Description
Engineering Entrepreneurship Dr. Amy Hsiao
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ENGI 8150:
Engineering Entrepreneurship
Dr. Amy Hsiao
Lecture 6
Memorial University of Newfoundland
Assessing a New Venture’s Financial Strength
and Viability
? Are we making or losing money?
? How much cash do we have on hand?
? How do our growth and net profits compare to those of our
industry peers?
? Where will the funds we need for capital improvements come
from?
? Are there ways we can partner with others to share risk and
reduce the amount of cash we need?
? Overall, are we in good shape financially?
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Financial Management and Objectives
? Raising Money
? Managing a company’s finances to achieve
the highest rate of return.
Profitability: A company’s ability to make a profit
Liquidity: A company’s ability to meet its short-term obligations
Efficiency: How productively a firm uses its assets
Stability: The overall health of the financial structure of the firm,
particularly as it relates to its debt-to-equity ratio
Financial Objectives of a Firm
? Profitability
? Is the ability to earn a profit.
? Many start-ups are not profitable during their first one to three
years while they are training employees and building their brands.
? However, a firm must become profitable to remain viable and
provide a return to its owners.
? Liquidity
? Is a company’s ability to meet its short-term financial
obligations.
? Even if a firm is profitable, it is often a challenge to keep enough
money in the bank to meet its routine obligations in a timely
manner.
3
Financial Objectives of a Firm
? Liquidity
? Accounts receivable – money owed to the firm by
its customers
? Inventory – merchandise, raw materials, and
product waiting to be sold
? If a firm allows levels of either of these assets to
get too high, it may not be able to keep sufficient
cash on hand to meet its short-term obligations.
? Ex. Small that sells to larger companies may get paid
30-60 days from the time of sale.
Financial Objectives of a Firm
? Efficiency
? Is how productively a firm utilizes its assets relative to its
revenue and its profits.
? Southwest Airlines, for example, uses its assets very productively.
Its turnaround time, or the time its airplanes sit on the ground
while they are being unloaded and reloaded, is the lowest in the
airline industry.
? Stability
? Is the strength and vigor of the firm’s overall financial
posture.
? For a firm to be stable, it must not only earn a profit and remain
liquid but also keep its debt in check.
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Debt-to-Equity Ratio
? If a firm continues to borrow from its lenders and its
D/E ratio gets too high, it may have trouble meeting
its obligations and securing the level of financing
needed to fuel its growth.
? Calculated by dividing its long-term debt by its
shareholders’ equity (the owners' residual interest in
the assets of an enterprise after deducing all its
liabilities)
The Process of Financial Management
? Importance of Financial Statements
? To assess whether its financial objectives are being met,
firms rely heavily on analysis of financial statements.
? A financial statement is a written report that quantitatively
describes a firm’s financial health.
? The income statement, the balance sheet, and the statement of cash
flows are the financial statements entrepreneurs use most
commonly.
? Forecasts
? Are an estimate of a firm’s future income and expenses,
based on past performance, its current circumstances, and
its future plans.
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The Process of Financial Management
? Forecasts (continued)
? New ventures typically base their forecasts on an estimate
of sales and then on industry averages or the experiences
of similar start-ups regarding the cost of goods sold and
other expenses.
? Budgets
? Are itemized forecasts of a company’s income, expenses,
and capital needs and are also an important tool for
financial planning and control.
The Process of Financial Management
? Financial Ratios
? Depict relationships between items on a firm’s financial
statements.
? An analysis of its financial ratios helps a firm determine
whether it is meeting its financial objectives and how it
stacks up against industry peers.
? Importance of Financial Management
? Many experienced entrepreneurs stress the importance of
keeping on top of the financial management of the firm.
6
Process of Financial Management
? Financial Statements
? Income statement
? Balance sheet
? Statement of cash flows
The Process of Financial Management
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Financial Statements
? Historical Financial Statements
? Reflect past performance and are usually prepared on a
quarterly and annual basis.
? Publicly traded firms are required by the SEC to prepare financial
statements and make them available to the public. (Ex. 4-Q of
Facebook)
? Pro Forma Financial Statements
? Are projections for future periods based on forecasts and
are typically completed for two to three years in the future.
? Pro forma financial statements are strictly planning tools and are
not required by the SEC.
Financial Statements and Forecasts
? Pro forma financial statements are projections
for future periods based on forecasts and
typically completed for 2-3 years in the future.
? For planning only, confidential, internal
8
Importance of Keeping Good Records
The first step toward prudent
financial management is
keeping good records.
Income Statement
? Reflects the results of the operations of a firm over a
specified period of time.
? Monthly, quarterly, or annual.
? Shows whether the firm is making a profit or
experiencing a loss.
? Multiyear format – used to evaluate effect of past
strategies and help project future sales and earnings.
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Consolidated Income Statements for New
Venture X-TECH
Dec. 31, 2006 Dec. 31, 2005 Dec. 31, 2004
Net Sales 586,600 463,100 368,900
Cost of sales 268,900 225,500 201,500
Gross Profit 317,700 237,600 167,400
Operating Expenses
Selling, general, and admin. Expenses 117,800 104,700 90,200
Depreciation 13,500 5,900 5,100
Operating Income 186,400 127,000 72,100
Other Income
Interest Income 1,900 800 1,100
Interest Expense (15,000) (6,900) (6,400)
Other Income (expense), net 10,900 (1,300) 1,200
Income before taxes 184,200 119,600 68,000
Income tax expense (53,200) (36,600) (18,000)
Net income 131,000 83,000 50,000
Earnings per share 1.31 0.83 0.50
Income Statement
? Net sales: total sales minus allowances for returned
goods and discounts
? Cost of sales (or COGS): include all the direct costs
associated with producing or delivering a product or
service, including the material costs and direct labor.
? Operating expenses: marketing, administrative costs,
and other expenses not directly related to producing a
product or service.
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Income Statement
? Compare ratios of COGS to Net Sales
? Compare ratio of operating expenses to Net
Sales
55%, 49%, 46% for 2004, 2005, 2006 respectively
Steadily decreasing its material and labor costs per dollar of
sales – good trend
Income Statement
? Profit Margin (return on sales)
? Net Income/Net Sales
13.6%, 17.9%, 22.3% for 2004, 2005, 2006 respectively
Firm is either boosting its sales without increasing expenses or
doing a better job of controlling its costs.
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Income Statement
? Price-to-earnings ratio (P/E ratio)
? Price of a company’s stock against its earnings
? Generally, the higher a company’s P/E ratio, the
greater the market thinks it will grow.
? Say the stock of X-TECH was trading at $20
per share, so its P/E ratio would be 15.3.
Balance Sheet
? Snapshot of a company’s assets, liabilities, and
owners’ equity at a specific point in time
? Left/Top shows a company’s assets
? Right/Bottom shows a company’s liabilities and
owners’ equity
? Assets are listed in order of liquidity (length of
time it takes to convert them to cash)
? Must always balance
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Balance Sheet – Categories of Assets
? Current assets – include cash plus items that are
readily convertible to cash, such as A/R,
marketable securities, and inventories
? Fixed assets – used over a longer time frame,
such as real estate, buildings, equipment, and
furniture
? Other assets – accumulated goodwill, etc.
