Ent300 module11

ENT/ETR300 – FUNDAMENTALS OF ENTREPRENEURSHIP
THE FINANCIAL PLAN

FINANCIAL PLAN

MODULE 11

THE FINANCIAL PLAN

LEARNING OUTCOMES

At the end of the session, students should be able to:

• Understand the importance of preparing a financial
plan
• Understand the process of developing a financial plan
• Identify the components of a financial plan
• Analyse the financial position of the proposed business
• Prepare a financial plan for a small business

THE FINANCIAL PLAN

INTRODUCTION

A financial plan incorporates all financial data derived from
the operating budgets i.e. the marketing, production (or
operations) and administration budgets. Financial
information from the operating budgets is then translated or
transformed into a financial budget.

Based on the financial data, projections are prepared via
the following pro forma statements:
 Cash flow
 Income (or profit and loss) statement
 Balance sheet.

THE FINANCIAL PLAN

THE IMPORTANCE OF A FINANCIAL PLAN

A financial plan is crucial to the overall business plan that is
developed for a particular business or project. Its importance
can be summarised as follows:
 To determine the size of investment
 To identify and propose the relevant sources of finance
 To ensure that the initial capital is sufficient
 To analyse the viability of the project before actual investment is

committed
 To be used as a guideline for project implementation

THE FINANCIAL PLAN

THE PROCESS OF DEVELOPING A FINANCIAL PLAN

To develop a workable and meaningful financial plan, the
entrepreneur has to follow these steps:
 Step 1: Gather all financial inputs
 Step 2: Determine the project implementation cost
 Step 3: Determine the sources of finance
 Step 4: Prepare the pro forma cash flow statement
 Step 5: Prepare the pro forma income statement
 Step 6: Prepare the pro forma balance sheets
 Step 7: Perform basic financial analysis

THE FINANCIAL PLAN

Step 1: Gather the Financial Input (contd.)

• The process of developing a financial plan for a specific
project begins with the accumulation of financial
information from the marketing, operations and
organizational plans.

• The financial requirements for each plan are presented in
the form of budgets known as operating budgets (i.e.
marketing, operations and organisation budgets)

THE FINANCIAL PLAN

Step 1: Gather the Financial Input (contd.)

• In addition, the monthly or annual sales forecast derived
earlier in the marketing plan is a very important input for
the financial plan.

• After gathering all information the financial plan is
prepared in terms of financial budget.

THE FINANCIAL PLAN

Marketing Plan Organizational Plan
Sales Forecast Administrative Budget
Marketing Budget Financial Plan
Project implementation cost
Sources of financing
Pro forma cash flow statement
Pro forma income statement
Pro forma balance sheet
Financial Analysis

Operations Plan
Operations Budget

THE FINANCIAL PLAN

Step 2: Determine the Project Implementation Cost

• A project implementation cost incorporates both long-
term and short-term expenditure needed to start a
project.

• Long-term expenditure refers to such expenditure as
the procurement of plant, machinery, equipment,
vehicles and other fixed assets needed by the new
business.

THE FINANCIAL PLAN

Step 2: Determine the Project Implementation Cost
(contd.)

• Short-term expenditure, such as payments of utilities,
salaries and wages, factory overheads, purchase of raw
materials or inventories, represent the amount of initial
working capital required to finance the daily operation
until the business gets its first sale.
• Components of project implementation cost:
 Capital expenditure
 Working capital
 Other expenditure
 Contingency cost

THE FINANCIAL PLAN

THE FINANCIAL PLAN

Step 3: Determine the Sources of Finance

• Sources of finance refers to the sources where funds
to finance a particular project’s implementation costs
can be secured.

• These can be categorised into internal and external
sources. The internal sources mainly come in the
form of equity contributions from the entrepreneurs.
These contributions can either be in the form of cash
or other assets.

THE FINANCIAL PLAN

Step 3: Determine the Sources of Finance (contd.)

• External sources of finance are mainly derived from
commercial banks, finance companies and
government agencies. It may come in the form of
term loans, hire purchase or grants.

