – VALUATION & OTHER CHALLENGES .................................................................. 87

8.1 INCREASING YOUR BUSINESS VALUATION ................................................................................................. 89 8.2 MERGERS& ACQUISITIONS............................................................................................................................... 89

8.2.1 Vertical Integration ................................................................................................................................ 91 8.3 DUE DILIGENCE ........................................................................................................................................... 92 8.4 EXITING YOUR BUSINESS ............................................................................................................................ 93

9 REVIEWING YOUR FORECAST .................................................................................................................... 94



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1 INTRODUCTION

Entrepreneurship has its glamour. However behind the world of intense negotiations, last minute deals and garage visionaries madegood lie the less glamorous concepts that you must get right – cashflow, working capital, pricing strategy etc.

This eBook is all about financial forecasting. It addresses the truism“failing to plan is planning to fail”. A forecast is simply a translation of

the vision and strategy of your company into financial numbers. Manyentrepreneurs and managers find this process tedious and intimidating.

External support is not always there for you. This eBook is here to assist you.

Your company must be self ‐sustaining over the short term and profitable over the long term. Itmust generate sufficient cash to pay the bills and maintain increasing levels of sales.

I wrote this having spent many years working with fast growing dynamic Small & MediumEnterprises. These dynamic companies continually faced the longer term financial issues whichwould help determine their success.

Most businesses use adequate to good Management Accounting packages such as MYOB, andQuicken. These tools are perfect for audit and for a historical review of the enterprise. Butwhat of the future? How are key expansion questions such as the following answered?

• What is our company worth today? How can we increase its value in the future?• Can we afford to fund our growth? Will our need for ever increasing amount of

working capital sink our company?• Should we purchase? Should we build / buy that new automation system or factory?• Our new venture? Should we pursue the opportunity to develop and market a new

product range?• Buy versus build? Should we invest in the capacity to produce key inventory ourselvesor outsource this?

• Our acquisition plans? Will the anticipated future profit streams and the savings fromsynergies justify the cost of acquisition?



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The forecasting process is often one of iteration, where you can try out different ‘what if’ levelsof investment in your budget model and see the different outcomes. If you increase the salesbudget, how many additional sales people will you need to generate that level of extra sales?

Developing your forecast on a spreadsheet or specialist software allows you more flexibility andcomplexity in trying out these different scenarios.

The different scenarios will also show the impact of relevant risk factors. How will interestrates affect the demand for housing? What is the relationship between the amount of rain nextsummer and my ice cream sales?

There are a couple more points, I’ll make before getting into the detail:

Firstly, there's no need to reinvent the wheel in regards to building your own forecastingspreadsheets. There are a wide range software packages and spreadsheets commerciallyavailable. They vary in quality, robustness, price and applicability to your demands of yourparticular industry. I have not specifically mentioned any in this booklet, but would bedelighted to understand more about your company and talk you through your options.

Secondly, I’ve tried to cover as many different types of industry, position on the supply chain,and way of doing business as I can within the limited space below. I haven’t managed to cramin every variable for every company, but would be delighted to receive your feedback aboutwhat needs to be addressed. The booklet remains a PDF soft copy only at present, meaning Ican update it whenever I get the urge to. Hence your insight would be most welcome.

Happy reading and most important of all, good luck with your business!

Mark [email protected] July 2008



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2 STRATEGIC VISION

It is often said that there are four types of company:

Those that make things happen.Those that watch things happen and respond.Those that watch things happen and don’t respond.Those that didn’t notice that anything had happened.

We’d all like to be in the first group, but no matter how visionary we are, much of our work is inresponding to other’s first moves. We’ve even got it wrong from time to time, and notresponded when we needed to!

This eBook is all about planning to make things happen – having a strategy. We’ll also try tohelp you with responding to market shifts – mainly by guessing that they may occur and doingsome scenario planning (what if….?), some sensitivity analysis (if interest rates increase by x%what will be the effects on sales?) and some risk management.

Crudely, you can liken any business to a poker machine that swallows up money put into it, andhopefully spits out more. However that chance is based on the operators skill rather than theluck of the pull.

A business entity is simply a collaboration of resources that is must make the greatest possiblereturn on a flow of financial inputs provided to it. These inputs are DEBT, primarily fromfinancial institutions and EQUITY from shareholders.

For the long term, your company is only sustainable if for a given level of risk:

• A holder of EQUITY in your company (i.e. a part ‐owner) can get a greater return on thatinvestment compared with other investment opportunities

• A holder of DEBT in your company earns a market competitive rate of interest forlending funds to your company.

Along the way there are a series of stakeholders in the company that also need to be satisfied



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The process of generating these figures also adds reality to your expansion plans. For example,

if you want to open up offices or factories in China you will have to research and allocate thecosts for doing so. Having performed that financial anlysis, you will be in a better position toassess alternatives such as building a distribution channel instead.

A supplier of funds will also see where you are more financially vulnerable and where you aremost likely to require financial injections. You may find that you do not require all $5m investedupfront and by having it staged over time you have the opportunity to obtain a higher valuationfor your company as you move through from start up to expansionary phase.

In short, while no investor is expecting you to get your future projections "correct", the

discipline required in doing the projections in the first place alerts you to potentialopportunities or threats that you may not have otherwise considered.

2.2 PROFILE OF SUCCESS

The financial data that you forecast will tend to quantify some of the characteristics thatunderly a successful company. Successful growth companies will share many of the followingcharacteristics:

• Proprietary technology, owned by the company. This acts as a barrier to entry,

preventing other players from coming into the market. That way margins remain high,and there’s less need to discount price.

• Entrepreneurs with a great track record.• Large and growing potential market for the product or service. Typically with a forecast,

the demand curve will start off slowly as the product or serviceestablshes itself as“needed” by its target market. Early versions may be slower sellers, and the companyhas to adjust its operating cost base in order to fulfil growing demand. Here’ workingcapital pressures can be at their greatest.

• Good potential and sustainable margins. This can be through ownership of IP or

proprietary know ‐how or through the organisation always remaining innovative and onthe cutting edge of technology

• Proven market need for the product.• A sustainable competitive advantage with high barriers to entry for potential

competitors.



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"Planning differs between budgeting and forecasting in intent. While the budget is used tocontrol, the forecast is used to predict, the plan sets out desired outcomes and expectationsusually over a longer ‐term period. In essence plans are used to affect change." PA ConsultingGroup

There are several major steps to ensure that the forecasting approach is effective and that theresults are credible:

Forecasts imply a plan so your team should be familiar at least with the aims of their ownfunctional or strategic area. Issues such as confidentiality which may preclude full opennessshould be ironed out prior to a session.

Parameters and assumptions such as the size of the market, major production or productchanges, expected sales growth, exchange rates and so on should be set early and disseminateduniformly to form the basis of the plan.

The sales budget should be the first part to be tackled, as it reflects the economic andcompetitive forecasts and shapes all of the other component parts of the budget. All otherbudgets should be developed consistently with the sales volumes. Manufacturing production

targets, stock levels and product support are all dependent.Once the forecast has shaped up, your cash flow forecast is needed to assess affordability. Thiswill ensure that the forecast when finalised is consistent with broad financial parameters anddoes not, for example, assume unrealistic borrowing requirements.

Effective forecasting requires good communications throughout your organisation. Thebudgeting component may move up and down the organisation and sanity checks betweensenior managers of the various divisions may be required before all changes are agreed.

Once agreed, the final figures need to be reviewed and confirmed that at a corporate level thereturn on assets / investment is sufficiently high. If not, consideration needs to be given tocutting costs, selling more or increasing efficiency.

2.4 UNDERSTANDIN G CUSTOMERS



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An important aspect of forecasting is in understanding the makeup of customers who purchase

your products. One key issue for planning is – are they profitable? Consider the types of products they purchases and they services that they may require with them. Consider also theimplications of negotiating a volume deal over time with a large company.

Will the discounted price, plus all of the free priority support and service offering they mayrequire, make Big Complany overall a viable customer.

And what if Big Company doesn’t renew or repurchase in the future. Might you have lost thefocus or even the contact of smaller customer companies?

2.4.1 MARKET SEGMENTATION

Importantly, you will also need to consider what customers you effectively wish to target.Some target markets can be addressed more profitably than others. As a general rule, you cansegment your market by dividing up your total market into a series of niches, and reviewingeach niche (below) in order to rank the priority levels that you will address those markets.Some niches may never be cost efffective, as it will cost you more to service them than therevenues you can expect from them.

Take the potential markets for a product such as a device to test water quality. Management

and advisors have determined that given limited personnel , promotional; budget and R&Dfunds, it would be best to concentrate on two specific niches (1.3 and 2.1) initally, beforeattempting to grab the woder market.



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2.5 REALISTIC ASSUMPTIONS

Ensure that all assumptions are documented out with the forecast. Some of these assumptionsmay be controllable e.g. the per capita take up of a new medical device over time, and someuncontrollable such as the future price of a barrel of oil.

Taking the Australian car industry as an example, the total population of Australia is 21millionand car ownership is at around 12 million. To forecast the total sales of a particular car brand,you would take into account:

• The growth of total population of Australia in the forecasting period.• The number of people under 17, or those in the upper age bracket ineligible to drive.• The trend in car ownership per household.• The trends in type of car (sedan, convertible, 4WD) likely to occur.• The trends in public transport available.• The costs of car parking in major cities.• The reputation of the particular brand and model of the car• Relative running costs of that model compared with competing models



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And a whole host of other factors.

Thus key determinants may be based on actual results from you or from companies of a similarsize in a similar industry.

2.6 GETTING STARTED WITH YOUR FORECAST

Before you calculate and type in your first numbers, you have to consider a series of issuespertaining to your forecast. These include:

CUSTOM SOFTWARE OR EXCEL SPREADSHEET?

The market for purpose built financial software is expanding, both as downloadable software orsoftware ‐as‐a‐service, where you log on to a provider via an internet connection. Amongstspreadsheets, typically Excel(R) based, you may choose to build your own from scratch (with itsinherent time consuming challenges) or purchase ready made forecasting spreadsheets. Themerits and pitfalls of each option call for another booklet worth of discussion!

TIME SPAN OF FORECAST

How long do you want to forecast forward for (in years)? This answer will depend on what youwant from your forecast. If you want to do a discounted cash flow for a valuation, or if you

want to track the longer term performance of return on your assets, you’ll probably want to doat least five years. Conversely, if your concern is running out of money and you want to trackyour end of month, or even end of week bank balance, you’ll need to focus on one year or less.

LENGTH OF PERIOD

When you’ve decided how many months or years out yourwish to forecast, consider then, anideal number of columns that are useful for your business and are not time consuming orunecessary for you to fill in. A 60 column spreadsheet (monthly forecast for five years) isuncessaryily large , unwieldy to view on your screen and the monthly figures will likely becomemeaningless as your move toward the distant future.

