BMSH2009

BUSINESS PLAN QUANTIFICATION

FINANCIAL STATEMENTS
Financial statements are written records of a business' financial situation. Four (4) financial statements
are used to analyze the business's position.

1. The Balance Sheet. It is also known as the Statement of Financial Position. It lists the firm’s assets
and liabilities, providing a snapshot of its financial position at a given time (Brigham & Houston,
2020).

The left side of the statement shows the company's assets, while the right side shows the firm’s
liabilities and stockholder’s equity, which are claims against the firm’s assets. Figure 1.0 illustrated
the typical balance sheet.

Figure 1.0 The Typical Balance Sheet

The two (2) major categories of assets are current and fixed or long-term.

• Current Assets. These assets could be converted into cash within one (1) year. Current assets include
the following:

1. Cash and other marketable securities – Short-term, low-risk investments that can be easily sold
and converted to cash.

2. Accounts receivables – Amounts owed to the firm by customers who have purchased goods or
services on credit.

3. Inventories – Composed of raw materials as well as work-in-progress and finished goods.

4. Other current assets – A catch-all category includes prepaid expenses such as rent or insurance
paid in advance.

• Long-term assets. These are assets expected to be used for more than a year. They include property,
plant, equipment, and intellectual property such as patents and copyrights. These are not expected
to be consumed or converted into cash within a year.

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The claims against assets are of two (2) basic types:

• Liabilities. It is the money that the company owes to others. Like assets, liabilities are also
categorized as current, and long-term: (1) Current liabilities are a company’s short-term financial
obligations due within one (1) year or a normal operating cycle. Examples of current liabilities are
accounts payable, short-term debt, notes payable, and dividends payable (Tuovila, 2019); and (2)
Long-term liabilities are financial obligations of a company that are due more than one (1) year in
the future. Long-term liabilities are also known as non-current liabilities. Examples of long-term
liabilities are bonds payable, present value of lease, mortgages, car payments and other loans to be
paid more than a year.

• Stockholder’s equity can be thought of in two (2) ways. First, the amount the stockholders paid to
the company when they bought shares the company sold to raise capital, to all of the earnings the
company has retained over the years.

𝑆𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟 ′ 𝑠 𝑒𝑞𝑢𝑖𝑡𝑦 = 𝑃𝑎𝑖𝑑 − 𝑖𝑛 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 + 𝑅𝑒𝑡𝑎𝑖𝑛𝑒𝑑 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠

Retained Earnings are not just the earnings retained in the last year–they are the cumulative total
of all the earnings the company has earned and retained during its life. Second, as a residual where:

𝑆𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟 ′ 𝑠 𝑒𝑞𝑢𝑖𝑡𝑦 = 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝑇𝑜𝑡𝑎𝑙 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

Assets Liabilities
Current Assets Current Liabilities
Cash xxx Accounts Payable xxx
Accounts Receivable xxx Accrued Expense xxx
Prepaid Rent xxx Unearned Revenue xxx
Inventory xxx Total Current Liabilities xxx
Long-term Liabilities xxx
Total Current Assets xxx Total Liabilities xxx
Stockholders’ Equity
Long-term Assets Ordinary Share Capital
Machinery xxx Preference Share Capital xxx
Accumulated (xxx) xxx Retained Earnings xxx
Depreciation
Total Long-term Assets xxx Total Stockholders’ Equity xxx
Total Assets xxx Total Liabilities and Stockholders’ xxx
Equity

Table 1. Balance Sheet (Statement of Financial Position) Sample Format

2. The Income Statement

The income statement (the Statement of Financial Performance) lists the firm’s revenues and
expenses. The last part of the income statement shows the firm’s net income, which measures its
profitability during the period. The income statement is sometimes called a profit and loss, or “P&L”
statement, and the net income is also referred to as earnings.

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Earnings Calculations

The income statement shows the cash flow and expenses generated by the assets and liabilities
between two (2) dates.

• Sales. It is the company’s revenue from sales or services, which reflects the very top of the
statement.

• Cost of Goods Sold (COGS). This line item accumulates the direct costs associated with selling
products to costs, including labor, parts, and materials.

• Gross Profit. The first two (2) lines of the income statement list the revenues from the sales of
products and the costs incurred to make and sell the products. Other costs such as administrative
expenses, research and development, and interest expenses are not included in sales. As gross profit
is in the third line, it shows the difference between sales revenues and the costs.

• Net sales. It is the sum of a company’s gross sales minus its returns, allowances, and discounts.

• Operating Expenses. These are expenses from the ordinary course of running the business not
directly related to producing the goods or services sold. Operating expenses include administrative
expenses and overhead, salaries, marketing costs, and research and development expenses. The
third type of operating expense, depreciation and amortization, is not an actual cash expense but
represents an estimate of the costs that arise from wear and tear or obsolescence of the firm’s
assets. The firm’s gross profit net of operating expenses is called operating income.

• Operating Income. It is derived from the firm’s regular core business. Operating income is calculated
before deducting interest expenses and taxes, which are considered to be non-operating costs.
That’s why it is also called EBIT (earnings before interest and taxes).

𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒 (𝑜𝑟 𝐸𝐵𝐼𝑇) = 𝑆𝑎𝑙𝑒𝑠 𝑟𝑒𝑣𝑒𝑛𝑢𝑒𝑠 − 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑜𝑠𝑡𝑠

• Depreciation and Amortization Expense. Depreciation and amortization are non-cash expenses that
accountants create to spread out the cost of capital assets such as Property, Plant, and Equipment.

• EBITDA (Earnings Before Interest and Taxes, Depreciation, and Amortization). This is not present
in all income statements. It is calculated by subtracting SG&A expenses (excluding depreciation and
amortization from gross profit.

• Interest. Common for all companies to split out interest expense and interest income as a separate
line item in the income statement.

• Income Taxes. It refers to the relevant taxes charged on pre-tax income. The total tax expense can
consist of both current taxes and future taxes. Philippines corporations are subject to a 30%
corporate income tax (Rastogi, 2019).

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Sales xxx
Less: Sales Returns and Allowances xxx
Net Sales xxx
Less: Cost of goods sold xxx
Gross Profit xxx
Less: Operating Expenses xxx
Income from operations xxx
Less: Interest expense xxx
Income before income tax xxx
Less: Income Tax (30%) xxx
Net Income/Net Loss xxx
Table 2. Income Statement Sample Format

3. The Statement of Cash Flows

The firm’s statement of cash flows is a report that shows how items that affect the balance sheet and
income statement affect the firm’s cash flows (Brigham & Houston, 2019). It utilizes the income
statement and balance sheet information to determine how much cash the firm has generated and how
that cash has been allocated during a set period. Cash flows are divided into three (3) sections:
operating activities, investment activities, and financing activities (Berk & DeMarzo, 2017).

a. Operating Activities. This section deals with items that occur as part of normal ongoing
operations.
• Net income. The first source of cash. If all sales were for cash, all costs required immediate
cash payments, and if the firm were in a static situation, net income would equal cash from
operations. Adjustments shown in the remainder of the statement must be made.
• Depreciation and amortization. The first adjustment relates to depreciation and amortization.
Depreciation is deducted from computing net income because it is a non-cash charge.
Therefore, depreciation must be added back to net income when cash flow is determined.
• Increase in inventories. The firm must use cash to make or buy inventory items. Some of this
cash may be received as loans from its suppliers and workers (payables and accruals), but
ultimately, any increase in inventories requires cash.
• Increase in accounts receivable. Inventories sold on credit must be replaced to stay in
business, but they would not yet have received cash from the credit sale. So, if the firm’s
accounts receivable increase, this will amount to using cash.
• Increase in accounts payable. Accounts payable represent a loan from suppliers.
• Increase in accrued wages and taxes. The same logic applies to accruals as to accounts
payable.
• Net cash provided by operating activities. All of the previous items are part of normal
operations arising from doing business. When summed up, the net cash flow from operations
will be obtained.
b. Investing Activities. This section shows the cash required for investment activities (Berk and De
Marzo, 2017). All activities involving long-term assets are covered (Brigham and Houston, 2019).

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• Additions to property, plant, and equipment. It is shown in parentheses because it is an

outflow.
• Net cash used in investing activities. The excess of cash outflow against cash inflow.
c. Financing Activities. Company’s financing activities are shown in this section.
• Increase in notes payable. If the firm borrows money, that is a cash inflow. When the firm
repays the loan, that’s an outflow.
• Increase in bonds (long-term debt). If the firm issues bonds to its long-term investors in
exchange for cash, this is shown as inflow. When the firm repays the bonds, this will be an
outflow.
• Payment of dividends to stockholders. Dividends are paid in cash, and all payments issued
to stockholders are shown as a negative amount.
• Net cash provided by financing activities. The sum of the above financing entries is shown
here. These funds can help to cover deficits resulting from operations.
d. Summary. This section summarizes the change in cash and cash equivalents over the year.
• Net decrease in cash. The net sum of the operating, investing, and financing activities.
• Cash and equivalents at the beginning of the year. Cash or cash equivalents such as treasury
bills, money market funds (with three (3) months or less original maturity), and taxable
municipal bonds accumulated at the beginning of the year.
• Cash and equivalents at the end of the year. Cash or cash equivalents such as treasury bills,
money market funds (with three (3) months or less original maturity), and taxable municipal
bonds are left at the end of the year.
2019
I. Operating Activities
Net Income xxx
Depreciation and Amortization xxx
Increase in Inventories (xxx)
Increase in Accounts Receivable (xxx)
Increase in Accounts Payable xxx
Increase in Accrue Wages and Taxes xxx
Net Cash provided by (used in) operating activities XXX
II. Investing Activities
Addition to property, plant, and equipment xxx
Net cash used in investing activities xxx
III. Financing Activities
Increase in Notes Payable xxx
Increase in Bonds xxx
Payment of Dividends to Stockholders (xxx)
Net Cash provided by financing activities xxx
IV.
Net decrease in cash (Net sum of I, II, and III) (xxx)
Cash and equivalents at the beginning of the year xxx
Cash and equivalents at the end of the year XXX
Table 3. Statement of Cashflows Sample Format

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4. Statement of Stockholders’ Equity

Changes in stockholders’ equity during the accounting period are reported in the Statement of
Stockholders’ equity. Stockholders allow management to retain earnings and reinvest them in the
business, use retained earnings for additions to plant and equipment, add inventories, and the like.
Firms do not just pile up cash in a bank account. As reported on the balance sheet, retained earnings
do not represent cash and are not “available” for dividends or anything else (Brigham & Houston,
2020).

