Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of...

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Transcript of Chapter 7 Concept & Development of Entrepreneurship Entrepreneurial Decision Process Types of...

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Chapter Learning Objectives
To understand the role of budgets in preparing pro forma statements.
To understand why positive profits can still result in a negative cash flow.
To learn how to think strategically about financial management decisions
To learn how to prepare monthly pro forma cash flow, income, balance sheet, and sources and uses of funds statements
To explain the break-even point for the new venture.
To illustrate how ratio analysis can assist the firm
To illustrate the alternative software packages that can be used
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd.
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Wireless, Rogers Cable, and Rogers Media
Recently purchased Microcell (aka Fido)
Pushed its debt to $8 billion (i.e. 5 times the company’s earnings before interest, taxes and depreciation)
Investing heavily in broadband and technology
Wants to be the dominant communications player in Canada
Entering the local phone provider marketplace
Offers complete package of cable TV, Internet, local, long distance, and wireless telephone services
Wants to defeat Bell Canada
His challenge will be to manage his company’s cash flow and debt load
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd.
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Preparing Financial Statements
Entrepreneurs should be aware of a couple of points prior to engaging in this process
The size of the company will dictate the extent of financial planning
The “intent” of the business plan may also dictate the extent of financial planning
Entrepreneurs should not estimate or assume too much in an initial plan
Be careful not to overpay yourself
investors like to see an entrepreneur “sharing the pain”
Do not spent too much time on these statements
Many great entrepreneurs were not necessarily great financial planners
Financial planning is an ongoing process
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd.
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Operating and Capital Budgets
The financial plan is a key component of the business plan for several reasons:
Can be used to determine/prove feasibility of the venture
Allows planning for capital requirements
Provides confidence for investors and lenders
Key statements:
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Reducing Expenses
As an entrepreneur, the less cash spent, the more left over
to pay yourself!
Beware of an entrepreneur who is not careful about their spending
Key tip-off: expensive vehicle lease in the business plan!
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd.
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Shop around for the best deal
Haggle whenever possible
Don’t buy things you don’t need
Watch where you rent
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Pro forma income (definition): projected net profit calculated from projected revenues minus projected costs and expenses
Monthly numbers for the first several years
Starts with sales forecast
Sales numbers should be based on market research, industry sales, or trial experience
Market share information can be key
Operating expenses can be based on industry standards, estimates, and experience
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd.
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Experienced entrepreneurs will keep track of these
expense areas
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Pro forma cash flow (definition): projected cash available
calculated from projected cash accumulations minus projected
cash disbursements
Cash flow is not the same as profitability
A growing business that is profitable can very easily run out of cash
Most new ventures will have negative cash flow during the start-up phase
Two methods to project cash flow
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd.
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Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd.
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Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd.
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Needed to raise “owner’s equity” for her renovation project
Some money came from an economic development group
She also obtained a government-guaranteed loan
Obtained a matching grant program
Used a state program for energy-efficient upgrades
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd.
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Pro forma balance sheet (definition): summarizes the projected assets, liabilities, and net worth of the new venture
Assets (definition): represents items that are owned or available to be used in the venture operations
Liabilities (definition): represents money that is owed to creditors
Owner’s equity (definition): represents the amount owners have invested and/or retained from the venture operations
Pro Forma Balance Sheet
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Entrepreneurs have argued that traditional financial planning does not align well with what happens “in the real world”
Cash is king
Entrepreneurs are more concerned about their ability to raise capital than what is expressed in textbooks
Entrepreneurs are concerned about increasing the value of their company over time
not so interested in short term financial results
Entrepreneurs are emotionally tied to the company
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd.
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Entrepreneurs have argued that traditional financial planning
does not align well with what happens “in the real world”
Entrepreneurs often break financial management down to a series of questions:
where is the company headed
what will happen in the future
what can go wrong
what has to happen so the company can achieve its financial goals
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd.
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Break-even Analysis
Break-even (definition): the volume of sales where the venture neither makes a profit nor incurs a loss
Concept used when determining feasibility of the venture
Need to determine the costs of producing one unit (variable costs) and the fixed costs of operating the business
Selling price charged needs to cover the variable costs of producing the unit and the remainder (gross margin) contributes to paying the fixed costs of operating the business
Formula for break-even:
B/E (Q)= TFC/(SP-VC)
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It reveals your company’s exposure to debt
(how much ya owe)
Ratio of current assets to current liabilities
This reveals your ability to pay for things in the short term
Wages to sales ratio
Crucial for restaurants, construction firms .. Companies that have a high portion of costs eaten up by salary
Inventory to sales ratio
Expressed as the number of days to turn over a given inventory
Indicates how fast you are selling stuff from the point when you obtained the materials to make it
Gross profit margin
This ratio enables an entrepreneur to determine the level of sales they need to break even
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd.
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Pro Forma Sources and Applications of Funds
Proforma applications and sources of funds (definition): summarizes all the projected sources of funds available to the venture and how these funds will be discharged
The purpose is to show how net income and financing were used to increase assets or to pay off debt
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd.
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Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd.
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Chapter Closing Comments
To understand the role of budgets in preparing pro forma statements.
To understand why positive profits can still result in a negative cash flow.
To learn how to prepare monthly pro forma cash flow, income, balance sheet, and sources and uses of funds statements for the first year of operation.
To explain the application and calculation of the break-even point for the new venture.
To illustrate the alternative software packages that can be used for preparing financial statements.
Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd.
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