MGT403 Entrepreneurship Organization Chapter 7 Break-Even Analysis PDF

Because learning changes everything. ® Section 3: From the Opportunity to the Business Plan Chapter 10: The Financial Plan © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hil...

Because learning changes everything. ® Section 3: From the Opportunity to the Business Plan Chapter 10: The Financial Plan © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  The Financial Plan The financial plan shows how and when funds enter the organization, where funds go, available cash, and projected financial position of the firm. This chapter It provides a short-term basis for discusses: pro budgeting and prevents a lack of cash. forma income It explains how the firm will meet its statement, pro forma cash flow, obligations and maintain liquidity. pro forma In general, three years of projected balance sheet, financial data are needed for investors. and break-even analysis. © McGraw Hill LLC 2  Budgeting Before developing the pro forma income statement, prepare the operating and capital budgets. Final determination of budgets ultimately rests with the owners. Develop a sales budget—expected sales by month. Then determine the cost of these sales. Include an ending inventory to buffer against demand fluctuations. A production budget allows projected cash flows for the cost of goods produced, including inventory. This provides actual production needed each month to meet demand. It determines how much is spent and for what purpose. © McGraw Hill LLC 3  Operating Budget The next focus is on operating costs. List fixed expenses. Incurred regardless of sales volume. Rent, utilities, salaries, advertising, depreciation, and insurance. Calculate variable expenses. Vary by month depending on sales or marketing strategy. This budget and the manufacturing budget provide the basis for the pro forma statements. © McGraw Hill LLC 4  Capital Budget Capital budgets are used for evaluating expenditures that will impact the business for more than 1 year. A capital budget may project expenditures for new equipment, vehicles, computers, or new facilities. Decisions may include evaluating the cost of make or buy or a comparison of leasing, buying used, or buying new equipment. Enlist the assistance of an accountant for large projects. © McGraw Hill LLC 5  Forecasting Sales There are many different methods for projecting sales, some quantitative and some qualitative. To project sales simply and reasonably, use qualitative methods. Research everything about other start-ups in the same industry. Local chambers of commerce or other business organizations may provide information on expected first year sales. Be aware that sales estimates can be wrong. The pro forma income statement has monthly projections. Seasonality should be reflected in the sales figures. © McGraw Hill LLC 6  Pro Forma Income Statements In preparing the pro forma income statement, first calculate sales by month—may be higher is some months. The pro forma income statement provides projections for operating expenses for each month of the first year. Salaries and wages reflect the number of personnel employed and their roles in the organization. Consider increasing selling expenses as sales increase. Investors want conservative projections for years two and three. © McGraw Hill LLC 7  Pro Forma Cash Flow Cash flow is not the same as profit, it is the difference of cash receipts and cash payments. The indirect method adjusts net income for cash not yet in or out. The direct method determines cash in less cash out. A monthly projection of cash is a pro forma cash flow. When outflow is greater than inflow, funds need to be secured. Invest large short-term sources of positive cash flow. Negative cash flows are likely for a new venture. Revise projections and provide scenarios based on varying sales levels. © McGraw Hill LLC 8  Pro Forma Balance Sheet The pro forma balance sheet reflects the company’s position at the end of year one. Assets represent everything of value owned by the business. Current assets—cash and anything convertible to cash within 1 year. Fixed assets are tangible and used over a long period of time. Liabilities represent everything owed to creditors. Current liabilities are owed within a year, unlike long-term liabilities. Owner’s equity is the excess of all assets over all liabilities. Owner equity represents the net worth of the business. Any profit is included in the net worth as retained earnings. © McGraw Hill LLC 9  Break-Even Analysis This technique determines how many units need to sell to break-even—sales must cover fixed cost obligations. TFC B /E(Q )  SP  VC unit A weakness is determining if a cost is fixed or variable. If a firm produces more than one product, allocate fixed costs to each product, then calculate a break-even point. Adjust variables to see the impact on break-even and profit. © McGraw Hill LLC 10  Pro Forma Sources and Applications of Funds The pro forma sources and application of funds shows the disposition of earnings from operations and other financing. Its purpose is to show how net income and financing were used to increase assets and pay off debts. It is often difficult to understand how the net income of the year was disposed of. Typical sources of funds are from operations, new investments, long- term borrowing, and sales of assets. Major uses or applications of funds are to increase assets, retire long- term liabilities, reduce owner equity, and pay dividends. This statement emphasizes the interrelationship of these items to working capital. © McGraw Hill LLC 11  Software Packages There are several financial software packages that can track financial data and generate important financial statements. Spreadsheets are the easiest and Microsoft Excel is widely used. Using spreadsheets in the start-up phase helps present different scenarios and assess their impact on pro forma statements. In the start-up stage, when the venture is small and resources are limited, software should be simple and easy to use. Most allow check writing, payroll, invoicing, inventory management, bill paying, credit management, and taxes. One of the simplest and easiest to use is Intuit’s Quickbooks. © McGraw Hill LLC 12  End of Main Content Because learning changes everything. ® www.mheducation.com © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.