COMPANY STRCUTURE



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How will you sub ‐divide your forecast as to make it meaningful without overburdening yourself

with data? Assume you have 10 product groupos with a total of 700 SKU’s and sales offices in10 territories in Australia and another 20 worldwide. Will you try and incoroprate all of thisdata on a single spreadsheet? Will you ccreate sepatate spreadsheets and feed in the macrodata into a master spreadsheet? How will you make allowance for future products orterritories?

DEALING WITH COMPLEXITY.

To produce a thorough forecasting model may be much more complex that you will have giveallowance to. Consider some of the following challenges:

• The phasing in of receipt and payment of Sales Taxes such as GST abnd their impact oncash flow.

• Taking account of the time span between receiving an order, completion, delivery,invoicing and payment for the goods and services.

• The capacity to produce meaningful working capital estimates when so many variableshave to be factored in.

• Applying deprecaition and amortisation estimates to tanglibe and intangible assets.

HISTORICAL DATA

You’ll need to have an up to date set of financial statements with sufficicently detailedbackground information behind them to get started. The key detail may also relate to trends insales across product lines and seasonal fluctuations. Details of this data may help you detectand programme in growth trends. You’ll also need to know the detail behind your currentstatus of payables, receivables, loans and other balance sheet items, as they will form a part of your near term forecast.

Also you will need to factor out (or in) the following:

• Historical items of income or expense that were unusual, non recurring or unlikely tohave any influence within the forecasting period.

• Revenue that was derived from assets no longer operating within the company.

INTEGRATION WITH YOUR ACCOUNTING SOFTWARE



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Will you want to integrate a feed of the ACTUALfinancial performance into your forecasting

spreadsheet / software? This would:• Save manually rekeying to input your actual financials.• Provide comparisions between your actual financials and what you had previously

forecast.

DESIGN AND USABILITY

If you are opting to build your own forecasting spreadsheet, make sure that it is well designed,easy to manipulate, well documented and understood by other users. Design tips include:

• Modularise the model into differnet sections with summary sheets that bring togetherthe various components.

• Ensure that you can support a simple sensitivy analysis, looking at the effects of achange in one variable on the financials.

• Show clearly which cells are iinput cells and which cells are calculated by the software.• Document your assumptions separately.• Do not hard code variables into a formula. P (price) and Q (quantity)

Here’s an example of the need to modularise your model into different sections in order to nothave one overly complex summary sheet.

You may have a summary sheet of overall operating expenses:

But feeding in to that toital Administrative Expense, there may be a sheet where theseexpenses are broken down into their individual components – salaries, leases, office equipmentetc. This sheet in itself, may also be a summary of what has be calculated at a lower level. Forexample, the staff costs would have been calculated by a lower level sub ‐sheet:



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3. REVENUES

The first, key financial statement is the Income Statement, sometimes known as a Profit andLoss.

The forecasted income statement is a summary of all of the expected revenues and expensesincurred during the forecast period. These includes the sales of major items, their cost of sales,operating expenses, a portion of the capital costs of operating the company, interest and tax.

This statemnent takes account of when revenues and costs were earned or incurred, not whenpayment and receipts were made. Making a profit here, does not necessarily mean that yourcompany won’t go broke. In business, cash is king and survival is only guaranteed if either your

inflow of cash is greater than your outflow, or that you have the means to fund a haeomoragingcompany through external funding. We’ll discuss the all important cash flow statement inSection 7

Looking through each of the components of the Income Statement.



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3.1 PRODUCT SALES

The sales revenues for each product / service line are a major component for theforecast. Everything else is geared around your company’s' ability to exploit its sales potential.

Our approach to forecasting product and service revenues is:

Key factors affecting the sales forecast include:

• Previous year’s sales – is there a trend?• Sales trends in the overall market

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• New promotions, sales initiatives or other marketing drives

• New product launches• Overall changes in the economy• Changes in consumer tastes• Seasonal trends – ice cream sales in summer compared to winter• Changes in competitive strategy• Varying competitor scenarios

If you have multiple product lines, services, divisions or geographical locations, you’ll naturallybe forecasting each as a sepatrate line item.It is important to forecast each of the productlines. Consider also what the effects are on sales of one product line on another product line:

• One product may be complementary to another in which case there is a directrelationship between one and the other. As one increases, so does the other.

• Increases in sales for one product may negatively affect the sales of another product• The sales of two lines of product may both increase as a result of outside factors – sales

of gym memberships generally increase at the beginning of the year after people makeNew Year resolutions.

Next, factor in all of the potential revenue streams that could accrue to your company in the

coming years? These may be new revenue streams that you currently do not enjoy, including:

• Existing products into new market• Complementary products• Packaged bundles of product• Upgrade revenues• Support revenues• Training revenues• Service revenues•

Consulting revenues• Licencing revenues

When considering future revenues, it is important to keep a running total of the installed baseof total users of your product or service. They may require service, upgrades or support at any



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tiume in the future. They would also be a great propsect for future compoany offerings,

provided they are satisfied with their current products. So• How many people are out using your product (installed base)?• What is the propensity for customers (in % terms of installed base) to seek out

additional products, services or support?• Can you increase the frequency of purchases for each customer? Or, the value of each

purchase made.

Total Revenue is simply price per unit x number of units sold. This can be increased in one of three ways:

• Increasing the number of customers• Increasing the value of each sale• Increasing the value of each sale.

3.2 PRICING

Price is a key business driver and a proper pricing policy can assist growth more than eitherincreases in volume or cost reductions. Depoending on your industry and your company’sstrength within it, you may have the capability to set price. If not, you still may have thecapacity to create your own niche (perhaps through sustasinable product differentiation)inorder to obtain economic profit. The introduction of 3,4, and now 5 bladed shavers haveallowed producers such as Gilette to charge enormous price premiums oin what was once a lowmargin industry.

Here are some alternative pricing strategies. Consider which you would want to apply to what

products or services you sell or intend to sell, and how your pricing policy may change overtime:

PRICINGAPPROACH

DESCRIPTION ADVANTAGES DISADVANTAGES

Cost Plus Standard margin Easy to calculate and Doesn’t take market



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above cost administer conditions into account.Pricew may be lower thanwhat many consumersare prepared to pay.

Market Based Sets price tocapture the fullvalue thatcustomers placeon your product

Higher profit margins.Flexibility to reduce ascompertitive conditions change

Determine the value thateach customer places oneach of your productsacross each geographicalterritory.

PenetrationPricing

Setting price lowto gain marketshare or achievevolume andeconomies of scale.

Opportunity to grab marketshare rapidly and hence deliverthose economies.Damage to competitors

Risk of competitorretailiation, and that theproduct is successful atthe low price point.

Skimming Price high tomaximise marginfrom thosecustomers willingto pay the most.

High initial margins fromcashed up custoemrs.

Locking out a marketunprepred to pay thisprice.Competitor me ‐too’s

You will also want to consider the impact of discounting your price on your Gross Margin over

time

Discount pricing impact overview(1) If your present margin is:

20% 30% 40% 50%(2) And you reduce priceby 10,20, or even 30%:

(3) Then to produce the same gross

revenue your sales volume mustincrease by:10% 100% 50% 33% 25%20% ‐ 200% 100% 67%30% ‐ ‐ 300% 150%



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If a company is operating on a 30% gross profit margin and introduces a 10% discount sale (10%discount on gross revenue), the company would need to generate an additional 50% in sales tomaintain that 30% profitability level.

This is optimistic at the best of times: 50% more sales, half as much again! Even more startling,at 25% discount strategy (25% discount on gross revenue at 30% margin); sales would have toincrease by an enormous 500% to maintain that profitability. This would be unheard of andillustrates how ridiculous such a discount would be.

More broadly, does a particular customer’s sales volume justify the discounts, rebates, orpromotion structure you provide to that customer?

Conversely, if you adopt a premium pricing strategy

Premium pricingimpact overview(1) If your present margin is:

20% 30% 40% 50%(2) Then you increase price by10,20% or even 30%:

(3) Your sales could decline by theamount below before your gross profitis reduced

10% 33% 25% 20% 17%20% 50% 40% 33% 29%30% 60% 50% 43% 38%

This shows the amount by which your sales would have to decline following a price increasebefore your gross profit would be reduced below its present level. For example, at the same40% margin, a 10% increase in price could sustain a 20% reduction in sales volume. Less workfor more return!



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Finally, if competitive pressures are forcing you to evaluate your current pricing, consider some

of the following options for offering “a better deal” to certain customers:• Discounts on volume.• Time dependent promotional bonuses.• If selling through channels, marketing allowances and co ‐operative advertising• Alternate payment terms e.g. discount on early payments.• Bundling multiple products.• Money back guarantees

All of these initiatives would need to be included in a forecast.

3.3 GEOGRAPHICA L EXPANSION

New markets may be alluring whether you are considering increasing sales, improvements inoperational cost ‐ effectiveness or new international customers, but your forecasting processneed to rigourusly assess their cost benefit. This is particualrly so in the sales start up phaseswhere it may be expensive to establish a brand and a suitable distribution channel in a marketthat may have little awareness of your products and services.

In short, doesa my international expansion add value to the company or simply just grow mytop line revenue figures?

When cdonsidering expansion the forecast needs to evaluate the prioritisation of countrys (sizeand accessibility) and an entry plan for each including company expansion, acquisition orpartering with a local provider.

When forecasting product revenues, you need to consider and evaluate the following

• Determining the total customer base or market size• Segmenting the market to identify what portion should be targeted by your product or

service• Expected penetration of the product or service into the market segment• Competitive envrionment



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• Are there obsolescence costs that will created for the customers current way of doing

things?

Once the new product has launched:

• How quickly will sales ramp up?• What are the costs of bringing this product to market?• How much will it cost to achieve adequate exposure in the market?

The commercial viability for any new product needs to ber established early in the new productdevelopment programme. Aside from the bottom line financial impact, consider the following:

• Will it encourage customers to buy other products as well?• Can the development act as a catalyst for improvements in overall manufacturing

efficiency and quality?• Can new intellectual property be generated or new manufacturing techniques

exploited?

3.5 BUSINESS SEGMENTS

Your forecast should break down product and service revenue figures into appropriate businessand geographical segments:

Geographical Segment ‐ This will be segmented by geographical territory, either within acountry (Northern Division, Southern Division) or internally (Americas, Europe)

Business Segments ‐ Distinguishable component of an enterprise providing a product or servicethat faces different risks from other businesses within the enterprise.

