Description
This abstract tell institute institute for strategy strategy and business business economics.
A primer in Entrepreneurship
Prof. Dr. Ulrich Kaiser
Institute for Strategy and Business Economics Institute for Strategy and Business Economics
University of Zurich
Fall Semester 2009
Chapter 8: Assessing the Financial Strength and
Viability of New Ventures
Table of contents
I. Introduction to Financial Management
A. Financial Objectives of a Firm
B. The Process of Financial Management
II. Financial Statements and Forecasts
A. Historical Financial Statements
B. Forecasts
III P F Fi i l S III. Pro Forma Financial Statements
A. Pro Forma Income Statement
B. Pro Forma Balance Sheet
C Pro Forma Statement of Cash Flo s C. Pro Forma Statement of Cash Flows
D. Ratio Analysis
University of Zurich
ISU – Institute for Strategy and Business Economics
Ulrich Kaiser
A primer in Entrepreneurship
Fall Semester 2009
2
I. Introduction to Financial Management
1. Financial management deals with two things: raising money and managing
a company’s finances in a way that achieves the highest rate of return. p y y g
2. We cover the process of raising money in Chapter 10. This chapter
focuses on how a company manages its finances in an effort to increase its
financial strength and earn the highest rate of return financial strength and earn the highest rate of return.
University of Zurich
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Ulrich Kaiser
A primer in Entrepreneurship
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I. Introduction to Financial Management
3. The financial management of a firm deals with questions, such as the
following, on an ongoing basis:
How much cash do we have on hand? How much cash do we have on hand?
Do we have enough cash to meet our short?term obligations?
How efficiently are we utilizing our assets?
d h d f h f d 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 other firms to share risk and
reduce the amount of cash we need?
Overall are we in good shape financially? Overall, are we in good shape financially?
4. A properly?managed firm stays on top of these questions through the
tools and techniques that are discussed in this chapter.
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I. Introduction to Financial Management
A. Financial Objectives of a Firm
Primary Financial Objectives of Entrepreneurial Firms Primary Financial Objectives of Entrepreneurial Firms
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A primer in Entrepreneurship
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I. Introduction to Financial Management
A. Financial Objectives of a Firm
f b l b l f Profitability: 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. y g p y g
However, a firm must become profitable to remain viable and provide a
return to its owners.
Liquidity : Ability to meet its short?term financial obligations.
Even if a firm is profitable it is often a challenge to keep enough money in 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.
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A primer in Entrepreneurship
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I. Introduction to Financial Management
A. Financial Objectives of a Firm
ff d l f l l Efficiency: How productively a firm utilizes its assets relative to its revenue
and its profits
Southwest Airlines, for example, uses its assets very productively. Its , p , y p y
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: 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 , y p q
also keep its debt in check.
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I. Introduction to Financial Management
1 T h th it fi i l bj ti b i t fi l
B. The Process of Financial Management
1. To assess whether its financial objectives are being met, firms rely
heavily on analysis of financial statements, forecasts, and budgets.
2. A financial statement is a written report that quantitatively describes a p q y
firm’s financial health. The income statement, the balance sheet, and
the statement of cash flows are the financial statements entrepreneurs
use most commonly. use most commonly.
3. Forecasts are an estimate of a firm’s future income and expenses, based
on its past performance, its current circumstances, and its future plans.
New ventures typically base their forecasts on an estimate of sales and 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.
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I. Introduction to Financial Management
4 B d t it i d f t f ’ i d
B. The Process of Financial Management
4. Budgets are itemized forecasts of a company’s income, expenses, and
capital needs and are also an important tool for financial planning and
control.
5. The final step in the process of financial management is the ongoing
analysis of a firm’s financial results. Financial ratios, which depict
relationships between items on a firm’s financial statements, are used to relationships between items on a firms financial statements, are used to
discern whether a firm is meeting its financial objectives and how it
stacks up against its industry peers.
Many experienced entrepreneurs stress the importance of keeping on Many experienced entrepreneurs stress the importance of keeping on
top of the financial management of the firm.
In the competitive environment in which most firms exist, it’s simply not
d h t h t f th hi h ki fi i l d i i good enough to shoot from the hip when making financial decisions.
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I. Introduction to Financial Management
B. The Process of Financial Management
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A primer in Entrepreneurship
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I. Introduction to Financial Management
1 Hi t i l fi i l t t t fl t t f d ll
B. The Process of Financial Management
1. Historical financial statements reflect past performance and are usually
prepared on a quarterly and annual basis.
