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ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

FINANCIAL PLAN
Assoc. Prof. Dr. Ismail Ab.Wahab Assoc. Prof. Hj. Wan Ismail Wan Mamat Assoc. Prof. Dr. Mohamed Dahlan Ibrahim

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

LEARNING OUTCOMES At the end of the session, students should be able to: Understand the importance of preparing a financial plan Understand the process of developing a financial plan Identify the components of a financial plan Analyse the financial position of the proposed business Prepare a financial plan for a small business

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

INTRODUCTION A financial plan incorporates all financial data derived from the operating budgets i.e. the marketing, production (or operations) and administration budgets. Financial information from the operating budgets is then translated or transformed into a financial budget. Based on the financial data, projections are prepared via the following pro forma statements: Cash flow Income (or profit and loss) statement Balance sheet.

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

THE IMPORTANCE OF A FINANCIAL PLAN A financial plan is crucial to the overall business plan that is developed for a particular business or project. Its importance can be summarised as follows:
To determine the size of investment

To identify and propose the relevant sources of finance To ensure that the initial capital is sufficient To analyse the viability of the project before actual investment is committed To be used as a guideline for project implementation

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

THE PROCESS OF DEVELOPING A FINANCIAL PLAN To develop a workable and meaningful financial plan, the entrepreneur has to follow these steps:
Step 1: Step 2: Step 3: Step 4: Step 5: Step 6: Step 7: Gather all financial inputs Determine the project implementation cost Determine the sources of finance Prepare the pro forma cash flow statement Prepare the pro forma income statement Prepare the pro forma balance sheets Perform basic financial analysis

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 1: Gather the Financial Input (contd.) The process of developing a financial plan for a specific project begins with the accumulation of financial information from the marketing, operations and organizational plans. The financial requirements for each plan are presented in the form of budgets known as operating budgets (i.e. marketing, operations and organisation budgets)

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 1: Gather the Financial Input (contd.) In addition, the monthly or annual sales forecast derived earlier in the marketing plan is a very important input for the financial plan. After gathering all information the financial plan is prepared in terms of financial budget.

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Marketing Plan Sales Forecast Marketing Budget Financial Plan Project implementation cost Sources of financing Pro forma cash flow statement Pro forma income statement Pro forma balance sheet Financial Analysis

Organizational Plan Administrative Budget

Operations Plan Operations Budget

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 2: Determine the Project Implementation Cost A project implementation cost incorporates both longterm and short-term expenditure needed to start a project. Long-term expenditure refers to such expenditure as the procurement of plant, machinery, equipment, vehicles and other fixed assets needed by the new business.

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 2: Determine the Project Implementation Cost


(contd.)

Short-term expenditure, such as payments of utilities, salaries and wages, factory overheads, purchase of raw materials or inventories, represent the amount of initial working capital required to finance the daily operation until the business gets its first sale. Components of project implementation cost: Capital expenditure Working capital Other expenditure Contingency cost

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 3: Determine the Sources of Finance Sources of finance refers to the sources where funds to finance a particular projects implementation costs can be secured. These can be categorised into internal and external sources. The internal sources mainly come in the form of equity contributions from the entrepreneurs. These contributions can either be in the form of cash or other assets.

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 3: Determine the Sources of Finance (contd.) External sources of finance are mainly derived from commercial banks, finance companies and government agencies. It may come in the form of term loans, hire purchase or grants. The total amount of funds that has to be sourced should equal the total project implementation cost calculated earlier. This is to ensure that the project is fully funded and to avoid the risks of under-financing.

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 3: Determine the Sources of Finance (contd.) Components of sources of finance:


Internal sources Equity contributions (cash and/or assets) External sources Term loan Hire purchase Others

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 4: Prepare Pro Forma Cash Flow Statement Pro forma cash flow statement refers to the projected statement of cash inflow and outflow throughout the planned period. Under normal circumstances, the pro forma cash flow statement is prepared for three consecutive years, detailed by month for the first year and by year for the second and third years. However, longer periods are sometimes needed depending upon the projects undertaken.

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 4: Prepare Pro Forma Cash Flow Statement (contd.) The total amount of funds that has to be sourced should equal the total project implementation cost calculated earlier. This is to ensure that the project is fully funded as well as to avoid the risks of under-financing.

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 4: Prepare Pro Forma Cash Flow Statement (contd.) The pro forma cash flow statement must be able to show the following information:

Cash inflows the projected amount of cash flowing into the business. Cash outflows the projected amount of cash flowing out of the business. Cash deficit or surplus the difference between cash inflows and outflows. Cash position the beginning and ending cash balances for a particular period.

