cash planning (16)

Growing and Managing

a Small Business

An Entrepreneurial Perspective

Chapter 16Cash Planning and Start-up Financing

Learning Outcomes

• Describe the process for calculating how much capital is needed to start the business.

• Explain how to forecast sales and capital expenditures using triangulation.

• Discuss the major sources of capital for a start-up venture.

• Compare and contrast financing with equity and with debt.

Chapter Outline

• Cash Needs Assessment

• Financing with Equity Sources

• Financing with Debt• Government

Sources of Funding

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Cash Needs Assessment

• Triangulation

Approaching the problem from three different angles:– the entrepreneur’s own knowledge,– the industry and – the market or customer.

Triangulation

• The six steps:– Prepare a process flow chart– Identify the business’s position on the value

chain – Develop a business timeline – Develop financial premises – Forecast sales and capital expenditures – Calculate start-up capital requirements– Conduct a sensitivity analysis

Triangulation

Step One: Prepare a Process Flow Chart

• Depicts all the activities of the business

• Illustrates personnel needs and equipment required

Marketing

Apparel Design

ForwardingServices

One-stop retail shop

Designer(s) (1) Prorotype Material

Outsourced Manufacturing Costs Transportation Costs Travel Expenses US Custom fees

Employee(s) salary (1) Payroll Taxes (1) Beneftis (1) Office supplies and equipment

Employee(s) salaries (1) Payroll Taxes (1) Benefits (1) Direct Mail Costs Advertising Costs Office Supplies

Retail location remodeling and design Sales person(s) salary (2 FT, 3PT) Payroll Taxes for Sales person(s) (4) Benefits (2) Store Supplies and furniture Retail space lease Utilities Insurance Business Taxes Merchant account fees

Forwarder Fees

Purchasing

Cost of goods

Primary Customer

Employee(s) salaries (1) Payroll Taxes (1) Benefits (1) Accounting Software Office Supplies

OutsourcedManufacturing

Third partyproducts

Accounting

The Process Flow Chart

Triangulation

Step Two: Identify the business’s position in the value chain

• To determine how much the company can charge for its product or service

• To know how much it costs to acquire inventory or raw material.

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Triangulation

Step Three: Develop a business timeline

• Depict the seasonal patterns in the industry

• Mark the key events that affect the business

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Triangulation

Step Four: Develop Financial Premises

• Financial assumptions to carry explanations and justifications

• Make forecasts of sales and demand

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Estimating Demand & Revenue – an illustration

DR. HAPPY TOOTH wants to assess demand for tooth whitening and root canal surgery in Berrien Springs, Mich.

Census Data for Berrien Springs:Population = 12,800

20% - Under 20 yrs old = 2560 people

22% - 21 to 40 yrs old = 2816 people

26% - 41 to 60 yrs old = 3328 people

23% - 61 to 80 yrs old = 2944 people

9% - over 80 years old = 1152 people

Target Markets:

Tooth Whitening > 21 to 40 year olds = 2816 people

Root Canal Surgery > 41 to 80 year olds = 6272 people

Estimating Demand

Target Markets:

Tooth Whitening > 21 to 40 year olds = 2816 people

Root Canal Surgery > 41 to 80 year olds = 6272 people

Dr. Happy Tooth assumes he can capture between 2 and 5% of the target market for tooth whitening in his first year of operation (due to limited competition for this service). He also assumes he can get between 1 and 3% of the root canal business. Thus, we generate the forecast below, noting optimistic, pessimistic, and most likely scenarios:

Optimistic Pessimistic Most Likely

(5%) (2%) (3.5%)

Tooth Whitening Clients 141 56 99

(3%) (1%) (2%)

Root Canal Procedures 188 63 125

Estimating Revenue

If the standard fee for tooth whitening is $300 and the standard charge for a root canal is $500, Dr. Happy Tooth can use the projected demand figures to estimate the revenues that would be generated under each assumed condition (see revenue estimates in red below):

Optimistic Pessimistic Most Likely

(5%) (2%) (3.5%)

