Transcript The Strategy Process

Financial Management for
Entrepreneurs I
Business Innovation Competition
Workshops
Innovation & Entrepreneurship Institute
Alchemy of Wealth Creation
• A successful business organizes natural resources,
human resources and sweat into product or
service plus profit,
– Thus transforming human and natural capital into
financial capital.,
• One goal of business is to generate wealth and
stores it as money, as capital, which can then be
rented (lent) or invested to help build more
wealth…
Capital vs. Cash
• Cash is not always cash: There is a difference
between the cash needed to run a firm and the
capital needed to develop it.
• Operating cash is a lubricant that facilitates the
exchange of goods and services.
– Successful firms are well lubricated: They cover operations from
revenues.
• Capital is stored energy and is used to build
capability.
– Capital (from investments and loans) is stored profit from past ventures.
This energy from the past helps firms build more rapidly than would be
possible with sweat and profit.
Financial Statements & Projections
• Track the alchemical transformation of labor, land
and capital into financial capital.
• Monitor flow of money through a business – as
cash and capital.
• Support planning and measure progress.
• Support judgments about the coherence of a
business plan.
• Help sell business plans to others.
Transparent Financial Statements
• Use standard formats
– With account categories and formats that fit one’s
business
• Support numbers with narrative and notes
– Narrative: “After three months of losses, firm A turns
profitable; by the end of year, two, firm A should show
steady profits of and settles into profits of 10% per
year.”
– Notes: Assumptions, caveats, what-ifs.
• Are checked by professionals
– Taxes and acceptability
Financial Statements
• Income Statement
– Definition: Profit or loss of a business over time
– Use: Project & monitor profit & so operating efficiency
• Cash Flow Statement
– Definition: Tracks the inflows & outflows of cash
– Use: Project & monitor the cash available for operations & growth
• Balance Sheet
– Definition: Snapshot of a firm’s wealth – and how it has funded
that wealth
– Use: Project & monitor the growth or decline of a firm’s
value/capital - and so potential
Income Statement
• Income Statement
–
–
Definition: Profit or loss
of a business over time
Use: Project & monitor
profit & so operating
efficiency
+ Net Revenues
- Cost of Goods Sold
= Gross Profit
- Operating Expenses
= Operating Profit
+/- Other Income/Expenses
= Profit before tax
- Tax
= Profit after tax
Income Statement
Revenues
Gross Profit
Other Income
Operating
Profit
Net Profit
P.A.T.
COGS
Op. Exp.
R/E>B/S
Other
Exp.
Tax
Div>CF
Income Statement
• Net Revenues
–
Sales after discount, less
returns
• Cost of Goods Sold
–
Direct goods + direct labor per unit
sold
• Gross Profit
–
•
Amount left to cover operations
COGS/Sales
Constant or improving as percentage
– Perils and pleasures of volume
–
+ Net Revenues
- Cost of Goods Sold
= Gross Profit
Income statement
• Operating Expenses
–
–
–
–
–
–
•
Salaries (benefits, taxes)
Sales & Marketing
General Administration (supplies,
IT, insurance)
Space (rent, maintenance,
utilities)
Depreciation (spreading capital
expense over use/ time)
Professional fees
Operating Profit
–
Basic measure of success
= Gross Profit
- Operating Expense
= Operating Profit
Income Statement
• Other Income
Sidelines (can be very valuable
and/or indicate new businesses
or products)
– Interest
–
• Other Expense
Cost of financing, especially
interest on loans
– Other miscellaneous expenses
–
• Profit before Taxes
–
Net income
= Operating Profit
+/- Other Inc or Exp
= Profit before taxes
Income Statement
• Income Taxes
= Profit before Taxes
– State and local
- Income Taxes
– Don’t confuse tax management
= Profit after Taxes
with management
• Profit after Taxes
–
–
–
Captured wealth
Reinvest (retained earnings) >
B/S
Distribute (dividends) > CF
Account Categories That Matter
• Revenues
–
–
Major lines and/or channels
Other income sources
• COGS
–
Direct labor, raw materials, subcontracts
• Operating Expenses
–
–
Reflect business model: Marketing/Sales, GA
Subdivide important categories; lump together
unimportant ones
• Other Expenses
Account Categories Exercise
+ Net Revenues
- Cost of Goods Sold
= Gross Profit
- Operating Expenses
= Operating Profit
+/- Other Income/Expenses
= Profit before tax
- Tax
= Profit after tax
• Planning: What
categories should
matter?
