ENGI 8607: Business Planning and Strategy in an Entrepreneurial Environment ZipCar Dr. Amy Hsiao Lecture 5 Memorial University of Newfoundland ZipCar Components of a Business Model How It Works http://www.zipcar.com/cambridge/findcars?zipfleet_id=94396 Robin Chase, Sprouter [retrieved January 29, 2012] http://sprouter.com/blog/how-robin-chase-built-zipcar-largest-car-sharing-service-world/ Partnerships http://www.yorku.ca/trnsprt/zipcar.htm Core Strategy 1-5 Strategic Resources Business Core Mission competencies Product/Market Strategic Scope assets Basis for differentiation 1-5 Partnership Network Suppliers Partners Other key relationships 1-5 Customer Interface Target customer Fulfillment and support Pricing structure 1-5 Strategic Positioning Varietybased Needsbased Accessbased Evidence of Sustainable Strategy Trade-offs for Real Growth Fit Profitable Growth Role of Leadership Pricing & Other Comparisons http://carsharingtoronto.com/ 1
Lecture 5 Assessing a New Venture s Financial Strength and Viability Are we making or losing money? How much cash do we have on hand? How do our growth and net profits compare to those of our industry peers? Where will the funds we need for capital improvements come from? Are there ways we can partner with others to share risk and reduce the amount of cash we need? Overall, are we in good shape financially? Financial Management and Objectives Raising Money Managing a company s finances to achieve the highest rate of return. Profitability: A company s ability to make a profit Liquidity: A company s ability to meet its short-term obligations Efficiency: How productively a firm uses its assets Stability: The overall health of the financial structure of the firm, particularly as it relates to its debt-to-equity ratio Financial Objectives of a Firm Profitability Is the ability to earn a profit. Many start-ups are not profitable during their first one to three years while they are training employees and building their brands. However, a firm must become profitable to remain viable and provide a return to its owners. Liquidity Is a company s ability to meet its short-term financial obligations. Even if a firm is profitable, it is often a challenge to keep enough money in the bank to meet its routine obligations in a timely manner. Financial Objectives of a Firm Liquidity Accounts receivable money owed to the firm by its customers Inventory merchandise, raw materials, and product waiting to be sold If a firm allows levels of either of these assets to get too high, it may not be able to keep sufficient cash on hand to meet its short-term obligations. Ex. Small that sells to larger companies may get paid 30-60 days from the time of sale. Financial Objectives of a Firm Efficiency Is how productively a firm utilizes its assets relative to its revenue and its profits. Southwest Airlines, for example, uses its assets very productively. Its turnaround time, or the time its airplanes sit on the ground while they are being unloaded and reloaded, is the lowest in the airline industry. Stability Is the strength and vigor of the firm s overall financial posture. For a firm to be stable, it must not only earn a profit and remain liquid but also keep its debt in check. Debt-to-Equity Ratio If a firm continues to borrow from its lenders and its D/E ratio gets too high, it may have trouble meeting its obligations and securing the level of financing needed to fuel its growth. Calculated by dividing its long-term debt by its shareholders equity (the owners' residual interest in the assets of an enterprise after deducing all its liabilities) 2
The Process of Financial Management Importance of Financial Statements To assess whether its financial objectives are being met, firms rely heavily on analysis of financial statements. A financial statement is a written report that quantitatively describes a firm s financial health. The income statement, the balance sheet, and the statement of cash flows are the financial statements entrepreneurs use most commonly. Forecasts Are an estimate of a firm s future income and expenses, based on past performance, its current circumstances, and its future plans. The Process of Financial Management Forecasts (continued) New ventures typically base their forecasts on an estimate of sales and then on industry averages or the experiences of similar start-ups regarding the cost of goods sold and other expenses. Budgets Are itemized forecasts of