Week 7 Discussion
Pg 312
Sources and Use of Funds
If you are seeking outside financing, either through loans or investors, those contemplating giving you money will naturally want to know what you’re going to do with the money you raise. They will also want to see what other sources of money you have, if any, and whether you have contributed any of your own funds.
To provide such information, devise a one-page description of the sources and use of funds. This can go in the business plan itself or can be sent with the cover letter to potential financing sources. It should tell a potential investor that you have specific plans for the money you raise, that you are not taking on debts or giving up equity thoughtlessly, and that you will use funds to make your business grow.
Your Sources and Use of Funds statement on page 311 is particularly helpful to you with investors or lenders if you show you are using your funds to start or expand a business rather than to offset existing debts (a use that investors notoriously dislike), or if you already have some commitment of financing already from respected sources (which shows that other people believe in your company), or if you are committing significant personal funds (which shows you believe in the project enough to take substantial personal risk).
In “Sources of Funds,” you should include both funds you have received to date and the amounts you are now seeking, clearly delineating each.
In preparing the “Sources and Use of Funds” statement, consider the following issues and terms:
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Funding Rounds. The number of development stages at which you will seek financing from the investment community.
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Total Amount. Amount of money sought in this round of financing, from all funding sources.
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Equity Financing. Amount you will raise by selling ownership interest in the company.
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Preferred Stock. Outstanding stock for which dividends will be paid, before other dividends can be paid for common stock or before other obligations of the company are paid; investors often want preferred stock.
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Common Stock. Stock for which dividends are paid when the company is profitable and has paid preferred stock dividends and other obligations.
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Debt Financing. Amount of money you will raise by taking out loans.
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Long-Term Loans. Loans to be paid back in more than a year’s time.
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Mortgage Loans. Loans taken out with property as collateral.
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Short-Term Loans. Bridge loans, credit lines, and other loans to be paid back in less than a year.
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Convertible Debt. Loans that are later convertible to stock at the funder’s option, giving both the security of a loan and the potential of stock.
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Investment from Principals. Amount of money that you or other key employees are contributing to the company; this can be in the form of cash or property.
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Capital Expenditures. Purchase of necessary equipment or property.
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Working Capital. Funds to be used for the ongoing operating expenses of the business.
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Debt Retirement. Funds used to pay off existing loans or obligations.
“In the financials, I look for a well-prepared, well-annotated balance sheet. And I like an Assumption Sheet with the Income Statement, so I know exactly how those figures got there.”
Ann Winblad
Venture Capitalist
Assumption Sheet
Financial forms are merely meaningless numbers unless they are based on decisions and facts. Your potential financing sources want to see how you arrived at your numbers and must be convinced that your assumptions are reasonably accurate. If, for instance, you have indicated your sales at a certain amount, investors want to see what size you are assuming the market to be and what percentage of the market you are assuming you will be able to secure. If those figures seem realistic, you increase your credibility; if those assumptions seem based on inaccurate numbers or overly optimistic projections, investors are going to look at the rest of your plan with greater skepticism.
It is good discipline for you, as well, to learn to develop an assumption sheet whenever you do financial projections. Otherwise, you can be too easily tempted to write down figures that look good on paper but have little to do with reality.
If you have worked through the business planning process, putting together an assumption sheet should be a relatively easy task. You have already asked yourself most of the questions called for on this form and have the answers available to you.
An assumption sheet should list purely straightforward information; it does not require substantial detail or explanation. You do not even need to use sentences; just provide the data in each category. (You can use the first sentence, as written on the worksheet, on your own assumption sheet.) Be familiar with these assumptions so that you are ready to defend your assumptions when meeting with investors.
Pg 313-314
Break-Even Analysis
Finally, you want to determine how much income you must earn to pay your expenses — at what point you break even. At the break-even point you are neither making a profit nor losing money; you have just covered the cost of staying in business and making your sales. Most people new to business assume their break-even point is when sales equal the amount of fixed expenses: rent, telephone, insurance, and so forth. Fixed expenses are easy to determine, since they are in place from the time you first open your doors, and they remain relatively stable regardless of the amount of sales.
But because almost all sales have some costs associated with them, you must also figure the variable cost of sales into your break-even analysis; otherwise you do not have a true picture of your cost of doing business.
