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Entrepreneurial Finance


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Entrepreneurial Finance

  1. 1. Management of Technological Innovation Andrew Maxwell
  2. 2. Entrepreneurial finance
  3. 3. Why you need to start with financial forecasting <ul><li>Establishes cash needs of business </li></ul><ul><li>Allows entrepreneurs to compare expected value of strategic alternatives </li></ul><ul><li>Demonstrates value of company to investors </li></ul><ul><li>Helps identify appropriate benchmarks for measuring company development </li></ul>
  4. 4. Most importantly growing companies need cash <ul><li>Understand why they need cash </li></ul><ul><li>How much they are likely to need </li></ul><ul><li>In the next lesson we will identify: </li></ul><ul><ul><li>Ways of reducing the amount of cash required </li></ul></ul><ul><ul><li>Sources of cash, types of investment </li></ul></ul><ul><ul><li>What entrepreneurs will have to give up to get required cash and deal structures </li></ul></ul>
  5. 5. Three types of financial statements <ul><li>Balance sheet is a “snap shot” of a company’s affairs; it shows companies’ assets and liabilities, shareholders’ equity and change from year to year </li></ul><ul><li>Income statement shows companies’ revenue and expenses, plus profit for a specific period </li></ul><ul><li>Cash flow shows how much cash the company generates or needs in a period </li></ul><ul><li>All three statements are important and linked together </li></ul>
  6. 6. The importance of each <ul><li>The income statement shows the health of the company and provides important guidance for entrepreneurs’ weekly/monthly decisions. </li></ul><ul><li>The cash flow statement and forecast provides guidance on daily tactics to preserve cash and ultimately on how much cash to borrow. </li></ul><ul><li>The balance sheet is used for valuation, comparison and progress assessment. It is more a consequence of the other two. </li></ul>
  7. 7. Forecasting revenue <ul><li>Use market research to identify market size and pricing strategy </li></ul><ul><li>Use the adoption curve to forecast number of units sold </li></ul><ul><li>Create a three to five year revenue forecast </li></ul><ul><li>Use the unit numbers to forecast marginal cost </li></ul><ul><li>Calculate the fixed costs </li></ul><ul><li>Create a Profit and Loss account </li></ul>
  8. 8. Typical P and L 2008 2009 2010 Sales $100,000 $400,000 $1,000,000 Cost of Sales $50,000 $180,000 $400,000 Gross Margin $50,000 $220,000 $600,000 Other costs $200,000 $300,000 $400,000 Profit ($150,000) $80,000 $200,000
  9. 9. What is included in other costs? <ul><li>Salaries </li></ul><ul><li>Rent </li></ul><ul><li>Overheads </li></ul><ul><li>Marketing </li></ul><ul><li>Research and development (special case) </li></ul>
  10. 10. Calculating a simple initial balance sheet: Step 1 Investment in the business
  11. 11. Step 2: Accounting for set up costs of business
  12. 12. Step 3: Accounting for leasehold improvements
  13. 13. Step 4: Accounting for fixed asset purchase
  14. 14. Step 5: Accounting of purchase for inventory
  15. 15. Step 6: Accounting for sales
  16. 16. A Step-By-Step Example:
  17. 17. A Step-By-Step Example:
  18. 18. A Step-By-Step Example:
  19. 19. Step 10: Accounting for depreciation & amortization
  20. 20. Key Components of Cash Flows <ul><li>Sales </li></ul><ul><li>- Cost of Goods Sold </li></ul><ul><li>- Selling, General and Administration Expenses Net Income </li></ul><ul><li>- Interest </li></ul><ul><li>- Income Taxes </li></ul><ul><li>+Non-cash expenses e.g.depreciation </li></ul><ul><li>= Cash Flows From Operating Activities </li></ul><ul><li>- Increase in Accounts Receivable </li></ul><ul><li>- Increase in Inventory Change in Net Working Capital </li></ul><ul><li>+ Increase in Accounts Payable </li></ul><ul><li>- Purchases of Fixed Assets Net Capital Expenditures </li></ul><ul><li>+ Sales of Fixed Assets </li></ul><ul><li>- Payments to Owners of Business </li></ul><ul><li>= Cash Generated (Used) By Business Available for Repayment of Debts </li></ul>
  21. 21. Cash flows prior to sales <ul><li>+ Initial investment from entrepreneur </li></ul><ul><li>- Cost of setting up company </li></ul><ul><li>- Acquisition of licenses </li></ul><ul><li>Labour/materials </li></ul><ul><li>Travel and general </li></ul><ul><li>Rent/utilities </li></ul><ul><li>Capital (even if leased) </li></ul><ul><li>Legal and professional services </li></ul><ul><li>+ Bank or credit card loans </li></ul><ul><li>+ SRED </li></ul><ul><li>+ Government grants </li></ul><ul><li>= Cash Flows From Research (cash hole) </li></ul>
  22. 22. Key Components of Cash Flows Components of Cash Flows for Sylvia’s Satins
  23. 23. Financing Cash Flow Deficiencies <ul><li>If Sylvia’s Satins used up $31,000 cash in its on-going operations, how was this financed? </li></ul><ul><li>Opening Cash Balance $20,000 </li></ul><ul><li>Less: Cash Used $31,000 </li></ul><ul><li>Cash Surplus (Deficiency) - $11,000 </li></ul><ul><li>Deficiency was financed by overdraft </li></ul>
  24. 24. Eleven Key Cash Flow Drivers <ul><ul><ul><li>Relationship with Cash Flow </li></ul></ul></ul><ul><li>Sales Growth usually negative </li></ul><ul><li>Gross Margin % (Gross Profit/Sales) positive </li></ul><ul><li>Selling, General and Administration </li></ul><ul><li>(SGA) as % of Sales negative </li></ul><ul><li>Interest Expense negative </li></ul><ul><li>Non-cash Expenses positive </li></ul><ul><li>6. Income Tax Rate negative </li></ul><ul><li>7. Average Collection Period (ACP) negative </li></ul><ul><li>8. Inventory Conversion Period negative </li></ul><ul><li>9. Accounts Payable Period positive </li></ul><ul><li>10. Net Capital Expenditures negative </li></ul><ul><li>11. Owner’s Withdrawals from Firm negative </li></ul>
  25. 25. Impact of Doubling of Sales on Cash Flow of Firm
  26. 26. Relationship of sales growth to cash flow <ul><li>With increased sales, Sylvia’s Satins would increase its profit from $3,900 to $8,700 but experience an increase in cash outflow from -$31,000 to -$43,000 and therefore end the year with a higher bank overdraft </li></ul><ul><li>Situation would be worse where firm experiences substantial growth and is capital intensive i.e. it needs more capital expenditures to facilitate expansion </li></ul><ul><li>These expenditures place greater pressure on the cash flow of the firm (a fact that is probably true for all the businesses for which you are developing business plans </li></ul>
  27. 27. Preparing Comprehensive Pro Forma Financial Statements Sales Forecast Production Forecast Cash Flow Forecast Pro Forma Income Statement Pro Forma Balance Sheet Sales, production and cash flow forecasts - monthly pro forma income and balance sheets - annually