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The Financial Forecasts for the Business Plan

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The Financial Forecasts for the Business Plan Principles of Entrepreneurship 2005 ... Shelley Write. Freddy Khan. Sara Jesper. Antonio Balgeras. $100,000.00. $100,000.00. – PowerPoint PPT presentation

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Title: The Financial Forecasts for the Business Plan


1
The Financial Forecasts for the Business Plan
  • Principles of Entrepreneurship
  • 2005

2
Introductions
  • Ken Hartviksen
  • Ken.hartviksen_at_lakeheadu.ca
  • 343-8497

3
Tonights Agenda
  • Introductions
  • Purpose of Financial Forecasts
  • Characteristics of Good Financial Forecasts
  • How to forecast and how to recognize assumptions
  • A tour of the financial forecasts required
  • Purpose of each forecast and their
    interrelationships
  • Data requirements and how they are generated
  • Annual Sales Forecast
  • Monthly Sales Forecast
  • Monthly Cash Budget
  • Pro forma Financial Statements

4
What we Hope to Accomplish This Evening
  • Understand the importance and use of
  • Cash flow
  • Financial forecasts
  • Learn how to develop loan amortization schedules
    and CCA schedules
  • Learn how to incorporate this forecast
    information into financial forecasts
  • Get you started on your own forecasts

5
The Purpose of Financial Forecasts
  • To
  • Predict the financial consequences of our
    business plan
  • Allow us to change our plans in advance to
    optimize the real financial results after
    analyzing the forecast financial statements.
  • To demonstrate to prospective financial partners
    that we understand our business, the business
    model and how to manage it effectively to produce
    positive financial results.
  • Demontrate the potential of the business to
    produce an adequate return on investment.

6
The Purpose of Financial Forecasts What do
investors Look For?
  • Ability to generate cash flow early enough and in
    sufficient quantity to ensure on-going financial
    solvency
  • Time to break even
  • Time to positive cash flow
  • Time to profitability
  • Return on investment

7
Characteristics of Good Forecasts
  • Reasonable/plausible
  • Based upon good primary and secondary research
  • Congruent with operating and marketing plans
  • Can withstand stress testing
  • Conservative/achievable

8
Where do you Start?
  • When generating integrated financial statements
    you start with
  • Sales forecast
  • You will modify the annual sales forecast to a
    monthly sales forecast for the first year
  • Make projections of all expenses for the first
    year.
  • Start with a guess about the amount of initial
    financing required and where it is likely to be
    invested.
  • Remember
  • The big difference between the cash budget and
    the pro forma Income Statement is that you
    include depreciation in the Income Statement and
    ignore it in the cash budget.
  • The other big difference is that you use total
    interest expense for the year in the income
    statement, but you use the total payments in the
    cash budget.

9
Integrated Financial Forecasts
Analyze forecasts, adjust inputs and forecast
again.
10
Before we Get StartedLets Review Some Things
about Business Plans
  • A Business Plan is a forecast of what you hope
    to do.and how and when you hope to do it!

11
Characteristics of a Good Plan
  • readable
  • organized
  • targeted to the audience
  • integrated
  • complete
  • short

12
Uses of A Business Plan
  • Helps you understand the steps to implementing
    your idea and what key factors you must monitor
    to ensure success.
  • Support an application for financing
  • Solicit potential financial partners

13
How a Business Plan is Read
  • Determine the characteristics of the company and
    industry
  • Determine the terms of the deal
  • Read the latest balance sheet
  • Determine the caliber of the people in the deal
  • Determine what is different about this deal
  • Give the plan a once-over lightly

14
Abbreviated Contents
  • Title Page (with disclaimer)
  • Executive Summary
  • Table of Contents
  • Business Idea
  • Industry/Company
  • Market Research and Analysis
  • Economics of the Business
  • Marketing Plan
  • Design and Development Plans
  • Manufacturing and Operations Plan
  • Management Team
  • Overall Schedule
  • Critical Risk, Problems and Assumptions
  • The Financial Plan
  • Financing
  • Appendices

NOTE the location of the financial documents
15
IV. Economics of the Business
  • Gross and operating margins
  • Profit potential and durability
  • Fixed, variable and semivariable costs
  • Months to Break even
  • Months to reach positive cash flow

16
XI. The Financial Plan
  • Actual financial statements (if an already
    established business)
  • initial investment required
  • cash budget
  • pro forma balance sheet
  • pro forma income state
  • break even chart
  • cost control

17
XII. Financing
  • Proposed sources of financing
  • use of funds
  • investors forecast rate of return on invested
    capital

18
The Basic Financial Forecasts
  • Principles of Entrepreneurship

19
Types of Financial Forecasts
  • Initial Investment Schedule
  • Monthly Cash Budget
  • Pro forma Income Statements
  • Pro forma Balance Sheets
  • Subsidiary forecasts
  • Loan Amortization schedule
  • CCA schedule
  • Statement of Forecast Assumptions

