1. business and industrial

If the Business Plan is the
then the financials are the measurement of your
expectations for the future. This document is a tool to help guide you through the basic understanding
of how to build a great financial model. It will introduce the essential understanding of what to include;
cover what the Balance Sheet and Cash Flow Statements are & how to create them, plus include some
key principles to keep in mind. A lot of material exists out there for you to use and build really complex
models; but start with these basic building blocks keeping it simple and you will be ok.
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Barry Bisson, Shad’s President has made available an excellent excel template, I recommend you
download this and try and use this model in the creation of your company’s financial projections. The
following tutorial will help you understand the basic fundamentals behind this model. Hey! Numbers
can be fun; the trick is to keep them realistic with plenty of backed-up assumptions.
When it comes to numbers, investors aren’t always looking for the
business plan with the best and most ambitious financial
projections. Investors are smart; they know anyone with some basic excel skills can build financial
models with 4th and 5th year sales projections of $30 to $60 million. What they are looking for here is
your reasoning behind the projections and your understanding of how you plan on obtaining them.
How you plan on scaling your business, which revenue model makes sense for your idea to determine
how much capital ($) you need, and whether you have considered all your assumptions in the business
plan carefully when it comes to mapping out a financial cost/reward analysis.
→
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. (I’ll talk about each of
these as we go through the different elements)
Typically you are required to think at least 5 years down the road, detail out a 12-18 month plan and
yearly after that. Don’t over think the financials; spend your time in your groups coming up with the
startup story, the technology, the market you want to jump into & why you think you have something of
value to change the world and “
”. Talk to people; don’t be afraid to ask
questions, getting information is the most important thing when it comes to building great value
propositions and financial models around them. Map out the strategy to execute your plan; the
financials are just a reflection of what you need to get you there, and why it will be rewarding to make
an impact in that area.
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OCE Shad Valley Financial Tutorial 2008
– Dwight
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D Eisenhower
Eisenhower of course was the General of the US army during the Second World War. Planning is always
important, and writing out this plan is absolutely a critical start. It ties everything together and prepares
you for the first step, the action part.
There are four basic financial statements;
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: Reporting a company’s assets, liabilities, and net equity at a point in time
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: Also referred to as the
, reports income, expenses and profits
: Explains the changes in a company’s retained earning
: Reports on a company’s cash flow activities, operating, investing and financing activities
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Let’s go over each now to get a basic understanding and visual:
Assets
Current Assets:
Cash
Accounts Receivable
Inventories
Liabilities and Owners' Equity
Liabilities
Notes Payable
$
30,000
Accounts Payable
0
Total Liabilities
$
30,000
Owners equity
Capital Stock
$7,800
Retained Earnings
$0
Total owners' equity
$7,800
A Balance sheet is the
snapshot of the company’s
financial condition. It is the
sum of all the Assets,
Liabilities and Owners
Long-term Assets:
Equity at any given point in
Tools and equipment
25000
time. You can see how the
Assets = Liabilities, this is
Total
$37,800
Total
$37,800 always the case. Of all the
basic financial statements, the balance sheet is the only statement which applies to a single point in
time. At the startup stage you will be more driven to focusing your efforts on the Income & Cash Flow
Statements because there we can evaluate the Revenues vs. Expenses more closely & keep an eye on
the all important Cash balances.
$6,600
6000
200
Assets - Liabilities = Owners Equity
is the magic equalizer; basically all the Assets (cash, equipment, inventories, and
accounts receivables) less all that you owe, your Expenses (Bank debt, Accounts Payable) equal the
remaining capital is your company’s net worth. This net worth or “equity” then becomes the value to its
owners “shareholders”. So you can see in a minute when we look at the Income Statement, when a
company makes money: Revenue is greater > then Expenses = a net income occurs (which gets feed back
into the Balance Sheet under Retained Earnings (this is the Retained Earnings Statement).
