Financial Plan - Chapter 8 PDF

Chapter 8 THE FINANCIAL PLAN © BE AN ENTREPRENEUR 2021 8 THE FINANCIAL PLAN Cash Budgets Cash Inflows Cash Outflows Financing Section Measuring Risks © BE AN ENTREPRENEUR 2021  Chapter 8 overview In chapter 8, we take a close look at financial risks...

Chapter 8 THE FINANCIAL PLAN © BE AN ENTREPRENEUR 2021 8 THE FINANCIAL PLAN Cash Budgets Cash Inflows Cash Outflows Financing Section Measuring Risks © BE AN ENTREPRENEUR 2021  Chapter 8 overview In chapter 8, we take a close look at financial risks, how to measure them, and express them. We relate risk to the rewards of a business. We find ways to evaluate if the business is “worth the risk” or “worth the trouble.”  Coverage of the Chapter Cash Budgets Cash Inflows Cash Outflows Financing Section Measuring Risks  Learning Objectives Define a financial plan and discuss its importance to an investor State the goals of a financial plan Discuss ways to set up the time frame for a cash budget Explain how a cash budget helps determine the funding need Discuss measures of return of an investment Discuss the required rate of return, break-even analysis, and sensitivities as measures of risk.  Story from Real Life Ms. Yong Suk Daley, a Korean-American, opened a clothing-alteration shop in Springboro, Ohio, in 2000 and operated it successfully. Business slowed down in 2005. She renovated her business in 2006 and called it, “Young’s Special Occasion Apparel.” She refocused on altering and fixing clothes for special occasions like weddings, where the consumer budgets are bigger. The purchase of her inventory and display was financed with her personal credit cards.  Story from Real Life In August 2006, Ms. Yong finally got a business coach who helped her develop a proper business plan. She prepared a cash budget as part of an application for a loan, to supplant the credit card debt. She strengthened recordkeeping and financial management. She improved the marketing plan. A loan was finally granted to her in October 2006. Because of the loan, she no longer had to use her credit card to finance inventory.  THE FINANCIAL PLAN Financial plan: The business plan expressed in numbers of money terms. It includes the cash budgets, the amount of external financing required and an assessment of the risks and rewards of the business. The financial plan is a convenient summary of all the components of your business plan. It expresses how high the start-up costs will be, how much the new factory will cost, and what sort of working capital will be required.  THE FINANCIAL PLAN The financial plan quantifies all of your plans into measurable units of money. It explains the total investment required this year, how much will be in fixed assets, how much in working capital, and how big are salary expenses versus raw material costs.  THE FINANCIAL PLAN The financial plan shows the rewards. It shows how much the investor's money can grow. Your financial plan has three goals: To demonstrate the need for funds. To demonstrate the reward or return of a business. To measure financial risks.  THE FINANCIAL PLAN To address these goals, your financial plan will have three components: the cash budgets the conclusions reached from the cash budgets ways to measure risk.  THE FINANCIAL PLAN The time frame or period of a cash budget will usually cover several years. If you estimate that it will take five years to build up the business, and that the business will be stable by the fifth year, it would mean that your cash budget should be enough to cover five years.  THE FINANCIAL PLAN Another way to determine the time frame is to take the point of view of the investor (the provider of funds). The time frame of the cash budget has to be equivalent to the time frame of the investor. Five years would be a reasonable time frame, for most investors.  THE FINANCIAL PLAN Cash outflows or costs may be sorted into variable and fixed costs. Variable costs change or vary with the number of units sold. The more you sell, the higher your variable costs will be.  THE FINANCIAL PLAN Raw materials and labor used in production are examples of variable costs. Because of their relation to sales, variable costs are usually expressed as a percent of sales.  THE FINANCIAL PLAN By contrast, fixed costs do not change with the number of units sold. The amount remains constant for a wide range of sales volume, or constant for a time period.  THE FINANCIAL PLAN For most new businesses, the first years are years of investment and hard work. We see this in the cash budget as negative net cash flows in the first years.  THE FINANCIAL PLAN If the beginning cash balance is small, a negative net cash flow will lead to a smaller, even negative, ending cash balance. External funds will then be required to bring the amount back to minimum operating cash level, in the sub-period. That is how, you find out, how much external funding is required.  Glossary Cash Budget: A cash budget tracks the expected flow of cash as it comes into and goes out of a business over a future time frame.  Glossary Terminal Value: The forecast value of your business at the end of a specified period. It is used to limit the time frame in a cash budget.  Glossary Variable costs: Costs that change or vary with the number of units sold. Because of their relation to sales, variable costs are often expressed as a percent of sales.  Glossary Fixed costs: Costs where the amount does not change or remains fixed over a wide range of sales volume. Minimum operating cash: The least amount of cash a business needs for day-to-day operations.  Glossary Payback period: The time it takes for a business to fully recover or pay back the initial investment. Shorter payback periods represent more attractive businesses.  Glossary Internal rate of return: The percentage rate that equates the cash outflows and cash inflows. An internal rate of return higher than the required rate, means the venture is attractive.  Glossary Net present value: Today’s value of future cash flows minus the initial investment. The rate used to convert future cash flows to today’s value is the required rate of return. A business with positive NPV is attractive.  Glossary Breakeven point: The number of units your business must sell to just cover all costs resulting in zero profit.  Glossary Sensitivities: Forecasts that differ from the original forecast because one or several variables are changed. Sensitivities are used to find out the effects on the financials (like the cash budget) as a result of such changes.  Measuring risks Net present value is today’s value of all future cash flows minus the initial investment. You need to input a required rate of return in the calculation, to see if the business gets to earn sufficient money each year, to pass the test of the investor, and to see if it still produces a net positive amount, by the end of the project.  Measuring risks A business with positive NPV is attractive. Required rate of return: the minimum reward a business must provide for an investor to invest in it. It is expressed as a percentage.  Measuring risks The breakeven point is the number of units your business must sell to just cover all its costs or “break even” or to achieve at least zero profit. Below break-even, your business is not profitable.  Measuring risks If you present alternative cash budgets, you would be giving sensitivities. You can present an optimistic and a pessimistic scenario. You can present a best-case and a worst-case scenario. This is how you know what would happen if: (a) sales is higher than expected or (b) lower than expected.  Do your Financial plan https://knowhow.ncvo.org.uk/tools- resources/business-plan-template/writing-your- business-plan/11-cost-and-income-structure