EntrepreneurialFinance

FormtheIdeatotheBusinessPlan

OskarKowalewski
 CreatingaBusinessPlan

58%ofthemostrecentInc. CEOsdidnotcreateaformal
writtenplan.
Butbusinessplansdohelpentrepreneursprepareenough
resourcesandstayfocusedonkeyobjectives.
 WhatisBusinessPlan?

Thebusinessplanisawrittendocument
preparedbytheentrepreneurthatdescribesall
therelevantinternalandexternalelementsand
strategiesforstartinganewventure.
Itisaintegrationoffunctionalplanssuchas
marketing,finance,manufacturing,salesand
humanresources.

A set of hypotheses about an opportunity

 Whoshouldwritetheplan?

Thebusinessplanshouldbepreparedbythe
entrepreneur.
Theentrepreneurmayconsultwithmanyother
sourcesinitspreparation,suchaslawyers,
accountants,marketingconsultants,and
engineers.
 ScopeandValueoftheBusinessPlan
WhoReadsThePlans?

Thebusinessplanmaybereadbyemployees,
investors,bankers,venturecapitalists,suppliers,
customers,advisors,andconsultants.

Therearethreeperspectivesshouldbe
consideredinpreparingtheplan:
Perspectiveoftheentrepreneur
Marketingperspective
Investorsperspective
TypesofBusinessPlans
 BusinessPlanOutline
Section Heading
Cover Page
Table of Contents
Executive Summary
Industry, Target Customer, and Competitor Analysis
Company Description
Product/Service Plan
Marketing Plan
Operations and Development Plan
Management Team
Critical Risks
Offering
Financial Plan
Appendix of Supporting Documents
 Executive Summary

In many instances an investor will ask for a copy

of a firms executive summary and will ask for a
copy of the entire plan only if the executive
summary is sufficiently convincing.

The executive summary, then, is

arguably the most important
section of a business plan.
 PresentingThePlan

Itisoftennecessaryforanentrepreneurto
orallypresentthebusinessplanbeforean
audienceofpotentialinvestors.

Inthistypicalforumtheentrepreneurwouldbe
expectedtoprovideashort(perhaps20
minutesorhalfhour)presentationofthe
businessplan.
 The 12-13 Page PowerPoint Pitch

Summary
Mission statement
What is the idea?
How will it create value?
Timeline / milestones
Expected results
Specific request (e.g., $)
 Preparing An Elevator Speech

An elevator speech is a brief, carefully constructed

statement that outlines the merits of a business
opportunity.
There are many occasions when a carefully constructed
elevator speech might come in handy.

Most elevator speeches are 45 seconds to 2 minutes

long.
 Elevator Speech

Step 1 Describe the opportunity or problem 20 seconds

that needs to be solved.
Describe how your product meets the 20 seconds
Step 2
opportunity or solves the problem.

Step 3 Describe your qualifications. 10 seconds

Describe your market.

Step 4 10 seconds

Total 60 seconds
 Preparetowriteabusinessplan

Thesixsteps:
Prepareaprocessflowchart
Identifythebusinessspositiononthevaluechain
Developabusinesstimeline
Developfinancialpremises
Forecastsalesandcapitalexpenditures
Calculatestartupcapitalrequirements
Conductasensitivityanalysis
 Triangulation

PrepareaProcessFlowChart

Depictsalltheactivitiesofthebusiness
Illustratespersonnelneedsandequipment
required
 TheProcessFlowChart
Retail location remodeling and design
Primary Customer One-stop retail shop Sales person(s) salary (2 FT, 3PT)
Payroll Taxes for Sales person(s) (4)
Benefits (2)
Store Supplies and furniture
Marketing Retail space lease
Utilities
Insurance
Business Taxes
Employee(s) salaries (1)
Merchant account fees
Payroll Taxes (1)
Benefits (1)
Direct Mail Costs
Advertising Costs
Office Supplies

Apparel Design

Forwarding
Services
Accounting
Forwarder Fees

Designer(s) (1)
Prorotype Material Employee(s) salaries (1)
Payroll Taxes (1)
Benefits (1)
Accounting Software
Office Supplies
Outsourced
Manufacturing

Outsourced Manufacturing Costs

Transportation Costs
Purchasing Travel Expenses
US Custom fees

Employee(s) salary (1)