a company s income, expenses, and capital needs and are also an important tool for financial planning and control. The Process of Financial Management Financial Ratios Depict relationships between items on a firm s financial statements. An analysis of its financial ratios helps a firm determine whether it is meeting its financial objectives and how it stacks up against industry peers. Importance of Financial Management Many experienced entrepreneurs stress the importance of keeping on top of the financial management of the firm. Process of Financial Management Financial Statements Income statement Balance sheet Statement of cash flows The Process of Financial Management Financial Statements Historical Financial Statements Reflect past performance and are usually prepared on a quarterly and annual basis. Publicly traded firms are required by the SEC to prepare financial statements and make them available to the public. (Ex. 10-Q of ZipCar ) Pro Forma Financial Statements Are projections for future periods based on forecasts and are typically completed for two to three years in the future. Pro forma financial statements are strictly planning tools and are not required by the SEC. 3
Financial Statements and Forecasts Pro forma financial statements are projections for future periods based on forecasts and typically completed for 2-3 years in the future. For planning only, confidential, internal Importance of Keeping Good Records The first step toward prudent financial management is keeping good records. Income Statement Reflects the results of the operations of a firm over a specified period of time. Monthly, quarterly, or annual. Shows whether the firm is making a profit or experiencing a loss. Multiyear format used to evaluate effect of past strategies and help project future sales and earnings. Consolidated Income Statements for New Venture X-TECH Dec. 31, 2006 Dec. 31, 2005 Dec. 31, 2004 Net Sales 586,600 463,100 368,900 Cost of sales 268,900 225,500 201,500 Gross Profit 317,700 237,600 167,400 Operating Expenses Selling, general, and admin. Expenses 117,800 104,700 90,200 Depreciation 13,500 5,900 5,100 Operating Income 186,400 127,000 72,100 Other Income Interest Income 1,900 800 1,100 Interest Expense (15,000) (6,900) (6,400) Other Income (expense), net 10,900 (1,300) 1,200 Income before taxes 184,200 119,600 68,000 Income tax expense (53,200) (36,600) (18,000) Net income 131,000 83,000 50,000 Earnings per share 1.31 0.83 0.50 Income Statement Net sales: total sales minus allowances for returned goods and discounts Cost of sales (or COGS): include all the direct costs associated with producing or delivering a product or service, including the material costs and direct labor. Operating expenses: marketing, administrative costs, and other expenses not directly related to producing a product or service. Income Statement Compare ratios of COGS to Net Sales Compare ratio of operating expenses to Net Sales 55%, 49%, 46% for 2004, 2005, 2006 respectively Steadily decreasing its material and labor costs per dollar of sales good trend 4
Income Statement Profit Margin (return on sales) Net Income/Net Sales 13.6%, 17.9%, 22.3% for 2004, 2005, 2006 respectively Firm is either boosting its sales without increasing expenses or doing a better job of controlling its costs. Income Statement Price-to-earnings ratio (P/E ratio) Price of a company s stock against its earnings Generally, the higher a company s P/E ratio, the greater the market thinks it will grow. Say the stock of X-TECH was trading at $20 per share, so its P/E ratio would be 15.3. Balance Sheet Snapshot of a company s assets, liabilities, and owners equity at a specific point in time Left/Top shows a company s assets Right/Bottom shows a company s liabilities and owners equity Assets are listed in order of liquidity (length of time it takes to convert them to cash) Must always balance Balance Sheet Categories of Assets Current assets include cash plus items that are readily convertible to cash, such as A/R, marketable securities, and inventories Fixed assets used over a longer time frame, such as real estate, buildings, equipment, and furniture Other assets accumulated goodwill, etc. Balance Sheet Categories of Liabilities Current liabilities obligations that are payable within a year, including A/P, accrued expenses, and the current portion of long-term debt Long-term liabilities notes or loans that are repayable beyond 1 year, including liabilities associated with purchasing real estate, buildings, and equipment Owners equity equity invested in the business by its owners plus the accumulated earnings retained by the business after paying dividends Balance Sheet Does not record fair market value Ex. Real estate value Value of IP Goodwill Not listed: Intangible assets training 5
