Review/Study Guide for Midterm Exam - MGT 321 – Financing New Ventures

*Note. This is only a guide. Consequently, it is not a comprehensive list of concepts to be tested.
Inevitably, there will be material covered in class that is not covered here. This is really just my
review of the material and I do not recommend relying solely on this content for your
examination preparations.
Entrepreneurship Foundations
- What is entrepreneurship and why is it important?
- The process of changing ideas into commercial opportunities
- 80% of new jobs are associated with small businesses
- Why is the study of ENT finance important?
- Most startups fail because of financial issues that may have been avoided
- Financial Risks of ENT
- Lack of steady pay
- Loss of capital
- The entrepreneurial process
- Converting ideas into commercialized opportunities to create value
- Sources of entrepreneurial opportunities
- Prior work experience, hobbies, friends, education, chance occurrences, interests
- Trends
- Types of new venture firms
- Typically classified according to growth aspirations: aggressive (entrepreneurial
firms), managed growth, lifestyle, survival (salary replacement)
- Components of a successful business model
- Value proposition, profit formula, resources, processes
- Must generate revenues, eventually make profits, and produce free cash flows
- What do investors want/need to know
- Is there a viable opportunity
- Development and production challenges
- Breakeven and other financial profitability estimates
- Team capabilities and exit strategy
Sources and Stages
- Principles of ENT finance
- Real, human, and financial capital must be rented from owners; Risk and expected
reward go hand in hand; Cash is the currency of new businesses; Venture
financing involves search, negotiation and privacy; New ventures aim to increase
value; It is dangerous to assume that people act against their own self-interests
- Successful venture life cycle (stages)
- Development, startup, survival, rapid growth, early maturity
- Financing through the venture stages (financing stages and associated venture stages)
- Early stage ventures (Seed, startup, first-round, second round, mezzanine,
liquidity). Seasoned stages (bank loans, bonds, stocks)
 - Sources of financing and stages of venturing (and differences among various sources):
- FFF, Bootstrapping, Incubators, Accelerators, Bank loans (why ventures may not
get this type of funding), Grants, SBA, Crowdfunding, Initial Public Offerings,
Angels, Venture Capitalists
- Process for VC funds
- Determine fund objectives, organize fund, solicit investments, obtain
commitments, conduct due diligence and invest, arrange liquidation events,
distribute proceeds, repeat
- Due diligence process for VC’s and most Angels (what are they looking for)
- VC firm requirements (e.g., cash out potential, equity share, location, control, rate
of return, stage of ventures, etc.)
- Characteristics of the ENT team (e.g., abilities to evaluate risk and articulate
venture value creation strategy, background, experience, qualifications, stake in
the firm)
- Nature of the industry (e.g., market attractiveness, size, threats, risks, alignment to
VC expertise)
- Strategy of the business (e.g., proprietary elements, product differentiation, etc.)
Analyzing and Projecting Financial Statements
- Types of statements and their uses
- Income Statement
- Balance Sheet
- Cash Flow Statement
- Major components of statements
- Income statement: revenues, COGS, Other expenses (marketing, interest,
depreciation, etc.), net income or profit
- Balance sheet: total assets (cash, equipment, accounts receivables, etc.) =
liabilities (accounts payables, loans, etc.) + equity (common shares, retained
earnings)
- Cash Flow Statement – operations, investing, and financing activities all use or
produce cash
- E.g., changes in inventories (if increasing this is a use of cash)
- Net cash burn = sum of cash flows from operations and investing is
negative
- Net cash build = sum of cash flows from operations and investing is
positive
- New venture activities and statements
- Common Balance Sheet items for early stage ventures: assets (cash, office
equipment, inventories, equipment), liabilities (credit cards, small loans, family
loans), equity (entrepreneur’s assets, shares to family and friends, other early
stage investments)
- Common Income Statement items for early stage ventures: revenues (small if
any), expenses (rent, utilities, salaries, marketing)
- Survival break-even analysis
 - In terms of revenues: amount of revenues needed to offset variable and cash
affected fixed costs = Cash Fixed Costs/(1-Variable costs revenue ratio)
- Cash fixed costs = fixed costs that are uses of cash
- Variable costs revenue ratio= costs that vary with revenues/revenues
- Drivers of break-even
- Contribution profit margin – amount of each sale that contributes to paying for
fixed costs; in other words, whats left after deducting the cost of goods sold from
sales
- Fixed costs – higher fixed costs means more revenues needed to break even
- What is an operating budget
- A short term look at the how the venture will earn and spend revenues
- Operating and Cash conversion cycles
- Time it takes to purchase, produce, and sell a venture’s products plus the time it
takes to collect on receivables
- How fast a company can convert cash on hand to inventory, payables, sales,
receivables and back to cash
- Avg inventory/avg COGS + avg receivables/avg daily sales – avg
payables/avg COGS
- Forecasting sales for seasoned firms
- Forecasting sales for new ventures
- Steps include identifying the market and gathering information, determining
overall industry demand and the size of your target market, estimating market
share, estimating sales price and unit sales volumes, calculating revenues,
comparing to other similar type firms, knocking back projected growth rates
based on contingencies (best, works, most likely scenarios)
- Projecting statements for new ventures
- Forecast sales, estimate first year expenses that vary with sales, estimate fixed
expenses over time, apply tax rate, use percent of sales method to project future
time periods
- Sustainable growth rates – rate at which a firm can grow based on retaining profits
- Sustainable growth rate = (net income/beginning equity) * retention rate
- Additional funds needed – gap between the financial capital needed to fund projected
growth and the funds generated by business operations
- AFN = required increase in assets – spontaneously generate funds – increased
retained earnings
 TA o APo  ALo NIo
AFN  (NS) - (NS) - (NS1) (RRo)
NSo NSo NSo
where : TA  Total assets
NS  Net sales
NS  Change in net sales between next year and current year
AP  Accounts payable
AL  Accrued liabilitie s
NI  Net Income
RR  Retention Rate

