Quiz Entrep

operating and capital budgets.

Before developing the pro forma income statement, the entrepreneur should prepare

sole proprietor

If the entrepreneur is a __, then he or she is responsible for the budgeting decisions.

partnership

In the case of a __, or where employees exist, the initial budgeting process may begin with one of these individuals, depending on his or her role in the venture.

owners or entrepreneurs.

Final determination of these budgets will ultimately rest with the

sales budget

in the preparation of the pro forma income statement, the entrepreneur must first develop a ___ that is an estimate of the expected volume of sales by month.

projected sales

The key element in the budget is

qualitative techniques

the entrepreneur can rely on more __ to estimate sales.

internally or subcontracting them to another manufacturer.

In a manufacturing venture, the entrepreneur could compare the costs of producing these

actual production

The important information from this budget is __ required each month.

inventory

that is necessary to allow for sudden changes in demand.

budget

is a real determination of how much will be spent and for what purpose money will be used.

operating costs

First, a list of fixed expenses (these are expenses that are incurred regardless of sales volume) such as rent, utilities, salaries, advertising, depreciation, and insurance should be completed.

Estimated costs

for many of these items can be ascertained from personal experience or industry benchmarks, or through direct contact with real estate brokers, insurance agents, and consultants.

Capital budgets

are intended to provide a basis for evaluating expenditures that will impact the business for more than one year. For example, may project expenditures for new equipment, vehicles, computers, or even a new facility. It may also consider evaluating the costs of make or buy decisions in manufacturing or a comparison of leasing, buying used, or buying new equipment. Because of the complexity of these decisions, which can include the computation of the cost of capital and the anticipated return on the investment using present value methods, it is recommended that the entrepreneur enlist the assistance of an accountant.

FORECASTING SALES

As stated earlier, there are many different methods some is very quantitative and some more qualitative. Most start-ups would not likely use any of the quantitative techniques but would rely on more qualitative methods. Our focus here will be to try to understand how to project sales simply and reasonably using more qualitative methods. To begin with, the entrepreneur should research everything he or she can find about other start-ups in the same industry. Reviewing their experience can often provide reasonable expectations for early sales. Local chambers of commerce, or any other business organization, may provide contacts and information on what might be expected in first year sales. No matter what approach entrepreneurs use, they must be aware that sales estimates may be wrong. As a result, it is sometimes beneficial for the entrepreneur to provide sales estimates at different levels of activity. For example, sales estimates may be shown at one level and also at levels such as 5 percent less or 10 percent less. Each sales estimate may reflect different assumptions about the market and show costs and profits or losses with each sales forecast.

FS-Sales

Since the pro forma income statement requires monthly projections, it is important not to just make a sales forecast and divide by 12. __ may vary each month depending on the seasonality of the product and need to be reflected in the monthly projections. In addition, changes in strategy may also affect sales and would need to be included in the estimates. Using as much information as possible to project sales can make the pro forma statements more meaningful.

PRO FORMA INCOME STATEMENTS

is a projected financial document that estimates a company's future revenue, expenses, and profitability over a specific period, such as the next 12 months. Or projects a company's profit or loss over a specific period (usually 12 months for a new venture). It serves as a financial roadmap, helping managers and lenders anticipate operating cash flows and the financial impact of different marketing strategies. With this sales by month must be calculated at first. As indicated above, sales may be projected using many different techniques. Again, it is important to try to estimate variations in sales that may result from changes in such factors as marketing strategy.

Internet start-up

Sales revenue for an___is often more difficult to project since extensive advertising will be necessary to attract customers to the Web site. Projections for web-based businesses often rely on "hits" (traffic), conversion rates (percentage of visitors who buy), and average transaction value.

cost of goods sold

The ___ expense can be determined either by directly computing the variable cost of producing a unit times the number of units sold or by using an industry standard percentage of sales.

Salaries and wages

for the company should reflect the number of personnel employed as well as their role in the organization.

entrepreneur

The should also consider increasing selling expenses as sales increase, adjusting taxes because of the addition of new personnel or raises in salary, increasing office expenses relative to the increase in sales, and modifying the advertising budget as a result of seasonality or simply because in the early months of start-up the budget may need to be higher to increase visibility.

projected net sales.

Selling expenses, advertising, salaries and wages, and taxes may be represented as a percentage of the

Internet start-up, capital budgeting and operating expenses

For the will tend to be consumed by equipment purchasing or leasing, inventory, and advertising expenses.

Direct costs

are directly traceable expenses linked to producing specific goods or services (e.g., raw materials, direct labor) and are listed in the Cost of Goods Sold (COGS).

Indirect costs (overhead)

are expenses required to run the business that cannot be directly linked to a specific product or project, such as rent, utilities, and administrative salaries.

Cash flow

Is not the same as profit.

Profit

is the result of subtracting expenses from sales.

cash flow.

results from the difference between actual cash receipts and cash payments and when actual payments are received or made.

income statement

These purchases on credit, however, would still be counted as expenses on your.

