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The Financial Plan Chapter 10

Operating and Capital Budgets

In proprietorship, owner prepares that whereas in partnership/corporation, Managers
prepare it and owner approves it.

First find expected sales and from it, find the cost of these sales and ending inventory.
Important considerations are total production required and level of inventory

Second find Operating Costs that includes Fixed Expenses like rent, utilities, salaries
interest, deprecation and Variable Expenses like Adv. and Selling expenses etc.

Capital Budget provides the basis for expenditures impacting business for more than
one year e.g. new equipments, vehicles, computers or new factory etc.

Proforma Income Statement

Proforma income is the projected net profit calculated from projected revenues minus
projected costs and expenses

Preparing the Proforma Income Statement involves, calculate Sales by months, basis
may be marketing research, industry sales and some trial experiences. Certain
forecasting techniques like survey of buyers intentions, sales force opinions, expert
opinions etc can be used to calculate the sales.

List down Projected Operating Expenses that shall have room for adjustment. E.g.
selling expenses increase with increase in business sales and they are usually high in
start.

Finding cost of goods sold that can be either computed variable cost of production and
times number of units sold or by industry percentage of sale

Salaries and wages can be calculated by number of employees required and their roles.

Increased insurance costs, trade show participation or added space for warehousing
shall also be considered. Unusual expenses like Trade Show participation etc shall be
flagged at the bottom of Proforma Income Statement.

New machinery depreciation shall be added

Proforma Income statement shall be prepared First year month wise, and for the year 2
and 3, it shall also be prepared year wise. This can be done through calculating
percentages of cost of goods sold and operating expense in relation to the sales and
multiplying these percentages with the next year forecasted figures.
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For projected expenses in year 2 and 3, first look at the expenses that remain stable
e.g. depreciation, utilities, rent, insurance etc. Be conservative for initial planning
purposes.

In case of an Internet Startup, purchase/lease computers, extensive advertising
expenses e.g. banner advertisement, Search Engine Listing etc, and inventory
expenses are more important.

Proforma Cash Flow

Cash flow is the difference between cash receipts and cash payments (not all sales are
made in cash and not all bills are paid in cash)

Deprecation expense dont account for cash outflow, similarly in an internet startup, fee
going as merchant charges through credit card transactions sales are not received by
the companies.

Using profit as the only measure of a success may mislead if there is a negative cash
flow

Mostly used method for calculating cash flow is Indirect method, objectives of which is
to understand that 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 (figure 10.5)

Monthly projections of cash flow shall be prepared.

If disbursement are more than receipts, entrepreneur has to borrow or use cash in bank
an if receipts are more, he shall invest in short term or deposit in banks

It is difficult to project cash flows on exactly on the basis of monthly receipts and
disbursements. One method is anticipate that 60% of sale in each month is received as
cash and 40% in the subsequent month.

Per month cash flow helps in determining level of borrowings and surplus cash can be
used to repay any debt or invested in highly liquid assets or used to purchase any new
equipment.

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Proforma Balance Sheet
Summarizes the projected assets, liabilities and net worth of the business. It depicts the
situation of the business at end of the year.

Assets represents items that are owned or available to be used by the business.
Divided in to Current Assets, those are highly liquid assets including cash or can be
converted in to cash and consumed in a period of less than one year. Fixed Assets are
tangible and will be used over a long period of time.

Liabilities represent every thing that is owed to the creditors. Current Liabilities are
those which are due within a year whereas Long term Liabilities includes loans/debts
taken by the business for a long time period.

Owner Equity represents excess of all assets over all liabilities showing net worth of the
business. It is the amount invested by the owner. Profits are shown as Retained
Earnings in the Proforma Balance Sheet.

Break Even Analysis
Break Even is the volume of sales where the venture neither makes a profit nor incur a
loss. This point dictates volume of sales need to cover Total Variable and Fixed
Expenses.

It is important to find out when a profit may be achieved thus showing financial potential
for the startup business. Break Even analysis shows how much units must be sold or
how much sales volume must be achieved in order to break even.

Determining the Break Even Formula

Total Revenue (TR) = Total Cost (TC)
Where TR = Selling Price x Quantity (SP x Q)
And TC = Total Fixed Cost (TFC) + Total Variable Cost (TVC)
SP x Q = TFC + TVC
where TVC = Variable cost per unit x Qty (VC/Unit x Q)
SP x Q = TFC + VC/Unit x Q
(SP x Q) VC/Unit x Q = TFC
Q(SP VC/Unit)) = TFC
Q = TFC/SP-VC/unit
Which is the break even quantity

There is a major problem in declaring which cost is variable and which is fixed.
Reasonably deprecation, salaries, wages, rent and insurance are considered as fixed
whereas materials, selling expenses and direct labor are taken as variable costs.

Companies having more than one product, Break Even is calculated for every product
differently.
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Proforma Sources and Uses of Funds

Summaries all the projected sources of funds available for the venture and how these
funds will be disbursed.

Purpose is to show how net income and financing were used to increase assets or pay
off debts.

Typical sources of funds are from operations, new investments, long term borrowings
and sale of assets. Profit is also included as source of fund and deprecation is added
back as it does not go out of pocket.

Applications of funds may include increased assets, retire long term liabilities, reduce
owner equity and pay dividends.

The statement of Proforma Sources and Application of funds statement helps the
entrepreneur and investors in understanding the financial well being of the company
and effectiveness of financial management policies of the company.

Software Packages

Used for tracking financial data and generate financial statements. Other purpose may
include check writing, payroll, invoicing, inventory management, bill paying, credit
management and taxes. They are helpful in presenting different scenarios and to asses
their impact on the Proforma statements. MS Excel, Quick Book, Peach Tree
Accounting, MS Financial Manager are few good options as ready made packages.

Startup Company shall select very simple and easy to use soft wares.