Tse financial planning_2014

Financial Planning

Financial modelling

A financial model or plan: • venture’s financial position and development over time

• based on a set of assumptions

• in a set of financial statements

Income & expenditureCash flowBalance sheet

• plus Sensitivity analyses to model changes in assumptions

Copyright of Bart Clarysse and Sabrina KieferThe Smart Entrepreneur

Why? Financial planning…

• estimates the value of a new venture/ project

• evaluates the cash need to get up and running the business

• compares alternatives for developing the business and selects the one with the best prospects

• benchmarking

• provides idea of financial returns when talking to investors


How to make a financial plan?

Before you start you need to have some idea of

• What your company will do

• When you expect to do x, y, and z

• How much the costs will be

• Where the money to start could come from

• How and when will the company will pay for itself and earn a return – either by profits or exit sale

See Roadmap exercise in the ToolboxCopyright of Bart Clarysse and Sabrina Kiefer

The Smart Entrepreneur

How to make a financial plan?

1. Incomings/Outgoings

2. Timing

3. Financing needs of the venture

4. Financial statements

5. Analyses


1. Incomings/Outgoings

a) Revenuesb) Costsc) Investments in assetsd) Income statement (P&L)


A. Revenues

• depend on your market estimates (see your entrepreneurial market research and market testing)

» market size» market development speed / growth» Pricing, sales forecasts


MARKET SIZE FOR PRODUCT/COMPANY

TOTAL MARKET

WITNESSES

Bottom Up – market research, concept and market testing

Top Down – desktop research

Quantitative Market size estimation


Forecast revenue: Sales Plan and targets

1 2 3 4 5 6 7Quarter Sales target contracts

(value per contract = 2000)

visits (2 per contract)

% failure (50%)

Total visits Vists/Quarter/sales person (6 per week)

Amount of sales people needed per Quarter (FTE)

Q1 Q2 10000.00 5.00 10.00 5.00 15.00 72.00 0.21Q3 20000.00 10.00 20.00 10.00 30.00 72.00 0.42Q4 40000.00 20.00 40.00 20.00 60.00 72.00 0.83Q5 80000.00 40.00 80.00 40.00 120.00 72.00 1.67Q6 95000.00 47.50 95.00 47.50 142.50 72.00 1.98Q7 118000.00 59.00 118.00 59.00 177.00 72.00 2.46Q8 141000.00 70.50 141.00 70.50 211.50 72.00 2.94Q9 164000.00 82.00 164.00 82.00 246.00 72.00 3.42Q10 187000.00 93.50 187.00 93.50 280.50 72.00 3.90Q11 210000.00 105.00 210.00 105.00 315.00 72.00 4.38Q12 233000.00 116.50 233.00 116.50 349.50 72.00 4.85Q13 256000.00 128.00 256.00 128.00 384.00 72.00 5.33Q14 279000.00 139.50 279.00 139.50 418.50 72.00 5.81Q15 302000.00 151.00 302.00 151.00 453.00 72.00 6.29Q16 325000.00 162.50 325.00 162.50 487.50 72.00 6.77


B. Costs – different types

• Direct: directly attributable to product sold/manufactured » e.g.: raw materials, production labour

• Indirect: related to overall operations, not a specific product » e.g. machinery, administrative staff, marketing, rent

• Variable: vary with the level of activity or number of products sold / manufactured.

» e.g.: raw materials used to make one unit of product, varying factory wages, sales commission

• Fixed – unchanging or flat rate, aka ‘overheads’, » e.g. rent of premises, fixed salaries, services

• Semi-variable: contain fixed and variable components» e.g. Utility bills – partly based on a fixed flat rate and partly

based on variable usage

B. Costs - Types of cost


Raw materials for a specific product

Rental of equipmentfor specific product line

Monthly salaries for admin staff

Direct Indirect

Variable

Fixed Hourly wages for production workers

Production tools

Rent of buildingFlat wage for production staff

Factory energy use

RoyaltiesCopyright of Bart Clarysse and Sabrina Kiefer


Valeryia Kazheunikava, 12/01/2014

de bedoeling om een oefening te maken?

