MG4011 - Entrepreneurship

Instructor: Ms. Amna Babar Tirmizey

Email: [Link]@[Link]
❑ Describe actions taken
Learn about the importance
of understanding the
financial management of an
entrepreneurial firm.
❑ Identify the four main
financial objectives of
entrepreneurial firms.
❑ Describe the process of
financial management as
used in entrepreneurial
firms.
❑ Explain the difference
between historical and pro
forma financial statements.
❑ Describe the different
historical financial
statements and their
purpose.
❑ Discuss the role of forecasts
in projecting a firm’s future
income and expenses. ASSESSING A NEW VENTURE’S FINANCIAL
❑ Explain the purpose of pro
forma financial statements. STRENGTH AND VIABILITY
Chapter 8
Issues to Consider in Choosing a Legal
Form of Business Ownership
Factors Critical in Selecting a Form of Business Organization
Choosing a Form of Business Ownership
When a business is launched, a form of legal entity must be chosen. The most
common legal entities are shown below:
❑ Sole Proprietorship
❑ Partnership
❑ Corporation
❑ Limited Liability Company
❑ Franchising
 Form of Business Ownership
SOLE PARTNERSHIP JOINT STOCK
PROPRIETORSHIP COMPANY

“Sole proprietorship form of Partnership is the relation A company is an artificial

business ownership in between persons who have person created by law
which the Business is agreed to share the profits of having a separate entity
owned and operated by one a business carried on by all with a perpetual succession
person”. or anyone acting for all and common seal.
(Partnership act 1932) (company ordinance1984)
(SECP)
Formation of Business
SOLE PARTNERSHIP JOINT STOCK
PROPRIETORSHIP COMPANY
No separate legal entity Registration application Promotion stage
Verification of documents Incorporation stage
Changes (if applicable) Subscription of capital
Penalties (if wrong statement Commencement of
provided) business
Sole Proprietorship
❑ The simplest form of business entity is the sole
proprietorship.
❑ A sole proprietorship is a form of business organization
involving one person, and the person and the business are
essentially the same.
❑ A sole proprietorship is not a separate legal entity. The
sole proprietor is responsible for all the liabilities of the
business, and this is a significant drawback.
Advantages and Disadvantages of a Sole
Proprietorship
Advantages Disadvantages
Creating one is easy and inexpensive. Liability on the owner’s part is unlimited.
The owner maintains complete control of The business relies on the skills and
the business and retains all of the profits. abilities of a single owner to be
Business losses can be deducted against successful. Of course, the owner can hire
the sole proprietor’s other sources of employees who have additional skills and
income. abilities.

It is not subject to double taxation Raising capital can be difficult.

(explained later). The business ends at the owner’s death or
The business is easy to dissolve. loss of interest in the business.
The liquidity of the owner’s investment
is low.
Partnerships
❑ If two or more people start a business, they must
organize as a partnership, corporation, or limited
liability company.
❑ Partnerships are organized as either general or limited
liability partnerships.

An association of two or more

Partnership individuals who agree to operate
a business together for profit.
Classification of Company

There are mainly two types of Company

Private Limited Public Limited

Company Company
Advantages of Private Limited Company

Large sum of Capital

Advantages of
Private Ltd. Limited Liability
Company

Control Over Business

Private Ltd. Company Will Be Suitable For

❑ For family businesses

❑ Who wants to raise sufficient funds
❑ Partners are well-known to each other
Public Limited Company & its Features
A Public Limited Company must have at least seven members
to form it.
There is no restriction on the maximum Number of shares

Invites People to Purchase its Shares

The Liability of the Members is Limited

Shares are Freely Sold and Purchased

Advantages of Public Limited Company
Limited Liability

Continuity
Advantages
of Transferability of Shares
Public Ltd.
Company
Large Amount of Capital