3.6 ALLIANCES, PARTNERSHIPS, LICENSING AND DISTRIBUTION AGREEMENTS

There are a wide range of allainces that can be formed using your unique know how, location,technology, intellectual property. These allainces can help you increase your revenues andproftabilty without the risk that “going direct” would assume. Broadly speaking such allainces



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and partnerships incude: joint ventures, marketing alliances, licensing arrangements,

selling/distribution agreements, channel partnerships and software agreements.

These alliances and partnerships may give you a competitive advantage, create barriers toentryand help you reach customers more efficiently.

Thre MindMap diagram below looks through the process timeframe for considering apartnership / allaince, through the evaluation of benefits, negotiation process and exitprovisions. The process starts at 1 and runs clockwise to 9.

The alliances pathway may actually be a more flexible, less resource intensive and lower riskmethod of achieving your goals than a merger or acquisition.

3.6.1 LICENSING



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Licensing is the capacity to exploit another parties IP, perocess or technology in return for

agreed fees.

Licensing can generate a revenue stream by giving permission to others to sell your products orintegrate your technology or know how into their products orservices.

This revenue stream may potentially be lower risk as many of the costs of market entry may beremoved. In addition, the licencee may incorporate their own know ‐how into the final solutionthat may be well targeted at their customer base.

Licensing works by transferring technology to a licensee and fees can be generated throughroyalties, management assistance etc. These royalties can be either upfront payments, runningroyalties or a combination of both.

Can negotiate multiple non ‐ exclusive licenses, minimum guaranteed license revenues

From a business and forecasting perspective, the following needs to be considered:

• Is the license exclusive or nonexclusive?• How long should the license be granted for?• What is the size of the market and market penetration?• Without the license, what is the investment required for manufacture?• Does the market already exist or must it be created?• Without the license, how much will it cost to establish sales channels?• What is the prospective return on investment?• What are the nature and extent of competition to be expected?• What is the market life for the licensed technology?• What kind of lead time will the license afford?• What technical help, know ‐how, or show ‐how is provided?• Without the license, what would it cost to “reinvent the wheel”?• Will we create a new market or reduce production costs?• Are profit margins in the industry sufficiently high?• How do we wish to get paid?• Can the licencee sub ‐license?

Finally, there’s an often quoted 25%rule of thumb for licensing revenue. It’s 25% to licensor,75% to licensee of an expected profit margin. Probably best used as a starting point fornegotiations!



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3.6.2 STRATEGIC ALLIANCES

The world doesn’t come looking for a better mousetrap, and the economy is a machine thatinvolves companies acting together as well as competiting. It’s very difficult to build a whollyself sufficient company, so it makes sense to assemble a group of companies together that forma sustainable force.

Alliance opportuniies enable:

• INNOVATION: Generate new product ideas and acelerate commcialisation• EXTENSION: enable your company to enter new channels and reach new custom

segments• GEOGRAPHIC EXPANSION: Enable your company to entedr new markets or improve

existing international or interstate operations using the alliance partners local assets• PERFORMANCE IMPROVEMENT: Enable improvements in efficiency and lower

operating costs and capital requirments through outsourcing.

3.6.3 DISTRIBUTION CHANNELS

It’s easy to see why a food manufacturer would use wholesalers or supermnarkets to sell theirproducts, but a component of your forecast is to evaluate whether your financial interests arebest served by using a channel strategy. If you wre comparing product revenues and costs byusing direct sales versus via indirect, here are some of the key considerations:

• LOWER COST: Using resellers can save on the costs of a direct salesforce whileextending the range of customers you are effectively speaking to. Simuilar you maysavbe on warehouse management, inventory management and logistics by taking upspace in a distributors facilties rather than building your own.

• INTEGRATION WITH OTHER PRODUCTS: Your products may require intengration orbundling with other products in order to provide a complete solution to a custoemrsrequirements. In this instance you may require specialist resellers with integration skillsto sell complementary technology and effectively support and advise customers.



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• CUSTOMER REACH: As your business grows you may require resellers to reacha diverse

range of customers. If your product addresses many market segments and requiresgeographical coverage then customer convenience in accessing a reseller becomes akey criteria

If you are considering usinf non ‐direct sales, remember to evaluate a range of options, thatultimately will depend on your own industry structure:

Master distributors

Local distributors

Value added resellers

eSelling via the web (auction sites, catalogues etc)

Integrators

3.7 FRANCHISING

With brand name backing and reliable systems in place, it’s no surprise that franchising is oneof the fastest growing forms of business strcutre in Australia. In indsutries from fast food toaccountancy advice, franchising removes much of the need for promotiuonal expenditure tobrand build and gives clients the reassurance that they can trust the products and services of the franchisee.

Franchising works best for businesses that have a good past sales and profit history, can beeasily replicated in new territories, are easy and inexpensive to operate and have good brandname recognition.

3.7.1 BEING A FRANCHISOR

The "franchisor" authorizes the proven methods and trademarks of their business to the"franchisee" for a fee and a usually a percentage of gross monthly sales. In return for this,



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support systems, advertising, training and other benefits will be made available to the

franchisee.

The key financial benfits of franchising your operation are:

• Once you have a methodology and a strcutre in place,,its easier to open “cookie cutter”type operations through franchisees than doing it yourself.

• Costas are substantially lower as the franchisees upfront fees will defray much of therisk.

• The franchisee may have much greater exerpoeice dealing with their local market.• Greaer motivation on the franchisees behalf to make it successful than ifd you were to

do it through your own employees.

The key downsides of franchising your operations are:

• There may be some loss of control, as it may be more difficult to manage and get thingsdone through an individual franchisee than through a staff member.

• Getting the price right. Price it too highrelative to the franchisees income streams andit’s a permanent demotivator to the franchisee. Price it too low, and you’ve left valueon the table.

• Potential for conflicts: An incompetent franchisee can damage the customers goodwillfor the brand by providing inferior goods and services

The key issues and controls you need to put into place are:

Length of agreement – could be from five (sufficnet time to realise returns from the initialoutlay and the lean start up period) to twenty years.

What would trigger an early termination of a contract?

What is the extent of a territory?

Exclusive or non exclusive?



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3.7.2 BEING A FRANCHISEE

The key financial benfits of purchasing a franchise are:

• You have likely to have a recognised brand and an exclusive territory such that you cango to market and earn postitive cash flows comparatively quickly.

The key downsides of being a franchisee are:

• An incompetent franchisor can destroy their franchisees by not promoting the brand

adequately or being too aggressive for profits.

3.8 PROJECT MANAGEMENT

Much of the emphasis of this book so far is on the production and sale of tangible goods andservices. If your company’s busiuness is based on the successful completion of specific projectsincludinga whole series of differtent financial and forecasting considerations come into play.

Your scucess id managed a set of resources – people and expertise, materials, money in orderto achieve the objectives of a project. The goal is profit, the classic constraints are time, quality

and budget.

Your initial analysis determines the price you will charge for the project based on an estimate of the costs involved. From a financial viewpoint the key risk is that the project timescales or costsoverrun, and this can be partially mitigated by:

• Thorough pre ‐planning and consideration of each variable.• A clear understadning and alignment with the customers requirements.• Taking account of all potential risks and having a strategy in place to address them.• Having flexibility in the contract to be able to pass on unforseen challenges to the

customer.• Effective people, process and budgetary management throughout the project phases,

including sub ‐contractors.

To ensure that the project remains on cost and ontime, consider the following:



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• Ewha tis the critical path and what are the interrelationsips and interactions and

interdependencies between the resources?• What key events, milestones, progress evaluations and critical activities been identified?• Has time been allocated for quality, customer and stakeholder involvement?• How has time contingency been incorporated into the plan?• How thoroughly have target or actual project costs been clearly identified and

documented?• Does the project cost estimation involve cost related risks and how are these managed?• Is the project budget consistent with the project requirements, assumptions, risks and

contingencies? How are the project costs managed to ensure that the project is

completed within budget?• Is there a satisfactory process for accounting of project purchasing and other

expenditure? Has this purchasing process been documented?• Can you identify the root causes for budget variances, both favourable and

unfavourable? Is this revciewed?• How has cost contingency been incorporated into the plan?

3.9 CONSULTANCY

There’s a lot of cynicism about Consultants, but good ones, well briefed can do much to helpcompanies evaluate their market opportunities, strategies and tactics.

3.10 OTHER INCOME

There are a wide rang eof other items that can fall into the “Other Income” category of yourPfoit and loss. These can range from Grants from governments of private bodies, donations oreven the proceeds of your intellectual property. Some examples follow, but you’ll haVE your

own

3.10.1 GRANTS & FINANCIAL ASSISTANCE

Financial asssitance programmes at a federal (AusIndustry), state and export body (Austrade)level can assist with grants and loans and tax offsets.



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Examples include:

• AusIndustry’s COMET support program gives financial support to innovative early stagecompanies, their R&D Tax Concession prgorammes allows tax concession of up to 125%of expedniture incurred on R&D and they offers specific industry support in areas suchas Tourism, Automoativer, Biofuels, Climiate change and green based initiatives.

• EFIC (Export Finance & Insurance Corporation) is Australia’s export cr3edit agency offersexport guarantees and direct loans.

• State governments offer a variety of programmes for SME’s. In NSW, for example, theDeaprtment of State & Regional Development (DSRD) provides assistance withcommercialising R&D, regional relocation incentives, export incentives and payroll taxrebates.

• Austrade, Australia’s export authority provides an Export Market Development Grant(EMDG), as a rebate on the proprtion of total expenses incurred on eligible exportpromotion activities.

3.10.2 INTELLECTUAL PROPERTY INCOME

Obtaining a royalty stream from yourIntellectual Property can, once the IP has been developed,protected and marketed, be one of the significant income streams as it goes straight to the

bottom line. (IBM for example have over $1 billion dollars of income annually accruing fromtheir past IP).

Here’s a MindMap checklist of the considerations when embarking on a ruote to market thatinvolves the devlopment and licencing of IP.



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4. COSTS

This section looks at each of the key costs payable by your company, both vairaible (expensesthat change in proportion to the activity of a business) and fixed (those which don’t chang einproprtion to the business).

This simple diagram illustrates the two types of cost:

Greater margins and profit are achieved by greater revenues and less costs and the businesschallenge pre ‐empted by your company forecast is to regularly eliminate unecessarty costs andreallocate resources to activitries that will generate the greatest returns.

• Forecasting to reduce costs need to take the following into account:• Likely cost savings given risks of executin and variability of outcomes• Vosts and investments required to achieve savings e.g. sverence fees, new strcurtures

and technologies

Fixed Costs

Variable Costs

TOTAL COSTS

Units Produced

$Costs



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• Impact on revenue and earnings

• Timing required to implement initiatve and realize benefits• Execution risks.

4.1 COST OF SALE

Cost of sale refers to the direct costs attributed to the production of goods sold by yourcompany, including the material costs and labour costs incurred when producing the goods.