C. Investments in Assets

Tangible property & equipment acquired to run the business (machinery, computers, land and buildings)

Intangible assets: costs incurred for product development can sometimes be booked as an investment

Intangibles acquired, such as patents bought from a third party (not licensed)

Goodwill (doesn’t usually apply to startups unless you buy another startup)

• You need to determine:

The amount they cost and the life expectancy of the assets acquired (Depreciation)

the timing of these investments (Cash flow) Copyright of Bart Clarysse and Sabrina KieferThe Smart Entrepreneur

Investment and depreciation

P&L Matching principle: match costs and revenues over time periods

• A £100,000 Machine will be used to generate revenue over 5 years

• For profit analysis, spread the machine cost over 5 years, aka ‘depreciation’, and deduct £20,000 each year from the Revenue in your Profit/Loss (P&L), aka Income Statement

2004 2005 2006 2007 2008

-£20,000 → P&L

-£20,000 → P&L

-£20,000 →P&L

-£20,000 →P&L

-£20,000 →P&L


Investment Timing and Cash Flow

Example: In 2004, purchase of machine for assembling furniture

• The machine has a useful life of 5 years • purchase price: £100,000

Cash Flow event: one purchase date, one cash outflow

2004 2005 2006 2007 2008

- £100,000 → cash flow statement


D. Income Statement (aka Profit & Loss or ‘P&L’)

Income statement

Revenues

– Direct , variable costs

= Gross profit

– Admin, services and other goods

– Salaries & other social costs

– Depreciation of property/plant

– Provisions for future losses

– Other expenses

= Operating Profit (=EBIT)

- Interest expenses

+/- Exceptional income/expenditure

= Profit before tax

- Tax charged on profit

= Profit after taxCopyright of Bart Clarysse and Sabrina Kiefer


How to make a financial plan

1. Incomings/Outgoings2. Timing3. Financing the venture4. Financial statements5. Analyses


2. Timing

a) Cash flow vs. Cost/Revenueb) Net Working Capital needsc) Cash flow projection


A. Timing differences – Sales/profit vs. Cash flow

• Suppose you pay your suppliers 30 days after invoice• And your customers pay you 60 days after invoice• Your profit figures and cash in hand will be different at any given time,

because your invoice date is considered the revenue date for profit analysis, but the actual payment date is your cash flow date

• Your profit breakeven and cash breakeven will also occur at different times

November December January February

Profit & Loss

Sales (invoiced) 10000 8000 8000 9000

Costs (incurred) -5000 -5000 -4000 -4000

Profit for period 5000 3000 4000 5000

Cash flow

Sales (receipts in) 0 0 10000 8000

Costs (paid out) 0 -5000 -5000 -4000

Opening cash 0 0 -5000 0

Net cash flow (S-C) 0 -5000 5000 4000

Closing cash (Treasury position) 0 -5000 0 4000


• Suppose you pay your suppliers 30 days after invoice



• Suppose you pay your suppliers 30 days after invoice• And your customers pay you 60 days after invoice



• Suppose you pay your suppliers 30 days after invoice• And your customers pay you 60 days after invoice• Your profit figures and cash in hand will be different at any given

time, because your invoice date is considered the revenue date for profit analysis, but the actual payment date is your cash flow date





• Your profit breakeven and cash breakeven will also occur at different times



Other Differences between Revenue and Cash inflow

• Some P&L items are non-cash events, such as adjustments to previous statements.

• Some Cash in-flow items are not related to sales revenue (e.g. loans received, capital from investors)

Cash-in

Revenue

Borrowing

Capital raised

Sales

Interest received

Adjustments to

depreciations


Other differences between cost and cash outflow

Cash-out Costs

Asset Investment

Lending

Loan Repayment

Dividends

Personnel costs

Interest payments

Depreciations

Provisions

Amounts written off on inventories and accounts receivable

• Some cash-outflow items are not operating costs or costs related to making products, which would go on a P&L. They are outlays related to how a business is financed.

• Some Costs in the P&L, such as depreciation and write-offs, are not cash events.


Purchase raw material

Pay supplier

Credit from supplier

Production and stock period

Sale of product

Customer pays

Credit to customer

Time

B. Timing differences in operations and Negative NWC

Negative Net Working Capital



Company is financed by suppliers during part of production period, but needs to cover financial needs for remaining time until customer pays invoice

Day 1 Day 8 Day 15 Day 22 Day 29 Day 36 Day 43 Day 50 Day 57 Day 64 Day 71purchase raw

materials

You owe cash to supplier manufacture product and hold in stock

pay supplier for materials

sell product and invoice customer

Customer owes you cash

customer pays

for product

Time you are out of pocket, i.e. negative NWC


N.B. Credit and payment timing conditions vary according to industry and your bargaining power


Net Working Capital - Summary• Working Capital is your current (short-term) operating

liquidity

cash

stock (since it can be sold in the short term)

receivables (money owed and soon to be paid to you by customers).

• Net Working Capital refers to your current assets minus any current liabilities; the latter include

payables (money you owe to suppliers and staff)

and any loan interest due in the next 12 months, including interest on bank overdrafts.

