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Chapter 10 - The Financial Plan

Chapter 10
THE FINANCIAL PLAN

LEARNING OBJECTIVES

01: To understand the role of budgets in preparing pro forma statements.

02: To understand why positive profits can still result in a negative cash flow.

03: To learn how to prepare monthly pro forma cash flow, income, balance sheet, and sources
and applications of funds statements for the first year of operation.

04: To illustrate the benefits of cost-benefit analysis.

05: To explain the application and calculation of the break-even point for the new venture.

06: To illustrate the alternative software packages that can be used for preparing financial
statements.

10-1
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Education.
Chapter 10 - The Financial Plan

CHAPTER OUTLINE AND TEACHING NOTES


OPENING PROFILE—Nailah Ellis-Brown.

I. THE FINANCIAL PLAN Discussion point: It can be beneficial


to have several sets of financial
A. The financial plan provides a complete picture statements available to illustrate the
of: principles in this chapter.

1. How much and when the funds are coming


into the organization.
2. Where the funds are going.
3. How much cash is available.
4. The projected financial position of the firm.
B. The financial plan provides the short-term basis
for budgeting and helps prevent a common
problem—lack of cash.
C. The financial plan must explain how the
entrepreneur will meet all financial obligations This chapter discusses each of the
and maintain its liquidity. major financial items included in the
financial plan: pro forma income
D. In general, the financial plan will need three statements, pro forma cash flow, pro
years of projected financial data for outside forma balance sheet, and break-even
investors. analysis.

II. OPERATING AND CAPITAL


Learning Objective 01
BUDGETS To understand the role of budgets in
preparing pro forma statements.
A. Before developing the pro forma income

10-2
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Chapter 10 - The Financial Plan

CHAPTER OUTLINE AND TEACHING NOTES


statement, the entrepreneur should prepare
operating and capital budgets.
1. If the entrepreneur is a sole proprietor, they
will be responsible for budgeting decisions.
2. In a partnership, or where employees exist, Entrepreneur in Action: An off-hand
remark at a cocktail party – How come
the initial budgeting process may begin with no one makes horizontal cords? –
one of these individuals. proved to be the launching point of Chris
Lindland’s Clothing. By the time the first
3. Final determination of budgets will saleable product was available, it was
ultimately rest with the owners or January and the stores were buying
entrepreneurs. summer apparel. Rather than wait – with
the related cash flow problems – he set
B. In the preparation of the pro forma income up a website. He sold 2000 pairs of
statement, the entrepreneur must first develop a trousers at $88 each and has over 500
e-mails from women wanting a female
sales budget, an estimate of the expected volume version. (Null, Christopher “Nice
of sales by month. (Horizontal) Pants!” Business 2.0
December 2005, pg. 68
1. The key element in the budget is projected http://money.cnn.com/magazines/
sales. business2/business2_archive/
2005/12/01/8364593/index.htm)
2. From sales forecasts, the entrepreneur will
determine the cost of these sales.
3. Also included will be the estimated ending
inventory needed as a buffer against possible
fluctuations in demand and the costs of direct Table 10.1
“A Sample Manufacturing Budget for
labor and materials. First Three Months”
C. Production or Manufacturing Budget Tables 10.1, and 10.2 provide the basis
for the pro forma statements discussed
1. This budget provides a basis for projecting in this chapter.
10-3
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Chapter 10 - The Financial Plan

CHAPTER OUTLINE AND TEACHING NOTES


cash flows for the cost of goods produced,
which includes unit in inventory.
2. The important information from this budget
is the actual production required each month
and the inventory needed to allow for
changes in demand.
3. This budget is a real determination of how
much will be spent and for what purpose
money will be used.
4. This budget can be a valuable tool to assess
cash needs in ventures which require high
levels of inventory or where demand
fluctuates because of seasonality.
Table 10.2
D. Operating Budget “A Sample Operating Budget for First
Three Months”
1. The next focus is on operating costs. Tables 10.1, and 10.2 provide the basis
2. List fixed expenses (incurred regardless of for the pro forma statements discussed
in this chapter.
sales volume) – rent, utilities, salaries,
advertising, depreciation, and insurance.
3. Calculate variable expenses, which vary
from month to month depending on sales ETHICS
activity or changes in marketing strategy. Ethical Dilemma

4. This budget along with the manufacturing Is it ethical to apply your


professional
budget provides the basis for the pro forma skills for external
statements. benefits?