Payroll Taxes (1)
Beneftis (1)
Office supplies and equipment
Third party
products
Cost of goods
 Triangulation

Identifythebusinessspositioninthevaluechain
Todeterminehowmuchthecompanycancharge
foritsproductorservice
Toknowhowmuchitcoststoacquireinventoryor
rawmaterial.
 Core Strategy

It is important that a new venture

differentiate itself from its competitors in
Basis of some way that is important to its customers.
Differentiation If a new firms products or services arent
different from those of its competitors, why
should anyone try them?
 Pricing

. Pricing models vary, depending on a firms

Pricing target market and its pricing philosophy.
Structure
 TheContentofaBusinessPlan

IndustryDescription
Broaderindustryinwhichthefirmwillcompete
Industrysize,growthrate,trends,andcompetitors
Differentsegmentsoftheindustry
Nicheinwhichthefirmplanstoparticipate
TargetCustomers
Demographicsandpsychologicalvariablesvalues,
attitudes,andfears
CompetitorAnalysis
Productorserviceattributesthatareorarenot
providedbycompetitors
 GoalsofMarketResearch
Tofindout:
Whoismostlikelytopurchasetheproductor
serviceatmarketintroduction?
Whatdothesecustomerstypicallybuy,howdo
theybuyit,andhowdotheyhearaboutit?
Whatistheirbuyingpattern?Howoftendothey
buy?
Whatarethecustomersneedsandhowcanthe
newventuremeetthoseneeds?
 MinimumPopulationRequirementsto
SupportaRetailStoreSCHWAB
GROCERIES 700
RESTAURANTS 1200
DRUGSTORES 3500
HARDWARE 6000
SHOES 7000
FLORISTS 9500
APPLIANCES 10000
SPORTINGGOODS 15000
STATIONERY 25000
HOBBY/TOY 30000
DEPARTMENTSTORE 40000
CAMERA/PHOTOSUPPLY 50000
 Marketing Plan
This is a detailed explanation of your sales strategy, pricing plan,
proposed advertising and promotion activities, and product or
service's benefits.

The Marketing Plan section explains how you're going to get your
customers to buy your products and/or services.

The marketing plan, then, will include sections detailing your:

Products and/or Services and your Unique Selling Proposition

Pricing Strategy
Sales/Distribution Plan
Advertising and Promotions Plan
 EstimatingDemand&Revenue
DR.HAPPYTOOTHwantstoassessdemandfortoothwhiteningand
rootcanalsurgeryinBerrienSprings,Mich.

CensusDataforBerrienSprings:
Population=12,800

20% Under20yrs old =2560people

22% 21to40yrs old =2816people
26% 41to60yrs old =3328people
23% 61to80yrs old =2944people
9% over80yearsold =1152people

TargetMarkets:
ToothWhitening>21to40yearolds=2816people
RootCanalSurgery>41to80yearolds=6272people
 EstimatingDemand

TargetMarkets:
ToothWhitening>21to40yearolds=2816people
RootCanalSurgery>41to80yearolds=6272people

Dr.HappyToothassumeshecancapturebetween2and5%ofthetargetmarketfortooth
whiteninginhisfirstyearofoperation(duetolimitedcompetitionforthisservice).He
alsoassumeshecangetbetween1and3%oftherootcanalbusiness.Thus,we
generatetheforecastbelow,notingoptimistic,pessimistic,andmostlikelyscenarios:

Optimistic Pessimistic MostLikely

(5%) (2%) (3.5%)
ToothWhiteningClients 141 56 99

(3%) (1%) (2%)

RootCanalProcedures 188 63 125
 EstimatingRevenue
Ifthestandardfeefortoothwhiteningis$300andthestandardchargeforarootcanalis
$500,Dr.HappyToothcanusetheprojecteddemandfigurestoestimatetherevenues
thatwouldbegeneratedundereachassumedcondition:

Optimistic Pessimistic MostLikely

(5%) (2%) (3.5%)
ToothWhiteningClients 141 56 99
Est .WhiteningRevenue $42,300 $16,800 $29,700

(3%) (1%) (2%)

RootCanalProcedures 188 63 125
Est.RootCanalRevenue $94,000 $31,500 $62,500

TOTALREVENUE $136,300 $48,300 $92,200

 Operating Plan
A description of your business' physical location, facilities and
equipment, kinds of employees needed, inventory requirements and
suppliers, and any other applicable operating details, such as a description
of the manufacturing process.