A simple way of calculating this is:

INVENTORY AT BEGINNING OF PERIOD + TOTAL AMOUNT OF PURCHASES MADE DURING THEPERIOD – INVENTORY AT END OF PERIOD = COST OF INVENTORY SOLD BY COMPANY IN PERIOD

In a retailing or wholesaling company a large proportion of your cost of sale will be finishedgoods inventory. A full discussion on reducing the risks from an extended working capital cyclemay be found in the section on xxx.

You may be reviewing your sourcing strategy as there may be substantial cost savings fromsourcing from outside Australia, particularly in the Asia Pacific region. However, these reducedcosts must be weighed up against

• the costs and risks of a buildup in inventory from having to purchase more,• the costs involved in having a lengthier supply chain with much of your stock “on the

water”• advanced contractual commitments to produce more in remote manufacturing plants.

Thus you have to weigh up reduced costs with the potential of carrying greater inventory andless flexibility.

Also, a lower cost of sale will also result from making adjustments to the costs involved inserving a customer. This could result from automated order taking processes to reducingdelivery costs to automated purchasing set up based on minimum reorder quantities beingreached by the customer.

4.1.1 REFUNDS, WARRANTIES AND GUARANTEES



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• The probability that they will be redeemed at all. Some customers may simply not both

with the free gift or service.• The cost of them being redeemed. Returning to the airline example, the marginal cost

of giving away a seat on a plane that wasn’t full anyway is lower than the cost of turningaway a paying passenger because their seat had already been taken by a free flightredeemer.

• Expiry dates on redemption. This will lower the liability, but could also engender ill willwqhen customers lose out when they simply don’t take up an offer prior to expiry.

4.2 OPERATING EXPENSES / OVERHEADS

Overheads refer to the ongoing expenses involved in running a company. These refer to all of the necessary costs in running a company – rent, telecommunications, accounting fees that donot directly generate revenue.

A component of your forecasting process should involve consideration of what percentage of revenues should be spent on overhead. More importantly,

• How do they compare with other organisations in your market space?• How can you reduce this percentage over time, and therefore increase your profits,

without affecting the efficiency of your company?

In the long term, you may need to review your entire operating processes, ensuring that theycan evolve to be the best in the industry and that they can see the company through bothbooms and busts in the economic cycle. Key issues include:

• Where can work can conducted most cost effectively? Are there parts of your operationthat can be relocated to other (non CBD) offices, interstate or overseas?

• Can you shift work to a supplier based their capabilities? Do they have a superior cost

structure compared to yours?• Can you outsource or use shared services? In recent years, internal telemarketing

teams have been outsourced to call centres, while IT departments have been replacedby specialist IT service companies monitoring your network performance with back upfacilities and timed response rates.



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• Can you transform your entire way of doing business? How can you optimise your

workforce, processes and technology to provide the most productive and efficientenvironment for your company?

The following sections look at all of the different components of your overheads.

4.2.1 MARKETING

Budgets need to be developed in order to ensure that your products and services are exposedto your target audience. The methods of marketing used and the marketing spend / totalrevenue ratio will vary across firms and industries and across the life cycle of a particularproduct. First of all, seek out and use available data (online industry reports) to gauge an ideaof a realistic cost of creating a brand, and creating an awareness and desire for them topurchase your goods.

Managers frequently underestimate the costs of marketing, and in order to cut through theadvertising clutter in order to obtain consumer awareness, these costs have to be maintained

over an extended period of time.

Within the marketing budget, has your company taken the following into account?

Advertising Placements Fees, Concept Development, Channel or Industry Specific

Bundling Cost of bundled product, Promotion, Packaging, Fulfillment, Support

Channel Distributor & Reseller expenses including ‐ catalogues, co ‐operativemarketing, product management services, PR Programmes,publications, reseller presentations, technical training, trade showappearances, vendor nights, website listings



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Collaterals Logo, Domain Registration, Brochures, Case Studies, CD's, DemoDisks, folders, electronic presentation, Not For Resale Software,Merchandise (caps, mugs etc), Packaging

Direct Marketing Direct Mail, Direct Fax, Infomercials, TelemarketingElectronic Marketing Website development & maintenance, Web ad development, CD

ROM distribution, Search Engine costs.

General Administration Training, Equipment Rental, Hardware, Meals & Entertainment,Research, Consulting, couriers, Resource Materials, Software, Travel,Web Hosting

Public Relations Editorial Guides, launch events, Press Kits, PR Agency, Press Mailings

Sales Promotions Bundling Costs, Design Development, Price Promotions, Seminars &Other Events

Sponsorship Physical facilities, Causes, Events, Celebrities

Trade Shows & Events Stand costs, Personnel costs, transport & accommodation, advertising

Ultimately, your company will need to have a realistic proportion of forecast revenue set asidefor promotional expenditure. This can be in the range of 15 ‐30% of total revenue and willdepend on criteria like the number of new product releases, how competitive the market is etc.A good guide is to look at the financial statements of publicly listed companies to review therelationship between their marketing expenditure and revenue / profit. However, do notassume an instant correlation between promotional spend and revenue. It takes a lot of exposure and brand building before the effect on sales can be truly felt.

In addition to the marketing spend involved in promoting current and forrthcoming products,you will also need to allocate expenditure on the following:

4.2.1.1 MARKET RESEARCH



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Market Research: This is essential. Understanding the consumers mind, their need for your

services and their perceptions of your products can greatly assist in the new productdevelopment, launch and sales cycle for your products. Some key questions need to beaddressed within your Market Research brief:

• What is the potential size of the market and the estimated level of sales?• Is this market growing or declining? What factors will affect this market?• Have you clearly defined the market sector for your product or service?• Have you researched your market territories been researched thoroughly? What local

differences, customers, languarge and regulation are likely to affect your final product?• What is the consequence of making product changes for these different geographical

territories?• If you are exporting, how competitive will your products remain if exchange rates

change?• What are the appropraite channels to market? Direct selling, online, agents,

distributors, retailers? What is the possibility of channel conflict if more than one routeis utilised?

• What branding and other promotional effort is required?• What is the shape of the competitive market place like now and what is it likely to look

like in the future? What competitors and competing products have been identified?What future developments are there likely to be in these products and how will yourcompetitor respond to your product launch?

4.2.1.2 MARKETING EFFECTIVENESS

You should se t some budget aside for measuring the effectiveness of alternative forms of promotion, and use the knowledge derived to plan alternate marketing strategies. With online

marketing and Web analytics, it has become a whole lot easier in recent years to quantify keyinterrelationships between customer exposure – customer interest – leads and customer sales.

4.2.1.3 COMPETITIVE INTELLIGENCE



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There are a wide number of Customer Rentention strategies, but they can be summarised in

the following ways:

Customer retnetion and the capacity to provide them with new and additional services, renewtheir subscriptions, charge them retainer fees etc, provides some interesting financial modellingchallenges.

Here’s a sample Excel(R) based model for a company that sells hardware, software and servicesto both new and existing customers:



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The model has been set up so only the yellow cells need to have an input.

There is a known population of pieces of Hardware out in the market at the beginning of aperiod, plus a forecasted assumption that around 65% of that existing population will purchasea “renewal”. This 65% renewal rate on existing customers plus the new customers acquired inthat period then become the new Hardware population at the beginning of the followingperiod, and the calculation is made again at that point.

4.2.2 INFORMATION TECHNOLOGY

The use of technology within your company can loosely fall under two categories – as aninvesmtnet in driving revenue, profitability and growth, or as a cost of doing business.



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4.2.2.1 AS A REVENUE & PROFIT DRIVER

Excellence in information technology can drive real improvements to your company’s bottomline. IT must deliver value to your company, rather than simply be a cost that should becontained.

The rapid adoption rate in E ‐ Commerce, Enterprise Resource Planning (ERP) systems, CustomerRelations Management (CRM), Knowledge Management, Business Intelligence & Analytics andmany web based technologies elevate IT considerations from being merely a cost to being adriver of profitability and growth.

Effective use of technology creates competitive advantage. IT expenditure tied to yourcompany's business strategy will have the most clear ‐cut business value, in terms of return oninvestment. Moreover, when IT solutions and business strategy are woven together, companiesare finding that business benefits are often broader and deeper than expected.

Investments in the following technologies can all have long term highly positive payback interms of customer relationships and business efficiency:

• E‐Commerce: including a web store, inventory management process, order fulfillmentprocess and accounting system.

• Customer Relationship Management (CRM): Systems for tracking customer data andcustomer interactions, as well as internal project tracking.

• Enterprise Resource Planning (ERP): An integration suite of most of the internalprocesses within an organisation including manufacturing (scheduling, materials,workflow and quality), supply chain management (inventory, suppliers, scheduling),financials and project management.

• Management Accounting Software. While common low cost generic software such asMYOB and Quicken may service your organisation for a while, at what point do yourequire the greater functionaluity of mid ‐range accounting packages.

As you grow, you will also need to cost in other applicatins such as [purchasing managementsoftware, business process automation, document automation, asset management and otherapplications specific to your production, R&D and warehousing operations.



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Consider with each the following costs: the “per seat” licence, the implementation costs, the

renewal costs, the additional customisation costs through their life, and the costs involved inmigrating the data to larger systems should your growth take hold.

4.2.2.2 AS A COST OF BUSINESS

Outside of staffing costs, Information Technology costs can be one of the most significantoperating costs of your company. As you grow your company, consider the future costs of some of the following necessities:

• Hardware, software and networking products for your team• Connectivity solutions with customers, suppliers, distributors etc.• Disaster recovery and contingency planning requirements.• Network and data security.

Even without the business benefits, there are commercial costs for not investing intechnology. Consider the costs of the following lost hours due to printer problems, networkproblems, loss of unsaved work & failure to back ‐up documents, equipment purchase delays,inadequate computer training, inefficient processing power, computer downtime(crashes/system failure) associated with inexpensive or inferior equipment,inefficient systems

and double entry, poor document management and access, complicated systems or retrieval of data

Also consider the lost revenue because your phone lines are engaged or your equipment isinefficient, because sales data is not immediately accessible to your sales team and becauseyour sales team does not have a contact management system to remind them to call backpotential clients.

Key areas for considering appropriate levels of IT expense include:

Personal Computers Considerations:Required power of a new computerAbility to upgrade PC’s versus purchasing new onesRent v Lease v Buy equation

Software Considerations:Are software upgrades always necessary?Are service / support agreements with software vendors being fully utilised?



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What about SaaS? (software as a service)Is there an appropriate level of documentation being purchased with thesoftware, particularly as most vendors no longer package documentation?

Servers There is likely to continue to be a rapid increase in the number of serversthat your company operates as it continues to grow.There are also technologies (e.g. virtualisation software) that can reduce thenumber of servers, as well as the use of distributed applications.

