Enterprise Project
Making Sense of the Numbers
Presentation by
Geraldine Hudson
Lecturer, Strategy and Enterprise
Date11/02/2019
A reminder
In today’s session
Financing your business
Cash flow Forecasting
Break – Even Analysis
Exit Strategy – when is it appropriate?
Two important questions:-
What are my business’s realistic financial needs? In other words, what capital (£) do I need to launch my business?
How do I satisfy these needs?
Ekanem (2016)
Through a combination (usually)
Debt financing – money borrowed – (usually from a bank) which will have to be repaid eventually.
Bank Manager will want to see a cash flow statement for 2-3 years.
He will also be interested in a break even analysis, and possibly a gearing ratio.
Equity Financing - This is money put into the business by the owner or shareholders through an initial public offering (IPO) if it is a public company. Equity finance for small businesses or start-ups is usually mainly through personal investment by the founder or family. Or Venture Capital.
A venture capital can be defined as a financial investment in unquoted companies, which have significant growth potential, with a view to yielding substantial capital gains in line with the additional risk ,Deakin and Freel, (2012), Ekanem (2016). Therefore, it is capital that clearly involves a degree of risk.
Debt financing : The thing to remember about banks is that they are not in the risk business (Burns, 2014). They are looking to obtain a certain rate of interest over a specified period of time and to see their capital repaid. They do not share in the extra profits a business might make, so they do not expect to lose money if the fi rm encounters any problem. In addi- tion, the bank manager stands to lose a lot if he or she lends to a business that subsequently fails. Therefore, your business plan should demonstrate clearly how the interest on the loan will be paid even in the worst possible circumstances and how the capital will be repaid on the due date.
Equity Financing - Shareholders may withdraw their money, and they expect the directors to increase the value of their shares and provide a stream of dividends. If you do not meet shareholders’ expecta- tions, they may sell their shares or refuse to provide more money, and they may change the board. Through an IPO, you may sell shares of your company to the public.
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Beware –Venture Capitalists will try to mitigate this risk
They will offer their capital in exchange for an ownership stake in your company.
This will put pressure on your business.
In a way, these investors will attempt to ‘control’ your business and may ‘force’ it to become profitable in the first few years…………
Financing Requirements
Some questions:
Why do you need the money?
What type of money do you need?
When will you need it?
What deal are you offering your investors?
What exit routes are open to your investors?
The 5 Cs
Character – can the bank trust you? This may consist of the owner- managers’ characteristics such as qualifications and experience in the field of business. _ (Exec Summary)
Capacity – financial strength and past record. In other words, the bank manager will consider the viability of the business proposition or business case made in the business plan. (cash flow, break even)
Capital – you must be prepared to sink your own money in the business. The bank manager will definitely consider the extent of the client’s stake in the business. (Nominal £ 5,000 in Module handbook guidelines)
Collateral – banks are not risk takers. Therefore, they need a collateral security in the form of a building property. (if appropriate, and identified in your operations plan)
Conditions – the bank will consider the prevailing economic, industry and local conditions. (Your industry and market analysis) Ekanem (2016)
Get the narrative right
Decide on financing – justify investment through either debt financing and equity financing (with your cash flow forecast, payback calculation) and weave this through your business plan.
So …. Onto the numbers
The Cash Flow Forecast
Note that profit is not cash and that cash is not profit. Therefore, a cash flow statement is not the same as a profit and loss account
A business can survive in the short term if it is not making a profit so long as it has sufficient cash reserves.
You need to show this with your cash flow forecast………..
Cash flow forecast
Your CFF is part of your narrative
It will give insight into the financial workings of your business
Major assumptions – Sales, Spend, Expenses
Feeds in from your own research and assumptions that you have in your business plan.
Appropriating Value - Sales
Assumptions:-
What are you going to sell?
How many items/ units of service are you going to sell?
How much will you sell it for?
Forecasting Sales
Forecasting is an art rather than a science.
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Techniques for Forecasting Sales
Differ, depending on the industry that you are in.
Retail Sales (Stores) - £ per square foot.
Restaurants – Average Bills and table turnovers
Use secondary data to help with your forecast – Statistica -
Apple is the largest Apple – £3,250 per square foot. No surprise here. ...
Burberry – £2,300 per square foot. ...
GAME – £1,300 per square foot. ...
Selfridges – £1,230 per square foot. ...
Harrods – £1,200 per square foot. ...
Aldi – £1,170 per square foot. ...
Space NK – £1,170 per square foot. ...
Tesco – £985 per square foot.
Reataurants means average bill per table times number of times table is turned over – filled in one sitting – times the number of sittings
For example, Statistica -
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Cost of goods
How much will it cost me to make my product or service?
Cost of goods
Other assumptions
How much start up capital will you need?
What are your preliminary expenses?
What are your operational expenses?
