Week 6 Slides (3) (1).pptx

Dr Bridget Irene
International Centre for Transformational Entrepreneurship
(ICTE)
Week 6
4004ICTE
Financial Feasibility

Resources to help
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Session Outline
After this session, you should be able to:
Explain the meaning and purpose of financial plan.
Describe the content of financial plan
Forecast a new venture’s profitability.
Determine asset requirements, evaluate financial sources,
and estimate cash flows for a new venture.
Conduct break-even analysis.

The Financial
Plan
 It provides the entrepreneur with a complete picture of:
 The amount funds and when they are coming into
the organization.
 Where funds are going and how much cash is
available.
 The projected financial position of the firm.
 The plan explains how the entrepreneur intends to
meet financial obligations and maintain the venture’s
liquidity.

Elements of Financial plan
 Financial plan consists of four elements:
(i) Proforma income statement: Revenue and expenses projections,
(ii) Proforma balance sheet: Assets, liabilities and capital projections
(iii) projected cash flow/Cash budget: Sources and uses of funds
projections.
(iv) Break-even analysis: Projections on the relationships between
revenue, cost and profit.

Format for Proforma Income statement

Pro Forma
Income
Statements
• Revenue/Sales Budget:
• Sales by month is calculated first.
• Basis of the figures - Marketing research,
industry sales, trial experience, forecasting,
and financial data on similar start-ups.
• Projected sales=expected Unit price *expected
Quantity to be sold

Pro Forma Income Statements
How to create a sales forecast:
1.List out the goods and services
you sell
2.Estimate how much of each you
expect to sell
3.Define the unit price or dollar
value of each good or service sold
4.Multiply the number sold by the
price
 For example, if a book shop expects to sell
120 books in their month one and each
book costs $20, their sales budget would be
120 books x $20 =$2,400 for their first month.

A Sample Revenue or sale Budget for First year ($000s)

Pro Forma
Income
Statements
Cost of sales/manufacturing projections:
• Cost of sales can be determined from the sales forecasts.
• It includes the costs of raw materials, direct labor costs,
freight-in costs, and direct factory overhead costs, such as
utilities for the manufacturing site.
• Usually a percentage of sales
• Includes estimated ending inventory required as a buffer.
• In manufacturing ventures, costs of internal production and
subcontracting are compared.
• COGS often appears as the second line item in an income
statement, right after the revenue.
• It is subtracted from revenue to calculate gross profit.
• Expected unit cost* projected production units.

Pro Forma Income Statements
How to create cost of sales forecast
1.Determine how much it will cost to
produce and sell each good or service
2.Estimate the number of units to
produce or customer to serve
3.Multiply this cost by the estimated
sales volume
 For example, if a book shop expects to
sell 120 books in their month one and
each book costs $12, their cost of sales
budget would be:
 120 books x $12 =$1,440 for their first
month

A Sample Manufacturing Budget for First Three
Months (in units)
• In manufacturing ventures, costs of internal production and subcontracting
are compared.
• Includes estimated ending inventory required as a buffer.

Pro Forma
Income
Statements
 Operating costs budgets:
• Projections of all operating expenses for each of
the months during the first year should be made.
• Includes fixed expenses incurred regardless of
sales volume.
• Variable expenses must be linked to strategy in
the business plan.
 Capital budgets provide a basis for evaluating
expenditures that will impact the business for more
than one year.

A Sample Operating Budget for First
Three Months ($000s)

Pro Forma
Income
Statements
(cont.)
• Increasing selling expenses as sales
increase should be taken into account.
• Changes in expenses during the first year
can necessitate month-by-month
illustration.
• Increase in individual expenses need to
be reflected in the first year’s pro forma
income statement.
• Projections should be made for years 2
and 3 as well; consider expenses that are
likely to remain stable over time.

MPP Plastics Inc., Pro Forma Income Statement,
First Year by Month ($000s)
Net Profit

Pro Forma
Cash Flow
• Projected cash available calculated from
projected cash accumulations minus
projected cash disbursements.
• It is not the same as profit.
• Sales may not be regarded as cash.
• Use of profit as a measure of success
may be deceiving if there is significant
negative cash flow.
• Cash flow can be projected using the
indirect or direct method.

