1. 14
Financing Requirements, Pro Forma Financial Statements, and Sources of Financing
PowerPoint Presentation by
Ian Anderson, Algonquin College

2. Looking Ahead After studying this chapter, you should be able to:
Estimate the amount of financing a new or existing business will need.
Create pro forma (forecast) cash flows, income statements, and balance sheets.
3. Describe the types and sources of financing available.
4. Describe the appropriateness of types of financing at various stages of a venture’s life.
5. Evaluate the choice between debt financing and equity financing.
6. Discuss the most important factors in the process of obtaining start-up financing.

3. Businesses Needs Businesses need cash for three core reasons:
LO 1
Businesses Needs
Businesses need cash for three core reasons:
1. To purchase assets such as equipment and inventory
2. To pay for other costs incurred such as payroll, advertising, taxes, etc.
3. Pre-start-up costs which include R&D and expert advice

4. Types of Assets Current assets (working capital) Fixed Assets
LO 1
Types of Assets
Current assets (working capital)
Assets that can be converted to cash within the firm’s operating cycle—cash, accounts receivable, and inventories.
Fixed Assets
Relatively permanent resources intended for the use of the firm.
Net fixed assets = gross fixed assets – accumulated depreciation
Other Assets
Intangible assets (patents, copyrights, goodwill)

5. LO 1
Business Decisions
The business owner must make two additional decisions which are:
Buy or lease the equipment?
Acquire new or used equipment?
Bootstrapping
See In The Trenches, p. 419

6. Advantages and Disadvantages of Leasing
LO 1
Advantages and Disadvantages of Leasing
Advantages:
It requires no up-front cash, freeing up the firm’s cash for other purposes.
Leasing provides a hedge against equipment obsolescence.
Disadvantages:
Leasing requires the business to make regular payments.
May be significant cost or tax implications.

7. Working-Capital and Cash Budgets
LO 1
Working-Capital and Cash Budgets
Working Capital Management
The management of current assets and current liabilities
Cash budget or cash flow forecast
A planning document strictly concerned with the receipt and payment of dollars
Inflow and outflow of cash

8. Accounts Receivable Accounts Payable
LO 1
Accounts Receivable Accounts Payable
Accounts Receivable is the amount of credit extended to customers that is currently outstanding
Accounts Payable (trade credit) is outstanding credit payable to suppliers.

9. Flow of Cash Through A Business
Borrowed
Funds
Collection of
Accounts
Receivable
Owner's
Investment
Sale of
Fixed Assets
Payment of
Expenses
Payment for
Inventory
Dividends
Cash
Sales
Purchase of
14-9

10. LO 1
Cash Flow Forecast
The difference between total cash available (beginning cash = cash incoming from operations = cash outflow from non-operating activities) is the ending cash balance, which becomes the cash balance for the next month.
Beginning cash + Cash coming from operations +
Cash coming from financing and other activities
- Cash outflow from operations – Cash outflow from non-operating activities

11. Forecasting Assets and Financing Requirements
LO 1
Forecasting Assets and Financing Requirements
Estimating Asset Requirements
Use industry ratios for assets-to-sales
Use breakeven analysis and empirical data
Percentage-of-Sales Technique
Forecasting asset investment and financing requirements using a percentage of the total sales for a firm as the basis for forecasting the level of assets to be held by a firm.

12. Types of Financing Debt Capital Current (short-term) Debt
LO 1
Types of Financing
Debt Capital
Financing provided by a creditor
Current (short-term) Debt
Accounts payable
Accrued expenses
Short-term notes
Long-Term Debt
Loans and mortgages from banks and other lenders with maturities greater than one year
…continued

13. Types of Financing Spontaneous financing External equity
LO 1
Types of Financing
Spontaneous financing
Short term debt
External equity
Funds that derive initially from the owner’s investment in a firm
Profit retention
The re-investment of profit in a firm
Internal equity
Funds that come from retaining profits within a firm.

14. LO 2
Cash Flow Forecast
Most critical financial projection for new or growing business
Without cash the business dies
Brings together elements of Balance sheet and Income statement
Concerned with the timing of inflows and outflows of cash

15. Pro Forma Income Statements & Balance Sheets
LO 2
Pro Forma Income Statements & Balance Sheets
First – identify which items belong on the income statement and balance sheet
Balance sheet items include
Cash, accounts receivable, inventory, prepaid expenses, accounts payable, start-up capital, financing, and capital expenditures
All other items are income statement items

16. LO 3
Sources of Financing
Exhibit 14-2

17. Other Forms of Capital Personal Savings Friends and Relatives
LO 3
Other Forms of Capital
Personal Savings
Friends and Relatives
Informal capital
Funds provided by wealthy private individuals to high risk ventures such as startups
Business angels
Private investor who finances new, risky, small ventures

18. LO 3
Sources of Funds
Exhibit 14-3

19. Venture Capitalists (VCs)
LO 3
Venture Capitalists (VCs)
VCs look for:
People: strong management team
Products: high value-added features and competitive advantage
Markets: large and growing
Margins: gross margins of 40-50%
Return: short ROI cycles

20. Business Suppliers and Asset-Based Lenders
LO 3
Business Suppliers and Asset-Based Lenders
Trade Credit (Accounts Payable)
Financing provided by a supplier of inventory to a company, which sets up an account payable for the amount.
Short-duration financing (30 days)
Amount of credit available is dependent on type of firm and supplier’s willingness to extend credit
…continued

