The Power of Numbers 10-1Copyright © 2011 Nelson Education Ltd. Explore Your Financial Vision chapter 1010 Prepared by Ron Knowles Algonquin College & Jennifer Rouse Barbeau Canadore College

Chapter Overview Chapter 10 will:   Describe financial statements and ratios important to the financial health of a start- up business.   Define cash flow as a key financial statement.   Build a financial plan.   Help you stay in control. 10-2Copyright © 2011 Nelson Education Ltd. chapter 1010

Learning Opportunities  Formulate a personal financial vision.  Test your financial fitness.  Assemble a team of financial advisers.  Estimate your start-up costs.  Create your own balance sheet.  Project monthly sales and propose a sales forecast. 10-3Copyright © 2011 Nelson Education Ltd. chapter 1010

Learning Opportunities  Understand that cash is the lifeblood of your business.  Understand that bills are paid with cash, not profit.  Create a cash flow projection and a pro forma income statement.  Use ratios to measure the financial health of your business. 10-4Copyright © 2011 Nelson Education Ltd. chapter 1010

Begin Your Financial Journey 10-5 Check out your personal financial fitness (Box 10.1)  Formulate a personal financial vision  Examples are:  To be financially independent.  To be able to afford to travel to other countries.  To be able to afford a new home and the furniture to fill it.  To have the financial ability to retire and smell the roses before turning 50.  Put your financial vision in writing  Complete Action Step 45. Copyright © 2011 Nelson Education Ltd.

Get Advice   If finance is not your strength, you do not have to do it yourself.   Network to find people who can provide financial help.   Make a list of possible financial advisors (Table 10.1)  a mentor  a business guru—how about a banker, real estate broker or a retired business person  a financial advisor or business broker  personal financial coach   Assemble a financial team (Action Step 46). 10-6Copyright © 2011 Nelson Education Ltd.

5 Financial Tables Application of Funds (start-up funding) 2.Opening Balance Sheet 3.Projected Cash Flow 4.Projected or Pro Forma Income Statement 5.End of Period or Year-End Balance Sheet 1.Application of Funds (start-up funding) 2.Opening Balance Sheet 3.Projected Cash Flow 4.Projected or Pro Forma Income Statement 5.End of Period or Year-End Balance Sheet Copyright © 2011 Nelson Education Ltd.

Application of Funds 10-8 How much start-up money do you need?  Complete an application of funds table (See Table 10.3). Start-up expenses or application of funds can be divided into 4 categories: 1. General Start-up Costs 2. Leasehold Improvements 3. Equipment Costs 4. Cash Reserve Funds Copyright © 2011 Nelson Education Ltd.

Start-Up Expenses General Start-up Costs Organizational costs Prepaid Expenses Opening Inventory/Office Supplies 2. Leasehold Improvements Carpeting, mirrors, light fixtures, etc. 3. Equipment Costs Tables, chairs, desk, filing cabinet, etc. 4.Cash Reserve Fund Total cash on hand immediately before the business opens (Table 10.2). Copyright © 2011 Nelson Education Ltd.

Opening Balance Sheet   An opening balance sheet is a snapshot of the financial position of your business in the period immediately before you open your doors   See Table Copyright © 2011 Nelson Education Ltd.

Opening Balance Sheet A balance sheet is normally divided into 3 major components: 1. Assets are usually divided in 3 major categories:  current assets  fixed assets  other assets 2. Liabilities are normally divided into 2 major categories:  current liabilities  long-term liabilities 3. 3.Equity  The basic balance sheet equation: Assets = Liabilities + Equity 10-11Copyright © 2011 Nelson Education Ltd.

Liquidity Balance Sheet Ratios: Liquidity  Liquidity ratios measure the number of dollars of liquid assets available to cover each dollar of current debt. current ratio quick ratio.  Two basic liquidity indicators are the current ratio and the quick ratio. Current ratio = Current liabilities Most liquid assets Current assets Quick ratio = Current liabilities Copyright © 2011 Nelson Education Ltd.