PRO FORMA
CASH FLOW
STATEMENT
 In financial accounting, a cash flow statement (also known as
statement of cash flows or funds flow statement)
 The cash flow statement, as the name suggests, provides a picture of
how much cash is flowing in and out of the business during the fiscal
year.
 The cash flow is widely believed to be the most important of the three
financial statements because it is useful in determining whether a
company will be able to pay its bills and make the necessary
investments.
 A company may look really great based on the balance sheet and
income statement, but if it doesn’t have enough cash to pay its
suppliers, creditors, and employees, it will go out of business.
 A positive cash flow means that more cash is coming into the company
than going out, and a negative cash flow means the opposite.

Cash flows are used for:
 Measure liquidity and the capacity to change cash flows in future
circumstances
 Provide additional information for evaluating changes in assets,
liabilities, and equity
 Compare between different firms’ operating performance
 Predict the amount, timing, and probability of future cash flows
Purpose of Proforma Cash Flow Statements

CASH FLOW
STATEMENT
The cash flow statement is partitioned into
three segments, namely:
• Cash flow resulting from operating activities
• Cash flow resulting from investing activities
• Cash flow resulting from financing
activities.
• Net increase / Decrease in cash
It also may include a disclosure of non-cash
financing activities.

Pro Forma
Cash Flow
(cont.)
 Entrepreneurs must make monthly
projections of cash.
• If disbursements are greater than receipts
- entrepreneur must either borrow funds
or have cash in a bank.
• Large positive cash flows need to be
invested or deposited in a bank for
periods when disbursements are greater
than receipts.
• Determining the exact monthly receipts
and disbursements is difficult.
 Pro forma cash flow is based on best
estimates.

Cash flow from
operating
activities
 Receipts:
Collections from customers
Receipts of interests and dividends
Other operating receipts
 Payments:
Payments to suppliers
Payments to employees
Payments of interest and income tax
Other operating disbursements
Operating Activities -
activities that generate
revenues or expenses in
the company’s major
line of business.

Cash flow from
Investing
Activities
 Receipts
Sale of plant assets
Sale of long term investments
Receipts on loans receivable
 Disbursements
Acquisition of plant assets
Purchase of long term investments
 Making loans
Investing Activities -
activities that increase
or decrease the long
term assets of a
business

Cash flow from
financing
activities
 Receipts:
Issuing of stock
Selling treasury stock
Borrowing money using notes and bonds
payable
 Disbursements:
Payment of dividends
Purchase of treasury stock
Payment of principal amount of debts
Financial Activities -
activities that obtain the
cash needed from
investors and creditors
to launch and sustain
the business.

Cash flows from operating activities:
Cash receipts (individually): Inflows $ XXX
Cash payments to suppliers (separately): outflows ($ XXX)
Net cash flow from operating activities $ XXX
Cash flows from investing activities:
(List of individual inflows and outflows) $ XX
Net cash flow from investing activities $ XXX
Cash flows from financing activities:
(List of individual inflows and outflows) $ XX
Net cash flow from financing activities $ XXX
Abridged Format of the Statement
of Cash Flows: Direct Method

The final section comprises the net cash
increase or decrease for the period as
well as the cash balance at the beginning
and end of the period.
4. Net Increase / Decrease in Cash

Expanded format of Cash flow statement:

Sample of Cashflow statement: Direct method

MPP Plastics Inc., Pro Forma Cash Flow,
First Year by Month ($000s)

Pro Forma
Balance
Sheet
 Summarizes the projected assets, liabilities, and
net worth of the new venture.
• It is a picture of the business at a certain
moment in time and does not cover a period of
time.
• Consists of:
• Assets - Items that are owned or available to
be used in the venture operations; can be
current or fixed.
• Liabilities - Money that is owed to creditors;
can be current or long-term debt.
• Owner’s equity - Amount owners have
invested and/or retained from the venture
operations.

