Plan Parts Your Financial Plan Pieces Start-up funding Use of funds Sales forecast Cash flow Balance sheet/income statement Break-even analysis...

Plan Parts

Your Financial Plan Pieces

• Start-up funding

• Use of funds

• Sales forecast

• Cash flow

• Balance sheet/income statement

• Break-even analysis

• Valuation after 5 years

• Exit strategy

Start-Up Funding and Use of Funds

Start-up funding is the amount of cash you will need to support your idea before it becomes sustainable. In other words, it's how much money is required to pay bills before your idea is sound enough to attract customers to pay all the monthly expenses. The investors will want to know how much is required to start your idea, how long it will take to break even, and how the money will be used.

Start your business with at least $300,000 total. ($100,000 comes from the team; $200,000 comes from your bank or equity investor.) You can increase this up to $600,000 ($200K team/$400K bank or equity investor) with permission from your instructor. Your instructor will most likely give you permission, but explain why you need more money up front (i.e., you're buying land or a building, or you have a high equipment expense). Just be careful: As your start-up capital goes up, so will your five-year projections, and the numbers can start to get out of control and hard to work with when there are too many zeros at the end.

In this first part of your financial plan, you should describe in short detail how much funding you need to start the business and how you plan to use these funds. This information will also be part of your Executive Summary, but more details are required in this section.

When you start your financial section, you will not know how much you need, but after working on your income statement and cash flow, you will see how many quarters you will need funding in order to support your business.

Where do you get this start-up funding? This course offers you two methods of obtaining your investment capital. The method by which your team decides to obtain it will determine how your plan will be created.

Method 1: Request financing from equity investors. Equity investors are individuals or companies investing money on behalf of wealthy clients. There are many different kinds of equity investors, because some only invest in specific industries. Equity investors provide funding in return for an ownership share of your company. Because of their ownership stake, equity investors expect an active role in managing your business, and their experience can be valuable to your success. A special subset of equity investors is called angel investors. Angel investors are usually individuals who invest their own money in a business in return for an equity share of ownership. Angels are usually "passive," meaning that even though they have a share of company ownership, they allow company founders to run the business. Method 2: Borrow the money from a bank. In this instance, a bank will be interested in your ability to repay the loan with interest. Banks do not take on a management role, although a number of banks have small business experts who will share advice about running your business. Borrowing money from a bank is a reasonable approach, although you need to make sure you can have your business on stable footing by the time your loan is repaid. Your bank will likely be willing to keep up a line of credit for future use and this might give you more time to build the business. Typically, banks look at more concrete provisions for your method of paying back the money than do venture capitalists. Instead of competing for money (as you are doing with equity investors), you are simply trying to prove to the bank that you can and will pay back its money, over time, along with an agreed-upon interest rate. Typically, banks will require the principals of the business to pony up some personal collateral—such as houses, cars, or other tangible assets. This way, if the business doesn't make it, the bank can come take those personal assets to get paid. Thus, if you use the bank method of obtaining investment capital, be prepared to put your life savings on the line and "share the risk" over your entire personal assets. Also, using this method means you must factor into your plan the interest payments and monthly payments to the bank in the area set up for that in your Electronic Financial Statements. Instead of a 5-year valuation at the end of the plan, which you will use to "convince" the bankers to give you money, instead, you need to work into the plan proof that you can pay this money back, and you will need to show that you have factored those payments into the entire plan. Further, you must include in your plan the collateral requirements that at least one real banker has stated you would have to provide in order to acquire the loan you are requesting. You will need to include the bank's name, address, and contact person, along with the actual terms for collateral and/or personal guarantees from that bank.

Use of funds: One you have established your source of funding (equity investment or bank loan), your Business Plan should include a section that describes how you will use the funds. This section can summarize the expenses you have identified for business start-up, marketing, and operations. In other words, if you are using your funding to renovate a building or lease a property, include that in the use of funds. You will likely need to purchase equipment and supplies, which you include in this summary along with your marketing expense. Remember that staffing is also an expense and can be included. While you might keep some funding in a cash reserve, this section is intended to show your potential investor that you are promptly using your source funding to launch and sustain your business.

Sales Forecast and Cash Flow

Sales Forecast

To begin creating your financial statements, you will make assumptions that will help explain your sales forecasts. Use your industry analysis and target market analysis to help determine a reasonable sales forecast. From your research, what are the annual sales of similar competitors in your industry? If you cannot find this information, use the DeVry Ask a Librarian feature under Student Resources for help. Remember that a sales forecast requires a statement of units and dollars over a period of time. You cannot just state your sales in Years 1–5 without an explanation of how you arrived at the figures! Your potential investor expects you to "build out" how you arrived at your sales projection. To do this, you will need to include a table or a formula with the expected number of units you will sell during a stated time period times the price of those units. The number of units you select should be directly related to your definition of the target audience from your Marketing Plan. In other words, if you are selling craft beer in the Chicago suburb of Naperville, your marketing plan should include an estimate of the number of qualified prospects in this trading area, and what share of those prospects you expect to sell. For your sales projection, you would state the expected number of monthly or annualized units (perhaps six-packs) that those qualified prospects would purchase, multiplied by the selling price of those units, to arrive at your sales forecast. This approach is also true if you are selling a service, or even selling consulting contracts. You still need to show your investors units and dollars and their relationship to your gross sales projection.

Because the entire financial plan hinges on your sales forecast, you should include your team while creating these numbers.

Create your sales forecast using 12 months for Year 1, and then build into quarterly sales forecasts over the next 4 years. Your software templates will help you do this.