21. Business Suppliers and Asset-Based Lenders
LO 3
Business Suppliers and Asset-Based Lenders
Asset-based Loan
A line of credit secured by working-capital assets
Factoring
Obtaining cash by selling accounts receivable to another firm.
Accounts are sold to factor at a discount to invoice value
Factor can refuse questionable accounts
Factor charges fees for servicing accounts and for amount advanced to firm prior to collection
…continued

22. Business Suppliers and Asset-Based Lenders
LO 3
Business Suppliers and Asset-Based Lenders
Chartered Banks and Credit Unions
Primary providers of debt capital to small companies.
Banks limit lending to providing for the working-capital needs of established firms, but some initial capital does come from this source.
Credit Unions are growing in popularity
with SMEs
Line of credit
Maximum amount that lender
will permit firm to borrow.
…continued

23. Business Suppliers and Asset-Based Lenders
LO 3
Business Suppliers and Asset-Based Lenders
Term loans
Loans for 5 to 10 years to finance equipment
Chattel mortgage
Loan collateralized by inventory or moveable property
Real estate mortgage
Long-term loan with real property held as collateral

24. The Lender’s Perspective
LO 3
The Lender’s Perspective
Lenders’ Concerns
How much the bank will earn on the loan?
What is the likelihood that the lender will be able to repay the loan?
The Five Cs of Credit
Character of the borrower
Capacity of the borrower to repay the loan
Capital invested in the venture by the borrower
Conditions of the industry and economy
Collateral available to secure the loan

25. Questions Lenders Ask Lender’s Questions
LO 3
Questions Lenders Ask
Lender’s Questions
What are the strengths and qualities of the management team?
How has the firm performed financially?
How much money is needed?
What is the venture going to do with the money?
When is the money needed?
When and how will the money be paid back?
Does the borrower have qualified support people, such as a good public accountant and lawyer?

26. Selecting a Lender Many reasons for selecting a lender exist
LO 3
Selecting a Lender
Many reasons for selecting a lender exist
Chequing account facilities
Flexibility of loan arrangements
Management advice
Location

27. Financial Information Required for a Loan
Three years of the firm’s historical statements
Balance sheets, income statements, and statements of cash flow
The firm’s pro forma financial statements
The timing and amounts of the debt repayment included as part of the forecasts
Personal financial statements
The borrower’s personal net worth (assets – debts) and estimated annual income

28. Negotiating a Loan Terms of Loans Interest rate Loan maturity date
Fixed or floating rates
Loan maturity date
Repayment schedule
Equal monthly or annual payments
Decreasing monthly or annual payments
Loan covenants
Lender-imposed restrictions on a borrower that enhance the chances of timely repayment
Filing financial statements, restricting salaries and personal loans, requiring personal loan guarantees

29. Repayment Schedule Term loan
Schedule for re-payment is generally arranged in one of two ways:
The loan can be repaid in one equal monthly or annual payments covering both interest on the remaining balance and payment on the principal
Decreasing monthly or annual payments that cover equal payments on the principal and interest on the remaining balance.
…continued

30. LO 3
Repayment Schedule
Assume a firm is negotiating a $250,000 term loan, at an interest rate of 10%, to be repaid in five equal annual payments.
PV = -250, (present value)
N = (number of payments)
I/YR= (interest rate per year)
FV = (future value in 5 years)

31. Government-Sponsored Programs and Agencies
LO 3
Government-Sponsored Programs and Agencies
Canada Small Business Financing Program (CSBFP)
Federal program that provides financing to small businesses through private lenders
Federal government guarantees repayment
Business Development Bank of Canada (BDC)
Industrial Research Assistance Programme (IRAP)
Program for Export Market Development (PEMD)

32. Other Sources of Financing
LO 3
Other Sources of Financing
Large corporations
Stock sales
Private placement
Public sale
Initial public offerings (IPO)

33. Finding Sources of Financing
LO 4
Finding Sources of Financing
Three basic types of financing:
Spontaneous financing
Profit retention
External financing
Comes from outside investors
First ask, “Should I use debt or equity financing?”

34. Debt or Equity Financing?
LO 5
Debt or Equity Financing?
Potential Profitability
Borrowing increases potential for higher rates of return on owners’ equity; exposes firm to more financial risk.
Financial Risk
Investing more owner equity limits potential return on equity; lowers financial risk for firm.
Voting Control
Increasing equity through borrowing requires owners to share control with external investors.

35. Using the Cost of Debt as an Investment Criterion
LO 5
Using the Cost of Debt as an Investment Criterion
Favourable Financial Leverage
A benefit gained by investing at a rate of return that is greater than the interest rate on a loan.
Debt Capacity
The limit at which a firm cannot assume more debt without additional equity investment by its owners.

36. Tradeoffs Among Potential Profitability, Financial Risk, and Voting
LO 5
Tradeoffs Among Potential Profitability, Financial Risk, and Voting
Equity
financing
Debt
HIGH
LOW
Financing
Potential
Profitability
Financial Risk/Control
14-36

37. Keeping the Right Perspective
LO 6
Keeping the Right Perspective
Amar Bhide at Harvard University offers the following advice to aspiring entrepreneurs wanting to start their own businesses
Get operational. Stop planning.
Go for quick break even.
Fit growth goals to available personal resources.
Have a preference for high-ticket, high profit margin items that can sustain personal selling.
Start with only a single product or service.
Forget about having a crack management team.
Focus on cash.
Cultivate the banker.