1 Understanding Financial Statements Entrepreneurial Workshop II How Your Personal and Business Financial “Pictures” Are Linked- Introductions- Have participants state their name, name of business (if they have one) and indication as to whether they have ever applied for a loan (business or personal).
2 AGENDA What Financial Statements Can and Can’t Do Determining Your Personal Cash Flow NeedsThe Personal Financial StatementPricing
3 AGENDA (con’t) Variable and Fixed Costs Break-even Analysis Business Cash FlowThe Balance SheetThe Income Statement
4 Financial Statements CAN: Provide an indication of the value of your businessHelp you keep track of your income and expensesReflect profits and lossesHelp you know when you can afford to borrow moneyProvide you with a sales history for purposes of anticipating inventory and staffing needs.
5 Financial Statements CAN NOT: Increase or create salesKeep your financial recordsPay your billsPay your taxesCollect accounts receivableImprove your bottom line
6 Personal Cash Flow • Estimate Disposable Income based on past 12 monthsGross Incomeless taxes paidRefer them to the hand out
7 Personal Cash Flow (con’t) Estimate Living Expenses for the past12 months- Housing Utilities- Food Insurance- Recreation Child Care- Transportation Medical Care- Clothing/Personal Care - Miscellaneous- Financial/Legal Services
8 Personal Financial Statement Reflects your personal assetsand liabilitiesCan be verified by a personalcredit checkIs required for any loan applicationMust be included in yourbusiness plan
10 Assets Cash on hand & in banks Savings Accounts IRA or other Retirement AccountsAccounts and Notes ReceivableLife Insurance – cash surrender valueonlyStocks and BondsCash on hand and savings – basically all the same. No need to separate if it’s too difficult to itemize. If you are a sole proprietor, this would also reflect your business account.IRA – Includes all retirement accounts including KEOGH, Deferred Comp. etc. Not considered liquidAccounts and notes receivable- If you’re a sole proprietor, this would reflect all business accounts/notes receivable as well as any personal accounts receivable.Life Insurance – Be sure to reflect cash surrender value only – this generally much lower than the fact value of the policy. Noting the type of policy in the description area is also helpful (full life vs. term)Stocks and Bonds – Don’t worry about itemizing in description are is you have mututal funds. However, a copy of the Fund statement should be available if bank asks for it.
11 Assets (cont.) Real Estate Automobile- present value Other personal propertyOther assetsReal estate – make note that they should put their best estimate for the appraised or assessed valueOther personal property – detail things like boats, furniture, appliances, jewelry, fine art, etc.Other assets- might be the value of your ownership in a business (not a sole proprietorship)
13 Liabilities Accounts Payable Notes Payable to Bank and Others Installment Account (auto)Installment Account (other)Loan on Life InsuranceMortgages on Real EstateUnpaid TaxesOther LiabilitiesAccounts Payable – If you’re a sole proprietor, both business and personal accounts payable are shown here. Note difference between AP and notes payable. AP is an expense that you are paying over time but will be paid within the year.Notes payable – include home equity loans/lines here and equipment loansInstallment accounts – don’t forget to note the monthly payments. Can include credit cards here or under other liabilitiesMortgages – remind them to fill in all detail in Section 4 on back pageUnpaid taxes – hopefully there are none. But, again, note all details in Section 6Other liabilities – might include alimony, child support, credit cards
14 Can mean the difference between success and failure PROPER PRICING:Can mean the difference between success and failure
15 UNDER-PRICINGUnder-pricing can cause a business to fail:If products/services are drastically under-priced, the business loses money every time a sale is made.
16 OVER-PRICINGOver-pricing can cause sales to disappear altogether, as customers buy from lower-priced competitors.
17 Determining the Right Price Customer SurveysAsk your potential customers.“Shop” your CompetitionFind out how your competitors are pricing their goods/services and treating their customers.
18 Determining the Right Price (con’t) Market Research Sales Try selling your goods/services on a temporary basis at a fair or marketplace and ask for customer feedback.Break Even AnalysisDetermine how many products/services you must sell to cover ALL expenses of your business.
19 EXPENSES Cost of Goods Sold Also known as direct or variable expenses These are the costs incurred in creating your product/service. They are directly related to your sales volume and should be controlled thus.
20 EXPENSES (con’t) Fixed Expenses Also known as operating expenses You must pay them every month (or regularly) regardless of sales levelsSome “controllable” fixed expenses are: advertising, payroll and taxes
21 A Few More Terms It is from Gross Profit that fixed expenses are paid. GROSS INCOME = the amount of income a business earns before expenses are considered.GROSS PROFIT = Gross Income - Cost of Goods SoldIt is from Gross Profit that fixed expenses are paid.PRE TAX PROFIT = Gross Profit - Fixed Expenses
22 The Break Even Analysis The Formula for Break Even is:Gross Income – Cost of Goods Sold =Gross ProfitFixed Expenses ÷ Gross Profit = BreakEvenRemind them that this formula provides a product/service number related to the fixed expenses projection. To make it more relevant, they’ll want to break it down to the appropriate daily/weekly figure. Refer to the Sarah Sue’s example in their packet and point out the formulas.
