The document discusses business planning and financial statements for startups. It covers: 1) The business cycle of a typical company, including how equity/debt is used to fund operations and the flow of cash through production, sales, collections, and dividends/reinvestment. 2) The key financial statements - balance sheet, income statement, and cash flow statement - and how they reflect the business cycle and financial condition. 3) Components of the balance sheet in more detail, including assets like cash, receivables, inventory, fixed assets; and liabilities. It also discusses accounting principles like depreciation.

1. Please respond in 150 with what you understand from the
reading below
Financial and Business Planning
CHAPTER OVERVIEW
The business planning of startups is often summarized in a
document called the business plan. However, it is important to
understand that business planning is much broader than the
business plan document. This chapter reviews the main aspects
of the general business planning process, while emphasizing the
factors that are important to early stage companies.
The first part of the chapter discusses the company's business
cycle and the manner of presenting information in the financial
statements. Understanding the principles underlying the
financial statements, the manner of preparing them, and the
presentation of the data is essential to anyone involved in the
high tech industry in general, and to persons engaged in
business planning in particular. The second part of this chapter
reviews the main methods of financial forecasting. The last part
of this chapter reviews other issues relating to strategic
planning and reviews the business plan, which is one of the
products of business planning.
The Company's Business Cycle
Understanding the company's business cycle is important for
financial forecasting and for understanding the company's cash
flow.
Figure 3-1
presents the business cycle of a typical company: The

2. company's equity providers or debt holders infuse money (in the
form of capital and debt, respectively) into the company's cash
account. This cash is used by the company to pay for services,
salaries (human capital), and raw materials for the production
process and to purchase production equipment. The human
capital and the raw materials are used for the development and
production (through means of production such as machinery and
computers) of services and products. Products pass through the
company's inventory and are sold to customers, and services are
provided to customers directly. Customers either pay for the
products or services in cash or receive credit from the company
that is paid later. At the end of each period (cycle), any cash not
returned to the company's debt holders is paid to the tax
authorities, distributed to the shareholders in the form of
dividends, or is re-invested in the company to allow further
business cycles.
Figure 3-1 The Company's Business Cycle
Financial Statements
The company's business cycle is reflected in its financial
statements; the main ones are the company's balance sheet,
income statement, and cash flow statement. The company's
financial statements provide information about its financial
condition: The main purpose of the balance sheet is to describe
the assets and liabilities of the company on a given date; the
main purpose of the income statement is to describe the
transactions and changes in the assets and liabilities of the
company over a period of time; and the cash flow statement
describes the changes in the company's cash flow over a period
of time.
The company's financial statements are usually prepared in
accordance with generally accepted accounting principles
(GAAP). In most cases, the company prepares two sets of
statements: One is used for reporting to the company's
shareholders and debt holders, and the other, which is based on
the tax rules governing the recording of transactions, is used for
reporting to the tax authorities. Obviously, the statements report

3. the same business results, but different rules used for different
needs create differences between the reported results. The
reason for the differences in most cases is the existence of
specific directives for tax reporting, as opposed to other
financial reporting principles that attempt to reflect the
company's business condition in general.
In order to understand the company's financial condition and
prepare financial and business plans accordingly, entrepreneurs
need to understand the meaning of the different statements and
the logic behind the reflection of the company's business cycle.
The following explanation of the statements and their
components is consistent with the customary reporting rules, but
is based on the economic principles underlying them, rather
than on the precise reporting rules.
Balance Sheet
The company's balance sheet reflects the company's overall
assets and liabilities or, in other words, its financial condition
at a given point of time. The balance sheet may be likened to a
snapshot of the company's financial condition. It distinguishes
among various types of assets and liabilities, such as cash held
by the company or in its bank accounts, as opposed to
inventories. The balance sheet also reflects the shareholders'
equity, namely, the investment in the company made by the
shareholders and the profits accumulated in the company
(retained earnings). The company's total recorded assets are
always equal to the sum of its liabilities plus the shareholders'
equity (see
Figure 3-2
).
Figure 3-2 The balance sheet
According to the reporting principles, the company is required
to distinguish between current assets and liabilities which may
be liquidated or are due within one year or less, and other assets
and liabilities, referred to as long-term assets and liabilities,
whose life span is longer than one year. Assets are presented in
a declining order of liquidity, i.e., the most liquid assets appear

