Business Plan

Two of the most important areas of management responsibilities are:

 Capital Budgeting and

 Planning

A business plan must be developed before any funds are sought for a
new product or venture.

The capital budgeting function may be divided into several categories

depending upon the time frame involved.

• Strategic planning involves setting the goals, objectives, and broad

business plans for a 5- to 10-year time period in the future.
• Tactical planning involves the detailing of the strategic planning for
say 2–5years in the future.
• Capital budgeting involves a request, analysis, and approval of
expenditures for the coming year.
Business plans minimally consist of the following information along
with a projected timetable:

• Perceived goals and objectives of the company

• Market data
Projected share of the market
Market prices
Market growth
Markets the company serves
Competition, both domestic and global
Project and/or product life

•Capital requirements
Fixed capital investment
Working capital
Other capital requirements
• Operating expenses
Manufacturing expenses
Sales expenses
General overhead expenses

• Profitability
Profit after taxes
Cash Flow
Payout period
Rate of return
Returns on equity and assets
Economic value added
• Projected risk
Effect of changes in revenue
Effect of changes in direct and indirect expenses
Effect of cost of capital
Effect of potential changes in market competition

• Project life
Estimated life cycle of the product or venture
SOURCES OF FUNDS

The funding available for corporate ventures may be obtained from

internal or external sources.

Internal Sources:
 The capital from internal sources is from retained earnings or from
an allowance known as reserves.
 Internal financing is “owned” capital, and it is argued that it could be
loaned or invested in other ventures to receive a given return.

Retained Earnings
• Retained earnings of a company are the difference between the
after-tax earnings and the dividends paid to stockholders.
• If a firm plans no growth, then theoretically all the after-tax earnings
could be distributed as dividends to the stockholders.
• The company retains a certain part of the profits, and a part is paid
to the stockholders as dividends. That part retained may be used for
research and development expenditures or for capital projects
Reserves
• The reserves are to provide for depreciation, depletion, and
obsolescence.
• Deprecation reserves seldom cover the replacement costs of
equipment because improved technology results in more expensive,
sophisticated equipment.
• Also, inflation severely cuts into reserves. Therefore, with the
necessity of providing for dividends to stockholders and to purchase
equipment, it is essential to seek external funding
External Sources:

A general rule is the riskier the project, the safer should be the type of
financing the capital used.

There are three sources of external financing:

 Debt,
 Preferred stock, and
 Common stock.

A new venture with modest capital requirements could be funded by

common stock. In contrast, a well-established business area may be
financed by debt.

Debt
For discussion purposes, debt may be classified arbitrarily as follows:
Current debt—maturing up to 1 year
Intermediate debt—maturing between 1 and 10 years
Long-term debt—maturing beyond 10 years
1. Current Debt

Let’s consider this case: A company has the opportunity of purchasing a raw
material at a low price, but the company doesn’t have ready cash. The
company wants to pay off the debt in 90–120 days.

There are three options available.

First, it could be obtained from a bank by means of a commercial loan.

As an alternate, if the company has a good line of credit, it could borrow the
money in the open market. It would draw a note to the order of the bearer of
the note and have it discounted by a dealer in this type of note or by the
purchaser of the note. This type of borrowing is a negotiable note known as
commercial paper.

A third method is through what is known as open-market paper or banker’s

acceptance. If a raw material is to be purchased from a single source, the
company could sign a 90-day draft on its own bank paid to the order of the
vendor. The company will pay a commission to its own bank to accept in
writing the draft and the company has an unconditional obligation to pay the
full amount on the maturity date.
2. Intermediate Debt.

This form of debt is retired in 1–10 years. This is usually the smallest form of
debt based on the total debt. There are three types of intermediate debt,
namely,
 Deferred-payment contract,
 Revolving credit, and
 Term loans.

In the deferred-payment contract, the borrower signs a note that specifies a

series of payments are to be made on a time schedule over a period of time,
perhaps 5 or 10 years. This type of debt may be used for the purchase of
equipment, the title of which rests with the note holder until the debt is retired.
Institutional investors, banks, and insurance companies are examples of typical
lenders.

Revolving credit is an agreement in which the lender agrees to loan a company

an amount of money for a specified time period. A commission or fee is paid on
the unused portion of the total credit. Banks usually are the lenders.
Term loans are divided into installments that are due at specified
maturity dates that may be as long as 10 years. There are a variety of
arrangements that can be made, such as monthly, quarterly,
semiannual, or annual payments. These obligations may be paid off
prior to maturity, both with and without penalties, depending on how
the agreement is drawn. Large commercial banks and insurance
companies are typical lenders
3. Long-Term Debt.
Bonds or long-term notes are examples of this type debt. They are special
kinds of promissory notes and are negotiable certificates that are issued at
par values of $1000. They are securities promising to pay a certain amount of
interest every 6 months for a number of years until the bond matures. There
are four types of bonds in the market, namely,
 Mortgage,
 Debenture,
 Income, and
 Convertible bonds.

Mortgage bonds are backed by specific pledged assets that may be claimed if
the terms of the indebtness are not met and particularly if the company
issuing the bonds goes out of business. Utilities and railroads often use this
type of debt.

Debenture bonds are only a general claim on the assets of a company. This
type of bond is usually preferred by companies because it is not secured by
specific assets but by the future earning power of the company and allows
the company to buy and sell manufacturing facilities without being tied to
specific assets.
Income bonds are different from other forms of long-term debt in that a
company is obligated to pay no more of the interest charges that have
accrued in a certain period than were actually earned in that period.
These types of bonds find use when a company has, to recapitalize after
bankruptcy and the company has uncertain earning power.

Convertible bonds are hybrids. In periods of inflation, an investor may

become wary of putting funds in bonds that merely repay the principal in
dollars that have deteriorated in purchasing power. To tempt the investor
back into bonds, corporations resort to convertible bonds. If inflation
sends stocks upward, one can convert the bonds to stocks and protect
the rea purchasing power of the principal. In periods of low inflation or
deflation, bonds are safe investments but in periods of inflation, stocks
reflect the inflationary trend so that purchasing power may be retained.
Stockholders’ Equity
This is the total equity interest that stockholders have in a corporation.
There are two broad classes of equity: preferred stock and common stock.

Preferred Stock: The word “preferred” means that these stockholders

receive their dividends before common stockholders. In the event of
company liquidation, preferred stockholders will recover funds from the
company assets before common stockholders. Preferred stockholders
generally have no vote in company affairs. Most preferred stock offered
today is cumulative, which means that if in any year no dividends are paid,
the dividends accumulate in favor of the preferred stockholders. The
cumulative dividends must be paid before any common stockholders receive
dividends.

There is also a convertible preferred stock offered by companies. This stock,

like a convertible bond, carries for a stated period of time the privilege of
converting preferred stock to common stock. Usually, convertible preferred
stock pays a lower dividend than preferred stock.
Common Stock: The holders of common stock are the source of venture
capital for a corporation. As such, they are at the greatest risk because they
are the last to receive dividends for the use of their money. When the
company grows and flourishes and the earnings are high, they receive the
greatest benefits in the form of dividends. An added feature is that the
common stockholder has a voice in company affairs at the company annual
meetings
.
Venture capital firms fund start-up companies in return for common stock
that someday might be offered as an initial public offering (IPO) that may
be worth a lot of money. In some cases the venture capitalists seek
positions in the start-up company. Normally, a venture capital firm doesn’t
put money in a firm and watch from afar to see what happens to the young
firm. These firms are likely to stay active in the firm until the IPO is offered.