Broadband Rapid increases in broadband take up in recent years. However the marketwill continue to become more competitive and technologies will ensure that“Moore’s Law” continues.

Outsourcing The extent to which high fixed costs e.g. IT professionals be outsourced.Wide range of personnel and procedures outsourced to specialisedcompanies providing full system monitoring, application development etc.

4.2.3 EMPLOYEE / PERSONNEL COSTS

Staff costs can account for a large proportion of total business costs for your enterprise.

In addition to salaries, bonuses and commissions you will need to factor in the following otheremployee entitlements.

• Superannuation• Annual Leave• Long Service Leave• Cumulative sick leave• Post employment benefits• Termination benefits

Depending on how your organisation remunerates its employees there may also be share based

benefits ‐ such as shares owned, options etc.

According to a recent study (AMI ‐ Partner Inc 2002) less than 50% of total human resourcesspending are on direct staff salaries and wages:

• Staffing Services 49%



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Another example where you need to evaluate your peronnel resource is in the availability of

sales people or pre ‐sales engineers to close business. Particularly, what are the costs of gettinga new customer or getting an existing customer to buy more?

When looking at obtaining a new customer, you need to consider a Sales Funnel for your owncompany. How many initial contacts do you need to obtain one sale? What is the cost of servicing those initial contacts (salesforce, presentations, proposals etc) in order to make thatsale?

In this example, 250 initial prospects, pipelines through to only 10 sales, but you must cost inthe resource of making contact with all of those initial 250.

4.2.3.1 INCENTIVES (COMMISSIONS, BONUSES)

Depending on the nature of your industry a considerable componet of your employee costs willbe variable and relate to performance based incentives –

250 Cold Calls

100 Initial Discussions

50 Presentations

25 Evaluations

15Negotiations

10 Sales



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These incentives will relate to the achievement of a predefined target.

For sales staff and managers this achievement could include any of the following, and more:

Calculated as a total company, as a team or as an individual:

• Total sales• Total sales growth• Total growth in gross margin

Calculated as a total company

• Profitability• Growth in profitability• Growth in business value (e.g. share price of a listed company)

Performance based incentives may also apply to project staff for ontime delivery of projects,production & warehouse staff for efficient scheduling and working capital management, and fora whole host of other individuals and teams in your company.

You’ll need to design incentive schemes as part of the forecasting process. However, ensurethat you take the following ointo considertation:

Is the behaviour that you are trying to incentivise creating the most desirable outcome for thecompany in general? Will, for example, individuals:

• Achieve targets that may be detrimental to the performace of the company e.g. asalesman targeted on revenue, may not care about the profitability of his / hercustomer transactions.

• Defend the performance of their own silos instead of helping to shape action across thewhole organisation

• Tend to be ego driven and seek to enrich themselves at the expense of the organisation.

Ultimately, incentives and performance goals should be related to achieve best results. Theywill need to be constantly re ‐evaluate as there may be circumstances where they candemotivate if the individual is not achieving goals or if the maximum earn outs has already beenachieved and the individual is squirreling away some achievement for the next period!



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4.2.3.1 DIRECTORS / ADVISORS PAYMENTS

While evaluating personnel costs you may need to consider an allocation for non executivedirectors, and external advisers.

4.2.4 ADMINISTRATIVE COSTS

4.2.4.1 BUILDING LEASE

The size and functionalitiy of premises for office space, manufacturing facilities and warehousesneed to be constantly considered, and a forecast that assumes rapid growth must also take intoaccount, the extent to which current premises may be stretched or dysfunctional in the eventof that growth.

Leases are a commitment on space and while premises may be subleased in the event they areinadequate, conside rthe following costs:

• Built in CPI (Consumer Price Index) increases• Option to extend lease at a pre ‐agreed pricing formula.• Whether the lease includes services such as cleaning, security etc.

Important to cost in proper control of your bookkeeping – importance of decent accountspackage – what to look out for in accounts package – costs of not having decent package etc.

4.2.4.2 INSURANCE

There are a wide range of different types of insurance required for your company. The purpose

of most of this insurance is to transfer some of the risk within your operations onto an insurerin return for a premium. Some such as Workers Compensation are compulsory, others such asProfessional Indemnity high recoomended, and others such as Key person life insuranceoptional.



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They can be grouped into sections as follows:

• Professional Indemnity –important if you are involved with providing special servicesor advice where the consequences of following your advice could lead todetrimental outcomes.

• Public Liability – Either for the public to protect your company when customerscould suffer personal injury or property damage, or for employees to insure fornegligence against injuries resulting in the place of business or while travelling.

• Workers compensation ‐ This insurance is usually required by the state in which thecompany operates. It provides valuable protection to workers and their employers inthe event of a workplace ‐related injury or disease.

• Property Insurance ‐ This type of coverage will insure inventories, facilities,furnishings, and equipment from fire, theft, etc.

• Key person life ‐ This type of coverage insures for business interruptions and/orfinancial loss due to the death of a key officer or owner.

4.2.4.3 TELECOMMUNICATIONS

4.2.5 LEGAL COSTS

Legal costs are often underestimated by high growth organisations, particularly where they areseeking to enter new markets, protect intellectual property, and form contractual relationshipswith suppliers and customers or change shareholder agreements. Consider and cost in some of the following:

• Changes in ownership & structure of your company. Legal negotiation and agreementmay be required where the classes of shares and their rights change over time or wherecommitments are honoured to provide shares, options or profit share.

• Trading Agreements: An expanding company will be subjected to the necessity tocreate a wide range of trading agreements including franchisee / franchisor, exclusivityon particular geographical territories or market sectors, royalties on revenues received,licensing of product etc.



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• Intellectual Property: The cost of researching, registering, protecting , enforcing and

ligitating major IP forms IP such as patents, trade marks, copyright and designs can bevery large for a company on the cutting edge of research , design and prototypemanufacture.

• Environmental Regulation: Environmental considerations are important to proposeddevelopments in Australia and the continued operation of a project or venture.Legislative controls cover a wide range of relevant areas including: land use anddevelopment, environmental impact assessments, building and pollution, waste andcontamination.

.

4.2.6 TAXES

4.2.6.1 GST (GENERAL SALES TAX)

GST is a broad ‐based tax calculated at the rate of 10% on the value of the supply of a broadrange of goods and services. It is paid at each step of the supply chain and the liability to pay ison the supplier of the GST items. Assuming your company is registered for GST (your projectedannual turnover is > $50,000) you will claim an input tax credit which offsets the GST ncluded inthe price of GST items.

Your forecasting process needs to take account of

• The GST component of each transaction.• The due date (monthly, quarterly etc) when GST payables and receivables due are

netted out.



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4.2.6.2 INCOME TAX

The plethora of assumptions in the forecast need to be continually updated with real figures if the cash flow needs of the company are to be adequately understood.

The tax situation will vary whether your company is classed as a sole trader, partnership,company or trust.

Company Income is taxed at the company tax rate of 30% and distributed to shareholders viadividends will be subject to top up tax at personal tax rates. However companies can retainafter tax profits indefinitely. Tax rules are different for other forms of company structure such

as a Partnership or Trust.Your forecasting will need to account of issues such as tax refunds due from previous tradingactivity, losses carried forward, tax concessions and timings of tax payments.

4.2.6.3 OTHER TAXES



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You will also need to take the following additional taxes into account when forecasting:

• Fringe Benefits Tax (FBT) ‐ Levied in respect of the total value of taxable benefits(technology, cars, discounted looans, family schooling) prvided to your employees aspart of their package.

• Customs Duty ‐ imposed on various goods imported into Australia at rates prescribed inthe customs legislation.

• Payroll Tax ‐ imposed by the various States and Territories on wages paid or payable byan employer to an employee.

• Stamp Duty ‐ levied by each of the States on documents and transactions such astransfers of property (including businesses and other business assets), sales of marketable securities which are not quoted on ASX (including shares and units in unittrusts), leasing and hiring arrangements and most secured lending transactions andsome unsecured lending transactions.

• Land Tax – imposed by each of the States on the ownership of land within the State orTerritory.

• Municipal Rates ‐ a common levy imposed on the value of land serviced by local ormunicipal governments.

When operating internationally, your company will also need to factor in the various national

and local taxes and other charge applicable within that jurisdiction.

4.2.6.4 TAX PLANNING

Income Tax deductions can be claimed for a wide variety of expenses. Typically, any expense istax deductable if it is incurred in order to run the company. These could typically includeborrowing expenses, bad debts written off, and an increase in inventory value across thefinancial year, insurance, tax advice and recruitment costs.

In addition, take advantage of any tax breaks and schemes. For example,

You can claim an Entrepreneurs Tax Offset if your turnover this year is likely to be less than$75,000.



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You can claim capital works deductions for property improvements. This applies to extensions,

alterations and improvements to buildings and structural improvements. To qualify for thededuction, the building must be used for the production of assessable income.

Naturally a range of opportunities to take advantage of tax breaks. Specialist advice is mostappropriate here.

One final message. Before entering overseas markets it is important to get professional taxadvice as to your obligations and how to structure overseas transactions.



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5. BALANCE SHEET, WORKING CAPITAL & CAPITAL EXPENDITURE

One of the key financial statements required to be produced by any private registered orpublicly listed company is a Balance Sheet. The Balance Sheet shows the assets, liabilities andequity in your company as a snapshot at a particular point in time.

The Balance Sheet is a snapshot of what you own and owe and

Simply speaking – assets are what the company owns and liabilities are what it owes. Thebalance sheet equation can be expressed simply as

ASSETS = LIABILITIES + EQUITY



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It also shows the liquidity of your company, which is the ease in which assets can be convertedinto cash in order of liquidity.

It does not show the value of the firm, quality of management, and economic and marketconditions in which your company operates.

5.1 BUSINESS CHALLENGES – MANAGING YOUR CASH FLOW



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Estimating and monitoring the future value of assets, liabilities and equity is a very important

component of the forecasting process. You must consider the company’s capacity to fund theownership or access to assets which help to create value for the company by generating profitsand growth.

Conversely it is possible to go broke while making a profit. How? Simply through shortages inworking capital where continual growth consumes cash. Debts generated by increasing salescannot be collected quickly enough to pay off the increasing bills from suppliers whoseproducts you are selling more products from. You require more inventories to service thegrowing number of customers who will eventually purchase your goods, given a time lag. If youdon't have enough cash fluidity in the working capital cycle, you capacity to fund expansion isseverely limited.

5.1.1 MANAGING WORKING CAPITAL

Working capital measures the funds that are readily available to operate a company. Workingcapital comprises the total net current assets of a company, which are its stocks, debtors, andcash—minus its creditors.

