MODULE 11 Financial Planning and New Ventures

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SUGGESTED READINGS

Toward a Framework of Financial Planning in New Venture Creation
Benjamin B. Gansel
http://usasbe.org/knowledge/proceedings/proceedingsDocs/USASBE2005proceedings-
Gansel%2025.pdf

Making Financial Projections in Your Business Plan
http://www.allbusiness.com/business-planning-structures/business-plans/1729-1.html

Business Planning: The Road Less Travelled
http://www.ctinnovations.com/blog/?tag=financial-projections

Prepare to Impress the Investor …
http://www.getinvestorready.com/financials.php

The 5 Most Important Numbers in Your Business Plan
http://upstartadvisors.wordpress.com/tag/financial-projections/
WHY IS FINANCIAL PLANNING IMPORTANT?

Gansel (2005) defines financial planning as “the process of systematic and
quantitative forecasting of all cash in and outflows relevant for the exploitation of
entrepreneurial opportunities, in order to support financial decisions within the future
planning period.” As a result, financial planning serves as a means of identifying and
addressing uncertainty.

The previous module on business planning highlighted the fact there are internal
and external users of the business plan. Both groups have a keen interest in the financial
aspects of the plan. Projected profitability is of particular interest to the entrepreneur and
his/her team as well as potential investors; after all it represents one way in which they
hope to earn a return on their investment. Potential creditors are especially interested in
the ability of the business to generate cash flow that will support timely repayment of
debt obligations. In addition to projected profitability and cash flow, entrepreneurs and
potential funders also need to know the financial requirements of the business. As a
result, the financial plan should address a number of key questions as follows:

• How much money does the business need?
• When will the money be needed?
• What will the money be used for?
• How will the money be paid back and when?

Financial projections are necessary to investigate the financial aspects of the
business. The financial plan also should bring together the implications of the rest of the
business plan and provide the basis to evaluate the feasibility of the proposed venture.
Further, financial planning is critical to establishing the capital structure of the business
and to the determination of appropriate sources of capital (to be discussed in the next
module).

THE FINANCIAL PLANNING PROCESS

The sales forecast is the starting point for developing the financial plan. The
marketing research described in module 8 should provide the information on projected
sales volume and pricing necessary to develop the sales forecast. The revenue or sales
forecast can then be translated into a cost and production plan, the latter subsequently
providing the foundation to project additional expenses of an administrative, sales, and
research and development nature. The production and operations plan also allows the
entrepreneur to estimate requirements for fixed assets, which when combined with the
operating budget provide the basis for estimating the required level of capital investment.
The process as outlined here provides the foundation to subsequently derive projected
cash budgets, income statements and balance sheets. Given the uncertainties, all
projections should be subjected to scenario or sensitivity analysis. For a more complete
discussion of developing financial projections the reader should review the article,
Toward a Framework of Financial Planning in New Venture Creation by Benjamin B.
Gansel (2005).
WHAT SHOULD BE INCLUDED IN THE FINANCIAL PLAN?

To address the above questions and others, the business plan should include
financial projections of start-up costs, pro forma balance sheets and income statements,
and projected cash flow statements. In Gansel’s (2005) terms, the pro forma financial
plan is viewed as the numerical result of the financial planning process. More
specifically, the following financial statements should be included in the financial plan:

 Estimate of the start-up costs
 An opening balance sheet
 Forecast annual income statements (three years)
 Projected balance sheets (three years)
 Monthly cash flow statement (first year)
 Quarterly cash flow statements

The purpose here is not to have you develop each of these statements but rather to
understand the role they play in addressing the identified financial questions and to
understand the process of developing projections. To that end it is useful to focus on the
question of determining capital requirements for a business. To do so it is necessary to
distinguish between start-up capital and operating capital. Start-up capital refers to the
total requirement for funds to get the business to the point where it is able to start
generating revenue. Even for the most straightforward of business ventures it may take
several months of start-up activities before you are ready to open the doors and make
your first sale. During that time the business is incurring both operating and capital costs.
Operating costs includes such things as salaries, rent, insurance, etc. Capital costs
include purchases of furniture, fixtures, equipment, etc. In addition, the business may
need to purchase inventory, which will be sold at a later date to generate revenue. The
key point to keep in mind is that start-up costs result in cash outflows that must be funded
until such time as the business can generate cash inflows from operations. Consider the
following example of projected start-up costs.

Sample Start-up Costs

Lease (2 months during renovations) 2, 200
Lease deposit 800
Renovations 25,000
Equipment 14,000
Furniture & fixtures 9,000
Wages 1,200
Training 600
Insurance 575
Membership fees 950
Legal costs 850
Permits & licenses 300
Office supplies 300
Opening inventory 50,100
Opening advertising 4,100
$ 109,975

A number of points related to start-up costs are worth noting. First, some items
such as renovations, equipment and furniture are capital items that appear on the balance
sheet and will be expensed over the life of the asset. Second, inventory is also an asset
that will be sold and expensed against revenue at the time of the sale. Third, other items
such as wages, insurance, and office supplies are normal operating expenses. In the
normal course of operations these items will be expensed against revenue. Quite simply,
start-up costs ignores the general accounting principle of matching revenues with the
expenses incurred to earn them. With start-up costs the issue is one of timing – when do
you incur the cost. Once start-up costs are estimated, the question becomes one of how to
pay for them. Does the entrepreneur(s) have sufficient capital to cover these costs? If
not, where will s/he get the money (to be discussed in the next module)?

The other financial statement deserving of discussion here is the cash budget. In
some respects the cash budget is similar to start-up costs - the issue is one of timing of
cash flows not of matching revenues and expenses. Insufficient cash flow is often a
problem for new businesses even those that are profitable. As a result, new businesses
need to focus on cash flow and the cash budget provides the means to do so. The
following illustration highlights the key components of a cash budget or cash flow
statement.

Sample Cash Flow Statement

Sources of Cash (Cash Inflow)

Cash from Operations
- cash sales
- collection of accounts receivable
Other Sources
- sale of fixed assets
- loan proceeds
- investor proceeds
- fixed asset sale (vehicle)

Uses of Cash (Cash Outflow)

For Operations
- payment of accounts payable
- payment of expenses (e.g. payroll, rent)
Other Uses
- purchase fixed assets
- repay loan principal
- income tax payments
- dividend payments

As with start-up costs, it is worth noting the focus of the cash flow statement is
not on determining profitability or matching costs and revenues. The focus is on
recognizing when money comes in and when money goes out. A number of items in the
cash budget illustrate this point. For example, the timing of the sale is irrelevant (unless
it’s a cash sale). What’s important is when you collect from the customer, hence the
collection of accounts receivable generates cash inflows. A number of one-time events
also can have a significant impact on cash inflow, such as the sale of fixed assets or
obtaining a loan. Similarly, cash outflows may be heavily influenced by the need to
make a loan or dividend payment or by the purchase of fixed assets. The bottom line is
the cash budget is critical to determining cash shortfalls and when they will occur. The
entrepreneur can use this information to support requests for short-term funding to cover
cash deficits.

SUMMARY

In summary financial planning is crucial to determining the feasibility of the
proposed venture and to building credibility among potential investors, creditors,
customers, and suppliers. The process can be particularly difficult for a new venture with
no history. Nevertheless, the entrepreneur and her or his team must systematically
develop sound financial projections, which are supported by clearly stated and logical
assumptions, and tested for their sensitivity to changes in key parameters. The results
should provide a basis for financial decision making by both internal and external
stakeholders.