Consolidated Balance Sheets for X-TECH Consolidated Balance Sheets for X-TECH Dec 31, 2006 Dec 31, 2005 Dec 31, 2004 Current Assets Cash and cash equiv. 63,800 54,600 56,500 A/R, less allowance for doubtful accounts 39,600 48,900 50,200 Inventories 19,200 20,400 21,400 Total Current Assets 122,600 123,900 128,100 Property, land, equipment Land 260,000 160,000 160,000 Building and Equipment 412,000 261,500 149,000 Total property, plant, and equipment 672,000 421,500 309,000 Less: accumulated depreciation 65,000 51,500 45,600 Net property, land, and equipment 607,000 370,000 263,400 Total Assets 729,600 493,900 391,500 Liabilities and Shareholders Equity Dec 31, 2006 Dec 31, 2005 Dec 31, 2004 Current liabilities Accounts payable 30,200 46,900 50,400 Accrued expenses 9,900 8,000 4,100 Total current liabilities 40,100 54,900 54,500 Long-term liabilities Long-term debt 249,500 130,000 111,000 Total liabilities 289,600 184,900 165,500 Shareholders equity Common stock (100,000 shares) 10,000 10,000 10,000 Retained earnings 430,000 299,000 216,000 Total shareholders equity 440,000 309,000 226,000 Total liabilities and shareholders equity 729,600 493,900 391,500 Balance Sheet Working Capital Current assets minus current liabilities $82,500 = amount of liquid assets the firm has available Current Ratio Firm s current assets divided by its current liabilities Current Ratio 3.06 It has $3.06 in current assets for every $1.00 in current liabilities Healthy can meet current liabilities Trend 2.35, 2.26, 3.06 Balance Sheet Debt Ratio Divide total debt by total assets The present debt ratio is 39.7%, which means that 39.7% of its total assets are financed by debt and the remaining 60.3% by owners equity. Healthy for a young firm. Trend is good too 42.3, 37.4, 39.7 Over time, the company is relying less on debt to finance its operations Less debt creates more freedom for the firm in terms of taking different actions. Balance Sheet Note that the $131,000 net income reported on its 2006 income statement shows up as the difference between its 2006 and 2005 retained earnings on its 2006 balance sheet. No dividends were paid to its stockholders so the company retained all of its $131,000 in earnings. Statement of Cash Flows Summarizes the changes in a firm s cash position for a specified period of time and details why the change occurred. Three categories: Operating activities net income (or loss), depreciation, changes in current assets and liabilities other than cash and short-term debt. A firm s net income, taken from its income statement, is the first line on the corresponding period s cash flow statement. 6
Statement of Cash Flows Three categories: Investing activities: include the purchase, sale or investment in fixed assets, such as real estate, equipment, and buildings Financing activities: include cash raised during the period by borrowing money or selling stock and/or cash used during the period by paying dividends, buying back outstanding stock, or buying back outstanding bonds Consolidated Statement of Cash Flows for X-TECH Cash flows from operating activities Dec 31, 2006 Dec 31, 2005 Net income 131,000 83,000 Additions (sources of cash) Depreciation (deducted in income statement but not cash expenditure) 13,500 5,900 Decreases in A/R 9,300 1,300 Increase in accrued expenses 1,900 3,900 Decrease in inventory 1,200 1,000 Subtractions (uses of cash) Decrease in A/P (16,700) (3,500) Total adjustments 9,200 8,600 Net Cash from Operating Expenses 140,200 91,600 Consolidated Statement of Cash Flows for X-TECH Cash flows from investing activities Dec 31, 2006 Dec 31, 2005 Purchase of building and equipment (250,500) (112,500) Net cash flows from investing activities (250,500) (112,500) Cash flows from financing activities Proceeds from increase in long-term debt 119,500 19,000 Net cash flows provided by financing activities Total Increase in cash 9.200 (1,900) Cash and cash equiv. at the beginning of the year 54,600 56,500 Cash and cash equiv. at the end of the year 63,800 54,600 Ratio Analysis Ratio Analysis The most practical way to interpret