Entrepreneurial Finance - Pre Midterm Flashcards
What is the difference between cash and profit?
Cash is not always collected when revenue is collected (accounts receivable)
Why is it important to distinguish between cash and profit?
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
What is the key principle of entrepreneurial finance?
While accounting is the language of business, cash is the currency. Remember, CASH IS KING
What are the three possibilities for the cash budget balances?
- Deficiency (finance deficiency + minimum -> ending balance = minimum required)
- Excess > minimum (surplus is available to repay borrowing -> ending balance = minimum required + any remaining surplus not needed for repayment)
- Excess < minimum (finance = minimum required -> ending balance = minimum required)
What does the cash budget determine?
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
What is the cash build rate
How quickly a venture builds cash through collections on sales
What is the cash burn rate
How quickly a venture “burns through”/uses cash
What is the monthly net cash burn rate formula?
(Total build - total burn) / # months
OR
(average monthly build) - (average monthly burn)
How do you determine the weeks of cash remaining?
Compare the monthly net cash burn rate to the cash balance
What is liquidity?
The ability of the venture to maintain a build rate high enough to meet its obligations as they come
Explain what the survival/cash flow breakeven is used for
You need to know the level of sales (survival revenue) necessary to cover your costs and break even on a cash basis
What are the two categories that costs fall into?
Variable costs (VC) and fixed costs (CFC)
What are variable costs? Give some examples
Costs that vary depending on the level of sales. Eg. labour costs, material costs, purchasing costs, cost of goods sold, etc.
When do VC remain constant?
As a percentage of total sales (cost of goods sold / sales revenue)
What are fixed costs? Give some examples
Costs that do not change no matter how many sales you make. Eg. salaries, rent, overhead, etc.
When do CFC change?
Although the total amount is constant, CFC as a percentage of total revenue varies
When is breakeven/survival revenue reached?
When contribution remaining from sale covers cash fixed costs
What is VCRR?
Variable cost revenue ratio: variable cost as a % of revenue OR the % of the sale that goes towards covering variable cost
When do you do a cash budget?
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
Why do you do a cash budget?
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
Why do you do a worksheet?
It helps you see when cash actually comes in from sales and when cash flows out through payments
What does the cash burn rate tell you?
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)
How do you calculate VCRR?
VCRR = COGS / Revenue
OR
$x = CFC / (1-VCRR)
Why do you do a breakeven analysis?
To decide if you should go through with your venture or not
How can you reduce your breakeven value if it is too high? In what order?
- Reduce your VCRR
- Reduce your fixed costs (for example, working out of home instead of renting office space)
- Change price (very integrate with other activities, so that’s your last resort)
Explain how a company can use operating leverage to lower their VCRR
They can increase their operating leverage by increasing their CFC to lower their VC
Explain how using operating leverage can lead to higher risk
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
What is the benefit to using operating leverage?
The lower variable costs results in a higher contribution and therefore the return is higher above breakeven
What is the key principle of entrepreneurial finance?
Risk and expected reward go hand in hand: known as the risk-reward tradeoff
When is it sensible to increase operating leverage?
As long as the risk is not too high: you have to be able to sell your breakeven units