10-4
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Chapter 10 - The Financial Plan

CHAPTER OUTLINE AND TEACHING NOTES


E. Capital budgets are used for evaluating
expenditures that will impact the business for Any significant capital expenditure or
more than one year. project can be subject to a simple cost Learning Objective 04
benefit analysis. To illustrate the benefits of cost-benefit
1. A capital budget may project expenditures analysis.
for new equipment, vehicles, computers, or 1. Determine all the costs. Some
new facilities. may be direct and some
indirect. Take the time to
2. These decisions may include evaluating the brainstorm all the costs. AS SEEN IN BUSINESS NEWS:
cost of make or buy decisions in 2. Brainstorm with management How to do a Simple Cost Benefit
the benefits of the additional Analysis
manufacturing or a comparison of leasing, expenditure. A cost-benefit analysis can often help in
buying used or buying new equipment. 3. If an investment is expected to determining whether an investment in
increase revenue by $500,000 capital equipment is necessary. A
3. The entrepreneur should enlist the assistance in the first year and total costs discussion of this technique can be
of an accountant for large projects. were estimated at $197,300, found in text box and summarized in the
then the payback of the middle column.
III. FORECASTING SALES investment is
$197,300/$500,000 = .39 of a
A. There are many different methods for projecting
year or 4 months.
sales, some quantitative and some qualitative. 4. The revenue stream is critical.
Most startups rely on more qualitative methods.
There is uncertainty in such an analysis
B. In order to project sales simply and reasonably but it gives a sense of value to attach to
using qualitative methods: an expenditure.

1. Research everything about other startups in Cost benefit analysis is a simple


the same industry – their experience can approach that does not consider the
cash flows or the value of money over a
provide expectations for early sales.
period of time. However, as an initial
2. Local chambers of commerce or other review it can be helpful in making
important decisions where the costs and
business organizations, may provide
benefits are fairly straight forward.
information on expected first year sales.
10-5
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Chapter 10 - The Financial Plan

CHAPTER OUTLINE AND TEACHING NOTES


3. Be aware that sales estimated may be wrong,
irrespective of what approach of research
they use. It may be beneficial to estimate
sales at several levels reflecting contingency
estimates as part of the financial plan.
C. The pro forma income statement requires
monthly projections. Sales figures may vary
each month depending on seasonality and should
be reflected in the monthly projections.

Learning Objective 03
IV. PRO FORMA INCOME STATEMENTS
To learn how to prepare monthly pro
A. Sales are the major source of revenue; since The marketing plan discussed in Chapter forma cash flow, income, balance
08 provides an estimate of sales for the sheet, and sources and applications of
other activities relate to sales, it is usually the
next twelve months. funds statements for the first year of
first item that must be defined. operation.
B. In preparing the pro forma income statement,
sales by month must be calculated first. KEY
TER M
1. It takes a while for any new venture to build
up sales. Pro forma income
Projected net profit calculated from
2. The costs of achieving these increases in projected revenue minus projected
sales can be disproportionately higher in costs and expenses

some months. Table 10.3


C. Sales revenues for an Internet startup are often “MPP Plastics Inc., Pro Forma Income
Statement, First Year by Month”
more difficult to project. The company begins to earn a profit in
1. Extensive advertising is needed to attract the eleventh month.
10-6
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Chapter 10 - The Financial Plan

