Chapter 6

• 1. Chapter 6: Analyzing Cash Flow and Other Financial Information

2. How Important is Cash Flow?

• Cash flow is the most critical item for a new business

• • A lack of cash flow is the greatest cause of failure for a new business

• Note that profits are not the same as cash

• • Profits are only when revenues exceed expenses

• • • Revenues are not necessarily purchased with cash.

3. New Business Dilemma Part 1

• Inputs are often paid in cash (new businesses often dont have the credit worthiness to purchase on credit

• Most sales are on credit

• • Often the credit accounts arent paid for 60-90 days

4. New Business Dilemma Part 2

• It is possible for a new businesses to be profitable but not be cash flow positive

• Without a positive cash flow, how does the new business pay for its inputs, salaries, etc.?

5. Measuring Cash Flow

• Simplest way to measure cash flow is to compare all cash inflows to all cash outflows.

• Compare all initial cash on hand from investors or owners (equity), future expected cash sales, expected cash collections from credit purchases, less the expenses for COGS as well as expenses such as payroll and taxes.

6. What is the BIG Question?

• Need to develop a set of tools to decide whether or not it is wise to pursue a potential business

• • Cash flow, balance sheet, income statement

• Being able to forecast future financial outcomes is critical in determining the future viability of the small business.

7. Cash Flow

• Profits are great in the public investing community, but is not the focus of the small business investor

• The key is being able to bring in on a monthly and cyclical basis more cash than is paid out.

8. Why Is Cash So Important?

• Bills, Salaries, etc are paid in cash

• • You dont get the money from your paycheck in 60 days

• Most vendors are paid in cash

• • Even on a good day, the small business will owe its debts in 30 days

• • Those purchasing products/services from the small business though will have 90 days to pay their debts.

9. What is Float?

• Float refers to the difference in time between when the check is deposited and cash is received

• • i.e. the 60-90 day intervals in the previous slide

• • Problem is that others are collecting the interest on your money

• As the small business needs more supplies and inputs to make products, these intervals become even more severe

• • This can be a large cause of failure for a small business.

10. How can the Small Business Combat Float?

• By making cash flow projections that are:

• • ACTIVE

• • ACCURATE

• • and most importantly

• • REALISTIC!!!

11. Cash Flow Statement

• Cash flow statementsARE NOTbudgets

• Cash flow statements are concerned only withACTUALcash inflows and outflows.

12. An Example of the Difference Between Budgets and Cash Flows

• Take a prepaid insurance for a year costing $1,800 or $150 a month

• A budget will account for 12 equal installments of $150

• A cash flow statement will recognize a 1-time only outflow of $1,800.

13. How To Develop an Accurate Initial Cash Flow Projection

• Contact vendors/suppliers and ask about payment terms

• Check with credit card companies and get information about when the accounts will be processed as well as what the percentages are.

14. What About When the Company is Up and Running?

• It is important to compare actual cash flow with the projected cash flow

• This will illustrate the differences in actual performance

• Comparing today will help the business make more realistic forecasts for the future.

15. Possible Information Gained from Cash Flow Analysis

• Why were sales revenue so far below expectations?

• Why was traveling expenses so high?

• Why was advertising revenue so little?

• • A possible explanation for lack of sales???

16. Developing a Cash Flow Statement Part 1

• The cash flow statement of a small business is different than that of a corporation

• • Corporation will have operating, investing, and financing sections to their Statement of Cash Flows

• • The small business is only interested in the cash flows resulting from operations

• • • Operations signifies all the cash flows in/out of the business

17. Developing a Cash Flow Statement Part 2

• A cash flow statement will maintain an accurate representation of the overall cash position if used effectively

• An accurate long-term history with ones cash flow statement will assist the company with loans, credit lines, gathering equity capital, and valuation if the owner decides to sell the company

18. Developing a Cash Flow Statement Part 3

• A cash flow statement begins with expenses

• • Examples of possible expenses

• • • Salaries

• • • Cost of Goods Sold

• • • Taxes

• • • Office Supplies (often underestimated)

• • • Rent

• Important to account forEVERYexpense

19. Developing a Cash Flow Statement Part 4

• Begin accounting for revenues once done with all expenses

• If possible, the company should separate their revenues into separate categories

• • It will help focus the business on which sectors of its revenues are important and will influence the operations of the business

20. Developing a Cash Flow Statement Part 5

• Multiple cash flow statements are useful if a business is considering pursuing a new business idea

• • What is the likely scenario?

• • What is the best case scenario?

• • What is the worst case scenario?

• The scenarios will help identify the potential risk/reward associated with the new idea.

21. Breakeven

• Breakeven is the point where expenses and sales equal each other

• Understanding the break even point allows a new small business to predict how much money it will need to survive.

22. How to Predict Sales

• Look towards similar small businesses in your area

• • These individuals are great sources of information

• Key is to be conservative in projections

• • It is much better to underestimate and get a pleasant surprise vs. overestimating and getting a nasty present.

23. Developing the Income Statement

• Sales minus COGS gives the firms gross profit margin

• Subtract out other expenses (i.e. salary) to get the earnings before taxes

• Taxes are then calculated and subtracted out giving the firms profit.

24. Using the Breakeven Point to Plan a Targeted Profit 25. Break-even Chart for Determining Target Return Price and Break-even Volume Dollars (in thousands) 1200 1000800 600 400 200 0 Total Cost Fixed cost Profit Total revenue 10 20 30 40 50 Sales volume in units (thousands) Break-even point Loss 26. Using The Breakeven Formula Rather Than The Chart

• Break Even Point = Total Fixed Costs/Price Variable Cost

• From the chart it appears that each unit sells for $20

• Total Fixed Costs are $300,000

• From the chart we can see that the Break Even Point is $800,000 so we can now calculate the Variable Cost

• $800,000=$300,000/$20 Variable Costs

• Variable Cost = $16.25 per unit(This means that profit per unit is $3.75).

27. Using the Breakeven Point to Plan a Targeted Profit

• Variable Cost = $16.25 per unit(This means that profit per unit is $3.75)

• Amend the formula to reflect break even plus target profit

• Break Even Point = (Total Fixed Costs + Target Profit)/Price Variable Cost

• Breakeven Point = $300,000 + $100,000/$20 16.25

• Breakeven Point = $400,000 /$3.75

• Breakeven Point = $106,666.67

28. Break-even Chart for Determining Target Return Price and Break-even Volume Dollars (in thousands) 1200 1000800 600 400 200 0 Total cost Fixed cost 10 20 30 40 50 Sales volume in units (thousands) Break-even point Fixed cost +$100K Profit Total cost + $100K Profit Break-even point +$100K Profit Total Revenue 29. Chapter Exercises

• Using the information that you developed in your cash flow statement, develop a breakeven chart

• Using all of the information from this chapter, develop a short (one to two paragraph) discussion of the financial projections for your proposed company.