20
Initial Investment Schedule
21
Initial Investment Schedule
  • The purpose of the initial investment schedule
  • Identify proposed sources of capital
  • Identify proposed initial uses of capital

22
The Monthly Cash Budget
23
The Monthly Cash Budget
  • The purposes of the monthly cash budget
  • Illustrate projected sources of cash timing and
    magnitude
  • Illustrated projected uses of cash timing and
    magnitude
  • Demonstrate the time to producing a positive cash
    flow

24
The Pro Forma Income Statement
25
The Pro Forma Balance Sheet
26
Subsidiary Forecasts
  • You will need to make a series of forecasts that
    will be incorporated into your overall financial
    forecasts.
  • Some of it will require outside data gathering
    for example
  • Employer contributions to CPP and EI
  • WSIB premiums
  • The most common subsidiary forecasts are
  • Loan amortization schedule
  • Capital Cost Allowance Schedule

27
Types of Small Business Loans
  • Standard Bank Financing
  • Fixed term
  • Fixed rate
  • Variable rate
  • Operating Line of Credit
  • Government Financing
  • Northwestern Ontario
  • FedNor
  • Thunder Bay Ventures
  • Business Development Bank of Canada

28
Fixed Term Blended Payment Loans
This is a diagram of the cash flows involved
29
Effective Annual Rate Calculations
  • You wish to borrow 10,000
  • Assume you are quoted a fixed term, fixed payment
    loan at 2.5 percent above the prime lending rate
  • The prime lending rate is currently 4.5
  • The loan amortization period is 1 year

30
Calculating an Effective Monthly Rate
  • Since most loans require monthly payments, it is
    necessary to determine the monthly rate that
    would equal the effective annual rate

31
Calculating the Monthly Loan Payment
  • Now we know all of the variables
  • 10,000 loan
  • 7 APR 1-year term loan
  • We can calculate the loan payment

32
Preparing a Loan Amortization Schedule
33
Use of the Loan Amortization Schedule
  • The loan payment each month is a cash outflow
    that must be included in your cash monthly cash
    budget.
  • The total interest expense for the year is
    included in the pro forma income statement.
  • NOTE - repayment of principal is not a tax
    deductible expense.
  • - the total payment is a cashflow burden
    borne by the firm

34
Effective Annual Rates of Return
  • Most loan rates are quoted in APR terms (annual
    percentage rate)
  • However, APR financing does not take into account
    the effects of compounding
  • Most loans are compounded semi-annually. (ie.
    Interest is calculated and credited every six
    months). This effectively increases the rate of
    interest that the consumer faces.

35
The Nature of Depreciation
  • Capital assets such as buildings and equipment
    and land are very costly, but usually have a
    useful life of greater than one year.
  • Buildings and equipment tend to wear out over
    time (ie. They have a useful life of perhaps 10,
    20 or 30 years)
  • Land doesnt wear out.
  • The cost of the buildings and equipment is spread
    out over their useful lives, and only the amount
    of wastage (wear and tear) is deductible from
    income in that year for the purposes of
    calculating taxes.
  • CCRA predominantly uses one method of
    depreciationit is known as Capital Cost
    Allowance.

36
CCA gives rise to a Tax Shield Benefit to the
Company
  • CCA is a non-cash deduction from income that
    would otherwise be subject to income taxation.
  • As a result of the CCA deduction, taxable income
    is reduced.
  • This results in a savings in tax payable.
  • The tax shield benefits is equal to T(CCA)
  • t corporate tax rate
  • CCA the dollar amount of CCA claimed
  • A firm with a 40 corporate tax rate and a 2,000
    CCA deduction will save 800 in taxes.

4
K. Hartviksen
37
ExampleConsider two firms that report 10,000
in earnings before CCA and taxes, face a 40 tax
rate. One firm has no CCA to claim, the other
can claim 2,000 in CCA
  • Company A Company B
  • Earnings Before CCA Tax 10,000 10,000
  • CCA 2,000 0
  • Taxable Income 8,000 10,000
  • Taxes _at_ 40 3,200 4,000
  • Net Income 4,800 6,000
  • Add back non-cash expense 2,000 0
  • Cash flow from Operations 6,800 6,000

Note that company A is better off by 800 because
of the 2,000 non-cash deduction of CCA. That is
the amount of taxes saved.
5
K. Hartviksen
38
CCA Rules
  • Assets are grouped into pools or classes and
    depreciated as a group
  • CCA rates are found in the regulations to the
    Income Tax Act and can be changed by
    Order-in-Council
  • There is no need for an estimate of salvage value
    or useful life
  • 1/2 of the regular CCA rate for the class applies
    to the net additions to the pool for that year.
  • CCA cannot be used to create a tax loss.