customers to the website. Entrepreneur in Action: NurseSwap is a


web-based service geared to aid in more
2. There will be little sales revenue until site efficient employment of freelance nurses.
traffic increases. Employers looking to hire nurses or other
healthcare professional pay a listing fee.
3. A giftware Internet startup could project the Once the employee is located there is
number of average hits expected per day or another fee based on the type of job.
(Copeland, Michael V., Malik, OM, &
month based on industry data. Schonfeld, Erick “Do This, Get Rich”
4. From the number of “hits” it is possible to Business 2.0, May 2005, pg. 78)

project the number of consumers who will


buy products and the average dollar amount
per transaction. In the Press: Experts agree: having a
budget is how a small business stays in
D. The pro forma income statements also provide control of its cash flow. It’s best to have
projections of all operating expenses for each both a short-range and a long-range
budget, as well. (Rosemary
month of the first year. Peavler,”Definition of Budgeting for
1. Selling expenses as a percentage of sales Business, updated April 08, 2018
https://www.thebalancesmb.com/budgeting
may also be higher initially. -for-business-393264)
2. The cost of goods sold can either be directly
computing cost of producing a unit times the Some industries publish standard cost
number of units sold or by using an industry ratios, which can be found in sources such
standard percentage of sales. as those listed in Table 7.2.

3. Salaries and wages reflect the number of


personnel employed and their roles in the See the organization plan in Chapter 09.

organization.
4. The entrepreneur should also consider
increasing selling expenses as sales increase,
adjusting taxes due to the addition of new

10-7
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Chapter 10 - The Financial Plan

personnel or raises in salary, increasing


These adjustments actually occur in Table
office expenses relative to the increase in 10.3 and are reflected in the month-by-
sales, and modifying the advertising budget month pro forma income statement for year
for seasonality or visibility. one.

5. Any noteworthy changes that are made in


the pro forma income statement should be
labeled, with explanations provided.
E. In addition to the monthly pro forma income
Table 10.4
statement for the first year, projections should be “MMP Plastics Inc., Pro Forma Income
made for years 2 and 3. Statement, Three-Year Summary ”
Year one totals were calculated in
1. Investors generally prefer to see three years Table 10.3, this table shows yearly
of income projections. totals for each of the first three years.

2. Some expenses will remain stable over time,


like depreciation, utilities, rent, insurance,
and interest.
3. Calculation of percent of sales for each of the
expense items for year 1 can be used as a
guide for determining projected sales and
expenses for year 2, and then for year 3.
4. Selling expenses, advertising, salaries and
wages, and taxes may be represented as a
percentage of projected net sales.
5. When calculating the projected operating
expense, it is important to be conservative
for initial planning purposes.

10-8
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Chapter 10 - The Financial Plan

F. For the Internet startup, capital budgeting and


operating expenses will involve equipment
purchasing or leasing, inventory, and advertising
expenses.

V. PRO FORMA CASH FLOW


Learning Objective 02
A. Cash flow is not the same as profit. To understand why positive profits can
still result in a negative cash flow.
1. Profit is the result of subtracting expenses
from sales.
2. Cash flow is the difference between actual In the Press: How do you improve your
cash receipts and cash payments. cash flow? Here’s some advice:
1. Require a down payment on projects.
3. Cash flows only when actual payments are 2. Set your terms to be paid in full upon
made or received. completion.
3. Negotiate terms with your vendors for
4. Depreciation is an expense, which reduces 20 days or more.
profit, not a cash outlay. 4. Have a collection process in place and
follow through.
B. For an Internet startup, transactions involve the 5. Set up an emergency line of credit at
use of a credit card—1-3% of the sale would be your bank.
paid as a fee to the credit card company. 6. Factor your receivables.
7. Minimize the draws you take from the
C. On many occasions, profitable firms fail because business.
of lack of cash; therefore, using profit as a means (Newman, Pam “7 Tips for Improving Your
Cash Flow” Entrepreneur June 2006
of success may be deceiving. http://www.entrepreneur.com/
D. There are two standard methods used to project money/moneymanagement/financial
managementcolumnistpamnewman/
cash flow – direct and indirect. article159782.html)
1. In the indirect method some adjustments are
made to the net income based on the fact that Table 10.5
“Statement of Cash Flows: The
10-9
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Chapter 10 - The Financial Plan

actual cash may not have actually been Indirect Method”