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I’ll return to the importance of seeking Investment in my section on Raising Money:
OCE Shad Valley Financial Tutorial 2008
- Income Statement :ABC Corp For year end December 31 2008
Revenues:
Gross Profit
“Top Line”
$496,397
Expenses:
Advertising
Insurance
Legal & Consulting Services
Utilities
Printing, Postage & Stationary
Licenses
Band & Credit Card fees
Bookkeeping
Employees
Rental Mortagaes and Fees
Total Expenses
Cash
outflows
incurred
during
period for
delivering
product or
service *
The Income Statement: is where you
will really have an opportunity to see
the model in action. This example is
a snapshot of the year end
accumulation, but you can
extrapolate this out on a month to
month spreadsheet as well. This
statement indicates how
(Money received from the sale of a
product or service before expenses) are
shown, then transformed into
which are (the results after all
12500
1500
25000
3000
35000
5000
1200
6500
120000
45000
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revenue and expenses
* are accounted
for, also known as the bottom line).
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-$ 254,700
Net Income
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“Bottom Line”
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$241,697
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Because unlike in the Balance Sheet
the Income Statement shows a
period of time & not a single
moment in time, we can build a
projection model around this basic
principle:
Notes & Assumptions
- 5 full time employees (owners) $2k/month
- Mortgage small commercial building ($3500/month)
- Legal work on 3 Int. patents & consulting fees
- Licenses & Shipping costs to distribution partners
Revenue – Expenses = Net Income
*I mention that the expenses included here are only those incurred to produce the revenue (
). Other larger expenditures are recorded on the Cash Flow and Balance Sheet statements,
stuff like buying an office building, a car, or equipment.
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(Balance Sheet and Income Statement changes)
Let’s say you need to buy a $50,000 pieces of assembly equipment, this amount does not show
up in month 1 of your Income Statement, it does however have to be recorded. So back in the Balance
Sheet
you would indicate (let’s say bank debt is used, then liabilities ↑ by $50,000 (bank
note) and assets also ↑ by $50,000, equipment – but all the costs associated with running that machine
are included in expense here in the Income Statement; the rent paid to house it, the utility costs, all the
materials, including let’s say the 7% bank fee on the $50K, so 7% annual over let’s say 20 years (so treat
it like you would a mortgage) Cost $50,000, interest rate 7% annual, period 20 years – find a good
mortgage calculator online and bingo- Annual payment $4,719.65 (its gets complicated when you start
looking into it, annual vs. monthly payments- it all has to do with the interest periods) but don’t worry, the
important thing here is to show what gets recorded in the Balance Sheet and what gets recorded in the
Income statement.
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Income statements can get allot more complex, including things like Operating Profit, Dividends,
Irregular items, and stuff like that- stick to the basics and you’ll have a great model that makes sense.
Next you may want to start extracting some breakdowns from this information. For example the
expenses represent your COGS “
”, so you can capture a per unit value on this by
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OCE Shad Valley Financial Tutorial 2008
dividing the total expenses by the number of units produced, this will give you an idea on how to price
your product/service. Show some charts on your expense curves as you change prices (which will affect
your revenues and bottom-line numbers), include more people on your payroll, or reduce costs by
purchasing more equipment, or even form key partnerships and distribution deals down the road- all
will influence your model and various financial statements. In the building of your model you will begin
to realize certain items are linked to key drives, like the number of units you sell over time, the
price/sales factor, all tie into your company’s growth story here and all are reflected in your Income &
Cash Flow Statements.
So as mentioned previously; the statement of retained earnings is
simply the link between the Income Statement and the Balance
Sheet. Retained earnings are part of the balance sheet as you
recall under the
Section, (sometimes also referred to
as the Stockholders Equity- I’ll get to this later.) The retained earnings account on the balance sheet is said
to represent an “
” since net profit and losses are added/subtracted from this
section over time.
The General equation can be expressed as the following:
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Ending Retained Earnings= Beginning Retained Earnings – Investments – Dividends Paid + Net Income
The basic principle if you recall is that the balance sheet always balances. So let’s merge the two
statements previously presented (the Income and Balance Sheet Statements): After 1 year in business
the company’s net income was
at the end of 2008. But we are missing one important
deduction on this, anyone recognize what it is? Well Brad Pitt put it best in the movie Meeting Joe
Black- “
” don’t forget the Canadian government is a
partner in this business to. Check out the local tax laws in the province you want to incorporate. It
looks like the Canadian Government will be lowering tax rates in 2008, to 19.5% and the small business
tax rate falls to 11% based on Federal tax applying to the first $400,000 of active business income.