FINANCIAL STATEMENT ANALYSIS

Financial statement (FS) analysis involves carefully selecting data from financial statements to assess and
evaluate the firm’s past performance, present condition, and future business potential.
Objectives of Financial Statement Analysis (Garrison, Noreen, & Brewer, 2018)
The primary purpose of FS analysis is to evaluate and forecast the company’s financial condition.
Interested parties, such as managers, investors, and creditors, can identify the company’s financial
strengths and weaknesses and know about the following:
• Profitability of the firm
• Solvency of the firm
• Safety of the investment in the business
• Effectiveness of management in running the firm.

I. Vertical Analysis
It focuses on the relations among financial statements at a given time (Garrison, Noreen, & Brewer,
2018). A common-size financial statement is a vertical analysis in which each account is expressed
as a percentage. In the statement of financial position, all items are expressed as a percentage of
total assets and total liabilities, and equity. In contrast, all items are expressed as a percentage of
net sales in income statements. A common-size balance sheet and income statement are shown on
the next page.

Guzman Corporation
Common-Size Statement of Financial Position
December 31, 201B and 201A
201B 201A
Assets
Current Assets
Cash 100,000 8.13% 127,000 9.68%
Marketable Securities 40,000 3.25% 40,000 3.05%
Accounts Receivable, net 80,000 6.50% 100,000 7.62%
Inventory 200,000 16.25% 140,000 10.67%
Prepaid Expenses 30,000 2.44% 20,000 1.52%
Total Current Assets 450,000 36.57% 427,000 32.53%

Long-Term Investments 180,000 14.63% 162,500 12.38%

Property, Plant, and Equipment 510,400 41.48% 603,000 45.94%
Intangible Assets 90,000 7.31% 120,000 9.14%
Total Assets 1,230,400 100% 1,312,500 100%

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Liabilities
Current Liabilities 140,000 11.38% 162,000 12.34%
Long-Term Liabilities 130,000 10.57% 220,000 16.76%
Total Liabilities 270,000 21.94% 382,000 29.10%
Stockholders' Equity
Preferred Stock, 6%, P100 par 150,000 12.19% 150,000 11.43%
Common Stock, P30 par 480,000 39.01% 480,000 36.57%
Retained Earnings 330,400 26.85% 300,500 22.90%
Total Stockholders' Equity 960,400 78.06% 930,500 70.90%
Total Liabilities and Stockholders' Equity 1,230,400 100% 1,312,500 100%

Table 4. Vertical analysis - Common-size statement of financial position

Guzman Corporation
Common-Size Income Statement
December 31, 201B and 201A (in pesos)
201B 201A
Sales 455,000 101.11% 390,000 100.8%
Less: Sales Returns and Allowances 5,000 1.11% 3,000 0.8%
Net Sales 450,000 100.00% 387,000 100.0%
Less: Cost of goods sold 297,000 66.00% 288,750 74.6%
Gross Profit 153,000 34.00% 98,250 25.4%
Less: Operating Expenses 52,000 11.56% 22,000 5.7%
Income from operations 101,000 22.44% 76,250 19.7%
Less: Interest expense 18,250 4.06% 21,000 5.4%
Income before income tax 82,750 18.39% 55,250 14.3%
Less: Income Tax (30%) 24,825 5.52% 16,575 4.3%
Net Income 57,925 12.87% 38,675 10.0%

Table 5. Vertical analysis - Common-size income statement

Example:
Cost of goods sold
× 100
Total Sales
297,000
= 0.25 × 100 = 𝟐𝟓%
455,000

II. Horizontal Analysis. It is also known as trend analysis. It is a financial statement analysis technique
that shows changes in the amounts of corresponding financial statement items over a period. It is
useful for evaluating trend situations (Accounting for Management, 2021).

The statements for two (2) or more periods are used in horizontal analysis. The earliest period is
usually used as the base period. The items on the statements for all later periods are compared with
items on the statements of the base period. The changes are generally shown both in dollars and
percentages.

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Example:

A comparative balance sheet with horizontal analysis:

Comparative Balance Sheet

December 31, 201x and 202x

Increase or (Decrease)
201x (Php) 202x (Php) Amount Percent
Assets
Current assets 550,000 533,000 17,000 3.2%
Long-term investments 95,000 177,500 (82,000) (46.5)%
Plant assets (net) 444,500 470,000 (25,500) (5.4)%
Intangible assets 50,000 50,000 ________
Total assets 139,500 1,230,500 (91,000) (7.4)%
Liabilities
Current liabilities 210,000 243,000 (33,000) (13.6)%
Long-term liabilities 100,000 200,000 (100,000) (50.0)%
Total liabilities 310,000 443,000 (133,000) (30.0)%
Stockholders’ Equity:
Preferred 6% stock, P100 par 150,000 150,000
Common stock, P10 par 500,000 500,000
Retained earnings 179,500 137,500 42,000 30.5%
Total stockholders’ equity 829,500 787,500 42,000 5.3%
Total liabilities and 1,139,500 1,230,500 (91,000) (7.4)%
stockholders’ equity