For instance, if you are a florist and your fixed expenses (rent, utilities, salaries, and so on) are $20,000 a month, it’s not just enough to make $20,000 in sales: You would still be losing money. You must pay for flowers, vases, delivery, and commissions to floral wire services before you earn income on a sale. If these costs amount to an average of 30% of the cost of each sale, at $20,000 in income, you’re still $6,000 in the hole ($20,000 in fixed expenses plus $6,000 in costs of goods).
“The best business plans are a combination of a PowerPoint presentation and a succinct and well-thought-out operating model, showing how the business would be run on the revenue and expense side. The most important thing is that it’s based on the formula: revenue equals price times quantity. It should be a ‘bottom up’ financial model rather than ‘I’m going to get 10% of the market.’ ”
Mark Gorenberg
Venture Capitalist
The total cost of goods keeps rising as your sales rise; unlike your fixed costs, the figure keeps changing and is harder to pin down. But your gross profit margin — the average percentage you earn on each sale after direct costs are deducted — stays basically the same. (As you sell greater amounts, you may be able to increase your profit margin by receiving volume discounts; for the purpose of this exercise however, you can assume a stable gross profit margin.)
To determine an actual break-even point, you must know your:
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Fixed expenses
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Gross profit margin (average percentage of gross income realized after cost of goods)
Then, to figure the amount of total sales needed to break even, you work the equation:
In the above example of the florist, we know:
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Fixed Expenses = $20,000
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Gross Profit Margin (GPM) = 70% (since cost of goods is 30%)
So, the numbers would look like:
Doing the arithmetic, we see that this florist must make $28,571 to reach the break-even point.
A break-even analysis is an important tool for your internal planning. However, it is not necessary for you to include a break-even analysis in a business plan submitted to outside funding sources. (Of course, there is nothing wrong with including it if you wish.)
Break-Even Analysis
Complete the worksheet above to figure your own break-even point. The supplemental Business Plan Financials package available from www.PlanningShop.com will perform a break-even analysis for you.
Chapter Summary
The financial portion of your business plan will consist mostly of the actual financial projections. You should include the following forms:
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Income Statement
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Cash Flow Analysis
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Balance Sheet
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Sources and Use of Funds
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Assumption Sheet
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Start-up Costs (for a new business)
Additionally, you will want to do a break-even analysis for your internal planning.
It is advisable to get professional help in putting together your financial forms and setting up accounts. Set good financial procedures in place from the beginning of your business and stick to them. If yours is an existing business, review your procedures to make sure you have adequate control of billing and payments.
Get in the habit of reviewing your financial statements regularly and understanding what you read. Don’t leave the finances entirely up to others, and don’t be intimidated by numbers.
Pg 325
SAMPLE PLAN: ASSUMPTIONS
ASSUMPTIONS
The figures on the previous financial forms are based on these assumptions:
These sales figures reflect price increases of 10% annually for Corporate Training Center classes and online classes; 15% in 2015 and 10% in 2016 for corporate on-site training classes, and 10% in 2015 and 15% in 2016 for Saturday classes.
Personnel
The staff size of the company (two FT professionals and one PT support) will stay constant for the remainder of 2014. In 2015, the payroll increases to four FT professionals, one FT support, and one PT support. In 2016, the payroll is projected at four FT professionals, one PT professional, and two FT support.
Expansion
Figures in these projections assume opening a second Training Center classroom on 1/1/15. Direct costs associated with expansion include leasehold improvements, equipment/furniture, and marketing. Additional operating costs include equipment rental and addition of a staff trainer. This expansion increases capacity in corporate training classes by 100%.
Financing
To date, ComputerEase has been financed by a $60,000 investment from Scott E. Connors; a $30,000, 10% interest-only loan from L. Silver (Mr. Connors’ sister-in-law), due 12/31/14; and a $40,000 no-interest loan from Mr. Connors, principal due on or before 3/31/15. Projections call for the retirement of $30,000 of the Connors loan in 2014, with the remainder by 3/31/15, and the remainder of the Silver loan when due. The 2015–16 financial projections assume securing an additional $160,000 of investment income by 1/1/15.