or make sense of a firm s historical financial statements is through ratio analysis, as shown in the next slide. Comparing a Firm s Financial Results to Industry Norms Comparing a firm s financial results to industry norms helps a firm determine how it stacks up against its competitors and if there are any financial red flags requiring attention. Ratio Analysis Historical Ratio Analysis Profitability Ratios Return on Assets (ROA) = net income/average total assets Return on Equity (ROE) = net income/average shareholders equity Profit Margin = net income/net sales Liquidity Ratios Current Ratio = current assets/current liabilities Overall Financial Stability Ratios Debt = total debt/total assets Debt-to-Equity = total liabilities/owners equity 7
Historical Financial Statements Three types of historical financial statements Comparison Data for Dell (05-06 Fiscal Year) Financial Statement Income Statement Balance Sheet Statement of Cash Flows Purpose Reflects the results of the operations of a firm over a specified period of time. It records all the revenues and expenses for the given period and shows whether the firm is making a profit or is experiencing a loss. Is a snapshot of a company s assets, liabilities, and owner s equity at a specific point in time. Summarizes the changes in a firm s cash position for a specified period of time and details why the changes occurred. Dell Inc. Industry Median Market Median Gross profit margin 17.50% 34.00% 51.80% Net profit margin 6.00% 3.00% 4.80% ROE 75.6% 10.3% 9.5% ROA 14.9% 3.5% 1.6% 12-month revenue growth 11.1% 10.7% 12.3% Comparison Data for X-TECH and All Incorporated Competitors X-TECH Others Sales 100% 100% COGS 45.8% 42.9% Current ratio 3.05% 1.1% D-E Ratio 0.65% 4.5% Sales per Square Foot Tests efficiency of operations (how productively assets are used) Year Peets Coffee 2002 $696 McDonalds 2002 $543 Starbucks 2002 $521 New Venture Coffee 2004 $512 Panera Bread 2002 $418 Ruby Tuesdays 2002 $377 Average sales per square feet Discussion Report on Business, www.globeandmail.com Forecasts The analysis of a firm s historical financial statements are followed by the preparation of forecasts. Forecasts are predictions of a firm s future sales, expenses, income, and capital expenditures. A firm s forecasts provide the basis for its pro forma financial statements. A well-developed set of pro forma financial statements helps a firm create accurate budgets, build financial plans, and manage its finances in a proactive rather than a reactive manner. 8
Financial Statements and Forecasts Pro forma financial statements are projections for future periods based on forecasts and typically completed for 2-3 years in the future. For planning only, confidential, internal Forecasts A sales forecast is a projection of a firm s sales for a specified period (such as a year). It is the first forecast developed and is the basis for most of the other forecasts. A sales forecast for a new firm is based on a good-faith estimate of sales and on industry averages or the experiences of similar start-ups. A sales forecast for an existing firm is based on (1) its record of past sales, (2) its current production capacity and product demand, and (3) any factors that will affect its future product capacity and product demand. Forecasts Forecast of Costs of Sales and Other Items Once a firm has completed its sales forecast, it must forecast its cost of sales (or cost of goods sold) and the other items on its income statement. The most common way to do this is to use the percentageof-sales method, which is a method for expressing each expense item as a percentage of sales. If a firm determines that it can use the percent-of-sales method and it follows the procedures described in the textbook, then the net result is that each expense item on its income statement will grow at the same rate as sales (with the exception of items that can be individually forecast, such as depreciation). Forecast of Costs of Sales Percent-of-sales method expresses each expense item as a percentage of sales COGS averaged 47.5% over past two years ( 05, 06) Project for future year: 47.5% of sales forecast ($821,200) = $390,000 in 2007 Constant ratio method of forecasting Percent-of-sales is applied to all other accounting of expenses Forecasts Historical and Forecasted Annual Sales for X-TECH Breakeven Analysis Total fixed costs / (price average variable costs) If the total fixed cost associated with opening a new company is $101,000 per year, the average price for the company s product is $2.75, and the variable cost for each product is $1.10, then the breakeven point is 61,212 units per year 170 per day, based on a 360-day year 9