10-13 Total Assets Total Liabilities (debt) Owner’s Investment 1. Proprietorship ratio = 2. Debt-to-equity ratio = Owner’s Equity Copyright © 2011 Nelson Education Ltd. Solvency ratios measure the ability of a company to meet its long term obligations. solvency ratios  The two standard solvency ratios are: Solvency Balance Sheet Ratios: Solvency

Projected Cash Flow pro forma cash flow A projected or pro forma cash flow is:  A financial statement which helps you control the money that comes into your business and the money that is spent. Why is a cash flow so important?  Shows you can pay for day-to-day operations.  Shows the lender you have the cash to make loan payments.  Provides a format for planning the most effective use of cash.  Provides a schedule of receipts and payments of accounts.  Helps plan for of unexpected changes in circumstances Copyright © 2011 Nelson Education Ltd.

Creating a Cash Flow Five steps to creating a cash flow: 1.Calculate your opening balance sheet 2.Calculate projected sales for each month 3.Forecast receipts 4.Forecast disbursements 5.Summary of cash flow 10-15Copyright © 2011 Nelson Education Ltd.

Income Statement pro forma income statement A projected or pro forma income statement is:  An itemized statement of sales (or revenues) and corresponding expenses over a period of time.  Normally for a 1 year period (sometimes on a quarterly basis) Major elements of an income statement include: - sales- cost of goods sold - gross profit- operating expenses - other expenses- net profit Remember: Profit is not cash. Action Step 49 will help you project your own income statement Copyright © 2011 Nelson Education Ltd.

Key Income Statement Ratios Income statement ratios Income statement ratios help to:   determine how healthy your business is and   how it compares to other businesses in your selected industry Copyright © 2011 Nelson Education Ltd.

4 key income statement ratios: 1.Gross profit margin = Gross Profit / Total Sales 2.Profit margin = Net Profit / Total Sales 3.Inventory turnover = Cost of Goods Sold / Average Inventory 4.Gross margin return on inventory investment (GMROI) = Gross Profit Margin (%) x Sales to Stock Ratio 10-18Copyright © 2011 Nelson Education Ltd. Key Income Statement Ratios

Ending Balance Sheet & Key Ratios   The closing balance sheet provides a final indicator of the financial health of your business.   A closing balance is shown in Table   Two key ratios based on the ending balance sheet and income statement are: 1.Return on Investment (ROI) = net profit / total assets 2.Return on owner investment = net profit / owners’ equity 10-19Copyright © 2011 Nelson Education Ltd.

What is a Break-Even Analysis break-even level of sales A break-even level of sales occurs when the sales (revenues) equals total expenses or costs (fixed and variable).   To calculate break-even you will have to know the value of your fixed and variable costs and your output capacity Copyright © 2011 Nelson Education Ltd.

Break-Even Analysis   Two ways to calculate break-even are:  unit method.  revenue method.   For many businesses the projected break-even is the first step in establishing its viability Copyright © 2011 Nelson Education Ltd.

Chapter 10 helps you prepare Parts H, I & J of your business plan:  Financial Section  Financial statements  Financial ratios  Cash Flow 10-22Copyright © 2011 Nelson Education Ltd. Business Plan Business Plan Building Block

  Do you have a financial vision?   What are your estimated start-up costs?   Validate your sales forecast.   Identify all your cost and pricing assumptions.   Prepare an opening balance sheet.   Prepare a monthly cash flow Copyright © 2011 Nelson Education Ltd. Your Business Plan Checklist for Your Business Plan

  What is your fallback position if your sales forecast and cash flow do not reach expectations?   Prepare a projected income statement and closing balance sheet.   What concerns might a banker have? What would be your response?   Is your break-even within range of your minimum sales forecast?   How do your financial ratios compare to industry averages? 10-24Copyright © 2011 Nelson Education Ltd. Your Business Plan Checklist for Your Business Plan

Financing A Business Case Study 1: Your Business If you are ready with the financial information for your business, prepare:  An opening balance sheet.  A projected monthly cash flow for the first year of operation.  A projected income statement for the first year.  An ending balance sheet after the first year of operation Copyright © 2011 Nelson Education Ltd. Case Study

Case Study 2: DISCovery Books and Magazines Inc. If you’re not ready to do a financial plan:   complete the financial statements for DISCovery Books and Magazines Inc Copyright © 2011 Nelson Education Ltd. Financing A Business Case Study