Keeping focused on the bottom line will help you organize this part of
the business plan; think of the operating plan as an outline of the capital
and expense requirements your business will need to operate from day
to day.

You need to do two things for your readers in the operating section of
the business plan: show what you've done so far to get your business off
the ground (and that you know what else needs to be done) and
demonstrate that you understand the manufacturing or delivery process
of producing your product or service.
 Management Plan
An outline of your business' legal structure and management
resources, including your internal management team, external
management resources, and human resources needs.

The Management Plan section describes your management team

and staff and how your business ownership is structured. People
reading your business plan will be looking to see not only who's on
your management team but also how the skills of your management
and staff will contribute to the bottom line.
 Financial Projections

The final section of a business plan presents a firms pro

forma (or projected) financial projections.
Items to include in this section:
Sources and uses of funds statement
Assumptions sheet
Pro forma income statements
Pro forma balance sheets
Pro forma cash flows
Ratio analysis
 Forecasting for a New Venture
No track record on which to rely

Yardstick approach
Comparable firms in relevant dimensions
IPO prospectuses
Other data sources

Fundamental analysis
Market and market share
Engineering cost estimates
Demand-side approach - How much customers would buy
Supply-side approach - How fast the venture can grow
Credibility and support for assumptions

Mixed approach
The Firm as a Cash Conversion Process

Cash Future
Firm
Cash
 Cash Needs Assessment

Approaching the problem from three different

angles:
the entrepreneurs own knowledge,
the industry and
the market or customer.
32
TheCashFlowofaBusinessVenture
Capital
(equityanddebt)

Infusions
Beginningcash
Reinvestment
Expenditures (toretainedearnings)

Employees Materials FixedAssets

Production

Inventory CreditSales

Cashsales Accounts
Receivable

EndingCash Collections

EquityReturns DebtService Taxes

New Corporation (PSA)

34
New Corporation (PSA)

35
36
37
38
 Statement of Cash Flows
Statement of Cash Flows:
shows how cash, reflected in accrual accounting, flowed into & out of a firm
during a specific period of operation

Can be used to determine if a venture has been

building or burning cash

Net Cash Burn occurs when the sum of cash flows

from operations and investing is negative

39
 Short-term cash planning tools

Sales Schedule
Purchase Schedule
Wages and Commission Schedule
Cash Budget
 PDC Company operating & cash budget
SALES SCHEDULE
MARCH APRIL MAY JUNE
Schedule 1:
Sales Forecast $92 000 $115 000 $184 000 $138 000
Credit sales, 40% 36 800 46 000 73 600 55 200
Cash 60% 55 200 69 000 110 400 82 800

Schedule 2:
Cash Collections
Cash sales this month 69 000 110 400 82 800
100% last month's
credit sales 36 800 46 000 73 600
Total colections 105 800 156 400 156 400
 PDC Company operating & cash budget

PURCHASES SCHEDULES
MARCH APRIL MAY JUNE
Schedule 3:
Purchases
Ending inventory $110,400 $149,040 $123,280 $110,400
+CGS 64,400 80,500 128,800 96,600
=Total needed 174,800 229,540 252,080 207,000
-Beginning inventory 97,520 110,400 149,040 123,280
=Purchases 77,280 119,140 103,040 83,720
Schedule 4:
Purchase Disbursements
50% last mo's purch 38,640 59,570 51,520
+50% this mo's purch 59,570 51,520 41,860
=Disbursements for
purchases 98,210 111,090 93,380

42
 PDC Company operating & cash budget
WAGES & COM M ISSIONS SCHEDULE
MARCH APRIL MAY JUNE
Schedule 5:
Wages & Commiss.
Wages (fixed) $5,750 $5,750 $5,750 $5,750
+Commissions 15%
of current sales 13,800 17,250 27,600 20,700
=Total 19,550 23,000 33,350 26,450
Schedule 6:
Disbursements-
Wages/Commiss.
50% last mos exp. 9,775 11,500 16,675
+50% this mos exp. 11,500 16,675 13,225
=Total 21,275 28,175 29,900
44
 Check With Projected Financials

