McGuire + Farry

Financial Projections

Keith McManusPartner McGuire + Farry Tel: 028 908137447th November 2008

Email:keith@mcguirefarry.com

Agenda

• How to measure the performance of your business ?

- Review of key profitability, liquidity and leverage ratios

- Worked example

- Invest NI ratio analysis

Agenda

• The Importance of Cash

- causes of business failure

– defining cashflow

– link between profit and cash

– worked example

– how to establish the funding requirement

Agenda

• Funding Requirements / Sources

– difficulties faced when seeking initial funding

– sources of funding

– what do Banks look for

– repayment capacity

Agenda

• The Business plan process

– different uses of the business plan

– a walkthrough of the key contents of a business plan

McGuire + Farry

Measuring the Performance of your Business

- business financial ratios

Business Financial Ratios

Simple example – Gross Profit Margin (GPM)

A Sales are £500,000

B Cost of sales are £350,000

C Gross Profit is £150,000 (A minus B)

D GPM margin is 30% (C as % of A)

Business Financial Ratios

• Main Ratio Categories– Profitability – Liquidity and solvency– Leverage (Gearing)

Profitability – how successfully is the business being run?

(1) Sales Growth Current Year SalesPrior Year Sales x 100 = %

(2) GPM Gross Profit x 100 = % Sales

(3) Net Profit Margin Profit before Tax x 100 = % Sales

(4) Return on Capital Profit before Tax x 100 = %Employed (ROCE) Shareholders Funds

Liquidity – Can the company meet current obligations when they fall due?

(1) Current Ratio Current Assets =Ratio

Current Liabilities

(2) Quick Ratio Current Assets-Stocks = RatioCurrent Liabilities

(3) Debtors days

Debtors x 365 = days

Sales

Liquidity – Can the company meet current obligations when they fall due?

(4) Creditor days Trade Creditors Purchases x 365 = days

(5) Stock turnover Average stock x 365 = days

Cost of sales

Leverage – Dependency on external debt ?

(1) Gearing Ratio Total External Debt Shareholders funds x 100 =

%

Business financial ratios

• Interpretation of ratios– Banks / HP and finance companies– Investors

Widgets NI Ltd

2004 2005 2006

Profit & Loss £ £ £

Sales 2,652,000 2,754,000 2,856,000

Cost of goods sold 2,121,000 2,203,200 2,284,800

Gross profit 531,000 550,800 571,200

General admin & selling 204,000 224,400 244,800

Depreciation 81,600 102,000 122,400

Miscellaneous 41,400 85,700 122,400

Total Overheads 327,000 412,100 489,600

Net profit before tax 204,000 138,700 81,600

Widgets NI Ltd

2004 2005 2006

Balance Sheet £ £ £

FIXED ASSETS

Land and buildings 49,000 130,600 122,400

Machinery 151,000 118,300 102,000

Motor vehicles 28,600 8,200 6,100

228,600 257,100 230,500

CURRENT ASSETS

Stock 306,000 550,000 876,600

Debtors 245,000 306,400 448,000

Cash 61,000 28,600 20,000

612,000 885,000 1,344,600

Widgets NI Ltd

2004 2005 2006

Balance Sheet (cont’d) £ £ £

CURRENT LIABILITIES

Bank - 102,000 286,000

Creditors 98,000 155,000 306,000

Accruals 49,000 57,000 77,500

147,000 314,000 669,500

NET CURRENT ASSETS 465,000 571,000 675,100

Creditors>1 year – Loan 45,000 40,800 36,700

NET ASSETS 648,600 787,300 868,900

SHARE CAPITAL 365,000 365,000 365,000

Reserves 283,600 422,300 503,900

SHAREHOLDERS FUNDS 648,600 787,300 868,900

Performance ratios - Profitability

2004 2005 2006

Sales growth 3.8% 3.7%

Gross profit margin % 20% 20% 20%

Net profit margin % 7.7% 5.0% 2.8%

Return on Capital Employed 31.5% 17.6% 9.4%

Performance Ratios -Liquidity & Gearing

2004 2005 2006

Current Ratio 4.16:1 2.82:1 2.0:1

Quick ratio 2.08:1 1.1:1 0.69:1

Debtors days 34 41 57

Creditors days 17 26 49

Stock Turnover days 71 114

Gearing 7% 18% 37%

Invest NI

Invest NI – Ratio Analysis • ROCE• GPM• Current ratio• Quick ratio• Stock turnover• Debtors days• Creditors days• Gearing ratioOther; • Value added per employee

McGuire + Farry

The Importance of Cash

Contents

• Causes of business failure

• What is the cashflow?

• Relationship of profit to cash

• Example

• Establishing the funding requirement

Causes of business failure

• Poor cashflow management

• Poor business planning

• Market failure

• Inadequate or inappropriate financing

What is cashflow?

• Links the Profit & Loss Account to the Balance Sheet

• Shows how much cash was physically received/spent during the period

• Shows whether the organisation had a net inflow or outflow of cash

PROFIT DOES NOT EQUAL CASH !