Balance Sheet – Categories of Liabilities
? Current liabilities – obligations that are payable within
a year, including A/P, accrued expenses, and the
current portion of long-term debt
? Long-term liabilities – notes or loans that are repayable
beyond 1 year, including liabilities associated with
purchasing real estate, buildings, and equipment
? Owners’ equity – equity invested in the business by its
owners plus the accumulated earnings retained by the
business after paying dividends
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Balance Sheet
? Does not record “fair market value”
? Ex. Real estate value
? Value of IP
? Goodwill
? Not listed: Intangible assets – training
Consolidated Balance Sheets for X-TECH
Dec 31, 2006 Dec 31, 2005 Dec 31, 2004
Current Assets
Cash and cash equiv. 63,800 54,600 56,500
A/R, less allowance for doubtful accounts 39,600 48,900 50,200
Inventories 19,200 20,400 21,400
Total Current Assets 122,600 123,900 128,100
Property, land, equipment
Land 260,000 160,000 160,000
Building and Equipment 412,000 261,500 149,000
Total property, plant, and equipment 672,000 421,500 309,000
Less: accumulated depreciation 65,000 51,500 45,600
Net property, land, and equipment 607,000 370,000 263,400
Total Assets 729,600 493,900 391,500
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Consolidated Balance Sheets for X-TECH
Liabilities and Shareholders’ Equity Dec 31, 2006 Dec 31, 2005 Dec 31, 2004
Current liabilities
Accounts payable 30,200 46,900 50,400
Accrued expenses 9,900 8,000 4,100
Total current liabilities 40,100 54,900 54,500
Long-term liabilities
Long-term debt 249,500 130,000 111,000
Total liabilities 289,600 184,900 165,500
Shareholders’ equity
Common stock (100,000 shares) 10,000 10,000 10,000
Retained earnings 430,000 299,000 216,000
Total shareholders’ equity 440,000 309,000 226,000
Total liabilities and shareholders’ equity 729,600 493,900 391,500
Balance Sheet
? Working Capital
? Current assets minus current liabilities
? $82,500 = amount of liquid assets the firm has available
? Current Ratio
? Firm’s current assets divided by its current liabilities
Current Ratio 3.06
It has $3.06 in current assets for every $1.00 in current liabilities
Healthy – can meet current liabilities
Trend – 2.35, 2.26, 3.06
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Balance Sheet
? Debt Ratio
? Divide total debt by total assets
The present debt ratio is 39.7%, which means that 39.7% of its total assets
are financed by debt and the remaining 60.3% by owners’ equity.
Healthy for a young firm.
Trend is good too – 42.3, 37.4, 39.7
Over time, the company is relying less on debt to finance its operations
Less debt creates more freedom for the firm in terms of taking different
actions.
Balance Sheet
? Note that the $131,000 net income reported on
its 2006 income statement shows up as the
difference between its 2006 and 2005 retained
earnings on its 2006 balance sheet.
? No dividends were paid to its stockholders so
the company retained all of its $131,000 in
earnings.
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Statement of Cash Flows
? Summarizes the changes in a firm’s cash position for a
specified period of time and details why the change
occurred.
? Three categories:
? Operating activities – net income (or loss), depreciation,
changes in current assets and liabilities other than cash and
short-term debt. A firm’s net income, taken from its income
statement, is the first line on the corresponding period’s cash
flow statement.
Statement of Cash Flows
? Three categories:
? Investing activities: include the purchase, sale or
investment in fixed assets, such as real estate, equipment,
and buildings
? Financing activities: include cash raised during the period
by borrowing money or selling stock and/or cash used
during the period by paying dividends, buying back
outstanding stock, or buying back outstanding bonds
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Consolidated Statement of Cash Flows
for X-TECH
Dec 31, 2006 Dec 31, 2005
Cash flows from operating activities
Net income 131,000 83,000
Additions (sources of cash)
Depreciation (deducted in income statement but not cash expenditure) 13,500
5,900
Decreases in A/R 9,300 1,300
Increase in accrued expenses 1,900 3,900
Decrease in inventory 1,200 1,000
Subtractions (uses of cash)
Decrease in A/P (16,700) (3,500)
Total adjustments 9,200 8,600
Net Cash from Operating Expenses 140,200 91,600
Consolidated Statement of Cash Flows
for X-TECH
Dec 31, 2006 Dec 31, 2005
Cash flows from investing activities
Purchase of building and equipment (250,500) (112,500)
Net cash flows from investing activities (250,500) (112,500)
Cash flows from financing activities
Proceeds from increase in long-term debt 119,500 19,000
Net cash flows provided by financing activities 119,500 19,000
Total Increase in cash 9,200 (1,900)
Cash and cash equiv. at the beginning of the year 54,600 56,500
Cash and cash equiv. at the end of the year 63,800 54,600
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Ratio Analysis
? Ratio Analysis
? The most practical way to interpret or make sense of a
firm’s historical financial statements is through ratio
analysis, as shown in the next slide.
? Comparing a Firm’s Financial Results to Industry
Norms
? Comparing a firm’s financial results to industry norms
helps a firm determine how it stacks up against its
competitors and if there are any financial “red flags”
requiring attention.
Ratio Analysis
? Profitability Ratios
? Return on Assets (ROA) = net income/average total assets
? Return on Equity (ROE) = net income/average shareholders’ equity
? Profit Margin = net income/net sales
? Liquidity Ratios
? Current Ratio = current assets/current liabilities
? Overall Financial Stability Ratios
? Debt = total debt/total assets
? Debt-to-Equity = total liabilities/owners’ equity
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Historical Ratio Analysis
Historical Financial Statements
Three types of historical financial statements
Financial Statement Purpose
Income Statement
Balance Sheet
Statement of Cash Flows
Reflects the results of the operations of a firm over a
specified period of time. It records all the revenues and
expenses for the given period and shows whether the firm
is making a profit or is experiencing a loss.
Is a snapshot of a company’s assets, liabilities, and
owner’s equity at a specific point in time.
Summarizes the changes in a firm’s cash position for a
specified period of time and details why the changes
occurred.
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Comparison Data for Dell
Dell Inc.
(05-06
fiscal yr)
Industry Median
(05-06 fiscal yr)
Market Median
(05-06 fiscal yr)
Gross profit margin 17.50% 34.00% 51.80%
Net profit margin 6.00% 3.00% 4.80%
ROE 75.6% 10.3% 9.5%
ROA 14.9% 3.5% 1.6%
12-month revenue
growth
11.1% 10.7% 12.3%http://www.wikinvest.com/stock/Dell_(DELL)/Data/Key_Metrics
Comparison Data for X-TECH and All
Incorporated Competitors
X-TECH Others
Sales 100% 100%
COGS 45.8% 42.9%
Current ratio 3.05% 1.1%
D-E Ratio 65% 4.5%
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Sales per Square Foot
? Tests efficiency of operations (how productively assets are
used)
Year Average sales per
square feet
Peets Coffee 2002 $696
McDonalds 2002 $543
Starbucks 2002 $521
New Venture Coffee 2004 $512
Panera Bread 2002 $418
Ruby Tuesdays 2002 $377
Forecasts
? The analysis of a firm’s historical financial statements are
followed by the preparation of forecasts.
? Forecasts are predictions of a firm’s future sales, expenses,
income, and capital expenditures.