NWC is commonly calculated as ‘Stock + Receivables – Payables’


Net Need for Working Capital - NNWC

Because of Timing differences between invoicing and actual payment, money in and money out, NWC could be negative.

Thus you will need to find a pool of cash to cover that shortfall in Net Working Capital (NNWC = Net Need for WC), for instance:

» Persuade customers to pay you sooner, or in advance!!» Arrange to pay your suppliers later (not easy!)» Have an overdraft facility for your bank account (risky and not

recommended for very large amounts)» Forecast your NNWC and take out a loan ahead of time

(safer and more predictable than an overdraft)» Sell shares to an equity investor for cash (if you are not

making sales yet, you can’t get a bank loan)Copyright of Bart Clarysse and Sabrina Kiefer


How much NWC does a company need?• A company is healthy if NWC position is positive (you hold or

receive more stock and cash than you must pay out in a given period)

» e.g.: :supermarkets are paid instantly by customers at the till, but they usually pay their food suppliers 90 days after invoice.

» This means supermarket’s NWC is always in surplus, because suppliers are effectively financing it.

• Small companies are less likely to be granted generous credit facilities by suppliers; they are more likely to have to pay their suppliers before they receive money from customers and thus have negative NWC.

• Consequently, Startups usually need to raise cash from other sources of finance (e.g. convertible debt, equity investors) to cover Negative NWC until it can be covered by consistent sales revenue.


Making a Cash Flow Statement

How do you draft a cash flow projection?

• Method 1: “Direct method” - tally everything up item by item -- time consuming!

• Method 2: Intuitively – approximate overall figures, okay for a rough forecast

• Method 3: “Indirect Method” using P&L and Net Working Capital – precise, used in financial statement accounting, but technical


Cash Flow statement: intuitive method

e.g.: Year 4

IN½ of the sales from year 3 + ½ of the sales from year 4 are to be paid in year 4

= ½ of 400.000 + ½ of 600.000 = 500.000

OUTPersonnel costs = 300.000

Other costs =25.000

Marketing costs = 10.000

Taxes = 15.200

Cash Flow for year: 500,000 - 400,000 - 25,000 - 10,000 - 33,600 = 149,800


Cash Flow Projection – Indirect method extrapolated from P&L and NWC

Cash Flow statement

Operating Profit (from P&L statement)

+ Depreciations* - Change in NNWC

Cash Flow from operations

- Reimbursements (loan repayments)

- Interest paid

- Investments in assets

- Taxes paid

+ Capital raised (cash for equity shares, subsidies)

+ Long-term Financing (loans received)

Cash Flow for period (+ or -)Closing Cash Position (Treasury)

* Depreciation in the P&L is not a cash event, so it is added back in the cash flow statement.


Summary - Timing of financial events

• From your sales forecast, you should estimate not just when you make revenues and costs, but when you will receive and pay out these monies

• There is usually a time-lag between invoice dates and actual payment dates – varies by industry, location, company size

• You should estimate this information to determine your Net Working Capital and your Cash Flow needs

• Some cash inflows and outflows are not related to sales or profits

In: Loans, share capital from investors; Out: Loan repayments, interest payments

• Cash flow is the main factor determining how much you will need to raise externally (debt or equity) to finance the venture



1. Incomings/Outgoings2. Timing3. Financing the venture4. Financial statements5. Analyses


1. Financinga) Financing need and sourcesb) Balance Sheet


A. Financing need

• Start-ups usually spend a long time in the red before a cash break-even from sales

• They need financing to cover NWC needs, fixed asset investments and other expenses until then

-

+

Time

‘Valley of death’ [negative net cash flow]

‘Promised land’[positive net cash flow]

Amount of finance needed

Ban

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alan

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0

From Birley & Norburn (1985)


A. Financing needs

• You will need to have enough financing to cover your net working capital needs (to produce, hold stock and pay expenses) until you receive cash from sales.

• You will also need financing to cover investment in non-current (aka ‘fixed’) assets such as equipment and fixtures, property, etc.

• “Golden rule of financing”: each asset with a limited life expectancy is preferably matched by a funding source with approx. the same life expectancy. Ergo:

» Fixed assets (+ part of current assets) are financed with long-term funding (LT loans or share capital from equity investors)

» Some current assets are financed by short-term funding (credit from suppliers, ST loans, bank overdraft, credit cards)


Financing need and sources– Golden rule

• Your financing requirement should be divided into long-term and short-term finance:

• ‘Each asset with a limited life expectancy is paid for by a funding source with approx. the same life expectancy’

• For instance: equipment expected to last five years should be financed ideally with a 5-year loan.

