Entrepreneurship Successfully Launching New Ventures 1e Bruce R

Financial Management (1 of 2) • Financial Management – Financial management deals with two things: • Raising money and • Managing a company’s finances to achieve the highest rate of return – Chapter 10 focuses on raising money – This chapter focuses primarily on: • How a new venture tracks its financial progress through preparing, analyzing, and maintaining past financial statements. • How a new venture forecasts future income and expenses by preparing pro forma (or projected) financial statements. © 2006 Prentice Hall 2

Financial Management (2 of 2) The financial management of a firm deals with questions such as the following on an ongoing basis: • How are we doing? Are we making or losing money? • How much cash do we have on hand? • Do we have enough cash to meet our short-term obligations? • How efficiently are we utilizing our assets? • How does our growth and net profits compare to those our industry peers? • Where will the funds we need for capital improvements come from? • Are there ways we can partner with other firms to share risk and reduce the amount of cash we need? • Overall, are we in good shape financially? © 2006 Prentice Hall 3

Financial Objectives of a Firm (1 of 3) Figure 7. 1 Primary Financial Objectives

Financial Objectives of a Firm (2 of 3) • Profitability – Is the ability to earn a profit. • Many start-ups not profitable during their first 1 -3 years – Often because they are training employees and building their brands. • A firm must become profitable to remain viable and provide a return to its owners • Liquidity – Company’s ability to meet short-term financial obligations • Even if profitable, it is often a challenge to keep enough money in the bank to meet routine obligations in a timely manner. © 2006 Prentice Hall 5

Financial Objectives of a Firm (3 of 3) • Efficiency – How productively a firm utilizes its assets relative to its revenue and its profits • Example: Southwest Airlines – Uses its assets very productively – Turnaround time is the lowest in the airline industry » (time its airplanes sit on the ground while they are being unloaded and reloaded) • Stability – Strength and vigor of firm’s overall financial posture • To be stable firms must not only earn a profit and remain liquid but also keep its debt in check © 2006 Prentice Hall 6

The Process of Financial Management (1 of 4) • Importance of Financial Statements – To assess if financial objectives being met, firms analyze financial statements • Financial statement: a written report that quantitatively describes a firm’s financial health • Financial statements entrepreneurs use most: income statement, balance sheet, statement of cash flows – Used to assess current status of venture and future potential » Forecasts – Statements are an estimate of firm’s future income and expenses, based on past performance, its current circumstances, and its future plans. © 2006 Prentice Hall 7

The Process of Financial Management Figure 7. 2 The Process of Financial Management ©

Financial Statements • Historical Financial Statements – Reflect past performance – Usually prepared on a quarterly and annual basis • Publicly traded firms: required by SEC to prepare financial statements and make available to public • Pro Forma Financial Statements – Projections for future periods based on forecasts – Typically completed for two to three years in the future • Pro forma financial statements are strictly planning tools • Not required by the SEC. © 2006 Prentice Hall 9

New Venture Fitness Drinks • New Venture Fitness Drinks – To illustrate how financial statements are prepared, we will use New Venture Fitness Drinks (fictitious sports drink co. ) • New Venture Fitness Drinks has been in business for five years • Sells a line of nutritional fitness drinks • Opened single location in 1999, added a second location in 2004, plans to add a third in 2005 • The company’s strategy is to place small restaurants, similar to smoothie restaurants, near large outdoor sports complexes • The company is profitable and is growing at a rate of 25% per year © 2006 Prentice Hall 10

Historical Financial Statements (1 of 7) Three types of historical financial statements Financial statement Purpose • Reflects results of operations over a specified period of time Income Statement • Records all revenues & expenses for given period • Shows whether firm making a profit/ experiencing a loss Balance Sheet • A snapshot of company’s assets, liabilities, and owners’ equity at a specific point in time • Summarizes changes in cash position for a specified period of time Statement of cash flows • Details why the change occurred • Similar to a month-end bank statement © 2006 Prentice Hall 12