4. before the less liquid assets. The first assets presented (namely,
the most liquid) include cash and traded securities, and the
assets presented last are the company's fixed assets, such as
industrial equipment and real estate.
It is important to note that the presentation of assets and
liabilities in financial statements is guided by the principle of
conservativeness: Assets are recorded according to their lowest
reasonable value (in other words, they are not likely to be
liquidated for less), whereas liabilities are recorded according
to their highest reasonable value.
The main assets and liabilities appearing on the balance sheet
(see
Figure 3-2
), are the following:
Assets
Cash, cash-equivalents and securities—
These are the first among the company's current assets. Cash,
cash-equivalents, and securities include, except for the cash in
the company's bank account, all short-term deposits owned by
the company and traded securities, including treasury bills. The
guiding principle underlying the classification of these assets is
that they entail a relatively low risk in proportion to their value
at the time of liquidation, and can be liquidated quickly
(usually, within less than three months).
Accounts Receivable—
Since most companies do not receive payment in cash for all of
their sales, almost every company that has reached the stage of
sales has an Accounts Receivable (or Receivables) item. These
are short-term customer debts that the company records on its
balance sheet after offsetting allowance for doubtful debts
which it does not expect to collect. For example: a company by
the name of Speed is owed $1,000 by its customers, but predicts
that only $800 will be paid. The company will present in its
balance sheet a net amount of $800 under this item, representing

5. the portion of the debts that the company expects to collect.
This amount is produced by deducting an allowance of $200 for
doubtful debts from the gross debt of $1,000.
Inventory—
Inventories are assets in various stages of production that the
company expects to sell as products. Inventories are divided
into several types in accordance with their stage along the
production process. Companies usually specify the types of
inventories they have, since investors attribute a different value
to different types of inventories. For instance, in most cases, an
inventory of raw materials is easier to liquidate than an
inventory of products in progress. A manufacturing company
will generally have three types of inventories: an inventory of
raw materials, an inventory of goods in process, and an
inventory of finished goods. Inventories are estimated according
to their cost, not according to the revenue they are expected to
produce, unless such revenue is lower than the cost of
production (in which case, the principle of conservativeness
directs that they be recorded according to their net realizable
value). The reporting of inventories in progress, as well as
inventories of finished products, usually includes also allocated
labor and overhead costs (such as electricity and some of the
depreciation of the equipment used to manufacture them).
When analyzing inventories, it is important to pay attention to
the method of recording of the inventories, since a company
selling products uses inventories of raw materials and finished
products which might be recorded according to different prices.
For instance, let us assume that Speed manufactures instruments
that it combines with tractors that it purchases. In one month,
the company purchased three identical tractors at different
prices (according to the order of acquisition): $100,000,
$120,000 and $115,000. At the end of the month, the company
sold one set of equipment (a tractor on which the company's
equipment was assembled) for $200,000. Obviously, the
reported financial results reported by Speed will be affected by

6. the choice of the tractor that constitutes a material part of the
sold equipment. If the company uses an inventory method called
FIFO (First In, First Out), then, assuming that Speed had no
prior inventories, it will report an inventory of $235,000.
$100,000 (the cost of the first tractor) will be reported as part
of the cost of the equipment sold (see the next subsection for a
further discussion of revenues and expenses). If the company
uses the method of LIFO (Last In, First Out), then the company
will report an inventory of $220,000. According to yet another
method, the inventory (and the components of the cost of the
goods sold) is calculated according to the average cost of the
components of the sale. In our case, the inventory at the end of
the period will be reported at: (100,000 + 120,000 +
115,000)*(2/3) = 223,333.33.
Advance payments—
Although companies usually try to defer payments, in many
cases they pay in advance for services they will receive after the
date of the balance sheet. For instance, companies often pay
rent for several months in advance. The principle in the
statements is to report expenses and revenues at the time of the
economic occurrence of their underlying events. In other words,
since the services will be received after the date of the
statements, the expenses will be recorded concurrently with the
receipt of the service. Therefore, the balance sheet will reflect
an asset incorporating the cost for which the services or product
was not yet received.
Long-term assets—
Assets that are expected to contribute to the production of
revenues over a period longer than one year are referred to as
long-term assets. They are divided into two main groups:
tangible assets and intangible assets (intellectual property).
Tangible assets include real estate, office equipment, production
equipment, long-term financial assets, and stocks in other
companies. These assets are usually recorded according to their

