Generating Financial Pro Forma

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					  The Financial Forecasts for the
  Business Plan

Principles of Entrepreneurship

      Ken Hartviksen

  Tonight’s Agenda
      Introductions                Purpose of each
      Purpose of Financial          forecast and their
       Forecasts                     interrelationships
      Characteristics of Good      Data requirements and
       Financial Forecasts           how they are generated
      How to forecast and          Annual Sales Forecast
       how to recognize             Monthly Sales Forecast
       assumptions                  Monthly Cash Budget
      A tour of the financial      Pro forma Financial
       forecasts required            Statements

  What we Hope to Accomplish
  This Evening
      Understand the importance and use of:
              Cash flow
              Financial forecasts
      Learn how to develop loan amortization
       schedules and CCA schedules
      Learn how to incorporate this forecast
       information into financial forecasts
      Get you started on your own forecasts

  The Purpose of Financial
      To:
              Predict the financial consequences of our business
              Allow us to change our plans in advance to
               optimize the real financial results after analyzing
               the forecast financial statements.
              To demonstrate to prospective financial partners
               that we understand our business, the business
               model and how to manage it effectively to
               produce positive financial results.
              Demontrate the potential of the business to
               produce an adequate return on investment.

  The Purpose of Financial Forecasts –
  What do investors Look For?

      Ability to generate cash flow early
       enough and in sufficient quantity to
       ensure on-going financial solvency
      Time to break even
      Time to positive cash flow
      Time to profitability
      Return on investment

  Characteristics of Good Forecasts
      Reasonable/plausible
      Based upon good primary and
       secondary research
      Congruent with operating and
       marketing plans
      Can withstand stress testing
      Conservative/achievable

      Where do you Start?
     When generating integrated financial statements you start with:
          Sales forecast
     You will modify the annual sales forecast to a monthly sales forecast
      for the first year
     Make projections of all expenses for the first year.
     Start with a guess about the amount of initial financing required and
      where it is likely to be invested.
     Remember:
                  The big difference between the cash budget and the pro forma Income
                   Statement is that you include depreciation in the Income Statement
                   and ignore it in the cash budget.
                  The other big difference is that you use total interest expense for the
                   year in the income statement, but you use the total payments in the
                   cash budget.

        Integrated Financial Forecasts

                 Loan Amortization              Capital Cost
Sales Forecast       Schedule               Allowance Schedule

 Investment       Cash Budget                 Pro Forma                 Pro Forma
  Schedule                                     Income                 Balance Sheet


                    Analyze forecasts, adjust inputs and forecast again.

  Before we Get Started
  Let’s Review Some Things about Business Plans

      A Business Plan … is a forecast of what you hope to
       do….and how and when you hope to do it!

  Characteristics of a Good Plan
      readable
      organized
      targeted to the audience
      integrated
      complete
      short

  Uses of A Business Plan
      Helps you understand the steps to
       implementing your idea and what key
       factors you must monitor to ensure
      Support an application for financing
      Solicit potential financial partners

    How a Business Plan is Read
   Determine the characteristics of the company
    and industry
   Determine the terms of the deal
   Read the latest balance sheet
   Determine the caliber of the people in the deal
   Determine what is different about this deal
   Give the plan a once-over lightly

  Abbreviated Contents
      Title Page (with disclaimer)      Manufacturing and
      Executive Summary                  Operations Plan
      Table of Contents                 Management Team
      Business Idea                     Overall Schedule
      Industry/Company                  Critical Risk, Problems and
      Market Research and                Assumptions
       Analysis                          The Financial Plan
      Economics of the Business         Financing
      Marketing Plan                    Appendices
      Design and Development
       Plans                                  NOTE the location of the
                                                financial documents

  IV. Economics of the Business
      Gross and operating margins
      Profit potential and durability
      Fixed, variable and semivariable costs
      Months to Break even
      Months to reach positive cash flow

  XI. The Financial Plan
      Actual financial statements (if an already
       established business)
      initial investment required
      cash budget
      pro forma balance sheet
      pro forma income state
      break even chart
      cost control

  XII. Financing

      Proposed sources of financing
      use of funds
      investor’s forecast rate of return on
       invested capital

The Basic Financial Forecasts

           Principles of Entrepreneurship

  Types of Financial Forecasts
      Initial Investment Schedule
      Monthly Cash Budget
      Pro forma Income Statements
      Pro forma Balance Sheets
      Subsidiary forecasts
              Loan Amortization schedule
              CCA schedule
      Statement of Forecast Assumptions

  Initial Investment Schedule

  Initial Investment Schedule
   The purpose of the initial investment
              Identify proposed sources of capital
              Identify proposed initial uses of capital