Tooth Whitening Clients 141 56 99

Est . Whitening Revenue $42,300 $16,800 $29,700

(3%) (1%) (2%)

Root Canal Procedures 188 63 125

Est. Root Canal Revenue $94,000 $31,500 $62,500

TOTAL REVENUE $136,300 $48,300 $92,200

Triangulation

Step Five: Forecast Sales and CapitalExpenditures Three sources of information enable agood estimate of sales:

1. Industry sources - distributors, vendors, and experts

2. Customers3. Like or substitute products

Triangulation

Step Six: Start-up Capital Requirements

• A cash flow statement is needed to figure start-up capital requirements.

Triangulation

Step Six: Start-up Capital Requirements

• Hard costs: equipment, furniture etc.

• Soft costs: deposits, training costs etc.

• Working capital: to maintain business until it generates revenue

• Contingency factor: a cushion

Cash Needs Assessment

Conduct a Sensitivity Analysis -- the seventh step

To identify the critical numbers:

• time to develop sales

• volume of sales

• price maintenance

• costs more than anticipated.

Finance Sources

• Financing With Equity Sources

• Financing With Debt

• Government Sources Of Funding

• Customers And Suppliers

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Finance Sources

Financing with Equity Sources • Getting an ownership stake• No guaranteed returns• No protection against losses• Appreciation in value through

– growth in earnings and – growth in assets– Takes time to float

Finance Sources

Financing with Debt

• Using Convertible Debt

• Commercial Banks

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Finance Sources

Using Convertible Debt

• Better returns to lenders

• Lenders get returns from day one

• Possibility to get back the loan amount

• Venture gets immediate use of funds

• Conversion relieves the burden of debt

• Planning the timing is possible

Finance Sources

Commercial Banks

• Are highly regulated

• Look at the five “C’s”: character, capacity, capital, collateral, conditions

• Favor ventures that can give hard assets as collateral

• Are difficult to get financing from

Finance Sources

Commercial Banks look at:

• The primary source of repayment of a loan

• The secondary source of repayment

• The character of the parties involved

• Profitability ratios

• Operating margin

Finance Sources

Commercial finance companies or asset based lenders:

• Are less rigid compared to regular banks

• Often charge a higher rate of interest

• Consider the quality of the assets of the business

Finance Sources

Government Sources of Funding

1. Small Business Investment Company (SBIC)

2. Venture Capital Institutes and Networks

3. Small Business Administration (SBA) Loans

4. State-Funded Venture Capital

5. Small Business Innovative Research (SBIR)

Government Finance Sources

Small Business Investment Company (SBIC)

• Provide long-term loans • Provide equity capital• invest in small and growing

businesses • invest over longer periods of time

Venture Capital Institutes and Networks

• Institutes established on the campuses of major universities

• Act as conduits to bring together the entrepreneurs and investors

• Entrepreneur easily locates interested investor

Small Business Administration (SBA) Loans • provide aid, counsel, and protection • Many loan programs:• Micro loans-up to $35,000• LowDoc Loans -- up to $150,000• SBA Express loans -- up to $250,000• Guarantees given to intermediaries who

sanction loan

State-Funded Venture Capital

States give incentives• Tax holidays• Tax exemption and relief• Equity participation• Loan programs• Convertible debt

Small Business Innovative Research (SBIR)• Federal agencies sanction grants• To carry on research on products• Grants to technology based ventures• Having fewer than 500 employees• Independently owned ventures

Small Business Innovative Research (SBIR) grants have three levels:

1. Phase I is the project feasibility stage, providing up to $100,000 for initial feasibility to be completed in six month..

2. Phase II provides up to an additional $750,000 for projects that have the most potential after completing Phase I. This funding lasts for two years.

3. Phase III brings in private sector funds to commercialize the new technology.

Finance Sources

Customers and Suppliers

• Understand the entrepreneur’s business

• Have a vested interest

• May grant extended payment terms

• May offer special terms favorable to the business.

End Chapter 16

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