Creating a Successful Financial Plan


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Creating a Successful Financial Plan

  1. 1. Creating a Successful Financial Plan Volume is vanity; profitability is sanity …Brad Skelton It is better to solve problems than crises …John Guinther
  2. 2. Financial Management <ul><li>A process that provides entrepreneurs with relevant financial information in an easy-to-read format on a timely basis; it allows entrepreneurs to know not only how their businesses are doing financially, but also why they are performing that way. </li></ul>
  3. 3. Basic Financial Statements <ul><li>The Balance Sheet </li></ul><ul><li>a financial statement that provides a snapshot of a business’s financial position, estimate its worth on a given date; it is built on the fundamental accounting equation: </li></ul><ul><li>Assets = </li></ul><ul><li>Liabilities + Owner’s Equity </li></ul>
  4. 4. Basic Financial Statements (cont’d) <ul><li>current assets- assets such as cash and other items to be converted into cash within one year or within the company’s normal operating cycle. </li></ul><ul><li>fixed assets- assets acquired for long-term use in a business. </li></ul><ul><li>liabilities- creditors’ claims against a company’s assets. </li></ul><ul><li>current liabilities- those debts that must be paid within one year or within the normal operating cycle of a company. </li></ul><ul><li>long-term liabilities- liabilities that come due after one year. </li></ul><ul><li>owners equity- the value of the owner’s investment in the business. </li></ul>
  5. 5. Basic Financial Statements (cont’d) <ul><li>The Income Statement </li></ul><ul><li>a financial statement that represents a “moving picture” of a business, comparing its expenses against its revenue over a period of time to show its net profit (or loss). </li></ul><ul><li>cost of goods sold- the total cost, including shipping of the merchandise sold during the accounting period. </li></ul><ul><li>gross profit margin- gross profit divided bye net sales revenue. </li></ul><ul><li>operating expenses- those costs that contribute directly to the manufacture and distribution of goods. </li></ul>
  6. 6. Basic Financial Statements (cont’d) <ul><li>The Statement of Cash Flows </li></ul><ul><li>a financial statement showing the changes in a company’s working capital from the beginning of the year by listing both the sources and the uses of those funds. </li></ul>
  7. 7. Creating Projected Financial Statements <ul><li>Pro Forma Statements for the Small Business </li></ul><ul><li>Pro Forma Income Statement </li></ul><ul><li>Pro Forma Balance Sheet </li></ul><ul><li>Pro Forma Statement of Cash Flows </li></ul>
  8. 8. Creating Projected Financial Statements (cont’d) <ul><li>Pro Forma Income Statement </li></ul><ul><li>1. Net Sales 2 options: </li></ul><ul><li>a) Net Profit (Industry)= </li></ul><ul><li>Net Profit Wanted/Net Sales </li></ul><ul><li>or </li></ul><ul><li>b) Net Sales=Sales Forecast </li></ul><ul><li>Which one is Most Likely? Optimistic? Pessimistic? </li></ul><ul><li>Tip: Compute for Average Daily Sales </li></ul><ul><li>2. Estimated Monthly Expenses, see pages 393 & 394 </li></ul>
  9. 9. Creating Projected Financial Statements (cont’d) <ul><li>Pro Forma Balance Sheet -Assets </li></ul><ul><li>Cash: </li></ul><ul><li>Cash Requirement=Cash Expenses/AITR* </li></ul><ul><li>*Average Inventory Turnover Ratio </li></ul><ul><li>Inventory: </li></ul><ul><li>AITR=Cost of Goods Sold/Inventory Level </li></ul>
  10. 10. Creating Projected Financial Statements (cont’d) <ul><li>Pro Forma Balance Sheet- Liabilities </li></ul><ul><li>Accounts Payable (supplier financing) </li></ul><ul><li>Short-term Notes Payable </li></ul><ul><li>Long-term Notes Payable </li></ul>
