Presentation on theme: "14 Financing Requirements, Pro Forma Financial Statements, and Sources of Financing PowerPoint Presentation by Ian Anderson, Algonquin College."— Presentation transcript:
1 14Financing Requirements, Pro Forma Financial Statements, and Sources of FinancingPowerPoint Presentation byIan 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 1Businesses NeedsBusinesses need cash for three core reasons:1. To purchase assets such as equipment and inventory2. 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 1Types of AssetsCurrent assets (working capital)Assets that can be converted to cash within the firm’s operating cycle—cash, accounts receivable, and inventories.Fixed AssetsRelatively permanent resources intended for the use of the firm.Net fixed assets = gross fixed assets – accumulated depreciationOther AssetsIntangible assets (patents, copyrights, goodwill)
5 LO 1Business DecisionsThe business owner must make two additional decisions which are:Buy or lease the equipment?Acquire new or used equipment?BootstrappingSee In The Trenches, p. 419
6 Advantages and Disadvantages of Leasing LO 1Advantages and Disadvantages of LeasingAdvantages: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 1Working-Capital and Cash BudgetsWorking Capital ManagementThe management of current assets and current liabilitiesCash budget or cash flow forecastA planning document strictly concerned with the receipt and payment of dollarsInflow and outflow of cash
8 Accounts Receivable Accounts Payable LO 1Accounts Receivable Accounts PayableAccounts Receivable is the amount of credit extended to customers that is currently outstandingAccounts Payable (trade credit) is outstanding credit payable to suppliers.
9 Flow of Cash Through A Business BorrowedFundsCollection ofAccountsReceivableOwner'sInvestmentSale ofFixed AssetsPayment ofExpensesPayment forInventoryDividendsCashSalesPurchase of14-9
10 LO 1Cash Flow ForecastThe 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 1Forecasting Assets and Financing RequirementsEstimating Asset RequirementsUse industry ratios for assets-to-salesUse breakeven analysis and empirical dataPercentage-of-Sales TechniqueForecasting 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 1Types of FinancingDebt CapitalFinancing provided by a creditorCurrent (short-term) DebtAccounts payableAccrued expensesShort-term notesLong-Term DebtLoans and mortgages from banks and other lenders with maturities greater than one year…continued
13 Types of Financing Spontaneous financing External equity LO 1Types of FinancingSpontaneous financingShort term debtExternal equityFunds that derive initially from the owner’s investment in a firmProfit retentionThe re-investment of profit in a firmInternal equityFunds that come from retaining profits within a firm.
14 LO 2Cash Flow ForecastMost critical financial projection for new or growing businessWithout cash the business diesBrings together elements of Balance sheet and Income statementConcerned with the timing of inflows and outflows of cash
15 Pro Forma Income Statements & Balance Sheets LO 2Pro Forma Income Statements & Balance SheetsFirst – identify which items belong on the income statement and balance sheetBalance sheet items includeCash, accounts receivable, inventory, prepaid expenses, accounts payable, start-up capital, financing, and capital expendituresAll other items are income statement items
17 Other Forms of Capital Personal Savings Friends and Relatives LO 3Other Forms of CapitalPersonal SavingsFriends and RelativesInformal capitalFunds provided by wealthy private individuals to high risk ventures such as startupsBusiness angelsPrivate investor who finances new, risky, small ventures
19 Venture Capitalists (VCs) LO 3Venture Capitalists (VCs)VCs look for:People: strong management teamProducts: high value-added features and competitive advantageMarkets: large and growingMargins: gross margins of 40-50%Return: short ROI cycles
20 Business Suppliers and Asset-Based Lenders LO 3Business Suppliers and Asset-Based LendersTrade 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 3Business Suppliers and Asset-Based LendersAsset-based LoanA line of credit secured by working-capital assetsFactoringObtaining cash by selling accounts receivable to another firm.Accounts are sold to factor at a discount to invoice valueFactor can refuse questionable accountsFactor charges fees for servicing accounts and for amount advanced to firm prior to collection…continued
22 Business Suppliers and Asset-Based Lenders LO 3Business Suppliers and Asset-Based LendersChartered Banks and Credit UnionsPrimary 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 popularitywith SMEsLine of creditMaximum amount that lenderwill permit firm to borrow.…continued
23 Business Suppliers and Asset-Based Lenders LO 3Business Suppliers and Asset-Based LendersTerm loansLoans for 5 to 10 years to finance equipmentChattel mortgageLoan collateralized by inventory or moveable propertyReal estate mortgageLong-term loan with real property held as collateral
24 The Lender’s Perspective LO 3The Lender’s PerspectiveLenders’ ConcernsHow 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 CreditCharacter of the borrowerCapacity of the borrower to repay the loanCapital invested in the venture by the borrowerConditions of the industry and economyCollateral available to secure the loan
25 Questions Lenders Ask Lender’s Questions LO 3Questions Lenders AskLender’s QuestionsWhat 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 3Selecting a LenderMany reasons for selecting a lender existChequing account facilitiesFlexibility of loan arrangementsManagement adviceLocation
27 Financial Information Required for a Loan Three years of the firm’s historical statementsBalance sheets, income statements, and statements of cash flowThe firm’s pro forma financial statementsThe timing and amounts of the debt repayment included as part of the forecastsPersonal financial statementsThe 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 ratesLoan maturity dateRepayment scheduleEqual monthly or annual paymentsDecreasing monthly or annual paymentsLoan covenantsLender-imposed restrictions on a borrower that enhance the chances of timely repaymentFiling 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 principalDecreasing monthly or annual payments that cover equal payments on the principal and interest on the remaining balance.…continued
30 LO 3Repayment ScheduleAssume 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 3Government-Sponsored Programs and AgenciesCanada Small Business Financing Program (CSBFP)Federal program that provides financing to small businesses through private lendersFederal government guarantees repaymentBusiness Development Bank of Canada (BDC)Industrial Research Assistance Programme (IRAP)Program for Export Market Development (PEMD)
32 Other Sources of Financing LO 3Other Sources of FinancingLarge corporationsStock salesPrivate placementPublic saleInitial public offerings (IPO)
33 Finding Sources of Financing LO 4Finding Sources of FinancingThree basic types of financing:Spontaneous financingProfit retentionExternal financingComes from outside investorsFirst ask, “Should I use debt or equity financing?”
34 Debt or Equity Financing? LO 5Debt or Equity Financing?Potential ProfitabilityBorrowing increases potential for higher rates of return on owners’ equity; exposes firm to more financial risk.Financial RiskInvesting more owner equity limits potential return on equity; lowers financial risk for firm.Voting ControlIncreasing equity through borrowing requires owners to share control with external investors.
35 Using the Cost of Debt as an Investment Criterion LO 5Using the Cost of Debt as an Investment CriterionFavourable Financial LeverageA benefit gained by investing at a rate of return that is greater than the interest rate on a loan.Debt CapacityThe 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 5Tradeoffs Among Potential Profitability, Financial Risk, and VotingEquityfinancingDebtHIGHLOWFinancingPotentialProfitabilityFinancial Risk/Control14-36
37 Keeping the Right Perspective LO 6Keeping the Right PerspectiveAmar Bhide at Harvard University offers the following advice to aspiring entrepreneurs wanting to start their own businessesGet 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.