Formula:

1. 𝐏𝐞𝐬𝐨 𝐂𝐡𝐚𝐧𝐠𝐞 = Amount of the item in comparison year − Amount of the item in base year
𝑃𝑒𝑠𝑜 𝐶ℎ𝑎𝑛𝑔𝑒
2. 𝐏𝐞𝐫𝐜𝐞𝐧𝐭𝐚𝐠𝐞 𝐜𝐡𝐚𝐧𝐠𝐞 = 𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑡ℎ𝑒 𝑖𝑡𝑒𝑚 𝑖𝑛 𝑏𝑎𝑠𝑒 𝑦𝑒𝑎𝑟 × 100

*𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡 = 550,000 − 533,000 = 17,000

17,000
( ) × 100 = 𝟑. 𝟐%
533,000
III. Ratio Analysis
a. Liquidity Ratios

These show the relationship between a firm’s cash and other current assets to its current liabilities. A
liquid asset is an asset that can easily be converted into cash within a short amount of time, such as
cash/money and market instruments (treasury bills, commercial paper, and certificates of deposit)
(Chen, 2019).
• Current ratio. This ratio is calculated by dividing current assets by current liabilities. It indicates
how current liabilities are covered by those assets expected to be converted to cash in the near
future.
Current assets
Current ratio =
Current liabilities
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• Current assets. These include cash, marketable securities, accounts receivable, and inventories.
If a company experiences financial difficulty, it begins to pay its accounts payable more slowly
and borrow more from its bank, increasing current liabilities. If current liabilities happen to
increase more than the current assets, the current ratio will drop, which is a sign of possible
trouble for the firm.
o The value of an acceptable current ratio varies from industry, but a good ratio would often be
between 1.5 and 2.0 (Debitoor.com, n.d.).
• Quick (acid test) ratio. This ratio is calculated by deducting inventories from current assets and
dividing the remainder by current liabilities.
Current assets − Inventories
Quick (Acid Test)Ratio =
Current liabilities
o Inventories. It is listed as a type of asset on the balance sheet. Inventories are the collection
of unsold products waiting to be sold and are the least liquid of a firm’s assets.
o A ratio greater than 1:1 is good and indicates the business can pay its current liabilities
without being dependent on the sale of inventory. Financial institutions and investors want
this ratio as high as possible to ease the risk of investing in any retail business (Hudson, 2019).
b. Debt Management Ratios
These are a set of ratios that measure how effectively a firm manages its debt. There are two (2)
procedures that analysts use to examine the firm’s debt:
• Total debt to total capital ratio. It measures the percentage of the firm’s capital provided by
debt holders.
TOTAL DEBT
TOTAL DEBT TO TOTAL CAPITAL RATIO =
TOTAL DEBT + EQUITY
O A high ratio indicates that the company extensively uses debt to finance its operations,
whereas a low metric means it raises funds through current revenues or shareholders.
Likewise, creditors use this measurement to assess whether the company is suitable for a loan
or is too leveraged to afford one (My Accounting Course, 2020).
• Times-interest earned (TIE) ratio. The ratio of earnings before interest and taxes (EBIT) to
interest charges determines the firm’s ability to meet its annual interest payments. TIE ratio is
determined by dividing earnings before interest and taxes (EBIT) by the interest charges:
EBIT
TIE RATIO =
INTEREST CHARGES
O A higher TIE ratio is good because the company presents less risk to investors and creditors
regarding solvency. From an investor or creditor’s perspective, an organization with a TIE ratio
greater than 2.5 is considered an acceptable risk. Companies with a lesser TIE ratio than 2.5
are considered at higher risk for bankruptcy or default and, therefore, financially unstable
(Horton, 2019).
C. Asset Management Ratios
It measures how effectively the firm is managing its assets. This ratio is important to obtain capital
from banks or other sources in acquiring assets.
• Inventory turnover ratio. This ratio shows how often a company has sold and replaced inventory
during a given period (Hargrave, 2019).

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Sales
Inventory Turnover Ratio =
Inventories
o A good inventory turnover for a retail business is between 2 and 4. Low inventory turnover
may mean either a weak sales team performance or a decline in the products' popularity. In
most cases, the higher the inventory turnover rate, the better the business goals are met.
However, an extremely high turnover rate is not always positive. For instance, if a retail store
goes through its inventory nine (9) times a year, purchasing levels might be too low,
potentially leading to lost sales if the product is sold out (Nicasio, 2019).
• Days sales outstanding (DSO) ratio. It is also known as the average collection period (ACP),
which evaluates accounts receivables. It is calculated by dividing accounts receivable by the
average daily sales to find how many days’ sales are tied up in receivables. The DSO represents
the average length of time the firm must wait after making a sale before receiving cash.
Receivables Receivables
DSO = or = Annual sales
Average sales per day ⁄365