Forecasts Used to Prepare Pro Forma Income Statements Net sales Historic: Average sales increase of 25% per year 2007: Increase to 40% as the result of increased brand awareness and the opening of a 2 nd location 2008: increase 25% as the result of increased brand awareness COGS Historic: Average of 47.5% of sales the past 2 years 2007: 47.5% of sales 2008: 47.5% of sales Forecasts Used to Prepare Pro Forma Income Statements Selling, general, and administrative expenses Historic: average 22% of sales the past 2 years 2007: increase to 25% of sales as result of 2 nd location opening 2008: 25% of sales Interest expense Historic: 6-7% of long-term debt 2007: 7% of long-term debt 2008: 7% of long-term debt Forecasts Used to Prepare Pro Forma Income Statements Other income Historic: licensing income of $10,900 per year 2007: licensing income will increase to $20,000 as a result of a renegotiation of a contract 2008: licensing income will be $20,000 Pro Forma Income Statement for New Venture X-TECH Actual 2006 Projected 2007 Projected 2008 Net Sales 586,600 821,200 1,026,500 Cost of sales 268,900 390,000 487,600 Gross Profit 317,700 431,200 538,900 Operating Expenses Selling, general, and admin. Expenses 117,800 205,300 256,600 Depreciation 13,500 18,500 22,500 Operating Income 186,400 207,400 259,800 Other Income Interest Income 1,900 2000 2000 Interest Expense (15,000) (17,500) (17,000) Other Income (expense), net 10,900 20,000 20,000 Income before taxes 184,200 211,600 264,800 Income tax expense 53,200 63,600 79,400 Net income 131,000 148,300 185,400 Earnings per share 1.31 1.48 1.85 Forecasts Used to Prepare Pro Forma Balance Sheets Accounts Receivable Historic: A/R down to 7% sales in 2003 from 13.6% of sales in 2001 2007: 7% of sales 2008: 7% of sales Inventories Historic: Trended down to 3.3% of sales in 2003 from 45.8% of sales in 2002 2007: 4% of sales 2008: 4% of sales Forecasts Used to Prepare Pro Forma Balance Sheets Land, buildings, and equipment 2007: $100,000 in equipment purchases and capital improvements made to existing buildings 2008: $275,000 in capital improvements, including a $100,000 real estate purchase and $175,000 in buildings and equipment Accounts Payable Historic: A/P trended down to 5% of sales in 2003 from 13.6% of sales in 2001 because of better collection method 2007: 7% of sales 2008: 7% of sales 10
Forecasts Used to Prepare Pro Forma Balance Sheets Long-term debt $75,000 reduction in long-term debt from earnings $150,000 will be borrowed to finance $275,000 to acquire land, equipment, and buildings (the balance of the acquisition costs will be funded from earnings) Pro Forma Balance Sheets for X-TECH Dec 31, 2006 2007 projected 2008 projected Current Assets Cash and cash equiv. 63,800 53,600 80,200 A/R, less allowance for doubtful accounts 39,600 57,500 71,900 Inventories 19,200 32,900 41,000 Total Current Assets 122,600 143,800 193,100 Property, land, equipment Land 260,000 260,000 360,000 Building and Equipment 412,000 512,000 687,000 Total property, plant, and equipment 672,000 772,000 1,047,000 Less: accumulated depreciation 65,000 83,500 106,000 Net property, land, and equipment 607,000 688,500 941,000 Total Assets 729,600 832,300 1,134,100 Pro Forma Balance Sheets for X-TECH Liabilities and Shareholders Equity Dec 31, 2006 2007 Projected 2008 Projected Current liabilities Accounts payable 30,200 57,500 71,900 Accrued expenses 9,900 12,000 14,000 Total current liabilities 40,100 69,500 85,900 Long-term liabilities Long-term debt 249,500 174,500 274,500 Total liabilities 289,600 244,000 360,400 Shareholders equity Common stock (100,000 shares) 10,000 10,000 10,000 Retained earnings 430,000 578,300 763,700 Total shareholders equity 440,000 588,300 773,700 Total liabilities and shareholders equity 729,600 832,300 1,134,100 Pro Forma Statement of Cash Flows for X-Tech Operating Activities 12/31/2006 Projected 2007 Projected 2008 Net income 131,000 148,300 185,400 Changes in working capital Depreciation 13,500 18,500 22,500 Inc(dec) in A/R 9,300 (17,900) (14,400) Inc(dec) in accrued expenses 1,900 2,100 2,000 Inc(dec) in inventory 1,200 (13,700) (8,100) Inc(dec) in A/P (16,700) 27,300 14,400 Total adjustments 