The indirect method is more popular
received or disbursed. than the direct method because it is
2. The direct method, a simple determination of easier to assemble.

cash in less cash out, gives a fast indication


of the cash position of the new venture at a
point in time.
E. It is important for the entrepreneur to make KEY
TER M
monthly projections of cash, pro forma cash
flow. Pro forma cash flow
Projected cash available calculated
1. If disbursements are greater than receipts in from projected cash accumulations
any time period, funds will have to be minus projected cash disbursements
borrowed or cash reserve tapped.
2. Large positive cash flows may need to be
invested in short-term sources.
3. Usually, the first few months of startup will Chapter 13 discusses how the
require external cash (debt) to cover outlays. entrepreneur can manage growth and
hence cash flow in the early years of a new
4. Negative cash flows are very likely for a new venture while this chapter focuses on how
venture. to project cash flow before the venture is
launched.
F. The most difficult problem with projecting cash Table 10.6
flows is determining the exact monthly receipts “MPP Plastics Inc., Pro Forma Cash
Flow, First Year by Month”
and disbursements. This statement shows a negative cash
flow for the first eleven months of
1. Assumptions should be conservative so operation.
enough funds can be maintained to cover the
negative cash months.
2. Using conservative estimates, cash flow can

10-10
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Chapter 10 - The Financial Plan

be determined for each month.


3. These cash flows will also help determine
how much money will need to be borrowed.
G. The pro forma cash flow is based on best
estimates and may need to be revised to ensure
accuracy.
H. It is useful to provide several scenarios, each
based on different levels of success.

VI. PRO FORMA BALANCE SHEET


A. Using the pro forma income and cash flow KEY
TER M
statements, the entrepreneur should prepare a
projected balance sheet. In the Press: Should you hire an Pro forma balance sheet
accountant? Here’s some good reasons for Summarizes the projected assets,
1. The pro forma balance sheet reflects the liabilities, and net worth of the new
doing so:
position of the business at the end of year 1 They can help you decide what sort of venture
one. legal business entity you should adopt.

2. It summarizes the assets, liabilities, and the 2 They can design your accounting
system. Table 10.7
net worth of the entrepreneurs. “MPP Plastics Inc., Pro Forma
3 They will ensure you pay the correct
3. Every business transaction affects the taxes and correct amounts. Balance Sheet, End of First Year”
Total assets equal the sum of
balance sheet. 4 They will ensure tax forms go out at the
liabilities and owners’ equity.
proper times.
4. The balance sheet is a picture of the business 5 They can advise you on deduction and
at one moment in time and does not cover a separating your business and personal
period of time. expenses.
6 They will help you through an audit if
B. Assets necessary. KEY
TER M
1. Assets represent everything of value that is 7 They can advise whether it’s better to

10-11
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Chapter 10 - The Financial Plan

owned by the business. lease or buy. Assets


8 They can help you understand what Items that are owned or available to
2. Value is not necessarily replacement cost—it your financial statements are saying. be used in the venture operations
is the actual cost expended for the asset. (Lowe, Keith “Why You Need an
Accountant” Entrepreneur June 3, 2002
3. The assets are either current or fixed.
a. Current assets include cash and anything http://www.entrepreneur.com/
that will be converted into cash or money/moneymanagement/
consumed in the operation within a year. bookkeeping/article52324.html)

b. Fixed assets are tangible and will be used


over a long period of time.
c. Management of receivables, or money
that is owed to the new venture from
customers, is important to the cash flow A more detailed discussion of receivables
of the business. in included in Chapter 13.