Relationship of Profit to Cash

ProfitAdd Back:DepreciationTax= Profit from operating activities

Movement in working capital assets:(Increase)/Decrease in stock(Increase)/ Decrease in debtorsIncrease/(Decrease) in creditorsIncrease/(Decrease) in accruals(Loan repayments) / New loans(Capital expenditure)= Net Operating Cashflow

Widget NI Ltd

2005 £ £

Profit 138,700

Add Back – Depreciation 102,000

Profit from operating activities 240,700

Movement in working capital assets

Increase in stock (244,000)

Increase in debtors (61,400)

Increase in creditors & accruals 65,000

Loan repayments (4,200)

Capital expenditure (130,500) (375,100)

Net Operating Cashflow (192,600)

Widget NI Ltd

2006 £ £

Profit 81,600

Add Back – Depreciation 122,400

Profit from operating activities 204,000

Movement in working capital assets

Increase in stock (326,600)

Increase in debtors (141,600)

Increase in creditors & accruals 171,500

Loan repayments (4,100)

Capital expenditure (95,800) (396,600)

Net Operating Cashflow (134,400)

Establishing the Funding Requirement

• Establish the three year funding requirement

- Capital expenditure

- Working capital

• Peak funding requirement

McGuire + Farry

Sources of Funding

Overall Perspective of the Finance Market

• Initial funding is most difficult• Combination of funding sources• Capital grants have reduced• NI is generally a favourable place to borrow.

Equity Capital

• Capital introduction

- Own capital

- Business Angels

- Venture capital

Finance - Who are the debt providers?

• Main tier (4 Clearing Banks)• Second Tier- Anglo Irish Bank- Bank of Scotland- Barclay's Bank- HSBC Bank plc- Internet banks

Bank Products – Short Term

- Extension of overdraft facility

- Invoice discounting

- Stock financing

- Forward contracts

Bank Products – Medium term

- Fixed rate loans

- Variable term loans

- Hire purchase / leasing

- Small Firm's Loan Guarantee Scheme

Approach to lending

Three major areas of importance:

1. The borrower

2. Capacity to repay

3. Security

The Borrower

Key issues:

Track record Integrity Management ability Quality of MIS Can they successfully carry the project through?

Repayment Capacity

• The adequacy and stability of cash generation to meet:– working capital needs– capital expenditure needs– dividends– tax– debt reduction

while keeping leverage at acceptable levels

• Demonstrating satisfactory repayment capacity

Security

If all else fails -

• Receivership/liquidation/bankruptcy costs• Personal guarantees• Guarantors

Other Sources of Funding

• Invest NI• Business Angels• Venture Capitalists• Going public

Invest Northern Ireland

• focussing on stimulating entrepreneurship

• target grants in high growth sectors

• target exporting, R&D, mktg & training

Business Angels

PATRON ANGELS• invest £1million • little involvement in day to day affairs

ENTREPRENEURIAL ANGELS• invest between £50,000 - £1million• provide 'hands-on' support

OCCUPATIONAL• up to £50,000 to invest• seeking full time employment

Venture Capitalists

• Generally for investment over £1 million

• venture capitalists look for a high return

• expect demanding targets

• will have knowledge of your industry

• experience in how to realise their investment

• specific interest in growing your business quickly

What do Venture Capitalist's and Business Angels look for?

• Attractive market

• ability to sustain a competitive edge

• strong growth opportunities

• strong management

Going Public

• Key markets

• Full Listing on the LSE

• AIM (Alternative Investment Market)

• Others

AIM

• Junior Stock Market launched 1995

• no set requirements for size

• generally market capitalisations of £1 - £10 million

• used primarily to raise money to grow rather than payout existing shareholders

• must appoint NOMAD to advise

Full Listing

• demands strict admission criteria

• requires three year track record

• directors and senior management with expertise

• market capitalisation of at least £700,000

• 25% of shares must be in public hands

• publish a comprehensive prospectus including financial information

McGuire + Farry

The Business Plan Process

Uses of a Business Plan

Internal• as a plan for the business

• as a means of measuring performance

• as a way of communicating with employees

• as a way to detect adverse trends early and to be able to correct them

Uses of a Business Plan (contd)

External

• to be used to raise finance

• to demonstrate control of the business

• to provide information about the business

Contents of a Business Plan

• Executive Summary• Background• Ownership, management and control• Market and marketing strategy• Product and production • Historical financial information• Projected financial information• Funding proposal

Background & Terms of Reference

• Brief overview of business

- When business will start

- Core business / core products / services

- Market trends

- Market share / competitors

Background & Terms of Reference

• Purpose of the business plan

- Business objectives

- Key business issues to meet

- Management resources

- Production / product development

- Sales / marketing etc

Ownership, Management & Control

Ownership• - Status of Business• - Identify owners / directors / partners

Ownership, Management & Control

Management

- Planned organisational chart

- Identify key functional managers (Sales / production / technical / finance)

- Identify any resource gaps

- Require job specifications / job descriptions

Ownership, Management & Control

• Control

- Describe accounting and control system(Sales / purchases / overheads / stock /payroll / computer system)

- Detail management information system

Marketing

• Market overview

• Sales / marketing resource

• Target customers / markets

• Competition

Marketing (contd)

• Pricing

• SWOT analysis

• Marketing strategy / tactics

• Promotion / selling methods

• Action plan and budget

Production

• Product / service range

- Competitive advantage

• New product development

• Premises

• Materials

Production (contd)

• Labour

• Quality control

• Cost control

• Capital equipment

Financial Projections

• Source of business comparison

• Key business ratios

- Profitability

- Liquidity

- Leverage

Financial Projections

• Three year financial projections:– Balance Sheet– Profit & Loss– Cashflow

• Detail out assumptions

• Funding proposal falls out of this

• Failing to plan is planning to fail

• “Prediction is very difficult, especially about the future” (Niels Bohr)