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

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Step 4: Prepare Pro Forma Cash Flow Statement (contd.) Elements of cash inflows:

Equity contribution (cash) Term loan Cash sales Collection of receivables Others

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 4: Prepare Pro Forma Cash Flow Statement (contd.) Elements of cash outflows:

Marketing expenditure Operations expenditure Administrative expenditure Term loan repayment Hire purchase repayment Purchase of fixed assets Pre-operating expenditure Payments for deposits Miscellaneous expenditure

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

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Example: Pro Forma Cash Flow Statement

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN


Example: Pro Forma Cash Flow Statement (contd.)

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 5: Prepare Pro Forma Income Statement The next step in developing a financial plan is to prepare the pro forma income statement which shows the expected profit or loss for the planned period, usually for three consecutive years. The pro forma income statement consists of the following elements:

Sales Gross Income Net Income Before Tax

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 5: Prepare Pro Forma Income Statement (contd.) Net income before tax is derived as follows:
Sales - Cost of Sales = Gross Profit Gross Profit - Operating Expenses = Net Income before tax

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Example: Pro Forma Income Statement


Year 1 240,000 94,600 145,400 Year 2 276,000 103,900 172,100 Year 3 317,400 108,940 208,460

Sales Cost of sales Gross profit


Less: Operating Expenses Marketing expenses Administrative expenses Depreciation charges Miscellaneous Operating income Less: Financing expenses: Interest on term loan Interest on hire-purchase Net profit before tax

18,000 96,000 7,200 2,700 123,900 21,500

18,900 100,800 7,200 600 127,500 44,600

19,845 105,840 7,200 600 133,485 74,975

4,500 1,600 6,100 15,400

3,600 1,600 5,200 39,400

2,700 1,600 4,300 70,675

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 6: Prepare Pro Forma Balance Sheet While the pro forma income statement shows the financial performance of the business for the planned period, the pro forma balance sheet shows the financial position of the business at a specific point in time in terms of assets owned and how those assets are financed.

The pro forma balance sheet is normally prepared for a period of three years.

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 6: Prepare Pro Forma Balance Sheet (contd.) The pro forma balance sheet consists of the following elements:

Assets Owners equity Liabilities

The balance sheet shows the following equation: Assets = Owners equity + Liabilities

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 6: Prepare Pro Forma Balance Sheet (contd.) Assets are the economic resources of a business that are expected to be of benefit in the future. Assets reported in the balance sheet are generally categorised into two categories: non-current and current assets. Non-current assets include fixed assets and other assets that are owned and usually held to produce products or services. These assets are not intended for sale in the short term. Examples: property, plant, machinery, equipment, vehicles, major renovations and long-term investments. For fixed assets, the values shown in the balance sheet are the book value i.e. the original cost less the accumulated depreciation.

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 6: Prepare Pro Forma Balance Sheet (contd.) Current assets are short-term assets that can be converted into cash within a year. Examples: cash, inventories (raw materials, work-in-process and/or finished goods), receivables and other short-term investments. Owners equity refers to capital contributions from the owners or shareholders in terms of cash or assets plus the accumulated amount of net income. However, if the business suffers a loss, the amount of loss will be deducted from the capital contributions.

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 6: Prepare Pro Forma Balance Sheet (contd.)

Liabilities are the amounts owed by the business to outsiders. They are categorised as non-current (longterm) and current liabilities. Non-current or long-term liabilities refer to the long-term obligations of the business that mature in a period of more than one year. They usually include long-term loans as well as hire purchase.
Current liabilities refer to the short-term obligations of the business that mature within a period of less than a year. The most common forms of current liabilities are accounts payable and accrued payments

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 6: Prepare Pro Forma Balance Sheet (contd.)

Liabilities are the amounts owed by the business to outsiders. They are categorised as non-current (longterm) and current liabilities. Non-current or long-term liabilities refer to the long-term obligations of the business that mature in a period of more than one year. They usually include long-term loans as well as hire purchase.

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Example: Pro Forma Balance Sheet


Year 1 Non-Current Assets (book value) Land & building Machinery & equipment Furniture & fixtures Renovation Vehicles Deposit Current Assets Inventory of raw materials Inventory of finished goods Cash Total Assets Owners Equity Capital Accumulated profit Long-term Liabilities Term loan Hire-purchase Total Owners Equity & Liabilities 45,000 18,400 5,600 3,200 20,000 800 93,000 3,000 3,000 40,900 46,900 139,900 Year 2 45,000 13,800 4,200 2,400 15,000 81,200 3,500 4,000 77,600 85,100 166,300 Year3 45,000 9,200 2,800 1,600 10,000 69,400 4,000 5,000 145,575 154,575 223,975

72,500 15,400 87,900 36,000 16,000 52,000 139.900

72,500 54,800 127,300 27,000 12,000 39,000 166,300

72,500 125,475 197,975 18,000 8,000 26,000 223,975

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Step 7: Perform Basic Financial Analysis

Financial analysis is a technique of examining financial statements to help the entrepreneur analyse the financial position and performance of the business. Financial analysis involves two basic steps: generating the information from the financial statements and interpreting the results. The most common form of financial analysis is ratio analysis.