You will need to think about paying yourself(at least) a salary
This way you can:
(have) NO SURPRISES
FORSEE SHORTAGES
So, how much do I need?
Capital requirements = The highest cumulative negative cash amount
Simple Cash Flow Forecast
Opening balance
Cash in – cash out – closing balance
Credit terms
Example – Geri’s handbags
(Geri’s handbags)
Financing by £6,000 as capital – paid in February
I also expect income from a loan in February £ 4,000
I have family paying a small amount into the business each month (Receipts)
I expect to incur the following expenses: • Purchases -Materials approx. £ 42,000 payable over first 12 months
Fixtures and fittings: 3 15,000 payable in February
Loan repayment and interest of £ 325 over 10 months
Also mortgage, rates, advertising insurance and drawings from business:
My cash flow forecast looks like this
Example : Geri’s handbags
Here’s one I made earlier
Break even
Why use break even?
Knowing your break-even point means you know how many units you need to sell
in simple terms, refers to the point where all costs (fixed and variable) are covered by revenue and the business is making neither profits nor losses but is moving into a situation of profitability.
The higher the fixed cost, the longer it takes to reach breakeven and profitability.
A break-even analysis is not as complicated as it sounds. To carry out a break-even analysis, you need the following information:
Break even analysis
What level of sales do you need in order to stop making a loss and achieve profit?
In terms of units of sales
At break even you have covered all of your costs
Beyond break-even you are making a profit
Up to break-even you are making a loss
You need
fixed costs per year
• variable costs per unit
• average price per unit.
Break even - graph
Source: Burns (2007)
The quick equation (for break-even)
Total fixed costs
(average price–average variable costs) = break even (units)
Break even analysis
Fixed costs (overheads) vs. variable costs
Fixed costs
| Fixed Costs are NOT affected by the level of sales | Rent Rates Wages Advertising Marketing Admin Charges Mobile phone Rental |
What are Variable Costs
These ARE affected by the level of sales
| Raw Materials Commissions (Sales Staff) Delivery Costs Direct Labour Packaging |
Break even formula
Contribution [to overheads]
Contribution = Unit sales price – unit variable costs
The simplest way to calculate the break even point is to use the formula:
Break Even Point (BEP) = Fixed Costs
Contribution per unit
Contribution per unit = selling price – variable costs
Break Even Analysis – An Example
Adrian makes cakes which he sells to a local restaurant. Each cake sells for £2.50. His fixed costs per year are £1,500 and variable costs are £0.50 per unit.
Using the Break Even equation, calculate the Break even point
Break Even Point (BEP) = Fixed Costs
Contribution per unit
Answer…….
Break Even Point (BEP) = Fixed Costs
Contribution per unit
BEP = £1,500 (Fixed Costs)
2.50 – 50 (unit sales price – unit variable costs)
Adrian needs to sell 750 cakes to break even…….
Another
Using the Break Even equation, calculate the BEP for:
Adrian has diversified into wedding cakes.
He sells to private customers.
Each cake sells for £275.00
His fixed costs per month are £1,800 and variable costs are £50.00 per unit
Answer
What time period are you using breakeven?
BEP = 8 cakes per month
(96 cakes per year)
Break-even chart
Break Even Chart - Labelling
Break Even Chart - Labelling
Costs and Revenue (£)
Number of Units Sold
Fixed Costs Line
Sales Revenue
Total Costs Line
Break Even Point
Margin of Saftey
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Why exit strategy
If you are just starting your business and intending to seek angel investors or venture capitalists, most will require you to have a viable exit strategy in place before they’ll consider investment
When / is an exit strategy appropriate?
Having an "exit strategy" tells others you associate with that you are in control of your business and your destiny, that you’re aware of the goal and focused on achieving it, and that you have a plan for an organized and profitable ending.
What will it consist of?
current valuation (or estimated at the time of exit) of your business
The factors that drive the value of your business,
methods to increase that value,
the potential future value, the best option or two for an ownership change,.
Finally, Where should the financials be?
The cash flow forecast sits at the back of the plan
But should tie in with the whole of your business plan and be a part of your narrative also.
Some FAQs
Q. What period should my cash flow forecast cover? A. Please discuss this with your supervisor, however the cash flow forecast should usually cover the period from pre-start-up (i.e. when you start incurring costs) up until when you pay off any debt (loans). As a minimum it should cover the first 12 months; for most businesses it would be typically be between three and five years (on a monthly basis).
FAQ 2
Q. What period should my cash flow forecast cover if I’m not taking on any additional funding? A. Please discuss this with your supervisor, however the cash flow forecast should usually cover the period from pre-start-up (i.e. when you start incurring costs) up until when you break even. As a minimum it should cover the first 12 months; for most businesses it would be typically be between three and five years (on a monthly basis).
FAQ 3
Q. What period should my cash flow forecast cover if I’m using equity funding? A. This can often be case specific so please discuss this with your supervisor.
Questions?