o DSO of above 45 days is considered high in a normal situation. DSO, just like other ratios,
tends to vary depending on the nature and structure of the business. Therefore, high and low
DSO is relative, considering the nature and structure of the business and across different areas
and regions (Study Finance, 2020).
• Fixed assets turnover ratio. It is the ratio of sales to net fixed assets, which measures how
effectively the firm uses its plant and equipment:
Sales
Fixed assets turnover ratio =
Net fixed assets
o A high fixed-asset turnover ratio is better for a small business and indicates that it generates
strong sales for the level of fixed assets being sued. Still, it can have some negative
implications in some cases.
o The fixed-asset turnover ratio is generally considered high when it is greater than other
companies in the industry. Ratios of competitors are a good benchmark because these
companies typically use assets that are similar to each other. For instance, Company A’s
competitors have fixed-asset ratios of 2.5, 1.75, and 3, then Company A’s ratio of 4 would be
the highest (Keythman, 2020).
• Total assets turnover ratio. This ratio measures the turnover of all the firm’s assets and is
calculated by dividing sales by total assets.
Sales
Total assets turnover ratio =
Total assets
o This ratio measures the efficiency of a firm in using its assets to generate sales, which means
a higher ratio is always favorable. Lower ratios mean the company is not using its assets
efficiently and most likely faces problems in management or production (My Accounting
Course, 2020).
d. Profitability ratios are a group of ratios that show the combined effects of liquidity, asset
management, and debt on operating results.

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• Operating margin. It is calculated by dividing operating income (EBIT) by sales.

EBIT
OPERATING MARGIN =
SALES
o Higher operating margins are generally better than lower operating margins. It is fair to state
that the only good operating margin is positive and increasing over time (Ross, 2019).
• Profit margin. It is also called “net profit margin,” calculated by dividing net income by sales.
NET INCOME
PROFIT MARGIN =
SALES
o Good retail profit margin varies by industry and products sold. Industries with minimal
overhead costs typically have higher profit margins. Building supply and distribution retailers
tend to have the strongest margins, as high as 6%, according to Investopedia (as cited in
Stubbs, 2020). For instance, consider the industry and its common costs: A consulting business
will likely have higher profit margins than a retail business. Retail businesses tend to pay more
overhead expenses, such as payroll and the creation or procurement of many products
(Stubbs, 2020).
• Return on total assets (ROA). It is calculated by dividing net income by total assets.
NET INCOME
RETURN ON TOTAL ASSETS (ROA) =
TOTAL ASSETS
o The higher the return, the more productive and efficient management is in utilizing economic
resources (CFI, 2020).
• Return on Common Equity (ROCE). It tells how well a firm is doing in an accounting sense.
NET INCOME
RETURN ON COMMON EQUITY (ROCE) =
COMMON EQUITY
O A high ROCE indicates that the company is generating high profits from its equity investments,
making dividend payouts more likely (CFI, 2020).
• Return on Invested Capital (ROIC). It measures the total return that the company has provided
for its investors.
(NET INCOME − DIVIDEND)
RETURN ON INVESTED CAPITAL (ROIC) =
(DEBT + EQUITY)
o An ROIC higher than the cost of capital means a company is healthy and growing, while an ROIC
lower than the cost of capital suggests an unsustainable business model (Investopedia, 2020).
ESTIMATING BUSINESS STARTUP COSTS
In starting a business, it is crucial to start planning early to avoid unforeseen expenses. An entrepreneur
must begin researching and estimating the cost of the business (Berry, 2021).

Startup costs are expenses incurred before the business runs, which involve the bills needed to cover
leading up to the business's launch. While every business needs to account for specific startup costs, the
business will generally fall under a store, online, or service-based organization.

Estimating startup costs is part of building a roadmap for your business. Even a rough estimate can help
the entrepreneur avoid unnecessary risks and stay on track during more volatile months.

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Types of Startup Costs

1. Startup Expenses. These are expenses or upfront costs that happen before the business launch and
start bringing in any revenue. These should be split into one-time and ongoing expenses. By separating
them, the entrepreneur can identify a more accurate estimate of what it will take to launch the
business. Here are some common expenses to consider in both categories:

• One-time expenses • Ongoing expenses

• Permits and licenses • Rent
• Incorporation fees • Payroll
• Logo design • Taxes
• Website design • Legal services
• Brochure and business card printing • Loan payments
• Signage • Insurance payments
• Down payment on rental property • Utilities
• Improvements to the chosen location • Marketing costs

These are just a handful of the potential costs to be considered. Some will remain fixed, others will operate
as variable costs, and some may shift between the two (2) over time. Having these outlined this way from
the start, the entrepreneur will keep better track of the business’ expenses and identify any natural cost-
cutting options over time.
2. Startup Assets. These are costs associated with long-term assets purchased to start the business.
While cash in the bank is the most basic startup asset, there are some other common assets the
entrepreneur needs to invest in:

• Starting inventory
• Computers or other technological equipment
• Office equipment
• Office furniture
• Vehicles

It is necessary to separate costs into assets and expenses because expenses are deductible against income,
reducing taxable income. Assets, on the other hand, are not deductible against income. The business can
save money on taxes by separating the two (2).
3. Cash required to get started. Cash requirements estimate the money the startup company needs in
its checking account when it starts. The entrepreneur’s cash balance on the starting date is the money
raised as investments or loans minus the cash spent on expenses and assets.

In building the plan, it is essential to watch the cash flow projections. If the cash balance drops below
zero, there is a need to increase financing or reduce expenses.

