MGT340 Supplement A: Financial Statements & Projections PDF

Supplement A: Financial Statements and Projections for Startups Dr. Kipp A. Krukowski MGT 340 – Fundamentals of Entrepreneurship Importance to Understanding Financials • Window into financial health and performance • Projections provide entrepreneur with a tool for planning resource acquisitio...

Supplement A: Financial Statements and Projections for Startups Dr. Kipp A. Krukowski MGT 340 – Fundamentals of Entrepreneurship Importance to Understanding Financials • Window into financial health and performance • Projections provide entrepreneur with a tool for planning resource acquisition • Potential investors will want to see that entrepreneurs have thought through the future to lower risk • Startup projections should be based on reasonable assumptions Income Statement Income (P&L) Statement Revenue COGS Gross Profit Operating Expenses Depreciation & Amortization Operating Profit Interest Expense Taxes Net Income $1,000,000 -$500,000 $500,000 -$250,000 -$50,000 $200,000 -$10,000 -$40,000 $150,000 Income Statement • Measures financial performance of the business • Operating expenses - What company spends to generate income • Reflects depreciation and amortization – Depreciation is referred to as a “noncash” expense (Replacement is needed in the long term) • Operating profit - Amount left over from revenue once all costs and expenses are subtracted • Interest expense - Extent of the company’s debt burden • Net income - Income left after all costs, expenses, and taxes have been paid Balance Sheet Balance Sheet • Shows what the company owes and owns (assets, liabilities, and shareholder equity) • Current assets: Cash and other assets that can be converted to cash – Inventory – Accounts receivable: Money owed to the company – Prepaid expenses: Payments the company has already made • Fixed assets: Property, plant, and equipment • Other Types of Assets: – Goodwill (price paid for an asset) – Intangible assets (value of patents, etc.) Balance Sheet • Liabilities and Shareholder Equity: – Liabilities (economic obligations of the company) – Current liabilities (bills that must be paid soon) – Accounts payable (money owed to suppliers) – Accrued expenses (wages and taxes) – Short-term debt (bank loans) Cash Flow Statement • Details the inflows and outflows of cash – • Think of it like your bank account and the money you earn and the payments you make with time being a factor All 3 statements link to one another – Example: Making a sale gets recorded on the income statement, depending when you get paid will determine where it shows up on the balance sheet (cash or accounts receivable) and depending on when you pay for the materials, labor, etc. and when you receive payment will show up on you cash flow statement Cash Conversion Cycle • Cash Conversion Cycle – Number of days cash is tied up DSO = Days Sales Outstanding DOI = Days of Inventory DPO = Days Payables Outstanding Mechanics of a Pro Forma Financial Statement Research • Primary Research – data gathered by yourself through sources such as focus groups, interviews, surveys • Secondary Research – data gathered from external sources such as industry publications, websites, government agencies Revenue Worksheet • Bottoms Up or Build Up Method to forecast sales – Estimate revenue and build Cost of Goods Worksheet Operating Expense Worksheet Labor Worksheet Capital Equipment/Other Expenditures Worksheet Operating Policies and Key Assumptions • Affect the speed of cash flow into the company • Critical policies include: – Purchasing Policy – Pricing Policy – Compensation Policy – Credit Policy – Payables Policy – Inventory Policy • Training time for new hires • Other considerations: Inflation and taxes Pulling It All Together • Build connected statements in Excel – Minimum of 2 years (by month) then years 3-5 annually • Understand changes and their effects • Understand the drivers and which items are the difference between success and failure Sensitivity Analysis • Address critical assumptions: Revenue and cost drivers • Three scenarios analysis recommended - best case, worst case, likely case • Things to consider: – Seasonality – Customer traffic – Cost of raw materials Reasonableness Test • Research comparable data from industry – • Account for seasonal changes in demand – • Should be similar (unless a disruptive business) Account for seasonal changes in demand, rate of sales growth, growing expenses in lockstep with sales Consider questions investors might ask – Be prepared to answer using data from research and comparable analysis 3 Key Points • It is critical to understand your financials, especially when money is coming in and going out. Put another way, you are starting a journey with the goal of making it through the startup period, you don’t want to run out of gas! • Going through the development of monthly income and expenses for the first 2 years is important to figuring how much gas you need in the tank. It is likely there will be loses for a number of months and thus need money in the bank (money from the entrepreneurs or from investors). If you are seeking investment this provides you with the amount to seek and answers the question why you are seeking the amount. • Researching your industry for “special” or “unique” situations is important for developing these projections. For example, seasonality or time needed before making initial sales is important to build into the model. Questions? Dr. Kipp A. Krukowski MGT 340 – Fundamentals of Entrepreneurship