Sources of Funding

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					The cash flow forecast
A cash flow statement or forecast represents the flow of payments and receipts
over a period - not the formal accounting transactions, which are based on
invoice date or tax point

Cash flows may be useful for historical analysis but are vital in business
planning: the cash flow forecast or plan allows the calculation of funding
requirements and demonstrates how these may vary over time

Cash transactions may lag or lead accounting transactions, depending on
relative payment periods on sales and purchases - the ‘terms of trade’

 Reminder: Not all items appear on both P&L and cash flow:

Cash flow only                                  P&L only
Fixed asset purchases                          Depreciation
Stock purchases                                Cost of sales (i.e direct material cost)
VAT: input tax, output tax & settlement
Injection / repayment of loans
Injection of equity capital
           The basic logic of a cash flow forecast



Electronic Cheque                                         Forecast        Forecast       Forecast       Forecast
           Cheque
transfers Cheque    Payments from customers
                    VAT collected from customers         cash inflows    cash inflows   cash inflows   cash inflows
                    VAT refunded by government             Month 1         Month 2        Month 3        Month 4
 Amex 10p 50p
Visa   5p           Capital injections from investors
                    Loans from lenders                      Total           Total          Total          Total
 £20 £5                                                  cash inflows    cash inflows   cash inflows   cash inflows
     £10                                                 Month 1 (A)     Month 2 (A)    Month 3 (A)    Month 4 (A)


        Payments to suppliers
                                    Electronic Cheque      Forecast      Forecast      Forecast      Forecast
        Wages and salaries                      Cheque
                                     transfers Cheque    cash outflows cash outflows cash outflows cash outflows
        VAT paid to suppliers
                                  Amex 10p 50p             Month 1       Month 2       Month 3       Month 4
        VAT paid to government
                                 Visa       5p
        Payments to investors                                Total         Total         Total         Total
        Interest paid to lenders   £20 £5                cash outflows cash outflows cash outflows cash outflows
        Loan repayments to lenders       £10              Month 1 (B)   Month 2 (B)   Month 3 (B)   Month 4 (B)

                                                           Forecast        Forecast      Forecast      Forecast
                                                         net cash flow   net cash flow net cash flow net cash flow
                                                           Month 1         Month 2       Month 3       Month 4
                                                             (A-B)           (A-B)         (A-B)         (A-B)

                                                           Forecast     Forecast     Forecast     Forecast
                                                         bank balance bank balance bank balance bank balance
                                                           at end of    at end of    at end of    at end of
                                                           month 1      month 2      month 3      month 4
What goes               INPUTS                                   OUTPUTS
 where?
                       Revenues             Business or      Direct costs (of sales)
                       from sales             ‘revenue’      e.g. materials, packaging
     Income and                             transactions     delivery etc.
A     costs that
    appear on the                                            Indirect costs
         P&L            These are P&L         Expense
                         transactions       transactions     e.g. wages, insurance,
                                                             rent, interest etc.

       Payments
    resulting from                          Business or      Payments to suppliers
B                    Payments from           ‘revenue’       In respect of direct and
        type A         customers
     transactions                           cash flows       indirect costs

                                           Investments in    Payments for capital
         Other                               the business    purchases: e.g. computers,
                       B, C and D are                        vehicles, equipment
    purchases that                          infrastructure
                          cash flow
C   appear on the       transactions
       cash flow                                             Stock purchases:
                                           Investments in    materials, ingredients etc.
     forecast only                             stock         that are eventually sold

                     VAT levied on                           VAT paid to suppliers,
                     sales and collected        VAT          VAT settlements to
        Cash-only
      transactions   from customers         transactions      government
D   that appear on
     the cash flow   Capital injections:                     Capital repayments:
     forecast only                            Capital        e.g. loan repayments
                     e.g bank loans,
                     owner’s capital       transactions      mortgage repayments
                           Structure of a cash flow forecast

Sales forecasts         Cash from
Payment terms                                   Forecasted cash inflows
                        sales
                  Capital injections
                     VAT on sales
                         Variable
                           costs
                         Payroll
Cost forecasts
Payment terms
                            Fixed
                            costs               Forecasted cash outflows



                          Interest
              Capital repayments
              VAT on purchases
                   VAT payments