• The total amount of funds that has to be sourced
should equal the total project implementation cost
calculated earlier. This is to ensure that the project is
fully funded and to avoid the risks of under-financing.

THE FINANCIAL PLAN

Step 3: Determine the Sources of Finance (contd.)

• Components of sources of finance:

 Internal sources
 Equity contributions (cash and/or assets)
 External sources
 Term loan
 Hire purchase
 Others

THE FINANCIAL PLAN

Step 4: Prepare Pro Forma Cash Flow Statement

• Pro forma cash flow statement refers to the projected
statement of cash inflow and outflow throughout the
planned period.

• Under normal circumstances, the pro forma cash flow
statement is prepared for three consecutive years,
detailed by month for the first year and by year for the
second and third years. However, longer periods are
sometimes needed depending upon the projects
undertaken.

THE FINANCIAL PLAN

Step 4: Prepare Pro Forma Cash Flow Statement (contd.)

• The total amount of funds that has to be sourced should
equal the total project implementation cost calculated
earlier. This is to ensure that the project is fully funded
as well as to avoid the risks of under-financing.

THE FINANCIAL PLAN


• The pro forma cash flow statement must be able to show
the following information:
 Cash inflows – the projected amount of cash flowing
into the business.
 Cash outflows – the projected amount of cash flowing
out of the business.
 Cash deficit or surplus – the difference between cash
inflows and outflows.
 Cash position – the beginning and ending cash
balances for a particular period.

THE FINANCIAL PLAN


• Elements of cash inflows:
 Equity contribution (cash)
 Term loan
 Cash sales
 Collection of receivables
 Others

THE FINANCIAL PLAN


• Elements of cash outflows:
 Marketing expenditure
 Operations expenditure
 Administrative expenditure
 Term loan repayment
 Hire purchase repayment
 Purchase of fixed assets
 Pre-operating expenditure
 Payments for deposits
 Miscellaneous expenditure

THE FINANCIAL PLAN

Example: Pro Forma Cash Flow Statement

THE FINANCIAL PLAN

Example: Pro Forma Cash Flow Statement (contd.)

THE FINANCIAL PLAN

Step 5: Prepare Pro Forma Income Statement

• The next step in developing a financial plan is to
prepare the pro forma income statement which shows
the expected profit or loss for the planned period,
usually for three consecutive years.

• The pro forma income statement consists of the
following elements:
 Sales
 Gross Income
 Net Income Before Tax

THE FINANCIAL PLAN

Step 5: Prepare Pro Forma Income Statement (contd.)

• Net income before tax is derived as follows:

Sales - Cost of Sales = Gross Profit
Gross Profit - Operating Expenses = Net Income before tax

THE FINANCIAL PLAN

Example: Pro Forma Income Statement

Year 1 Year 2 Year 3
Sales 240,000 276,000 317,400
Cost of sales 94,600 103,900 108,940
Gross profit 145,400 172,100 208,460

Less: Operating Expenses
Marketing expenses 18,000 18,900 19,845
Administrative expenses 96,000 100,800 105,840
Depreciation charges 7,200 7,200 7,200
Miscellaneous 2,700 600 600
123,900 127,500 133,485
Operating income 21,500 44,600 74,975
Less: Financing expenses:
Interest on term loan 4,500 3,600 2,700
Interest on hire-purchase 1,600 1,600 1,600
6,100 5,200 4,300
Net profit before tax 15,400 39,400 70,675

THE FINANCIAL PLAN

Step 6: Prepare Pro Forma Balance Sheet

• While the pro forma income statement shows the
financial performance of the business for the planned
period, the pro forma balance sheet shows the financial
position of the business at a specific point in time in
terms of assets owned and how those assets are
financed.

• The pro forma balance sheet is normally prepared for a
period of three years.

THE FINANCIAL PLAN

Step 6: Prepare Pro Forma Balance Sheet (contd.)

• The pro forma balance sheet consists of the following
elements:
 Assets
 Owners’ equity
 Liabilities
• The balance sheet shows the following equation:

Assets = Owners’ equity + Liabilities

THE FINANCIAL PLAN


• Assets are the economic resources of a business that
are expected to be of benefit in the future. Assets
reported in the balance sheet are generally categorised
into two categories: non-current and current assets.

