Therefore, the income statement and cash f low statement should be month-to-month during the first two years to show how much cash is needed until the firm can become self-sustaining.. A
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plan are the income statement, cash f low statement, and balance sheet I typi-cally call for five years of financials, recognizing that the farther out one goes, the less accurate the forecasts are The rationale behind five years is that the first two years show the firm surviving and the last three years show the upside growth potential The majority of new ventures lose money for the first two years Therefore, the income statement and cash f low statement should be month-to-month during the first two years to show how much cash is needed until the firm can become self-sustaining Month-to-month analysis shows cash
f low decreasing and provides an early warning system as to when the entrepre-neur should seek the next round of financing Years 3 through 5 need to be il-lustrated only on an annual basis, because these projections communicate your vision for growth but are likely to be less accurate because they are further out The balance sheet can be on an annual basis for all five years since it is report-ing a snapshot on the last day of a particular period
Once the financial spreadsheets are completed, a two-to-three-page ex-planation of the financials should be written and it should precede the state-ments Although you understand all the assumptions and comparisons that went into building the financial forecast, the reader needs the background spelled out The explanation should have four subheadings: overview, income statement, cash f low, and balance sheet The overview section should highlight the major assumptions that drive your revenue and expenses This section should explain several of the critical risks you identified earlier The income statement description goes into more detail as to some of the revenue and cost drivers that haven’t been discussed in the overview section The cash f low de-scription talks about the timing of cash infusions, accounts payable, accounts receivable, and so forth The balance sheet description illustrates how major ratios change as the firm grows
Appendices (as many pages as necessar y)
The appendices can include anything that you think further validates your concept but doesn’t fit or is too large to insert in the main parts of the plan
EXHIBIT 9.14 Headcount char t.
Month Month Month Month Month Month Month
Trang 2Common inclusions would be one-page resumes of key team members, articles that feature your venture, and technical specifications
CONCLUSION
The business plan is more than just a document; it is a process Although the finished product is often a written plan, the deep thinking that goes into that document provides the entrepreneur keen insight needed to marshal resources and direct growth The whole process can be painful, but the returns on a solid effort almost always minimize the costs of starting a business, because the pro-cess allows the entrepreneur to better anticipate, instead of reacting to, the many issues the venture will face More important, the business plan provides a talking point so that entrepreneurs can get feedback from a number of experts, including investors, vendors, and customers Think of the business plan as one
of your first steps on the journey to entrepreneurial success
OTHER R ESOURCES
A number of resources exist for those seeking help to write business plans There are numerous software packages, but I find that generally the templates are too confining The text boxes asking for information box writers into a dull, dispassionate tone The best way to learn about business plans is digging out the supporting data, writing sections as you feel compelled, and circulating drafts among your mentors and advisors I also think that the entrepreneur should read as many other articles, chapters, and books about writing business plans as possible You will want to assimilate different perspectives so that you can find your own personal voice To that end, I want to suggest a number of sources that you might want to check out
FOR FURTHER R EADING
Timmons, J A., New Venture Creation, 5th ed (New York: Irwin/McGraw-Hill,
1999) Classic textbook on the venture creation process
Tracy, J., How to Read a Financial Report, 5th ed (New York: John Wiley, 1999).
Classic book on how to create pro forma financial statements and how these statements tie together
Sahlman, W., “How to Write a Great Business Plan,” Harvard Business Review
(July–Aug 1997): 98–108
Bhide, A., “The Questions Every Entrepreneur Should Ask,” Harvard Business Re-view (Nov.–Dec 1996): 120–130.
Kim, C., and R Mauborgne, “Creating New Market Space,” Harvard Business Re-view (Jan.–Feb 1999): 83–93.
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INTER NET LINKS
Business Plan Sites
www.pasware.com
www.brs-inc.com
www.jian.com
Other Usef ul Sites
www.entreworld.org
www.babson.edu/entrep
NOTES
1 P Thomas, “Rewriting the Rules: A New Generation of Entrepreneurs Find
Themselves in the Perfect Time and Place to Chart Their Own Course,” Wall Street Journal, May 22, 2000, R4.