9,200 16,300 16,400 Net cash by OA 140,200 164,600 201,800 Pro Forma Statement of Cash Flows for X-Tech Investing Activities 12/31/2006 Projected 2007 Projected 2008 Purchase of bldg and equipment (250,500) (100,000) (275,000) Net from IA (250,500) (100,000) (275,000) Cash flow from Financing Activities Proceeds from increase in LTD (or principle reduction in LTD) 119,500 (75,000) 100,000 Increase in cash 9,200 (10,400) 26,800 Cash & cash equiv. at the beg. of the year Cash & cash equivalents at the beginning of the year 54,600 63,800 53,400 63,800 53,400 80,,200 Pro Forma Financial Statements Pro Forma Financial Statements A firm s pro forma financial statements are similar to its historical financial statements except that they look forward rather than track the past. The preparation of pro form financial statements helps a firm rethink its strategies and make adjustments if necessary. The preparation of pro forma financials is also necessary if a firm is seeking funding or financing. 11
Ratio Analysis Ratio Analysis Based on Historical and Pro-Forma Financial Statements Ratio Analysis The same financial ratios used to evaluate a firm s historical financial statements should be used to evaluate the pro forma financial statements. This work is completed so the firm can get a sense of how its projected financial performance compares to its past performance and how its projected activities will affect its cash position and its overall financial soundness. Types of Pro Forma Financial Statements Financial Assumptions Financial Statement Pro Forma Income Statement Pro Forma Balance Sheet Pro Forma Statement of Cash flows Purpose Shows the projected results of the operations of a firm over a specific period. Shows a projected snapshot of a company s assets, liabilities, and owner s equity at a specific point in time. Shows the projected flow of cash into and out of a company for a specific period. Reasons behind the numbers How you calculated the amounts in the Financial Statements What is critical What is sensitive Consider sensitivity analysis around key assumptions Ready for the pitch just in case you are asked! Financial Assumptions Key assumptions Sales growth Cost of goods sold Growth in Sales volumes Selling prices Selling & distribution costs Research & development Interest rates Tax rates Management/administration Bad debt provisions Depreciation rates Material costs Financial Assumptions The key assumptions have been based on the following: Sales projections derived in 7.4 Sales Forecasts and based on 7. Marketing Strategies, Sales Plans & Projections. R&D expenditure as described in 8. Technology and R&D. Operational plans and expense projections as presented in 9. Operational Plans. Funding of $xx (equity) and $xx (loans) will be secure in the first quarter of 20XX as proposed in 12. Funding below. and so on... 12
Sources and Uses of Funds Keep it factual and avoid any "over-the-top" hyping of your business as the greatest investment ever! If planning to raise equity from venture capital or "angel" sources, allow adequate time to raise it. Describe what sources you plan to secure and how you plan to use them. Indicate planned uses, possible sources and forms (equity, loans, grants, credit etc.) and time scales. Mention any conditional or firm funding commitments already secured. Sources and Uses of Funds For each element of funding describe the preferred form of funding amounts required likely timing security offered desired terms repayment schedules exit options Financial Mistakes to Avoid Here are some of the most common mistakes found in the financial projection sections of feasibility studies and business plans: Failing to include the "Big 3" statements and projections (income statement, balance sheet, cash flow). Presenting sales and profit projections that are unrealistic and unfounded. Omitting financial assumptions to explain where the "numbers" originated. Financial Mistakes to Avoid Presenting "creative" rather than "accepted" financial statements. Underestimating expenses and not budgeting for unexpected costs. Lack of financial investment on the part of the founders. Including excessive salaries and office expenses at start-up. Offering a lower percentage of ownership than the investment requirement demands. Offering a return on investment that is out of line for your industry. Absence of contingencies and projections for worst case scenarios. Midterm Review 13