                       Net cash flow            Forecasted net cash flow
                      Bank balance              Forecasted cash (bank) balance
    Constructing the cash flow forecast
   1)   GENERATE THE CASH FLOW FROM THE P&L, NOT VICE VERSA
   2)   Copy down the sales and cost categories from the P&L projection
   3)   Delete depreciation line and include other cash flow-only items
   4)   Estimate average expected collection period for credit sales
   5)   Link cash inflows to sales forecast, allowing for the collection period
   6)   Add additional income from VAT on sales (*)
   7)   Add appropriate lines for capital injections
   8)   For each cost category, estimate expected payment period
   9)   Link each cost line to that on the P&L, allowing for payment period
   10) Enter capital injections and repayments
   11) Add additional payments against VAT on purchases (*)
   12) Include repayments of VAT to tax authority at appropriate intervals
   13) Calculate net cash flow and generate rolling bank balance
   14) Identify funding requirement - and reiterate!


* VAT can be added to cash inflows from sales and outflows from purchases, or (better)
 ‘VAT on sales’ and ‘VAT on purchases’ treated as separate entries on the cash flow
              Modelling cash inflows from sales - no
               credit

P&L forecast: Your Business Ltd. Jun 2009 - May 2010

                      Jun-09       Jul-09     Aug-09         Sep-09   Oct-09

Sales                      0       2,450       3,876          5,820   6,760




Cash flow forecast: Your Business Ltd. Jun 2009 - May 2010

                      Jun-09       Jul-09     Aug-09         Sep-09   Oct-09

Cash from sales            0       2,450       3,876          5,820   6,760
        Modelling cash inflows from sales - one week’s credit



P&L forecast: Your Business Ltd.   Jun 2009 - May 2010

                       Jun-09        Jul-09      Aug-09        Sep-09   Oct-09

Sales                       0        2,450        3,876         5,820   6,760




Cash flow forecast: Your Business Ltd.   Jun 2009 - May 2010

                       Jun-09        Jul-09      Aug-09        Sep-09   Oct-09

Cash from sales             0             0       2,450         3,876   5,820
    Modelling cash inflows from sales - two weeks’ credit


P&L forecast: Your Business Ltd.   Jun 2009 - May 2010

                       Jun-09        Jul-09      Aug-09        Sep-09   Oct-09

Sales                       0        2,450        3,876         5,820   6,760




Cash flow forecast: Your Business Ltd.   Jun 2009 - May 2010

                       Jun-09        Jul-09      Aug-09        Sep-09   Oct-09

Cash from sales             0             0           0         2,450   3,876
                                         A typical pattern of cash flows
    £   Initial injections of capital
+



                             Sales
                             begin
                                                       Sales revenues


0                                                                          Time
                                     G   Fixed costs

                                                        Variable costs


-
                                                                   Further
                                                                 investment
   First
                                                                   in fixed
expenditure
                                                                    assets
            Other start-up
                costs
+   bank       Cash flow - the good
    balance
                                                    Time
0


-
                                      Cash flow - the bad
+
0



-
+
0




-
           Cash flow - the ugly
              Cash flow and payment terms

          +



cash
          0                                                               Time
balance

          _
                a) Receipts leading payments (positive terms of trade)



          +



cash
          0                                                               Time
balance

          _

                 b) Receipts lagging payments (negative terms of trade)
bank
           Cash Flow and Growth
balance
+



                                      Time


-


+
          Cash Flow and Seasonality


                                      Time


-
    Sales, cash and cumulative profit: typical profiles
£



                                                Sales



                                                 Cash (cumulative)




                                                Profit (cumulative)

                                                          Time
  What needs to be funded?
  Before sales start
• The purchase of fixed assets
• Start-up costs: refurbishment, shop-fitting, decoration, web-site,
  recruitment, promotion etc.
• Initial working capital (cash, stock and debtors)
• Pre-payments to suppliers (e.g. rent and insurance)
• Losses due to fixed costs during the pre-sales period

  After sales start
• Increases in working capital
• Losses before break-even is reached
• Cash flow deficits arising from seasonality

 After sales take off (i.e. growth starts)
• Additional investment in fixed assets
• Increases in fixed costs
• Further increases in working capital
             A typical pattern of funding requirements

    Pre-payments:
    e.g. rent, insurance
                                                         Further
                                                       investment
£                                                         to fund
             Purchase of
                                                          growth
            opening stock
                                                        e.g. stock,
                                                      fixed assets
         Purchase of
         fixed assets                                                 Seasonal
                                   Losses incurred                    cash flow
                                   until break-even                    deficit
    Premises conversion,
       refurbishment,              is reached
       shopfitting etc.