? A firm’s forecasts provide the basis for its pro forma
financial statements.
? A well-developed set of pro forma financial statements
helps a firm create accurate budgets, build financial plans,
and manage its finances in a proactive rather than a
reactive manner.
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Financial Statements and Forecasts
? Pro forma financial statements are projections
for future periods based on forecasts and
typically completed for 2-3 years in the future.
? For planning only, confidential, internal
Forecasts
? A sales forecast is a projection of a firm’s sales for a specified
period (such as a year).
? It is the first forecast developed and is the basis for most of the
other forecasts.
? A sales forecast for a new firm is based on a good-faith estimate of
sales and on industry averages or the experiences of similar start-ups.
? A sales forecast for an existing firm is based on (1) its record of past
sales, (2) its current production capacity and product demand, and (3)
any factors that will affect its future product capacity and product
demand.
23
Forecasts
? Forecast of Costs of Sales and Other Items
? Once a firm has completed its sales forecast, it must
forecast its cost of sales (or cost of goods sold) and the
other items on its income statement.
? The most common way to do this is to use the percentage-
of-sales method, which is a method for expressing each
expense item as a percentage of sales.
? If a firm determines that it can use the percent-of-sales method and
it follows the procedures described in the textbook, then the net
result is that each expense item on its income statement will grow
at the same rate as sales (with the exception of items that can be
individually forecast, such as depreciation).
Forecast of Costs of Sales
? Percent-of-sales method expresses each
expense item as a percentage of sales
? COGS averaged 47.5% over past two years (‘05,
‘06)
? Project for future year: 47.5% of sales forecast
($821,200) = $390,000 in 2007
? Constant ratio method of forecasting
? Percent-of-sales is applied to all other accounting of
expenses
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Forecasts
Historical and Forecasted Annual Sales for X-TECH
Breakeven Analysis
? Total fixed costs / (price – average variable costs)
? If the total fixed cost associated with opening a new
company is $101,000 per year, the average price for
the company’s product is $2.75, and the variable
cost for each product is $1.10, then the breakeven
point is 61,212 units per year
? 170 per day, based on a 360-day year
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Forecasts Used to Prepare Pro Forma
Income Statements
? Net sales
? Historic: Average sales increase of 25% per year
? 2007: Increase to 40% as the result of increased brand
awareness and the opening of a 2
nd
location
? 2008: increase 25% as the result of increased brand
awareness
? COGS
? Historic: Average of 47.5% of sales the past 2 years
? 2007: 47.5% of sales
? 2008: 47.5% of sales
Forecasts Used to Prepare Pro Forma
Income Statements
? Selling, general, and administrative expenses
? Historic: average 22% of sales the past 2 years
? 2007: increase to 25% of sales as result of 2
nd
location opening
? 2008: 25% of sales
? Interest expense
? Historic: 6-7% of long-term debt
? 2007: 7% of long-term debt
? 2008: 7% of long-term debt
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Forecasts Used to Prepare Pro Forma
Income Statements
? Other income
? Historic: licensing income of $10,900 per year
? 2007: licensing income will increase to $20,000 as
a result of a renegotiation of a contract
? 2008: licensing income will be $20,000
Pro Forma Income Statement for New
Venture X-TECH
Actual 2006 Projected 2007 Projected 2008
Net Sales 586,600 821,200 1,026,500
Cost of sales 268,900 390,000 487,600
Gross Profit 317,700 431,200 538,900
Operating Expenses
Selling, general, and admin. Expenses 117,800 205,300 256,600
Depreciation 13,500 18,500 22,500
Operating Income 186,400 207,400 259,800
Other Income
Interest Income 1,900 2000 2000
Interest Expense (15,000) (17,500) (17,000)
Other Income (expense), net 10,900 20,000 20,000
Income before taxes 184,200 211,600 264,800
Income tax expense 53,200 63,600 79,400
Net income 131,000 148,300 185,400
Earnings per share 1.31 1.48 1.85
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Forecasts Used to Prepare Pro Forma
Balance Sheets
? Accounts Receivable
? Historic: A/R down to 7% sales in 2003 from 13.6% of
sales in 2001
? 2007: 7% of sales
? 2008: 7% of sales
? Inventories
? Historic: Trended down to 3.3% of sales in 2003 from
45.8% of sales in 2002
? 2007: 4% of sales
? 2008: 4% of sales
Forecasts Used to Prepare Pro Forma
Balance Sheets
? Land, buildings, and equipment
? 2007: $100,000 in equipment purchases and capital
improvements made to existing buildings
? 2008: $275,000 in capital improvements, including a
$100,000 real estate purchase and $175,000 in buildings
and equipment
? Accounts Payable
? Historic: A/P trended down to 5% of sales in 2003 from
13.6% of sales in 2001 because of better collection method
? 2007: 7% of sales
? 2008: 7% of sales
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Forecasts Used to Prepare Pro Forma
Balance Sheets
? Long-term debt
? $75,000 reduction in long-term debt from earnings
? $150,000 will be borrowed to finance $275,000 to acquire
land, equipment, and buildings (the balance of the
acquisition costs will be funded from earnings)
Pro Forma Balance Sheets for X-TECH
Dec 31, 2006 2007 projected 2008 projected
Current Assets
Cash and cash equiv. 63,800 53,600 80,200
A/R, less allowance for doubtful accounts 39,600 57,500 71,900
Inventories 19,200 32,900 41,000
Total Current Assets 122,600 143,800 193,100
Property, land, equipment
Land 260,000 260,000 360,000
Building and Equipment 412,000 512,000 687,000
Total property, plant, and equipment 672,000 772,000 1,047,000
Less: accumulated depreciation 65,000 83,500 106,000
Net property, land, and equipment 607,000 688,500 941,000
Total Assets 729,600 832,300 1,134,100
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Pro Forma Balance Sheets for X-TECH
Liabilities and Shareholders’ Equity Dec 31, 2006 2007 Projected 2008 Projected
Current liabilities
Accounts payable 30,200 57,500 71,900
Accrued expenses 9,900 12,000 14,000
Total current liabilities 40,100 69,500 85,900
Long-term liabilities
Long-term debt 249,500 174,500 274,500
Total liabilities 289,600 244,000 360,400
Shareholders’ equity
Common stock (100,000 shares) 10,000 10,000 10,000
Retained earnings 430,000 578,300 763,700
Total shareholders’ equity 440,000 588,300 773,700
Total liabilities and shareholders’ equity 729,600 832,300 1,134,100
Pro Forma Statement of Cash Flows
for X-Tech
Operating Activities 12/31/2006 Projected 2007 Projected 2008
Net income 131,000 148,300 185,400
Changes in working capital
Depreciation 13,500 18,500 22,500
Inc(dec) in A/R 9,300 (17,900) (14,400)
Inc(dec) in accrued
expenses
1,900 2,100 2,000
Inc(dec) in inventory 1,200 (13,700) (8,100)
Inc(dec) in A/P (16,700) 27,300 14,400
Total adjustments 9,200 16,300 16,400
Net cash by OA 140,200 164,600 201,800
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Pro Forma Statement of Cash Flows
for X-Tech
Investing Activities 12/31/2006 Projected 2007 Projected 2008
Purchase of bldg and
equipment
(250,500) (100,000) (275,000)
Net from IA (250,500) (100,000) (275,000)
Cash flow from Financing Activities
Proceeds from increase in LTD
(or principle reduction in LTD)
119,500 (75,000) 100,000
Increase in cash 9,200 (10,400) 26,800
Cash & cash equiv. at the
beg. of the year
54,600 63,800 53,400
Cash & cash equivalents at
the beginning of the year
63,800 53,400 80,,200
Pro Forma Financial Statements
? Pro Forma Financial Statements
? A firm’s pro forma financial statements are similar to its
historical financial statements except that they look
forward rather than track the past.