  The Monthly Cash Budget

  The Monthly Cash Budget
   The purposes of the monthly cash
              Illustrate projected sources of cash – timing
               and magnitude
              Illustrated projected uses of cash – timing and
              Demonstrate the time to producing a positive
               cash flow

  The Pro Forma Income

  The Pro Forma Balance Sheet

  Subsidiary Forecasts
      You will need to make a series of forecasts
       that will be incorporated into your overall
       financial forecasts.
      Some of it will require outside data gathering
       for example:
              Employer contributions to CPP and EI
              WSIB premiums
      The most common subsidiary forecasts are:
                   Loan amortization schedule
                   Capital Cost Allowance Schedule

  Types of Small Business Loans
      Standard Bank Financing:
              Fixed term
                   Fixed rate
                   Variable rate
              Operating Line of Credit
      Government Financing:
              Northwestern Ontario
                   FedNor
                   Thunder Bay Ventures
              Business Development Bank of Canada

     Fixed Term Blended Payment
 This is a
diagram of
 the cash


                       Monthly fixed payments
  Effective Annual Rate Calculations
      You wish to borrow $10,000
      Assume you are quoted a fixed term, fixed
       payment loan at 2.5 percent above the prime
       lending rate
      The prime lending rate is currently 4.5%
      The loan amortization period is 1 year

  Calculating an Effective Monthly
      Since most loans require monthly payments,
       it is necessary to determine the monthly rate
       that would equal the effective annual rate:

  Calculating the Monthly Loan
      Now we know all of the variables:
            $10,000 loan
            7% APR 1-year term loan

           We can calculate the loan payment:

  Preparing a Loan Amortization

  Use of the Loan Amortization
          The loan payment each month is a cash
           outflow that must be included in your cash
           monthly cash budget.
          The total interest expense for the year is
           included in the pro forma income statement.

   NOTE:       - repayment of principal is not a tax
                deductible expense.
                - the total payment is a cashflow burden
                borne by the firm
  Effective Annual Rates of
      Most loan rates are quoted in APR terms (annual
       percentage rate)
      However, APR financing does not take into account
       the effects of compounding
      Most loans are compounded semi-annually. (ie.
       Interest is calculated and credited every six months).
       This effectively increases the rate of interest that the
       consumer faces.

  The Nature of Depreciation
      Capital assets such as buildings and equipment and land are
       very costly, but usually have a useful life of greater than one
      Buildings and equipment tend to wear out over time (ie. They
       have a useful life of perhaps 10, 20 or 30 years)
      Land doesn’t wear out.
      The cost of the buildings and equipment is spread out over their
       useful lives, and only the amount of wastage (wear and tear) is
       deductible from income in that year for the purposes of
       calculating taxes.
      CCRA predominantly uses one method of depreciation…it is
       known as Capital Cost Allowance.

  CCA gives rise to a ‘Tax Shield
  Benefit’ to the Company
    CCA is a non-cash deduction from income that would
     otherwise be subject to income taxation.
    As a result of the CCA deduction, taxable income is
    This results in a savings in tax payable.
    The tax shield benefits is equal to: T(CCA)
           t = corporate tax rate
           CCA = the dollar amount of CCA claimed
    A firm with a 40% corporate tax rate and a $2,000
     CCA deduction will save $800 in taxes.

                           K. Hartviksen             4
  Consider two firms that report $10,000 in earnings before CCA and taxes,
  face a 40% tax rate. One firm has no CCA to claim, the other can claim
  $2,000 in CCA

                                Company A            Company B
Earnings Before CCA & Tax         $10,000               $10,000
CCA                                  2,000                     0
Taxable Income                     $ 8,000              $ 10,000
Taxes @ 40%                          3,200                 4,000
Net Income                         $ 4,800               $ 6,000
Add back non-cash expense            2,000                     0
Cash flow from Operations          $ 6,800               $ 6,000

            Note that company A is better off by $800 because
            of the $2,000 non-cash deduction of CCA. That is
            the amount of taxes saved.
                              K. Hartviksen                            5
  CCA Rules
      Assets are grouped into pools or classes and
       depreciated as a group
      CCA rates are found in the regulations to the Income
       Tax Act and can be changed by Order-in-Council
      There is no need for an estimate of salvage value or
       useful life
      1/2 of the regular CCA rate for the class applies to
       the net additions to the pool for that year.
      CCA cannot be used to create a tax loss.