PRACTICE QUESTIONS
1. Which of the following characteristics are typically associated with entrepreneurs of
aggressive growth oriented firms?
a. Exhibiting optimism regarding the ventures potential
b. Planning mentality
c. Ability to recognize and capitalize on opportunities that others cannot
d. All of the above

2. A business model represents:

a. A framework for generating revenues, making profits, and producing free cash flows
b. A guide for new ventures to identify their key sources of funding
c. The way in which new firms can produce products better than their competitors
d. The market and industry the firm serve and the products and services the firm will
provide

3. Discuss the similarities and differences between business incubators and accelerators in
terms of objectives, motivations, expertise, etc.

4. The type of financing that occurs during the growth stage of a venture’s life cycle is typically
referred to as:
a. seed financing
b. startup financing
c. first round financing
d. second round financing

5. Explain why it is dangerous to assume that people act against their own self-interests as it
relates to entrepreneurial finance.
6. Wealthy individuals who invest in early stage ventures in exchange for the excitement of
launching a business and a share in any financial rewards are known as:
a. creditors
b. white knights
c. corporate raiders
d. business angels
e. stakeholders

7. Star Wars Inc. had $500 million in sales, with a cost of goods sold of $200 million, and fixed
costs of $200 million. What is Star Wars’ survival revenues (breakeven)?
a. Answer = 200M/ (1-(200m/500m)) = 333.333

8. What is the 2018 AFN for a company with the following information in the year 2017:
a. Sales = 1,000,000
b. Total Assets = 750,000
c. Net Income = 125,000
d. Accounts Payable = 25,000
e. Paid dividends of 25,000
f. 20% project sales growth

750k/1m * (200k) - 25k/1m *(200k) - 1.2M*(125k/1m)*.8

.75*200k - .025*200k - 1.2M*.125*.8
150k - 5k - 120k
= 25k

What is the cumulative 2 year AFN (2018 and 2019) for the company?
.75(440k) - .025(440k) – 2.64m*(.125)*.8 = 55k cumulative

55k-25k = 30k for 2019 only

9. All of the following are steps in the process of projecting financial statements for new
ventures except
a. Estimate future year variable expenses as a percentage of first year sales
b. Estimate Year 1 sales
c. Project future year fixed costs as a percentage of first year sales
d. Estimate Year 1 variable and fixed costs
10 If a business had the following amounts in their statement of cash flows, would the company be in a
state of net cash burn or net cash build?
Cash from Operating activities: 1,500
Cash from Investing activities: -2,500
Cash from Financing activities: 2,000

Answer = Burn

11. Which one of the following would decrease a firm’s need for additional funds?
a. a decreasing profit margin
b. an increasing expected sales growth rate
c. a decrease in payables
d. a decreasing dividend payout rate

12. An increasing (lengthening) sale-to-cash conversion period (avg receivables/avg daily sales)
indicates a more efficient management of the cash conversion cycle? True or False

13. Assume your company has the following projected financial information:
2019 2020
Revenues 150,000 210,000
COGS 75,000
Gross Profit 75,000
Marketing 25,000
Depreciation 3,000 3,000
EBT(before tax)47,000
Taxes (20%) 9,400 13,400
Net Income 37,600

A. What is Gross Profit in 2020?

105,000
B. What are Marketing expenses in 2020?
35,000
c. Assuming a constant growth rate, what are projected sales for 2021?
294,000
14. If your company decided to pay its investors a total of $100,000 from the $350,000 in earnings this
year, what is your company’s retention rate?

71.43%