2. Pro forma financial statements are projections for future periods based
on forecasts and are typically completed for two to three years in the
future.
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A primer in Entrepreneurship
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Chapter 8: Assessing the Financial Strength and
Viability of New Ventures
I. Introduction to Financial Management
Table of contents
A. Financial Objectives of a Firm
B. The Process of Financial Management
II. Financial Statements and Forecasts
A Hi i l Fi i l S A. Historical Financial Statements
B. Forecasts
III. Pro Forma Financial Statements
A Pro Forma In ome Statement A. Pro Forma Income Statement
B. Pro Forma Balance Sheet
C. Ratio Analysis
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II. Financial Statements and Forecasts
Include the income statement, the balance sheet, and the statement of cash
A. Historical Financial Statements
c ude e co e s a e e , e ba a ce s ee , a d e s a e e o cas
flows. The statements are usually prepared in this order because
information flows logically from one to the next. In start?ups, financial
statements are typically scrutinized closely to monitor the financial progress statements are typically scrutinized closely to monitor the financial progress
of the firm.
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II. Financial Statements and Forecasts
A. Historical Financial Statements
Example: New Venture Fitness Drinks a p e: e e tu e t ess s
To illustrate how financial statements are prepared, we used New Venture
Fitness Drinks, the fictitious sports drink company introduced in Chapter 3.
New Venture Fitness Drinks has been in business for five years New Venture Fitness Drinks has been in business for five years.
Targeting sports enthusiasts, the company sells a line of nutritional fitness
drinks.
It opened a single location in 2003 added a second location in 2006 and It opened a single location in 2003, added a second location in 2006, and
plans to add a third in 2007.
The company’s strategy is to place small restaurants, similar to smoothie
l d l restaurants, near large outdoor sports complexes.
The company is profitable and is growing at a rate of 25% per year.
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A primer in Entrepreneurship
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II. Financial Statements and Forecasts
Three types of historical financial statements
A. Historical Financial Statements
Three types of historical financial statements
Financial Statement Purpose
Income Statement
The income statement 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.
Balance Sheet
whether the firm is making a profit or is experiencing a loss.
The balance sheet is a snapshot of a company’s assets,
liabilities and owners’ equity at a specific point in time
St t t f C h
liabilities, and owners equity at a specific point in time.
The statement of cash flows summarizes the changes in a
firm’s cash position for a specified period of time and
Statement of Cash
Flows
firm s cash position for a specified period of time and
details why the changes occurred. The statement of cash
flows is similar to a month?end bank statement.
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A primer in Entrepreneurship
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II. Financial Statements and Forecasts
A. Historical Financial Statements
Income Statement:
The income statement reflects the results of the operations of a firm over
a specified period of time. It records all the revenues and expenses for
Income Statement:
the given period and shows whether the firm is making a profit or is
experiencing a loss.
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A primer in Entrepreneurship
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II. Financial Statements and Forecasts
Income Statement (cont’d):
A. Historical Financial Statements
The three numbers that receive the most attention when evaluating an income
statement are the following:
Income Statement (cont d):
a. Net sales consists of total sales minus allowances for returned goods
and discounts.
b Cost of sales includes all the direct costs associated with producing or b. Cost of sales includes all the direct costs associated with producing or
delivering a product or service, including the material costs and direct
labor.
c. Operating expenses include marketing, administrative costs, and other
expenses not directly related to producing a product or service.
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II. Financial Statements and Forecasts
A. Historical Financial Statements
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II. Financial Statements and Forecasts
Balance Sheet:
A. Historical Financial Statements
Balance Sheet:
1. Unlike the income statement, which covers a specified period of time, a
balance sheet is a snapshot of a company’s assets, liabilities, and
’ i ifi d i i i owners’ equity at a specified point in time.
2. The left?hand side of a balance sheet (or the top, depending on how it is
displayed), shows a firm’s assets, while the right?hand side (or bottom) p y ), , g ( )
shows its liabilities and owners’ equity.
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II. Financial Statements and Forecasts
Balance Sheet (con‘d):
A. Historical Financial Statements
Balance Sheet (con d):
3. The major categories of assets listed on a balance sheet are the
following:
i Current assets include cash plus items that are readily convertible to i. Current assets include cash plus items that are readily convertible to
cash, such as accounts receivable, marketable securities and
inventories.
ii. Fixed assets are assets used over a longer time frame, such as real
estate, buildings, equipment, and furniture.
iii Other assets are miscellaneous assets including accumulated iii. Other assets are miscellaneous assets, including accumulated
goodwill.