The working capital cycle describes capital (usually cash) as it moves through a company: it firstflows from a company to pay for supplies, materials, finished goods inventory, and wages toworkers who produce goods and services. It then flows into a company as goods and servicesare sold, and as new investment equity and loans are received. Each stage of this cycleconsumes time. The more time the stages consume, the greater the demands on workingcapital.

Early warning signs of insufficient working capital include:

• pressure on existing cash;• exceptional cash ‐ generating activities such as offering high discounts for early payment;• increasing lines of credit;• partial payments to suppliers and creditors;• a preoccupation with surviving rather than managing;



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• Introduce retainer payments – a guaranteed fixed sum payment, usually monthly

that enables the customer to call on you for regular work.• Try to have the customer make as much payment upfront e.g. ask for 1/3 rd when the

job commences, 1/3 rd while in progress and the remaining third on completion.• Send the invoice as quickly as possible.• Offer discounts for early payments – say within seven days.• Ensure that your credit reference checking is stringent prior to offering credit terms.• Ensure that your customers know the payment terms and other credit policies.

Make them highly visible in the invoice.• Incentivise the customer to make payments using the method least costly to you –

direct debit to your bank account avoids the fees payable to the providers of creditcards.

• Use collections as a way to motivate your sales force. Delegate to them theresponsibility for timely receipt as a condition of bonuses.

• Ensure that regular statements are sent to customers to act as a reminder.• Be prepared to follow up late payments with phone calls or emails.• Charge interest or service charges on overdue balances.• Aim for partial payment where you know that the customer may be experiencing

financial pain.• Keep records including client’s reasons for slow payment. It will make it easier for

you to validate the reasons the client gives the next time they pay late.• Don’t hesitate for too long in using debt collection services.

Note that as you grow you may lack the capacity or inclination to manage accounts receivableprocesses internally. There are many professional services you can utilise by outsourcing thedebt to a reputable collector.

5.1.1.2 PAYABLES

Accounts payable is the process of paying your suppliers, and like accounts receivable there areplenty of opportunities to improve your cash flow and profitability here.



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• Before looking at some simple ways to improve your cash flow, review first whether it is

necessary to buy the goods and services that you are purchasing in the first place.Above all are your variable costs increasing faster than your revenue? Are youpredicting those sales accurately? Can you purchase second hand rather than new? Inthe current economic downturn, the auction sites are spilling over with great bargains innearly new office furniture.

• Don't be too hasty when paying suppliers. Dun &Bradstreet estimate that the averagelargish company is taking more than 50 days to pay suppliers – and that those areincreasing as we head towards a downturn.

• Are you asking your supplier for discounts? Negotiate with each of them as you may be

surprised at what they can offer you, particularly if you are likely to purchase inquantity, be a regular customer over time or when your supplier is operating in acompetitive market.

• Try to get credit rather than cash terms with suppliers, but ensure that your ownsystems can cope with that.

• Make sure that you are being accurately billed. Suppliers do make mistakes. Theirinvoice personnel may not know about the discount you were offered by thesalesperson.

• Have a good payments tracking system so that it make sit easier to go back to them for

better trading terms and bulk discounts.• However, don't damage your credit rating or string out supplier payments too long. It

may not help in your future dealing with the supplier. If there was a shortage of productthat you normally rely on from that supplier, would you expect to receive your fairallocation?

5.1.1.3 INVENTORY

The ultimate key to success here is to ensure that you have sufficient stock in your warehouseor retail premises to meet your customer’s needs, that you are not holding onto unsold stockfor long and that you can order and receive stock from supplier at just the right time to achievethis. Remember that y our value of stock you carry can be magnified by slow moving items,which in turn tie up your cash in an unproductive way.



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Effective inventory management is imperative in ensuring proper cash flow management and

profitability. You need to know how quickly items are selling, as well as what products areobsolete, what are trends, seasons and fashions depending on your products, what it costs youto store inventory and what your margins are on finished products.

Consider your inventory in three categories

• Raw Materials – Components or materials required to produced finished goods – thenuts and bolts

• Work in Progress – Work that has not been completed but has already incurred a capitalinvestment from the company. This could include partly finished products in an

assembly line, an unfinished house on a property development or even a consultanttime or knowledge in a service business.

• Finished Goods – Ready for sale to the customer.

Now what can go wrong?

• Inadequate tracking system or a mismatch between supply and demand that couldresult in too much overall stock, too much old or obsolete stock. There needs to beproper control over inventory ordered, with optimal ordering cycles, supplier flexibility,regular stock takes and efficient warehouse system. The challenges can be multiplied by

a factor of thousands when you consider all of the individual unique SKU’s • Theft, shrinkage and spoilage are all important aspects and you should budgets for

proper physical safeguards over inventories including locked storage areas for highvalue items, limited access to secured areas and adequate security at warehouselocations.

• Review your supply base, could you rationalise the number of suppliers and thusnegotiate better discounts, service, quality or delivery lead times

• Inevitably you will have slow moving items. You will need to make allowance where thevalue of the inventory falls below its cost e.g. when you need to respond to acompetitors price discounting initiative, when newer versions of products outdatecurrent stock. The magnitude of this will depend on the industry you operate within.Fashion items may rapidly decrease in value over time, as will the value of newlyreleased DVD's



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Ultimately, accept that you will never get things totally right. You’ll need a rule of thumb for a

proportion of total items that are going to be sold for less than cost. This also include fixing ordamaged inventory as well as staff discounts.

When producing a forecast, it is important to consider that some costs will be variable andsome fixed, and some costs will fluctuate more over time. Consider the longer term input costsand maintain the flexibility to transfer components of cost from variable to fixed such asbuilding factories rather than outsourcing manufacturing.

5.1.1.4 FACTORING

This is typically arranged with a financial institution and involves them lending cash to youbased a proportion of the face value of invoices. The institution provides a flexible line of creditand promptly pays up to 90% of your book debts in cash.The balance is paid to your companywhen the debt has been collected from your customer. This process creates a flexible line of credit, allowing you to fund your rising cost of working capital that will come from businessexpansion.

Naturally this comes with costs attached and while it brings forward your cash receivables, itdoes so at the expense of the loss of some of the gross margin you would obtain from thecustomer.

5.2 BUSINESS GROWTH – INVESTING IN THE FUTURE

A key forecasting principle is that over the long term, the assets must generate profit. That rateof profit generated must be higher than the rate of interest incurred on the interest bearingliabilities. When you plan to purchase assets, review the long term value that will be derivedfrom them, whether those assets are tangible (plant & equipment), intangible (patents,goodwill) or even entire companies in an acquisition.

• Sale & Leaseback: Opportunity to derive cash by selling property or large equipmentand leasing it back. You remain the tenants or continue to use the property andequipment.



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• Appreciating Assets: Certain assets, particularly land and buildings may rapidly

appreciate in value over time. Other assets integral to the operation of the companysuch plant & equipment and motor vehicles may depreciate.

• Intangibles: In certain industries, intangible may form a major part of your longer termassets. These include patents and other intellectual property, brands and goodwill, andcan be the liveblood of your company, the source of many of the high value sales and animportant item in the valuation of the company.

• Investment in associates or other non related businesses: Investments are additionalassets not needed for the main part of the company. They are generally acquired usingsurplus cash that the company is not using for working capital or CapEx.

• Acquisitions: Your company may perceive that it needs to make strategic investments inrelated companies ‐ suppliers, customers and associates. These may in the future leadto strategic acquisitions. This is covered in Section 8.

• Investments in unrelated property, shares, trusts and interest bearing securities : Thesehave no relationship to the core business, but may be a simpler way of obtaining higherreturns (at least in the short ‐ medium term) that deploying those funds in companyrelated activities.

Throughout your forecasting period you may want to look at the structural nature of your

organisation and how well it handles a given set of inputs (cash, resources, labour etc) in orderto produce the most efficient set of outputs – finished products, profits and growth.

The following are a series of questions that need to be addressed and include in your growthcostings:

5.2.1 MANUFACTURING CHALLENGES

• Can you make any improvements in efficiency?• How close are the manufacturing facilities to your distribution channels? Is

responsiveness affected? Could you reduce transportation charges? Is theregovernment or other incentives for you to relocate company facilities?

• How available are raw materials and what are the likely cost fluctuations?



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• What is the maintenance requirement of the manufacturing plant? Have they been

costed in, in downtime costs?• What opportunities are there for vertical integrating your manufacturing? Can you

create efficiencies by manufacturing rather than sourcing components? If you supplyproduct to another manufacturer, can you enhance the value of their end product byproducing it yourself?

• How effective are your inventory control systems?• How effective are your QA system?• How old is your equipment? Can newer technologies create cost efficiencies?• What is likely to be the turnover of key personnel? What value do these personnel

bring to your organisation and how dramatic is the learning curve for replacementpersonnel?

5.2.2 RESEARCH & DEVELOPMENT CHALLENGES

One of the key challenges here is to ensure a pipeline of new product innovations that relaceand enhance the current product offering. Dedicated resource in terms of research, market

analysis, partner involvement and the devlreopment of buisness cases need to be costed andincluded in the forecast.

For both new product development and general R&D consider the following:

• What is the research capability of your development team? Are there any skill sets thatyou are lacking? How well equipped are your laboratories and development areas? Canthey be improved? What access can you have to superior, shared resources?

• What manufacturing support is there for R&D? Can tests and small production runs befed through to your plant?

• Do your research staff have a true vision of how the marketplace is evolving? Can theirmanagers inspire a vision and facilitate an innovative & creative environment? Do theyunderstand costs and benefits? Are they focused on market realities and optimise costwith performance



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• How able is your company to recruit and retain specialists? Tech managers who

understand financials,• How proprietary is their technical knowledge and are there risks of that changing?• Can they both create and shape future developments as well as act in the defensive

through lowering offensive manufacturing costs, low cost product improvements andsupporting economies of scale requirements?

5.3 LIMITS TO GROWTH – CAN YOU GROW TOO QUICKLY?

Economic downturns can challenge the most successful rapidly growing companies, but muchof the problem could be that they grew too fast in the first place, by undertaking sub ‐optimalgrowth. Recently Starbucks in the USA announced the closure of 600 unprofitable locations,opening during times of economic growth, but built in the first place without rigid demographicanalysis. It is possible to grow too fast when an investor’s demand for growth exceeds thestrategic business rationale for doing so and it turns into growth only for the sake of growing.

5.4 DEPRECIATION & AMORTISATION

Realistic methodologies need to be attached to the calculation of depreciation, where anyproperty, plant or equipment that "wears out" over time is revalued based on its current value.

The two key methods of depreciation are:

• Straight line ‐ where the same amount of depreciation is charged each year, and

• Reducing Balance, which gives a reducing charge over the life of the assets.

