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					Financial Preparation for New
Ventures - Budgeting

      Lesson 11
Budgeting

   A budget can be no better than the
    assumptions used to create it.
   These assumptions should be clearly stated
    in the Financial section of the feasibility
    plan.
       Place all assumptions in the form of footnotes in
        the Input section of the Financial section.
       That is where your readers will go looking for
        them.
Budgeting

   Preparing the Financial section of a
    Feasibility Plan begins by building sound
    financial assumptions and a realistic budget.
       This will take some thought.
   Such preparation includes estimating sales,
    cost of goods sold (COGS), gross margin,
    expenses, and pre-tax profit.
   A service firm does not have COGS. It has COS.
Budgeting

   You will not be preparing the more
    traditional financial statements that
    appear in a formal business plan, such
    as:
       Income statements
       Balance sheets
       Ratio analyses
Budgeting

   Essentially, the Financial section of a
    Feasibility plan indicates:
    A. The sales level necessary to generate
       positive cash flow.
    B. The sales level sufficient for a quick
       payout usually within 3 to 4 years.
    C. The Economic Profile.
Budgeting

   Developing the Financial section is a
    way to objectively assess whether your
    business idea is “doable” and has the
    potential to earn an adequate profit on
    its investment.
Budgeting

   In addition, the Financial section
    includes estimating start-up costs
    (Month 0) and sufficient cash to allow
    the firm to operate for two or three
    years – until breakeven.
Budgeting
Chart of accounts (Next slide.)
 A chart of accounts lists any expenses that
  will be incurred during everyday business
  transactions, such as rent, salaries, utilities,
  insurance, and so forth.
       During your preparation, think of all the major
        expenses you can. But you can always add
        expenses to the chart later.
   A chart of accounts does not include any
    costs of producing a product or service.
Budgeting - Chart of Accounts
   Advertising                 Office supplies
   Automobile                  Postage
   Bad debts & collection      Rent
   Donations                   Salaries
   Dues & subscriptions        Withholding taxes
   Insurance                   Taxes general
   Legal & accounting          Telephone
   Miscellaneous               Utilities
Budgeting

   To begin building a chart of accounts,
    you should contact an accounting firm.
   Such firms usually have examples and
    free pamphlets which are available
    covering the different expenses
    incurred by similar businesses in your
    industry.
Budgeting

   Better than that idea, contact your
    local Small Business Administration
    (SBA) office for an appointment with a
    SCORE representative in your
    industry.
Budgeting

   An assumption is an estimate of how
    much you will spend for each cost
    incurred in operating your new firm.
   Your assumptions must explain to your
    reader how you developed your
    financial projections.
       In other words, “Where did you get your
        data?” This gives your plan additional
        credibility.
Budgeting

   For example, if your venture requires renting
    or leasing a location, call a local real estate
    agent for the approximate costs of office or
    retail space similar to the one you plan to
    use.
       Footnote this by saying, “Information supplied by
        Dave Talley, Foothills Reality Company by
        phone interview on March 12, 2006.”
Budgeting

   Next, contact an insurance agent for
    an estimate of insurance costs that
    would cover fire, liability, theft, and the
    like.
       Footnote this information the same way.
Budgeting

   Then contact your state's department
    of revenue to learn about any business
    licenses that may be required.
       Footnote.
   Also inquire about the applicable state
    and local taxes you will need to include
    in your budget.
       Footnote.
Budgeting

   After carefully researching every
    conceivable expense, you are now
    ready to write your assumption
    section.
   Follow the example on the next slide:
Budgeting
1. Rent: $15/ sq. ft. per year + net (property
   taxes and insurance)
2. Advertising: Advertising budgeted @ $400/
   month for the first year, plus an additional
   $600 in September for a direct-mail
   campaign
3. Telephone: Average telephone cost $200,
   except for October, November, December,
   and January, which will be $300 per month
Budgeting

   You will always wonder how accurate
    the projected assumptions are in your
    Feasibility plan and will question
    whether solid business decisions can
    be made from their assumptions.
       They can and they must. Do not succumb
        to “paralysis of analysis.”
Budgeting

   You should collect as much data as possible
    researching your business concept so you
    can answer the assumption questions from
    potential investors as accurately as
    possible.
   Then you can take action by starting the firm
    or terminating the Feasibility plans because
    the assumptions indicated that your
    business would or would not be successful.
Budgeting

Determining the cost of goods sold
  (COGS)
   Finding out how much it will cost to produce
    a product is usually first determined by
    talking to subcontractors, suppliers, and
    others producing a similar product.
   They might not be able to provide a
    concrete estimate of the exact cost, but they
    can provide a reasonable cost estimate.
Budgeting

   Determining costs for services (COS)
    is more difficult.
   You must consider any printed
    materials, specialized software
    programs, packaging, etc. involved in
    your service as your COS.
Budgeting

   There may be some instances when
    producing a service does not involve
    any additional costs other than your
    time.
   This expense will be reflected under
    salary expense - not as COS.
Budgeting

Gross margin
   Since producing and selling events occur at
    different times during the year, the retailer
    uses an estimated gross margin referred to
    as "'maintain markup percentage" for
    determining gross margin.
   The true gross margin will not be known
    until a physical count of the inventory is
    taken.
Budgeting

   Entrepreneurs in the restaurant industry
    encounter some of these same variables, so
    they cost out their menus by projecting the
    cost of each item.
   Then they can use a percentage for
    "shrinkage," meaning such expenses as
    spoilage, giveaways, theft, and employee
    meals, to arrive at their COGS.
Budgeting