C. Liabilities KEY
TER M
1. Liabilities represent everything owed to
creditors. Liabilities
Money that is owed to creditors
2. Current liabilities represent everything owed
to the creditors and due within a year.
3. Long-term liabilities extend over one year.
4. During recessions many firms hold back
payment of their bills to better manage cash
flow.
D. Owners’ equity is the excess of all assets over all
liabilities. KEY
TER M

10-12
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Chapter 10 - The Financial Plan

1. Owner equity represents the net worth of the Owner equity


The amount owners have invested
business. and/or retained from the venture
2. Any profit from the business will also be operations

included in the net worth as retained


earnings.

VII. BREAK-EVEN ANALYSIS


Learning Objective 05
A. In the initial stages of the new venture the Discussion point: Given the following To explain the application and
information, calculate breakeven: calculation of the break-even point for
entrepreneur should know when a profit may be Annual rent = $10,000 the new venture.
achieved. Salaries = $50,000
Miscellaneous fixed costs = $40,000
1. Break-even analysis is a technique for Raw materials = $4.00/unit
Packaging = $.10/unit
determining how many units must be sold in Direct labor = $3.40/unit
order to break even. Sales price = $10/unit
(ANSWER: 40,000)
2. The firm has fixed cost obligations that must What if annual capacity is only 30,000?
What will the entrepreneur need to charge
be covered by sales volume in order for a to achieve breakeven in the first year
KEY
TER M
company to break even. (assuming the market will bear the
increased price)? Breakeven
3. Breakeven is that volume of sales at which Formula: Volume of sales where the venture
$ 100,000
the business will neither make a profit nor 30,000 = SP – 7.50 neither makes a profit nor incurs a loss
incur a loss. (ANSWER: $10.8333 or $10.84)
What if the market will only pay $10? What
4. The break-even sales point is the volume of must the company do to achieve breakeven
in the first year?
sales needed to cover total variable and fixed (ANSWER: find a way to lower fixed or
expenses. variable costs OR a way to increase
capacity.)

Table 10.8
B. The break-even formula is: B/E(Q) = break even quantity “Determining the Break-Even Formula”
TFC = total fixed costs
10-13
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Chapter 10 - The Financial Plan

B/E (Q) = TFC   SP = selling price


SP-VC/unit (marginal contribution) VC/unit = variable cost per unit

1. As long as the selling price is greater than


the variable costs per unit, some contribution
can be made to cover fixed costs.
2. The major weakness in calculating
breakeven is determining whether a cost is
fixed or variable – may require judgment.
3. Fixed costs are usually depreciation, salaries
Figure 10.1
and wages, rent, and insurance. “Graphic Illustration of Breakeven”
One of the unique aspects of
4. Materials, selling expenses, and direct labor
breakeven is that it can be graphically
are most likely to be variable costs. displayed.
C. When the firm produces more than one product,
and it is feasible to allocate fixed costs to each
product, then it is possible to calculate a break-
even point for each product.
D. The entrepreneur can adjust variables such as
price to see the impact on breakeven and profits.

VIII. PRO FORMA SOURCES AND KEY


TER M

APPLICATIONS OF FUNDS Pro forma sources and applications


A. The pro forma sources and applications of of funds
Summarizes all the projected sources
funds statement illustrates the disposition of of funds available to the venture and
earnings from operations and other financing. how these funds will be disbursed