Equity and liabilitiesAssets

Fixed Assets

Current Assets

Equity

Long Term Loans

Short Term Debt

Long Term

Short Term


Every asset has an appropriate funding source

Assets Equity and Liabilities

Long Term

Short Term

Equity

Long Term Loans

Short Term Debt

Machinery purchase

Raw materials

Office supplies

Management salaries

Product development activities

Big marketing campaign

Patenting costs

Temp labour for seasonal production


B. Balance Sheet – how you will finance assets

Spe

ed o

f cas

h co

nver

sion

(li

quid

ity)

Priority to claim

repay ment

ASSETS EQUITY & LIABILITIES

• Accounts payable and Short-term loans (due in <1 year)

• Long-term (>1 year) Loans

• Accumulated P&L (aka ‘Retained profit’)

• Reserves

• Capital from shareholders

The balance sheet is a snapshot of a company’s holdings and its sources of finance at a specific date• Every £ of Assets (holdings) has a corresponding £ of Equity or

Liabilities (sources of finance)• Hence the “balance” (one side minus the other will equal £0)

• Cash

• Accounts Receivable

• Inventory and Work in Progress

• Financial Fixed Assets (shares of other co.s, bonds)

• Tangible Fixed Assets

• Intangible Fixed Assets


Terminology for Balance sheet: Assets

Assets what a company uses to do business and generate revenue

A. Current Assets Stock aka ‘Inventory’ (raw materials, work-in-progress, finished goods

not yet sold)Cash in hand or on deposit Receivables/debtors (short-term credit you granted to your customers)

B. Fixed (aka “Non-current “) Assets: long-term investments used to generate revenues

> Tangible – property, equipment, fleet of cars or vans, etc.> Intangible –

» intellectual property (patents and trademarks bought from 3rd parties)

» certain product development/design costs N.B. R&D: ‘Research’ is an administrative expense in the P&L, not an asset;

however, ‘Development’ of commercial products from research, such as Prototyping activities, may be considered an asset investment


Equity and Liabilities show the sources of capital which fund Assets

Current Liabilities (amounts due in less than one year)•Payables/creditors

• Amounts you owe to suppliers, due within 12 months• Interest and repayments on any loans due within next 12 months• Tax due during the next 12 months

•Bank overdraftNon-current (long-term) Liabilities•Long-term debt (repayments due in more than one year)Equity•Capital paid in by founders or equity investors for shares in the company•Accumulated P&L aka ‘Retained profit’ (profits accumulated by the company, not paid out to shareholders)•Other Reserves, e.g. share premium (when new shares issued for higher price than in previous round) or obligation in certain industries (statutory reserves requirement)

Terminology for Balance sheet: Equity & Liabilities


Balance sheet format

*Assets = Equity + Liabilities



1. Incomings/Outgoings2. Timing3. Financing needs4. Financial statements5. Analyses


4. Outputs of the financial plan

• Income (aka P&L) Projection» Overview of revenues, costs and profits » Indicates future value of a company

• Cash Flow Projection» Timed projection of future cash receipts and outlays

Basis to estimate financing need, timing of financing and when financing can be repaid

• Balance sheet Projection» Snapshot of company assets predicted at a given date, for

instance end of Year 1, and how they will be financed (debt and equity)

Every £ of Assets has a corresponding £ of Equity or Liabilities; that’s why the sheet “balances”

Examples shown in previous sectionsCopyright of Bart Clarysse and Sabrina Kiefer


12

3

ASSETS EQUITY & LIABILITIES

Formation Expenses Capital

Intangible Fixed Assets Reserves

Tangible Fixed Assets Accumulated P&L

Financial Fixed Assets Debts payable after 1 year

Stocks and Work in Progress Debts payable within 1 year

Accounts Receivable Accounts payable

Cash

Balance Sheet

Cash Flow statement

Operational result

+ Depreciations

- Change in NWC

Cash Flow from operations

- Reimbursements

- Interests

- Investments

- Taxes

+ Capital raised

+ Financing

- Investments

Cash Flow period

Cash Position

Income statement

Turnover

- Direct , variable costs

Gross margin

- Services and other goods

- Renumerations and other social costs

- Depreciations

- Provisions

- Others

Operational result (=EBIT)

Financial result

Exceptional result

Result before taxes

Taxes

Profit After Tax

Linking the components of the financial plan



1. Incomings/Outgoings2. Timing3. Financing needs4. Financial statements5. Analyses and ratios


Gross margin on product

Investors may ask for the gross margin your product can earn.Gross profit = Sale price – direct variable costs

Gross margin = gross profit expressed as a percentage of sales

Example:

Price = £110

Cost of production = £20

Gross margin = 80/110 = 72%

The higher the gross margin, the more money there is to cover fixed costs and end up with a net profit, and the faster you can pay back investors.