As a check on the cash budget, you can get the

exact same cash balance by constructing a full
set of financial statements.
46
47
48
 Cash Needs Assessment

Conduct a Sensitivity Analysis

To identify the critical numbers:
time to develop sales
volume of sales
price maintenance
costs more than anticipated.
 10 Warning Signs That
a Business is Growing Too Fast
FinancialMeasurebyLifeCycle

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 Cash Burn

Cash Burn:
cash a venture expends on its operating and financing expenses and its
investments in assets

Cash Burn Rate:

cash burn for a fixed period of time, typically a month
 Cash Burn
CashBurn=Inventoryrelatedexpenses+Admin
expenses+Marketingexpenses+R&Dexpense+
Interestexpenses+Changeinprepaidexpenses
(Changeinaccruedliabilities+Changeinpayables)+
Capitalinvestment+Taxes

MPCfor2008:
Cashburn=425,000+65,000+39,000+27,000+
20,000+0 (1,000+27,000)+50,000+8,000=
606,000

53
 Cash Burn
Cash Build = Net sales Change in receivables
MPC for 2008:
Cash build = 575,000 - 30,000 = 545,000
Cash Build Rate:
Cash build for a fixed period of time, typically a month

Net Cash Burn = Cash burn Cash build

= 606,000 - 545,000 = 61,000
 OperatingBreakevenAnalysis:
BasicTerms
VariableExpenses:
costsorexpensesthatvarydirectlywithrevenues

FixedExpenses:
coststhatareexpectedtoremainconstantoverarangeof
revenuesforaspecifictimeperiod

EBITDA:
earningsbeforeinterest,taxes,&depreciation&amortization

55
 Survival Breakeven Analysis:
Some Basics
Basic Equation:
EBDAT = Revenues (R) - Variable Costs (VC) Cash Fixed Costs
(CFC)

Where:
CFC includes both fixed operating (e.g., general & administrative,
& possibly marketing expenses) & fixed financing (interest) costs

When EBDAT is Zero:

R = VC + CFC

56
 Solving for the Breakeven Level of
Survival Revenues
Starting Point:
Ratio of variable costs (VC) to revenues (R) is a
constant (VC/R) & is called the Variable Cost
Revenue Ratio (VCRR)
Survival Revenues (SR) = VC + CFC
Rewriting, CFC = SR VC
By substitution, CFC = SR[1 (VCRR)]
Solving for SR, SR = [CFC/(1 VCRR)]

57
 Survival Revenues Breakeven:
An Example
If the PSA venture were expecting:
Revenues = $1,000,000
Cost of Goods Sold = $650,000
Administrative Expenses = $200,000
Marketing Expenses = $180,000
Depreciation Expenses = $100,000
Interest Expenses = $20,000
Tax Rate = 33%

58
 Survival Revenues Breakeven:
An Example (continued)
Note: only Cost of Goods Sold is expected
to vary directly with Sales
VCRR = $650,000/$1,000,000 = .65
CFC = $200,000 + $180,000 + $20,000 = $400,000
SR = $400,000/(1 - .65) = $1,143,000 rounded
 Survival Revenues Breakeven:
An Example (continued)
Check:
Survival Revenues $1,143,000
Cost of Goods Sold (65%) -743,000
Gross Profit 400,000
Administrative Expenses -200,000
Marketing Expenses -180,000
Interest Expenses -20,000
EBDAT $0
Graphically

61
 Identifying Breakeven Drivers in
Revenue Projections
Contribution Profit Margin = 1 VCRR
higher contribution profit margins mean lower levels of survival
revenues are needed to break even (EBDAT = 0)

Example:
Assume cash fixed costs are $400,000 & the VCRR declines
from 65% to 60%

[A]: SR = $400,000/(1 - .65) = $1,143,000

[B]: SR = $400,000/(1 - .60) = $1,000,000
63
64
 IdentifyingBreakevenDriversin
RevenueProjections(continued)
AmountofCashFixedCosts
lowercashfixedcostsresultinlowerlevelsofsurvivalrevenues
neededtobreakeven(EBDAT=0)