• Non-current assets include fixed assets and other
assets that are owned and usually held to produce
products or services. These assets are not intended for
sale in the short term. Examples: property, plant,
machinery, equipment, vehicles, major renovations and
long-term investments. For fixed assets, the values
shown in the balance sheet are the book value i.e. the
original cost less the accumulated depreciation.

THE FINANCIAL PLAN


• Current assets are short-term assets that can be
converted into cash within a year. Examples: cash,
inventories (raw materials, work-in-process and/or
finished goods), receivables and other short-term
investments.

• Owners’ equity refers to capital contributions from the
owners or shareholders in terms of cash or assets plus
the accumulated amount of net income. However, if the
business suffers a loss, the amount of loss will be
deducted from the capital contributions.

THE FINANCIAL PLAN


• Liabilities are the amounts owed by the business to
outsiders. They are categorised as non-current (long-
term) and current liabilities.
• Non-current or long-term liabilities refer to the long-term
obligations of the business that mature in a period of
more than one year. They usually include long-term
loans as well as hire purchase.
• Current liabilities refer to the short-term obligations of
the business that mature within a period of less than a
year. The most common forms of current liabilities are
accounts payable and accrued payments

THE FINANCIAL PLAN


• Liabilities are the amounts owed by the business to
outsiders. They are categorized as non-current (long-
term) and current liabilities.

• Non-current or long-term liabilities refer to the long-term
obligations of the business that mature in a period of
more than one year. They usually include long-term
loans as well as hire purchase.

THE FINANCIAL PLAN

Example: Pro Forma Balance Sheet

Year 1 Year 2 Year3
Non-Current Assets (book value)
Land & building 45,000 45,000 45,000
Machinery & equipment 18,400 13,800 9,200
Furniture & fixtures 5,600 4,200 2,800
Renovation 3,200 2,400 1,600
Vehicles 20,000 15,000 10,000
Deposit 800 - -
93,000 81,200 69,400
Current Assets
Inventory of raw materials 3,000 3,500 4,000
Inventory of finished goods 3,000 4,000 5,000
Cash 40,900 77,600 145,575
46,900 85,100 154,575
Total Assets 139,900 166,300 223,975

Owners’ Equity
Capital 72,500 72,500 72,500
Accumulated profit 15,400 54,800 125,475
87,900 127,300 197,975
Long-term Liabilities
Term loan 36,000 27,000 18,000
Hire-purchase 16,000 12,000 8,000
52,000 39,000 26,000
Total Owners’ Equity & Liabilities 139.900 166,300 223,975

THE FINANCIAL PLAN

Step 7: Perform Basic Financial Analysis

• Financial analysis is a technique of examining financial
statements to help the entrepreneur analyse the
financial position and performance of the business.

• Financial analysis involves two basic steps: generating
the information from the financial statements and
interpreting the results.

• The most common form of financial analysis is “ratio
analysis”.

THE FINANCIAL PLAN

Step 7: Perform Basic Financial Analysis (contd.)

• Financial ratios are normally used to compare figures
from the financial statement with other figures, so that
the true meaning of financial pictures can be obtained.
• There are various financial ratios that the entrepreneur
can look at. However, the most commonly considered
ratios in small business decision-making fall into four
categories: liquidity, efficiency, profitability and solvency.
• For illustrative purposes, financial data presented in pro
forma financial statements in the next slides will be
used.