Reducing Balance is best used on assets that

• have a higher maintenance cost as the asset ages or

• are subject to early obsolescence because of technological advances



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5.4.1 INTANGIBLE ASSETS & AMORTISATION

These include trade names, licenses, patents and goodwill i.e. any non physical asset. It alsoincludes the value of a customer base, the value of competent and loyal employees.

Much of a company’s value lies in these important assets, yet often they are not accounted foron the balance sheet. Tyhis is why there is often a large gap between the market capitalisationof a listed company and its book value. It also explains why the market value of your companywill hopefully be significnatly greater than the value of its assets!

Goodwill, the difference between the purchase price and the fair value of the assets and

liabilities acquired, can only be reduced in value‐

through impairment. This is throughamortisation, using the straight line method.



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6 FINANCING

The freeing up of excess working capital may be the cheapest form of financing. However,there will be some occasions in your growth cycle where external finance is the mostappropriate way of achieving a large scale input of funds into your operations. You may beexpanding your product range, processes, research capabilities or your geographical reach, andsimply making internal adjustments will not give you the financial flexibility you need.

As well as having an operational strategy in place, a rapidly growing company also requires a

financial strategy, which is a set of policies that determines the sourcing and distribution of funds.

Even smaller organisations must have a framework for assessing their financial strategy andensuring that it is aligned with the operations of the company. Why?

• To assist in making acquisitiosn that can help grow the company through diversification,horizontal / vertical integration or simply scale by acquiring competitors.

• Ensure that there is sufficient access to finance that the company can draw on in periodsof underachievement.

• Ensure that free cash flows are either profitably reinvested into the organisation, ordistributed to shareholders if such reinvestments cannot obtain a market rate of return.

• Ensure that the cash reserve is deployed appropriately.

Key issues:

Most companies will be financed by a mixture of debt and equity. A healthy growing companyshould have an “appropriate” balance of debt (borrowings) and equity (ownership). This“appropriate” capital strcuture needs to give consideration to your company’s future revenuesand investment requirements.

Debt finance is less costly because debt holders expect a lower rate of return in exchange forgreater certainty of repayment and a preferential position in the event of bankruptcy. Debt isalso tax deductible, thus further reducing the cost of debt to the company.



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One of the purposes of forecasting is to ensure that you have sufficient debt capacity in place to

be able to cope with a range of different scenarios that could occur. One key issue is to watchthe interest charges incurred by borrowings. Profits can be reduced or even eliminated byborrowings which in turn have to be funded by a reduction in owners’ equity. In the currenteconomic circumstances with rising interest rates this is all the more prevalent.

Equity includes

The original share capital rose for the companyAny additional capital raisingsPrevious year’s profits not dispersed through dividends.

. Debt is …….

funding are the interest deductibility on the debt lowering the cost of capital relative to equity.

6.1 DEBT

Your company is more viable long term if the borrowings match the assets e.g. a company withmainly long term assets requires mainly long term borrowings. You should not arrange shortterm borrowings to acquire non current assets, as the short term cash inflows from revenuesgenerated by the non current asset will more than likely not match the outflows from paymentsdue on the asset.

You will need to consider appropriate levels of debt. Too much debt as a percentage of totalcompany value can mean:

• Interest payments will swell and put pressure on your company to be able to coverinterest and principal repayments.

• A lower credit rating for companies who are rated by credit agencies such as Moody’sand Standard & Poors



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Loans have the potential to be substantially reduced if other cash flow components could bemanaged

The timing of borrowing repayments is important as sufficient cash will be required, or newborrowings arranged. You'll need to predict the likely cash situation at the time and the likelyneed to arrange new funds.

You may also have given commitments to lenders, such as banks, that the company maintainscertain pre ‐agreed ratios for liquidity (cash buffers) and other criteria. These are known ascovenants, and commit the compan y to agree limit other borrowing or to maintain a certainlevel of gearing. Other common limits include levels of interest cover, working capital and cashflow.

6.2 EQUITY

Along your growth path, you are going to be reviewing a range of issues pertaining to

ownership of your company. While you may have 100% yourself, have the ownership splitamongst a number of shareholders, or indeed have an external investor such as a businessangel or venture capitalist involved, your needs for funding and your need to keep your ownmanagers motivated and incentivised may result in a dilution of this ownership.

The issues that surround deal making with external investors and employee share and optionprogrammes go beyond the scope of this booklet, but from a financial forecast, you need to becognizant of the following:

Dividend payments to shareholders after reporting periods. Shareholders may want to seesome return on their shares even prior to a planned trade sale or ASX listing. The rationalapproach to dividend payments is that if the company cannot reinvest the earnings at a higherexpected return that the shareholder would obtain through use of the money in an alternativeinvestment proposition, then the company should pay the Dividend.



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6.2.1 RETAINED PROFITS

Explain issues of declaring dividends, retained earnings etc.

You've got a positive NPAT (net profit after tax), so how is that money best deployed? Discussdividend payouts versus reinvestment vs idle cash

Several factors should be considered when thinking about investing retained profits. Theseinclude

RETURNS‐ The percentage you earn on an investment is key. Some products, like bonds, offer aspecific, guaranteed return. Some products offer a higher return, but it is not guaranteed.

SAFETY‐ What’s the risk factor? Conservative investors might choose a bank savings accountbecause the return is safe. Aggressive investors might prefer to lean towards property orshares, but their money is not insured, nor is the return guaranteed.

LIQUIDITY‐ If and when you need your invested money, how quickly can you access it? Moneymarket accounts and savings accounts are considered liquid assets because they can be turnedinto cash quickly. Products with staggered maturity dates give you access to cash at differenttimes.

DIVERSITY‐ A smart way to reduce risk is by spreading your money among several types of investment products. For example, you could bonds and shares.

6.2.2 SHARE CAPITAL ISSUED

Determinants ‐

Large issues have proportionately much lower costs of issuing than small ones



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6.2.3 DIVIDENDS DECLARED & PAID

Consider the necessity of declaring a dividend.

Determinants include:

• How much cash is available ‐ liquidity• Debt covenants restricting the payout amounts to shareholders• Stability of earnings.

Dividend policy revolves around public perception rather than rational company objectives ‐ i.e.that the firm should maintain or increase its dividend payout every year. However, the realissue is whether the firm can gain a better return on those funds than the shareholder.

6.2.4 RESERVES

Types of ReservesShareholder Contributions This includes

a) options, where investors subscribe funds to acquire an option thatgives them the right to acquire funds at a later date.

b) Forfeited shares reserve, where investors failed to pay a call onpartly paid shares.

Realised Gains These include:Gains made on disposal of capital types of profitRetained earningsGeneral reserveCapital profits reserve

Unrealised Gains These include:Asset revaluation reservesForeign currency transaction reserves



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7 REPORTING & ANALYSIS

Behind the financial statements sit a whole series of analysis about whether your company isheading in the right direction. This section is dedicated to:

a) Reviewing your cash flow forecast.b) Reviewing your performance ratios.c) Tracking your actual performance to your budgetd) Explaining the value of considering alternative scenarios for your company

7.1 CASH FLOW & CASH MANAGEMENT FORECASTING



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“You can lose money for a while, but you only run out of cash once”

The cash flow forecast is an absolutely essential part of your company. It will help you to seehow much cash is in the company at a future point in time determining your requirements forexternal financing and your capability to expand. A properly formulated forecast will help youunderstand whether you can afford the growing working capital requirements of an expandingcompany, whether you can pay your debts and reward your shareholders and whether youafford the capital expenditure required to future growth.

Cash flow is simply the movement of cash in and out of the company. Cash flow managementis essential as a discipline that keeps a company is kept in a healthy state. It reduces the risk of insolvency and can reduce the cost of financing an entity. This is by reducing the amount of capital employed.



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In your forecasts , there will be cetain danger signals, where ther eis insufficient cash being

generated from operations:• Net cash flows from operations are negative• Receipts from customers are lower than payments to suppliers and employee.• Cash flow from operating activities is lower than the after tax profit

Most likely, your forecasting software will generate for you a forecasted cash flow based non allof the revenue and cost inputs that you have made into the software. The key consideration is

that you have sufficient cash in the bank / funds to cover any periods where your cash outflowsexceed your cash inflows. You also need to consider shortfalls and seasonal fluctuations. Youmay have slow sales periods or periods in which customers are more likely to pay late.

With this forecast, you must also take into account, various risk factors. If you’ve got very littleset aside in your account, what percentage shortfall in revenues earned will make you unableto meet your month end payments?

7.1.1 CASH FLOW AND INVESTORS

Finally viewing the cash flow statement from a potential investors standpoint, before investingthe investor needs to be convinved that cash will be created, that can be eventually taken outof the business by the investor. The investor will seek a cash flow model incorporating thefollowing variables with built in scenarios that can be changed in a “What If…? Type format.

• The estimated costs of acquiring a customer• pricing and gross margins,• accounts receivables aging,• realistic administrative costs,• taxation• depreciation.



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7.2 RATIO ANALYSIS

You need to include within your forecast, a series of ratios that review the forecastedperfroamcne of your company across a range of criteria. These include:

Short Term Solvency /Liquidity

Can the company pay its duedebts?

• Current Ratio = Current Assets / CurrentLiabilities

• Quick Ratio = Quick Assets / Current Liabilities

Activity / Efficiency How well is working capitalmanaged? How well do yourcompany’s assets generatesales?

• Asset Turnover = Revenue / Total Assets• Receivables Turnover = Revenue / Receivables• Inventory Turnover = Cost of Goods Sold /

Average Inventory

Financial Leverage How does your financialstrcuture change over time?How much financial risk areyou exposed to?

• Debt ratio = Total Debt / Total Assets• Debt/Equity ratio = Total Debt / Total Equity• Debt / Capitalisation = Total Debt / (Total Debt

plus Equity• Interest Cover = Earnings before interest and

taxes (EBIT) / Interest Expense• Profitability – measure performance / profit• Profit margin = Profit / Revenue• Return on Assets (ROA or ROI) = Profit / Total

Assets• Return on Equity (ROE) = Profit / Equity

Market Value Ratios If you are a listed company,whaty is the market’s view of your company?

• P/E ratio = market price per share / Earnings pershare (EPS)

• Dividend Yield = Dividend per share / Marketprice per share

• Market / Book = Market price per share / BookValue



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7.3 VARIANCE

Simply forecasting your company’s finances is not sufficnet enough. You need to be continuallymonitoring how your actual performance is comparing to your forecast.

Has your actual financial performance for the period lived up to the budgets and expectationsyou set at the beginning of the period? The difference is simply the variance and is a key set of statistics for presentation to the board, management and financiers.

If your company has not performed to expectation, how much of this can be attributed to:

• Unexpectedly high or low level of awareness or sales from promotional activity.• Poor purchasing policies or efficiency• Poor labour usage or efficiency• Poor distribution policies• Poor pricing strategy• Changes in consumer behaviour or attitudes• Unanticipated seasonal variations• Reputation of the company changing.