1. Its purpose is to show how net income and


financing were used to increase assets and Table 10.9
10-14
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Chapter 10 - The Financial Plan

pay off debts. In the Press: Changes in the procedures “MPP Plastics Inc., Pro Forma
followed by small businesses have recently Sources and Applications of Funds,
2. It is often difficult for the entrepreneur to been introduced. Previously small End of First Year”
understand how the net income of the year businesses conformed to procedures
known as the Generally Accepted
was disposed of. Accounting Principles (GAAP). For a
B. Typical sources of funds are from operations, number of years, small businesses argued
that these standards were not really
new investments, long term borrowing, and sale appropriate for them and are too costly for AS SEEN IN BUSINESS NEWS;
of assets. them to maintain. Sarbanes-Oxley (see Elevator Pitch For Safe Driving Apps
chapter 9), in particular can be onerous for
C. The major uses or applications of funds are to small businesses as well. OCBOA is the
increase assets, retire long-term liabilities, term used for a comprehensive basis of
reduce owner equity, and pay dividends. accounting other than GAAP principles.
(Abbot, Erin, “What is OCBOA?” July 17,
D. This statement emphasizes the interrelationship 2013).
of these items to working capital. https://www.schneiderdowns.com/our-
thoughts-on/audit/what-is-ocboa

Entrepreneur in Action: Ryuji Ishii is the Learning Objective 06


IX. SOFTWARE PACKAGES
US sushi king. He was able to convince a To illustrate the alternative software
A. There are several financial software packages west coast grocery chain, Vons, into a six packages that can be used for
month trial before he even had a company. preparing financial statements.
that can track financial data and generate any
Now he’s up to over 1,700 grocery stores
important financial statement. and a wide range of sushi types. (Darlin,
Damon, “Rise Of The Sushi King” Business
1. The easiest way to complete pro forma
2.0 December 2004 pg. 80
statements is to use a spreadsheet program. http://money.cnn.com/magazines
/business2/business2_archive/
2. Microsoft Excel is widely used.
2004/12/01/8192544/index.htm)
3. Using a spreadsheet for financial projections
in the startup phase helps present different
scenarios and assesses their impact on the
pro forma statements.
B. In the startup stage where the venture is very
10-15
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Chapter 10 - The Financial Plan

small and resources limited, the software


selected should be very simple and easy to use.
1. Most packages allow check writing, payroll,
invoicing, inventory management, bill
paying, credit management, and taxes. Discussion point: Visit the websites of
several of these software packages to
2. One of the simplest and most widely used in illustrate the pros and cons of the
small business if Intuit’s Quickbooks. You packages. If the school’s accounting
can purchase online use or software for the department advocates a certain software
package, consider a guest speaker who
desktop. can illustrate the package.
3. Other options are FreshBooks, Wave, and
Zoho Books.

X. IN REVIEW: SUMMARY.
See “Learning Objectives Revisited” below.

10-16
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Chapter 10 - The Financial Plan

LEARNING OBJECTIVES REVISITED

Learning Objective 01: To understand the role of budgets in preparing pro forma
statements.
● The entrepreneur must first develop a sales budget, an estimate of the
expected volume of sales by month.
● The production or manufacturing budget provides a basis for projecting
cash flows for the cost of goods produced.
● The operating budget focuses on operating costs, separating fixed from
variable costs.
● Capital budgets are used to evaluate expenditures that will impact the
business for more than one year.

Learning Objective 02: To understand why positive profits can still result in a negative
cash flow.
● Cash flow is not the same as profit.
● On many occasions, profitable firms fail because of lack of cash;
therefore, using profit as a means of success may be deceiving.
● If disbursements are greater than receipts in any time period, funds will
have to be borrowed or cash reserve tapped.
● Negative cash flows are common for new ventures.
● The pro forma cash flow is based on best estimates and may need to be
revised to ensure accuracy.

Learning Objective 03: To learn how to prepare monthly pro forma cash flow, income,
balance sheet, and sources and applications of funds
statements for the first year of operation.
● In preparing the pro forma income statement, sales by month must be
calculated first.
 The pro forma income statements also provide projections of all
operating expenses for each month of the first year.
 Any noteworthy changes that are made in the pro forma income
statement should be labeled and explanation provided.
 Projections should be made for years 2 and 3 as well.

