1. Copyright 2013 Jack M. Kaplan & Anthony C. Warren Managing The Resources Money and People Patterns of Entrepreneurship Management 4 th Edition, Chapter 11 Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building and Exiting Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

2. Copyright 2013 Jack M. Kaplan & Anthony C. Warren Presentation Outline Understanding Financial Statements –The Value of the Balance Sheet –The Value of the Income Statement –The Value of the Statement of cash flows Preparing financial projections Preparing Budget projections Prepare a Forecast of cash Flow Building a Culture for Innovation Human Resources Management –Hiring, Interviewing, Firing and Resignations –Conflict of Interest Resolution Important Legal Documents Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

3. Copyright 2013 Jack M. Kaplan & Anthony C. Warren The Three Basic Financial Documents 1.The balance sheet (also called the statement of financial position) 2.An income statement or profit-and-loss (P&L) statement. 3.The statement of cash flows (also called source and use of funds). Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

4. Copyright 2013 Jack M. Kaplan & Anthony C. Warren  Balance sheet = Liabilities + Shareholders equity  Book Value = total of the tangible assets less subtracting all the liabilities  Book value does not include intangible assets like Intellectual Property and goodwill  Goodwill includes factors like brand, market share, and human capital Value of the Balance Sheet Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

5. Copyright 2013 Jack M. Kaplan & Anthony C. Warren How to use Ratios for Financial Analysis - 1  Current Ratio  total current assets divided by the current liabilities  Quick Ratio  Only liquid current assets such as cash and account receivables divided by current liabiliti Financial Ratios are used by managers to monitor the health of the company and its operations. They are often used by bankers when lending to the company. These Two Ratios are used as a guide to the health of the company’s balance sheet: Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

6. Copyright 2013 Jack M. Kaplan & Anthony C. Warren  Current Liabilities to Net Worth  Total Liabilities to Net Worth  Fixed Assets to Net Worth How to use Ratios for Financial Analysis - 2 Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters These Three Solvency Ratios are used to gauge the sustainability and financial health of the company:

7. Copyright 2013 Jack M. Kaplan & Anthony C. Warren  Return on Investment (ROI) ratio compares the net profit of the business to the investment (net worth) of the business. It is calculated as net income after taxes (from the income statement) divided by total owner’s equity (from the balance sheet)  ROI = Net Income Shareholders’ equity Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters How to use Ratios for Financial Analysis - 3

8. Copyright 2013 Jack M. Kaplan & Anthony C. Warren EBITDA is the earnings before interest expense, interest income, income taxes, depreciation and amortization. It measures the profitability of a company’s operations without the impact of its debt, investments and long-term assets. It is the basic measurement of the day-to-day health of the company’s operations. Financial Definitions - 1 Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

9. Copyright 2013 Jack M. Kaplan & Anthony C. Warren A Break-even analysis is the point at which a given output results in neither profit or loss. It is a decision-making tool that helps the entrepreneur determine whether a certain volume of output will result in a profit or loss, or the minimum volume necessary to be just profitable. Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters Financial Definitions - 2

10. Copyright 2013 Jack M. Kaplan & Anthony C. Warren The formula: the price per unit (P) multiplied by the number of units sold (X) is equal to the fixed costs (F) plus the variable costs (V) multiplied by the number of units produced expressed as the following formula: P(X) = F + V(X) The Break-even Formula Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

11. Copyright 2013 Jack M. Kaplan & Anthony C. Warren As an example, if fixed costs (F) are $40,000, the variable costs per unit (V) are $15 and the price per unit (P) is $20, the break-even point (X) can be calculated by plugging these values into the equation:  20(X) = 40,000 + 15(X)  20X – 15X = 40,000  5X = 40,000  X = 8,000 units Example of Break Even Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

12. Copyright 2013 Jack M. Kaplan & Anthony C. Warren Young companies are usually short of cash and therefore it is important to forecast cash needs long before starting to raise capital as equity or debt. A Forecast of Cash Flow is a month to month projection of receipts and disbursements activity including: Receipts from Sales. The detail from sales, the payment terms the company extends its customers, and the company’s collection history Other Receipts. Other receipts include bank loans, equity investments, tax refunds or any other inflows of cash Disbursements from Expenses. The detail from expenses and the payment terms Other Disbursements. This includes capital equipment acquisitions and payment of debt. Forecast of Cash Flow Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

