Financial Planning. Presented by Emma's Garden

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1 + Financial Planning Presented by Emma's Garden

2 Financial Planning A comprehensive financial plan helps you to forecast and set your financial goals and milestones. Your financial forecasts are an essential part of your business plan. Put the right assumptions in place and the rest will follow.

3 Glossary Gross Profit - Total sales less cost of goods sold (COGS) Gross Profit Margin - % of income made from sales after COGS Cost of Goods Sold Cost to produce products and services for sale e.g. materials, direct labor, supplies, etc.

4 Glossary Net Profit Profit after all expenses the bottomline Net Profit Margin Ratio of net profit to sales expressed as a % Sales Income from selling of goods and services Revenues Income from sales, interest, investments, sale of assets, etc. Fixed Cost Cost that remain constant regardless of change in business activity e.g. rent, insurance, interest expense, etc. Variable Cost Cost that change in proportion to business activity e.g. raw materials, labor, advertising, equipment purchases, etc. Note: over time all cost are variable.

5 Cash Basis In cash basis accounting, revenues are recorded when cash is actually received and expenses are recorded when they are actually paid no matter when they were actually due. 1. Simple and saves time less entries in accounting system 2. Can help with tax planning

6 Accrual Basis In accrual basis accounting, income is reported in the period it is earned, regardless of when money is received, and expenses are deducted in the fiscal period they are incurred, whether they are paid or not. When using accrual basis accounting, you record both revenues and expenses when they occur. More comprehensive and accurate picture of actual business activity Preferred method especially for larger companies

7 Step 1: Calculate your set up costs Accounting fees Registrations and licenses Equipment and Built out Initial working capital By comparing your start up costs to your start-up equity investment, you can work out how much money you need to borrow to kick-start your business. Set-up cost on excel

8 Profit and Loss A financial statement showing the profit or loss sustained by a business during a particular period of time and includes: 1. All revenues and sales of the business 2. All expenses of the business

9 Step 2: Profit and loss forecast A forecast of sales and expenses, usually for the next 12 months of operations. By comparing your potential sales revenue to your cost of goods sold and your fixed costs of doing business, you can calculate your likely margins and put your pricing model to the test.

10 Example Profit and Loss (P&L) Sales Candles and Holders 40,000 Cost of Goods Sold (10,000) Gross Profit 30,000 Operating Expenses Rent 6,000 Insurance 1,000 Advertising 1,500 Wages 9,000 Utilities 2,200 Equipment 2,000 Interest 800 Supplies 1,500 Total Expenses 24,000 Net Income 6,000

11 P&L Margins Gross Profit Margin Gross Profit / Total Sales 30,000/40,000 = 75% Rule of thumb at least 35% Net Profit Margin (bottom line) Profit Margins by Industries Net Profit / Total Sales Airline = 3.6 6,000/40,000 = 15% Health Care/Hospitals = 3.3 Pharmaceuticals = 15.8 Mining and Oil = 23.8 Copper Mining = 11.5 to 87.7 Utilities = 7.9 Hotels/Casino/Restaurant = 7.3

12 Step 3: Cash flow forecast A cash flow forecast is vital. New businesses can be hungry for cash to build the capacity they need to service their customers and those same customers may be slow to pay. That can open up a cash flow gap that could leave you vulnerable if you re not prepared.

13 Balance Sheet Summary of the assets and liabilities a company has Assets = Liabilities + Owner s Equity A company has to pay for all the things it has (assets) by borrowing or getting equity (shareholders investments)

14 Step 4: Balance sheet forecast This is a snapshot of the business in 12 months time. Your forecast of the business assets and liabilities after 12 months of operations will be based on the purchases you anticipated in your set-up costs, together with the results of your profit and loss forecast.

15 Example: Balance Sheet Assets Current Cash 5,000 Inventory 5,000 Receivables 5,000 Total 15,000 Other Assets Equipment 6,000 Furniture 4,000 Total 10,000 Total Assets 25,000 Liabilities Current (less than 1 year) Payables 1,500 Payroll Taxes 1,000 Total 2,500 Long-Term (over 1 year) Loans Payable 8,000 Total 8,000 Total Liabilities 10,500 Equity Retained Earning 6,000 Capital 10,000 Owner s Draw (1,500) Total Equity 14,500 Total Liabilities+Equity 25,000

16 Step 5: Break-even analysis Once you ve forecast your fixed costs, you can calculate how much revenue you need to break even and how many units you need to sell. If you ve already decided on your pricing, then obviously it s easy enough to calculate your revenue given a certain number of sales but how do you predict what your sales will be?

17 Breakeven Formula Breakeven Point = Fixed Cost/(Unit Selling Price Variable Cost)

18 Single Product Break even Fixed Costs: Monthly Rent $100 Insurance ($600/yr. $50/mth $ 50 Total Monthly fixed costs $150 Variable Costs: Materials $ 3 Labor $ 4 Total variable costs $ 7 Selling Price $ 10

19 Break Even $ Break Even Point= Fixed costs/selling price-variable costs Break Even Point = $150/($10-$7) Break Even Point = $150/$3 Break Even Point = $ 50 To break even, the company must sell 50 units per month.

