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 :

-          How are we doing? Are we making or losing money?

-          How much cash do we have on hand?

-          Over all, are we in good shape financially?

·         Financial objectives of a firm

Four main financial objectives :

-          Profitability : is the ability to earn profit.

-          Liquity : is a company’s ability to meet its short-term financial obligations.

-          Efficiency : is how productively a firm utilizes its assets relative to its revenue                and its profits.

-          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

-          Preparation of forecasts : Income, expenses, capital expenditures

-          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.

-          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.

-          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.

-          Fixed assets : used over a longer time frame, such as real estate, buildings, equipment, and furniture.

-          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 :

-          Operating activities : Include net income (or loss), depreciation, and chanes in current assets and cuurrent liabilities.

-          Investing activities : Include the purchase, sale . or iinvestment in fixed assets.

-          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.