7
K. Hartviksen
39
CCA Over Time - A Simple ExampleAssume you
acquire a depreciable asset with a cost base of
100,000 and there are no other assets in this
pool. The CCA rate for the pool is 10. Note
you are allowed only 1/2 the regular CCA rate on
the net additions to the pool in the year of
acquisition.
8
K. Hartviksen
40
CCRA Form
41
CCRA Form forecasting CCA out three years for one
asset class
42
NOTE Regarding Depreciation in your Financial
Forecasts
  • You never include depreciation (CCA) on a cash
    flow (cash budget) forecast
  • You use depreciation only in your pro forma
    income statement, and on your pro forma balance
    sheet.

43
Initial Startup Capital Required
  • The initial estimate can and probably will be
    revised depending on your first iteration of the
    forecasts.
  • Separate the estimate into two categories
  • Working capital
  • Fixed assets (plant and equipment)
  • You do this because when you look for financing
    for these investments, the fixed assets can
    usually be pledged as collateral for any
    borrowing, whereas the working capital needs
    usually has to be financed out of the owners
    equity.

44
Initial Investment
  • In your business plan you will have to prepare a
    schedule that details the initial financial
    investment that is required to make your business
    a success.
  • It is best is you divide the schedule up into two
    components
  • Working capital requirements
  • Capital Equipment

45
Initial Investment Required Example
46
The Cash Budget
  • Incorporates your startup capital estimates
  • Is strongly a function of your sales forecasts
    (that are predicated on your market research and
    some assumptions about your market penetration
    strategy)

47
Importance of Cash Flow
  • Planning to have cash available to pay bills of
    the business as they become due is a critical
    aspect of business survivalit is a management
    skill.
  • Understanding the cash flow cycle of a firm can
    help you manage those elements that are critical
    to ensuring you can pay your bills.
  • Cash flow forecasting through a cash budget
    provides important information to you and to your
    potential funding partners about your operating
    financial needs and most particularly, the timing
    and magnitude of any projected cash deficits or
    surpluses.

48
Cash and Materials Flow
Cash Sales
Cash
Shareholders equity
Debt
Taxes
49
The Cash Budget
  • Cash budgets are most often prepared on a monthly
    basis.
  • Most funding partners expect to see three years
    of projects. Some may require as many as seven
    years.
  • If your business expects to encounter any
    seasonality in the sales cycle, you will find
    some interesting effects that may dramatically
    affect the amount of start-up financing that you
    require.
  • If there is seasonality effects, you will have to
    carefully manage your cash flows, inventories and
    accounts receivable to remain solvent.

50
Cash Budgets
  • allow us to forecast the cash flows of a firm
    over time (between balance sheet dates).
  • identifies the timing and magnitude of expected
    cash surpluses and deficits - thereby providing
    the manager with the opportunity to prepare, in
    advance, to finance expected deficits, or to
    invest surpluses.
  • may be used as the basis for pro forma financial
    statements.

51
General Form - Cash Budget
52
Assumptions of Cash Budgets
  • that cash inflows and outflows occur evenly
    throughout the month.
  • this is rarely the case
  • disbursements often are predictable
  • wages/salaries due on 15th and 30th
  • payments to suppliers on 15th or 30th, etc.
  • cash receipts depend on how we manage accounts
    receivable....depending on how we do this they
    may largely occur between the 20th and 30th of
    the month...
  • what is the impact of the foregoing?
  • how can we overcome this?

53
General Form - Cash Budget
54
General Form - Cash Budget
55
Cash Balance
56
Analyzing your financial forecasts
  • Business Plan Boot Camp

57
Ratio Analysis
  • This is a technique used by investors and bankers
    (lenders) alike to assess the financial strength
    of your proposed business.
  • Once your business begins, ratios will be used to
    examine how well you are managing your business.

58
Ratio
  • Is one number divided by another!
  • Purpose is the provide some insight into the
    complexity of financial information.
  • Example
  • Current Ratio Current Assets
  • Current Liabilities

59
Categories of Ratios
  • Liquidity
  • Asset Management
  • Debt Management
  • Profitability

60
Liquidity Ratios
  • Purpose
  • to examine the ability of the business to pay
    its bills on time.
  • A firm that cant survive in the short-term wont
    have to worry about the long-term!