2 Running sidebar is a visual device that is positioned down the right hand side
of the page that periodically highlights some of the key points in the plan Don’t overload the sidebar, but one or two items per page can draw attention to highlights that maintain reader interest
3 Don’t confuse the executive summary included in the plan with the expanded executive summary that I suggested you write as the very first step of the business plan process Again, the two summaries are likely to be significantly different since the later summary incorporates all the deep learning that you have gained throughout the process
4 J Timmons, New Venture Creation, 5th ed (New York: Irwin/McGraw-Hill,
1999)
5 O Sacirbey, “Private Companies Temper IPO Talk,” The IPO Reporter,
Dec 18, 2000, 9
6 Burn rate is how much more cash the company is expending each month than earning in revenue
Trang 410 EXPENDITURE
Steven P Feinstein
A beer company is considering building a new brewery An airline is deciding whether to add f lights to its schedule An engineer at a high-tech company has designed a new microchip and hopes to encourage the company to manufac-ture and sell it A small college contemplates buying a new photocopy machine
A nonprofit museum is toying with the idea of installing an education center for children Newlyweds dream of buying a house A retailer considers building a Web site and selling on the Internet
What do these projects have in common? All of them entail a commit-ment of capital and managerial effort that may or may not be justified by later performance A common set of tools can be applied to assess these seemingly very different propositions The financial analysis used to assess such projects
is known as “capital budgeting.” How should a limited supply of capital and managerial talent be allocated among an unlimited number of possible projects and corporate initiatives?
THE OBJECTIVE: MAXIMIZE WEALTH
Capital budgeting decisions cut to the heart of the most fundamental ques-tions in business What is the purpose of the firm? Is it to create wealth for in-vestors? To serve the needs of customers? To provide jobs for employees? To better the community? These questions are fodder for endless debate Ulti-mately, however, project decisions have to be made, and so we must adopt a
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decision rule The perspective of financial analysis is that capital investment belongs to the investors The goal of the firm is to maximize investors’ wealth Other factors are important and should be considered, but this is the primary objective In the case of nonprofit organizations, wealth and return on invest-ment need not be measured in dollars and cents but rather can be measured in terms of benefits to society But in the case of for-profit companies, wealth is monetary
A project creates wealth if it generates cash f lows over time that are worth more in present-value terms than the initial setup cost For example, suppose a brewery costs $10 million to build, but once built it generates a stream of cash f lows that is worth $11 million Building the brewery would cre-ate $1 million of new wealth If there were no other proposed projects that would create more wealth than this, then the beer company would be well ad-vised to build the new brewery
This example illustrates the “net present value” rule Net present value (NPV) is the difference between the setup cost of a project and the value of the project once it is set up If that difference is positive, then the NPV is positive and the project creates wealth If a firm must choose from several proposed projects, the one with the highest NPV will create the most wealth, and so it should be the one adopted For example, suppose the beer company can either build the new brewery or, alternatively, can introduce a new prod-uct—a light beer, for example There is not enough managerial talent to over-see more than one new project, or maybe there are not enough funds to start both Let us assume that both projects create wealth: The NPV of the new brewery is $1 million, and the NPV of the new-product project is $500,000 If
it could, the beer company should undertake both projects; but since it has to choose, building the new brewery would be the right option because it has the higher NPV
COMPUTING NPV: PROJECTING CASH FLOWS
The first step in calculating a project’s NPV is to forecast the project’s future cash f lows Cash is king It is cash f low, not profit, that investors really care about If a company never generates cash f low, there can be no return to in-vestors Also, profit can be manipulated by discretionary accounting treat-ments such as depreciation method or inventory valuation Regardless of accounting choices, however, cash f low either materializes or does not For these reasons, cash f low is the most important variable to investors A project’s value derives from the cash f low it creates, and NPV is the value of the future cash f lows net of the initial cash outf low