? The preparation of pro form financial statements helps a
firm rethink its strategies and make adjustments if
necessary.
? The preparation of pro forma financials is also necessary if
a firm is seeking funding or financing.
31
Ratio Analysis
? Ratio Analysis
? The same financial ratios used to evaluate a firm’s
historical financial statements should be used to evaluate
the pro forma financial statements.
? This work is completed so the firm can get a sense of how
its projected financial performance compares to its past
performance and how its projected activities will affect its
cash position and its overall financial soundness.
Ratio Analysis Based on Historical and
Pro-Forma Financial Statements
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Types of Pro Forma Financial Statements
Financial Statement Purpose
Pro Forma Income
Statement
Pro Forma Balance
Sheet
Pro Forma Statement of
Cash flows
Shows the projected results of the operations of a firm
over a specific period.
Shows a projected snapshot of a company’s assets,
liabilities, and owner’s equity at a specific point in
time.
Shows the projected flow of cash into and out of a
company for a specific period.
Financial Assumptions
? Reasons behind the numbers
? How you calculated the amounts in the Financial
Statements
? What is critical
? What is sensitive
? Consider sensitivity analysis around key assumptions
? Ready for the pitch – just in case you are asked!
33
Financial Assumptions
? Key assumptions
? Sales growth
? Cost of goods sold
? Growth in Sales volumes
? Selling prices
? Selling & distribution costs
? Research & development
? Interest rates
? Tax rates
? Management/administration
? Bad debt provisions
? Depreciation rates
? Material costs
Financial Assumptions
The key assumptions have been based on the following:
• Sales projections derived in 7.4 Sales Forecasts and based on 7. Marketing
Strategies, Sales Plans & Projections.
• R&D expenditure as described in 8. Technology and R&D.
• Operational plans and expense projections as presented in 9. Operational Plans.
• Funding of $xx (equity) and $xx (loans) will be secure in the first quarter of 20XX
as proposed in 12. Funding below.
• and so on ......
34
Sources and Uses of Funds
? Keep it factual and avoid any "over-the-top" hyping of your
business as the greatest investment ever!
? If planning to raise equity from venture capital or "angel"
sources, allow adequate time to raise it.
? Describe what sources you plan to secure and how you plan to
use them.
? Indicate planned uses, possible sources and forms (equity,
loans, grants, credit etc.) and time scales.
? Mention any conditional or firm funding commitments
already secured.
Sources and Uses of Funds
? For each element of funding describe
? the preferred form of funding
? amounts required
? likely timing
? security offered
? desired terms
? repayment schedules
? exit options
35
Financial Mistakes to Avoid
Here are some of the most common mistakes found in the
financial projection sections of feasibility studies and business
plans:
? Failing to include the "Big 3" statements and projections
(income statement, balance sheet, cash flow).
? Presenting sales and profit projections that are unrealistic and
unfounded.
? Omitting financial assumptions to explain where the
"numbers" originated.
Financial Mistakes to Avoid
? Presenting "creative" rather than "accepted" financial
statements.
? Underestimating expenses and not budgeting for unexpected
costs.
? Lack of financial investment on the part of the founders.
? Including excessive salaries and office expenses at start-up.
? Offering a lower percentage of ownership than the investment
requirement demands.
? Offering a return on investment that is out of line for your
industry.
? Absence of contingencies and projections for worst case
scenarios.
36
Financial Forecasts
? Pro forma financial statements are projections
for future periods based on forecasts and
typically completed for 2-3 years in the future.
? For planning only, confidential, internal
Why Most New Ventures Need Funding
? Cash flow challenges
? Inventory to buy, employees to train and pay, advertising to pay
before cash is generated from sales
? Capital investments
? Costs of real estate, building facilities, buying equipment
exceeds available funds
? Lengthy product development cycles
? Some products take years before generating earnings
? Upfront costs exceed firm’s ability to fund activities on its own
37
Sources of Personal Funding
? Personal funds
? Financial resources
? Sweat equity (time and effort)
? Friends and family
? $10,000 loan from Grandma
? Can strain relationships if new venture does not pan out
? Bootstrapping
? Funding through creativity, ingenuity, thriftiness, or cost-cutting
? Buying used or leasing
? Sharing space or coordinating purchases with other businesses
? Starting in your garage/parents’ house
Preparing to Raise Debt or Equity Financing
? Determine precisely how much money the company
needs
? Determine the most appropriate type of financing or
funding
? Equity funding – exchanging partial ownership
? Angel investors, private placements, VC, and IPOs
? Debt financing – getting a loan
? Develop a strategy for engaging potential investors or
bankers
? Pitch or elevator speech
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Matching Characteristics of Venture to
Appropriate Form of Financing
? The business has high risk with an uncertain return
? Weak cash flow, high leverage, low-to-moderate growth,
unproven managenet
? ? personal funds, friends, family, bootstrapping
? The business has low risk with a more predictable
return
? Strong cash flow, low leverage, audited financials, good
management, healthy balance sheet
? ? debt financing
? The business offers a high return
? Unique business idea, high growth, niche market, proven
management
? ? equity
Sources of Equity Funding
? Business Angels
? Invest their personal capital in start-ups
? $10,000 - $20,000 to a single venture
? Remain anonymous
? Venture Capital
? Money invested by venture capital firms in start-ups and small
businesses with expectional growth potential
? Takes on a lot of risk
? IPO (Initial Publici Offering)
? First sale of stock by a firm to the public
39
Initial Public Offerings
? Way to raise equity capital to fund current and future
operations
? Way to raise a firm’s public profile, making it easier to
attract high-quality customers, alliance partners, and
employeees
? Serves as a liquidity event that provides a mechanism
for the company’s stockholders, including its investors,
to cash out their investments
? Provides another form of currency that can be used to
grow the company
IPOs
? Hire an investment bank
? Bank issues a preliminary prospectus, or “red herring”
? Obtain SEC (Securities Exchange Commission)
approval
? Bank issues a final prospectus, which sets the date and
price of offering
? Bank also may drum up support with a road show
? Private placement is the direct sale of an issue of
securities to a large institutional investor, no public
offering or prospectus prepared
40
Sources of Debt Financing
? Single-purpose loans
? Specific amount is borrowed that must be repaid in a fixed
amount of time with interest
? Line of credit
? Borrowing ‘cap’ established with periodic interest payments
? Commercial Banks
? Atlantic Canada Opportunities Agency (ACOA)
? Export Development Canada
Other Creative Sources of Financing and
Funding
? Leasing
? Government Grants
? Industrial Research Assistance Program (NRC-IRAP)
? Strategic Partners
? Genesis Centre
? Ocean Technology Enterprise Centre
doc_996566337.pdf
Engineering Entrepreneurship Dr. Amy Hsiao
1
ENGI 8150:
Engineering Entrepreneurship
Dr. Amy Hsiao
Lecture 6
Memorial University of Newfoundland
Assessing a New Venture’s Financial Strength
and Viability
? Are we making or losing money?
