Assessing A New Venture's Financial Strength and Viability

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Assessing a New Venture’s Financial Strength and Viability

Financial management – deals with two activities: raising money and managing a
company’s finances in a way that achieves the highest rate of return.
Introduction to Financial Management

Deals with:
 How are we doing? Are we making or losing money?
 How much cash do we have on hand?
 Do we have enough cash to meet our short-term obligations?
 How efficiently are we utilizing our assets?
 How do our growth and new profits compare to those of our industry peers?
 Where will the funds we need for capital improvements come from?
 Are there ways we can partner with other firms to share risk and reduce
the amount of cash we need?
 Overall, are we in good shape financially?
Financial Objectives of a firm
Profitability Liquidity Efficiency Stability
A company’s A company’s How productively The overall health of
ability to make ability to meet its a firm utilizes its the financial structure
a profit short- term assets of the firm, particularly
obligations as it relates to its debt-
to-equity ratio.
 Profitability – A firm must be profitable to remain viable and provide a return

to its owners. Many start-ups are not profitable their first 1-3 years.
 Liquidity - Accounts receivable = money owned to it by its customers.
Inventory= merchandise, raw material, products waiting to be sold.
 Efficiency – See above. Assets should not remain inactive for a long period.
 Stability – Debt-to-equity ratio = calculated by dividing its long-term debt by
its shareholders’ equity
The process of Financial Management
1. Financial statement
 Income statement
 Balance sheet
 Statement of cash flows
2. Preparation of Forecasts
 A firms future income and expenses based on past performance
 Current circumstances
 Future plans
3. Budgets (preparation of Pro Forma Financial Statement)
 Itemized forecast of income, expenses and capital needs
 Constitute its financial plan
4. Ongoing Analysis of Financial Results
 Ratio analysis – relationships between items of a firm’s financial results
 Measuring results versus plans
 Measuring results versus industry norms
Financial Statements and Forecasts
Historical financial statements
 Reflect past performance
 Are usually prepared on a quarterly and annual basis
 Are usually prepared under specific companies e.g. listed
Income statement – Results of the operations of a firm over a specific period of time
- Net sales – total sales – allowances for returned goods and discounts
- Cost of sales (cost of goods sold – all the direct costs associated with
producing or delivering a product/service (+ material cost)
- Operating expenses – marketing, administration cost, other expenses not
directly related to producing a product/service
- Revenue – Money company receive during a specific period, inclusive discounts
& deductions for returned merchandise
- Expense – costs that a business incures through its operations to earn revenue
1. How much did I make from my sales?

- Gross profit – sales – cost of goods sold
2. How much did I make from my usual activities?
- Operating income
3. How much did I make from other activities
- Earnings before taxes
- Financial expenses – interest to a bank (borrowing money)
- E.g. sell a car (other income) – something outside the “normal”
4. Where can I find a good accountant?
- Net income
E.g.:
Sales 10.000
- Cost of goods sold 5000
5000 Gross profit
- O.S 3000
2000 Operating
+ Other income 8000
Net income 10.000 income
Balance sheet
Right: Liabilities – To whom do I owe what I have? (Loan, money outside)

Left: Assets – what do I have – use for making profit (cash, clients, items)
Shareholders equity – owner’s money
Current assets
 Less than 1 year – cash
 Accounts receivable – clients owe us money – bought on credit – short period
 Inventory – everything that we have bought  purpose to sell
Fixed assets
 More than 1 year
 Long-term investment
 Land, buildings, plants & equipment, furniture
Current liabilities - money out
 Less than 1 year
 Account payable – pay back to suppliers
 Short term notes, taxes payable
Long-term liabilities - money out
 More than 1 year
 Mortage, long-term loans
Shareholders equity
 Capital stock
 Retained earnings – own money we didn’t take out when the company
was profitable
 Equity invested in the business by its owners plus
Statement of Cash Flows

- Summarizes the changes in a firm’s
cash position for a specific period of
time and details why the change
occurred.
- Similar to a month-end bank
statement Three activities:
1. Operating activities – include net income
(or loss), depreciation, changes in current
assets & current liabilities other than cash
and short-term debt. A firm’s net income,
taken from its income statement, is the
first line on the corresponding period’s
cash flow statement.
2. Investing activities – purchase, sale, or investment in fixed assets
3. Financing activities – cash raised during the period by borrowing money or
selling stock and/or cash used during the period of paying dividends, buying back
outstanding stock, or buying back outstanding bonds.
Analysis of financial statements

- Preliminary analysis
- Horizontal & vertical analysis –
income statement (horizontal =
previous year, vertical = 1 year)
- Financial ratio analysis
(Preliminary + horizontal &vertical = firm level)
(All three = industry level)
Ratios:
- Same for both historical and pro forma
- Profit margin (return of sales)
o Net income / Net sales
- Price-to-earnings ratio (P/E ratio)
o Company’s stock against its earnings
Forecast – predictions of a firm’s future sales, expenses, income and capital expenditures
Assumption sheet – an explanation in a new firm’s business plan of the sources of the
numbers for its financial forecast and the assumptions used to generate them
Sales forecast – a projection of a firm’s sales for a specific period. Based on:
1. Record of past sales
2. Current production capacity and product demand
3. Any factor/s that will affect its future production capacity and product demand
Regression analysis – tool to help firms project their future sales. Technique used to find
relationships between variables for the purpose of predicting future values.
Forecast of Cost of Sales and Other Items

Use percent-of-sales method – expressing each expense item as a percentage of sales.
Constant ratio method of forecasting – a forecasting approach using the percent od
sales method in which expense items on a firm’s income statement are expected to grow at
the same rate as sales. Used when preparing the pro forma.
Break-even point – the point where total revenue received equals total costs associated
with the sale of the product. Formula: Total fixed costs/(price-average variable cost)
Pro Forma Financial Statement

- Similar to historical finance statement – look forward instead of the past
- Should not be prepared in isolation – should be conjunction with the
firm’s overall planning
- Are projections for future periods based on forecasts
- Are typically completed for two or three years in the future
- Are strictly planning tools and usually confidential
- Do not have to be published
- Do not have to follow specific rules
Pro Forma income statement

- After a company forecast future income and expenses – do the
income statement
- Shows the projected results of the operations of a firm over a specific period
Pro Forma Balance Sheet
- Shows a projected snapshot of a company’s assets, liabilities, and
owner’s equity at a specific point in time
Pro Forma Statement of Cash Flow
- Shows the projected results flow of cash into and out of a company for
a specific period

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lOMoARcPSD|644712

Assessing a New Venture’s Financial Strength and Viability

Introduction to Financial Management

 Profitability – A firm must be profitable to remain viable and provide a return

1. How much did I make from my sales?

Right: Liabilities – To whom do I owe what I have? (Loan, money outside)

Statement of Cash Flows

Analysis of financial statements

Forecast of Cost of Sales and Other Items

Pro Forma Financial Statement

Pro Forma income statement

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