final-exam Flashcards
What are the three different types of expenses and how do they differ?
Variable Costs: Costs that change based on sales and production. Tend to be multiple of number of units sold or produced or percentage of sale revenue. Include Cost of Goods Sold or COst of services sold such as cost of materials and cost of direct labor. Other variable costs include sales commissions and shipping and handling.
Fixed Costs: Do not respond DIRECTLY to changes in sales. Not included in COGS, not direct costs of creating a product. Examples are expenses such as utility bills and rent. Fixed costs may change in response to a significant change in sales volume, but in a stepwise basis Or to inflation
Mixed Costs: Tend to be employee compensation where an employee is paid salary and commission or wages and overtime
What would cause fixed costs to change?
A significant change in sales volume but in a stepwise basis
Inflation, which is the general rise in the price of goods and services in an economy.
Distinguish between committed fixed costs and discretionary fixed costs.
Committed fixed costs: Long-term in nature and difficult to cut.
Discretionary Fixed costs: Annual in nature and can be cut back without major impact.
Why should committed fixed costs be avoided?
They increase risk
Must be paid whether or not your business has a gross profit
Be careful about taking on fixed costs, convert fixed to variable wherever possible, and keep a cushion of protection in case of emergencies
Define contribution margin per unit and contribution margin ratio.
Contribution Margin per unit:
Price per unit LESS COGS = Gross profit
Gross Profit less other variable costs per unit = Contribution Margin per unit
Contribution Margin Ration:
What is the “Contribution format income statement” and why is it useful?
Helps identify sources of profit:
Revenue Less direct expenses = operating margin
Operating margin less indirect expenses = EBIT(operating profit
Recognize the key assumptions that the entrepreneur must make.
Assumptions that drive EBIT and NI:
Units sold, prices per unit, COGS per unit or per dolar revenue, credit terms for customers, inventory needs, direct expenses for salaries, rent, utilities, telephone, transportation, insurance, indirect administrative expenses for manager’s salaries, accounting, insurance, equipment purchases, life, and deprciation, accounts payable, funding, interest rate on debt
What are the two key assumptions that must be made about sales?
Product development time: How many months before product can be sold to public? How long are you without revenue?
Once product is sold to public, how much can be sold in the first month, the second month, etc.
How are nonprofit financial statements different?
Revenue and support from contributors Less Program Costs Less General and Administrative Less Fund-raising costs Equal Change in net assets (not profit/loss)
Balance Sheet: Assets = Liabilities + Net asset
A non-profit has no owners, and no owners equity.
What are the three type of needs that funding must cover?
Funding must cover purchased equipment, expenses for salaries, rent etcs, and Working capital.
Working capital: Included in working capital is inventory purchased in advance of sale and accounts receivable which are the delayed payments from customers.
Distinguish between “time out of cash” and “burn rate.” Why are these ratios important?
Time out of cash: Estimate of how many months currently available cash will last. This is important because it tells you when revenue is zero or nearly zero.
Time out of cash = Cash / operating cash outflow per month
Burn rate: The amount of cash used in the current month.
In assessing risk sensitivity, the entrepreneur should examine multiple scenarios in what three areas?
Should exam sensitivy in different scenarios of demand, pricing and costs.
What if analysis: What if we have to cut our price? What if we lose our biggest customer?
In the business plan, there should be consistency between the text and the numbers in the financial statements particularly in which three areas?
Marketing plan should match revenue forecast. Operating plan should match expense forecast. Sales growth in financial statements supported by marketing plan and industry analysis.
Month-by-month forecasts are required for how many years?
Month by month forecast are require for at least two years.
Why are at least two full sets of financial statements required for the business plan?
One set is for the most likely case and the other set is for thte e worst case scenario
Why is it important to track the assumptions underlying the sales forecast?
So you can do addional administrative follow up. Such as if a customer does not make an order in a given month, administration will contact to see if this customer intends to make any future orders.
At some point, it may become necessary to modify one or more assumptions and adjust the financial plan accordingly.
What are milestones? What are they based on?
Based on TIme, Sales growth or events in company’s development.
Examples include take 50% of current salary in first year(time), take 50% of current salary until sales reach $500,000(sales growth), 50% of current salary until first office is fully operational.
How do we evaluate the current year’s financial performance?
You can use previous years performance, the budget, competitor, industry average and industry leader.
How can we get Competitor/ Industry numbers?
We can get competitor/industry numbers from the internet, trade journals, chamber of commerce, trade shows, conferences.
How many performance measures should we use?
We should choose 5-8 key performance measures. Should measure short-term performance, long-term performance and cash flow. Also avoid unfocused data dump.
Recognize the four categories of ratios. Be able to match each category with the question that it addresses. Be able to assign a ratio to one of the four categories.
Financial statement analysis: vertical analysis aka “commons=-size income statement”, compare this year’s financial statements to previous years.
Ration analysis:
Liquidity rations which tell companys ability to pay short term liabilities as the come due. Working capital = current assets - current liabilities.
Quick ratio = cash and cash equivalents + accounts receivables / Current liabilities
Activity rations-How effectively is management using the available assets? Solvency and coverage ratios-How risky is the firm’s debt? Profability ratios-Net income or EBIT compared to some other factor suc as sales, assets, or equity.