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II. Financial Statements and Forecasts
Balance Sheet (con‘d):
A. Historical Financial Statements
Balance Sheet (con d):
4. The major categories of liabilities listed on a balance sheet are the
following:
i Current liabilities include obligations that are payable within a year i. Current liabilities include obligations that are payable within a year,
including accounts payable, accrued expenses, and the current
portion of long?term debt.
ii L t li biliti i l d t l th t bl ii. Long?term liabilities include notes or loans that are repayable
beyond one year, including liabilities associated with purchasing real
estate, buildings, and equipment.
iii. Owners’ equity is the equity invested in the business by its owners
plus the accumulated earnings retained by the business after paying
dividends.
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A primer in Entrepreneurship
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II. Financial Statements and Forecasts
Consolidated Balance Sheets for New Venture Fitness Drinks Assets
A. Historical Financial Statements
Consolidated Balance Sheets for New Venture Fitness Drinks Assets
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A primer in Entrepreneurship
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II. Financial Statements and Forecasts
A. Historical Financial Statements
Consolidated Balance Sheets for New Venture Fitness Drinks Assets Consolidated Balance Sheets for New Venture Fitness Drinks Assets
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II. Financial Statements and Forecasts
Statement of Cash Flows:
A. Historical Financial Statements
State e t o Cas o s
The statement of cash flows summarizes the changes in a firm’s cash
position for a specified period of time and details why the changes occurred.
It i i il t th d b k t t t It l h h h i It is similar to a month?end bank statement. It reveals how much cash is on
hand at the end of the month as well as how the cash was acquired and
spent during the month.
a. The statement of cash flows is divided into three separate activities:
operating activities, investing activities, and financing activities.
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II. Financial Statements and Forecasts
Statement of Cash Flows (con’d):
A. Historical Financial Statements
State e t o Cas o s (co d)
b. These activities, which are explained in the following list, are the
activities from which a firm obtains and uses cash:
i. Operating activities include net income (or loss), depreciation,
and changes in current assets and current liabilities other than
cash and short?term debt. A firm’s net income, taken from the
income statement, is the first line on the corresponding period’s
cash flow statement.
ii. Investing activities include the purchase, sale, or investment in ii. Investing activities include the purchase, sale, or investment in
fixed assets, such as real estate, equipment, and buildings.
iii. Financing activities include cash raised during the period by
borrowing money or selling stock and/or cash used during the borrowing money or selling stock and/or cash used during the
period by paying dividends, buying back outstanding debt, or
buying back outstanding bonds.
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II. Financial Statements and Forecasts
Statement of Cash Flows (con’d):
A. Historical Financial Statements
State e t o Cas o s (co d)
c. As a management tool, it is intended to provide perspective on the
following questions:
i. Is the firm generating excess cash that could be used to pay down
debt or returned to stockholders in the form of dividends?
ii Is the firm generating enough cash to fund its investments from ii. Is the firm generating enough cash to fund its investments from
earnings, or is it relying on lenders or investors?
iii. Is the firm generating sufficient cash to pay down its short?term iii. Is the firm generating sufficient cash to pay down its short term
liabilities, or are its short?term liabilities increasing as the results
of an insufficient amount of cash?
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II. Financial Statements and Forecasts
Consolidated Statement of Cash Flows for New Venture Fitness Drinks
A. Historical Financial Statements
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II. Financial Statements and Forecasts
Ratio Analysis:
A. Historical Financial Statements
at o a ys s
The most practical way to interpret or make sense of a firm’s historical
financial statement is through ratio analysis.
Comparing a Firm’s Financial Results to Industry Norms: p g y
Comparing its financial results to industry norms helps a firm determine
how it stacks up against its competitors and if there are any financial “red
fl ” flags” requiring attention.
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II. Financial Statements and Forecasts
Link between Historic Financial Statements and Forecasts
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II. Financial Statements and Forecasts
1 The analysis of a firm’s historical financial statement is followed by the
B. Forecasts
1. The analysis of a firms historical financial statement is followed by the
preparation of forecasts. Forecasts are predictions of a firm’s future
sales, expenses, income, and capital expenditures. A firm’s forecasts
id th b i f it f fi i l t t t provide the basis for its pro forma financial statements.
2. A well?developed set of pro forma financial statements helps a firm
create accurate budgets, build financial plans, and manage its finances g p g
in a proactive, rather than a reactive, manner.