61
Liquidity Ratios
  • Examples
  • Current Ratio Current Assets
  • Current Liabilities
  • Quick Ratio Current Assets - Inventories
  • Current Liabilities

62
Asset Management Ratios
  • Purpose
  • to give some insight into how well the business
    is being managed.

63
Asset Management Ratios
  • Examples
  • Inventory Turnover Sales
  • Inventory
  • Average Collection
  • Period Receivables
  • Sales/365

64
Asset Management Ratios
  • Examples
  • Fixed Asset
  • Turnover Sales
  • Fixed Assets
  • Total Asset
  • Turnover Sales
  • Total Assets

65
Debt Management Ratios
  • Purpose
  • to examine the impact that the chosen methods of
    financing are having (likely to have) on the
    financial health of the business.
  • Lenders will also be concerned with your
    liquidity ratios because those ratios assess your
    firms ability to pay the bills when they come
    due.

66
Debt Management Ratios
  • Examples
  • Debt to
  • Total Assets Total Debt
  • Total Assets
  • Times interest
  • earned Operating Income
  • Interest Charges

67
Profitability Ratios
  • Purpose
  • to examine the historical (or prospective rate of
    return in the case of pro forma financial
    statements) rates of return earned on invested
    capital.

68
Profitability Ratios
  • Examples
  • Profit margin
  • on sales Net income
  • Sales
  • Return on
  • Equity Net income
  • Common Equity

69
Profitability Ratios
  • Examples
  • Return on
  • Assets Net income
  • Total Assets

70
Seasonality of Sales
  • most firms experience a seasonal variation in
    sales volume...times of the year when sales
    increase, and times of the year when sales
    volumes are low or non-existent.
  • there are financial implications for firms that
    experience a marked seasonal sales cycle
  • what is the best time in the seasonal sales cycle
    to have the fiscal year end?
  • how do we finance the seasonal build-up in
    inventory levels?
  • what happens to the balance sheet accounts at
    different points in the seasonal sales cycle?
  • how comparable are two firms in an industry with
    a marked seasonal sales cycle if they have differ
    fiscal year ends?

71
Balance Sheet Accounts over time
72
Selecting the Fiscal Year End
  • tax considerations
  • for smaller, owner/managed enterprises, there are
    greater tax-planning opportunities if the
    corporate fiscal year end is set sometime after
    the calendar year end
  • the firms financial position
  • firms will look most healthy if the fiscal year
    end is set sometime after the seasonal sales
    peak....long enough afterward to see receivables
    collected.
  • auditors preferences
  • auditors are busy around the calendar year
    end...with firms and individuals that have
    selected Dec 31 as their year end.
  • auditors are busy from February through May with
    income tax

73
Ratio Analysis
  • a ratio is just one number over another number.
    If the ratio is poor when compared to something
    else, it could be a result of the numerator, or
    the denominator, or both.
  • a ratio is just a number. It must be compared
    to something else if it is to begin to take on
    some meaning. Common comparators include
  • industry average ratios
  • historical ratios for the firm itself
  • other current ratios for the same firm
  • it is important to take the context into
    account when interpreting the financial
    performance of the firm...what industry is the
    firm in? how rapidly has the firm been growing?
    what is happening in the industry?
  • ratio analysis is a starting point in analyzing
    the firm. It must be supplemented by analysis of
    the overall economy, the industry, etc.

74
Income Statement Ratios
  • Absolute Common Size Industry Avg.
  • Sales 250,000 100.0 100
  • Cost of Goods Sold 173,000 69.2 70
  • Gross Margin 77,000 30.8 30
  • Admin Expenses 50,000 20.0 10
  • EBIT 27,000 10.8 20
  • Interest Expense 5,000 2.0 5
  • Net Income 22,000 8.8 15
  • Profit Margin on Sales 8.8 15
  • You can see from the common size data, that this
    firm differs from the industry in overhead costs
    and in interest expense. Without further
    information it is difficult to draw any specific
    conclusions, however, you should note, that
    direct operating costs are in line with the
    industry. Why is selling and admin. expenses
    double that of the industry? The firms fixed
    financing costs are low...is it just low cost or
    are they using less debt than others in the
    industry?

75
Use of Ratios
  • Evaluate your past financial performance
  • Evaluate your financial forecasts

76
Role of Ratios in Your Business Plan
  • Your business plan forecasts your firms future
    financial performance.
  • Conduct ratio analysis on your forecast position
  • determine whether you should pursue your plans
  • revise your plans.

77
Role of Ratios in Your Business Plan
Prepare Pro Forma Financial Statements based on
your business plans
Revise plan if necessary
Analyze your forecasts using ratio analysis
Once you are satisfied with your
forecastsproceed to raise the capital and
implement the plan
78
The Articulation of forecast Income Statements
and Balance Sheets
  • Articulation refers to the fact that the forecast
    income statements and balance sheets are
    integrally linked.
  • For example
  • Assets like building and equipment are stated on
    the balance sheet at their net value (net of
    depreciation)
  • The retained earnings account on the balance
    sheet will be the accumulated retained earnings
    over time as found historically on the income
    statements. (The difference between last years
    R/E balance and next years, is the amount of
    income after tax that is retained in the firm.)
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