Pro forma Balance Sheet Cont.
Assets
• Current assets: cash and cash equivalents (e.g., short-term government
bonds, treasury bills, and money market funds), accounts receivable, and
inventory.
• Non-currents/Fixed assets: property, plant, equipment, long-term
investments, and intangible assets (e.g., patents and licenses).
Liabilities
• Current liabilities: accounts payable, notes payable due within the year,
and current maturities of long-term debt.
• Non-current liabilities: long-term notes payable, deferred tax liabilities,
bonds payable, and long-term debt

Pro forma Balance Sheet Cont
Shareholders' Equity
 Shareholders' equity, also known as stockholders' equity, is the
amount of money the owners have invested in the business. It
includes:
• Share capital: the amount of money a company receives from its
owners (shareholders) for business purposes.
• Retained earnings: the amount of a company's profits that aren't
distributed to shareholders as dividends — the funds are
reinvested in the business instead.
 With this information in mind, let’s go over the step-by-step
process of creating a balance sheet.

Accounting Equation and the balance sheet

Proforma Balance Sheet
 For example 1, if you were to start a sole trade business with a
$10,000 investment then on the first day of trading the accounts of
the business would show that it has $10,000 of cash available and
that this came from an investment made by you. The accounting
equation would be:
ASSETS = CAPITAL + LIABILITIES
Cash $10,000 = Equity $10, 000 + $0

Proforma Balance Sheet: Accounting Equation
 For example 1, if on the second day of business, you were to use the $10,000 to buy Office equipment
costing $2,500, office furniture costing $2,000, pay rent expenses in advance $1000, fixtures and
fittings $ 800, buy inventory $1800 by cash and $200 on credit.. Then on the first day of trading the
accounts of the business would show that it has $1,000 of cash available and that this came from an
investment made by you. The accounting equation would be:
ASSETS = CAPITAL + LIABILITY
Office equipment $2,500 Equity $10,000 Creditors $200
office furniture $2,000
Rent Advanced payment $1000
Fixtures and fittings $ 800
Inventory (1800+200) $2000
Cash ($10,000-8,300) $1,900
Total 10,200 $10,000 + $200

MPP Plastics Inc., Pro Forma Balance
Sheet, End of First Year ($000s)

How to prepare Proforma Balance sheet for start-ups
Assets
 List all your projected assets
both fixed and current
 Find the market values (prices)
of all the assets listed
 Calculate the total market
values of all the assets.
Liabilities & Capital
 Identify the sources of funds for
the listed assets
 The sources from you the
entrepreneurs personal savings
becomes capital
 Borrowed funds becomes
liabilities

Aims for today
 To understand
what break even
means
How it can be
used to assist
entrepreneurs in
their planning
30/05/2023 Kwame Oduro Amoako (PhD)

What does break even mean?
 Break even is the level of activity where a firmsTOTAL
REVENUE is the same as its TOTAL COSTS
 At the break even point, a firm is neither making a
PROFIT nor A LOSS
Kwame Oduro Amoako (PhD)
30/05/2023

Break-even analysis?
 A break-even analysis is a useful tool for determining at
what point your company, or a new product or service, will be
profitable.
 Put another way, it's a financial calculation used to determine the
number of products or services you need to sell to at least cover
your costs.
 The break even analysis is important to business owners and
managers in determining how many units (or revenues) are needed
to cover fixed and variable expenses of the business.

Uses of break-even analysis
Break-even analysis enables a business organization to:
 Measure profit and losses at different levels of production and sales.
 Predict the effect of changes in sales prices on quantities to be sold.
 Analyze the relationship between fixed and variable costs.
 Predict the effect of cost and efficiency changes on profitability.

Assumptions of break-even
 All costs are divided into fixed and variable costs.
 Fixed costs will remain constant and will not change according to the level of production.
 Variable costs will change in direct proportion according to the level of production.
 Selling price remain constant even though there exists competition or any change in the
volume of production.
 The number of units of production is equal to sales. It means that there is no opening or
closing stock.
 The operating efficiency of the company remains the same.
 There is only one product or product mix in the case of many products will remain
unchanged.