Example:
Assumecashfixedcostsdeclinefrom$400,000to$350,000&
theVCRRis65%

[A]:SR=$400,000/(1 .65)=$1,143,000
[B]:SR=$350,000/(1 .65)=$1,000,000

65
 Liquidity ratios
Indicate the ability to pay short-term liabilities
when they come due

Current Ratio:
= Average current assets/Average current liabilities
= (250,000+180,000)/2
(204,000+110,000)/2
= 1.37
 Liquidity ratios
Liquid assets: sum of a ventures cash and marketable
securities plus its receivables

Quick Ratio =
Average current assets Average inventories
Average current liabilities
= (250,000 +180,000)/2 (140,000+95,000)/2
(204,000 + 110,000)/2
= .62

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 Liquidity ratios

Net working capital (NWC):

current assets minus current liabilities

NWC to Total Assets Ratio:

= Ave. current assets Ave. current liabilities
Ave. total assets
= (250,000+180,000)/2 (204,000+110,000)/2
(446,000 + 343,000)/2
=.147 or 14.7%

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MPC Burn rates and Liquidity ratios
RATIO 2007 2008 % Change
Cash burn 417,000 606,000 +45.3%
Monthly cash burn 34,750 50,500 +45.3%
Cash build 423,000 545,000 +28.8%
Monthly cash build 35,250 45,417 +28.8%
Net Cash burn -6,000 61,000 N/A
Monthly net cash burn -500 5,083 N/A
Year-end months of cash N/A .98 N/A
Current ratio 1.56 1.37 -12.2%
Quick ratio .76 .62 -18.4%
NWC-total assets ratio .174 .147 -15.5%
 Ratio Analysis

The same financial ratios used to evaluate a firms 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.
71
 Conversion Period Ratio

Conversion Period Ratio:

indicates the average time it takes in days to convert certain current
assets and current liability accounts into cash

Operating Cycle:
time it takes to purchase, produce, and sell the ventures products plus
the time needed to collect receivables if the sales are on credit

Cash Conversion Cycle:

sum of the inventory-to-sale conversion period and the sales-to-cash
conversion period less the purchase-to-payment conversion period

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 Measuring conversion times

Inventory-to-Sale Conversion Period

= Ave. Inventories
(CGS / 365)
= (140,000 + 95,000)/2 = 117,500
380,000/365 1041
= 112.9 days

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 Measuring conversion times

Sale-to-Cash Conversion Period:

= Ave Receivables
(Net Sales/365)
= (105,000 + 75,000)/2
575,000/365
= 57.1 days

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 Measuring conversion times

Purchase-to-Payment Conversion Period:

= Ave Payables + Ave Accrued Liabilities
(COGS / 365)
= (84,000+57,000)/2 + (10,000+9,000)/2
380,000/365
= 76.8 days

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 Measuring conversion times

CashConversionCycle
= InventorytoSaleConversionPeriod
+SaletoCashConversionPeriod
PurchasetoPaymentConversion

=112.9days+57.1days 76.8days
=93.2days

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MPC conversion period performance

Conversion Ratio Impact on

2007 2008 Conv. Cycle
Inventory-to-sale 105.7 days 112.9 days +7.2 days
Sale-to cash 56.3 days 57.1 days +0.8 days
Purchase-to-payment 77.5 days 76.8 days +0.7 days
Cash conversion cycle 84.5 days 93.2 days +8.7 days

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 Dells Business Model
Dells Approach to Selling PCs versus Traditional Manufacturers
 Leverage ratios

LeverageRatio:
indicatestheextenttowhichtheventureisindebtanditsability
torepayitsdebtobligations
LoanPrincipalAmount:
dollaramountborrowedfromalender
Interest:
dollaramountpaidontheloantoalenderascompensationfor
makingtheloan

79
 Measuring financial leverage

TotalDebttoTotalAssetRatio:
=Avetotaldebt/Avetotalassets
=(204,000+110,000)/2+(80,000+90,000)/2
(446,000+343,000)/2

=.6134or61.34%

80
 Measuring financial leverage

EquityMultiplier:
=Avetotalassets/Aveownersequity
=(446,000+343,000)/2
(162,000+143,000)/2

=2.587times

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 Measuring financial leverage

CurrentLiabilitiestoTotalDebtRatio:
=Ave.currentliabilities/Ave.totaldebt
=(204,000+110,000)/2
(284,000+200,000)/2

