aCCOUNTING HELP

Recall that managing cash is the primary financial focus for a new business, and you can use the Cash Flow worksheet found in Course Resources > Course Specific Resources to make a two year projection. One of the first assumptions you need to make is how to finance the start-up of the business. If you expect to finance it out of your assets, then you won't show any debt payments. If you expect to finance it partially with a bank loan, then you will need to assume an interest rate, loan period, and monthly (or quarterly) repayments. Consider the figure below, which comes from a Cash Flow worksheet.

The January beginning cash balance of $135,000 is an assumption. The fact that it was financed partially with a $50,000 bank loan at 9% over 24 payments is shown elsewhere in the worksheet, as illustrated below.

The assumptions you made about marketing, sales, operations, and management will come together to produce the Cash Flow Projection. You need to ensure that the cash flow projection is totally consistent with the underlying assumptions.

After you are satisfied with your financial projections, you can download other financial statement templates (Balance Sheet, Income Statement, and Sources and Uses of Funds) and fill in the blanks. There are a variety of online websites providing free downloads.

One question often asked by prospective new business owners is, "How much cash do I need for startup?"

Consider this:

An entrepreneur who started up her first business sought the advice of a seasoned entrepreneur who started, grew, and sold four businesses worth many millions of dollars.

She asked, "How do I know if I have enough cash to startup?"

The seasoned entrepreneur took a look at her financial projections and said, "Are these projections based on your worst case scenario for sales growth?"

"No," she said. "They reflect my most reasonable case."

"Then show me your worst case scenario."

She did, and he looked at the cash requirement number and said, "Double that number and you might come close. Most entrepreneurs don't know what can come along during startup that could cripple their business."

She took his advice, partially, and added another 50% to the cash at startup for her worst case scenario. Two months later, two AC roof units (not under any warranty) in her leased facility had to be replaced at a cost of $17,000. She never contemplated such a large expenditure in her repair budget.

The moral to this anecdote is, it is better to carry an umbrella in your car than is is to assume that you will always get indoor parking when it rains.

Listen

After you complete your cash flow projections, the next step is to test them for business reasonableness. Reasonableness is often in the eye of the beholder. For example, if your financial plan includes a $50,000 bank loan to be repaid over 24 months and you take an owner's draw of $4,000 per month, a sharp banker will rightly conclude that you have taken almost the total of the bank loan out in 12 months. In essence, the bank loan covers your living expenses for Year 1, while you have half the loan to repay. Can you see a loan covenant coming that restricts the amount of owner's draw over the period of the loan?

Other tests of reasonableness have to do with comparisons of your business with industry averages and or if the financials are internally consistent.

For example, if your gross margin percentage is a lot higher than the industry average, perhaps your Cost of Goods Sold (COGS) assumption is too low. The next question for an investor is "Why"? If you can explain some unique circumstances why this should be true, then the question will be fully answered. Suppose you plan to open a sit-down restaurant. If the industry average rent is about 7.2% of revenue and your proposed rent is 10.5% of revenue, you need to explain why it is necessary to pay that high a rental. If the rental fits with the restaurant concept and location, you may need to boost your prices in order to reduce the rental percentage. This is only a 3.3% increase on an average check. Many of these industry average figures can be found on trade association websites.

Let's stay with the restaurant analogy and test internal consistency. Suppose you estimate first year sales at $1,000,000. In your operational plan, you designed the restaurant to hold 160 seats with an average check of $19.50 per person. Assuming you are open 360 days per year, the average seat turnover (number of times per day occupied) is calculated as follows.

Avg. Seat Turnover = $1,000,000 / (160 x 360 x 19.50) = 0.89

That rate seat turnover is on the high side of the industry average range. For a new restaurant, even the industry average of 0.81 might be too high.

An aside on seat turnover:

Suppose you have 40 tables with four seats each to make up the 160 seats. When you seat a couple at a table, two of those seats stay empty. That leaves the turnover rate per seat (at that table) at 0.5. You need to seat many more 3's and 4's at your tables to get to the industry average of 0.81.

You will probably need to adjust your estimated sales downward or add about 20–30 more seats. Is your space estimate consistent with that many seats?

When you complete testing your financials for business reasonableness and make appropriate adjustments, you should be confident in discussing them with potential investors and or lenders.

Listen

No business plan is complete without an exit strategy. You need to consider the lifestyle you want, the risks inherent in any business over the long term, and your personal desires to run, grow, and leave the business for something new. Here are a few exit strategies.

• Sell the business to a financial investor.

• Sell the business to a strategic investor.

• Grow and run the business until you retire and then liquidate it.

• Train one or more of your family members to take over after a period of time.

• Bring in a financial or strategic partner in order to grow larger.

• Form a corporation and then cash out your investment via an IPO (Initial Public Offering) to shareholders.

• Liquidate the business entirely if you believe you cannot make it a success over the long term.

Each of these exit strategies implies different motivation for the owner. You have to know yourself before you can decide on an exit strategy. In addition, the exit strategy will help define how you manage the business. If you expect to sell the business to a strategic investor (one who owns a complementary or competing business), you need to manage the business in a way that makes your proposition attractive to the investor. For example, your business might fill a geographic need for a similar business owner in another locale. If you manage your business in a similar way, say in customer service or in talented staff, then the transition should be easy for the investor.

The IPO route has been a favorite for high-tech startups over the past 20 years. People such as Bill Gates and Steve Jobs started their businesses in garages (that well told tale makes a great story), expanded, became successful, made the leap into the IT stratosphere, and made a fortune from their share of an IPO.

In conclusion, the road you take in developing your business is heavily influenced by the destination you have in mind.