Ontario looks to be taxing small businesses at 5.5% - but do your own homework, check out the info
KPMG has posted or just Google it, you will find the tax rates posted for the next couple of years & this
should be incorporated into your models, it’s not that difficult- hopefully you have earnings to be taxed
☺. So after tax net income then becomes;
($241,697-(241,697*16.5%))
$
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Assuming that the company decides to do nothing else with that money earned (i.e. not to Pay out to
shareholders in the form of a dividend (
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pay debt back (
& if the company wishes to invest it will
) with these earnings. Remember always
keeping it balanced.
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Balance Sheet ABC Inc. Dec 31st 2008
Assets
Liabilities and Owners' Equity
Current Assets:
Liabilities
Cash
$208,417
Notes Payable
$
30,000
Accounts Receivable
6000
Accounts Payable
0
Inventories
200
Total Liabilities
$
30,000
Owners equity
Long-term Assets:
Capital Stock
$7,800
Tools and equipment
25000
Retained Earnings
$201,817
Total owners' equity
$209,617
Total
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$239,617
Total
$239,617
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So we would see the following happen on the
Balance Sheet:
Keep in mind that that money earned (Net income)
less the taxes and other expenses not only shows up
in our Retained Earning portion in the Balance Sheet,
but also our Cash, because we like the cash right!
That takes us to our next Financial Model: The Cash
Flow
OCE Shad Valley Financial Tutorial 2008
Period Ending
Opening Cash
ABC Inc. Cash Flow Statement
Sep-08
Oct-08
0 $ 1,412,910
Cash Flow From Operations
Net Income
-$
Plus Depreciation
$
(Increase)/Decrease in Accounts Recivable -$
(Increase)/Decrease in Inventory
-$
(Increase)/Decrease Accounts Payable
$
(Increase)/Decrease in Income Taxes Payable
-$
Total Cash Flow from Operations
-$
10,825
5,166
109,500
5,700
72,000
1,031
49,890
$
-4300
5000
-20000
-7000
30000
-950
2,750
---------------
0
0
0
0
0
-------------
0
-37350
0
0
37,350
-------------
This statement shows a company’s incoming
and outgoing money (sources and uses of
cash) during a period of time (often monthly
for startups.) This is where changes in the
Balance Sheet and Income Statement
affected cash and in particularly the three
;
areas cash is utilized:
and
. Simply put, this is where
the rubber hits the road for a startup, can
the company survive and grow, how long
can the company afford to pay bills, and
cover liabilities, while growing its top-line
Net Income.
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Cash Flow from Financing Activities
Increase in Borrowed Funds
(Loan Principlal Payments)
(Increase)/Decrease in Share Capital
(Dividend Payments)
Total Cash Flow from Financing Activities
-$
-$
-$
$
-$
100,000
250,000
150,000
500,000
$ 1,500,000
-37200
500000
$
$ 1,962,800 -$
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Cash Flow from Investing Activities
(Increase)/Decrease in Land
(Increase)/Decrease in Buildings
(Increase)/Decrease Equipment
(Increase)/Decrease Vehicles
Total Cash Flow from Investing Activities
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This example has been based on Barry
Bisson’s Excel file, which is a great tool you
can use to build your financial projections.
Test it out and you can begin to see how
Net Cash Flow
$ 1,412,910 -$
34,600
--these financial statements interact with
Closing Cash
$ 1,412,910 $ 1,378,310
--each other, each providing a different
Notes & Assumptions
perspective on the company’s status.
- Net Income from Income Statement
Barry’s model includes some complex
- large upfront Accounts Payable (due to payment cycle)
- Bank Loan $1.5 Million at x% rate
systems to record and display various
- Capital investments into Land Building and Equipment
financial metrics. These include the interest
expenses on capital equipment, the costs associated with borrowing money, setting up mortgages,
account payable and receivable systems for collections, and pricing and basic costing models. He has
also included detailed descriptions of each input, plus charts
that show you the growth of your projections. I highly
recommend you use this model, play with it and take some of
the basic lessons learned in this tutorial and apply them to this
terrific excel file, see how these statements link into each
other and interact.