10-17
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McGraw-Hill Education.
Chapter 10 - The Financial Plan

 When calculating the projected operating expense, it is important


to be conservative for initial planning purposes.
● It is important for the entrepreneur to make monthly projections of cash,
the pro forma cash flow statement.
 Cash flow results from the difference between actual cash receipts
and cash payments.
 Cash flow can be calculated by the indirect or by the direct
method.
 If disbursements are greater than receipts in any time period, funds
will have to be borrowed or cash reserve tapped.
 Large positive cash flows may need to be invested in short-term
sources.
 The most difficult problem with projecting cash flows is
determining the exact monthly receipts and disbursements.
 It is useful to provide several scenarios, each based on different
levels of success.
● The entrepreneur should also prepare a pro forma balance sheet depicting
the condition of the business at the end of the first year.
 The balance sheet is a picture of the business at one moment in
time and does not cover a period of time.
 Assets represent everything of value that is owned by the business,
and may be current or fixed.
 Liabilities accounts represent everything owed to creditors.
 Owner equity represents the excess of all assets over all liabilities,
or the net worth of the business.
● The pro forma sources and applications of funds statement illustrates the
disposition of earnings from operations and from financing.
 Its purpose is to show how net income and financing were used.
 Typical sources of funds are from operations, new investments,
long term borrowing, and sale of assets.
 The major uses or applications of funds are to increase assets,
retire long term liabilities, reduce owner equity, and pay dividends.

Learning Objective 04: To illustrate the benefits of cost-benefit analysis.

10-18
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McGraw-Hill Education.
Chapter 10 - The Financial Plan

● Any significant capital expenditure or project can be subject to a simple


cost benefit analysis.
 Determine all the costs. Some may be direct and some indirect.
Take the time to brainstorm all the costs.
 Brainstorm with management the benefits of the additional
expenditure.
 If an investment is expected to increase revenue by $500,000 in the
first year and total costs were estimated at $197,300, then the
payback of the investment is $197,300/$500,000 = .39 of a year or
4 months.
 The revenue stream is critical.
 There is uncertainty in such an analysis but it gives a sense of value to
attach to an expenditure.

 Cost benefit analysis is a simple approach that does not consider the cash
flows or the value of money over a period of time.
 However, as an initial review it can be helpful in making important
decisions where the costs and benefits are fairly straight forward.

Learning Objective 05: To explain the application and calculation of the break-even
point for the new venture.
● Break-even analysis is a technique for determining how many units must
be sold in order to break even.
● Breakeven is that volume of sales at which the business will neither make
a profit nor incur a loss.
● The break-even sales point is the volume of sales needed to cover total
variable and fixed expenses.

Learning Objective 06: To illustrate the alternative software packages that can be used
for preparing financial statements.
● In completing pro forma statements, it is probably easiest to use a
spreadsheet program on MS Excel.
● In the startup stage, select software that is very simple and easy to use.
● Most packages allow check writing, payroll, invoicing, inventory
management, bill paying, credit management, and taxes.

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Chapter 10 - The Financial Plan

KEY TERMS

Assets: Items that are owned or available to be used in the venture operations
Breakeven: Volume of sales where the venture neither makes a profit nor incurs a loss
Liabilities: Money that is owed to creditors
Owner equity: The amount owners have invested and/or retained from the venture
operations
Pro forma balance sheet: Summarizes the projected assets, liabilities, and net worth of
the new venture
Pro forma cash flow: Projected cash available calculated from projected cash
accumulations minus projected cash disbursements
Pro forma income: Projected net profit calculated from projected revenue minus
projected costs and expenses
Pro forma sources and applications of funds: Summarizes all the projected sources of
funds available to the venture and how these funds will be disbursed

RESEARCH TASKS AND CLASS DISCUSSIONS

The text includes several topics for student research and class discussions. These
questions are open-ended, and the answers will be different for each student. There are no
“correct” answers.