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II. Financial Statements and Forecasts
3 As mentioned earlier completely new firms typically base their
B. Forecasts
3. As mentioned earlier, completely new firms typically base their
forecasts on a good?faith estimate of sales and on industry averages
(based on a percentage of sales), or the experiences of similar start?ups
f t f d ld d th A lt l t l for cost of goods sold and other expenses. As a result, a completely
new firm’s forecast should be proceeded in its business plan by an
explanation of the sources of the numbers for the forecast and the
assumptions used to generate them.
a. This explanation is called an assumption sheet.
b Investors typically study assumption sheets like hawks to make b. Investors typically study assumption sheets like hawks to make
sure the numbers contained in the forecasts and the resulting
financial projections are realistic.
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II. Financial Statements and Forecasts
4 The two main forecasts are the sales forecast and the forecast of cost
B. Forecasts
4. The two main forecasts are the sales forecast and the forecast of cost
of sales and other items.
a. A sales forecast is a projection of a firm’s sales for a specified p j p
period (such as a year), although most firms forecast their sales
for two to five years in the future. A sales forecast for an existing
firm is based on (1) its record of past sales (2) its current 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 production capacity and product
demand demand.
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II. Financial Statements and Forecasts
b Forecast of Costs of Sales and Other Items Once a firm has
B. Forecasts
b. Forecast of Costs of Sales and Other Items. Once a firm has
completed its sales forecast, it must forecast its cost of sales and
the other items on its income statement.
i The most common way to do this is to use the percent of sales i. The most common way to do this is to use the percent?of?sales
method, which is a method for expressing each expense item
as a percentage of sales.
ii. Once a firm completes its forecast using the percent?of?sales
method, it usually goes through its income statement on an
item?by?item basis to see if there are opportunities to make item by item basis to see if there are opportunities to make
more precise forecasts.
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II. Financial Statements and Forecasts
iii If a firm determines that it can use the percent?of?sales
B. Forecasts
iii. If a firm determines that it can use the percent?of?sales
method and it follows the procedure described in the chapter,
then the net result is that each expense item on its income
statement (with the exception of those items that can be statement (with the exception of those items that can be
individually forecast) will grow at the same rate as sales. This
approach is called the constant ratio method of forecasting.
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II. Financial Statements and Forecasts
B. Forecasts
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Chapter 8: Assessing the Financial Strength and
Viability of New Ventures
Table of contents
I. Introduction to Financial Management
A. Financial Objectives of a Firm
B. The Process of Financial Management
II. Financial Statements and Forecasts
A. Historical Financial Statements
B. Forecasts
III P F Fi i l S III. Pro Forma Financial Statements
A. Pro Forma Income Statement
B. Pro Forma Balance Sheet
C Pro Forma Statement of Cash Flo s C. Pro Forma Statement of Cash Flows
D. Ratio Analysis
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III. 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.
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III. Pro Forma Financial Statements
Once a firm forecasts its future income and expenses the creation of the
A. Pro Forma Income Statement
Once a firm forecasts its future income and expenses, the creation of the
pro forma income statement is merely a matter of plugging in the numbers.
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III. Pro Forma Financial Statements
1 The pro forma balance sheet provides a firm with a sense of how its
B. Pro Forma Balance Sheet
1. The pro forma balance sheet provides a firm with a sense of how its
activities will affect its ability to meet its short?term liabilities, and how
its finances will evolve over time.
2. The pro forma balance sheet is also used to project the overall financial
soundness of a company.
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III. Pro Forma Financial Statements
1 The pro forma statement of cash flows shows the projected flow of cash
C. Pro Forma Statement of Cash Flows
1. The pro forma statement of cash flows shows the projected flow of cash
into and out of the company during a specified period.
2. The most important function of the pro forma statement of cash flows
is to project whether the firm will have sufficient cash to meet its
needs.
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III. Pro Forma Financial Statements
1 The same financial ratios used to evaluate a firm’s historical financial
D. Ratio Analysis
1. The same financial ratios used to evaluate a firms historical financial
statements should be used to evaluate the pro forma financial
statements.
2. This work is completed so the firm can get a sense of how its projected
financial performance compares to past performance, and how its
projected activities will affect its cash position and its overall financial p j p
soundness.
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III. Pro Forma Financial Statements
D. Ratio Analysis
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doc_975147666.pdf
This abstract tell institute institute for strategy strategy and business business economics.