   In the service industry you probably will not
    have COGS since you will not have any
    inventory and all expenditures can be
    considered an expense.
   Therefore, you would have a 100 % gross
    margin.
   On the other hand, you would calculate the
    cost of preparing brochures and other
    promotional expenses as part of your COS.
Budgeting

   Any item below your sales projections on
    your various financial documents can be
    considered to be an expense.
   However, it is better to have an account of
    all the expenses encountered in the COGS
    so better pricing decisions can be made.
   As you can see, there are no set rules on
    how to calculate expenses, COS or COGS.
Budgeting

   Each industry has its unique methods
    of estimating the COS or COGS and
    projecting gross margins.
   In order for you to better set your
    selling prices, it is important to
    understand your industry practices and
    to use them as guidelines in
    determining your costs.
Budgeting

Preparing sales projections
   To prepare a sales forecast, you might use
    a bottom-up method.
   Project all expenses for the year, including
    salaries, and estimate your COGS or COS.
   This will determine the sales volume and
    unit or per hour sales figure needed to break
    even and make a profit.
Budgeting

   However, you may want to use the
    top-down method.
   Project their sales volume and then
    estimate COS or COGS and other
    expenses needed to break even and
    make a profit.
Budgeting

   What most entrepreneurs agree on is
    that the type of business will determine
    which method you use.
       The retail business usually uses the
        bottom-up method, for example.
   It is easy to get good information on
    what to expect for expenses and costs
    from trade associations, accountants,
    and the SBA.
Budgeting

   Manufacturing firms use the top-down
    method a lot because they have to
    know their potential sales since this
    will determine how much space and
    machinery, how many employees, and
    other expenses are needed in order to
    make their products.
Budgeting

   Many times service companies will use
    the top-down method.
   They research how many customers
    they can handle in a year and what
    their services will cost.
   This determines their budgeted sales.
Budgeting

   There is not a single answer as to
    which method is best, so you should
    talk to other people in your industry.
   Then choose the method you think will
    provide the best results.
   Sales projections are an estimated and
    only that.
Budgeting

   In preparing sales forecasts, develop a
    range for the worst-case scenario and
    the best-case scenario.
   Use the worst-case scenario to
    determine if your business concept
    could be profitable. If not, it may be
    wise to rethink the business concept.
       Can you (a) make changes to appeal to
        more people or (b) charge more?
Budgeting

   If you have properly researched your
    industry, your actual sales volume should
    fall in between the ranges you develop.
   How to project sales volume is one of the
    most critical skills you can learn.
   Remember, your estimated sales volume
    directly affects all expenses and determines
    break-even and profitability for your
    business concept.
Budgeting

Start-up costs (Month 0)
 One method of determining how much
  money you will need to start your
  businesses is to do a mental
  walkthrough of what the firm will look
  like.
 Consider the following questions:
Budgeting

   Where will the business be located?
   What physical size will it be (square
    feet)?
   What types of walls and fixtures does it
    have?
   What type of equipment do you need?
       Computers? Furniture?
       Carpet? Copy machine? Shelving?
Budgeting

   How much opening inventory (value &
    volume) will the business need?
   How will you pay for it (COD or credit)?
   What kinds of deposits will you have to
    make, such as telephone, utilities, rent,
    first-and-last-month deposits?
   What types of signage will you need?
Budgeting

   Are there any applicable city codes?
   What types of supplies will need, such
    as cleaning, office, shipping, boxes?
   What type of training is necessary
    before opening for business?
   What types of government licenses will
    be required?
Budgeting

   Most financial institutions recommend that
    you plan on having a minimum of three
    months' operating capital (cash or available
    credit) on hand. Ideally, they prefer six
    months' operating capital in the bank.
   Operating capital is defined as funds to
    meet all expenses incurred that will be direct
    cash outlays.
Budgeting

   Warning: Do not force the results of
    budgeting. This is easy to do using an
    Excel spread sheet.
       Let the budgeting process indicate how
        much money your business concept
        really needs to be launched.
   The purpose of the Feasibility plan is
    to determine whether your business
    can be successful.
Budgeting

   If you raise enough money to start the
    venture, if your business produces the
    sales and controls costs and other
    expenses, and if your business
    supplies desired customer benefits,
    the business will be successful.
Budgeting

Pro forma for the Feasibility plan
 The following discusses what kind of
  financial information should be
  presented in the price and profitability
  section of a feasibility plan.
Budgeting

It will contain enough information to make
   a reasonable decision if the business
   concept is feasible.
 It should include a five-year monthly
   cash flow statement, including start-up
   capital needed.
Budgeting

   Such a document will show the
    accumulated cash needs and what
    time of the year the need for cash
    would be greatest.
       Note: A cash flow statement is about 3
        things:
           1) cash inflows,
           2) cash outflows, &
           3) timing of the first 2 events.
Budgeting

   You will then have to raise that amount of
    money to make sure that your businesses
    will be profitable.
   You could also increase or decrease sales
    projections and adjust variable expenses
    that are related to sales to determine how
    these changes would affect the cash needs
    of your business concept.
       “What if” scenarios.
Budgeting

   You might have a simple business
    concept that does not include
    inventory (a service business) and
    accounts receivable.
       A cash-only business will not have
        accounts receivable.
       Why?
Budgeting

Conclusions:
   Many entrepreneurs have difficulty
    determining their start-up costs.
   They might underestimate business start-up
    costs and market-penetration costs and
    forget to budget for many hidden expenses.
   Budgeting for all costs outlined in this lesson
    will assist you in overcoming these pitfalls.
Budgeting




        The end of lesson 11
      Financial Preparation for
     New Ventures - Budgeting.

				
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