Research tasks:

1. Go online and identify some of the new web-based financial


software packages. How are they different? What advantages do
Quickbooks (which seems to be the most popular) have over these web-
based services?
2. Companies planning to make an initial public offering (IPO) must
submit a financial plan as part of their prospectus. From the Internet
collect a prospectus from three different companies and analyze their
financial plan. What are the major assumptions made in constructing these
financial plans? Compare and contrast these financial plans with what we
would expect of a financial plan as part of a business plan.
3. A startup has sales in the first three months of $20,000 yet there is
not enough funds in the checking account to meet the payroll. How do you
10-20
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Chapter 10 - The Financial Plan

explain this? What can the owner do to assess this situation and improve
upon it to meet financial obligations?
4. What are the advantages and disadvantages of doing a simple cost
benefit analysis on a startup that is considering the investment in new
equipment that will cost $10,000?
Class Discussions
1. Is it more important for an entrepreneur to track cash or profits? Does it
depend on the type of business and/or industry? What troubles will an
entrepreneur face if she or he tracks only profits and ignores cash? What
troubles will an entrepreneur face if she or he tracks only cash and ignores
profits?
Answer:
Tracking both cash and profit is important for an entrepreneur. However,
tracking cash flow is more important and does not depend on the type of
business and/or industry. Tracking only profits and ignoring cash can
prove to be devastating to the venture. Profit is the result of subtracting
expenses from sales, whereas cash flow results from the difference
between actual cash receipts and cash payments. Sales may not be
regarded as cash because a sale may be incurred but payment may not be
received. In the indirect cash flow method, the objective is not to repeat
what is in the income statement but to understand there are some
adjustments that need to be made to the net income based on the fact that
actual cash may or may not have actually been received or disbursed. It is
difficult to determine the cash flow without tracking the profit because
cash is a result of profit. Cash flow is an adjustment of profit according to
the accounts receivables and accounts payables.

2. What volume of sales is required to reach breakeven for the following


business: The variable cost of producing one unit of the product is $5, the
fixed costs of plant and labor are $500,000, and the selling price of a
single product is $50. It is not always easy to classify a cost as fixed or
variable. What happens to the breakeven calculated above if some of the
fixed costs are reclassified as variable costs? What happens if the reverse
is the case—some of the variable costs are classified as fixed costs?
Answer:
Breakeven calculation:
B/E (Q) =
TFC                                                 
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Chapter 10 - The Financial Plan

SP-VC/unit (marginal contribution)

B/E (Q) =         $500,000          = $500,000


$50 -$5 $45

B/E (Q) = 11,111.1, or 11,112 units

If some of the fixed costs are reclassified as variable, breakeven would


increase. If some of the variable costs are classified as fixed costs,
breakeven would decrease.
3. How useful is a financial plan when it is based on assumptions of the
future and we are confident that these assumptions are not going to be 100
percent correct? Does it make more sense for the entrepreneur to evaluate
and modify financial plans monthly or wait for results from quarterly
reports? Why or why not?

Answer:
The financial plan provides the entrepreneur with a complete picture of
how much and when funds are coming into the organization, where funds
are going, how much cash is available, and the projected financial position
of the firm. It provides the short-term basis for budgeting control and
helps prevent one of the most common problems for new ventures—lack
of cash.
Assumptions of the future are useful even if they are not 100 percent
correct. If you can float your bills longer than your customers do, cash will
actually accumulate in your business. However, if your customers are
dragging their feet, cash is going out the door. The bigger the difference,
the faster the cash is flowing—in or out. The entrepreneur should also
consider the fact that sales may vary each month depending upon the
seasonality of the product and need to be reflected in the monthly
projections. Also, changes in operating and marketing strategies may also
affect sales and would need to be included in the estimates. Having a clear
idea of the kind of business, the seasonality of the product and taking a
cue from other businesses in the same industry will assist the entrepreneur
in making the right decision.

10-22
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