L561: Information Systems Design for Digital Entrepreneurship Financial statements I. Understanding...

L561: Information Systems Design for Digital Entrepreneurship

Financial statements

I. Understanding financials

• What is a financial plan?

• Types of financing and capital

II. Developing a financial statement

• What goes into it?

• How do you make projections?





It is a statement that outlines the financial requirements needed to achieve the goals of the business plan

It “is a quantified vision of your project upon which much of your credibility with investors will rest - get it right and you will give them confidence”Innovateurwww.innovateur.co.uk/financial_plans.html

It should be based on other information in the business plan

It will be carefully read and analyzed


Key questions:

What amount of financing is needed to make the planfeasible?

Given the current stage of the business, what type of financing is needed?

When and in what amounts will the financing be needed?

In what form (or forms) will financing be needed?

Who will provide the financing?

What is a realistic plan for repaying creditors and/or investors?


Key components:

Profit and loss statement: shows the underlying profitability of the operation

Focuses on operating performance

Cash flow statement: shows the movement and use of capital to fund operations in the P&L account

Also the acquisition or disposal of assets in the balance sheet

Balance sheet: a statement of assets and liabilities at a point in time

Money owed to creditors, to the bank (loans), fixed assets (equipment, land...), owed by customers, investment by shareholders...


What is needed to develop the plan

Operating plans and budgets

Sales forecasts: product/service revenues

Marketing budget

Historical financial statements and budgets

Published financial data for industry overview

Operating policies

Personnel policies: vacations, fringe benefits, healthcare

Inventory and purchasing procedures

Credit practices


Forms of financing

Debt financing: funds borrowed from a creditor under a legal contractual agreement

Stipulates terms of borrowing and repayment

Legally limits the involvement and influence of the creditor in the firm

Short-term: credit extended by suppliers and short term loans for purchase of goods

This obligation is a “current liability”

Long-term: typically 15 or 30 years

This obligation is a “long-term liability”


Equity financing

Investor has ownership interest in the business in exchange for the investment

Typically the owners of the business

May be cash or stock purchases

Assumed to continue for the life of the firm with returns reinvested in the firm

Internal financing

Funds from normal operations remaining after creditors, taxes and (perhaps) shareholders are paid

May be additional investment by the owners


Types of financing

Seed money: used to develop and refine the business concept

Could fund a prototype or meet start-up costs

Not easy to find because the business is too new and unproven

Start-up capital: short-term working capital that gets the business up and running (initial operations)

Long-term capital to support human and operational resources

Also difficult to obtain because of the risk to investors


A successful argument for seed and start-up capital emphasizes that

There is evidence of market acceptance of the concept

There is evidence of potential for commercial success

There is potential for large scale returns on investment

The management team has excellent credentials in the industry

The problem to overcome is that short term loans to a new business are very high risk

This is when pitches to venture capitalists become very important

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www.wfa.org/newsletter/archive/2003/0305_030131/seed_money.jpg


Working capital: short-term financing to cover costs of recurring accumulation of assets

Inventory, accounts receivable

Expected to turn into cash flow at the end of a cycle

Money provided by commercial banks

Trade creditors will extend credit anticipating future payment



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Venture capital is a subset of private equity

Used for the launch, early development or expansion of a business

Provides equity capital to enterprises not quoted at the stock market

Can be used to develop new products and technologies,

To expand working capital

To make acquisitions

To improve a company’s operations

Can be used to resolve ownership and management issues (succession in family-owned companies) or the buy-out or buy-in by experienced managers


Venture capital

Involves investments in unquoted companies

Is equity capital by nature

Is medium to long-term and targeted at companies with growth potential

Is combined with an active shareholder influence by the investor

Money come from private and institutional investors

Managers are in charge of the funds

VCs can provide their clients with management skills, contacts and market access

If appropriate they find external managers


seattlepi.nwsource.com/dayart/20040726/Venture-capital-0726.gif

VC investment is increasing but it is 20% of what it was in 2000




How the process works

www.themanager.org/Resources/The%20Venture%20Capital%20Industry-Dateien/image010.gif




How the process works II:

www.themanager.org/Resources/The%20Venture%20Capital%20Industry-Dateien/image027.gif


Efiltro. New Idea Center. (2003). Developing new business in new markets. http://newideacenter.com/Home/ Disclaimer.htm