A primer in Entrepreneurship
Prof. Dr. Ulrich Kaiser
Institute for Strategy and Business Economics Institute for Strategy and Business Economics
University of Zurich
Fall Semester 2009
Chapter 8: Assessing the Financial Strength and
Viability of New Ventures
Table of contents
I. Introduction to Financial Management
A. Financial Objectives of a Firm
B. The Process of Financial Management
II. Financial Statements and Forecasts
A. Historical Financial Statements
B. Forecasts
III P F Fi i l S III. Pro Forma Financial Statements
A. Pro Forma Income Statement
B. Pro Forma Balance Sheet
C Pro Forma Statement of Cash Flo s C. Pro Forma Statement of Cash Flows
D. Ratio Analysis
University of Zurich
ISU – Institute for Strategy and Business Economics
Ulrich Kaiser
A primer in Entrepreneurship
Fall Semester 2009
2
I. Introduction to Financial Management
1. Financial management deals with two things: raising money and managing
a company’s finances in a way that achieves the highest rate of return. p y y g
2. We cover the process of raising money in Chapter 10. This chapter
focuses on how a company manages its finances in an effort to increase its
financial strength and earn the highest rate of return financial strength and earn the highest rate of return.
University of Zurich
ISU – Institute for Strategy and Business Economics
Ulrich Kaiser
A primer in Entrepreneurship
Fall Semester 2009
3
I. Introduction to Financial Management
3. The financial management of a firm deals with questions, such as the
following, on an ongoing basis:
How much cash do we have on hand? How much cash do we have on hand?
Do we have enough cash to meet our short?term obligations?
How efficiently are we utilizing our assets?
d h d f h f d 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 other firms to share risk and
reduce the amount of cash we need?
Overall are we in good shape financially? Overall, are we in good shape financially?
4. A properly?managed firm stays on top of these questions through the
tools and techniques that are discussed in this chapter.
University of Zurich
ISU – Institute for Strategy and Business Economics
Ulrich Kaiser
A primer in Entrepreneurship
Fall Semester 2009
4
I. Introduction to Financial Management
A. Financial Objectives of a Firm
Primary Financial Objectives of Entrepreneurial Firms Primary Financial Objectives of Entrepreneurial Firms
University of Zurich
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Ulrich Kaiser
A primer in Entrepreneurship
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I. Introduction to Financial Management
A. Financial Objectives of a Firm
f b l b l f Profitability: 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. y g p y g
However, a firm must become profitable to remain viable and provide a
return to its owners.
Liquidity : Ability to meet its short?term financial obligations.
Even if a firm is profitable it is often a challenge to keep enough money in 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.
University of Zurich
ISU – Institute for Strategy and Business Economics
Ulrich Kaiser
A primer in Entrepreneurship
Fall Semester 2009
6
I. Introduction to Financial Management
A. Financial Objectives of a Firm
ff d l f l l Efficiency: How productively a firm utilizes its assets relative to its revenue
and its profits
Southwest Airlines, for example, uses its assets very productively. Its , p , y p y
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: 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 , y p q
also keep its debt in check.
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A primer in Entrepreneurship
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I. Introduction to Financial Management
1 T h th it fi i l bj ti b i t fi l
B. The Process of Financial Management
1. To assess whether its financial objectives are being met, firms rely
heavily on analysis of financial statements, forecasts, and budgets.
2. A financial statement is a written report that quantitatively describes a p q y
firm’s financial health. The income statement, the balance sheet, and
the statement of cash flows are the financial statements entrepreneurs
use most commonly. use most commonly.
3. Forecasts are an estimate of a firm’s future income and expenses, based
on its past performance, its current circumstances, and its future plans.
New ventures typically base their forecasts on an estimate of sales and 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.
University of Zurich
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I. Introduction to Financial Management
4 B d t it i d f t f ’ i d
B. The Process of Financial Management
4. Budgets are itemized forecasts of a company’s income, expenses, and
capital needs and are also an important tool for financial planning and
control.
5. The final step in the process of financial management is the ongoing
analysis of a firm’s financial results. Financial ratios, which depict
relationships between items on a firm’s financial statements, are used to relationships between items on a firms financial statements, are used to
discern whether a firm is meeting its financial objectives and how it
stacks up against its industry peers.
Many experienced entrepreneurs stress the importance of keeping on Many experienced entrepreneurs stress the importance of keeping on
top of the financial management of the firm.