  11. 11. Ratio Analysis <ul><li>A method of expressing the relationship between a y two accounting elements that allows business owners to analyze their companies’ financial performance </li></ul>
  12. 12. Ratio Analysis <ul><li>Liquidity Ratios : tell whether a small business will be able to meet its short-term obligations as they come due </li></ul><ul><li>Current Ratio : measures a small firm’s solvency by indicating its ability to pay current liabilities out of current assets </li></ul><ul><li>=Current Assets/Current Liabilities =$686,985/$367,850 </li></ul><ul><li>= 1.87:1 Good: 2:1 Industry: 1.5:1 </li></ul>
  13. 13. Ratio Analysis <ul><li>Liquidity Ratios (cont’d) </li></ul><ul><li>Quick Ratio : a conservative measure of a firm’s liquidity, measuring the extent to which its most liquid assets (minus inventory) cover its current liabilities </li></ul><ul><li>=(Current Assets-Inventory)/Current Liabilities </li></ul><ul><li>=($686,750-$455,555)/$367,850 </li></ul><ul><li>= 0.61:1 </li></ul><ul><li>Good: 1:1 Industry: 0.50:1 </li></ul>
  14. 14. Ratio Analysis <ul><li>Leverage Ratios : measure the financing supplied by a firm’s owners against that supplied by its creditors; they are a gauge of the depth of a company’s debt </li></ul><ul><li>Debt Ratio : measures the percentage of total assets financed by a company’s creditors compared to its owners </li></ul><ul><li>=Total Debt (Liabilities)/Total Assets </li></ul><ul><li>=($367,850+$212,150)/$847,655 </li></ul><ul><li>= 0.681:1 </li></ul><ul><li>Good: 1:1 Industry: 0.64:1 </li></ul>
  15. 15. Ratio Analysis <ul><li>Leverage Ratios (cont’d) </li></ul><ul><li>Debt to Net Worth Ratio : expresses the relationship between the capital contributions from creditors and those from owners and measures how highly leveraged the company is </li></ul><ul><li>=Total Debt (Liabilities)/Tangible Net Worth </li></ul><ul><li>=($367,850+$212,150)/($267,655-$3,500) </li></ul><ul><li>= 2.20:1 Industry: 1.90:1 </li></ul>
  16. 16. Ratio Analysis <ul><li>Leverage Ratios (cont’d) </li></ul><ul><li>Times Interest Earned Ratio : measures a small firm’s ability to make the interest payments on its debt </li></ul><ul><li>Times Interest Earned Ratio </li></ul><ul><li>=EBIT/Total Interest Expense </li></ul><ul><li>=($60,629+$39,850)/$39,850 </li></ul><ul><li>= 2.52:1 </li></ul><ul><li>Industry: 2.0:1 </li></ul>
  17. 17. Ratio Analysis <ul><li>Operating Ratios : help an entrepreneur evaluate a small company’s overall performance and indicate how effectively the business employs its resources </li></ul><ul><li>Average Inventory Turnover Ratio : measures the number of times its average inventory is sold out, or turned over during an accounting period </li></ul><ul><li>=Cost of Goods Sold/Average Inventory </li></ul><ul><li>=$1,290,117/($805,745+$455,455)/2 </li></ul><ul><li>= 2.05 times/year Industry: 4.0 times/year </li></ul>
  18. 18. Ratio Analysis <ul><li>Operating Ratios (cont’d) </li></ul><ul><li>Average Collection Period Ratio (DSO): measures the number of days it takes to collect accounts receivable </li></ul><ul><li>=Days/Receivables Turnover Ratio </li></ul><ul><li>=365/Credit Sales/Accounts Receivable </li></ul><ul><li>=365/$1,309,589/$179,225 </li></ul><ul><li>=365/7.31 </li></ul><ul><li>= 50 days Industry: 19.3 days </li></ul>
  19. 19. Ratio Analysis <ul><li>Operating Ratios (cont’d) </li></ul><ul><li>Average Payable Period Ratio : measures the number of days it takes a company to pay its accounts payable </li></ul><ul><li>=365/Payables turnover ratio </li></ul><ul><li>=365/Purchases/Accounts Payable </li></ul><ul><li>=365/$939,827/$152,580 </li></ul><ul><li>=365/6.16 </li></ul><ul><li>= 59.3 days </li></ul><ul><li>Industry: 43 days </li></ul>
