Entrepreneurial Finance - Pre Midterm

Question 1

What is the difference between cash and profit?

Answer 1

Cash is not always collected when revenue is collected (accounts receivable)

Question 2

Why is it important to distinguish between cash and profit?

Answer 2

It influences how quickly your company is using resources that are readily available to pay bills and make payments. It tells you whether or not the company will have enough cash on hand to pay their upcoming bills

Question 3

What is the key principle of entrepreneurial finance?

Answer 3

While accounting is the language of business, cash is the currency. Remember, CASH IS KING

Question 4

What are the three possibilities for the cash budget balances?

Answer 4

1. Deficiency (finance deficiency + minimum -> ending balance = minimum required)
2. Excess > minimum (surplus is available to repay borrowing -> ending balance = minimum required + any remaining surplus not needed for repayment)
3. Excess < minimum (finance = minimum required -> ending balance = minimum required)

Question 5

What does the cash budget determine?

Answer 5

The net cash inflows and outflows (assuming no start-up capital / financing), as well as the total cumulative financing required until you are cash flow positive

Question 6

What is the cash build rate

Answer 6

How quickly a venture builds cash through collections on sales

Question 7

What is the cash burn rate

Answer 7

How quickly a venture “burns through”/uses cash

Question 8

What is the monthly net cash burn rate formula?

Answer 8

(Total build - total burn) / # months

OR

(average monthly build) - (average monthly burn)

Question 9

How do you determine the weeks of cash remaining?

Answer 9

Compare the monthly net cash burn rate to the cash balance

Question 10

What is liquidity?

Answer 10

The ability of the venture to maintain a build rate high enough to meet its obligations as they come

Question 11

Explain what the survival/cash flow breakeven is used for

Answer 11

You need to know the level of sales (survival revenue) necessary to cover your costs and break even on a cash basis

Question 12

What are the two categories that costs fall into?

Answer 12

Variable costs (VC) and fixed costs (CFC)

Question 13

What are variable costs? Give some examples

Answer 13

Costs that vary depending on the level of sales. Eg. labour costs, material costs, purchasing costs, cost of goods sold, etc.

Question 14

When do VC remain constant?

Answer 14

As a percentage of total sales (cost of goods sold / sales revenue)

Question 15

What are fixed costs? Give some examples

Answer 15

Costs that do not change no matter how many sales you make. Eg. salaries, rent, overhead, etc.

Question 16

When do CFC change?

Answer 16

Although the total amount is constant, CFC as a percentage of total revenue varies

Question 17

When is breakeven/survival revenue reached?

Answer 17

When contribution remaining from sale covers cash fixed costs

Question 18

What is VCRR?

Answer 18

Variable cost revenue ratio: variable cost as a % of revenue OR the % of the sale that goes towards covering variable cost

Question 19

When do you do a cash budget?

Answer 19

When you’re worried about cash, or if you in a situation where it looks like cash is going to be unpredictable/it doesn’t look like you will have enough

Question 20

Why do you do a cash budget?

Answer 20

It helps you predict cash flows, helps you be prepared if you need to get more financing. It can also help you to make a more informed ask

Question 21

Why do you do a worksheet?

Answer 21

It helps you see when cash actually comes in from sales and when cash flows out through payments

Question 22

What does the cash burn rate tell you?

Answer 22

The cash burn rate is an implication of the cash budget: the burn tells you how much cash you are burning through on average: how long your cash last before you run out (it “crashes” on the runway)

Question 23

How do you calculate VCRR?

Answer 23

VCRR = COGS / Revenue
OR
$x = CFC / (1-VCRR)

Question 24

Why do you do a breakeven analysis?

Answer 24

To decide if you should go through with your venture or not

Question 25

How can you reduce your breakeven value if it is too high? In what order?

Answer 25

1. Reduce your VCRR
2. Reduce your fixed costs (for example, working out of home instead of renting office space)
3. Change price (very integrate with other activities, so that’s your last resort)

Question 26

Explain how a company can use operating leverage to lower their VCRR

Answer 26

They can increase their operating leverage by increasing their CFC to lower their VC

Question 27

Explain how using operating leverage can lead to higher risk

Answer 27

The higher fixed costs means that more has to be sold to cover those costs, and companies need a higher survival revenue (breakeven) to make a profit

Question 28

What is the benefit to using operating leverage?

Answer 28

The lower variable costs results in a higher contribution and therefore the return is higher above breakeven

Question 29

What is the key principle of entrepreneurial finance?

Answer 29

Risk and expected reward go hand in hand: known as the risk-reward tradeoff

Question 30

When is it sensible to increase operating leverage?

Answer 30

As long as the risk is not too high: you have to be able to sell your breakeven units