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 7: Perform Basic Financial Analysis (contd.)

Financial ratios are normally used to compare figures from the financial statement with other figures, so that the true meaning of financial pictures can be obtained. There are various financial ratios that the entrepreneur can look at. However, the most commonly considered ratios in small business decision-making fall into four categories: liquidity, efficiency, profitability and solvency.
For illustrative purposes, financial data presented in pro forma financial statements in the next slides will be used.

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Pro Forma Income Statement


Year 1 576,000 227,000 349,000 Year 2 662,400 254,600 407,800 Year 3 794,880 278,460 516,420

Sales Cost of sales Gross profit


Less: Operating Expenses Marketing expenses Administrative expenses Depreciation charges Other operating expenses Operating income Less: Financing expenses: Interest on term loan Net income before tax

56,500 226,000 21,000 5,000 308,500 40,500

62,150 248,600 21,000 4,000 335,750 72,050

68,365 273,460 21,000 4,000 366,825 149,595

16,500 24,000

13,200 58,850

9,900 139,695

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Pro Forma Balance Sheet


Year 1 Non-Current Assets (book value) Land & building Motor vehicles Office equipment Renovation Machinery Other assets (deposits) Current Assets Inventory of raw materials Inventory of finished goods Cash Total Assets Owners Equity Capital Accumulated profit Long-term Liabilities Term loan Current Liabilities Accounts payable Total Owners Equity & Liabilities 100,000 64,000 5,600 16,000 32,000 1,000 217,000 2,000 5,000 46,500 53,500 270,500 Year 2 100,000 48,000 3,000 12,000 24,000 1,000 188,000 3,000 6,000 105,350 114,350 302,350 Year3 100,000 32,000 2,000 8,000 16,000 1,000 159,000 4,000 8,000 244,645 256,645 415,645

105,500 24,000 129,500 132,000

105,500 82,850 188,350 99,000

105,500 222,545 328,045 66,000

9,000 270.500

15,000 302,350

21,600 425,645

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

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Step 7: Perform Basic Financial Analysis (contd.)

Liquidity Ratios

The term liquidity refers to the availability of liquid assets to meet short-term obligations. Thus, liquidity ratios measure the ability of the business to pay its monthly bills. The most widely used liquidity ratios are current ratio and quick ratio.

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 7: Perform Basic Financial Analysis (contd.)

Current ratio can be determined by dividing total current assets by total current liabilities. Generally, this ratio shows the business ability to generate cash to meet its short-term obligations. Current ratio = Total current assets Total current liabilities
Year 1 Year 2 Year 3

Current assets
Curent liabilities Current Ratio

RM53,500
RM 9,000 5.94

RM114,350
RM15,000 7.62

RM256,645
RM 21,600 11.88

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 7: Perform Basic Financial Analysis (contd.)

If the business current ratio falls below 1, it means that the business is in a serious liquidity situation. In most cases, the comfortable current ratio for most businesses is 2.
Quick ratio, also known as the acid test ratio, measures the extent to which current liabilities are covered by liquid assets.

To determine quick ratio, the calculation of liquid assets does not take into account inventrories since it is sometimes difficult to convert them into cash quickly.

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 7: Perform Basic Financial Analysis (contd.)

Quick ratio =

Total current assets-inventories Total current liabilities


Year 1 Year 2 RM114,350 RM 9,000 RM15,000 Year 3 RM256,645 RM 12,000 RM 21,600

Current assets Inventories Current liabilities

RM53,500 RM 7,000 RM 9,000

Quick Ratio

5.17

7.02

11.33

In most cases, the comfortable quick ratio is 1.

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

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Step 7: Perform Basic Financial Analysis (contd.)

Efficiency Ratios

The efficiency ratios measure how efficient the business uses its assets to generate sales. The most widely used efficiency ratio for planning purposes is inventory turnover ratio.

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 7: Perform Basic Financial Analysis (contd.)

Inventory turnover (or stock turnover) measures the number of times inventories have been converted into sales and indicates how liquid the inventory is. All other things being equal, the higher the turnover figure, the more liquid the business is.
This ratio divides the cost of sales (or cost of goods sold) by the average value of inventory. The average value of inventory is derived by adding the opening and closing balance of and dividing the total by two. Inventory turnover = Cost of sales Average inventory

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 7: Perform Basic Financial Analysis (contd.)


Year 1 Cost of sales Average inventory RM227,000 RM 7,000 Year 2 RM254,600 RM8,000 Year 3 RM278,460 RM 10,500

Inventory turnover

32.42 times

31.83 times

26.5 times

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

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Step 7: Perform Basic Financial Analysis (contd.)

