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Assessing A New Venture's Financial Strength and Viability: ©2010 Pearson Education

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56 views24 pages

Assessing A New Venture's Financial Strength and Viability: ©2010 Pearson Education

Uploaded by

Ayesha Latif
Copyright
© © All Rights Reserved
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Download as PPT, PDF, TXT or read online on Scribd
Download as ppt, pdf, or txt
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Assessing a New Venture’s

Financial Strength and


Viability

©2010 Pearson Education


Chapter Objectives
1 of 2

1. Explain the two functions of the financial


management of a firm.
2. Identify the four main financial objectives of
entrepreneurial ventures.
3. Explain the difference between historical and pro
forma financial statements.
4. Explain the purpose of an income statement.
5. Explain the purpose of a balance sheet.

©2010 Pearson Education


Chapter Objectives
2 of 2

6. Explain the purpose of a statement of cash flows.


7. Discuss how financial ratios are used to analyze and
interpret a firm’s financial statements.
8. Discuss the role of forecasts in projecting a firm's future
income and expenses.
9. Explain what a completely new firm bases its forecasts
on.
10. Explain what is meant by the term percent of sales
method.

©2010 Pearson Education


Financial Management
1 of 2

• Financial Management
– Financial management deals with two things: raising
money and managing a company’s finances in a way that
achieves the highest rate of return
– This chapter focuses on raising money. This chapter
focuses primarily on:
• How a new venture tracks its financial progress through preparing,
analyzing, and maintaining past financial statements.
• How a new venture forecasts future income and expenses by
preparing pro forma (or projected) financial statements.

©2010 Pearson Education


Financial Management
2 of 2

The financial management of a firm deals with questions


such as the following on an ongoing basis:

• How are we doing? Are we making or losing money?


• How much cash do we have on hand?
• Do we have enough cash to meet our short-term obligations?
• How efficiently are we utilizing our assets?
• How does our growth and net profits compare to those of our industry peers?
• Where will the funds we need for capital improvements come from?
• Are there ways we can partner with other firms to share risk and reduce the
amount of cash we need?
• Overall, are we in good shape financially?
©2010 Pearson Education
Financial Objectives of a Firm
1 of 3

©2010 Pearson Education


Financial Objectives of a Firm
2 of 3

• Profitability
– Is the ability to earn a profit.
• Many start-ups are not profitable during their first one to three years
while they are training employees and building their brands.
• However, a firm must become profitable to remain viable and
provide a return to its owners.
• Liquidity
– Is a company’s ability to meet its short-term financial
obligations.
• Even if a firm is profitable, it is often a challenge to keep enough
money in the bank to meet its routine obligations in a timely manner.

©2010 Pearson Education


Financial Objectives of a Firm
3 of 3

• Efficiency
– Is how productively a firm utilizes its assets relative to its
revenue and its profits.
• Southwest Airlines, for example, uses its assets very productively.
Its turnaround time, or the time its airplanes sit on the ground while
they are being unloaded and reloaded, is the lowest in the airline
industry.
• Stability
– Is the strength and vigor of the firm’s overall financial
posture.
• For a firm to be stable, it must not only earn a profit and remain
liquid but also keep its debt in check.

©2010 Pearson Education


The Process of Financial Management
1 of 4

• Importance of Financial Statements


– To assess whether its financial objectives are being met,
firms rely heavily on analysis of financial statements.
• A financial statement is a written report that quantitatively
describes a firm’s financial health.
• The income statement, the balance sheet, and the statement of cash
flows are the financial statements entrepreneurs use most
commonly.
• Forecasts
– Are an estimate of a firm’s future income and expenses,
based on past performance, its current circumstances, and
its future plans.

©2010 Pearson Education


The Process of Financial Management
2 of 4

• Forecasts (continued)
– New ventures typically base their forecasts on an estimate
of sales and then on industry averages or the experiences of
similar start-ups regarding the cost of goods sold and other
expenses.
• Budgets
– Are itemized forecasts of a company’s income, expenses,
and capital needs and are also an important tool for
financial planning and control.

©2010 Pearson Education


The Process of Financial Management
3 of 4

• Financial Ratios
– Depict relationships between items on a firm’s financial
statements.
– An analysis of its financial ratios helps a firm determine
whether it is meeting its financial objectives and how it
stakes up against industry peers.
• Importance of Financial Management
– Many experienced entrepreneurs stress the importance of
keeping on top of the financial management of the firm.

©2010 Pearson Education


The Process of Financial Management
4 of 4

©2010 Pearson Education


Financial Statements

• Historical Financial Statements


– Reflect past performance and are usually prepared on a
quarterly and annual basis.
• Publicly traded firms are required by the SEC to prepare financial
statements and make them available to the public.
• Pro Forms Financial Statements
– Are projections for future periods based on forecasts and
are typically completed for two to three years in the future.
• Pro forma financial statements are strictly planning tools and are
not required by the SEC.

©2010 Pearson Education


Importance of Keeping Good Records

The first step towards prudent financial management is keeping


good records.

©2010 Pearson Education


New Venture Fitness Drinks

• New Venture Fitness Drinks


– To illustrate how financial statements are prepared, we
used New Venture Fitness Drinks, the fictitious sports
drink company introduced in Chapter 3.
• New Venture Fitness Drinks has been in business for five years.
• Targeting sports enthusiasts, the company sells a line of nutritional
fitness drinks.
• The company’s strategy is to place small restaurants, similar to
smoothie restaurants, near large outdoor sports complexes.
• The company is profitable and is growing at a rate of 25% per year.

©2010 Pearson Education


Historical Financial Statements
Three types of historical financial statements

Financial Statement Purpose

Reflects the results of the operations of a firm over a


Income Statement specified period of time. It records all the revenues and
expenses for the given period and shows whether the
firm is making a profit or is experience a loss.

Balance Sheet Is a snapshot of a company’s assets, liabilities, and


owners’ equity at a specific point in time.

Summarizes the changes in a firm’s cash position for


Statement of cash flows a specified period of time and details why the
changes occurred.

©2010 Pearson Education


Historical Income Statements

©2010 Pearson Education


Historical Balance Sheets
1 of 2

©2010 Pearson Education


Historical Balance Sheets
2 of 2

Liabilities and Shareholder’s Equity

©2010 Pearson Education


Table :Statement of Cash Flows: The Indirect
Method

©2010 Pearson Education


Historical Statement of Cash Flows

©2010 Pearson Education


Ratio Analysis

• Ratio Analysis
– The most practical way to interpret or make sense of a
firm’s historical financial statements is through ratio
analysis, as shown in the next slide.
• Comparing a Firm’s Financial Results to Industry
Norms
– Comparing a firm’s financial results to industry norms
helps a firm determine how it stakes up against its
competitors and if there are any financial “red flags”
requiring attention.

©2010 Pearson Education


Historical Ratio Analysis

©2010 Pearson Education


Forecasts
1 of 4

• Forecasts
– The analysis of a firm’s historical financial statements are
followed by the preparation of forecasts.
– Forecasts are predictions of a firm’s future sales, expenses,
income, and capital expenditures.
• A firm’s forecasts provide the basis for its pro forma financial
statements.
• A well-developed set of pro forma financial statements helps a firm
create accurate budgets, build financial plans, and manage its
finances in a proactive rather than a reactive manner.

©2010 Pearson Education

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