• Analysis: What
categories has
management
chosen – and
what do they tell
you?
Cash Flow Projections
+ Revenues
• Cash Flow Statement
–
–
Definition: Tracks the inflows
& outflows of cash
Use: Project & monitor the
cash available for operations
& growth
-
Cost of Goods
Operating Expenses (excluding
depreciation)
= Cash flow from operations
+ Investment income
- Acquisition of space, r&d,
equipment, etc
= Cash flow from investment
+ Equity investment
+ Loans
- Repayments
- Dividends / owner withdrawals
= Cash flow from financing
Cash on Hand – End of Period
Three Sources of Cash
+ Revenues
• Operations
–
Revenue less cash
expenses (ultimately,
retained earnings)
• Investments
• Financing
–
Loans, equity
-
Cost of Goods
Operating Expenses (excluding
depreciation)
= Cash flow from operations
+ Investment income
- Acquisition of space, r&d,
equipment, etc
= Cash flow from investment
+ Equity investment
+ Loans
- Repayments
- Dividends / owner withdrawals
= Cash flow from financing
Cash on Hand – End of Period
Three Uses of Cash
• Operations
–
Cash necessary to
operate
• Capacity building
–
Cash necessary to build
the platform
• Pay back
–
Cash necessary to pay
lenders, investors,
owners
+ Revenues
-
Cost of Goods
Operating Expenses
(excluding depreciation)
= Cash flow from operations
+ Investment income
- Acquisition of space, r&d,
equipment, etc
= Cash flow from investment
+ Equity investment
+ Loans
- Repayments
- Dividends / owner withdrawals
= Cash flow from financing
Cash on Hand – End of Period
Building the Cash Flow Statement
• Inflows
Operating: Adjust revenues for bad debt and timing
– Investment: Any sales of hard assets?
– Financing: Capital inflows? Loans?
–
• Outflows
Operating: Inventory purchases
– Operating: Operating expenses (without depreciation), adjusted
for timing
– Investment: Capital purchases
– Financing: Principal repayment, investor repayment, owner
withdrawals
–
Avoiding the Cash Wall
• Detailed projections
Routine and extraordinary expenses
– Monthly, even weekly (once operating)
–
• Careful monitoring
• Calculate burn rate
–
Cash outflow per month
• Play with timing
–
Delay outflow or accelerate inflow
• Manage expectations
• Negotiate
Cash Flow Projections Exercise
+ Revenues
-
Cost of Goods
Operating Expenses (excluding
depreciation)
= Cash flow from operations
+ Investment income
- Acquisition of space, r&d,
equipment, etc
= Cash flow from investment
+ Equity investment
+ Loans
- Repayments
- Dividends / owner withdrawals
= Cash flow from financing
Cash on Hand – End of Period
• Planning: List one-time
and recurring cash
inflows and outflows.
Juggle the timing to
remain cash positive
while growing.
• Analysis: Calculate the
cash available for to
finance investment, new
initiatives, etc.