In the competitive environment in which most firms exist, it’s simply not
d h t h t f th hi h ki fi i l d i i good enough to shoot from the hip when making financial decisions.
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I. Introduction to Financial Management
B. The Process of Financial Management
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I. Introduction to Financial Management
1 Hi t i l fi i l t t t fl t t f d ll
B. The Process of Financial Management
1. Historical financial statements reflect past performance and are usually
prepared on a quarterly and annual basis.
2. Pro forma financial statements are projections for future periods based
on forecasts and are typically completed for two to three years in the
future.
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Chapter 8: Assessing the Financial Strength and
Viability of New Ventures
I. Introduction to Financial Management
Table of contents
A. Financial Objectives of a Firm
B. The Process of Financial Management
II. Financial Statements and Forecasts
A Hi i l Fi i l S A. Historical Financial Statements
B. Forecasts
III. Pro Forma Financial Statements
A Pro Forma In ome Statement A. Pro Forma Income Statement
B. Pro Forma Balance Sheet
C. Ratio Analysis
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II. Financial Statements and Forecasts
Include the income statement, the balance sheet, and the statement of cash
A. Historical Financial Statements
c ude e co e s a e e , e ba a ce s ee , a d e s a e e o cas
flows. The statements are usually prepared in this order because
information flows logically from one to the next. In start?ups, financial
statements are typically scrutinized closely to monitor the financial progress statements are typically scrutinized closely to monitor the financial progress
of the firm.
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II. Financial Statements and Forecasts
A. Historical Financial Statements
Example: New Venture Fitness Drinks a p e: e e tu e t ess s
To illustrate how financial statements are prepared, we used New Venture
Fitness Drinks, the fictitious sports drink company introduced in Chapter 3.
New Venture Fitness Drinks has been in business for five years New Venture Fitness Drinks has been in business for five years.
Targeting sports enthusiasts, the company sells a line of nutritional fitness
drinks.
It opened a single location in 2003 added a second location in 2006 and It opened a single location in 2003, added a second location in 2006, and
plans to add a third in 2007.
The company’s strategy is to place small restaurants, similar to smoothie
l d l restaurants, near large outdoor sports complexes.
The company is profitable and is growing at a rate of 25% per year.
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II. Financial Statements and Forecasts
Three types of historical financial statements
A. Historical Financial Statements
Three types of historical financial statements
Financial Statement Purpose
Income Statement
The income statement 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.
Balance Sheet
whether the firm is making a profit or is experiencing a loss.
The balance sheet is a snapshot of a company’s assets,
liabilities and owners’ equity at a specific point in time
St t t f C h
liabilities, and owners equity at a specific point in time.
The statement of cash flows summarizes the changes in a
firm’s cash position for a specified period of time and
Statement of Cash
Flows
firm s cash position for a specified period of time and
details why the changes occurred. The statement of cash
flows is similar to a month?end bank statement.
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II. Financial Statements and Forecasts
A. Historical Financial Statements
Income Statement:
The income statement reflects the results of the operations of a firm over
a specified period of time. It records all the revenues and expenses for
Income Statement:
the given period and shows whether the firm is making a profit or is
experiencing a loss.
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II. Financial Statements and Forecasts
Income Statement (cont’d):
A. Historical Financial Statements
The three numbers that receive the most attention when evaluating an income
statement are the following:
Income Statement (cont d):
a. Net sales consists of total sales minus allowances for returned goods
and discounts.
b Cost of sales includes all the direct costs associated with producing or b. Cost of sales includes all the direct costs associated with producing or
delivering a product or service, including the material costs and direct
labor.
c. Operating expenses include marketing, administrative costs, and other
expenses not directly related to producing a product or service.
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II. Financial Statements and Forecasts
A. Historical Financial Statements
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II. Financial Statements and Forecasts
Balance Sheet:
A. Historical Financial Statements
Balance Sheet:
1. Unlike the income statement, which covers a specified period of time, a
balance sheet is a snapshot of a company’s assets, liabilities, and
’ i ifi d i i i owners’ equity at a specified point in time.
2. The left?hand side of a balance sheet (or the top, depending on how it is
displayed), shows a firm’s assets, while the right?hand side (or bottom) p y ), , g ( )
shows its liabilities and owners’ equity.