And more important, what can be done to change this?

It is important to be able to track your actual overhead costs to that which you had budgetedfor. Costs have a way of spiraling out of control when there’s insufficient management scrutiny.

The greater the risks and volatility in your overall industry, the greater the time and emphasisshould be placed on tracking your performance to budget. The more unpredictable the future,the more often you need to be reforecasting and producing rolling forecasts in order to alignyour operating needs with the general competitive environment.

Increasingly, board reporting is simplified by a series of pre ‐developed digital dashboardsillustrating the perforamnce of key variables. Here is one such excample:



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Finally, what kind of financial reviews take place, who undertakes and how frequently are they

undertaken. These reviews could include:

STRATEGIC: Is the company focused and focused in the right direction? Review byperformance to budget, sales to expense ratios etc.

PROFITABILITY: Where is the company making most of its profit? Review by product,customer, territory or channel.

EFFICIENCY: How efficinet is expenditures in different areas relative to results. Review byproduction, R&D, marketing, sales, accounts, customer service and pretty well every business

function that has costs associated with its upkeep.

7.4 SCENARIO ANALYSIS



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A complete financial forecast will have alternate results reflects alternate outcomes that could

happen to the company. For example, they may reflect realism, optimism and pessimism in thefinancial plan

The impact on a cash flow of a pessimistic forecast must be taken into account. Can thecompany withstand the shocks, in terms of its current liabilities (interest to be repaid, creditorsetc) and reserves of one or more worse than expected reporting periods.

With the results of a pessimistic cash flow forecast, consider your strategies for the following:

• Would you seek to maintain or downscale future capital expenditures for subsequentperiods?

• Do you have the flexibility to adjust the debt repayment schedules?• What changes would you make to the operational side of the company in terms of

subsequent forecast periods of revenue and cost? In the end this would depend on thereason for the performance shortfall relative to base case.

• Has the overall market for your products and services changed? (How did yourcompetitors perform?) Are there structural changes in the way that your customershave their needs met (Airlines v Video & WebConferencing) or are there changes in theoverall economy (downturns in consumer spending)

You may want to develop a more sophisticated modeling environment for forecasting:

• What would be the profit impact of delaying a product launch?• What would be the impact on profits of offering discounts to increase sales volume?

Consider applications that provide sophisticated and powerful modeling and "what if"calculations.

The following layout compares the financial outcomes under a range of alternate sceanrios.



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7.5 FINANCIAL RISK MANAGEMENT

A majopr component of forecasting is the understanding of risks that could adversely affect thecash flows of your company, as well as a strategy for mitigating them, even if, like most of theserisks they are outside of your control.

Increasingly uncertain times, greater competiveness and greater industry volatility calls for RiskManagement processes even in the smallest of organisations.

Components such as interest rate fluctuations (both in Australia and overseas), changes inexchange rates and changes in the commodity prices, are all inevitable issues when doing

business. They create an unanticipated mismatch between prices, costs and debt and mostsignificantly affect trading margins and interest repayments.

You need to

a) considering where you are exposed to risk



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b) understand the size of that exposure

c) consider how this risk may be mitigated.

Risks may be classified as follows:

TYPE OF RISK EXPLANATION DETAIL MITIGATIONLiquidity Risk Insufficient funds

to meet dueliabilities.

Borrowed fundsnot available atacceptable terms.Loss of credit linefrom funder.

Maintain unused funding sources in viewof factors such as future debt repayment,capital expenditure, seasonal fluctuations,potential acquisitions and contingencies

Interest Rate Risk Movements ininterest rates willaffect financialperformance byincreasing interestexpenses

Include sensitivity analysis in yourforecasts.Use of pre ‐agreed fixed and locked ininterest rates.Offsetting the increases in interest paid inone part of business with interestreceived on another.Use of swaps – exchanging a floating rateobligation for a fixed obligation.

Foreign ExchangeRisk

Risk that exchangerate used toconvert foreignrevenues andexpenses andassets / liabilitiesto Australiandollars causesshareholderwealth to decline

Risk that thesemovements makeyour company’sproducts orservicesuncompetitiveinternationally.

Forward planning including buyingforward currencyOther hedging against currency movese.g. foreign currency bank accounts.

Commodity PriceRisk

Risk that a changein the price of acommodity that is

a key input /output of anorganisationsbusiness willadversely affectfinancial

Reducing reliance on specificcommoditiesForward buying



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performanceCredit Risk Risk that the other

party in atransaction willnot be able tomeet its financialobligations.

Could also be theconsequence of internationalgovernmentdirectives andpolicies or asettlementdelivery risk thatdestroys futurebusiness dealings

Assess counterparty risks prior toinvolvement. Use of prompt payments.Avoid creating an undue dependency of alimited number of suppliers, distributorsor customers

Here’s where the key risk elements may be create:

• Who are your customers? How much of your total revenue is made up by the top fivespenders? Top ten? Top twenty?

• Where are your customers located?• Where is your manufacturing done?• How much are your interest expenses, are they fixed or floating and in what currency

denomination?• What is the main currency denomination of your payables and receivables?• What are the main currency denominations of your major competitors?



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The following chart illustrates the average value of a bui8sness in different indsutries in the

first quarter of 2008 as a multiple of their EBIT:

SOURCE: BizExchange Index ‐ March 2008 Quarter Results

________________________

Generating forward cash flow figures and discounting them at the cost of capital enables you tocalculate the present value of your company. Your software is a useful valuation tool, as thesoftware helps you look ahead at those future cash flows and allows you to see what steps



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need to be taken to increase the valuation. Valuation is particularly important where future

profit may be a long way out, or where your cash flows are irregular.

Valuation is a versatile tool appropriate for buying or selling a company or as an importantmanagement focus and motivation tool. Agreeing and targeting a stream of anticipated futurecash flows, is a far better measure of business value that accounting statements!

8.1 INCREASING YOUR BUSINESS VALUATION

Your financial forecast should display numerical evidence that many of the following stragtegiesare being adopted as you grow your company:

• Implementing a marketing strategy based on differentiation, ost leadership or extremefocus .

• Create entry barriers through economies of scale, product differentiation.• Access to distribution channels.• Design a strategy to maintain market share•

Reduce costs in line with industry demand reduction• An effective relationship between total cumulative output and unit cost of your

production of products and/or services.• Attempt to identify profitable niche• The effectiove use of possible alliances/partnerships.

8.2 MERGERS & ACQUISITIONS

It is estimated that only 17% of acquisitions add shareholder value, while 53% actually loseshareholder value and the remaining 30% produce no added value.

An acquisition may be part of your “roll up” strategy to consolidate the number of players inyour industry. The advantages of this may include:



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• Revenue enhancements from improved marketing, less competition, capacity to enter

new markets and greater muscle when seeking large corporate or governmentcustomers through tendering opportunities.

• Cost reductions from economies of scale, economies of vertical integration, eliminationof inefficient management, purchase economies and the capacity to make better use of existing resources.

• Risk diversification through having either a broader geographic operation, the capcity todiversify into different customer segments

• Tax gains from transfer of operating losses, unused debt capacity and lower cost of capital.

A longer term strategy may also be the incrwase overall valuation of the combined companythrough obtaining the higher valuation multiples that corporates achieve relative to SME’s.However undertaking an acquisition for this purpose alone is risky as economic boom / slumpcycles also play a significant role in the determination of multiples.

In addition, many of the more successful “roll up” acquisitions are under the guidance of aPrivate Equity team. While Private Equityclearly has its role in strategic planning, drivingprocesses and financial strcutures etc, investors may well have different time horizons toowners and may be motivated more by the financial engineering than the long tern business

opportunities.

With potential acquisitions, you should be able to see a financial opportunity throughunderperforming assets or bad management. But they may be more than offset by the ControlPremium, the costs of acquisition, and post acquisition challenges such as potentialdiseconomies of scale includng loss of key staff dissatisfied by the acquisition etc.

Acquisition is only one of many alternatives for growth. Other quasi ‐ integration strategiesinclude technology licenses, strategic alliances, franchising, joint ventures or asset ownership.The chart in Chapter Three review the partnering and alloajnce process and argues that you

could achieve smilar objectives at a lower risk by considering this route.

Acquositions may also involve a Management Buy Out (MBO) of your company, where yourincumbent management team raises capital to buy your company. Alongside yourmanagement team, an investor or VC will take a stake in the company, and arrange debt



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funding for the management team The advantage of this is that the amangement team is now

focussed on the same goals as the shareholders.

8.2.1 VERTICAL INTEGRATION

Vertical Integration is a means of co ‐ordinating the different stages of an industry supply chain.Here your company may seek to owns its upstream suppliers and its downstream buyers. It’sdhowever a risky strategy, complex, expensive and hard to reverse.

The main circumstances given when it can be good to integrate are:

• When the vertical supply chain “fails”, transactions between the players become toorisky and too costly, and there needs to be some “control” or market power in its place.

• When vyou can create an exploit market power, usually be creating barriers to entry forother companies looking at competiing in this space.

• Where the industry life cycle is either too young – andf you have to forward integrate todevelop the market, or too old e.g. you have to fill gaps by others leaving market. (Youmay need the reassurance of product supply from a company considering exiting theindustry).

There are also spurious reasons for integration e.g. reducing cyclicality and assuring marketaccess.

In the end Long ‐term contracts, joint ventures, strategic alliances, technology licenses, assetownership, and franchising tend to involve lower capital costs and greater flexibility thanvertical integration.



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8.3 DUE DILIGENCE

Definition of due diligence….

If you are considering a takeover …

Large & complex subject in itslef, but this series of mindMaps will….



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9 REVIEWING YOUR FORECAST

How good a shape is your company in at the end of your forecast period? Have you costed in toyour forecast, expenses that ensure the following are covered:

• Your manufacturing plant remains effective, productive and not facing technicalobsolescence.

• The next generation of those products have been developed to replace and enhanceyour current revenue streams

• There is the potential spare capacity in manufacturing, or the flexibility to outsource inorder to cater for an upsurge in demand.

• You have the right skill set in your development division to respond to or create newdevelopments in your chosen market.

• You have made the right investment in environmental safeguards botho Positively ‐ "green" products that will appeal to a more concerned publico Negatively ‐ limit the potential for litigation for environmental damage caused by

products, manufacturing plants etc or via public opinion ‐ packaging etc.

The final words go to Woody Allen:

“More than anytime in history, mankind faces a crossroads. One pathleads to despair and utter hopelessness, the other to total extinction.Let us pray we have the wisdom to choose correctly”

planning to succeed - the definitive eguide for building company financial forecasts mark ostryn...

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