Ways to Estimate Expenses

There are two (2) potential methods that can be used to develop these estimates:

I. Traditional Method – The Startup Worksheet

It involves creating separate worksheets for starting costs and financing.
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Example:

Here’s the startup worksheet of a retail bicycle shop, including lists of startup expenses in the upper left,
startup assets in the lower left, and startup funding on the right.
The total startup costs in this example are $124,650, the sum of expenses ($3,150) and assets ($121,500)
required before lunch. The funding plan on the right shows that the owner plans to invest $25,000 of her
own money and $99,650 in loans. The loans include a $70,000 long-term loan and other loans, including
a commercial credit of $17,650, a $2,000 note, and other current debt (probably credit card debt) of
$10,000.
• In the illustration, the balance on one side shows the startup costs and the other shows where the
money will come from.
• Assets include $35,000 in cash and bank account. That estimate, in this example, comes from the
example shown above, which calculates the need for $25,708 in initial cash. The entrepreneur
estimates $35,000 instead to have a buffer.

Remember, the worksheet covers what happens before launch. It does not include ongoing sales, costs,
expenses, assets, and financing after launch.
This worksheet example shows an estimated $3,150 in expenses incurred before startup. That is the initial
loss when starting, meaning that these expenses can be deducted against income later for tax purposes.
This loss may look bad on the surface, but it’s quite normal for starting businesses. It’s financially
beneficial, as deducting expenses from future taxes reduces tax bills.

II. LivePlan Method — The Consolidated estimates

It is more innovative than the startup worksheet. LivePlan Method simplifies the consolidation with
rolling estimates for expenses, assets purchased, and financing to manage cash flow as a continuous
process. The estimates start when a business starts spending rather than when it launches and
generates revenues. There is no division between the launch date and pre-launch spending. Thus,
there is no specific startup table.

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For example, in the ‘Soup There It Is’ sample business plan, the revenue starts in April—but the spending
starts in January. In the illustration, this startup estimates $11,500 in startup expenses, including $4,000
each in January and March, plus $3,500 in March.

And, in the balance sheet, the startup projects needing $30,000 in initial cash investment can be spotted,
of which $21,375 is left at the end of the startup period. Founders have spent $11,500 on startup
expenses. Of that, they owe $2,875 in accounts payable. Therefore, the remaining cash results from
starting with $30,000 and spending $8,625. And the remaining $2,875 in accounts payable takes the sum
of expenses up to $11,500. These deductible expenses create a loss at the startup of $11,500.

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Estimating startup costs using the LivePlan Method should start with revenues, costs, and expenses
(including payroll). Add in assets. And then solve the resulting cash flow problem by adding financing,
including loans and investments.

For example, here is how the Soup There It Is balance sheet looked before the founders added investment,
loans, and inventory:

A business plan isn’t done until the projected cash balance is above zero at all times. Otherwise, checks
are bouncing, the bank is up in arms, and the business is in trouble. Therefore, the founders projected
where the money came in and out. From that, they can estimate how much financing, including
investment, need to make that work.

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Considerations in Estimating Startup Costs

1. Pre-launch versus normal operations

The launch date is the defining point. Rent and payroll expenses before launch are considered startup
expenses. The same expenses after launch are considered operating or ongoing expenses. And many
companies also incur some payroll expenses before launch — because they need to hire people to
train before launch, develop their website, stock shelves, and so forth.

The same defining point affects assets as well. For example, amounts in inventory purchased before
launch and available at launch are included in starting assets. Inventory purchased after launch will
affect cash flow and the balance sheet but isn’t considered part of the starting costs.

2. The launch month will likely be the start of the business’ fiscal year
The establishment of a standard fiscal year plays a role in the analysis. It can be convenient to establish
the fiscal year starting the same month the business launches. In this case, the startup costs and
startup funding match the fiscal year—and they happen in the time before the launch and beginning
of the first operational fiscal year. The pre-launch transactions are reported as a separate tax year,
even if they occur in just a few months or even one (1) month. Therefore, the last month of the pre-
launch period is also the last month of the fiscal year.

3. Consider startup financing as part of your startup costs

Startup financing isn’t technically part of the starting costs estimate. But in the real world, to get
started, there is a need to estimate the starting costs and determine what startup financing will be
necessary to cover these startup costs. The type of financing the entrepreneur pursues may alter the
startup or ongoing costs in a given period, so it’s essential to consider this upfront. The following are
the most common financing options to consider:
o Investment: This is what the entrepreneur or someone else puts into the company. It ends up as
paid-in capital in the balance sheet. It is the classic concept of business investment, taking
ownership of a company and risking money in the hope of gaining money later.
o Accounts payable: Debts that are outstanding or need to be paid after a certain time, according
to your balance sheet. This number becomes the starting balance of your balance sheet.
o Current borrowing: Standard debt, borrowing from banks, or other current borrowings.
o Other current liabilities: Additional liabilities that don’t have interest charges. It is where you put
loans from founders, family members, or friends.
o Long-term liabilities: Long-term debt or long-term loans.

4. Aim for long-term success with realistic startup costs

Whether the entrepreneur uses the LivePlan method or the traditional method for estimating startup
costs, s/he must ensure that every aspect of the business and related costs was considered to have a
better chance at securing loans, attracting investors, estimating profits, and understanding the cash
runway of your business.