Profitability Ratios

Profitability ratios are important indicators of the business financial performance. Investors will particularly be interested in these ratios since they measure the performance and growth potential of the business.

Some of the commonly used profitability ratios are gross profit margin, net profit margin, return on assets and return on equity.

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

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Step 7: Perform Basic Financial Analysis (contd.)

Gross profit margin give a good indication of financial health of the business. Without an adequate gross margin, the business will be unable to pay its operating and other expenses.
Gross profit margin is calculated by dividing the business gross income by sales.

Gross profit margin = Gross profit Sales

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

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Step 7: Perform Basic Financial Analysis (contd.)


Year 1
Gross profit Sales Gross profit margin RM349,000 RM576,000 60.59%

Year 2
RM407,800 RM662,400 61.56%

Year 3
RM516,420 RM794,880 64.97%

Net profit margin is an indication of how effective the business is at cost control. The higher the net profit margin, the more effective the business is at converting sales into actual profit.

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

THE FINANCIAL PLAN

Step 7: Perform Basic Financial Analysis (contd.)

Net profit margin is calculated by dividing the business net income by sales.
Net profit margin = Net profit Sales
Year 1 Net profit RM 24,000 Year 2 RM 58,850 Year 3 RM139,695

Sales
Net profit margin

RM576,000
4.16%

RM662,400
8.88%

RM794,880
17.57%

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

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Step 7: Perform Basic Financial Analysis (contd.)

Return of assets measures the overall return that the business is able to make on its assets.
This ratio is derived by dividing the business net profit by total assets. Return on assets = Net profit Total assets
Year 1 Net profit Total assets Return on assets RM 24,000 RM270,000 8.89% Year 2 RM 58,850 RM302,350 19.46% Year 3 RM139,695 RM415,645 33.61%

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

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Step 7: Perform Basic Financial Analysis (contd.)

Return of equity shows what the business has earned on its owners investment in the business.
This ratio is derived by dividing the business net profit by total equity. Return on equity = Net profit Total equity
Year 1 Net profit Total equity Return on equity RM 24,000 RM129,500 18.53% Year 2 RM 58,850 RM188,350 31.25% Year 3 RM139,695 RM328,045 42.58%

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

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Step 7: Perform Basic Financial Analysis (contd.)

Solvency Ratios

This final category of ratios is designed to help the entrepreneur measure the degree of financial risk that his business faces. By referring to this ratio, the entrepreneur can assess his level of debt and decide whether it is appropriate for the business.

The most commonly used solvency ratios are total debt (liabilities) to equity (also known as leverage or gearing), total debt to total assets, and times interest earned (also known as interest coverage).

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

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Step 7: Perform Basic Financial Analysis (contd.)

The total debt to equity ratio indicates what proportion of equity and debt that the company is using to finance its assets.
This ratio is calculated by dividing the the total debt by total equity. Debt to equity ratio = Total debt Total equity
Year 1 Total debt Total equity Debt to equity ratio RM141,000 RM129,500 1.09 : 1 Year 2 RM114,000 RM188,350 0.61 : 1 Year 3 RM 87,600 RM328,045 0.27 : 1

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

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Step 7: Perform Basic Financial Analysis (contd.)

The debt to asset ratio measures the percentage of the business assets financed by creditors relative to the percentage financed by the entrepreneur.
This ratio is calculated by dividing the total debts by total assets. Debt to equity ratio = Total debts Total assets
Year 1 Total debts Total assets Debt to total assets ratio RM141,000 RM270,500 52.13% Year 2 RM114,000 RM302,350 37.70% Year 3 RM87,600 RM415,645 21.08%

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Step 7: Perform Basic Financial Analysis (contd.)

Times interest earned ratio measures the number of times interest expense can be covered by profit before interest and tax.
This ratio is calculated by dividing total interest expense by profit before interest and tax. Time interest earned = Profit before interest & tax Interest expense
Year 1 Profit before interest Interest expense Time interest earned RM40,500 RM16,500 2.45 times Year 2 RM72,050 RM13,200 5.46 times Year 3 RM149,595 RM9,900 15.11 times

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

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SUMMARY

The financial plan is an important part of the business plan. It incorporates all financial data derived from the operating budgets, i.e. marketing, operations and administrative budgets.
Based on this financial data, several financial projection tools are prepared to provide the entrepreneur with a clear picture of the amount of money needed to start a business, sources of finance, the amount of cash available and the financial performance and position of the business.

ENT/ETR300 FUNDAMENTALS OF ENTREPRENEURSHIP

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SUMMARY (contd.)

The output of a financial plan covers project implementation cost schedule, sources of financing schedule, pro forma cash flow statement, pro forma income statement , and pro forma balance sheet.
The business financial data gathered in the financial statements are analysed in order to obtain an overall financial picture of the business. The financial ratios are used to analyse the financial performance of the business.

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END OF MODULE 11