You can see this page once you begin, (with red descriptive
tabs detailing each field) fill out as much information as
possible (Year 1-3) that fits with your strategy. Scroll through
the different pages to fill in each section, the financial
statements will be created around these inputs. Have fun!
OCE Shad Valley Financial Tutorial 2008
First let’s start with the story you have in your mind, this great new
technology that will change the world, but all you need is that million dollar
investment, right! So remember there are many ways to get to market, some
far better than others, depending on your situation.
Let’s look back at the Balance Sheet again, in particular the section on Owners
Equity; that magical equalizer in this “balance” between assets and liabilities.
This is your Share, Stock, Shareholders Equity whatever you call it, this is the
stake the original founders have. Right now its 100% yours. The trick is if you
really have that amazing new product, you want to keep as much of this
ownership as possible. So when your Net Income flips positive and keep growing as you build the
business you get to expand your wealth through that participation we call shares. So how can we get
the money we need, at the best risk/reward ratio; raising money:
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: (I’m sure there are more ways; these are just off the top of my head)
Investors (the ones who take equity in your company in exchange for lots of cash: you share
your pie with more people) – Venture Capitalists – basically in the Balance Sheet Cash goes up
and Owners Equity (Capital Stock) goes up the same amount- Barry Bisson puts this best in his
financial model- once you have all your info put into the model take the month with the largest
accumulated negative cash number and that is the basic amount of cash you need- plus a nice
cushion- many 2x this amount to be safe.
Friends, Family, Fools, & Angels, the friendlier of the bunch, they provide the seed capital to
many dreams regrettably 90%+ of all small business fail but let’s not go thereBanks – well basically they will lend you a million if you have a million, but many banks do have
small business loans and can provide the gateway to many funds that might help you out.
Partnerships & Licenses, basically you have a great idea so you go find the business partner to
bring it to reality. In exchange you might be transferring full rights to your intellectual property
for a piece of the action if successful. Key is to protect then seek partnership *Protect your IP*
Government programs, there are lots of support organizations out there, if all you need is a few
thousand and some supportive networked connections this is a great place to start.
Customers, yes what about the customer? This is perhaps the most overlooked by many startup
dreamers; why not focus on your first sale, an excellent place to start – probably the best. Gain
validation, leverage potential sales orders when you‘re looking for support money. Lookup the
term Bootstrapping
Keep in mind there is a balance between debt and equity you should maintain. The more you
borrow, the higher the debt/equity ratio – debt has the power to shut you down if you can’t
pay, equity is a little more flexible, remember selling shares of ownership (equity) means “selling
claims on future cash flows” which is ok as long as you are comfortable with the investor and
what you are giving up & gain from the deal $ – this is the risk/rewarded paradigm you need to
figure out.
OCE Shad Valley Financial Tutorial 2008
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Objectives of this model
• Most important part of this model is the segmentation of the market. You need
to learn how to segment your market. Know how you will target and grow your
business, expanding into new markets, timelines and volumes.
• The end result is the share capital requirement. How much equity financing will
you need, equal to or greater than the month with the highest negative closing
cash balance
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Price goes down as manufacturing becomes more efficient.
COGS “
” input can be several things such as raw material, labor, etc.
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1. This is where you determine your target market strategy. Careful not to double count when
calculating your market estimate! For example, when expanding to Canada, don’t count in
Ontario and Québec, which were your initial markets when you started.
2. Then go to estimate your market size, market share and growth.
3. Calculate unit sales forecast
4. Estimate dollars generated by sales
5. Apply a seasonality factor. It is normal to start with zero sales when you first open. For business,
product/service specific
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The number indicates the gross of the sum of all inputs. These are the direct costs attributable to the
production of the goods sold by a company. Includes the materials costs used in creating the goods, and
direct labour costs, it does not include the indirect expenses such as distribution costs and sales force
costs. COGS appears on the Income Statement and can be deducted from revenue to calculate the
company’s gross margin.
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Depends on how you are paying your sales force. Some people’s compensation is part salary (which is
expressed in the staffing plan sheet) and part commission (expressed in the promotion sheet) something
to consider.
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Here you have to identify key positions. Research their salary ask around what the salary ranges are.
Are you going to have any part-time employees? If not, make it zero on the assumptions sheet. Note:
that when your target market increases, you need to increase the number of employees in your sales
force. Your sales force has to increase as you grow.