Carefully consider the time it takes to build up sales. Remember that it takes time for new businesses to create a customer base. Valid sales forecasts accept this fact; thus, it is completely reasonable for a new company's sales to start off slowly and build up over time. Once you have your business established, your growth factor will increase. Be sure to provide a narrative of the logic you used to build up the forecast. Your sector analysis will be a helpful piece of this logic. It is very rare for a new business to grow at a rate faster than the rest of the industry. You should know your industry-annualized growth rate from research, and it makes sense to apply the same growth rate to your sales year to year.

IMPORTANT: At your option, your financial software can automatically apply a monthly grow rate to sales. If you use this feature, remember that the software uses a monthly growth rate, not an annual growth rate. If sales are growing at 4% per year in your industry, that is only a 0.33% monthly growth rate. Do not overstate sales by applying an annualized growth rate every month!

For businesses with seasonal changes, you will want to factor in these seasonal ups and downs to mirror reality.

Cash Flow

Your cash flow statement is one of the most important sections of your plan. This is where you show your projections on your solvency throughout the term of your business. Can you pay your bills every month? Will you meet payroll? Pay taxes? Cover your inventory needs for next quarter? All of these questions will be answered through your cash flow statement. There are three kinds of cash flows: (1) operational, (2) investment, and (3) finance. Typically, most cash flows in your business plans will be operational.

Note that cash flow statements can show the health of a company often more readily than will an income or balance statement. Companies that have large "goodwill" or overvalued intangible assets may have balance statements that seem more solvent than they really are; a cash-flow statement can show this.

Review your course textbook on cash flow statements and be sure that your statement demonstrates the ability to cover your liabilities throughout the term of your business. When your cash falls below 0, you have become insolvent and you will need to review your business strategy to ensure that your projections do not include this in your plan.

Balance Sheet and Income Statement

Your balance sheets and income statements are important to show your company's viability. You will create these based on your electronic finance statements and the numbers you include based on your team meetings, financial projections, and start-up capital. Balance sheets should be quarterly for Year 1 and annual thereafter. Below are some balance sheet tips.

1. These are your starting points for your financial statements.

2. Make sure they balance.

3. Include your initial investment monies (your paid-in captial).

The income statement is also very important. It is where you derive your cash balances and where you keep track of your expenses and payments. Please review the financial tutorial that is included in the finance section of this course to help refresh your memory about how to create your statements.

Break-Even Analysis

The financial software in the course will help you calculate the point at which your business is at the break-even point. This is the point at which your revenues cover your expenses. You can use the financial software to show your break-even point in a table or graphic format. You should also explain when and why break-even occurs in your written narrative. At this point, you might also want to provide a contingency plan in the event your break-even period is delayed by higher expenses or lower sales than expected. In the real world, an equity investor or bank officer will review your Financial Plan carefully and recommend changes before they make an investment or loan. Your break-even analysis can become a useful benchmark to check the validity of your sales and expense projections once you are officially "open for business."

Valuation After 5 Years

In this part of the business plan, you should outline what you think the value of your company will be after 5 years.

Many business valuation models exist for how to determine the value of a business. This course does not intend to force you into one method. You pick the method. This tutorial will simply point out various methods you can use to show your investors (or your team) what the projected value of your business will be at the end of 5 years. You have most likely learned at least one or two of these models over the course of your career at Keller. Utilize the one you feel most appropriately fits your business and explain why you picked it.

Typically, valuing businesses is in the realm of a CPA. However, MBA candidates and graduates need to know when a valuation provided by a qualified profession is reasonable. Thus, you need to know how this works, so that you can see through errors in judgment or valuation when you look at a business plan in the future. Click to visit a business valuation website where you can find some help in valuing your business. Note: This is not a site that gives you the answers. You will have to do the work, inputting the correct numbers. When you arrive at your answer, you will need to know how you got it well enough to explain that in your paper.

Below are some approaches to business valuation.

1. Income approach: Using this approach, you can determine the fair market value of your business by looking at the revenue stream and multiplying this against a capitalization (or growth) rate. You will want to use the discounted cash flow method because you will be using projected cash flows and not historical ones.

2. Asset valuation approach: Here, you take the value of your assets, add them together along with the cash value, and have your value. The difficult piece here is the valuation of goodwill, which most CPAs will ensure gets placed into the fair market value of the property. Goodwill is a subjective number that you will want to avoid getting into in your project—there is no such thing as a "projected" goodwill value.

3. Hybrid valuation approach: Here, the CPA combines the asset valuation approach with the income method and comes up with a more reasonable value. This really is the most realistic method, although it will be subject to the methods used. Here is an article comparing hybrid value to income and asset-based approaches written by David Jenkins, CPA, PhD. This article has two very well-described examples of using the different methods that really help explain this process.

4. The Gordon method: For many years, this method was required for all MGMT600 students to use to value their businesses. The downside to this method is that the Gordon Method is a "stock" valuation method, and your businesses are privately owned entities. We have included this method for your edification and you are certainly allowed to use this if you want to. When using this method, most students substitute an industry or sector-specific growth rate to help determine the numbers to use in the method. Here is a worksheet that helps explain how to use the Gordon method to value the business.

Exit Strategy

Long-term planning for success requires that you have an exit strategy. An exit strategy is not a series of steps to take if your business fails! Instead, an exit strategy is a statement of longer term final goals. Founders should be able to state these goals when a business is created, and potential investors also need to know your plans for the longer term future.

Here are some exit strategies for you to consider. Choose one of these approaches and explain why it makes sense for your business.