CALCULATING PROJECTED INCOME STATEMENT

A projected income statement shows profits and losses for a specific future period. It uses the same
format as a regular income statement but guesstimating the future rather than crunching numbers from
the past (Sherman, 2019).

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To create a projected income statement (also called a statement of projected earnings), the entrepreneur
can use historical information, customer research, and market data to estimate future changes in sales
volume. Then, adjust each line item on the income statement to reflect the change and put the data in an
income statement format (Garcia, 2019).

Steps in Preparing the Projected Income Statement

1. Determine Change in Sales Volume

Estimate how much the expected sales volume will increase. The entrepreneur must have a solid
understanding of the business’ market, sales channels, and customers. Moreover, consider the
following information (Garcia, 2019):
• Historical trends in sales volume growth for your company.
• Relationship with each major customer and how much is expected of them to purchase in t he
future.
• The entrepreneur’s ability to convert new customers through marketing.
• Popularity of products and services.
• Product seasonality affects purchasing behavior.

2. Convert Change in Sales Volume to a Percentage Format

Calculate the percentage of increase or decrease expected in sales volume. To do this, subtract the
prior year's sales volume from the projected sales volume, and divide it by the prior year's sales
volume.

𝐂𝐡𝐚𝐧𝐠𝐞 𝐢𝐧 𝐒𝐚𝐥𝐞𝐬 𝐕𝐨𝐥𝐮𝐦𝐞 (𝐢𝐧 𝐩𝐞𝐫𝐜𝐞𝐧𝐭𝐚𝐠𝐞)

(𝐏𝐫𝐨𝐣𝐞𝐜𝐭𝐞𝐝 𝐬𝐚𝐥𝐞𝐬 𝐯𝐨𝐥𝐮𝐦𝐞 − 𝐏𝐫𝐞𝐯𝐢𝐨𝐮𝐬 𝐲𝐞𝐚𝐫 ′ 𝐬𝐚𝐥𝐞𝐬 𝐯𝐨𝐥𝐮𝐦𝐞)
=
𝐏𝐫𝐞𝐯𝐢𝐨𝐮𝐬 𝐲𝐞𝐚𝐫 ′ 𝐬𝐚𝐥𝐞𝐬 𝐯𝐨𝐥𝐮𝐦𝐞

Example: 2,000 units of the rechargeable fan were sold last year, and the entrepreneur expects to sell
2,500 units this year.

(𝟐, 𝟓𝟎𝟎 − 𝟐, 𝟎𝟎𝟎)

𝑪𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑺𝒂𝒍𝒆𝒔 𝑽𝒐𝒍𝒖𝒎𝒆 (𝒊𝒏 𝒑𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆) =
𝟐, 𝟎𝟎𝟎

𝑪𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑺𝒂𝒍𝒆𝒔 𝑽𝒐𝒍𝒖𝒎𝒆 (𝒊𝒏 𝒑𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆) = 𝟎. 𝟐𝟓 𝒐𝒓 𝟐𝟓%

3. Project Sales Revenue

Multiply the number of units expected to be sold by the price at which each unit is expected to be
sold.
𝐏𝐫𝐨𝐣𝐞𝐜𝐭𝐞𝐝 𝐒𝐚𝐥𝐞𝐬 𝐑𝐞𝐯𝐞𝐧𝐮𝐞 = (𝐍𝐮𝐦𝐛𝐞𝐫 𝐨𝐟 𝐮𝐧𝐢𝐭𝐬 𝐞𝐱𝐩𝐞𝐜𝐭𝐞𝐝 𝐭𝐨 𝐛𝐞 𝐬𝐨𝐥𝐝)(𝐏𝐫𝐢𝐜𝐞 𝐩𝐞𝐫 𝐮𝐧𝐢𝐭)

Example: The rechargeable fan per unit is expected to be sold at Php2,500, and the entrepreneur
expects 2,500 units to be sold this year.

𝐏𝐫𝐨𝐣𝐞𝐜𝐭𝐞𝐝 𝐬𝐚𝐥𝐞𝐬 𝐫𝐞𝐯𝐞𝐧𝐮𝐞 = 2,500 × Php2,500 = 𝐏𝐡𝐩𝟔, 𝟐𝟓𝟎, 𝟎𝟎𝟎

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4. Project Expenses
To project expenses, it is important to understand how costs behave. Separate the costs into the
variable, mixed, and fixed costs and analyze each separately.
• Variable expenses are directly correlated with sales volume. That means if the sales volume
grows, these costs will grow at a proportional rate. Potential variable expenses include:
o Cost of goods sold, which is comprised of direct labor, direct materials, and manufacturing
overhead
o Sales commissions
o Credit card processing fees
o Freight and shipping (the goods and the process of transporting commodities, goods, and
cargo by land, sea, or air).