13. Copyright 2013 Jack M. Kaplan & Anthony C. Warren The annual budget presents a month-by-month projection of revenues. It is used for planning and control. Each month compare actual with budget and make adjustments as necessary. The budget is the foundation for projecting the other financial statements. An entrepreneur must always be aware of how long the current cash reserves will last…..the cash “runway”. It always takes much longer to raise funds than planned. Annual Budget Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

14. Copyright 2013 Jack M. Kaplan & Anthony C. Warren Developing a Culture for Innovation The ability to lead an organization on a mission where everyone is involved everyday in moving forward toward clearly defined goals makes the difference between success and failure. There are 10 leadership attributes that, above all others, should be practiced within companies to insure successful innovation. Building a culture Is a top-down, everyday leadership responsibility. EVERY action must reflect the culture that you are building and there should be NO inconsistences in behaviors. Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

15. Copyright 2013 Jack M. Kaplan & Anthony C. Warren 10 Attributes of a Successful Innovative Company AttributeDefinitionExample Honesty Degree to which employee has confidence in integrity, ability, and character of others within the organization “I trust people I work with and find it easy to be open and honest with people from all over the company” Alignment Degree to which the interests and actions of each employee support the clearly stated and communicated key goals of the organization “We have clear aims and objectives which everyone understands; we build consensus around key objectives; we recognize and reward loyalty” Risk Degree to which organization and individuals take risks “I am encouraged to experiment; we take calculated risks; we encourage and reward error” Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

16. Copyright 2013 Jack M. Kaplan & Anthony C. Warren 10 Attributes of a Successful Innovative Company AttributeDefinitionExample Teams The degree to which team performance is emphasized over individual performance “We promote teamwork, it’s the center of everything we do” Empowerment The degree to which each employee feels empowered by managers and the org. “As a manager I’m expected to delegate; we have a no-blame culture; we allow our staff to make decisions Freedom The degree to which self- initiated and unofficial activities are tolerated and approved throughout the organization “I’m allowed to do my own thing; we encourage people to take initiative; we recognize the individual” Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

17. Copyright 2013 Jack M. Kaplan & Anthony C. Warren 10 Attributes of a Successful Innovative Company AttributeDefinitionExample Support The degree to which new ideas are welcomed from all sources and responded to promptly and appropriately “We encourage fresh ideas; we reward innovative individuals and teams” Engagement The degree to which all levels of the organization are engaged with the customer and the operations of the organization “Management understands the operations of the company; I can share my problems with my managers; I know my job is important” Stimuli The degree to which it’s understood that unrelated knowledge can impact product, service, and operations improvements “I am encouraged to search externally for information and obtain data from many sources; we listen to suppliers’ suggestions” Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

18. Copyright 2013 Jack M. Kaplan & Anthony C. Warren 10 Attributes of a Successful Innovative Company AttributeDefinitionExample Communication The degree to which there is both planned and random interaction between functions and divisions at all levels of the organization “I am kept in the picture on how we’re performing; we have excellent formal channels of communication; we use best practice knowledge transfer between our departments; we actively manage our intellectual assets Does your leadership style exhibit these attributes? Work on demonstration each of these EVERY day A vibrant culture results from top-down leadership Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

19. Copyright 2013 Jack M. Kaplan & Anthony C. Warren Hiring Your company is only as good as the people that you hire Use networks to access potential hires Beware hiring friends and family members Hire to match your culture Values are inherent, skills can be learned If in doubt, don’t hire for expediency Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

20. Copyright 2013 Jack M. Kaplan & Anthony C. Warren Interviewing Be prepared and punctual Relax the candidate by telling YOUR story Clearly establish the cultural values of the company Invite them to tell their story Explore values, creativity and ambitions Use open-ended questions, challenge, change topics Invite their questions before summarizing Record impressions immediately Act promptly whether no or yes Check references if a hire is contemplated Seek second opinion if possible Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

21. Copyright 2013 Jack M. Kaplan & Anthony C. Warren 5 Reasons to Fire an Employee The company is short of funds The company is changing direction and no longer needs their specific skills Repeated poor performance Disruptive behavior For actual cause Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

22. Copyright 2013 Jack M. Kaplan & Anthony C. Warren Firing Procedures Try to avoid surprises. Have a warning system. It is better to help someone perform better than to fire them When there is no alternative, act promptly Remind them of their contractual obligations If you have to fire someone, keep the discussions unemotional, and try to retain trust If possible, allow them to preserve their self-esteem Offer to help if appropriate Ask them to leave the premises immediately “The day you enjoy firing someone, its time to leave yourself” Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

