Outline: Chapter 1

Introduction
Importance of knowing the numbers
Measuring success
What is entrepreneurial financial management?
What Makes Entrepreneurial Finance Similar to
Traditional Finance?
What Makes Entrepreneurial Finance Different
from Traditional Finance?
Ethics and entrepreneurial finance

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 Financial Management:
The “Language” of Business
Used to set clear financial goals
Used to make decisions
Used to forecast
Used to manage cash flow
Used to seek financing
Used to determine an exit process for the
business

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 Measuring “Success”

Income for entrepreneur

Wealth for entrepreneur
Goals derived from personal values of the
entrepreneur

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 Differences between Traditional and
Entrepreneurial Finance
Lack of historical data to measure risk
Lack of historical data and liquidity
complicate the practice of finance in early
stage firms

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Perspective of Investors
Prefer less risk Prefer quick return
Diversified investors Prefer liquidity
concerned with Investors face many
systematic risk different
Non-diversified opportunities
investors concerned No investors are
with total risk immune from these
Prefer more return expectations

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 Finance Relationships
 Total Risk = Diversifiable Risk + Nondiversifiable Risk
 Required Rate of Return = Rf + Beta(Rm - Rf)
 Rf = Risk-Free Rate of Return
 Rm = Return on Market Index like SP500
 Rm-Rf =Market Risk Premium
 Beta is a measure of Nondiversifiable Risk
 Beta < 1 means asset is less volatile than market (safe asset)
 Beta = 1 means asset is just as volatile as market (average
asset)
 Beta > 1 means asset is more volatile than market (risky
asset)

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 Figure 1.1
Building a Financial Forecast

Setting Revenue Expense Monitoring

Financial Forecasting Forecasting Performance
Goals

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 Table 1.1
Example of Stakeholder Analysis

Stakeholder Ethical Principle Application

Family Create balance between Establish a more moderate
work demands and family financial growth goal to allow
time. for time with family.

Investors Deal with all investors Develop a financial reporting

openly and honestly. system that provides full and
accurate historical information
as well as realistic forecasts.
Employees Share financial success with Profit sharing, stock option
those that helped create it. plans, phantom stock, ESOP,
etc. while still meeting goals
of entrepreneur.
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 Table 1.1
Example of Stakeholder Analysis (continued)

Stakeholder Ethical Principle Application

Customers Fair pricing Establish revenue forecasts that are
realistic given this pricing principle.

Suppliers Prompt payment for Establish cash forecasts that are

money owed. based on an assumption of prompt
payment of all invoices submitted
by suppliers/vendors.
Banker Honest disclosure of Assure timely and accurate
information financial reporting and reasonable
financial forecasting.

Community Reliable employment for Manage cash flow to allow for

the community. stable employment even during
times of temporary slowdowns
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 Outline: Chapter 2
Setting Financial Goals

Wealth vs. income

Integrating non-financial goals
Importance of self-assessment
The self-assessment process
The business plan

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 Figure 2.1
Model for Entrepreneurial Financial Management

Setting Revenue Expense Monitoring

Financial Forecasting Forecasting Performance
Goals

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Life Cycle of a Business Venture
Figure 2.2

Maturity
Pre-Launch Start-up Growth

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 “Quick and Dirty” Valuation
EBITDA
+ extra bonuses or compensation to owners
= adjusted EBITDA
X earnings multiple
= Valuation
- Outstanding Loans
= Cash proceeds to owner

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 Integrating Non-Financial Goals

Ethicsand values
Personal definition of “success” in business
Family
Community
Personal interests

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Business Plan Outline
Executive Summary
The Business Concept
Industry Analysis
Marketing Plan
Operating Plan
Financing Plan

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Importance of Self-Assessment
Keeps your goals front and center
Financial goals change
Non-financial goals change
Part of on-going exit planning

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Outline: Chapter 3
Understanding Financial Statements

Accounting equation
 Assets = Liabilities + Owners’ Equity
Basic financial statements
Limitations of business financial statements

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 Basic Financial Statements

Income Statement
Balance Sheet
Statement of Cash Flows

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Income Statement
Exhibit 3.1
The Company
Month ended April 30, 2002
Sales $35,000 100.0%
Cost of Goods Sold 10,000 28.6%
Gross Profit 25,000 71.4%
 Operating Expenses
Rent Expense 10,000 28.6%
Utilities Expense 2,000 5.7%
Wages Expense 5,000 14.3%
Depreciation Expense 1,000 2.8%
Total Operating Expenses 18,000 51.4%
 Earnings before interest and taxes (EBIT) 7,000 20.0%
Interest Expense 100 .3%
Earnings before taxes $ 6,900 19.7%

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Balance Sheet
Exhibit 3.2
The Company
April 30, 2002
ASSETS
Current Assets
Cash $ 58,900
Accounts Receivable 25,000
Inventory 30,000
Total Current Assets 113,900
Fixed Assets
Equipment 36,000
Less: Accumulated Depreciation (1,000)
Net Fixed Assets 35,000
TOTAL ASSETS $148,900
LIABILITIES
Current Liabilities
Notes Payable $ 15,000
Accounts Payable 22,000
Wages Payable 5,000
Total Current Liabilities 42,000
 STOCKHOLDERS’ EQUITY
Common Stock 100,000
Retained Earnings 6,900
Total Stockholders’ Equity 106,900
 TOTAL LIAB. & STOCKHOLDERS’ EQUITY $148,900