  20. 20. Ratio Analysis <ul><li>Operating Ratios (cont’d) </li></ul><ul><li>Net Sales to Total Assets Ratio : measures a company’s ability to generate sales in relation to its asset base </li></ul><ul><li>=Net Sales/Net Total Assets </li></ul><ul><li>=$1,870,841/$847,655 </li></ul><ul><li>= 2.21:1 </li></ul><ul><li>Industry: 2.7:1 </li></ul>
  21. 21. Ratio Analysis <ul><li>Profitability Ratios : indicate how efficiently a small company is being managed </li></ul><ul><li>Net Profit on Sales Ratio : measures a company’s profit per dollar of sales </li></ul><ul><li>=Net Profit/Net Sales </li></ul><ul><li>=$60,629/$1,870,841 </li></ul><ul><li>= 3.24% </li></ul><ul><li>Industry: 7.6% </li></ul>
  22. 22. Ratio Analysis <ul><li>Profitability Ratios (cont’d) </li></ul><ul><li>Net Profit to Assets Ratio : measures how much profit a company generates for each dollar of assets that it owns </li></ul><ul><li>=Net Profit/Total Assets </li></ul><ul><li>=$60,629/$847,655 </li></ul><ul><li>= 7.15% </li></ul><ul><li>Industry: 5.5% </li></ul>
  23. 23. Ratio Analysis <ul><li>Profitability Ratios (cont’d) </li></ul><ul><li>Net Profit to Equity Ratio : measures the owner’s rate of return on investment </li></ul><ul><li>=Net Profit/Owner’s Equity </li></ul><ul><li>=$60,629/$267,655 </li></ul><ul><li>= 22.65% </li></ul><ul><li>Industry:12.6% </li></ul>
  24. 24. Interpreting Business Ratios <ul><li>Critical numbers : indicators that measure key financial and operational aspects of a company’s performance; when these numbers are moving in the right direction, a business is on track to reach its objectives </li></ul>
  25. 25. Break-even Analysis <ul><li>Break-even point : the level of operation (sales dollars or production quantity) at which a company neither earns a profit or incurs a loss </li></ul><ul><li>Fixed expenses : expenses that do not vary with changes in the volume of sales or production </li></ul><ul><li>Variable expenses : expenses that vary directly with changes in the volume of sales or production </li></ul>
  26. 26. Break-Even Analysis <ul><li>Calculating the Break-Even Point </li></ul><ul><li>Step 1 : Determine Expenses expected to be incurred (646,000+$236,500) </li></ul><ul><li>Step 2 : Categorize the expenses into fixed and variable ($177,375+$705,125) </li></ul><ul><li>Step 3 : Calculate ratio of variable expenses to net sales ($705,125/$950,000)=74%, Contribution margin is 26%= </li></ul><ul><li>Step 4 : Compute Break-even Sales: </li></ul><ul><li>=Total Fixed Cost/Contribution Margin as % of sales </li></ul><ul><li>=$177,375/0.26 </li></ul><ul><li>= $686,212 </li></ul>
  27. 27. Break-even Analysis <ul><li>Better than Break-even Sales </li></ul><ul><li>=(Total Fixed Expenses + Desired Profit)/Contribution Margin as % of sales </li></ul><ul><li>=($177,375+$80,000)/0.26 </li></ul><ul><li>= $989,904 </li></ul>
  28. 28. Break-even Analysis <ul><li>Break-even point in units </li></ul><ul><li>=Total Fixed Costs/(Sale Price/unit-Variable cost/unit) </li></ul><ul><li>=$390,000/($17.50-$12.10) </li></ul><ul><li>=$390,000/$5.40 </li></ul><ul><li>= 72,222 </li></ul>
  29. 29. Break-even Analysis <ul><li>Constructing a Break-even Chart </li></ul><ul><li>Step 1 : Horizontal axis, mark a scale to plot sales volume </li></ul><ul><li>Step 2 : Vertical axis, mark a scale to plot income and expense in dollars </li></ul><ul><li>Step 3 : Draw fixed expense line </li></ul><ul><li>Step 4 : Draw a total expense line </li></ul><ul><li>Step 5 : Draw the revenue line </li></ul><ul><li>Step 6 : Locate break-even point: intersection of revenue line and total expense line </li></ul>