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II. Financial Statements and Forecasts
Balance Sheet (con‘d):
A. Historical Financial Statements
Balance Sheet (con d):
3. The major categories of assets listed on a balance sheet are the
following:
i Current assets include cash plus items that are readily convertible to i. Current assets include cash plus items that are readily convertible to
cash, such as accounts receivable, marketable securities and
inventories.
ii. Fixed assets are assets used over a longer time frame, such as real
estate, buildings, equipment, and furniture.
iii Other assets are miscellaneous assets including accumulated iii. Other assets are miscellaneous assets, including accumulated
goodwill.
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II. Financial Statements and Forecasts
Balance Sheet (con‘d):
A. Historical Financial Statements
Balance Sheet (con d):
4. The major categories of liabilities listed on a balance sheet are the
following:
i Current liabilities include obligations that are payable within a year i. Current liabilities include obligations that are payable within a year,
including accounts payable, accrued expenses, and the current
portion of long?term debt.
ii L t li biliti i l d t l th t bl ii. Long?term liabilities include notes or loans that are repayable
beyond one year, including liabilities associated with purchasing real
estate, buildings, and equipment.
iii. Owners’ equity is the equity invested in the business by its owners
plus the accumulated earnings retained by the business after paying
dividends.
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II. Financial Statements and Forecasts
Consolidated Balance Sheets for New Venture Fitness Drinks Assets
A. Historical Financial Statements
Consolidated Balance Sheets for New Venture Fitness Drinks Assets
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II. Financial Statements and Forecasts
A. Historical Financial Statements
Consolidated Balance Sheets for New Venture Fitness Drinks Assets Consolidated Balance Sheets for New Venture Fitness Drinks Assets
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II. Financial Statements and Forecasts
Statement of Cash Flows:
A. Historical Financial Statements
State e t o Cas o s
The statement of cash flows summarizes the changes in a firm’s cash
position for a specified period of time and details why the changes occurred.
It i i il t th d b k t t t It l h h h i It is similar to a month?end bank statement. It reveals how much cash is on
hand at the end of the month as well as how the cash was acquired and
spent during the month.
a. The statement of cash flows is divided into three separate activities:
operating activities, investing activities, and financing activities.
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II. Financial Statements and Forecasts
Statement of Cash Flows (con’d):
A. Historical Financial Statements
State e t o Cas o s (co d)
b. These activities, which are explained in the following list, are the
activities from which a firm obtains and uses cash:
i. Operating activities include net income (or loss), depreciation,
and changes in current assets and current liabilities other than
cash and short?term debt. A firm’s net income, taken from the
income statement, is the first line on the corresponding period’s
cash flow statement.
ii. Investing activities include the purchase, sale, or investment in ii. Investing activities include the purchase, sale, or investment in
fixed assets, such as real estate, equipment, and buildings.
iii. Financing activities include cash raised during the period by
borrowing money or selling stock and/or cash used during the borrowing money or selling stock and/or cash used during the
period by paying dividends, buying back outstanding debt, or
buying back outstanding bonds.
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II. Financial Statements and Forecasts
Statement of Cash Flows (con’d):
A. Historical Financial Statements
State e t o Cas o s (co d)
c. As a management tool, it is intended to provide perspective on the
following questions:
i. Is the firm generating excess cash that could be used to pay down
debt or returned to stockholders in the form of dividends?
ii Is the firm generating enough cash to fund its investments from ii. Is the firm generating enough cash to fund its investments from
earnings, or is it relying on lenders or investors?
iii. Is the firm generating sufficient cash to pay down its short?term iii. Is the firm generating sufficient cash to pay down its short term
liabilities, or are its short?term liabilities increasing as the results
of an insufficient amount of cash?
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II. Financial Statements and Forecasts
Consolidated Statement of Cash Flows for New Venture Fitness Drinks
A. Historical Financial Statements
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II. Financial Statements and Forecasts
Ratio Analysis:
A. Historical Financial Statements
at o a ys s
The most practical way to interpret or make sense of a firm’s historical
financial statement is through ratio analysis.
Comparing a Firm’s Financial Results to Industry Norms: p g y
Comparing its financial results to industry norms helps a firm determine
how it stacks up against its competitors and if there are any financial “red
fl ” flags” requiring attention.
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II. Financial Statements and Forecasts
Link between Historic Financial Statements and Forecasts
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II. Financial Statements and Forecasts
1 The analysis of a firm’s historical financial statement is followed by the
B. Forecasts
1. The analysis of a firms historical financial statement is followed by the
preparation of forecasts. Forecasts are predictions of a firm’s future
sales, expenses, income, and capital expenditures. A firm’s forecasts
id th b i f it f fi i l t t t provide the basis for its pro forma financial statements.