=.6488or64.88%

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 Measuring financial leverage

InterestCoverageRatio:
=EBITDA/Interest
=47,000+17,000/2
20,000

=3.20times

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 Profitability and efficiency ratios

Profitability Ratios:
indicate how efficiently a venture controls its expenses

Efficiency Ratios:
indicate how efficiently a venture uses its assets in producing sales
 Profitability and efficiency ratios

GrossProfitMargin:
=NetSales COGS
NetSales

=195,000/575,000
=.3391or33.91%

85
 Profitability and efficiency ratios

OperatingProfitMargin:
= EBIT.
NetSales

=47,000/575,000
=.0817or8.17%

86
 Profitability and efficiency ratios

NetProfitMargin:
= NetProfit
NetSales

=19,000/575,000
=.0330or3.30%

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 Profitability and efficiency ratios

SalestoTotalAssetsRatio:
= NetSales.
Avetotalassets

= 575,000.
(446,000+343,000)/2

= 1.458times

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 Profitability and efficiency ratios

ReturnonTotalAssets(ROA):
= Netprofit.
Avetotalassets

= 19,000_
(446,000+343,000)/2

=.048or4.8%

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 Profitability and efficiency ratios

ROAModel:
thedecompositionofROAintotheproductofthenetprofitmarginand
thesalestototalassetsratio
ROA
=(Netprofit/sales)x(Netsales/Ave.totalassets)
=(19,000/575,000)x(575,000/
(446,000+343,000)/2)
=.0330x1.458=.048or4.8%

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 ROAModelConsiderations

Case1:HighProfitMargins&LowAssetTurnovers
Examples:products&servicesbasedontechnologicalinnovations

Case2:LowProfitMargins&HighAssetTurnovers
Examples:commoditytypeproducts&services 91
 Profitability and efficiency ratios

ReturnonEquity(ROE):
= NetIncome.
Aveownersequity

= 19,000.
(162,000+143,000)/2
=.1246or12.46%(or12.5%rounded)

92
 Profitability and efficiency ratios

ROEModel:
thedecompositionofROEintotheproductofthenetprofitmargin,sales
tototalassetsratio,andequitymultiplier

ROE
=(Netprofit/sales)x(Netsales/Ave.totalassets)
x(Ave.totalassets/Ave.equity)
=3.3%x1.46%x2.59%=12.5%

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 MPCperformance

Impacton
Profitability
Ratio 2007 2008 orEfficiency
Grossprofitmargin 34.93% 33.91% lower
Operatingprofitmargin9.59% 8.17% lower
Netprofitmargin 4.79% 3.30% lower
Unlever.profitmargin 6.71% 5.72% lower
Salestototalassets 1.327 1.458 higher
ROA 6.36% 4.82% lower
ROE 15.85% 12.46% lower
 MPCIndustry comparables analysis

2008 Comparison
2008 IndustryAve. withindustry
LiquidityRatios
Currentratio 1.37 1.80 lower
Quickratio .62 .80 lower
ConversionPeriodRatios
Inventorytosale 112.9days 100days higher
Saletocash 57.1days 55.0days higher
Purchasetopayment 76.8days 74.1days higher
Cashconversioncycle 93.2days 80.9days higher

95
 MPCIndustry comparables analysis

2008 Comparison
LeverageRatios 2008 IndustryAve. withindustry
Tot.debttotot.assets 61.3% 60.0% higher
Interestcoverage 3.20 4.00 lower
Profitability/EfficiencyRatios
Grossprofitmargin 33.91% 35.0% lower
Operatingprofitmargin 8.17% 10.0% lower
Netprofitmargin 3.30% 4.5% lower
NOPATmargin 5.72% 6.00% lower
Salestototalassets 1.458 1.5 lower
Returnontotalassets 4.82% 6.3% lower
Returnonequity 12.46% 15.00% lower

96
ChinaFoodTruck
 ChinaFoodTruck

AgroupofIESEGstudentsdecidedtoopena
chainwithChinasFoodTrucks,whereasthefist
onewilloperateclosetothecampus.
Pleasecreateaproforma businessplan.
 ChinaFoodTruck

Thebusinessplanshouldinclude
a. investment,salesandoperating
management
b. financialstatement
c. financialanalysis