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The needs here are driven by sales. The bigger the sales are, the more raw materials you will need.
Note that this planning model is a guessing game. Sales are just a forecast.
What you’re doing is your inventory needs are being driven by sales. So if I'm selling chairs the
more chairs I sell the more raw materials I need to bring into inventory so I can make them into
chairs. It is a bit of a guessing game when deciding how much to buy…don't go too far and don't
make not enough.
Closing inventory must be greater than zero.
OCE Shad Valley Financial Tutorial 2008
Watch out for sales. Don’t over-buy or under-buy. Don’t build an inventory that is too big. It takes out
cash to pay suppliers and you don’t get cash back until you actually sell this inventory. Thus, this will
negatively affect your cash flow.
Inventory accounting formula:
Opening inventory + purchases – COGS = Ending Inventory
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Decide what you are buying.
Depreciation is spreading the cost of using an asset.
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You look at the capital investment for each year. You can’t finance 100% of the cost of the asset.
Guy Kawasaki puts it best in his terrific book called The Art of the Start, pg 122.
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Startups face one primary challenge: To never run out of cash! That is basic Financials 101
Best of Luck!
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s
:
(1992) Harvard Business School; Note on the financial Perspective: What Should Entrepreneurs Know?
Professor William A Sahlman: 9-293-045
(2004) Confronting Reality: Doing What Matters to Get Things Right: Larry Bossidy and Ram Charan;
Publisher: Crown Business
(2004) The Art of the Start: Guy Kawasaki; Publisher: The Penguin Group
:
KPMG Corporate Tax rates 2008: http://www.kpmg.ca/en/services/tax/documents/FPT_2008_09_CCPC.pdf
Wikipedia: Income Statements; Balance Sheets, Statement of retained earnings; Statement of Cash flows
About.com: Small Busienss Canada: Writing the Business Plan http://sbinfocanada.about.com/od/businessplans
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:
Guy Kawasaki : Blog- How to Change the World (A Practical Blog for impractical people) http://blog.guykawasaki.com/
StartupNorth: Great Canadian technology/software blog http://www.startupnorth.ca/
Business 2.0: Great source for ideas & new trends: http://money.cnn.com/magazines/business2/
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OCE Shad Valley Financial Tutorial 2008
Extra Material for you to consider:
The Private Equity Continuum
Venture funds in Canada typically have ten year lifespans. Most have five year
active investment windows. These fundamentals drive VC behaviour, in part.
Angel
Later Stage VC
Early Stage VC
Mezzanine
Buyout
Value Creation
M&A or IPO
Preferred Stock
“C” Round
(>$10-15 million)
This is a great chart presented by Tom
Sweeney, General Partner & Managing
Director of Garage Canada – a
Technology Ventures Capital firm based
in Montreal- it shows the lifecycle
investment pattern of a company from
startup to maturity over a typical 10
year horizon. You can see the typical
stages of investment rounds and when
each occurs in a company’s lifecycle
4-7 Years
Preferred Stock
“A” Round
($2-5 million)
Convertible Debt
or Common Stock
(<$500 K)
2-4 Years
~1 Year
Pre-Seed
Research
Seed
Start-Up
Signed
License
Prototype
Early Stage
Customer
Traction
Later Stage
Mezzanine
Market
Adoption
Cash Flow
IPO
Revenue
>$100M
Company Stage of Development
First
Pitch
VC Due Diligence Process
Family &
Angels
Grants
SR&ED
Receiver’s
Wall
Closing
($$)
Director’s
Wall
Under-funded company
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Properly funded company
Bootstrap and Seed Syndicate
6-12 months
Traction
Milestone
Due Diligence
Milestone
Similar to the above chart, you can
breakdown each key area a startup
needs to overcome if they wish to
attract and close an investment
round. Again we see this
term being used to show your
investors comfort that you are
doing something important with
what you have created &
envisioned.
New Money
Deposited
• Traction Milestone: achieve this key milestone before starting a financing
round
(gives investor confidence you’ve done something “important” already)
• Due Diligence Milestone: achieve this second key milestone during financing
(tell VC about it in “First Pitch”, hit the milestone, tell VC you did it)
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