Balance Sheet
• Balance Sheet
–
–
Definition: Snapshot of a
firm’s wealth – and how it
has funded that wealth
Use: Project & monitor the
growth or decline of a
firm’s value/ capital - and
so potential
Current Assets
Long-term Assets
= Total Assets
Current Liabilities
Long-term Liabilities
= Total Liabilities
Capital Investment
Retained Earnings
= Total Equity
A=L+E
• Assets = Wealth = Use of Funds
–
–
Cash, loans to customers (A/R), buildings, equipment,
inventory, partnerships
Platform for growth
• Liabilities = LeveragedSource of Funds
–
–
Nervous claims on wealth secured by contracts & collateral
such as loans from vendors, banks, other sources, bonds
Expand possibilities while increasing risk
• Equity = Capital = Invested Source of Funds
–
More patient claim on wealth secured by control, especially
owners’ capital plus retained profits
Balance Sheet
• Current Assets
Cash & similar
– Accounts receivable
– Inventory
–
• Long-term Assets
Equipment
– Leasehold Improvements
– Net of depreciation
–
Current Assets
Long-term Assets
= Total Assets
Uses of Cash
•
•
•
•
Payments
Supporting customers by offering terms
Inventory
Investing in capacity: machinery, know-how, new
products, partnerships
• Investing in financial instruments
Balance Sheet
• Current Liabilities
–
–
–
–
Accounts payable
Deposits
Line of credit
Current portion of longterm debt
• Long-term Liabilities
–
–
Loans
Bonds
Current Liabilities
Long-term Liabilities
= Total Liabilities
Balance Sheet
• Equity
–
–
–
Capital Investment
Additional Paid-in
Capital
Retained Earnings
Capital Investment
Retained Earnings
= Total Equity
Sources of Cash
• Initial equity
–
owners, family, friends
• Other equity:
–
angels, venture firms, partners, public markets
• Informal loans:
–
terms from suppliers, customers, landlords, partners
• Traditional loans:
–
credit cards, banks, leases, bonds
• Revenues
• Related business income
• Investment income
Matching Sources & Uses of Funds
• Short-term sources of cash to fund short-term needs
–
–
A/P <> A/R
Deposits <> inventory
• Long-term sources of cash to fund long-term needs
–
Loans for hard assets with collateral
•
•
–
Mortgage <> building
Lease <> equipment
Investments for softer assets like r&d
•
•
Angel <> r&d
Strategic investor <> new product
Matching Sources & Uses of Funds
• Farm Example
–
–
–
Seasonal cash flow – revolving line of credit
Equipment – leases
Buildings - mortgages
• Software Application Example
Personal & angel investment for proof of concept
– Stock options (personal investment) for building core staff
– Venture capital for commercialization and marketing roll
out
– Short-term loans for equipment
– Mid-term loans for leasehold improvements
–
Balance Sheet Exercise
Current Assets
Long-term Assets
= Total Assets
Current Liabilities
Long-term Liabilities
= Total Liabilities
Capital Investment
Retained Earnings
= Total Equity
• Planning: List necessary
assets & timing.
Brainstorm possible
sources of funds and
timing. Match them up.
• Analysis: Are sources and
uses of funds well
matched?
Tying the Statements Together
• Income Statement > Balance Sheet
–
Net income less dividends = additional retained earnings
on B/S
• Incomes Statement > Cash Flow
–
Direct method: All income (adjusted for timing) - all
expenses (adjusted for timing) + depreciation = operating
cash flow
•
–
(Remember other income/expense and taxes)
Interest payments provide clues about the loan situation
Tying the Statements Together
• Cash Flow > Balance Sheet
–
–
New capital, new loan principal, repaid capital, repaid loan
principal, purchases or sales of equipment
Dividends (which reduce net income’s contribution to
retained earnings)
• Cash Flow > Income Statement
–
Changes in loans should be reflected in changes in interest
Tying the Statements Together
• Balance Sheet > Income Statement
–
Change in retained earnings = Net income less dividends
• Balance Sheet > Cash Flow
–
–
Indirect method: Changes in balances (eg., Accounts
receivable, accounts payable, etc) are used to calculate
changes in cash
Similarly with changes in investing (equipment, equity) and
financing categories (loans)
Bibliography
• Richard A Brealey and Stewart C. Myers, Principles of Corporate Finance
(McGraw-Hill, 1996)
• Corporation for Enterprise Development: Financial Management for
Entrepreneurs (1995)
• Craig Fleisher & Babetter E. Bensoussan, Strategic and Competitive
Analysis: Methods and Techniques for Analyzing Business Competition
(Prentice-Hall, 2003)
• TL Hill lectures, 2002
• Nick Rowling, Commodities: How the World Was Taken to Market (Free
Association Books, 1987)
• Clyde Stickney & Roman Weil, Financial Accounting: An Introduction to
Concepts, Methods and Uses (Dryden Press/Harcourt Brace College
Publishers, 1994)
• G. Straughn & C. Chickadel, Building a Profitable Business (B Adams, 1994)