1. Dr. Alex White Ag & Applied Economics axwhite@vt.edu 540-231-3132 http://faculty.agecon.vt.edu/alexwhite/

2.  Why you need financial statements  What financial statements you need  Construction of statements ◦ Start-up capital exercise ◦ Labor cost exercise ◦ Balance sheet exercise  Breakeven analysis  Ratio Analysis

3.  Applying for loans ◦ Start-up loans, operating loans/lines, etc. ◦ Typical loan application (“loan app”)  2-3 years of balance sheets, income statements  Historical, projected ◦ Impress your lender with:  Cash flow statement and breakevens  Best/worst case scenarios

4.  Powerful management tools ◦ Compare the business to the industry averages ◦ Identify strengths/weaknesses of the business ◦ Identify trends within the business ◦ Identify strategies to improve ◦ Enterprise analysis!! (woo hoo!!)  Helps with tax preparation ◦ Improved recordkeeping

5.  Balance sheet ◦ Listing of what you own and how you paid for it  Assets = Liabilities + Net Worth  Value of Assets = Debt financing + “Owner financing” ◦ Tells lender  Liquidity and solvency position  Outstanding debts, creditors  Assets available for collateral ◦ Not a useful day-to-day tool for managers

6.  Income Statement ◦ Shows the economic profit for the period (year)  Revenues – COGS – Overhead = EBT ◦ Cash vs accrual accounting ◦ Lenders & managers use to assess:  Profitability, Repayment ability, and Financial efficiency  Breakevens, sensitivity analysis ◦ Retail operations usually do a weekly income statements

7.  Cash Flow Statement (Budget) ◦ Shows all cash coming in/going out and the timing ◦ Helps the lender and manager:  Estimate cash surplus/deficits for each period  Shift the timing of cash flows  Determine when to schedule loan payments  Determine operating loan needs and terms ◦ IMO – the most powerful statement for managers

8.  Calculate ratios and measures  Compare to benchmarks (RMA, S&P, etc.) ◦ Available at libraries  Usually at the reference desk  Robert Morris Associates – Annual Statement Studies  Look for trends over time ◦ Compare years side-by-side

9.  Alex’s preferred method 1.Start-up capital worksheet 2.Labor cost budgets 3.Balance sheet (Day 1, Year 1) 4.Projected cash flow statement 5.Projected income statement 6.Projected balance sheet (Day 1, Year 2) 7.Yadda yadda yadda

10.  Makes you think about all the assets you will need before opening the doors ◦ How you will pay for each item  Owner capital (cash or net worth)  Term loan  “Hard assets” - machinery, equipment, real estate, improvements  Operating loan/line  “Operating assets” – inventory, prepaids, etc.  Use a 10-25% fudge factor

11.  For each “type” of employee ◦ Manager, cashier, etc.  Estimates the payroll taxes ◦ FICA, FUTA, Medicare, worker’s comp.  Estimates cost of non-cash benefits ◦ Insurance, retirement, uniform, company car, etc.  Determines $cost/hour and $value/hour ◦ Useful in budgeting and negotiation!

12.  Assets = Value of things used in the business ◦ Only what you have that day!! ◦ Current Assets = life of about 1 year or less  Cash, savings, inventory, A/Rec., prepaids, supplies, etc. ◦ Non-current Assets = life greater than 1 year  Machinery, equipment, real estate, improvements ◦ List each at its purchase cost  Lenders want market value instead!

13.  Liabilities = what you owe as of that day ◦ Current Liabilities = owed within 1 year  Operating loan, A/Pay., principal due, accrued interest ◦ Non-current liabilities = owed AFTER 1 year  Remaining principal balances ◦ List the actual dollar amount owed as of that day  Net Worth = owner’s investment as of that day ◦ Original cash invested – withdrawals + additions ◦ Retained Earnings ~ net income from previous years

14.  Cash “Budget”  List cash inflows WHEN they occur  List cash outflows WHEN they occur  Bottom half deals with operating loan ◦ Thank goodness for computers!  Helps you do your projected balance sheet & income statement

15.  List of revenues and expenses  “Cheater’s” method = use total column of cash flow statement ◦ Except for principal payments, income taxes ◦ Add depreciation  For “accrual” statements ◦ Need to account for changes in inventories, payables, receivables, etc.

16.  From cash flow stmt ◦ Cash balance ◦ Operating loan balance & accrued interest  Adjust other asset values as needed ◦ Add another year of depreciation on hard assets  From income statement ◦ Net income helps determined retained earnings  4-step process for loans

17.  Measure of minimum performance needed  1,000s of ways to calculate BEs  Key equation ◦ (Price – COGS) x Qty sold – Overhead = $0  BE qty. = Overhead / (Price – COGS)  BE Price = Overhead / Qty Sold + COGS

18.  RMA Annual Statement Studies ◦ Indexed by NAICS codes  By Sales, by Assets, by Year ◦ Top, middle, bottom quartiles  Compare ratios to benchmarks  Look for trends over time ◦ That’s why lenders want 2-3 years of statements

19.  Identify strengths and weaknesses  Develop strategies to improve the financial condition ◦ Cost control ◦ Pricing ◦ Marketing ◦ Debt structure ◦ Labor efficiency, etc.

20.  Liquidity – ability to meet current obligations ◦ Current Ratio current assets/current liabilities ◦ Quick Ratio (current asset – inventory)/cur. liab.  Solvency – ability to meet all debts ◦ Debt/Asset total liabilities/total assets ◦ Debt/Worth total liabilities/net worth

21.  Repayment ability ◦ EBIT/Interest EBIT/Interest ◦ Debt Coverage Ratio (EBT + other income + Depreciation + Interest Expense – Taxes & Family Living) / Annual P&I payments  Profitability ◦ ROA EBT/Total Assets ◦ ROE EBT/Net Worth

22.  Financial Efficiency ◦ Sales/Total Assets ◦ COGS/Sales ◦ Operating Exp/Sales ◦ Operating Profit Margin EBT/Sales

23.  http://faculty.agecon.vt.edu/alexwhite/ http://faculty.agecon.vt.edu/alexwhite/ ◦ Go to the Small Business tab ◦ Built as a teaching tool for start-up businesses  Excel 2003 ◦ Can be used for existing businesses