Financial Management for Entrepreneurs

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Financial Management for Entrepreneurs

• Shirley J. Daniel
• Professor of Accounting,
• Henry A. Walker Distinguished Professor of
  Business Enterprise

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Attribution/Sources

• Peter Gardner, General Partner, Allegis Capital
  (from Berkeley BPC website)
• Harrison and Horngren, Financial Accounting, 4e,
  Prentice Hall
• Hanson and Mowen, Management Accounting, 5e,
  Southwestern
• Palo Alto Software, Business Planning Software

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2 Helpful Websites

• Free Berkeley Business Plan Competition
  (Workshops - 2002)
• http//bplan.berkeley.edu/
• Palo Alto Software Business Plan Pro
• www.paloalto.com

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Typical financial issues faced by entrepreneurs

• Planning future initiatives
• Managing the business operations
• Obtaining financing (debt or equity)
• Compliance with government reporting
• Cash Flow
• Cash Flow
• Cash Flow

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The economic model of business - 4 considerations

• Operating Leverage (fixed costs)
• Contribution Margin
• Volume
• Product Mix

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The VC Perspective

• Fear vs. Greed
• Have seen the good, bad and ugly
• Driven by percentage ownership
• Limited capacity for deals
• Long-term capital formation strategy
• Time is limiting factor
• Trust

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Investment Criteria

• Quality seed and early-stage investments
• Exceptional management teams
• Defensible, proprietary technology/IP
• Big, addressable markets
• High margin business
• Consistency with our domain expertise
• Opportunities to leverage LPs
• Strong investment syndicate, min. 2 VCs

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General

• Focus on the variables you can control, and be
  conservative on the ones you cant
• Use industry standard format and labels
• Monthly for first 12-24 mos., then quarterly
• Proof for inconsistencies and lumpiness
• Know the levers in the model and spend extra
  time on them

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Revenue Model

• Addressable market size
• Pricing
• Customer ROI
• Gross margin
• Sales cycle
• Channels vs. direct
• Reasonable ramp
• Modest penetration assumptions

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Expense Model

• Control the burn early keys are headcount and
  salary structure
• Small teams are more efficient
• Center of gravity should shift with time
• Bad habits start early
• Dont build ahead of market adoption

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Cash Flow

• Assume the worst, then double it
• Match expenses with revenue
• Balance sheet items are real
• Debt vs. Equity
• Think long-term
• Heavy capital requirements are scary find
  operational leverage

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Comparables

• Who do you resemble?
• How are they valued? (NI, EBITDA, etc.)
• What are their multiples?
• What does the Street look for?
• Who invested in them?
• What are their operating metrics?

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Fundraising Assumptions

• Long-term capital formation strategy
• Time rounds to milestones
• Dilution is cumulative
• Start early
• Know your customer (VC, etc.)

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VCs Financial Models

• Run financial projections
• Apply comparable multiples
• Calc. projected future value
• Apply ownership after dilution
• Achieve hurdle for multiple, IRR?

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Factors in Structuring Deals

• Ownership hurdles
• Time before next round
• Maintain incentives
• Leave room for step-ups
• Dry powder
• Co-investors

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VC Fund Structure

• Sample Early-Stage VC model
• 200M fund for 20 deals
• Subtract 30M for ops.
• Avg. of 8M per deal over its life
• Reserves of 75-150
• Avg. 20 start, 10-12 at liquidity
• Initial investment of 3-5M
• Post-money capped at 25M

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Examples
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Summary

• Cash is king
• Youre only as good as your worst assumption
• Know the economics in your market
• Admit what you dont know
• Adapt
• Timing is everything

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RELATIONSHIPS AMONG THE FINANCIAL STATEMENTS
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Question Answer Financial
Statement
1.
2.
3.
4.
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THE ACCOUNTING EQUATION

• The accounting equation presents the resources of
  the business and the claims to those resources

Economic Resources Claims to Economic Resources
or
Assets Liabilities Owners
Equity
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ACCOUNTING FOR BUSINESS TRANSACTIONS

• The table on the next slide summarizes the 11
  transactions and provides the data that Air Sea
  Travel used to create its financial statements
• Data for the statement of cash flows are aligned
  under the Cash account
• Income statement data appear as revenues and
  expenses under Retained Earnings
• The balance sheet data are composed of the ending
  balances of the assets, liabilities, and
  stockholders equities
• The statement of retained earnings, which shows
  net income (loss) and dividends, can be prepared
  from the Retained Earnings column

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ANALYSIS OF TRANSACTONS
Income Statement Data
Statement of Retained Earnings Data
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Common Stock Retained Earnings - Dividends
Revenues - Expenses
The accounting equation can be expanded to
include revenues and expenses
Liabilities
Assets