Expense on cash flow

Only the interest on the loan would be considered an expense.Also, depreciation on capital assets is an expense, which reduces profits, not a cash outlay.

indirect method

The most popular of these is the used to project cash flow. The objective is not to repeat what is in the income statement but to understand there are some adjustments that need to be made to the net income based on the fact that actual cash may or may not have actually been received or disbursed.

borrow funds or have cash in a bank

If disbursements are greater than receipts in any time period, the entrepreneur must either __account to cover the higher disbursements. Large positive cash flows in any time period may need to be invested in short-term sources or deposited in a bank to cover future time periods when disbursements are greater than receipts. Usually, the first few months of the start-up will require external cash (debt) to cover the cash outlays. As the business succeeds and cash receipts accumulate, the entrepreneur can support negative cash periods.

debt

If the entrepreneurs in our example had to use debt for the start-up, then they would need to show the interest payments in the income statement as an operating expense and indicate the principal payments to the bank as a cash disbursement, not as an operating expense. This issue often creates cash flow problems for entrepreneurs when they do not realize that __ is a cash disbursement only and that interest is an operating expense.

interest

is an operating expense.

any assumptions

The estimates or projections in cash flow should include ___so that potential investors will understand how and from where the numbers were generated.

projected balance sheet

The entrepreneur should also prepare a __depicting the condition of the business at the end of the first year. The balance sheet will require the use of the pro forma income and cash flow statements to help justify some of the figures. It reflects the position of the business at the end of the first year. It summarizes the assets, liabilities, and net worth of the entrepreneurs. In other words, it tells the entrepreneur a measure of the company's solvency.

Assets

These represent everything of value that is owned by the business. Value is not necessarily meant to imply the cost of replacement or what its market value would be but is the actual cost or amount expended for the asset. These are categorized as current or fixed. Management of these receivables is important to the cash flow of the business since the longer it takes for customers to pay their bills, the more stress is placed on the cash needs of the venture.

Current assets

include cash and anything else that is expected to be converted into cash or consumed in the operation of the business during a period of one year or less.

Fixed assets

are those that are tangible and will be used over a long period of time. These current assets are often dominated by receivables or money that is owed to the new venture from customers.

Liabilities.

These accounts represent everything owed to creditors. Some of these amounts may be due within a year (current liabilities), and others may be long-term debts. There are no long-term in our MPP Plastics example because the venture used funds from the founders to start the business. However, should the entrepreneurs need to borrow money from a bank for the future purchase of equipment or for additional growth capital, the balance sheet would show long-term liabilities in the form of a note payable equal to the principal amount borrowed. As stated earlier, any interest on this note would appear as an expense in the income statement, and the payment of any principal would be shown in the cash flow statement. Subsequent end-of-year balance sheets would show only the remaining. amount of principal due on the note payable. Although prompt payment of what is owed (payables) establishes good credit ratings and a good relationship with suppliers, it is often necessary to delay payments of bills to more effectively manage cash flow. Ideally, any business owner wants bills to be paid on time by suppliers so that he or she can pay any bills owed on time. Unfortunately, during recessions, many firms hold back payment of their bills to better manage cash flow. The problem with this strategy is that while the entrepreneur may think that slower payment of bills will generate better cash flow, he or she may also find that customers are thinking the same thing, with the result that no one gains any cash advantage.

Owner equity.

This amount represents the excess of all assets over all liabilities. It represents the net worth of the business. The $300,000 that was invested into the business by MPP Plastics' three entrepreneurs is included in the net worth section of the balance sheet. Any profit from the business will also be included in the net worth as retained earnings. In our MPP Plastics example, retained earnings is negative, based on the net loss incurred in year 1. Thus, revenue increases assets and owners equity, and expenses decrease owners' equity and either increase liabilities or decrease assets.

BREAK-EVEN ANALYSIS

In the initial stages of the new venture, it is helpful for the entrepreneur to know when a profit may be achieved. This will provide further insight into the financial potential for the start-up business. a useful technique for determining how many units must be sold or how much sales volume must be achieved to break even.These obligations, or fixed costs, must be covered by sales volume for a company to break even. Thus, breakeven is that volume of sales at which the business will neither make a profit nor incur a loss. The break-even sales point indicates to the entrepreneur the volume of sales needed to cover total variable and fixed expenses. Sales in excess of the break-even point will result in a profit as long as the selling price remains above the costs necessary to produce each unit (variable cost).

contribution

As long as the selling price is greater than the variable costs per unit, some can be made to cover fixed costs. Eventually, these will be sufficient to pay all fixed costs, which point the firm has reached breakeven.

fixed or variable.

The major weakness in calculating the breakeven lies in determining whether a cost is

fixed

reasonable to regard costs such as depreciation, salaries and wages, rent, and insurance as.

variable costs

Materials, selling expenses such as commissions, and direct labor are most likely to be

variable costs per unit

The usually can be determined by allocating the direct labor, materials, and other expenses that are incurred with the production of a single unit

Fixed costs

are determined by weighting the costs as a function of the sales projections for each product.

pro forma sources and applications of funds

The ___statement illustrates the disposition of earnings from operations and from other financing. Its purpose is to show how net income and financing were used to increase assets or to pay off debt. It is often difficult for the entrepreneur to understand how the net income for the year was disposed of and the effect of the movement of cash through the business. The major uses or applications of funds are to increase assets, retire long-term liabilities, reduce owner or stockholders equity, and pay dividends. emphasizes the interrelationship of these items to working capital. The statement helps the entrepreneur as well as investors to better understand the financial well-being of the company as well as the effectiveness of the financial management policies of the company.