An overview of venture capital funding





• Types of financing and capital



• How do you make projections




Break even analysis

Work with the main variables to understand how they interact and affect profit

Fixed costs and overhead: main costs incurred regardless of business activity

They are fixed within a period of time

Human resources: staff, stationery, insurance, lawyer, accountant

Other resources: mortgage, rent, utilities, insurance


Break even analysis

Variable costs: costs that vary directly with changes in business activity

The material costs to produce a single unit

Each unit incurs these costs - 10 will incur 10 lots of this cost

Sales price: the price you expect to sell the good or service

Sales volume: the number of units you expect to sell to cover your costs

Profit: the point at which revenues exceed expenses


Calculate the break even point

Unit price 20

Unit costs 5

Fixed costs 1000

BE point (units) Must sell 67 units

BE point (revenue) Must generate $1,333

BE point (units) = fixed costs/(unit price - unit costs)

BE point (revenue) = fixed costs/((unit price - unit costs)/unit price))


Calculate the price required to break even

Unit costs 5

Number of units to sell 67

Fixed costs 1000

Price required to break $19.93 even

Price = (fixed costs/(number of units to sell) + unit costs




home.ubalt.edu/ntsbarsh/Business-stat/otherapplets/BreakEvent.gif


Income statement: profit and loss

How much money will you have left after all expenses are paid?

Does not provide an overall picture of the business’ value

Begins with sales (revenues) and each subsequent line in the statement represents another cost (expenses)

Gross sales: $ ____

Then: employee benefits, depreciation/amortization, office supplies, marketing, travel, entertainment/meals, insurance, professional services, maintenance, commuication/computing


www.bplans.com/common/gifs/QA/bplans/StandardP&L.gif




Cash-flow projections

How much money the company has in the bank

Money going in and out of the business on a monthly basis

How much is needed to meet all of the regular expenses

Does not indicate profitability

Should account for seasonal change, fluctuations in inventory, sales based on credit

Should be compiled monthly

Separate revenue from business activities from loans or investments


Cash-flow projections

Includes money coming in

Cash sales, collections, interest income, loan proceeds

Includes money going out

Costs of goods.services, operating expenses, owner’s draw

Includes money held back

Reserves

Net cash flow: money left after disbursements have been deducted from all cash received

Opening cash balance: money in the bank at the start of the month (should match last month’s cash balance)


www.leadership-tools.com/images/cashflowcycle.gif




www.toolkit.cch.com/text/P06_6400.asp


Assumptions are important because they put the numbers into a context

The table makes a number of assumptions

The average price of the product will increase annually by 5%

The volume sold will increase annually by 15%

Depreciation is computed using the IRS's tables for 7-year property

Tax depreciation is used because it affects the outflow of cash in the form of tax payments

Fixed costs will increase by an annual rate of 5%

The tax rate is calculated at 34%


The bottom line issue is deciding how much capital is needed to get the business up and running

For example

Area of expenditure Finance Required

Office equipment 20,000

Production tools 50,000

Working capital and stock 40,000

Marketing 50,000

Overhead 100,000

Contingency 40,000

Total financing required 300,000


A related issue is how much of the business’ equity you are willing to exchange for investment dollars

For example

Shareholders Pre-financing Post-financing

CEO / Founder 50% 40%

Other Management 30% 24%

Current Investors 20% 16%

New Investors 20%

Total Equity 100% 100%


A balance sheet provides a snapshot of a business at a specific point in time

It lists all assets

Current assets: cash, accounts receivable, inventory, prepaid expenses

Fixed assets: land, buildings, equipment, furniture, fixtures (less accumulated depreciation)

Other assets

Total assets


A balance sheet provides a snapshot of a business at a specific point in time

It lists all liabilities

Current liabilities: accounts payable, accrued payroll, taxes payable, short-term notes payable

Long-term liabilities : long-term notes payable

Net worth: shareholder equity, retained earnings

Total liabilities and net worth

Total assets should match total liabilities




www.g2rgroup.com/images/investor/chart_balance_sheet.gif


Other financial concerns

Handling the money

Merchant account

Typically with a bank and enables credit card payments to be processed

There are usually costs associated with setting up a merchant account

Set-up cost, a monthly fee and per-transaction fees

A good arrangement: $100 setup, $10 per month and $.30 per transaction fee


Digital certificates

To accept payments through your website a digital certificate is needed (Verisign)

Also a secure server and secure sockets layer (SSL)

Payment information can be encrypted to protect against theft

Payment processing

For authentication of credit card numbers and passing payments to the bank you use a payment processing service (CyberCash, Paypal)

The service that you use may depend on the ISP and shopping cart that you use


Back end processing of orders

Many ebusinesses rely on email to get orders from their web sites into their order processing departments

Typically they are re-keyed into their existing system

You can remove intermediate processing and have on- line orders load directly into the order fulfillment and/or accounting systems

Many types of software packages that will do this

The tricky part is integrating the web front end with back end legacy systems

L561: Information Systems Design for Digital Entrepreneurship Financial statements I. Understanding...

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