1. BA 346 Working as an Entrepreneur Week 4-5

2. Accounting  “Language of Business”  Measurement What were our goals? How did we do?  Profit: The Bottom Line  The “Triple Bottom Line” Profit People Planet

3. Financial Statement Overview  What, Why, How for each  What Pro Forma means  Iterative development (AKA circular reasoning)  How good will your estimates be?  When will you update them?

4. Three Costs to Think About  Terminology: Price vs Cost vs Investment Fixed costs  The total stays “fixed” regardless of volume  e.g. Lease expense, salaries Variable costs  The total “varies” based on the volume  e.g. Raw Materials, wages Direct vs Indirect Costs  Direct costs are attributable to creating & selling the product  Some fixed costs are direct costs Investment in assets  What is needed to start & run the business  e.g. Equipment, working capital

5. Workshop Prep  What costs will your business have? Fixed CostsVariable Costs Indirect Costs Direct Costs Investment (assets needed)

6. The Break Even Point  What is the break even point?  When will you break even?  Why is it important?  What sales volume is needed to be profitable?  How much profit is desired?  What is the targeted sales volume?  Break even is calculated as (Fixed Costs) divided by (Selling Price per unit - Variable Cost per unit)

7. Workshop Prep Total Fixed Costs = _____________________ Variable Costs per unit = _____________________ Selling Price per Unit = _____________________ Contribution (Price – Variable) = _____________________ BREAKEVEN (Fixed) (Contribution) = __________ Units =

8. Revenue model  What product are you selling? Goods Services  What is the pricing of your product? Different tiers? Volume discount? Average price or segments?

9. Been to a video store lately?  The 80s video store  Video chains  Delivery  Streaming  Better streaming 1 Out Limited4.99$ 1 Out Unlimited8.99$ 2 Out Unlimited13.99$ 3 Out Unlimited16.99$ 4 Out Unlimited23.99$ etc. 1 Out Limited4.99$ 1 Out Unlimited9.99$ 2 Out Unlimited14.99$ 3 Out Unlimited19.99$ 4 Out Unlimited27.99$ etc.

10. Netflix  Sales Vol growth 51%, 18% 26%, 31% respectively  Sales Vol CAGR 31%

11. Netflix  Sales Price growth…  Sales Price CAGR…

12. Netflix  Sales $ growth 46%, 21%, 13%, 22% respectively  Sales $ CAGR 25%

13. Revenue Model, cont’d  How will customers pay? Immediate payment  Cash  Credit cards Invoicing  Accounts Receivable  Terms  Collections & aging

14. Building the Income Statement  Sometimes called the P&L (Profit & Loss) Statement Income – Expenses = Profit  Structure Income COGS (sometimes just Variable Costs ) Gross Profit Operating Expenses Operating Profit (sometimes EBIT) Other expenses, including Interest & Tax Net Income (Profit)  Usually easier to remember starting at the bottom…

15. Profit  Remember the break even point?  How much profit is required? Retained earnings for reinvestment, growth Dividends & other payouts to owners Net Income = Dividends + ΔRetained Earnings  Some industries have a Rule of Thumb for revenue, reinvestment & profit

16. Tax  Tax can be complicated You need a tax preparer or a CPA (or both) Depends on the structure of your business You need to strategize in advance with your tax experts – create value form tax planning  Tax rates Effective tax rate (average) Marginal tax rate (bracket)  Rule of thumb for estimating “Typical” Effective Rate for tax Tax Expense = Taxable Income x Effective Rate Net Income = Taxable Income – Tax Expense :. Net Income = Taxable Income x (1- Effective Rate) :. Taxable Income = Net Income ÷ (1- Effective Rate) Tax Expense = Taxable Income – Net Income

17. Interest  Interest is the cost of financing assets Creates a tax deduction Reduces profit  Placeholder for interest Fill this in once debt and terms are forecast

18. Depreciation  What is it? Creates a tax deduction from the investment in certain types of assets (e.g. Equipment) Non-cash Expense Has nothing to do with actual condition of equipment or possible resale value  Placeholder for depreciation Fill this in once the assets are forecast Straightline depreciation = (Purchase price – salvage value) ÷ Years allowed for that type of asset (check with your tax expert)

19. Operating expenses  Variable cost x volume Raw materials (direct) Worker wages (direct) Supplies (indirect)  Fixed costs Utilities (indirect?) Rent (indirect?) Supervisor salaries (indirect)

20. Revenue  Price x volume Sales target  Profit needed?  Net Income ÷ Contribution = Units Needed above Breakeven  Additional revenue Remember McKay envelope? Most businesses have other items to sell

21. Workshop Prep Profit Needed = $_____________ Contribution = $_____________ Profit ÷ Contribution = _________ units Plus Breakeven Units = _________ units Equals Sales Target _________ units

22. From Revenue to Assets  What assets will be required to sell this volume?  How much is the initial investment?

23. Building the Balance Sheet  Structure A = L + SE  Assets Current Non-current  Liabilities Current Non-current  Equity = Assets – Liabilities Invested Capital Retained Earnings

24. “Common Size” Financial Statements  Sometimes it is useful to look at financials as a % of a relevant total Expenses as a % of Sales Assets & Liabilities as a % of Total Assets  This is not always the best way to analyze financial structure, but it may give you a starting point

25. Current Assets

26. Accounts Receivable  What % of customers will you be invoicing?  How long will they take to pay?

27. Cash  How much will you need? Days sales in cash Need to cover expenses Need to not lose value

28. Inventory  How much will you need? Days sales in inventory Efficiency, cost, storage, issues

29. Fixed assets  PP&E

30. Other non-current assets  Depends on the business, most small businesses have none at startup Possibly patents or other intellectual property

31. Final thoughts on assets  Where are the assets going to come from?  Where will the cash for them come from?  Is debt good or bad?

32. Non-current liabilities

33. Accounts payable  Trade credit from suppliers  Other

34. Notes payable  Short Term Debt

35. Line of credit  Revolving Credit

36. Connecting the IS & BS: The Statement of Cash Flows  Structure Cash provided by Operations Cash provided by Investment Cash provided by Financing

37. Cash from operations  Start with Net Income, then add…  Depreciation for the year  Changes in Accounts Receivable  Changes in Liabilities  Changes in Inventory  Changes in Other Operating Activities  Cash provided (used) by Operations

38. Cash from (used by) investing  Negative numbers show investment  Capital Expenditures  Other Investments  Other Cash Flows from Investing Activities  Cash provided (used) by Investing Activities

39. Where will the cash come from?  At startup, all the investing comes from cash in the business Investment Loans

40. Financing CFs, cash from financing  Dividends  Sales (Repurchases) of Stock  Net New Debt  Other Cash Flows from Financing Activities  Cash provided (used) by Financing Activities

41. Change in Cash  Cash at Beginning of Year  + Change in Cash From Operations From (used by) Investing From (used by) Financing  = Cash at End of Year  Cash at EOY provides the figure on the balance sheet

42. Pro Forma Income Statement

43. Pro Forma Balance Sheet

44. Pro Forma Statement of Cash Flows

45. Reality check  Are the figures realistic?  How will you improve them?

46. Resources for real life  Bookkeepers  Quickbooks, et al  CPA  CFO

47. Workshop  Putting them in good form - template for workshop (printed & online)