? How much cash do we have on hand?
? How do our growth and net profits compare to those of our
industry peers?
? Where will the funds we need for capital improvements come
from?
? Are there ways we can partner with others to share risk and
reduce the amount of cash we need?
? Overall, are we in good shape financially?
2
Financial Management and Objectives
? Raising Money
? Managing a company’s finances to achieve
the highest rate of return.
Profitability: A company’s ability to make a profit
Liquidity: A company’s ability to meet its short-term obligations
Efficiency: How productively a firm uses its assets
Stability: The overall health of the financial structure of the firm,
particularly as it relates to its debt-to-equity ratio
Financial Objectives of a Firm
? Profitability
? Is the ability to earn a profit.
? Many start-ups are not profitable during their first one to three
years while they are training employees and building their brands.
? However, a firm must become profitable to remain viable and
provide a return to its owners.
? Liquidity
? Is a company’s ability to meet its short-term financial
obligations.
? Even if a firm is profitable, it is often a challenge to keep enough
money in the bank to meet its routine obligations in a timely
manner.
3
Financial Objectives of a Firm
? Liquidity
? Accounts receivable – money owed to the firm by
its customers
? Inventory – merchandise, raw materials, and
product waiting to be sold
? If a firm allows levels of either of these assets to
get too high, it may not be able to keep sufficient
cash on hand to meet its short-term obligations.
? Ex. Small that sells to larger companies may get paid
30-60 days from the time of sale.
Financial Objectives of a Firm
? Efficiency
? Is how productively a firm utilizes its assets relative to its
revenue and its profits.
? Southwest Airlines, for example, uses its assets very productively.
Its turnaround time, or the time its airplanes sit on the ground
while they are being unloaded and reloaded, is the lowest in the
airline industry.
? Stability
? Is the strength and vigor of the firm’s overall financial
posture.
? For a firm to be stable, it must not only earn a profit and remain
liquid but also keep its debt in check.
4
Debt-to-Equity Ratio
? If a firm continues to borrow from its lenders and its
D/E ratio gets too high, it may have trouble meeting
its obligations and securing the level of financing
needed to fuel its growth.
? Calculated by dividing its long-term debt by its
shareholders’ equity (the owners' residual interest in
the assets of an enterprise after deducing all its
liabilities)
The Process of Financial Management
? Importance of Financial Statements
? To assess whether its financial objectives are being met,
firms rely heavily on analysis of financial statements.
? A financial statement is a written report that quantitatively
describes a firm’s financial health.
? The income statement, the balance sheet, and the statement of cash
flows are the financial statements entrepreneurs use most
commonly.
? Forecasts
? Are an estimate of a firm’s future income and expenses,
based on past performance, its current circumstances, and
its future plans.
5
The Process of Financial Management
? Forecasts (continued)
? New ventures typically base their forecasts on an estimate
of sales and then on industry averages or the experiences
of similar start-ups regarding the cost of goods sold and
other expenses.
? Budgets
? Are itemized forecasts of a company’s income, expenses,
and capital needs and are also an important tool for
financial planning and control.
The Process of Financial Management
? Financial Ratios
? Depict relationships between items on a firm’s financial
statements.
? An analysis of its financial ratios helps a firm determine
whether it is meeting its financial objectives and how it
stacks up against industry peers.
? Importance of Financial Management
? Many experienced entrepreneurs stress the importance of
keeping on top of the financial management of the firm.
6
Process of Financial Management
? Financial Statements
? Income statement
? Balance sheet
? Statement of cash flows
The Process of Financial Management
7
Financial Statements
? Historical Financial Statements
? Reflect past performance and are usually prepared on a
quarterly and annual basis.
? Publicly traded firms are required by the SEC to prepare financial
statements and make them available to the public. (Ex. 4-Q of
Facebook)
? Pro Forma Financial Statements
? Are projections for future periods based on forecasts and
are typically completed for two to three years in the future.
? Pro forma financial statements are strictly planning tools and are
not required by the SEC.
Financial Statements and Forecasts
? Pro forma financial statements are projections
for future periods based on forecasts and
typically completed for 2-3 years in the future.
? For planning only, confidential, internal
8
Importance of Keeping Good Records
The first step toward prudent
financial management is
keeping good records.
Income Statement
? Reflects the results of the operations of a firm over a
specified period of time.
? Monthly, quarterly, or annual.
? Shows whether the firm is making a profit or
experiencing a loss.
? Multiyear format – used to evaluate effect of past
strategies and help project future sales and earnings.
9
Consolidated Income Statements for New
Venture X-TECH
Dec. 31, 2006 Dec. 31, 2005 Dec. 31, 2004
Net Sales 586,600 463,100 368,900
Cost of sales 268,900 225,500 201,500
Gross Profit 317,700 237,600 167,400
Operating Expenses
Selling, general, and admin. Expenses 117,800 104,700 90,200
Depreciation 13,500 5,900 5,100
Operating Income 186,400 127,000 72,100
Other Income
Interest Income 1,900 800 1,100
Interest Expense (15,000) (6,900) (6,400)
Other Income (expense), net 10,900 (1,300) 1,200
Income before taxes 184,200 119,600 68,000
Income tax expense (53,200) (36,600) (18,000)
Net income 131,000 83,000 50,000
Earnings per share 1.31 0.83 0.50
Income Statement
? Net sales: total sales minus allowances for returned
goods and discounts
? Cost of sales (or COGS): include all the direct costs
associated with producing or delivering a product or
service, including the material costs and direct labor.
? Operating expenses: marketing, administrative costs,
and other expenses not directly related to producing a
product or service.
10
Income Statement
? Compare ratios of COGS to Net Sales
? Compare ratio of operating expenses to Net
Sales
55%, 49%, 46% for 2004, 2005, 2006 respectively
Steadily decreasing its material and labor costs per dollar of
sales – good trend
Income Statement
? Profit Margin (return on sales)
? Net Income/Net Sales
13.6%, 17.9%, 22.3% for 2004, 2005, 2006 respectively
Firm is either boosting its sales without increasing expenses or
doing a better job of controlling its costs.
11
Income Statement
? Price-to-earnings ratio (P/E ratio)
? Price of a company’s stock against its earnings
? Generally, the higher a company’s P/E ratio, the
greater the market thinks it will grow.
? Say the stock of X-TECH was trading at $20
per share, so its P/E ratio would be 15.3.
Balance Sheet
? Snapshot of a company’s assets, liabilities, and
owners’ equity at a specific point in time
? Left/Top shows a company’s assets
? Right/Bottom shows a company’s liabilities and
owners’ equity
? Assets are listed in order of liquidity (length of
time it takes to convert them to cash)
? Must always balance
12
Balance Sheet – Categories of Assets
? Current assets – include cash plus items that are
readily convertible to cash, such as A/R,
marketable securities, and inventories
? Fixed assets – used over a longer time frame,
such as real estate, buildings, equipment, and
furniture
? Other assets – accumulated goodwill, etc.