Stockholders Equity
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Payments to suppliers
Collections from customers
Operating Activities
Payments to employees
Receipts of interest and dividends on investments
Payments of interest and income tax
Other operating receipts
Other operating disbursements
Acquisition of plant assets
Sale of plant assets
Investing Activities
Purchase of investments that are not cash
equivalents
Sale of investments that are not cash equivalents
Making loans
Receipts on loans receivable
Payment of dividends
Issuing stock
Financing Activities
Purchase of treasury stock
Selling treasury stock
Payment of principal amounts of debts
Borrowing money
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Converting from the Accrual Basis to the Cash
Basis for the Statement of Cash Flows
Adjust Revenues to Cash Receipts
Revenues
Cash Flows from Operating Activities
Net Income
Adjust Expenses to Cash Payments
Expenses
Accrual-Basis Accounting
Cash-Basis Accounting
The direct method is easier to understand, and it
provides more information for decision making
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Financial Management for Entrepreneurs

• Cost-Volume-Profit Analysis A Managerial
  Planning Tool
• (Break Even)

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Sample Questions Raised and Answered by CVP
Analysis

• 1. How many units must be sold (or how much sales
  revenue must be generated) in order to break
  even?
• 2. How many units must be sold to earn a
  before-tax profit equal to a specific dollar
  amount? A before-tax profit equal to 15 percent
  of revenues? An after-tax profit of a specific
  dollar amount?
• 3. Will total profits increase if the unit price
  is increased and units sold decrease?

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Sample Questions Raised and Answered by CVP
Analysis (continued)

• 4. What is the effect on total profit if fixed
  costs increase and sales increase by specific
  amounts?
• 5. What is the effect on total profit if the
  selling price per unit is decreased and sales
  increase?
• 6. What is the effect on total profit if the
  sales mix is changed?

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Cost Behavior
Fixed-Cost Behavior
Variable-Cost Behavior


Relevant Range
Units Produced
Units Produced
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Mixed-Cost Behavior
Linearity Assumption
Total Costs
Cost
Fixed Costs
Variable Costs
Number of Units Produced
Total cost Fixed cost Total variable cost
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Cost-Volume-Profit Graph
Total Revenue
Revenue
Profit
Total Cost
Y
X Break-even point in units Y Break-even
point in revenue
Loss
X
Units sold
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Simple CVP Example

• Fixed costs (F) 40,000
• Selling price per unit (P) 10
• Variable cost per unit (V) 6
• Tax rate 40
• 1. What is the break-even point in units?
• 2. What is the break-even point in dollars?

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Simple CVP Example BEP

• 1. Let X break-even point in units
• Operating income Sales revenue -Variable
  expenses - Fixed expenses
• 0 10X -6X - 40,000
• 10X - 6X 40,000
• 4X 40,000
• X 10,000 units
• 2. Break-even point in sales dollars is
• 10,000 x 10 or 100,000
• This can be shown with a variable-costing income
  statement.

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Variable-Costing Income Statement

• Sales (10,000 x 10) 100,000
• Less Variable costs (10,000 x 6) 60,000
• Contribution margin 40,000
• Less Fixed costs 40,000
• Profit before taxes 0
• Less Income taxes 0
• Profit after taxes 0

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Sales Revenue Approach

• Alternative approach to solving break-even point
  in sales dollars
• Let X equal break-even sales in dollars
• Operating income Sales revenue - Variable
  expenses - Fixed expenses
• 0 X - 0.6X - 40,000
• X - 0.6X 40,000
• 0.4X 40,000
• X 100,000
• Note V is the variable cost percentage which is
  found by
• Variable Cost per Unit 6
• Selling Price per Unit 10

0.6
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CVP Example Targeted Pretax Income
What sales in units and dollars are needed to
obtain a targeted profit before taxes of 20,000?

• Let X break-even point in units
• Sales 10X
• Less Variable costs 6X
• Contribution margin 60,000 4X
• Less Fixed costs 40,000
• Profit before taxes 20,000

Therefore, 60,000 4X 15,000 units
X Sales in dollars is (15,000 x 10)
150,000. Check this by completing the
variable-costing income statement.
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CVP Example Targeted Pretax Income (continued)

• Sales 150,000 15,000 x 10
• Less Variable costs 90,000 15,000 x 6
• Contribution margin 60,000
• Less Fixed costs 40,000
• Profit before taxes 20,000
• Therefore, it checks!

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2 Helpful Websites

• Free Berkeley Business Plan Competition
  (Workshops - 2002)
• http//bplan.berkeley.edu/
• Palo Alto Software Business Plan Pro
• www.paloalto.com

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Financial Management for Entrepreneurs

• Q A