20 If the company breaks even, P&L looks like this Sales Gross Sales ($10/unit x 50 units) $500 Less Cost of Goods Sold ($7/unit x 50 units) $350 Net Sales $150 Expenses Rent $100 Insurance $ 50 Total Expenses $150 Net profit $ 0

21 For a service business, set a benchmark based on the average number of hours worked per week. Generally base your figures on something between 60% and 70% utilization, rather than assuming 100% of your time will be spent on chargeable activities. For other businesses, start by scoping the size of your market, and then use a conservative estimate of your likely market share to estimate potential sales.

22 It can also be useful to prepare several forecasts, based on best-case, worst-case and average scenarios. Whatever approach you take, make sure you document your assumptions and the reasons behind them, then test and update them in line with your current knowledge and business performance.

23 Financing: Step 1: Create a list of how much money you will need How much of your own money you can invest. Where you will operate the business and how much that will cost each month. Don t forget, that even operating from home you will need to cover the additional costs like electricity. What equipment you need to buy and how much it will cost.

24 How much stock you need to keep on hand and how much it will cost. How many staff you will employ. Work out your cost of wages for yourself and your employees, including superannuation contributions. If you re considering a new car or truck list the cost of leasing or buying, registration, servicing and petrol. Any expected accounting, legal or marketing costs.

25 Step 2: Find the source, or sources, of finance to suit you Your own investment: Use your own money from savings or investment. But think about what you need to keep in your savings, just in case you need some spare cash. Keep another job for a short while to keep an income while testing a business idea.

26 Pros Debt Finance Interest payments are generally tax deductible. You retain complete ownership of your business and its profits. Equity Finance The investor shares your risk so if your business fails, there s no need to pay them back. There are no interest payments but you may need to pay an investor a share of profits, which could be more than interest. Cons You have to pay interest on your borrowings. You have to repay the amount you borrowed. In most cases, you will need to offer security for your loan. You share ownership of your business so if it s successful, a share of that success goes to someone else. You may lose control of your business. Your investor may take part in decision marking and take a share of each year's profits.

27 When you need to: Solutions: Improve cash flow or get extra cash in the short term Business Credit Card Credit Lines Grow your business over the longer term Business Line of credit Micro loans Buying vehicles and assets Car and Equipment Finance

28 Family and friends Many business owners approach family and friends to raise finance. While loved ones may give more generous terms than outsiders, this option is not for the faint-hearted. You have to disclose business details to those close to you, and if something goes wrong and they lose their investment, it could damage your relationship. Business partner When taking on a partner, you need to be very confident that you can work harmoniously together in the long term. It s essential to have a written partnership agreement setting out how disputes will be settled and what happens if one partner wants to leave the business. Business angel Business angels are wealthy individuals looking for fast-growing businesses to invest in. Often experienced business-people, they can be invaluable as mentors and advisers as well. Typically, they ll invest anything up to $2m. They re likely to be after businesses with exceptional growth prospects, so you ll need to demonstrate your potential.

29 Venture capital Private equity Venture capitalists are professional investors who invest in promising businesses and help them grow, often to the point where they re ready to be listed on the share market. They make money by selling their share in your business, either on the share market or to someone else. A venture capitalist will typically seek to exit your business in three to five years with a return of 35% p.a or more. Generally they ll look to invest between $2m and $10m, depending on your business. Private equity investors have an emphasis on larger businesses. They re often involved in management buyouts using borrowed funds. They aim to realize a large return in a relatively short time frame, allowing them to cover their cost of funds and compensating them for their risk. Private equity investors can give you access to amounts of $2m to $10m plus.

30 Tip: If you re buying an asset, match the length of the loan to the life of the asset you re buying so it can pay for itself over time out of the extra cash flow it generates. For example, if you re a printer buying a printing press with a life of 10 years, take out a 10-year loan and make repayments out of the extra income you earn from that press.

31 How will you fund the business? What is your desired debt and equity position? Who will provide capital debt funds? What role will leasing play in your financial strategy?

32 Will you use outside investors for equity capital? How will you manage the financial risks your business faces? What operating procedures, such as developing cash flow budgets or spending limits, will you have to ensure adequate money for debt repayment? What are the important assumptions that underlie your projections? These assumptions may be associated with both external or internal factors.

33 What procedures will be used for monitoring overall business performance? What level of performance will your business shoot for? These should be targets for next year and in five years. They should be financial performance standards used to monitor the overall business.

34 Risks and Rewards Risks Summarize risks of proposed project Addressing risk Summarize how risks will be addressed Rewards Estimate expected pay-off, particularly if seeking funding

35 Thank you!

36 Break even Example Fixed Cost Variable Operating Expense Rent 6,000 Advertising 1,500 Utilities 2,200 Wages 9,000 Interest 800 Supplies 1,500 Insurance 1,000 Equipment 2,000 Total 10,000 14,000 Total Sales ($5.00 per unit x 8000) 40,000 Cost of Goods Sold (variable cost) (10,000) Gross Margin 30,000 Variable Operating Expense ( ) Contribution Margin Contribution Margin % = 16,000/40,000 =.40 Fixed Operating/Contribution % = 10,000/.40 = 25,000

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