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Limitations of Financial Statements
Not all assets of a company are included (e.g.
employees or brand names)
Intellectual property not reflected as an asset
Assets are reflected at historical cost
Estimates must be used for depreciation, the
collectibility of accounts receivable, the salability
of inventory, and the amount of warranty liability
outstanding
Financial statements affected by the choice of
accounting methods (e.g. FIFO, LIFO or average
cost)
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Outline: Chapter 4
Revenue Forecasting
Common Forecasting Mistakes
The Link Between the Marketing Plan and
Revenue Forecasts
Creating Scenarios
The Link Between the Revenue Forecast and
the Cash Flow Forecast
The Impact of Business Type on Revenues
Quantitative Forecasting Techniques
Importance of Revenue Forecasting

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 Figure 4.1
Model for Entrepreneurial Financial Management

Setting Revenue Expense Monitoring

Financial Forecasting Forecasting Performance
Goals

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Common Forecasting Mistakes

 The linear forecast mistake

 The hockey stick forecast mistake
 The 20/80 vs. 80/20 mistake

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 Marketing Plan and Forecasting

Marketing Plan Revenue

Backbone Forecasts

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Marketing Plan and
Revenue Forecasting
 Identifying industry and market trends
 Market research
 Competitive analysis

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Sample Competitive Grid
Figure 4.3
Cleanliness Hours of Selection Price
of Facilities Operation
Generally clean Most commonly $5 - $20
Joe’s Inc. 8:00 – 6:00 purchased products
in public areas,
but back rooms available
usually messy
Consistently All commonly $12 - $30
Jane’s Inc. 8:00 – 8:00 purchased
clean and orderly
throughout all available and some
specialty items in
facilities stock
Public areas Many common $3 - $15
Sally & 9:00 – 4:00 items not in stock –
somewhat messy
Jim’s Shop and disorganized usually have to
special order
and back areas
very messy
Plan to be All common items $5 - $35
Dr. C’s 7:00 – 9:00 plus specialty
spotless
Place (New throughout items not found at
competitors’ stores
Business)
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Basic Guidelines for
Revenue Forecasts
Market research to assure the quality of
the assumptions behind the revenue
forecasts
Validate assumptions with more than
one source of data
Plan based on more conservative
assumptions

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Creating scenarios

Make Three Forecasts

1. Best-case
2. Worst-case
3. Most likely case
Track Key Assumptions

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Revenue Forecast and
the Cash Flow Forecast

Determine if credit is to be extended to

customers
Estimate the percentage of the sales that
will be on credit
Determine how long it will take to
collect credit sales

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Importance of Revenue Forecasting
Bank financing
Inventory assumptions
Staffing decisions
Space decisions
Investors

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Outline: Chapter 5
Expense Forecasting

Defining costs
Cost behavior
Break-even analysis
The impact of business type on expenses
Reducing expenses through bootstrapping

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 Figure 5.1
Model for Entrepreneurial Financial Management

Setting Revenue Expense Monitoring

Financial Forecasting Forecasting Performance
Goals

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Cost behavior
 Variable Costs
 Fixed Costs
 Mixed Costs

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 Variable Costs

Type of Expense Activity Base

Sales commissions Sales
Materials cost Units produced
Health insurance Number of employees
Wages expense Number of hours worked
Payroll tax expense Dollars of wages paid

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Figure 5.1
Variable Cost Behavior

$
Total Variable
Cost Line

Total Units Produced

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Fixed Costs

 Committed fixed costs

 Discretionary fixed costs

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Figure 5.2
Fixed Cost Behavior

Total Fixed
Costs

Total Units Produced

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Example – Merchandising Company
Exhibit 5.1
Assumptions used

Sales $100,000 100.0%

COGS 65,000 65.0 65% of sales
Gross profit 35,000 35.0 35% of sales
# of salespeople x monthly
Sales salaries 15,000 15.0 base
Sales commissions 1,500 1.5 1.5% of sales
Store rent 3,500 3.5 monthly rent
Total selling expenses 20,000 20.0
Office rent 2,500 2.5 monthly rent
Office salaries 12,000 12.0 # people x monthly pay
Depreciation 500 .5 cost of equip./mos. of life
Total gen. & admin. 15,000 15.0
EBIT 500 .5
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 Breakeven Analysis

Fixed Costs
Breakeven ____________________________________
=
Quantity
Price per unit Variable cost per unit
-

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Outline: Chapter 6
Integrated Financial Model
The entrepreneur’s aspirations reconsidered
Contribution format income statement
Inventory of assumptions
Determining the funds needed
Time out of cash
Assessment of risk/sensitivity
Integrating into business plan/funding
document

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 Figure 6.1
Building a Financial Forecast

Setting Revenue Expense Monitoring

Financial Forecasting Forecasting Performance
Goals

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 Time Out of Cash

Time Out of Cash = Cash

Operating Cash Outflow per Month

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