         Fixed costs



                                                                       Time

                           Sales
                           start
How profit and loss changes the total funding requirement



                      Total funding requirement

                                                        Accumulated
        Accumulated                                        profits
    £      losses



                      Current assets



                       Fixed assets




                                                  Time and sales growth
Three types
 of funding                      Sole trader/                 Limited
                                 partnership                  company



                           Profit is your income.      May be kept in the
    Internally generated   You will be taxed on it     business (as retained
       funds (profit)      but it may be left in the   earnings) or distributed
                           business                    to owners.


                           This is your money -        Share capital:
       Owners' capital     it may be invested          cannot be repaid but
         (equity)          and removed at will         shares may be sold



                           Effectively your            Funds borrowed by the
                                                       company (note: the
   Borrowed funds          personal borrowings -
                                                       owners may lend to the
 (debt or loan capital )   you have full liability
                                                       company as well as
                           for repayment               investing share capital)
Sources of Funding (1) -
Equity or owners’ funds

                         Sole trader/partnership            Limited company


          Your own      Personal savings, private     Personal savings, private
          investment    borrowings etc. -             borrowings etc. invested as
                        just paid into the business   owners’ share capital (which
                        bank account                  cannot be repaid)


                        Investments by ‘silent’ or    • Other shareholders' capital
          Outsiders’
                        ‘sleeping’ partners           • Venture capital (as shares)
          investment
                        (partnership only)            • ‘Business angels’
                                                         (informal venture capital)


                        Your money, which may be      The company’s money,
                        taken out of the business     which stays in its bank
  Retained earnings
                                                      account unless a formal
(accumulated profits)   or left in the bank account
                                                      decision is made to
                                                      distribute it to the owners
  Venture capital

• Formal venture capital - established industry of large and small firms

• VC firms typically received (many) applications for VC

• Business angels: ‘informal’ VC investors as private individuals

• Angel investment normally through networking

• Basic principle: share purchase as medium-term investment

• Expect substantial shareholding (25% +)

• Typically look for exit after 2-5 years

• Different expectations of management roles - more likely to be hands-on
  for challenging or risky investment

• Offer management experience as well as capital

• Unlikely to invest in a start-up (more likely for a business angel)
Sources of Funding (2) -
Debt or borrowed funds

                       Sole trader/partnership            Limited company


                      No difference from ‘equity’   • Directors’ loans (which the
                      - although private lenders      company may repay to you)
 Private borrowings
                      will probably want a          • Other private borrowings
                      formal agreement with you       by company


                      Lent to the owners as their    Lent to the company,
    Bank loans,                                      which has liability for
                      personal borrowing - they
   overdrafts and                                    repayment - but lender will
                      have direct personal
    mortgages                                        probably want personal
                      liability for repayment
                                                     guarantees from directors


                      • Credit cards                 • Corporate credit cards
  Other borrowing     • Hire purchase                • Hire purchase
                      • Lease purchase               • Lease purchase
          Forms of debt funding


                  DEBT FUNDING


Interest -bearing          Non-interest -bearing

• Bank loans               • Supplier credit
• Bank overdrafts          • Customer advance payments
• Mortgages                • Directors’ loans (may charge interest)
• Hire purchase            • Other interest-free loans
• Asset finance
• Credit factoring
• Other borrowing
• Subsidised loans
Sources of Funding (3)

    Grants           Mostly local initiatives, e.g.:

                     - Sectoral employment incentives (e.g. manufacturing
                       may be encouraged in certain regions)

                     - Enterprise allowance (grants for new start-ups)

     Note: the local Business Link is a valuable source of advice on grants


Trade credit        Suppliers (dependent on terms of trade - when positive,
                                this may be a very important source)

   Debtors          Credit Factoring

                    Invoice Discounting

Note: In appropriate circumstances (i.e. credit-worthy customers), a credit
factor or invoice discounter may lend against your debtor book (perhaps
50%). Credit factors will offer a broader service, including credit collection.
 External sources of finance: relative use

Percentage of respondents receiving additional finance from:


Banks                                            83.7

Hire Purchase / leasing                          44.6

Partners / working shareholders                  19.5

Trade credit                                       8.5

Venture capital                                    6.5

Factoring                                          6.0

Other private individuals                          5.6

Other sources                                      9.7


 Source: Cambridge University Small Business Research Centre
Bank Funding: loans versus overdrafts

LOANS

• are mutual commitments - not repayable on demand

• are appropriate for the funding of investment - not cash flow

• should be arranged over a term relating to the life of the asset being funded


OVERDRAFTS

• should be used to fund short term cash flow deficits

• are repayable on demand

• are sometimes deceptively attractive as short term commitments

• are frequently misused in the U.K.