THE FINANCIAL PLAN

Pro Forma Income Statement

Sales 576,000 662,400 794,880
Cost of sales 227,000 254,600 278,460
Gross profit 349,000 407,800 516,420

Less: Operating Expenses
Marketing expenses 56,500 62,150 68,365
Administrative expenses 226,000 248,600 273,460
Depreciation charges 21,000 21,000 21,000
Other operating expenses 5,000 4,000 4,000
308,500 335,750 366,825
Operating income 40,500 72,050 149,595

Less: Financing expenses:
Interest on term loan 16,500 13,200 9,900
Net income before tax 24,000 58,850 139,695

THE FINANCIAL PLAN

Pro Forma Balance Sheet

Year 1 Year 2 Year3
Non-Current Assets (book value)
Land & building 100,000 100,000 100,000
Motor vehicles 64,000 48,000 32,000
Office equipment 5,600 3,000 2,000
Renovation 16,000 12,000 8,000
Machinery 32,000 24,000 16,000
Other assets (deposits) 1,000 1,000 1,000
217,000 188,000 159,000
Current Assets
Inventory of raw materials 2,000 3,000 4,000
Inventory of finished goods 5,000 6,000 8,000
Cash 46,500 105,350 244,645
53,500 114,350 256,645
Total Assets 270,500 302,350 415,645

Owners’ Equity
Capital 105,500 105,500 105,500
Accumulated profit 24,000 82,850 222,545
129,500 188,350 328,045
Long-term Liabilities
Term loan 132,000 99,000 66,000

Current Liabilities
Accounts payable 9,000 15,000 21,600

Total Owners’ Equity & Liabilities 270.500 302,350 425,645

THE FINANCIAL PLAN


• Liquidity Ratios
 The term liquidity refers to the availability of liquid
assets to meet short-term obligations. Thus,
liquidity ratios measure the ability of the business
to pay its monthly bills.

 The most widely used liquidity ratios are current
ratio and quick ratio.

THE FINANCIAL PLAN


 Current ratio can be determined by dividing total
current assets by total current liabilities. Generally,
this ratio shows the business’ ability to generate cash
to meet its short-term obligations.
Current ratio = Total current assets
Total current liabilities
Current assets RM53,500 RM114,350 RM256,645

Curent liabilities RM 9,000 RM15,000 RM 21,600

Current Ratio 5.94 7.62 11.88

THE FINANCIAL PLAN


 If the business’ current ratio falls below 1, it means
that the business is in a serious liquidity situation. In
most cases, the comfortable current ratio for most
businesses is ‘2’.
 Quick ratio, also known as the acid test ratio,
measures the extent to which current liabilities are
covered by liquid assets.
 To determine quick ratio, the calculation of liquid
assets does not take into account inventrories since
it is sometimes difficult to convert them into cash
quickly.

THE FINANCIAL PLAN


Quick ratio = Total current assets-inventories
Total
current liabilities
Current assets RM53,500 RM114,350 RM256,645
Inventories RM 7,000 RM 9,000 RM 12,000
Current liabilities RM 9,000 RM15,000 RM 21,600
Quick Ratio 5.17 7.02 11.33

 In most cases, the comfortable quick ratio is ‘1’.

THE FINANCIAL PLAN


• Efficiency Ratios
 The efficiency ratios measure how efficient the
business uses its assets to generate sales.

 The most widely used efficiency ratio for planning
purposes is inventory turnover ratio.

THE FINANCIAL PLAN


 Inventory turnover (or stock turnover) measures the
number of times inventories have been converted into
sales and indicates how liquid the inventory is. All
other things being equal, the higher the turnover
figure, the more liquid the business is.

 This ratio divides the cost of sales (or cost of goods
sold) by the average value of inventory. The average
value of inventory is derived by adding the opening
and closing balance of and dividing the total by two.
Inventory turnover = Cost of sales
Average inventory

THE FINANCIAL PLAN


Cost of sales RM227,000 RM254,600 RM278,460
Average inventory RM 7,000 RM8,000 RM 10,500
Inventory turnover 32.42 times 31.83 times 26.5 times

THE FINANCIAL PLAN


• Profitability Ratios
 Profitability ratios are important indicators of the
business’ financial performance. Investors will
particularly be interested in these ratios since they
measure the performance and growth potential of
the business.

 Some of the commonly used profitability ratios are
gross profit margin, net profit margin, return on
assets and return on equity.

THE FINANCIAL PLAN


 Gross profit margin give a good indication of financial
health of the business. Without an adequate gross
margin, the business will be unable to pay its
operating and other expenses.