23 CASH FLOWPositive Cash Flow is achieved when money comes into your business faster then it goes out.Positive Cash Flow is a matter of timing.Managing your cash flow is a matter of planning.
24 Having cash is NOT the same thing as being profitable. REMEMBER:Having cash is NOT the same thing as being profitable.(and vice versa)E.G. You could start your business with $10,000 in cash but incur losses of $1,000 each month. You’d have cash flow, but how long would you be in business?
25 Projecting Cash Flow Don’t Let Your Business Manage YOU. Cash Flow Projections can help youanticipate how much money you willneed to cover “short” months.See Cathy’s Cleaning Service ExampleWhat are some of the strengths of Cathy’s business?- She is holding down expenses by doing cleaning herself.- She keeps her employees happy by reimbursing them for mileage.- Generally assume that when a close relative (her mother) works for you, they are more understanding during “tough” times.- She has a friend who is willing to lend her money.What are some of the weaknesses?- She may not have enough “Day One” cash- She has no plan and becomes overwhelmed with expenses.- It may be a problem to rely on friends for loans.Point out the need to make good estimates when developing projections.Point out the impact of providing terms to customers.Point out some cash management strategies (esp. accounts receivable and accountas payable management, lines of credit, etc.)
26 BALANCE SHEET The Balance Sheet is a financial “snapshot” of your business at a given point in time.It tells you, as of a specific date:What your business ownsThe Debt for which your business isliableThe Net Worth of your business
27 Balance Sheet (cont.) The information is categorized as follows: Assets (What you own)Liabilities (What you owe)Equity (Your Net Worth)Note: Assets – Liabilities = Equity
28 Income Statement Income (Revenue generated) The Income Statement is a financial “movie” that covers a specific period of time. It tells you if your business operated at a profit or a loss during a specific period of time.Income (Revenue generated)Expenses (Cost of Operations)Profit or Loss (Difference betweenincome and expenses)
29 Mary’s Financial Picture Mary’s take-home pay is $4,000/mo.Her living expenses total $3,600/mo.The difference between her income and expenses is $400.Mary puts her monthly “profit” into a savings account.She just bought a used car for $6,000.Use Flip Chart to record answers from the class.Identify each item as an asset, liability, equity, income or expense.And, indicate whether the item will be reflected on Mary’s balance sheet or income statement.
30 Mary (cont.) She has an auto loan with a balance of $5,000. 6. She put $1,000 down to buy the car.She has an auto loan with a balance of $5,000.Mary is buying a house. The purchase price is $300,000.She put $30,000 down on the house.She has a mortgage balance of $270,000.Answers:Income Income StatementExpense Income StatementProfit (loss) Income StatementAsset Balance SheetEquity Balance SheetLiability Balance Sheet
31 Mary’s Balance Sheet ASSETS Bank Balance $ 400 Car 6,000 House 300,000 TOTAL Assets$ 306,400LIABILITIESMortgage loan $ 270,000Car Loan ,000Liabilities ,000EQUITY (net worth)Home Equity $ 30,000Car Equity ,000ProfitEQUITY $ 31,400Total Liabilities & Equity$ 306,400
32 Mary’s Income Statement Salary $4,000EXPENSESMortgage Payment $2,000FoodUtilitiesInsuranceAuto PaymentMiscellaneousTOTAL EXPENSES $3,600Profit (Loss) $ 400Refer class to more complicated case study in their folder, including impact of cash vs. accrual based accounting methods.
33 In Conclusion . . .Predicting the future is never easy. But by following these dos and don’ts for financial projections, you can avoid some common mistakes.
34 Dos and Don’tsDon’t provide only an income statement, include a balance sheet and cash flow statement too;Do provide monthly data for the upcoming year and annual data for succeeding year;Don’t provide more than three years worth of projections unless your lender or investor has asked for them;
35 Dos and Don’ts (Cont.)Don’t provide more than two scenarios in your projections;Do ensure that the numbers reconcile;Don’t be too optimistic about sales growth or gross and operating profit margins;Do account for reasonable interest expense on your income statement if you have debt on your balance sheet;
36 Dos and Don’ts (Cont.)Don’t include every individual line item for each expense, asset and liability figure;And finally, be as prepared and honest as you can be ~ you may be meeting a long-time advisor and friend. Commercial lending is a relationship business!
37 Thank you for your attention! Questions?SEED Corporation80 Dean StreetTaunton, MA 02780(508)(508) (fax)