• are very popular with U.K. owner-managers because of their flexibility and
  the apparent short-term commitment
   Interest rates (1)

• Interest rates may vary widely with such factors as inflation, broader economic
  conditions, government policy and specific lenders’ pricing policies. Although
  characterised by large fluctuations in the past, UK rates are now relatively stable

• In the UK, lending rates are related to the ‘base rate’: the Bank of England’s
  ‘minimum lending rate’, now known as the Repo rate.

• The UK base rate is currently 1 % and expected to remain relatively stable
  (some commentators are predicting increases during 2010)

• Start-up businesses in the UK should expect to pay around 4 - 6 % over ‘base rate’
  on both loans and overdrafts

• Rates are normally variable but some lenders may insist on fixed rates

• Interest is only one aspect of banking and borrowing costs; many businesses pay
  more in charges on transactions and commission (for managing the account)

• An overdraft in excess of an agreed limit will incur a ‘penal’ rate of around 30%.
  This is levied on the total amount of the overdraft, not the over-limit excess
   Interest rates (2)
• Interest rates are negotiated as specific to the lending proposition; the
  bank tries to take an integrated view of the benefits and risks of dealing
  with you and with your business

• Rates may be subject to some reduction if an insurance policy or other
  financial product is taken out with the bank

  What rate should I assume?

 • With base rate at 1 %, you should expect to pay between 5% and 8% as a
   new business

 • A prudent assumption might be 6% - but you should be ready to negotiate
   with the bank

 • Remember that this is an annual rate - divide by 12 for monthly calculations


 A common error in financial projections is to forget to divide the annual rate
   by 12 and to model in interest at, for example, 10% per month. This may
     please the bank but will also hit your profit and cash flow forecasts!
 Bank charges - four categories
1) Transaction charges (for account usage)
e.g.    54p per debit ; 75p per credit      (Barclays Business Tariff)
        65p per credit or debit transaction (Yorkshire Bank)
        Automated transactions - free of charge (both Barclays and Yorkshire)

N.B. banking cash is expensive! A typical charge might be 0.5 % of the value
deposited (and can be as much as 1%) - if you have a retail business with a large
proportion of cash transactions, this can amount to a substantial cost

2) Account maintenance fee
e.g.   £3.00 per month (Yorkshire Bank Business Tariff)
       £7.50 per quarter (Barclays Small Business Tariff)
3) Lending fees
e.g.    0.5% - 1 % on value of agreed loan or overdraft facility, paid in advance
4) Special charges:
e.g.    Returned (dishonoured or ‘bounced’) cheques: £30.00
        Unauthorised overdraft or breaching overdraft limit: £20.00
N.B. Several banks currently offer free banking typically (charges categories 1 & 2
       only) for the first year for new businesses. Check the current offers!
Overdraft Facilities

An overdraft facility is negotiated on the basis of three parameters:
1)       the overdraft limit - the maximum agreed overdraft
2)       the period over which the overdraft facility is made available
3)       the interest rate

An overdraft facility must be agreed in advance with the bank, on the basis of
your cash flow projection:



bank
balance


     0
                                                                          Time
                                                 ?
                              overdraft limit

               agreed overdraft duration
          Negotiating overdrafts and limits


bank
balance

                  A
 0
                                                                         Time
                                                       ?
                       overdraft limit


              year 1                     year 2            year 3

          Question 1:

          If the maximum projected cash deficit (at point A) is £3,359
          what overdraft limit would you request?
             Negotiating overdrafts and limits

                                                                     Forecast cash
bank                                                                 deficit due to
                                                                      expansion
balance

                    A
 0
                                                                                 Time
                                                        ?
                         overdraft limit


                year 1                     year 2           year 3


          Question 2:

          How would you deal with the projected cash deficits in year 3?