We can illustrate the method of forecasting cash f lows with an example Let us continue to explore the brewery project Suppose project engineers in-form you that the construction costs for the brewery would be $8 million The
Trang 6expected life of the new brewery is 10 years The brewery will be depreciated
to zero over its 10-year life using a straight-line depreciation schedule Land for the brewery can be purchased for $1 million Additional inventory to stock the new brewery would cost $1 million The brewery would be fully opera-tional within a year If the project is undertaken, increased sales for the beer company would be $7 million per year Cost of goods sold for this beer would
be $2 million per year; and selling, administrative, and general expenses associ-ated with the new brewery would be $1 million per year Perhaps advertising would have to increase by $500,000 per year After 10 years, the land can be sold for $1 million, or it can be used for another project After 10 years the sal-vage value of the plant is expected to be $1.5 million The increase in accounts receivable would exactly equal the increase in accounts payable, at $400,000,
so these components of net working capital would offset one another and gen-erate no net cash f low
No one expects these forecasts to be perfect Paraphrasing the famous words of baseball player Yogi Berra, making predictions is very difficult, espe-cially when they are about the future! However, when investors choose among various investments, they too must make predictions As a financial analyst, you want the quality of your forecasts to be on a par with the quality of the forecasts made by investors Essentially, the job of the financial analyst is to es-timate how investors will value the project, because the value of the firm will rise if investors decide that the new project creates wealth and will fall if in-vestors conclude that the project destroys wealth If the inin-vestors have reason
to believe that sales will be $7 million per year, then that would be the correct forecast to use in the capital budgeting analysis Investors have to cope with uncertainty in their forecasts Similarly, the financial analyst conducting a cap-ital budgeting analysis must tolerate the same level of uncertainty
Note that cash f low projections require an integrated team effort across the entire firm Operations and engineering personnel estimate the cost of building and operating the new plant The human resources department con-tributes the labor data Marketing people tell you what advertising budget is needed and forecast revenue The accounting department estimates taxes, ac-counts payable, and acac-counts receivable and tabulates the financial data The job of the financial analyst is to put the pieces together and recommend that the project be adopted or abandoned
Initial Cash Outf low
The initial cash outf low required by the project is the sum of the construction cost ($8 million), the land cost ($1 million), and the required new inventory ($1 million) Thus, this project requires an investment of $10 million to launch
If accounts receivable did not equal accounts payable, then the new accounts receivable would add to the initial cash outf low, and the new accounts payable would be subtracted These cash f lows are tabulated in Exhibit 10.1
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Cash Flows in Later Years
We find cash f low in years 1 through 10 by applying the following formula:
Notice that we already have most of the data needed for the cash-f low formula, but we are missing the forecasts for income tax and windfall tax Before we can finalize the cash f low computation, we have to forecast taxes
Income tax equals earnings before taxes (EBT) times the income tax rate EBT is computed using the following formula:
The formula for EBT is similar to the formula for cash-f low, with a few impor-tant exceptions The cash-f low calculation does not subtract out depreciation, whereas the EBT calculation does This is because depreciation is not a cash
f low; the firm never has to write a check payable to “depreciation.” Deprecia-tion does reduce taxable income, however, because the government allows this deduction for tax purposes So depreciation inf luences cash f low via its impact
on income tax, but it is not a cash f low itself The greater the allowable depre-ciation is in a given year, the lower taxes will be, and the greater the resulting cash f low to the firm
Earnings before Taxes= Sales − Cost of goods sold
− Selling, administrative, and general expenses
− Advertising
− Depreciation
Cash Flow= Sales − Cost of goods sold
− Selling, administrative, and general expenses
− Advertising
− Income tax + Decrease in inventory (or − increase) + Decrease in accounts receivable (or − increase)
− Decrease in accounts payable (or + increase) + Salvage
− Windfall tax on salvage
EXHIBIT 10.1 Initial year cash f low for
brewer y project ($1,000s).
