Analyzing Cash Flow and Other Financial Information Chapter Six Analyzing Cash Flow and Other Financial Information

6-2 Learning Outcomes 6.1 Recognize the fundamental importance of Cash Flow Analysis 6.2 Prepare a Cash Flow Statement and a Budget 6.3 Identify other financial tools Refer to text page 104

6-3 Cash Flow The author defines Cash Flow as “actual cash that flows into the firm, minus the cash that goes out of the firm.” Refer to text page 106 Cash flow in a business is not the same as profit. A firm obtains profits when its sales revenue is higher than its expenses, including depreciation of assets. However, generating profits does not put cash in the bank for a business. Cash flow is one of the most critical areas in the survival of a new business. In its simplest form a Cash Flow Statement is a comparison of cash inflows to cash outflows

Understanding Cash Flow 6-4 Understanding Cash Flow The role of the Cash Flow Statement developed in the due diligence stage of a fledgling venture is substantially different from the financial analysis developed for an ongoing firm. The viability of a new business will be determined by Cash Flow. See Learning Outcome 6.1: Recognize the fundamental importance of cash flow analysis Refer to text page 107-109 The key to success of a new venture is its ability to bring in more cash each month than it spends and to bring that cash in on a cycle that is faster than the payout cycle. Equity-Investment into the small business by the owners of the firm Float-the difference between when the money goes out and when the money comes in.

Cash Flow Versus Budgets 6-5 Cash Flow Versus Budgets Budget example: See Learning Outcome 6.1: Recognize the fundamental importance of cash flow analysis Refer to text page 109-110 Budget-Statement that projects all the costs that will be incurred by the organization over a period of time and allocates those expenses evenly over the relevant time period. A budget projects all the costs that will be incurred by the organization over some period of time and allocates those expenses evenly over the relevant time period. A Cash Flow Statement does the exact opposite of a Budget.

Cash Flow Versus Budgets 6-6 Cash Flow Versus Budgets Cash Flow example: See Learning Outcome 6.1: Recognize the fundamental importance of cash flow analysis Refer to text page 111-112 The company which started with $10,000 from the founders was completely out of cash by March and had a negative cash position of almost $2000 in April. The firm was able to cover this shortfall with credit card cash advances and was able to survive. As a rule of thumb, calculate the entire cash flow projection without adding in any equity investment, and look for the point where the ending balance is at its lowest. Take that number and multiply it by 150 percent, because it always takes more cash than one expects.

Finalized Example Cash Flow Statement 6-7 Finalized Example Cash Flow Statement See Learning Outcome 6.1: Recognize the fundamental importance of cash flow analysis Refer to text page 112 Notice that the April low point for the ending balance is ($12,473) (see table 6.2). Multiplying that number by 150% yields a recommended initial investment of roughly $19,000 (see table 6.3). With that number inserted as the initial equity investment, the cash balance remains well above zero.

6-8 Deviation Analysis Deviation Analysis- analysis of the differences between the predicted and the actual performance. See Learning Outcome 6.1: Recognize the fundamental importance of cash flow analysis Refer to text page 113-114 Once the business venture actually begins operations, actual cash flow should be compared monthly to the projected cash flow statement in order to produce a deviation analysis.

Developing Cash Flow Statements: Expenses 6-9 Developing Cash Flow Statements: Expenses Salaries Basic Benefits Taxes/Fees Cost of Goods Sold Utilities Security System Tools/Machinery Office Supplies Travel Expenses Insurance Advertising Furniture and Computers Telephones Maintenance Cleaning Rent/Mortgage See Learning Outcome 6.2: Prepare a Cash Flow Statement and a Budget Refer to text page 115-116 Generating the cash flow statement should actually begin with the expenses of the organization because they are easier to forecast than revenues. Revenues should be separated into as many categories as possible to provide maximum insight to the owner. Separating out revenue lines aids both in predicting where the firm’s revenues will come from and in analyzing the actual revenue sources for the new firm.

Developing Cash Flow Statements: Revenues 6-10 Developing Cash Flow Statements: Revenues See Learning Outcome 6.2: Prepare a Cash Flow Statement and a Budget Refer to text page 116-117 Revenues should be separated into as many categories as possible to provide maximum insight to the owner. Separating out revenue lines aids both in predicting where the firm’s revenues will come from and in analyzing the actual revenue sources for the new firm. Sensitivity Analysis-an analysis by the small business person of the best- and worst-case scenarios, and a judgment of how sensitive the firm would be to such swings (see page 118 for an example).

6-11 Other Financial Tools Balance Sheet-a summary of the assets and liabilities of the business Income Statement-projects the future income of the organization Break–Even Analysis-a tool for estimating when a business’s income exceeds is expenses Pro Forma-a term describing estimates of what the balance sheets and income statement will look like See Learning Outcome 6.3: Identify other financial tools Refer to text page 119-123 Balance Sheet (see table 6.7) Current Assets-Assets such or those assets that can be easily converted to cash Fixed Assets-Assets that have a physical presence, including land, buildings, office equipment, machinery, and vehicles Current Liabilities-Liabilities or debts that the small business has to pay within one year Long-term Liabilities-Liabilities that are owed by the business and are ultimately due more than a year from the current date. Income Statement-revenue of the firm minus the expenses (see table 6.8)

Break-Even Analysis Classic Break-Even Diagram 6-12 See Learning Outcome 6.3: Identify other financial tools Refer to text page 123 Fixed Costs-costs that must be paid no matter how many goods are sold, such as rent. Variable Costs-costs that vary according to how many goods are produced The traditional Fortune 500 approach to break-even analysis would suggest that once revenues exceed the total of the fixed costs plus the variable costs, then the firm has reached break-even.

Break-Even Analysis Entrepreneurial Break-Even Diagram 6-13 See Learning Outcome 6.3: Identify other financial tools Refer to text page 124 Entrepreneurial ventures need to operate in a fundamentally different manner. The breakeven is calculated using the cash flow rather than profit. Time value of money-the value of money over time at a given rate of inflation or other type of return. Calculated as the value of your investment in time and money if you did not do the proposed venture.

Summary Cash Flow Statements-including inputs and outputs 6-14 Summary Cash Flow Statements-including inputs and outputs We examined a Balance Sheet and an Income Statement Brief examination of Entrepreneurial Break-Even Analysis. Refer to text page 124