Financial Planning and Management for a Startup Business

WZCC – NEN, Mumbai.Xerxes V. DasturMarch 24, 2013

Agenda

Introduction Some commonly used terms Break-even point Financial Statements Cost of Capital Time value of money NPV, IRR Working Capital Management Financing options

Why does one run a business ?

Some commonly used Terms

Income, Expenses, Profit & Loss, Balance Sheet Costs – Variable/ Fixed, Capital / Revenue Contribution Overheads Depreciation EBITDA/ EBITA/ PBT / PAT Creditors (AP) / Debtors (AR) Inventory Current Assets, Current Liabilities Fixed Assets Working Capital

Break-even Point

Sales at which total revenue earned equals total costs incurred (TR=TC).

TR = Selling Price x Quantity TC = Fixed Cost + (Variable Cost/unit x

Quantity) BEQ = FC/SP – VC

Break even Analysis Margin of Safety

What is the importance of BEP in a Business?What are the shortcomings of BEP Analysis ?

BEP - Example

Fixed costs:- Marketing cost : Rs. 3 mn- Executive Salaries : Rs. 2 mn- Rent, Electricity : Rs. 1 mn- Office & Admin Exp : Rs. 2 mnTotal Fixed cost : Rs. 8 mn

Variable cost/ unit :- Mfg cost : Rs. 70/-- Labour cost : Rs. 30/-

Selling Price / unit : Rs. 1,000/- BEQ = (8,000,000/1000) – 100 = 7,900 units

Financial Statements

Financial Statements

Purpose - medium by which a company discloses information concerning its financial performance.

Income Statement (P&L A/c)for a period

Balance SheetAs of a date

Cashflow Statementfor a period

Income Statement

Statement of Income and Expenses FOR A PERIOD Sales Other Income Expenses

Cost of Goods SoldMarketing expensesSelling & Distribution costIndirect expenses / Overheads

Depreciation/ Amortisation Financing cost Profit/ Loss Before Tax Income Tax Profit After Tax

Balance Sheet

AssetsFixed AssetsInvestmentsInventoryDebtors (AR)Other current assets (deposits, advances etc)

LiabilitiesTerm Loans/ Short Term loansCreditors (AP)Other current liabilities (advances taken)Provisions (provision for Sales taxes etc)

Shareholders’ FundsEquity CapitalPreference Share CapitalReserves & Surplus

Cash Flow Management

What is Cash Flow ? What are Sources and Uses of Cash

in a business ? How important is Cash Flow

Management in a business ? Relationship between Profit/Loss

and Cash Flow

Sources and Uses of Cash

Cash Inflows – Equity investment Term Loans/ Bank Overdraft etc. Credit period with suppliers Sales collection from customers

Cash Outflows – Payments to suppliers of goods and services Salaries, wages, other office exp. Purchase of Fixed Assets Increase in inventory of raw material/ finished goods Investments Credit given to customers Payment of Taxes Repayment of Loans, payments of interest on loans Dividend to shareholders

Cashflow Statement

Cashflow from operating activitiesOperating cash profit/lossIncrease in current liabilitiesDecrease in current assets

Cashflow from investing activitiesCapexInvestments

Cashflow from financing activitiesLoans/ EquityInterest costTaxes paid

Cashflow Considerations

Free cash flow signals a company's ability to pay debt, pay dividends, buy back stock and facilitate the growth of business.

It can be returned to shareholders or invested in new growth opportunities without hurting the existing operations. The most common method of calculating free cash flow is:

Net Income + Amortization/Depreciation – Changes in Working Capital – Capital Expenditures = Free Cash Flow

Cost of Capital

Cost of Capital

Indicates the rate of return that a business needs to deliver

Compares the rate of return with the rate of return on the investment in a similar instrument / asset

Generally derived as the weighted average of cost of all components of capital of a firm

Types of Cost of Capital

ExplicitInterest / dividend

ImplicitWhen profits are reinvested in business – opportunity cost of investment

Future cost /Historical cost Specific cost / Combined cost Average cost/ Marginal cost

Components of CoC

Consists of three componentsKo = Rj + b + fwhere,Risk less cost of a particular type of finance=RjBusiness risk premium=bFinance risk premium=f

Time Value of Money

Present Value of a future sum

PV = FV / (1+ i)n

Cummulative Present Value of Future Cash Flows

n

PV = ∑ [ FVt / (1+ i)t ] t=0

Net Present Value (NPV)

Each future cash inflow/outflow is discounted back to its PV and then they are summed.

n NPV = ∑ [ Ct / (1+ r)t ]

t=0

r is the discount rate (the rate of return that could be earned in financial market with similar risk).

Firm’s weighted avg. cost of capital is most commonly used. However, higher discount rate must be used for riskier projects.

To choose between alternative projects, - if the projects are independent, choose both projects if NPV > 0

- if the projects are mutually exclusive, choose the project with higher NPV.

Other measures of Project Feasibility

Payback Period= Investment / Cash flow : If cash flows are uniform during the project duration

Or Period after which NPV turns positive. IRR (Internal Rate of Return)

- commonly used in capital budgeting- indicative of whether the investment can be made in a project at a given cost of capital- Also indicates the ‘hurdle rate’ for a project.

IRR (Internal Rate of Return)

IRR is the discount rate that forces PV of inflows equal to cost, and the NPV = 0

n

0tt

t) IRR 1 (

CF 0

IRR Acceptance Criteria

If IRR > k, accept project. If IRR < k, reject project. If projects are independent, accept

both projects, if both IRR > k. If projects are mutually exclusive,

accept project whose IRR is greater than the other project’s IRR

Working Capital Management

Working Capital

What does working capital mean?

Working capital = Current Assets – Current Liabilities

What does + ve or – ve working capital indicate ?

How much working capital is adequate for a business ?

Some important indicators of Working capital

Working capital turnover:Sales / Working capital

Current RatioCurrent Assets / Current Liabilities

Days Sales outstandingReceivables/ Annual Sales/ 365 days

Inventory Turnover RatioCost of Goods sold/ Inventory

Financing options for a Startup

Equity Capital (High cost) Self Private Equity Investors Capital Market

Term Loan (Medium/ Low cost) Banks Financial Institutions Inter-corporate Deposits Public Deposits

Credit from Suppliers Advances/ Deposits from customers

Thank You

Xerxes V. DasturV. S. Dastur & Co.Chartered Accountants