Chapter 6: Analyzing Cash Flow and Other Financial Information

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Chapter 6 Analyzing Cash Flow and Other
Financial Information
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How Important is Cash Flow?

• Cash flow is the most critical item for a new
  business
• A lack of cash flow is the greatest cause of
  failure for a new business
• Note that profits are not the same as cash
• Profits are only when revenues exceed expenses
• Revenues are not necessarily purchased with cash.

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New Business Dilemma Part 1

• Inputs are often paid in cash (new businesses
  often dont have the credit worthiness to
  purchase on credit
• Most sales are on credit
• Often the credit accounts arent paid for 60-90
  days

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New Business Dilemma Part 2

• It is possible for a new businesses to be
  profitable but not be cash flow positive
• Without a positive cash flow, how does the new
  business pay for its inputs, salaries, etc.?

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Measuring Cash Flow

• Simplest way to measure cash flow is to compare
  all cash inflows to all cash outflows.
• Compare all initial cash on hand from investors
  or owners (equity), future expected cash sales,
  expected cash collections from credit purchases,
  less the expenses for COGS as well as expenses
  such as payroll and taxes.

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What is the BIG Question?

• Need to develop a set of tools to decide whether
  or not it is wise to pursue a potential business
• Cash flow, balance sheet, income statement
• Being able to forecast future financial outcomes
  is critical in determining the future viability
  of the small business.

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Cash Flow

• Profits are great in the public investing
  community, but is not the focus of the small
  business investor
• The key is being able to bring in on a monthly
  and cyclical basis more cash than is paid out.

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Why Is Cash So Important?

• Bills, Salaries, etc are paid in cash
• You dont get the money from your paycheck in 60
  days
• Most vendors are paid in cash
• Even on a good day, the small business will owe
  its debts in 30 days
• Those purchasing products/services from the small
  business though will have 90 days to pay their
  debts.

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What is Float?

• Float refers to the difference in time between
  when the check is deposited and cash is received
• i.e. the 60-90 day intervals in the previous
  slide
• Problem is that others are collecting the
  interest on your money
• As the small business needs more supplies and
  inputs to make products, these intervals become
  even more severe
• This can be a large cause of failure for a small
  business.

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How can the Small Business Combat Float?

• By making cash flow projections that are
• ACTIVE
• ACCURATE
• and most importantly
• REALISTIC!!!

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Cash Flow Statement

• Cash flow statements ARE NOT budgets
• Cash flow statements are concerned only with
  ACTUAL cash inflows and outflows.

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An Example of the Difference Between Budgets and
Cash Flows

• Take a prepaid insurance for a year costing
  1,800 or 150 a month
• A budget will account for 12 equal installments
  of 150
• A cash flow statement will recognize a 1-time
  only outflow of 1,800.

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How To Develop an Accurate Initial Cash Flow
Projection

• Contact vendors/suppliers and ask about payment
  terms
• Check with credit card companies and get
  information about when the accounts will be
  processed as well as what the percentages are.

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What About When the Company is Up and Running?

• It is important to compare actual cash flow with
  the projected cash flow
• This will illustrate the differences in actual
  performance
• Comparing today will help the business make more
  realistic forecasts for the future.

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Possible Information Gained from Cash Flow
Analysis

• Why were sales revenue so far below expectations?
• Why was traveling expenses so high?
• Why was advertising revenue so little?
• A possible explanation for lack of sales???

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Developing a Cash Flow Statement Part 1

• The cash flow statement of a small business is
  different than that of a corporation
• Corporation will have operating, investing, and
  financing sections to their Statement of Cash
  Flows
• The small business is only interested in the cash
  flows resulting from operations
• Operations signifies all the cash flows in/out of
  the business

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Developing a Cash Flow Statement Part 2

• A cash flow statement will maintain an accurate
  representation of the overall cash position if
  used effectively
• An accurate long-term history with ones cash
  flow statement will assist the company with
  loans, credit lines, gathering equity capital,
  and valuation if the owner decides to sell the
  company

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Developing a Cash Flow Statement Part 3

• A cash flow statement begins with expenses
• Examples of possible expenses
• Salaries
• Cost of Goods Sold
• Taxes
• Office Supplies (often underestimated)
• Rent
• Important to account for EVERY expense

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Developing a Cash Flow Statement Part 4

• Begin accounting for revenues once done with all
  expenses
• If possible, the company should separate their
  revenues into separate categories
• It will help focus the business on which sectors
  of its revenues are important and will influence
  the operations of the business

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Developing a Cash Flow Statement Part 5

• Multiple cash flow statements are useful if a
  business is considering pursuing a new business
  idea
• What is the likely scenario?
• What is the best case scenario?
• What is the worst case scenario?
• The scenarios will help identify the potential
  risk/reward associated with the new idea.

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Breakeven

• Breakeven is the point where expenses and sales
  equal each other
• Understanding the break even point allows a new
  small business to predict how much money it will
  need to survive.

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How to Predict Sales

• Look towards similar small businesses in your
  area
• These individuals are great sources of
  information
• Key is to be conservative in projections
• It is much better to underestimate and get a
  pleasant surprise vs. overestimating and
  getting a nasty present.

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Developing the Income Statement

• Sales minus COGS gives the firms gross profit
  margin
• Subtract out other expenses (i.e. salary) to get
  the earnings before taxes
• Taxes are then calculated and subtracted out
  giving the firms profit.

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Using the Breakeven Point to Plan a Targeted
Profit
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Break-even Chart for Determining Target Return
Price and Break-even Volume
Total revenue
1200
Profit
Total Cost
1000
Break-even point
800
600
Dollars (in thousands)
Loss
400
Fixed cost
200
0
10
20
30
40
50
Sales volume in units (thousands)
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Using The Breakeven Formula Rather Than The Chart

• Break Even Point Total Fixed Costs/Price
  Variable Cost
• From the chart it appears that each unit sells
  for 20
• Total Fixed Costs are 300,000
• From the chart we can see that the Break Even
  Point is 800,000 so we can now calculate the
  Variable Cost
• 800,000300,000/20 Variable Costs
• Variable Cost 16.25 per unit (This means that
  profit per unit is 3.75).

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Using the Breakeven Point to Plan a Targeted
Profit

• Variable Cost 16.25 per unit (This means that
  profit per unit is 3.75)
• Amend the formula to reflect break even plus
  target profit
• Break Even Point (Total Fixed Costs Target
  Profit)/Price Variable Cost
• Breakeven Point 300,000 100,000/20 16.25
• Breakeven Point 400,000 /3.75
• Breakeven Point 106,666.67

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Break-even Chart for Determining Target Return
Price and Break-even Volume
Total Revenue
Total cost 100K Profit
1200
Break-even point 100K Profit
Total cost
1000
800
Break-even point
600
Dollars (in thousands)
Fixed cost 100K Profit
400
Fixed cost
200
0
10
20
30
40
50
Sales volume in units (thousands)
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Chapter Exercises

• Using the information that you developed in your
  cash flow statement, develop a breakeven chart
• Using all of the information from this chapter,
  develop a short (one to two paragraph) discussion
  of the financial projections for your proposed
  company.