 Gross profit margin is calculated by dividing the
business gross income by sales.

Gross profit margin = Gross profit
Sales

THE FINANCIAL PLAN


Gross profit RM349,000 RM407,800 RM516,420
Sales RM576,000 RM662,400 RM794,880
Gross profit margin 60.59% 61.56% 64.97%

 Net profit margin is an indication of how effective the
business is at cost control. The higher the net profit
margin, the more effective the business is at
converting sales into actual profit.

THE FINANCIAL PLAN


 Net profit margin is calculated by dividing the
business net income by sales.

Net profit margin = Net profit
Sales

Net profit RM 24,000 RM 58,850 RM139,695
Sales RM576,000 RM662,400 RM794,880
Net profit margin 4.16% 8.88% 17.57%

THE FINANCIAL PLAN


 Return of assets measures the overall return that the
business is able to make on its assets.

 This ratio is derived by dividing the business net profit
by total assets.
Return on assets = Net profit
Total assets
Total assets RM270,000 RM302,350 RM415,645
Return on assets 8.89% 19.46% 33.61%

THE FINANCIAL PLAN


 Return of equity shows what the business has earned
on its owners’ investment in the business.

 This ratio is derived by dividing the business net profit
by total equity.
Return on equity = Net profit
Total equity
Total equity RM129,500 RM188,350 RM328,045
Return on equity 18.53% 31.25% 42.58%

THE FINANCIAL PLAN


• Solvency Ratios
 This final category of ratios is designed to help the
entrepreneur measure the degree of financial risk
that his business faces. By referring to this ratio,
the entrepreneur can assess his level of debt and
decide whether it is appropriate for the business.

 The most commonly used solvency ratios are total
debt (liabilities) to equity (also known as leverage
or gearing), total debt to total assets, and times
interest earned (also known as interest coverage).

THE FINANCIAL PLAN


 The total debt to equity ratio indicates what proportion
of equity and debt that the company is using to
finance its assets.
 This ratio is calculated by dividing the the total debt by
total equity.
Debt to equity ratio = Total debt
Total equity
Total debt RM141,000 RM114,000 RM 87,600
Total equity RM129,500 RM188,350 RM328,045
Debt to equity ratio 1.09 : 1 0.61 : 1 0.27 : 1

THE FINANCIAL PLAN


 The debt to asset ratio measures the percentage of
the business’ assets financed by creditors relative to
the percentage financed by the entrepreneur.
 This ratio is calculated by dividing the total debts by
total assets.
Debt to equity ratio = Total debts
Total assets
Total debts RM141,000 RM114,000 RM87,600
Total assets RM270,500 RM302,350 RM415,645
Debt to total assets ratio 52.13% 37.70% 21.08%

THE FINANCIAL PLAN


 Times interest earned ratio measures the number of
times interest expense can be covered by profit
before interest and tax.
 This ratio is calculated by dividing total interest
expense by profit before interest and tax.
Time interest earned = Profit before interest & tax
Interest expense
Profit before interest RM40,500 RM72,050 RM149,595
Interest expense RM16,500 RM13,200 RM9,900
Time interest earned 2.45 times 5.46 times 15.11 times

THE FINANCIAL PLAN

SUMMARY

• The financial plan is an important part of the business
plan. It incorporates all financial data derived from the
operating budgets, i.e. marketing, operations and
administrative budgets.

• Based on this financial data, several financial
projection tools are prepared to provide the
entrepreneur with a clear picture of the amount of
money needed to start a business, sources of finance,
the amount of cash available and the financial
performance and position of the business.

THE FINANCIAL PLAN

SUMMARY (contd.)

• The output of a financial plan covers project
implementation cost schedule, sources of financing
schedule, pro forma cash flow statement, pro forma
income statement , and pro forma balance sheet.

• The business financial data gathered in the financial
statements are analysed in order to obtain an overall
financial picture of the business. The financial ratios are
used to analyse the financial performance of the
business.

THE FINANCIAL PLAN

END OF MODULE 11

Ent300 module11

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