                        K. Hartviksen                  7
  CCA Over Time - A Simple Example
  Assume you acquire a depreciable asset with a cost base of $100,000 and there are
  no other assets in this pool. The CCA rate for the pool is 10%. Note you are
  allowed only 1/2 the regular CCA rate on the net additions to the pool in the year of

                                  K. Hartviksen                                   8
  CCRA Form

  CCRA Form forecasting CCA out
  three years for one asset class

  NOTE Regarding Depreciation in
  your Financial Forecasts:
      You never include depreciation (CCA)
       on a cash flow (cash budget) forecast
      You use depreciation only in your pro
       forma income statement, and on your
       pro forma balance sheet.

  Initial Startup Capital Required
      The initial estimate can and probably will be revised
       depending on your first iteration of the forecasts.
      Separate the estimate into two categories:
              Working capital
              Fixed assets (plant and equipment)
      You do this because when you look for financing for
       these investments, the fixed assets can usually be
       pledged as collateral for any borrowing, whereas the
       working capital needs usually has to be financed out
       of the owner’s equity.

  Initial Investment
      In your business plan you will have to
       prepare a schedule that details the
       initial financial investment that is
       required to make your business a
      It is best is you divide the schedule up
       into two components:
              Working capital requirements
              Capital Equipment
  Initial Investment Required

  The Cash Budget
      Incorporates your startup capital
      Is strongly a function of your sales
       forecasts (that are predicated on your
       market research and some assumptions
       about your market penetration

  Importance of Cash Flow
      Planning to have cash available to pay bills of the
       business as they become due is a critical aspect of
       business survival…it is a management skill.
      Understanding the cash flow cycle of a firm can help
       you manage those elements that are critical to
       ensuring you can pay your bills.
      Cash flow forecasting through a cash budget provides
       important information to you and to your potential
       funding partners about your operating financial needs
       and most particularly, the timing and magnitude of
       any projected cash deficits or surpluses.
  Cash and Materials Flow
                Finished Goods    Work-in-process   Raw Materials
                Inventory         Inventory         Inventory

      Cash Sales

              equity             Taxes

  The Cash Budget
      Cash budgets are most often prepared on a monthly
      Most funding partners expect to see three years of
       projects. Some may require as many as seven years.
      If your business expects to encounter any seasonality
       in the sales cycle, you will find some ‘interesting’
       effects that may dramatically affect the amount of
       start-up financing that you require.
      If there is seasonality effects, you will have to
       carefully manage your cash flows, inventories and
       accounts receivable to remain solvent.
  Cash Budgets
      allow us to forecast the cash flows of a firm
       over time (between balance sheet dates).
      identifies the timing and magnitude of
       expected cash surpluses and deficits -
       thereby providing the manager with the
       opportunity to prepare, in advance, to finance
       expected deficits, or to invest surpluses.
      may be used as the basis for pro forma
       financial statements.

  General Form - Cash Budget

  Assumptions of Cash Budgets
      that cash inflows and outflows occur evenly
       throughout the month.
              this is rarely the case
              disbursements often are predictable
                   wages/salaries due on 15th and 30th
                   payments to suppliers on 15th or 30th, etc.
              cash receipts depend on how we manage accounts
               receivable....depending on how we do this they may largely
               occur between the 20th and 30th of the month...
              what is the impact of the foregoing?
              how can we overcome this?

  General Form - Cash Budget

  General Form - Cash Budget

  Cash Balance
 $ Cash

           Jan Feb Mar Apr May Jun Jul Aug

Analyzing your financial forecasts

           Business Plan Boot Camp

  Ratio Analysis

      This is a technique used by investors
       and bankers (lenders) alike to assess
       the financial strength of your proposed
      Once your business begins, ratios will
       be used to examine how well you are
       managing your business.
      Is one number divided by another!
      Purpose is the provide some insight into the
       complexity of financial information.
      Example:

            Current Ratio =        Current Assets
                                   Current Liabilities

  Categories of Ratios
      Liquidity
      Asset Management
      Debt Management
      Profitability

  Liquidity Ratios
      Purpose:
              to examine the ability of the business to pay it’s
               bills on time.
      A firm that can’t survive in the short-
       term won’t have to worry about the

  Liquidity Ratios
      Examples:

           Current Ratio =   Current Assets
                             Current Liabilities

           Quick Ratio = Current Assets - Inventories
                             Current Liabilities

  Asset Management Ratios
      Purpose:
              to give some insight into how well the business
               is being managed.

  Asset Management Ratios
      Examples:

           Inventory Turnover    =    Sales

           Average Collection
           Period     = Receivables

  Asset Management Ratios
      Examples:

           Fixed Asset
           Turnover    = Sales
                         Fixed Assets

           Total Asset
           Turnover    = Sales
                         Total Assets

  Debt Management Ratios
      Purpose:
              to examine the impact that the chosen
               methods of financing are having (likely to have)
               on the financial health of the business.