Solvency and Coverage ratios: debt to equity = total liabilities / equity
debt ratio = Total liabilities / total assets
Times interest earned = EBIT / Interest expense
Profitability ratios: Return means net income.
Return on sales = net income / Sales or EBIT / Sales
Return on Assets = NI / Total Assets
Return on Equity = NI / Book Value of Equity
What does du Pont analysis tell us?
Formula is ROE(NI /Equity) = (NI/SALES) x (Sales/Assets) / (1-debt/assets) x (assets/equity)
Increased ROE (profit per dollar contributed by equity is driven by increased Return on sales(more profitability), Increased “Total asset turnover(more activity), and Increased”debt ratio” (less solvency)
How should ratio analysis be used in the business plan?
It should not be a data dump, only focus on a few key ratios that tell the story.
Tell firm’s story and use ratios to prove your point. Ratios cannot stand alone.
Which ratios are of interest to lenders? To equity investors?
Lenders are interested in solvency and coverage and liquidity. Equity investors interested in profitability and growth.
What tasks should we expect from a bookkeeper, a controller, a CFO, an external accountant?
bookkeeper: keeps accurate financial records.
controller: custom financial reports for better decision making. Manage day to day cash flows.
CFO: Structure complex financing, gernerate complex financial projections, manage relationship with bankers and other suppliers of capital.
External accountants: Prepare tax returns (review tax returns prepared by bookkeeper), perform annual review or audit.
Recognize the five common misconceptions about entrepreneurial financing.
1) Venture capitalists fund most businesses
2) Banks lend to start-ups
3) SBA lends money directly to entrepreneurs.
4) Entrepreneurs Tend to Rely onone single source of funding.
5) Government grants are a common source of money for small business.
Recognize the three factors that affect the level and type of financing.
1) The nature of the business model(category of business)
2) Aspirations of the entrepreneur.
3) the stage of development of the business venture.
Match the category of business to the type of financing normally used.
Lifestyle business(self-employed): Little or no need for outside funding.
Small Businesses (employees, slow to moderate growth): Entrepreneur, family, friends, and bank loans once established.
High growth, high potential ventures: Equity investors.
How do the entrepreneur’s aspirations affect funding needs?
You have to consider the entrepreneur’s need for wealth, income, and personal time.
Ambitious financial plans require more outside investment.
What types of financing are common in the early stages of a small business with modest growth potential?
In the early stages(prelaunch and start-up) it’s common to see seed financing, entrepreneur’s own resources, family and friends, careful cash management, and bootstrapping.
What types of financing are commonly added in the growth stage of a small business with modest growth potential?
During the growth stage there is a need for permanent space, additional equipment, and significant working capital(current assets). Common to add equity financing from local angel investors and loans as business becomes “bankable”.
Recognize six sources of self-financing
1) Cash from personal saving: purchase equipment, inventory, other start-up expenses and to cover at least six months of basic personal living expenses before quitting day job.
2) Other personal assets: tools and equipment, computers, cell phones, office furniture, vehicles.
3) Cash from unsecured personal loans (like credit cards).
4) Cash from second mortgage on home or other property.
5) Cash from loan secured by other personal assets (publicly traded stock or bonds.)
6) Cash from working second job.
Know advantages and disadvantages of self-financing
Advantages: relative easy of securing funding, avoid complexity created by adding partners, better alignment with entrepreneur’s aspirations, no dilution of profits or gains, eventual exit process is often simpler.
Disadvantages: May limit size and scope of start-up, may limit ability to grow, increases exposure to personal risk from business failure, entrepreneur may lack all necessary experience, contacts, skills, and/or knowledge.
What forms can funding from family and friends take. Which form(s) require a written agreement?
Can take the form of gifts, equity, and loans. You should put all forms in writing. If it is a gift, have the agreement say so. If it is a loan, have the agreement specify the exact interest and payment terms, if it is an equity investment, consider non-voting stock.
Recognize forms of personal gifts. Which form is most common?
Unpaid labor: 1/3 of small businesses report having unpaid labor contributed by family members. More than just a gift, loaded with special meanings(strings attached).
Other forms are cash, picking up the tab, accelerated cash-outs(inheritance, etc.), free use, overpayment, forgiveness, piggybacking.
What needs to be communicated to family and friends before they invest?
Make sure everyone has realistic expectations of risks, potential gains, time and money may be tied up. Determine their true motives, use a business plan and fully explain it, make sure investors understand that the business could fail.
What needs to be communicated to family and friends after they invest?
Provide accurate, objective, and full information about the business which should include quarterly or monthly reports, written and oral, progress, achievements, significant problems, updates for good or bad news.
What does “keep boundaries” mean?
Don’t discuss business at social gatherings.
What is a pass through entity? What provisions should be made for taxes on a pass through entity?
Partnerships, LLCs, LLPs, Subchapter S corps are pass through entities. There earnings are passed through to the shareholders.
You need to distribute 1/3 of profits to pay increased personal income taxes.
What flexibility can a loan from family or friends provide? What determines the minimum interest rate on a loan?
Flexibility: Loan payments cand be delayed when money is tight and the interest continues to accrue. Minimum interst rate is specificed by IRS (irs.gov)
Should be a formal loan agreement that defines the interest rate and payment terms. Also should specify if the loan is to the business or to the entrepreneur.