Balance Sheet – Categories of Liabilities
? Current liabilities – obligations that are payable within
a year, including A/P, accrued expenses, and the
current portion of long-term debt
? Long-term liabilities – notes or loans that are repayable
beyond 1 year, including liabilities associated with
purchasing real estate, buildings, and equipment
? Owners’ equity – equity invested in the business by its
owners plus the accumulated earnings retained by the
business after paying dividends
13
Balance Sheet
? Does not record “fair market value”
? Ex. Real estate value
? Value of IP
? Goodwill
? Not listed: Intangible assets – training
Consolidated Balance Sheets for X-TECH
Dec 31, 2006 Dec 31, 2005 Dec 31, 2004
Current Assets
Cash and cash equiv. 63,800 54,600 56,500
A/R, less allowance for doubtful accounts 39,600 48,900 50,200
Inventories 19,200 20,400 21,400
Total Current Assets 122,600 123,900 128,100
Property, land, equipment
Land 260,000 160,000 160,000
Building and Equipment 412,000 261,500 149,000
Total property, plant, and equipment 672,000 421,500 309,000
Less: accumulated depreciation 65,000 51,500 45,600
Net property, land, and equipment 607,000 370,000 263,400
Total Assets 729,600 493,900 391,500
14
Consolidated Balance Sheets for X-TECH
Liabilities and Shareholders’ Equity Dec 31, 2006 Dec 31, 2005 Dec 31, 2004
Current liabilities
Accounts payable 30,200 46,900 50,400
Accrued expenses 9,900 8,000 4,100
Total current liabilities 40,100 54,900 54,500
Long-term liabilities
Long-term debt 249,500 130,000 111,000
Total liabilities 289,600 184,900 165,500
Shareholders’ equity
Common stock (100,000 shares) 10,000 10,000 10,000
Retained earnings 430,000 299,000 216,000
Total shareholders’ equity 440,000 309,000 226,000
Total liabilities and shareholders’ equity 729,600 493,900 391,500
Balance Sheet
? Working Capital
? Current assets minus current liabilities
? $82,500 = amount of liquid assets the firm has available
? Current Ratio
? Firm’s current assets divided by its current liabilities
Current Ratio 3.06
It has $3.06 in current assets for every $1.00 in current liabilities
Healthy – can meet current liabilities
Trend – 2.35, 2.26, 3.06
15
Balance Sheet
? Debt Ratio
? Divide total debt by total assets
The present debt ratio is 39.7%, which means that 39.7% of its total assets
are financed by debt and the remaining 60.3% by owners’ equity.
Healthy for a young firm.
Trend is good too – 42.3, 37.4, 39.7
Over time, the company is relying less on debt to finance its operations
Less debt creates more freedom for the firm in terms of taking different
actions.
Balance Sheet
? Note that the $131,000 net income reported on
its 2006 income statement shows up as the
difference between its 2006 and 2005 retained
earnings on its 2006 balance sheet.
? No dividends were paid to its stockholders so
the company retained all of its $131,000 in
earnings.
16
Statement of Cash Flows
? Summarizes the changes in a firm’s cash position for a
specified period of time and details why the change
occurred.
? Three categories:
? Operating activities – net income (or loss), depreciation,
changes in current assets and liabilities other than cash and
short-term debt. A firm’s net income, taken from its income
statement, is the first line on the corresponding period’s cash
flow statement.
Statement of Cash Flows
? Three categories:
? Investing activities: include the purchase, sale or
investment in fixed assets, such as real estate, equipment,
and buildings
? Financing activities: include cash raised during the period
by borrowing money or selling stock and/or cash used
during the period by paying dividends, buying back
outstanding stock, or buying back outstanding bonds
17
Consolidated Statement of Cash Flows
for X-TECH
Dec 31, 2006 Dec 31, 2005
Cash flows from operating activities
Net income 131,000 83,000
Additions (sources of cash)
Depreciation (deducted in income statement but not cash expenditure) 13,500
5,900
Decreases in A/R 9,300 1,300
Increase in accrued expenses 1,900 3,900
Decrease in inventory 1,200 1,000
Subtractions (uses of cash)
Decrease in A/P (16,700) (3,500)
Total adjustments 9,200 8,600
Net Cash from Operating Expenses 140,200 91,600
Consolidated Statement of Cash Flows
for X-TECH
Dec 31, 2006 Dec 31, 2005
Cash flows from investing activities
Purchase of building and equipment (250,500) (112,500)
Net cash flows from investing activities (250,500) (112,500)
Cash flows from financing activities
Proceeds from increase in long-term debt 119,500 19,000
Net cash flows provided by financing activities 119,500 19,000
Total Increase in cash 9,200 (1,900)
Cash and cash equiv. at the beginning of the year 54,600 56,500
Cash and cash equiv. at the end of the year 63,800 54,600
18
Ratio Analysis
? Ratio Analysis
? The most practical way to interpret or make sense of a
firm’s historical financial statements is through ratio
analysis, as shown in the next slide.
? Comparing a Firm’s Financial Results to Industry
Norms
? Comparing a firm’s financial results to industry norms
helps a firm determine how it stacks up against its
competitors and if there are any financial “red flags”
requiring attention.
Ratio Analysis
? Profitability Ratios
? Return on Assets (ROA) = net income/average total assets
? Return on Equity (ROE) = net income/average shareholders’ equity
? Profit Margin = net income/net sales
? Liquidity Ratios
? Current Ratio = current assets/current liabilities
? Overall Financial Stability Ratios
? Debt = total debt/total assets
? Debt-to-Equity = total liabilities/owners’ equity
19
Historical Ratio Analysis
Historical Financial Statements
Three types of historical financial statements
Financial Statement Purpose
Income Statement
Balance Sheet
Statement of Cash Flows
Reflects the results of the operations of a firm over a
specified period of time. It records all the revenues and
expenses for the given period and shows whether the firm
is making a profit or is experiencing a loss.
Is a snapshot of a company’s assets, liabilities, and
owner’s equity at a specific point in time.
Summarizes the changes in a firm’s cash position for a
specified period of time and details why the changes
occurred.
20
Comparison Data for Dell
Dell Inc.
(05-06
fiscal yr)
Industry Median
(05-06 fiscal yr)
Market Median
(05-06 fiscal yr)
Gross profit margin 17.50% 34.00% 51.80%
Net profit margin 6.00% 3.00% 4.80%
ROE 75.6% 10.3% 9.5%
ROA 14.9% 3.5% 1.6%
12-month revenue
growth
11.1% 10.7% 12.3%http://www.wikinvest.com/stock/Dell_(DELL)/Data/Key_Metrics
Comparison Data for X-TECH and All
Incorporated Competitors
X-TECH Others
Sales 100% 100%
COGS 45.8% 42.9%
Current ratio 3.05% 1.1%
D-E Ratio 65% 4.5%
21
Sales per Square Foot
? Tests efficiency of operations (how productively assets are
used)
Year Average sales per
square feet
Peets Coffee 2002 $696
McDonalds 2002 $543
Starbucks 2002 $521
New Venture Coffee 2004 $512
Panera Bread 2002 $418
Ruby Tuesdays 2002 $377
Forecasts
? The analysis of a firm’s historical financial statements are
followed by the preparation of forecasts.
? Forecasts are predictions of a firm’s future sales, expenses,
income, and capital expenditures.