              Lenders will also be concerned with your
               liquidity ratios because those ratios assess your
               firm’s ability to pay the bills when they come

  Debt Management Ratios
      Examples:

           Debt to
           Total Assets   =   Total Debt
                              Total Assets

           Times interest
           earned      = Operating Income
                          Interest Charges

  Profitability Ratios
      Purpose:
              to examine the historical (or prospective rate of
               return in the case of pro forma financial
               statements) rates of return earned on invested

  Profitability Ratios
      Examples:

           Profit margin
           on sales    = Net income

           Return on
           Equity      = Net income
                         Common Equity

  Profitability Ratios

      Examples:

           Return on
           Assets = Net income
                     Total Assets

  Seasonality of Sales
      most firms experience a seasonal variation in sales
       volume...times of the year when sales increase, and times of
       the year when sales volumes are low or non-existent.
      there are financial implications for firms that experience a
       marked seasonal sales cycle
         what is the best time in the seasonal sales cycle to have the

           fiscal year end?
         how do we finance the seasonal build-up in inventory levels?

         what happens to the balance sheet accounts at different

           points in the seasonal sales cycle?
         how comparable are two firms in an industry with a marked

           seasonal sales cycle if they have differ fiscal year ends?

  Balance Sheet Accounts over time

  Selecting the Fiscal Year End
      tax considerations
              for smaller, owner/managed enterprises, there are greater tax-
               planning opportunities if the corporate fiscal year end is set
               sometime after the calendar year end
              the firm’s financial position
              firms will look most healthy if the fiscal year end is set
               sometime after the seasonal sales peak....long enough
               afterward to see receivables collected.
              auditors preferences
              auditors are busy around the calendar year end...with firms
               and individuals that have selected Dec 31 as their year end.
              auditors are busy from February through May with income
  Ratio Analysis
          a ratio is just one number over another number. If the ratio is ‘poor’
           when compared to something else, it could be a result of the numerator,
           or the denominator, or both.
          a ratio is just a number. It must be compared to something else if it is to
           begin to take on some meaning. Common comparators include:
                 industry average ratios
                 historical ratios for the firm itself
                 other current ratios for the same firm
          it is important to take the ‘context’ into account when interpreting the
           financial performance of the firm...what industry is the firm in? how
           rapidly has the firm been growing? what is happening in the industry?
          ratio analysis is a starting point in analyzing the firm. It must be
           supplemented by analysis of the overall economy, the industry, etc.

  Income Statement Ratios
                                         Absolute              Common Size            Industry
           Sales                         $250,000                    100.0%                 100%
           Cost of Goods Sold             173,000                     69.2%                  70%
           Gross Margin                    77,000                     30.8%                  30%
           Admin Expenses                  50,000                     20.0%                  10%
           EBIT                            27,000                     10.8%                  20%
           Interest Expense                 5,000                      2.0%                   5%
           Net Income                     $22,000                      8.8%                  15%

           Profit Margin on Sales                                      8.8%                  15%
           You can see from the common size data, that this firm differs from the industry in
           overhead costs and in interest expense. Without further information it is difficult to
           draw any specific conclusions, however, you should note, that direct operating costs
           are in line with the industry. Why is selling and admin. expenses double that of the
           industry? The firm’s fixed financing costs are it just low cost or are they
           using less debt than others in the industry?
  Use of Ratios

      Evaluate your past financial
      Evaluate your financial forecasts

  Role of Ratios in Your
  Business Plan
      Your business plan forecasts your firm’s
       future financial performance.
              Conduct ratio analysis on your forecast
              determine whether you should pursue your
              revise your plans….

  Role of Ratios in Your
  Business Plan
           Prepare Pro Forma Financial
           Statements based on your          Revise
           business plans
                                             plan if
           Analyze your forecasts using      necessary
           ratio analysis

           Once you are satisfied with
           your forecasts…proceed to
           raise the capital and implement
           the plan

  The Articulation of forecast Income
  Statements and Balance Sheets
      Articulation refers to the fact that the forecast income
       statements and balance sheets are integrally linked.
      For example:
              Assets like building and equipment are stated on the balance sheet
               at their net value (net of depreciation)
              The retained earnings account on the balance sheet will be the
               accumulated retained earnings over time as found historically on
               the income statements. (The difference between last year’s R/E
               balance and next years, is the amount of income after tax that is
               retained in the firm.)


Description: Generating Financial Pro Forma document sample