Wharton Business Plan Competition Business Plan Financials Objective: This workshop will cover generating the financial statements and accompanying

Transcription

1 Wharton Business Plan Competition Business Plan Financials Objective: This workshop will cover generating the financial statements and accompanying notes required for a business plan. The focus will be on building the income and cash flow projections based on reasonable assumptions that reflect the reality of your business. A major issue with most financial statements for new businesses is assumptions that are unrealistic. Should you project three years? Five years? How much detail? Find out the answers to these and other questions to help make your projections credible. Speaker: Lawrence Gelburd, Associated Faculty, Wharton Entrepreneurial Programs

2 Time: Tuesday, February 22, 4:30 pm Location: JMHH 255

3 Today s Workshop: 1.Why develop pro-forma financial statements and notes? 2.How should financial statements be researched? 3.How should financial statements and notes be projected and presented?

4 The three primary types of financial statements are: Income Statement Sometimes call P & L, profit and loss. Revenues Expenses = Profit or Loss for a defined period

5 Balance Sheet Assets Liabilities = Shareholder Equity on one specific date Both assets and liabilities can be subcategorized into current and noncurrent (long and short term)

6 Statement of Cash Flow for a period (month, quarter, year) Cash flows: Operations: Net income (profit/loss, earnings) from income statement Investing: Sales of noncurrent assets (plant, property, equipment) Acquisition of noncurrent assets Sub-total: cash flow from investing Financing: Issue of bonds Issue of common stock Dividends paid Reduction in financing (debt retirement) Sub-total: cash flow from financing Net change in cash for the period = the sum of cash flow from operations, cash flow

7 from investing, and cash flow from financing (each of these three individual cash flows can be positive or negative).

8 Definitions of pro forma: 1.Done as a formality; perfunctory. 2.Provided in advance so as to prescribe form or describe items: a pro forma copy of a document. For business plans, pro forma has come to mean projected for the future estimates.

9 Question 1: Why develop pro forma financial statements and notes? In decades of experience, the vast majority of potential investors review three sections of a business plan first: the Executive Summary, Management and Financial Projections with notes. Conversely: Harvard Professor William Sahlman writes in his article Some Thoughts on Business Plans: When I first started to study entrepreneurial ventures, I too turned first to the numbers. Of late, I have gotten to the point where I hardly even look at them. Indeed, if I receive a plan that has five years of monthly projections, I immediately and

10 enthusiastically throw the plan in the circular file next to my desk. I say: Is there a $25 million error in the financial statements in this business plan due to tax loss carryforwards? KPMG employee: (After review) Yes, but nobody looks at the numbers anyway.

11 Question 1 continued: Why develop pro forma financial statements and notes? 1.Forces the team to transform abstract, general ideas about the venture into quantitative forms which enhances their understanding of the venture and helps them identify key questions and assumptions 2.Provides measurable benchmarks for judging performance 3.Develops a shared basis for discussions with relevant stakeholders

12 Question 2: How should financial statements be researched? 1.Using both primary and secondary research 2.Primary talking directly to relevant individuals including customers, suppliers, distributors, competitors, regulators, industry experts, accountants and other financial professionals 3.Secondary collecting data from third party aggregators of information including US census, US bureau of labor statistics, trade associations, marketing firms, academic journals, annual reports and 10K statements of public companies 4.Review other business plans

13 When you have done this research, you can synthesize your own approach based on the features you thought were useful and avoiding the others.

14 Question 3: How should financial statements and notes be projected and presented? The most comprehensive and useful projections are both broad and deep. The statements should be structured for simplicity of review for those only interested in an overview at a glance. Concomitantly, the statements should have sufficient detail to satisfy critical scrutiny by financial professionals. How can you best display both breadth and depth in the income statement? Two common approaches are: 1.List full detail in one statement with subtotals 2.Show simplified statements and itemize the categories separately

15 Selecting one or the other is a matter of clarity and preference. You may develop both.

16 Five years versus three years? Those who favor presenting three years of projections argue that the uncertainty associated with a new venture s financial projection is so high that any projections beyond three years are meaningless. Those who argue for five years point out that most ventures only start to make significant profits in their third to fifth year, so having only three may be insufficient to adequately represent the venture s potential. Also, the reader can easily ignore the data for years four and five, but if they are not presented, the reader can t imagine them. In my work with clients and students, we develop five year projections. Successful ventures often exhibit hockey stick financial characteristics explosive growth in the third to fifth year is not unusual. I also recommend they try to raise enough capital, or at least access to sufficient

17 capital, to allow them to survive at least two years with no revenues at all. Many entrepreneurs are much more focused on avoiding failure than handling success, perhaps appropriately, but it is instructive to see what rewards and challenges growth and success generate. Remember that the investor wants a return of five to ten times their investment within a few years on their share of equity, not on the total outstanding stock. Monthly, quarterly, annually? For every business plan, annual numbers are essential. For start up ventures, additional quarterly numbers are useful for the first year or two. Monthly may be too much data versus information. If you include monthly and/or quarterly numbers, it is often wise to have annual numbers on one sheet and show

18 the monthly and/or quarterly breakdowns on a separate sheet. One set or three: Pessimistic, Expected, Optimistic (Low Medium High, Tall Grande Venti)? This is a matter of personal preference. Some investors prefer one, others three. As with five year projections, I recommend developing three sets of financials for your own use. You can always deliver a single set to an interested third party. Examine the effects of modifying key assumed numbers.

19 Notes accompanying the financial statements All assumptions should be clearly documented in the notes accompanying the financial statements: 1.When an investor asks Where did you get that number from? it is great to answer as you see in note 6, we surveyed 12 suppliers and calculated the average price from them. This applies to all revenues and expenses. 2.Honesty is not the best policy, it is the only policy. If you had to simply guess at some figure because of lack of time or data, state this clearly. This builds trust. It also allows the investor to help you if they have specific knowledge which may help you improve the quality of your projections.

20 Review accompanying notes in online annual reports and business plans.