? A firm’s forecasts provide the basis for its pro forma
financial statements.
? A well-developed set of pro forma financial statements
helps a firm create accurate budgets, build financial plans,
and manage its finances in a proactive rather than a
reactive manner.
22
Financial Statements and Forecasts
? Pro forma financial statements are projections
for future periods based on forecasts and
typically completed for 2-3 years in the future.
? For planning only, confidential, internal
Forecasts
? A sales forecast is a projection of a firm’s sales for a specified
period (such as a year).
? It is the first forecast developed and is the basis for most of the
other forecasts.
? A sales forecast for a new firm is based on a good-faith estimate of
sales and on industry averages or the experiences of similar start-ups.
? A sales forecast for an existing firm is based on (1) its record of past
sales, (2) its current production capacity and product demand, and (3)
any factors that will affect its future product capacity and product
demand.
23
Forecasts
? Forecast of Costs of Sales and Other Items
? Once a firm has completed its sales forecast, it must
forecast its cost of sales (or cost of goods sold) and the
other items on its income statement.
? The most common way to do this is to use the percentage-
of-sales method, which is a method for expressing each
expense item as a percentage of sales.
? If a firm determines that it can use the percent-of-sales method and
it follows the procedures described in the textbook, then the net
result is that each expense item on its income statement will grow
at the same rate as sales (with the exception of items that can be
individually forecast, such as depreciation).
Forecast of Costs of Sales
? Percent-of-sales method expresses each
expense item as a percentage of sales
? COGS averaged 47.5% over past two years (‘05,
‘06)
? Project for future year: 47.5% of sales forecast
($821,200) = $390,000 in 2007
? Constant ratio method of forecasting
? Percent-of-sales is applied to all other accounting of
expenses
24
Forecasts
Historical and Forecasted Annual Sales for X-TECH
Breakeven Analysis
? Total fixed costs / (price – average variable costs)
? If the total fixed cost associated with opening a new
company is $101,000 per year, the average price for
the company’s product is $2.75, and the variable
cost for each product is $1.10, then the breakeven
point is 61,212 units per year
? 170 per day, based on a 360-day year
25
Forecasts Used to Prepare Pro Forma
Income Statements
? Net sales
? Historic: Average sales increase of 25% per year
? 2007: Increase to 40% as the result of increased brand
awareness and the opening of a 2
nd
location
? 2008: increase 25% as the result of increased brand
awareness
? COGS
? Historic: Average of 47.5% of sales the past 2 years
? 2007: 47.5% of sales
? 2008: 47.5% of sales
Forecasts Used to Prepare Pro Forma
Income Statements
? Selling, general, and administrative expenses
? Historic: average 22% of sales the past 2 years
? 2007: increase to 25% of sales as result of 2
nd
location opening
? 2008: 25% of sales
? Interest expense
? Historic: 6-7% of long-term debt
? 2007: 7% of long-term debt
? 2008: 7% of long-term debt
26
Forecasts Used to Prepare Pro Forma
Income Statements
? Other income
? Historic: licensing income of $10,900 per year
? 2007: licensing income will increase to $20,000 as
a result of a renegotiation of a contract
? 2008: licensing income will be $20,000
Pro Forma Income Statement for New
Venture X-TECH
Actual 2006 Projected 2007 Projected 2008
Net Sales 586,600 821,200 1,026,500
Cost of sales 268,900 390,000 487,600
Gross Profit 317,700 431,200 538,900
Operating Expenses
Selling, general, and admin. Expenses 117,800 205,300 256,600
Depreciation 13,500 18,500 22,500
Operating Income 186,400 207,400 259,800
Other Income
Interest Income 1,900 2000 2000
Interest Expense (15,000) (17,500) (17,000)
Other Income (expense), net 10,900 20,000 20,000
Income before taxes 184,200 211,600 264,800
Income tax expense 53,200 63,600 79,400
Net income 131,000 148,300 185,400
Earnings per share 1.31 1.48 1.85
27
Forecasts Used to Prepare Pro Forma
Balance Sheets
? Accounts Receivable
? Historic: A/R down to 7% sales in 2003 from 13.6% of
sales in 2001
? 2007: 7% of sales
? 2008: 7% of sales
? Inventories
? Historic: Trended down to 3.3% of sales in 2003 from
45.8% of sales in 2002
? 2007: 4% of sales
? 2008: 4% of sales
Forecasts Used to Prepare Pro Forma
Balance Sheets
? Land, buildings, and equipment
? 2007: $100,000 in equipment purchases and capital
improvements made to existing buildings
? 2008: $275,000 in capital improvements, including a
$100,000 real estate purchase and $175,000 in buildings
and equipment
? Accounts Payable
? Historic: A/P trended down to 5% of sales in 2003 from
13.6% of sales in 2001 because of better collection method
? 2007: 7% of sales
? 2008: 7% of sales
28
Forecasts Used to Prepare Pro Forma
Balance Sheets
? Long-term debt
? $75,000 reduction in long-term debt from earnings
? $150,000 will be borrowed to finance $275,000 to acquire
land, equipment, and buildings (the balance of the
acquisition costs will be funded from earnings)
Pro Forma Balance Sheets for X-TECH
Dec 31, 2006 2007 projected 2008 projected
Current Assets
Cash and cash equiv. 63,800 53,600 80,200
A/R, less allowance for doubtful accounts 39,600 57,500 71,900
Inventories 19,200 32,900 41,000
Total Current Assets 122,600 143,800 193,100
Property, land, equipment
Land 260,000 260,000 360,000
Building and Equipment 412,000 512,000 687,000
Total property, plant, and equipment 672,000 772,000 1,047,000
Less: accumulated depreciation 65,000 83,500 106,000
Net property, land, and equipment 607,000 688,500 941,000
Total Assets 729,600 832,300 1,134,100
29
Pro Forma Balance Sheets for X-TECH
Liabilities and Shareholders’ Equity Dec 31, 2006 2007 Projected 2008 Projected
Current liabilities
Accounts payable 30,200 57,500 71,900
Accrued expenses 9,900 12,000 14,000
Total current liabilities 40,100 69,500 85,900
Long-term liabilities
Long-term debt 249,500 174,500 274,500
Total liabilities 289,600 244,000 360,400
Shareholders’ equity
Common stock (100,000 shares) 10,000 10,000 10,000
Retained earnings 430,000 578,300 763,700
Total shareholders’ equity 440,000 588,300 773,700
Total liabilities and shareholders’ equity 729,600 832,300 1,134,100
Pro Forma Statement of Cash Flows
for X-Tech
Operating Activities 12/31/2006 Projected 2007 Projected 2008
Net income 131,000 148,300 185,400
Changes in working capital
Depreciation 13,500 18,500 22,500
Inc(dec) in A/R 9,300 (17,900) (14,400)
Inc(dec) in accrued
expenses
1,900 2,100 2,000
Inc(dec) in inventory 1,200 (13,700) (8,100)
Inc(dec) in A/P (16,700) 27,300 14,400
Total adjustments 9,200 16,300 16,400
Net cash by OA 140,200 164,600 201,800
30
Pro Forma Statement of Cash Flows
for X-Tech
Investing Activities 12/31/2006 Projected 2007 Projected 2008
Purchase of bldg and
equipment
(250,500) (100,000) (275,000)
Net from IA (250,500) (100,000) (275,000)
Cash flow from Financing Activities
Proceeds from increase in LTD
(or principle reduction in LTD)
119,500 (75,000) 100,000
Increase in cash 9,200 (10,400) 26,800
Cash & cash equiv. at the
beg. of the year
54,600 63,800 53,400
Cash & cash equivalents at
the beginning of the year
63,800 53,400 80,,200
Pro Forma Financial Statements
? Pro Forma Financial Statements
? A firm’s pro forma financial statements are similar to its
historical financial statements except that they look
forward rather than track the past.