          Would you ask the bank for an overdraft to demonstrate your
          forward thinking?
   Loan Accounts
  A loan is negotiated on the basis of three parameters:
  1) the loan value - the capital amount borrowed
  2) the loan term - the period over which the loan is repaid
  3) The interest rate

   A loan will normally be repaid on the basis of a fixed total monthly repayment
   paid by monthly direct debit. This repayment includes both capital repayments
   and interest; the interest component of this will reduce as the capital is repaid:



 FIXED                                        CAPITAL REPAYMENT
 TOTAL
PAYMENT
               INTEREST
               (levied on reducing balance)




 to cash flow              to P&L (only interest component is a P&L cost)
 (total repayment
 is cash outflow)
 Loan Accounts - ‘repayment holidays’


• Under certain conditions, the bank may agree a ‘repayment holiday’,
  e.g. while premises are refurbished during start-up

• During the ‘holiday’, interest may be ‘rolled up’ or deferred, increasing
  the fixed total repayment, or interest-only payments may be required




                                                     CAPITAL REPAYMENT
    REPAYMENT
    HOLIDAY             INTEREST
Loan Accounts: calculation

Note: to calculate repayments and interest paid, set up a subsidiary spreadsheet
in order to model the total repayments and accrued interest:

                           Month 1            Month 2              Month 3

A Starting balance        20,000              = E1                  = E2
B Total repayment        e.g. 452             = B1                  = B2
C Interest accrued       = (A1 x rate / 12)   = (A2 x rate / 12)    = (A2 x rate / 12)
D Net repayment          = B1 - C1            = B2 - C2             = B3 - C3
E Closing balance        = A1 - D1            = A2 - D2             = A3 - D3

• the fixed total repayment may be calculated for a given term but it is generally
  easier and more instructive to treat it as a variable and to use experimentation
  (or trial and error) to arrive at an appropriate term and repayment.
• What matters most to the bank and to you is that the business’s cash flow can
  support the repayment
• When and if your cash flow allows, you should be able to repay the residual
  loan without penalty
The Bank’s Perspective: evaluation of a lending proposition

Barclays uses the mnemonic ‘CAMPARI’ for the criteria used to evaluate
a lending proposition:

C     CHARACTER (of the management team)

A     ABILITY (of the management team and business)

M     MARGIN (over base rate

P     PURPOSE (of the loan)

A     AMOUNT (of the loan)

R     REPAYMENT (term and repayment capability)

 I    INSURANCE (risk and security)
 The bank’s perspective - some key points

• The bank’s primary concern is that the business will be able to
  repay its loan or overdraft according to the agreed terms

• In making this judgement, the bank will assess the combination of
  the business plan and the management team

• The bank will expect to see commitment in the form of the owner’s
  money at risk

• The bank will not wish to lend more than the owners’ investment
  and will usually see this as a maximum level of total lending (loan
  plus overdraft)

• The bank will see the agreement as a relationship of trust and see
  failure to meet repayments or to observe an overdraft limit as a
  breach of trust
Lending criteria - some research findings

In an interesting piece of research, Deakins and Hussain took a real business plan
to thirty bank interviews as a lending proposition. In half of cases, the proposition
was rejected while in the other half it was approved. The key criteria quoted (for
rejection or approval) were as follows (selection only):

     Gearing assumptions (borrowing over 1:1)                                   83 %
     Entrepreneur’s personal financial position                                 73 %
     Lack of balance sheet / P & L projections                                  66 %
     Entrepreneur’s drawings                                                    63 %
     Entrepreneur’s contacts in industry                                        60 %
     Contingency plans                                                          57 %
     Market research                                                            50 %
     Business / managerial strategy                                             13 %
     Enterprise / small business experience                                     10 %


 Source: Deakins, D. (1999) : ‘Entrepreneurship and Small Firms’ (2nd. edn.), McGraw-Hill, p.107
              Four levels of start-up funding


Von Munchhausen start-up           Shoestring start-up
  (no start-up funding)
                                   • low level of funding
• funded entirely by profits
                                   • low initial costs
• may be funded by trade credit
                                   • Internally funded by positive
• needs early sales revenues         cash flow
                                   • danger of insufficient funding


Well-balanced start-up              Bloated start-up

• adequately funded to meet plan    • over-funded, with surplus cash
                                    • danger of ‘wealth trap’
                                              +ve                Possible Wealth Trap:
                                                                cash-richness can blunt
                                         Profit                   management focus
                          Business
                        under-funded:
                         Growth and                              Business
                         profitability             Zone of      may be over-
                           may be                   elegant      funded or
        The Poverty
                        compromised               sufficiency   cash under-
            Trap:
                           by cash                                utilised
        shortage of
                          shortage
            cash
           diverts                                   Cash
- ve                                                                                 +ve
       management
       focus to sort-     Chances of survival
       term survival           severely                  Losses may
             and           compromised by                be disguised
        firefighting      lack of profitability           by positive
                                                             cash



                                              - ve
 CASH FLOW,
FUNDING AND
BANK LENDING

				
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