CHAPTER 8
Assessing a New Venture’s
Financial Strength and Viability
·
Introduction to Financial
Management
One
of the most common mistakes young entrepremeurial firms make is not emphas zing
financial management and puttin in placce appropriate forms of financial
controls. Entrepreneurs must be aware of how much money they have in the bank. The
financial management of a firm deals with questions such as :
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How
are we doing? Are we making or losing money?
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How
much cash do we have on hand?
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Over
all, are we in good shape financially?
·
Financial objectives of a firm
Four
main financial objectives :
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Profitability : is the ability to earn profit.
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Liquity : is a company’s ability to meet
its short-term financial obligations.
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Efficiency : is how productively a firm
utilizes its assets relative to its revenue and
its profits.
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Stability : is the strength and vigor of the
firm’s overall financial posture.
·
The process of financial management
The
income statement, the balance sheet, and the statement of cash flow are the
financial statements entrepreneurs use most commonly. Forcasts are an
estimate of a fim’s fuuture income and expenses, based on its past performance.
The process :
-
Preparation
of historic financial statements : Income
statement, balance sheet, statement of cash flow
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Preparation
of forecasts : Income, expenses, capital expenditures
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Preparation
of pro forma financial statements : pro forma income statement, pro forma balace
sheet, pro forma statement of cash flow
-
Ongoing analysis
of financial results : Ratio analysis, measuring results versus plans, measuring
results versus industry norms
Next step is to prepare forecasts
for two to three years in the future. The final step is analysis of a firm’s
financial results.
·
Financial
statements
Historical financial statements reflect past performance and ar
usually prepared on a quarterly and annual basis. Publicly traded firms are
required by the Scurities and Exchangee Commision (SEC). Historical financial
statements include the income statement, the balance sheet, and the statement
of cash flows. If a firm does not have these statements, it may be precluded
from serious consideration for an investment or a loan.
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Income statement : it reflects the results of
the operations of a firm over a specified peroid of time. It records all the
revenues and expenses.
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Operating expenses : include marketing,
administrative costs, and other expenses not directly related to producing a
product or service.
-
Balance sheet : is a snapshot of a company’s
assets, liabilities, and equity at a specific point in time.
The major categories of assets
listed on a balance sheet are :
-
Current
assets : that are readily convertible to cash, accounts receivable,
marketable securities, and inventories.
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Fixed assets
: used over a longer time frame, such as real estate, buildings, equipment,
and furniture.
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Other assets
: are miscellaneous assets, including accumulated goodwill.
The major categories of liabilities
listed on a balance sheet are :
-
Current
liabilities : including accounts payable, accrued expenses, and the current
portion of long-term debt.
-
Long – term
liabilities : include notes or loans, liabillities associated with
purchasing real estate, buildings, and equipment
-
Owner’s
equity : is the equity invested in the business by its owners plus the
accumulated earnings retained by the business after paying dividends.
·
Statement
of cash flows
Is similar to a month-end bank
statement. It rveals how much cash is on hannd at the end of the month as well
as how the cash was acquired and spent during the month. The statement of cash
flows is divided into three separate activities :
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Operating
activities : Include net income (or loss), depreciation, and chanes in
current assets and cuurrent liabilities.
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Investing
activities : Include the purchase, sale . or iinvestment in fixed assets.
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Financing
activities : Include cash raised during the period by borrowing money or
selling stock and/ or cash used during the period by payinng dividens, buying
back outstanding stock, or buying back outstanding bonds.
Pro forma financial statements are projections for future periods
based on forecasts an are typically completed for two to three years in the
future and not required by the SEC.
·
Forecasts
Are predictions of a firm’s
future saled, expenses, income, and capital expenditures. A firm’s forecasts
provide the basis for its pro forma financial statements. A well-developed set
of pro forma financial statements helps a firm create accurate budgets, build
financial plans, and manage its finances in a proactive rather than a reactive
manner.
·
Sales
Forecast
Is a projection of a firm’s sales
for a specified period (such as a year), though moost firms fore cast their
saled for two to five years into the future.
·
Forecast of
costs of sales and other items
After completing its sales
forecast, a firm mut forecast its cost of sales (or cost of good sold) and the
other items on its oncome statement. Once completes, the percent-of-sales
method, it goes through its income statement on an item-by-item basis to see if
there are oopportunities to make more precise forcasts.
·
Pro forma
financial statement
Are similar to its historical
financial statements except that they look forward rather than track the past. New
ventures typically offer pro forma statements. The preparation of pro forma
statements also helps firms rethink their strategies and make adjustments if
necessary
·
Pro forma
income statement
Once a firm forecasts its future
income and expenses, the creation of the pro forma income statement is merely a
matter of plugging in the numbers.
·
Pro forma
balance sheet
It’s provides a firm a sense of
how its activities will affect its ability to meet its short-term liabilities
and how its financies will evolve over time. It can also quickly show how much
a firm’s money will be tied up in accounts receivable, inventory, and
equipment.
·
Pro forma
statement of cash flow
It shows the projected flow of
cash into and out of the company during a specified period. The most importance
fuction i to project whether the firm will havve sufficient cash to meet its
needs.
·
Ratio analysis
The same financial ratios used to
evaluate a firm’s historical financial statments should be used to evaluate the
pro forma financial statements.