Historical Financial Statements (2 of 7) Consolidated Income Statements for New Venture Fitness Drinks 46% 22% © 2006 Prentice Hall 49% 18% 55% 14% Income Statement: Ratio Analysis Decreasing ratio of COGS/Net Sales suggests steadily decreasing material & labor costs per dollar sales Rising profit margin means a firm is either boosting sales w/o increasing expenses or controlling costs better 13

Historical Financial Statements Consolidated Balance Sheets for New Venture Fitness Drinks Balance Sheet: Ratio Analysis • Working Capital: current assets – current liabilities = $82. 5 K • Tells s the amount of liquid assets the firm has available • Current Ratio: current assets/current liabilities = 3. 06 (2004); = 2. 26 (2003); = 2. 35 (2002) • Means the firm has $3. 06 in current assets for every $1. 00 in current liabilities • Debt Ratio: total debt/total assets = 39. 7 • Means 39. 7% of total assets are financed by debt and the remaining 60. 3% by owners’ equity © 2006 Prentice Hall 14

Historical Financial Statements (5 of 7) Consolidated Statement of Cash Flows for New Venture Fitness Drinks • Young firms should have a healthy cash balance But, • A large increase in a firm’s cash balance is not necessarily good • Could mean the firm is borrowing heavily, not paying down short-term liabilities, or accumulating cash that could more effectively be used © 2006 Prentice Hall 15

Historical Financial Statements (6 of 7) • Ratio Analysis – The most practical way to interpret or make sense of a firm’s historical financial statements is through ratio analysis, as shown in the next slide. • Comparing a Firm’s Financial Results to Industry Norms – Comparing a firm’s financial results to industry norms helps it determine how it stakes up against its competitors and if there any financial “red flags” requiring attention. © 2006 Prentice Hall 16

Historical Financial Statements (7 of 7) Table 7. 4 Ratio Analysis for New Venture

Forecasts (1 of 4) • Forecasts – Analysis of historical financial statements followed by preparation of forecasts – Forecasts are predictions of firm’s future sales, expenses, income, and capital expenditures. • Forecasts provide basis for pro forma financial statements • A well-developed pro forma financial statements help create accurate budgets, build financial plans, and manage finances in a proactive vs. reactive manner © 2006 Prentice Hall 19

Forecasts (2 of 4) • Sales Forecast – A sales forecast is projection of a firm’s sales for a specified period (such as a year) – Is the first forecast developed and is basis for most of the other forecasts • • Based on good-faith estimate of sales and industry averages or the experiences of similar start-ups For an existing firm, based on 1. Its record of past sales, 2. Its current production capacity and product demand, and 3. Any factors that will affect its future product capacity and product demand. © 2006 Prentice Hall 20

Forecasts (4 of 4) • Forecast of Costs of Sales and Other Items – After sales forecast, firm must forecast cost of sales (COGS) and other items on income statement – Most common to do this using the percentage-ofsales method • This expresses each expense item as a percentage of sales. – If firm uses percent-of-sales method and follows the procedures described in the textbook, the net result is that each expense item on its income statement will grow at the same rate as sales (with the exception of items that can be individually forecast, such as depreciation). © 2006 Prentice Hall 21

Pro Forma Financial Statements (1 of 3) • Pro Forma Financial Statements – Similar to historical financial statements except they look forward rather than track the past – Their preparation can help a firm rethink its strategies and make adjustments if necessary – Their preparation is also necessary if a firm is seeking funding or financing © 2006 Prentice Hall 23

Pro Forma Financial Statements (2 of 3) Three types of pro forma financial statements Financial statement Purpose Pro Forma Income Statement • Shows projected results of the operations of a firm over a specific period Pro Forma Balance Sheet • Shows projected snapshot of a company’s assets, liabilities, and owner’s equity at a specific point in time Pro Forma Statement of Cash flows © 2006 Prentice Hall • Shows projected flow of cash into and out of a company for a specific period 24

Pro Forma Financial Statements (3 of 3) • Ratio Analysis – Same financial ratios used to evaluate historical financial statements used to evaluate the pro forma financial statements – This is done to get a sense of: • How projected financial performance compares to past performance • How its projected activities will affect its cash position and its overall financial soundness © 2006 Prentice Hall 26