2. A well?developed set of pro forma financial statements helps a firm
create accurate budgets, build financial plans, and manage its finances g p g
in a proactive, rather than a reactive, manner.
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II. Financial Statements and Forecasts
3 As mentioned earlier completely new firms typically base their
B. Forecasts
3. As mentioned earlier, completely new firms typically base their
forecasts on a good?faith estimate of sales and on industry averages
(based on a percentage of sales), or the experiences of similar start?ups
f t f d ld d th A lt l t l for cost of goods sold and other expenses. As a result, a completely
new firm’s forecast should be proceeded in its business plan by an
explanation of the sources of the numbers for the forecast and the
assumptions used to generate them.
a. This explanation is called an assumption sheet.
b Investors typically study assumption sheets like hawks to make b. Investors typically study assumption sheets like hawks to make
sure the numbers contained in the forecasts and the resulting
financial projections are realistic.
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II. Financial Statements and Forecasts
4 The two main forecasts are the sales forecast and the forecast of cost
B. Forecasts
4. The two main forecasts are the sales forecast and the forecast of cost
of sales and other items.
a. A sales forecast is a projection of a firm’s sales for a specified p j p
period (such as a year), although most firms forecast their sales
for two to five years in the future. A sales forecast for an existing
firm is based on (1) its record of past sales (2) its current 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 production capacity and product
demand demand.
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II. Financial Statements and Forecasts
b Forecast of Costs of Sales and Other Items Once a firm has
B. Forecasts
b. Forecast of Costs of Sales and Other Items. Once a firm has
completed its sales forecast, it must forecast its cost of sales and
the other items on its income statement.
i The most common way to do this is to use the percent of sales i. The most common way to do this is to use the percent?of?sales
method, which is a method for expressing each expense item
as a percentage of sales.
ii. Once a firm completes its forecast using the percent?of?sales
method, it usually goes through its income statement on an
item?by?item basis to see if there are opportunities to make item by item basis to see if there are opportunities to make
more precise forecasts.
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II. Financial Statements and Forecasts
iii If a firm determines that it can use the percent?of?sales
B. Forecasts
iii. If a firm determines that it can use the percent?of?sales
method and it follows the procedure described in the chapter,
then the net result is that each expense item on its income
statement (with the exception of those items that can be statement (with the exception of those items that can be
individually forecast) will grow at the same rate as sales. This
approach is called the constant ratio method of forecasting.
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II. Financial Statements and Forecasts
B. Forecasts
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Chapter 8: Assessing the Financial Strength and
Viability of New Ventures
Table of contents
I. Introduction to Financial Management
A. Financial Objectives of a Firm
B. The Process of Financial Management
II. Financial Statements and Forecasts
A. Historical Financial Statements
B. Forecasts
III P F Fi i l S III. Pro Forma Financial Statements
A. Pro Forma Income Statement
B. Pro Forma Balance Sheet
C Pro Forma Statement of Cash Flo s C. Pro Forma Statement of Cash Flows
D. Ratio Analysis
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III. 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.
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III. Pro Forma Financial Statements
Once a firm forecasts its future income and expenses the creation of the
A. Pro Forma Income Statement
Once a firm forecasts its future income and expenses, the creation of the
pro forma income statement is merely a matter of plugging in the numbers.
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III. Pro Forma Financial Statements
1 The pro forma balance sheet provides a firm with a sense of how its
B. Pro Forma Balance Sheet
1. The pro forma balance sheet provides a firm with a sense of how its
activities will affect its ability to meet its short?term liabilities, and how
its finances will evolve over time.
2. The pro forma balance sheet is also used to project the overall financial
soundness of a company.
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III. Pro Forma Financial Statements
1 The pro forma statement of cash flows shows the projected flow of cash
C. Pro Forma Statement of Cash Flows
1. The pro forma statement of cash flows shows the projected flow of cash
into and out of the company during a specified period.
2. The most important function of the pro forma statement of cash flows
is to project whether the firm will have sufficient cash to meet its
needs.
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III. Pro Forma Financial Statements
1 The same financial ratios used to evaluate a firm’s historical financial
D. Ratio Analysis
1. The same financial ratios used to evaluate a firms historical financial
statements should be used to evaluate the pro forma financial
statements.
2. This work is completed so the firm can get a sense of how its projected
financial performance compares to past performance, and how its
projected activities will affect its cash position and its overall financial p j p
soundness.
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III. Pro Forma Financial Statements
D. Ratio Analysis
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