? The preparation of pro form financial statements helps a
firm rethink its strategies and make adjustments if
necessary.
? The preparation of pro forma financials is also necessary if
a firm is seeking funding or financing.
31
Ratio Analysis
? Ratio Analysis
? The same financial ratios used to evaluate a firm’s
historical financial statements should be used to evaluate
the pro forma financial statements.
? This work is completed so the firm can get a sense of how
its projected financial performance compares to its past
performance and how its projected activities will affect its
cash position and its overall financial soundness.
Ratio Analysis Based on Historical and
Pro-Forma Financial Statements
32
Types of Pro Forma Financial Statements
Financial Statement Purpose
Pro Forma Income
Statement
Pro Forma Balance
Sheet
Pro Forma Statement of
Cash flows
Shows the projected results of the operations of a firm
over a specific period.
Shows a projected snapshot of a company’s assets,
liabilities, and owner’s equity at a specific point in
time.
Shows the projected flow of cash into and out of a
company for a specific period.
Financial Assumptions
? Reasons behind the numbers
? How you calculated the amounts in the Financial
Statements
? What is critical
? What is sensitive
? Consider sensitivity analysis around key assumptions
? Ready for the pitch – just in case you are asked!
33
Financial Assumptions
? Key assumptions
? Sales growth
? Cost of goods sold
? Growth in Sales volumes
? Selling prices
? Selling & distribution costs
? Research & development
? Interest rates
? Tax rates
? Management/administration
? Bad debt provisions
? Depreciation rates
? Material costs
Financial Assumptions
The key assumptions have been based on the following:
• Sales projections derived in 7.4 Sales Forecasts and based on 7. Marketing
Strategies, Sales Plans & Projections.
• R&D expenditure as described in 8. Technology and R&D.
• Operational plans and expense projections as presented in 9. Operational Plans.
• Funding of $xx (equity) and $xx (loans) will be secure in the first quarter of 20XX
as proposed in 12. Funding below.
• and so on ......
34
Sources and Uses of Funds
? Keep it factual and avoid any "over-the-top" hyping of your
business as the greatest investment ever!
? If planning to raise equity from venture capital or "angel"
sources, allow adequate time to raise it.
? Describe what sources you plan to secure and how you plan to
use them.
? Indicate planned uses, possible sources and forms (equity,
loans, grants, credit etc.) and time scales.
? Mention any conditional or firm funding commitments
already secured.
Sources and Uses of Funds
? For each element of funding describe
? the preferred form of funding
? amounts required
? likely timing
? security offered
? desired terms
? repayment schedules
? exit options
35
Financial Mistakes to Avoid
Here are some of the most common mistakes found in the
financial projection sections of feasibility studies and business
plans:
? Failing to include the "Big 3" statements and projections
(income statement, balance sheet, cash flow).
? Presenting sales and profit projections that are unrealistic and
unfounded.
? Omitting financial assumptions to explain where the
"numbers" originated.
Financial Mistakes to Avoid
? Presenting "creative" rather than "accepted" financial
statements.
? Underestimating expenses and not budgeting for unexpected
costs.
? Lack of financial investment on the part of the founders.
? Including excessive salaries and office expenses at start-up.
? Offering a lower percentage of ownership than the investment
requirement demands.
? Offering a return on investment that is out of line for your
industry.
? Absence of contingencies and projections for worst case
scenarios.
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Financial Forecasts
? Pro forma financial statements are projections
for future periods based on forecasts and
typically completed for 2-3 years in the future.
? For planning only, confidential, internal
Why Most New Ventures Need Funding
? Cash flow challenges
? Inventory to buy, employees to train and pay, advertising to pay
before cash is generated from sales
? Capital investments
? Costs of real estate, building facilities, buying equipment
exceeds available funds
? Lengthy product development cycles
? Some products take years before generating earnings
? Upfront costs exceed firm’s ability to fund activities on its own
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Sources of Personal Funding
? Personal funds
? Financial resources
? Sweat equity (time and effort)
? Friends and family
? $10,000 loan from Grandma
? Can strain relationships if new venture does not pan out
? Bootstrapping
? Funding through creativity, ingenuity, thriftiness, or cost-cutting
? Buying used or leasing
? Sharing space or coordinating purchases with other businesses
? Starting in your garage/parents’ house
Preparing to Raise Debt or Equity Financing
? Determine precisely how much money the company
needs
? Determine the most appropriate type of financing or
funding
? Equity funding – exchanging partial ownership
? Angel investors, private placements, VC, and IPOs
? Debt financing – getting a loan
? Develop a strategy for engaging potential investors or
bankers
? Pitch or elevator speech
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Matching Characteristics of Venture to
Appropriate Form of Financing
? The business has high risk with an uncertain return
? Weak cash flow, high leverage, low-to-moderate growth,
unproven managenet
? ? personal funds, friends, family, bootstrapping
? The business has low risk with a more predictable
return
? Strong cash flow, low leverage, audited financials, good
management, healthy balance sheet
? ? debt financing
? The business offers a high return
? Unique business idea, high growth, niche market, proven
management
? ? equity
Sources of Equity Funding
? Business Angels
? Invest their personal capital in start-ups
? $10,000 - $20,000 to a single venture
? Remain anonymous
? Venture Capital
? Money invested by venture capital firms in start-ups and small
businesses with expectional growth potential
? Takes on a lot of risk
? IPO (Initial Publici Offering)
? First sale of stock by a firm to the public
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Initial Public Offerings
? Way to raise equity capital to fund current and future
operations
? Way to raise a firm’s public profile, making it easier to
attract high-quality customers, alliance partners, and
employeees
? Serves as a liquidity event that provides a mechanism
for the company’s stockholders, including its investors,
to cash out their investments
? Provides another form of currency that can be used to
grow the company
IPOs
? Hire an investment bank
? Bank issues a preliminary prospectus, or “red herring”
? Obtain SEC (Securities Exchange Commission)
approval
? Bank issues a final prospectus, which sets the date and
price of offering
? Bank also may drum up support with a road show
? Private placement is the direct sale of an issue of
securities to a large institutional investor, no public
offering or prospectus prepared
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Sources of Debt Financing
? Single-purpose loans
? Specific amount is borrowed that must be repaid in a fixed
amount of time with interest
? Line of credit
? Borrowing ‘cap’ established with periodic interest payments
? Commercial Banks
? Atlantic Canada Opportunities Agency (ACOA)
? Export Development Canada
Other Creative Sources of Financing and
Funding
? Leasing
? Government Grants
? Industrial Research Assistance Program (NRC-IRAP)
? Strategic Partners
? Genesis Centre
? Ocean Technology Enterprise Centre
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