Year 0
Trang 8Treatment of Net Work ing Capital
Changes in inventory, accounts receivable, and accounts payable are included
in the cash-f low calculation but not in EBT Changes in the components of working capital directly impact cash f low, but they are not deductible for tax purposes When a firm buys inventory, it has essentially swapped one asset, (cash) for another asset (inventory) Though this is a negative cash f low, it is not considered a deductible expenditure for tax purposes
Similarly, a rise in accounts receivable means that cash that otherwise would have been in the company coffers is now owed to the company instead Thus, an increase in accounts receivable effectively sucks cash out of the com-pany and must be treated as a cash outf low Increasing accounts payable has the opposite effect
One way to gain perspective on the impact of accounts payable and ac-counts receivable on a company’s cash f low is to think of them as adjustments
to sales and costs of goods sold If a company makes a sale but the customer has not yet paid, clearly there is no cash f low generated from the sale Though the sales variable will increase, the increase in accounts receivable will exactly off-set that increase in the cash f low computation Similarly, if the company incurs expenses in the manufacture of the goods sold but has not yet paid its suppliers for the raw materials, the costs of goods sold will be offset by the increase in accounts payable
Depreciation
According to a straight-line depreciation schedule, depreciation in each year is the initial cost of the plant or equipment divided by the number of years over which the asset will be depreciated So, the $8 million plant depreciated over
10 years generates depreciation of $800,000 each year Land is generally not depreciated Straight-line depreciation is but one acceptable method for deter-mining depreciation of plant and equipment The tax authorities often sanction other methods and schedules
Windfall Prof it and Windfall Tax
In order to compute windfall profit and windfall tax, we must be able to track
an asset’s book value over its life Book value is the initial value minus all pre-vious depreciation For example, the brewery initially has a book value of $8 million, but that value falls $800,000 per year due to depreciation At the end
of the first year, book value falls to $7.2 million By the end of the second year, following another $800,000 of depreciation, the book value will be $6.4 mil-lion By the end of the tenth year, when the brewery is fully depreciated, the book value will be zero
Windfall profit is the difference between the salvage value and book value We are told the beer company will be able to sell the old brewery for
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$1.5 million at the end of 10 years By then, however, the book value of the brewery will be zero Thus, the beer company will realize a windfall profit of
$1.5 million The government will want its share of that windfall profit Multi-plying the windfall profit by the tax rate determines the windfall tax In this particular case, with a windfall profit of $1.5 million and a tax rate of 40%, the windfall tax would equal $600 thousand (= $1.5 million × 40%)
Taxable Income and Income Tax
Exhibit 10.2 shows how taxable income and income tax are computed for the brewery example Income tax equals EBT times the company’s income tax rate
In each of years 1 through 10, EBT is $2.7 million, so income tax is $1,080,000 (= $2.7 million × 40%)
Interest Expense
Notice that the calculation of taxable income and income tax in Exhibit 10.2 does not deduct any interest expense This is not an oversight Even if the com-pany intends to finance the new project by selling bonds or borrowing from a bank, we should not deduct any anticipated interest expense from our taxable income, and we should not subtract interest payments in the cash f low compu-tation We will take the tax shield of debt financing into account later when we compute the company’s cost of capital The reason for omitting interest ex-pense at this stage cuts to the core of the purpose of capital budgeting We are trying to forecast how much cash is required from investors to start this project and then how much cash this project will generate for the investors once the project is up and running Interest expense is a distribution of cash to one class
of investors—the debt holders If we want the bottom line of our cash-f low computation to ref lect how much cash will be available to all investors, we must not subtract out cash f low going to one class of investors before we get to that bottom line
EXHIBIT 10.2 Income tax forecasts for brewer y
project (thousands).
Years 1–10
Selling, administrative, and general expenses (1,000)
Trang 10Putting the Pieces Together to
Forecast Cash Flow
We now have all the puzzle pieces to construct our capital budgeting cash-f low projection These pieces and the resulting cash-f low projection are presented
in Exhibit 10.3 Cash f lows in years 1 through 9 are forecast to be $2.42 mil-lion, and the cash f low in year 10 is expected to be $5.32 million Year 10 has a greater cash f low because of the recovery of the inventory and the assumed sale of the land and plant
GUIDING PR INCIPLES FOR
FOR ECASTING CASH FLOWS
The brewery example is one illustration of how cash f lows are forecast Every project is different, however, and the financial analyst must be keen to identify all sources of cash f low The following three principles can serve as a guide: (1) Focus on cash f low, not on raw accounting data, (2) use expected values, and (3) focus on the incremental
Principle No 1: Focus on Cash Flow
NPV analysis focuses on cash f lows—that is, actual cash payments and receipts
f lowing into or out of the firm Recall that accounting profit is not the same thing as cash f low Accounting profit often mixes variables whose timings dif-fer A sale made today may show up in today’s profits, but since the cash re-ceipt for the sale may be deferred, the corresponding cash f low takes place
EXHIBIT 10.3 Cash f low projections for brewer y project
(thousands).