Limitation of break even analysis
 Break-even analysis is based on the assumption that all costs and expenses can be
clearly separated into fixed and variable components.
 It assumes that fixed costs remain constant at all levels of activity. It should be noted
that fixed costs tend to vary beyond a certain level of activity.
 It assumes that variable costs vary proportionately with the volume of output is not
true.
 The assumption that selling price remains unchanged gives a straight revenue line
which may not be true.
 The assumption that only one product is produced or that product mix will remain
unchanged is difficult to find in practice.
 It assumes that the business conditions may not change which is not true.

Methods of conducting break even analysis
Graphical method
Tabular Method
 Use of equation method

Task 2: Draw the break even chart using your data
1. Label the vertical axis “sales and costs in pounds”.
2. Label the horizontal axis “sales/production (units)”.
3. Draw on the BE point
4. Draw a horizontal line for total fixed costs.
5. Starting at the Total costs point, draw the total cost line going through the break even point.
6. Starting at zero, draw the total revenue line through the break even.
7. Where the sales revenue crosses the total costs line is the break even point.
8. Read off the units of sales to give the break even level of sales.
9. The gap between the total costs line and sales revenue line after the break even point
represents the level of profit.
30/05/2023

Graphical method of Breakeven
$
Units Sold
Revenue

Graphic method of Breakeven
0
500
1000
1500
2000
2500
3000
3500
4000
4500
5000
0 25 50 75 100 125 150
Fixed Cost
Revenue
Units Sold
$

0
500
1000
1500
2000
2500
3000
3500
4000
4500
5000
0 25 50 75 100 125 150
Fixed Cost
Total Cost
Revenue
Units Sold
$

0
500
1000
1500
2000
2500
3000
3500
4000
4500
5000
0 25 50 75 100 125 150
Fixed Cost
Total Cost
Revenue
$
Units Sold

Calculating the break even point
Step 1.
Identify fixed & variable costs – add them together to get the TOTAL
costs
Step 2.
Calculate the TOTAL REVENUE
30/05/2023

Task 1: Calculating break even
 Use the following to
complete the table:
 FC=$2000
 VC=$2 per unit
 Selling price=$4
30/05/2023

Task 1: Calculating break even

The break even chart
30/05/2023

Task 3: Draw the margin of safety
30/05/2023

Self test
 BMC operates a hot dog stand in their branch
at Coventry.
 The salaries at the stand costs $200 per week.
Each hot dog needs one bread roll at 20p, one
sausage at 25p and sauces at 5p.
 The selling price of each hot dog is $1

Complete the table
At what quantity do total costs = total revenue? (Break even)
What profit is made when they sell 600 hot dogs?
QUANTITY FIXED
COSTS
VARIABLE
COSTS
TOTAL
COSTS
TOTAL
REVENUE
PROFIT OR
LOSS?
100
150
200
250
300
350
400
450
500
550
600
650

Complete the table
At what quantity do total costs = total revenue? (Break even)
What profit is made when they sell 600 hot dogs?
QUANTITY FIXED
COSTS
VARIABLE
COSTS
TOTAL
COSTS
TOTAL
REVENUE
PROFIT OR
LOSS?
100 200 50 250 100 -150
150 200 75 275 150 -125
200 200 100 300 200 -100
250 200 125 325 250 -75
300 200 150 350 300 -50
350 200 175 375 350 -25
400 200 200 400 400 0
450 200 225 425 450 25
500 200 250 450 500 50
550 200 275 475 550 75
600 200 300 500 600 100
650 200 325 525 650 125

Software
Packages
 A spreadsheet program (Microsoft Excel) is
most suitable for completing pro forma
statements.
• Helps present different scenarios and
assess their impact on the pro forma
statements.
 A simple and easy to use software is useful
in the start-up stage.
 Software packages vary in price and
complexity.

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