𝐏𝐫𝐨𝐣𝐞𝐜𝐭𝐞𝐝 𝐯𝐚𝐫𝐢𝐚𝐛𝐥𝐞 𝐞𝐱𝐩𝐞𝐧𝐬𝐞 = 𝐏𝐫𝐞𝐯𝐢𝐨𝐮𝐬 𝐲𝐞𝐚𝐫 ′ 𝐬 𝐞𝐱𝐩𝐞𝐧𝐬𝐞𝐬 (𝐟𝐨𝐫 𝐞𝐚𝐜𝐡 𝐥𝐢𝐧𝐞 𝐢𝐭𝐞𝐦) ×
𝐩𝐫𝐨𝐣𝐞𝐜𝐭𝐞𝐝 𝐢𝐧𝐜𝐫𝐞𝐚𝐬𝐞 𝐢𝐧 𝐬𝐚𝐥𝐞𝐬 𝐯𝐨𝐥𝐮𝐦𝐞(𝐢𝐧 𝐩𝐞𝐫𝐜𝐞𝐧𝐭)

Example: The variable expenses of rechargeable fans last year amounted to Php150,000. The
entrepreneur projects a 1.25% increase in sales volume.

𝐏𝐫𝐨𝐣𝐞𝐜𝐭𝐞𝐝 𝐯𝐚𝐫𝐢𝐚𝐛𝐥𝐞 𝐞𝐱𝐩𝐞𝐧𝐬𝐞 = Php150,000 × 1.25% = 𝐏𝐡𝐩𝟏𝟖𝟕, 𝟓𝟎𝟎. 𝟎𝟎

• Mixed Expenses can vary and increase along with production, but they don't necessarily increase
proportionally. At certain levels, they don't increase at all. Potential mixed costs include:
o Sales, customer service and operations salaries
o Health insurance, workers' compensation, and payroll taxes associated with increased
salaries
o Professional fees, such as those for legal and accounting services
o Utilities like phone, internet, energy, and trash
o Transportation and parking expenses

Knowledge of business operations must be used to project each mixed expense. For example, consider
whether the increase in sales volume means there is a need to hire additional staff in sales, customer
service, and operations. Consider whether the increased activity will force the entrepreneur to upgrade
his/her internet or phone plan or if the accountant will bill the entrepreneur more now that s/he has
increased transactions.

• Fixed Expenses tend to stay the same even when production changes. Potential fixed costs
include:
o Property taxes
o Rent
o Business fees and licenses
o Business insurance
o Salaries for non-operational staff, like the president, human resources, administration, and
accounting.
o Office supplies
o Depreciation
o Interest expense

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Expect these costs to stay the same yearly unless there’s an indication otherwise. For example, if the
entrepreneur knows that the rent will increase or need to buy a new office space, s/he must budget for
these expenses. If there’s the need to buy new equipment, increase depreciation expense accordingly.

5. Create the Projected Income Statement

Using last year's income statement as a template, input your projections for each revenue and
expense line item. Subtract total expenses from total revenues to arrive at projected net income
and have a helpful profit forecast. Date the document for the upcoming year and clearly label
it Projected Income Statement so that no one who reads it confuses it with an actual income
statement.

References
Berk, J. and DeMarzo, P. (2017). Corporate finance (4th ed). Pearson.
Berry, T. (2021). How to estimate realistic business startup costs — 2021 guide. Bplans. Retrieved April 28, 2021, from https://articles.bplans.com/estimating-
realistic-start-up-costs/
Bishop, K. (2020, December 4). Sales forecasting 101. Sales hacker. https://www.saleshacker.com/sales-forecasting-101/
Brigham, E. and Houston, J. (2020). Fundamentals of financial management. Cengage Learning.
Carlon, S., Kirk, N., Mladenovic, R., Mitrione, L., Palm, C., & Wong, L. (2016). Financial accounting: reporting, analysis, and decision making (5th ed.). Wiley.
Tuovila, A. (2021, April 23). Current liabilities. Retrieved April 14, 2021, from https://www.investopedia.com/terms/c/currentliabilities.asp
Tuovila, A. (2020, November 15). Long-term liabilities. Retrieved April 14, 2021, from https://www.investopedia.com/terms/l/longtermliabilities.asp
Business Model Canvas. (n.d.). In Bc campus. https://opentextbc.ca/organizationalbehavioropenstax/chapter/business-model-canvas/
Cameron, A. (2017, March 23). Sales projections for small business owners. Patriot. Retrieved April 17, 2021, from
https://www.patriotsoftware.com/blog/accounting/sales-projections-small-business-owners/#
Garcia, M. (2019, January 22). How to calculate a projected investment. Bizfluent. https://bizfluent.com/about-6402050-growth-trends-business.html
Grant, M. (2020, November 7). Vertical analysis. Investopedia. https://www.investopedia.com/terms/v/vertical_analysis.asp
Horizontal or trend analysis of financial statements. (2021). In Accountingformanagement.org. https://www.accountingformanagement.org/horizontal-analysis-of-
financial-statements/
Indeed Editorial Team. (2021, February 23). Vertical analysis: Definition and examples. Indeed. https://www.indeed.com/career-advice/career-
development/vertical-analysis
Robinson, C. (2021). Freight shipping. Freight quote. https://www.freightquote.com/define/what-is-freight-shipping/#:~:text=Freight
Sherman, F. (2019, March 1). How to make a projected income statement. Chron. Retrieved April 29, 2021, from https://smallbusiness.chron.com/make-projected-
income-statement-36221.html

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