23. Copyright 2013 Jack M. Kaplan & Anthony C. Warren Dealing with a Key Person Resignation Agree the procedures for hand-over Avoid taking it personally Keep the door open, you may want to re-hire them later Celebrate and let everyone know that you regret the decision but you wish them success Conduct an exit interview Remind them of their contractual obligations Analyze what went wrong – learn. Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

24. Copyright 2013 Jack M. Kaplan & Anthony C. Warren Conflicts of Interest Be continually aware that you may slip into a “conflict of interest” situation Carefully analyze any situation where a conflict may arise Even if there is no real conflict, others may not understand – make a point of explaining the issues and your position Take steps to resolve any perceived or actual conflict quickly Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

25. Copyright 2013 Jack M. Kaplan & Anthony C. Warren Three Steps to Resolve Ethical Dilemmas The “Gut-feel” test. If you have a feeling that there is a conflict or ethical issue, then there most likely is. Don’t try to hide it – deal with it. Stake-holder analysis. There are no GRAY or FUZZY LINES. Understand who is affected, how, and what obligations all parties have to each other. Full Disclosure. Expose and discuss the issues and concerns with ALL possible affected stakeholders. If in doubt, tell more parties than less, and provide more information, not less. Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

26. Copyright 2013 Jack M. Kaplan & Anthony C. Warren Key Legal Documents - Employment Agreement Every employee should execute this agreement which must contain at least these five obligations: - Confidentiality during and after employment -Return all company materials when they leave -Cannot work for another business -Cannot compete while employed or for an agreed period after leaving -All inventions must be assigned to the company Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

27. Copyright 2013 Jack M. Kaplan & Anthony C. Warren Key Legal Documents - Consulting Agreement Work-for-hire requirement All work output belongs to the company Confidentiality is required Project is clearly defined Consultant must keep records of time spent and out-of-pocket expenses Company is not responsible for insurances and taxes other than those required by the law Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

28. Copyright 2013 Jack M. Kaplan & Anthony C. Warren Key Legal Documents – Separation Agreement Used when an employee leaves voluntarily or is fired Re-define both parties obligations with regard to confidentiality Re-assert non-compete obligations with specific terms and conditions Agree and define any public statements that either may make General release from all other future legal obligations by both parties Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

29. Copyright 2013 Jack M. Kaplan & Anthony C. Warren Key Legal Documents – Sales and Marketing Agreement An agreement between two companies, one of which will market and sell the products or services of the other Important to clearly define the responsibilities of both parties Exclusive or not? Define products, pricing, payments, regions, commissions, publicity, quality, support etc. State term, renewable options, and terminatioin procedures Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

30. Copyright 2013 Jack M. Kaplan & Anthony C. Warren Key Legal Documents - Confidentiality Agreement Entered into between two or more parties to protect exchange of information needed to explore a possible business relationship May protect the information of one or more parties Defines the information to be disclosed and procedures for its treatment and return The term for confidentiality must be stated together with legal ramifications if the confidentiality is breached Also known as a “Non-Disclosure Agreement” Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

31. Key Legal Documents – Stock Option Agreement Used to incentivize key employees Component of compensation that can help preserve cash reserves Only available to employees of the company Two forms, ISO and NSO – differ in their tax implications Need to be approved by board and stock-holders Usual to set aside 10-15% of the outstanding shares of the company held in a pool for future key employees – this must be disclosed and approved by potential investors The tax implications can be complex and the entrepreneur should get professional advice when setting up the plan. Copyright 2013 Jack M. Kaplan & Anthony C. Warren Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters

32. Copyright 2013 Jack M. Kaplan & Anthony C. Warren Final Points A young company should try to minimize its legal costs as they can rapidly escalate But it is important that the legal affairs of the company are well managed Learn to use free legal documents whenever possible, but if in doubt, seek legal counsel Develop a relationship with a law firm that has experience with young companies – often they will reduce their fees in the hope that you will be a large client sometime in the future A good law firm can be invaluable in providing sound advice and access to their networks. Chapter 11 Financial Statements Financial Analysis Budget Projections Cash Flow Forecasts Building the Culture Hiring and Firing Conflicts of Interest and Ethics Legal Matters