Entrepreneurship 1: Lecture 8 Projecting your Financial Status for the first years Avimanyu (Avi) Datta, Ph.D.

Profit Planning: Conducting Cost- Volume Profit Analysis

Break even sales can be reflected in the following simplified table ItemsFiguresPercentage Sales$250,000100% Cost of Goods Sold-$125,00050% Gross Margin$125,00050% Profit or Loss Before Taxes-$125,00050% $00% Your Business will not be making profits unless you sales exceed $250,000

Profit Planning: Conducting Cost- Volume Profit Analysis

The above estimate can be reflected in the following income statement ItemsFiguresPercentage Sales$270,000100% Cost of Goods Sold-$135,00050% Gross Margin$135,00050% Profit or Loss Before Taxes-$125, % $10, %

Cash flow Projections As good as your assumptions of reality. Some of the assumptions are: (page 154) The projections in table 8-1a, 8-1b, 8-1c indicate a high rate of profit. The level of the profit will reduce substantially when: ◦ The business cannot generate estimated levels of sales. ◦ The gross margin is less than 50% of sales ◦ Operating expenses are underestimated ◦ Sales of the overall market did not grow as much as anticipated. ◦ The business did not get the anticipated market share.

Preparing your Pro forma financial statements A balance sheet is a financial statement that shows the worth, or value, of a business. A pro forma balance sheet projects the growth of a business in terms of how much capital value the business will have at a particular date in the future

Preparing your Pro forma financial statements Prior to the creation of the balance sheet you need ◦ Your First year sales ◦ Your Breakeven point ◦ Your initial capital requirement ◦ Whether you have enough money to start the business ◦ Your cash flow statements

Preparing your Pro forma financial statements You still need to prepare ◦ Your opening day balance sheet ◦ Your projected income statement for the first year ◦ The closing balance sheet for the first year ◦ The income statement for the second through fifth year

Preparing your Pro forma financial statements Every Dollar assets you have must be balanced by the dollar of liabilities of equity. ◦ Assets = liabilities + equity The assets side shows all property and capital to which the business claims ownership. The liabilities side shows all the debts of the business. The net worth of a business is determined by adding all the value of what is owned and subtracting from this the total debt of the business.

Preparing your Pro forma financial statements Assets ◦ Current assets include cash and assets that are easily converted into cash, such as inventory and accounts receivable. ◦ Fixed assets are those capital purchases that generally take a longer time to convert or liquidate into cash, such as property, equipment, and fixtures that require a special buyer.

Preparing your Pro forma financial statements Liabilities ◦ Current liabilities are debts that are to be paid within 12 months of the date of the balance sheet. ◦ Longterm liabilities are usually debts that come due more than 12 months after the date of the balance sheet.

Preparing your Pro forma financial statements Simplified Pro Forma Balance Sheet

Preparing your Pro forma financial statements Liquidity ◦ A balance sheet allows entrepreneurs, bankers, and investors to quickly determine the liquidity of a business operation. ◦ Liquidity is defined as a business’s ability to meet its debt obligations as they become due.

Preparing your Pro forma financial statements Determining a Business’s Liquidity Two common methods of determining a business’s liquidity are current ratio tests and acid-test ratios.

Preparing your Pro forma financial statements Current Ratio Test ◦ The current ratio test compares cash, as well as any assets that can be converted into cash within a year, with the debt (liabilities) that will become due and payable within the year. ◦ The ratio is expressed as: current ratio = current assets ÷ current liabilities ◦ A favorable current ratio would be 2:1. ◦ A minimum acceptable ratio would be 1:1.

Preparing your Pro forma financial statements Acid-Test Ratio ◦ The acid-test ratio is more restrictive as it eliminates inventory, the least liquid of current assets, from the numerator. ◦ The ratio is expressed as: acid-test ratio = (current assets – inventory) ÷ current liabilities

Preparing your Pro forma financial statements Cash Flow ◦ A cash flow statement is a month-by- month projection of financial activities. ◦ This analysis allows you to prepare for potential cash flow problems. ◦ A cash flow statement tells you what your business’s cash position really is ◦ A cash flow projection can be used to help determine the initial capital reserve for a start-up operation

Preparing your Pro forma financial statements Financial Records ◦ Entrepreneurs should maintain their own daily and monthly accounting records and use accountants for preparing tax returns and formal financial statements.

Preparing your Pro forma financial statements Small business owners should have access to Income and expense register Accounts payable ledger Accounts receivable ledger Furniture, fixture, and equipment ledger Notes payable ledger Payroll records