7. historical value, i.e., according to the price of purchase,
adjusted for depreciation.
The term “depreciation” attempts to reflect the devaluation of
assets over their economic life span or usage. The periodic
depreciation of an asset is part of the expenses reflected in the
income statement. There are various methods for calculating
depreciation that are deployed in accordance with the character
of the assets, the industry, and the company holding the asset.
The most widely-used method is that of the “straight line”:
First, the asset's economic life span is estimated, and a
proportionate part of the cost is recorded every year as an
expense. For instance, if a car was bought for $20,000, and its
economic life span is five years, then $4,000 are recorded every
year as an expense, and the asset is reported on the balance
sheet with a value that decreases by such amount every year.
Another common method is that of the “accelerated
depreciation,” whereby the asset is depreciated more in the first
years. This method reflects an accelerated depreciation in the
first years of the asset's life. The value of a new car, for
instance, is known to decline faster in its first few years.
There are other depreciation methods, and in many cases the
chosen method takes into account the amount of use made of the
asset. For instance, consider the case of a factory where one
million cars can be manufactured before it needs to be
renovated. Obviously, it would be logical to express the
depreciation of the factory over time as a function of the
number of cars actually manufactured in it.
Assets appear on the balance sheet according to their historical
value, less depreciation and any other devaluation resulting
from a decline in their market value below their cost. In fact,
the net fixed assets will be equal, at the end of each period, to
the net fixed assets at the end of the previous period, plus new
fixed assets acquired, minus the net cost of fixed assets sold and
minus periodic depreciation and any other reduction in the
recorded value of the fixed assets.
Where the statements of non-American companies are

8. concerned, it is important to understand that in different
countries the value of assets may be expressed differently, and
in many cases assets may be revalued according to their market
value at the time. Fixed assets may be revalued, for instance, in
the United Kingdom and in the Netherlands. The principle in
these countries is that assets are reflected according to the cost
to the company of replacing them. In other words, if the car on
Speed's balance sheet (which, for purposes of this example, will
be reported according to British rules) is one year old, then,
instead of reporting a depreciated value of $16,000 ($20,000 –
$4,000), the cost of a similar used car on the market will be
checked. If such cost is $21,000, then the car will be recorded
in the balance sheet with this value. This change in value will
concurrently be reflected under the item of the company's
shareholders' equity. In all countries, if the market value of an
asset considerably declined below its depreciated cost, and such
devaluation is not expected to be remedied, then the value of
the asset has to be reduced in the balance sheet by recording a
loss as a result of the devaluation of the asset (since such
devaluation is in lieu of future depreciation).
Intangible assets include items such as the cost of acquired
patents, trademarks and trade names, franchises, and the cost of
investments in other companies above the value of their tangible
assets (goodwill). These assets also appear on the balance sheet
and are depreciated in accordance with their expected life span,
with certain restrictions (in accordance with the accounting
rules applicable in each country) with respect to the manner of
recording of various assets and liabilities. For example, if
Speed bought a license to use a patent that will expire in ten
years in consideration for one million dollars, then it will be
depreciated over ten years, unless the patent is expected to
become worthless after a shorter period of time, or is expected
to continue being valuable after it expires.
Following an accounting rule change, effective from the year
2002, goodwill does not have to be depreciated if its value, as
deemed by the company's management, has not declined.