Break-Even Analysis: Profit

Profit Breakeven is the point at which your revenue covers all your costs, so your next sales will start to generate profit:

BE point = amount of sales for which costs (fixed+variable) = revenues

Revenue – Costs = 0

This figure can also tell you how many sales you need to target if you have to reach a breakeven within a certain timescale


Profit breakeven pointExample

Sales price per unit £5

Manufacturing cost per unit £1.5

Fixed costs £10,000

BE-point: number (x) at which:

Total Costs (variable + fixed) = Total Revenues (price times no. of units sold)

therefore: 10,000 + 1.5*x = 5*x (i.e. 10,000 = 5*x – 1.5*x)

or 10,000 = 3.5*x

or x= 2,857 units sales volume, or sales figure of £14,285


Breakeven analysis: Cash and cash flow

Cash Flow Breakeven is the point at which the company receives as much cash in a given period as it pays out.

e.g. in Quarter 3, Cash in – cash out = 0When cash in becomes > cash out, the company becomes “net

cash flow positive”.

Cash Breakeven is the point beyond that, where the company becomes solvent without need for external capital

i.e. the point where the company’s positive net cash flow from its operations covers the amount of capital put into the company from founders, investors or lenders

Put simply, the company has ‘paid for itself’, £ for £.


Cash breakeven

Diagram: Curtis MacDonald, Startup DE blog, http://startupde.com/?p=22


http://startupde.com/?p=22

The annualised discount rate at which cash proceeds of business = cash invested in business.

Example: you think the company will be worth £50m in 5 years, and you and your investors will invest £5m in it. That’s a 10x multiple, but the annualised rate of expected value growth is 58%: 50m= 5m*(1+x)5

Therefore 10=(1+x)5

101/5=1+x

101/5 – 1 = x = 0.58

IRR can be overly detailed.

It’s often sufficient for an entrepreneur to say that the exit value is expected to be a multiple of (in this case) “10 times the equity investment”.

Internal Rate of Return = IRR


Sensitivity analysis / Scenario analysis

• Step 1: assess the most sensitive parameters and risks• Step 2: determine the effect of these risks on

» Revenue and Profit» Financing need (need for cash)

e.g.: What if:• the sales price is not feasible? • the sales volume is not feasible?• launch is delayed; planned timing of first sales cannot be met?• prices of raw materials increase? Interest rates?• etc...

Run these simulations in a spreadsheet. • What are effects on profit and cash flow? • What is your margin of safety?• How can you mitigate the odds of risks becoming realities?


Types of risk which may affect operational and financial outcomes• Product risk, e.g.

» Problems/delays with product development» Cost of production increases (suppliers, processes)

• Technology risk, e.g. » Technology still unproven» Your tech could be superseded by new tech developments from other

companies• Market risk, e.g.

» Pricing and business model may not suit the market» Changes in customer sentiment, the competitive environment, market trends,

the economy• Operational risk, e.g.

» People, systems, processes, client management• Financial risk, e.g.

» Changes to interest rates and availability of credit, currency exchange rates, investment environment (required return and discount rate),

• Legal risk, e.g.» Problems with IP infringement (yours or others’)» Problems enforcing contracts, fraud, confidentiality

• Reputational risk, e.g.» Bad publicity due to negative events; negative brand image


Feasibility analysis: Possible outcomesMarket scale

Breakeven analysis

Return on investment

Comment

No Addressable market too small

Yes No No Big enough market, but chosen product not cost effective and hence poor return on investment

Yes Yes No Big enough market, competitive product, but limited expansion (or premium product) opportunities limit financial returns

Yes No Yes Big enough market, but product not competitive in early years

Yes Yes Yes Big enough market, competitive product and appropriate financial returns :


Improving the prospects – possible changes

Failed on Operational change

Financing change

Market scale Consider other complementary niche markets

n/a

Breakeven analysis Change the cost structure (new route to market, leasing key assets, cut salaries, staged launch). Consider adding complementary product line.

Change financing structure (financial investor/ strategic investor) so you can tolerate early stage losses for longer

Return on investment

As above and consider a faster roll out

Introduce more debt and/or equity investor


Further reading

Rice, A., Accounts Demystified: The Astonishingly Simple Guide to Accounting, Prentice Hall, 2007.

Berman, K. And Knight, J, Financial Intelligence for Entrepreneurs, Harvard Business Review Press, 2008.


Tse financial planning_2014

Economy & Finance

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