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Chapter 10
THE FINANCIAL PLAN
LEARNING OBJECTIVES
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.
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.
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Education.
Chapter 10 - The Financial Plan
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Chapter 10 - The Financial Plan
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Chapter 10 - The Financial Plan
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
organization.
4. The entrepreneur should also consider
increasing selling expenses as sales increase,
adjusting taxes due to the addition of new
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Chapter 10 - The Financial Plan
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Chapter 10 - The Financial Plan
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Chapter 10 - The Financial Plan
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
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Chapter 10 - The Financial Plan
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
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Chapter 10 - The Financial Plan
Table 10.8
B. The break-even formula is: B/E(Q) = break even quantity “Determining the Break-Even Formula”
TFC = total fixed costs
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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
X. IN REVIEW: SUMMARY.
See “Learning Objectives Revisited” below.
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Chapter 10 - The Financial Plan
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.
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Chapter 10 - The Financial Plan
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McGraw-Hill Education.
Chapter 10 - The Financial Plan
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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McGraw-Hill Education.
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
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:
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.
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.
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