High Reputation
Franchising
◻ A system in which semi-independent business owners
(franchisees) pay fees and royalties to parent company
(franchiser) in return for the right to become identified with
its trademark, to sell its products or services, and often to
use its business format and system.
Advantages and Disadvantages of
Franchising
Advantages Disadvantages
Management training and support Franchise fee and ongoing royalties
(Start-up & ongoing) Strict adherence to standardized
Brand name appeal operations
Standardized quality of goods/services Limited product line
Greater chances of success Restrictions on suppliers
Less freedom
The Franchising Relationship
Financial Management (1 of 2)
❑ Financial management deals with two things:
raising money and managing a company’s
finances in a way that achieves the highest rate
of return.
❑ Chapter 10 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.
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 do 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?
Financial Objectives of a Firm (1 of 3)
Figure 8.1 Primary Financial Objectives of Entrepreneurial Firms
Financial Objectives of a Firm (2 of 3)
Profitability Liquidity
Is the ability to earn a profit. Is a company’s ability to meet its
◻ Many start-ups are not profitable short-term financial obligations.
during their first one to three years ◻ Even if a firm is profitable, it is
while they are training employees often a challenge to keep enough
and building their brands. money in the bank to meet its
◻ However, a firm must become routine obligations in a timely
profitable to remain viable and manner.
provide a return to its owners.
Financial Objectives of a Firm (3 of 3)
Efficiency Stability
Is how productively a firm utilizes its Is the strength and vigor of the firm’s
assets relative to its revenue and its overall financial posture.
profits. ◻ For a firm to be stable, it must not
◻ Southwest Airlines, for example, only earn a profit and remain liquid
uses its assets very productively. Its but also keep its debt in check.
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.
The Process of Financial Management (1 of 3)
❑ 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.
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
The Process of Financial Management (2 of 3)
❑ Budgets
Are itemized forecasts of a company’s income, expenses, and capital needs and
are also an important tool for financial planning and control.
❑ 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 stacks 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.
Forecasts
❑ The preparation of forecasts follows the analysis of a firm’s historical
financial statements.
❑ 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.
Forecasts
◻ Sales Forecast
A sales forecast is a projection of a firm’s sales for a specified period (such as a year).
It is the first forecast developed and is the basis for most of the other forecasts.
■ A sales forecast for a new firm is based on a good-faith estimate of sales and on
industry averages or the experiences of similar start-ups.
■ A sales forecast for an existing firm is based on (1) its record of past sales, (2) its
current production capacity and product demand, and (3) any factors that will affect
its future production capacity and product demand.
Forecasts
◻ Forecast of Costs of Sales and Other Items
Once a firm has completed its sales forecast, it must forecast its cost of sales (or cost of
goods sold) and the other items on its income statement.
The most common way to do this is to use the percent-of-sales method, which is a
method for expressing each expense item as a percentage of sales.
■ If a firm determines that it can use the percent-of-sales method and it follows the
procedures described in the textbook, then the net result is that each expense item
on its income statement will grow at the same rate as sales (with the exception of
items that can be individually forecast, such as depreciation).
The Process
of Financial
Management
(3 of 3)
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 SECP to prepare financial
statements and make them available to the public.
❑ Pro Forma Financial Statements
Are projections for future periods based on forecasts and are typically completed
for 2-3 years in the future.
■ Pro forma financial statements are strictly planning tools and are not
required by the SECP.
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.
It opened a single location in 2016, added a second location in 2018, and plans
to add a third in 2019.
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.
Historical Financial Statements
Three types of historical financial statements
Financial Statement Purpose
Income Statement Reflects the results of the operations of a firm over a 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 experiencing a loss.
Balance Sheet Is a snapshot of a company’s assets, liabilities, and owner’s equity at a
specific point in time.

Statement of cash Summarizes the changes in a firm’s cash position for a specified period
flows of time and details why the changes occurred.
Consolidated Income Statements for New Venture Fitness Drinks, Inc.
Historical Income Statements
Blank Dec 31, 2018 Dec 31, 2017 Dec 31, 2016
Net sales $586,600 $463,100 $368,900
Cost of sales 268,900 225,500 201,500
Gross profit 317,700 237,600 167,400
Operating expenses blank blank blank
Selling, general, and administrative expenses 117,800 104,700 90,200
Depreciation 13,500 5,900 5,100
Operating income 186,400 127,000 72,100
Other income blank blank blank
Interest income 1,900 800 1,100
Interest expense (15,000) (6,900) (6,400)
Other income (expense), net 10,900 (1,300) 1,200
Income before income taxes 184,200 119,600 68,000
Income tax expense 53,200 36,600 18,000
Net income 131,000 83,000 50,000
Consolidated Balance Sheets for New Venture Fitness Drinks, Inc.

Historical Balance Sheets (1 of 2)

Assets Dec 31, 2018 Dec 31, 2017 Dec 31, 2016
Current assets
Cash and cash equivalents $63,800 $54,600 $56,500
Accounts receivable, less allowance for 39,600 48,900 50,200
doubtful accounts
Inventories 19,200 20,400 21,400
Total current assets 122,600 123,900 128,100
Property, plant, and equipment Blank Blank Blank
Land 260,000 160,000 160,000
Buildings and equipment 412,000 261,500 149,000
Total property, plant, and equipment 672,000 421,500 309,000
Less: accumulated depreciation 65,000 51,500 45,600
Net property, plant, and equipment 607,000 370,000 263,400
Total assets 729,600 493,900 391,500
Consolidated Balance Sheets for New Venture Fitness Drinks, Inc.

Historical Balance Sheets (2 of 2)

Assets Dec 31, 2018 Dec 31, 2017 Dec 31, 2016
Liabilities and shareholders’ equity
Current liabilities
Accounts payable 30,200 46,900 50,400
Accrued expenses 9,900 8,000 4,100
Total current liabilities 40,100 54,900 54,500
Long-term liabilities Long-term debt 249,500 130,000 111,000
Long-term liabilities 249,500 130,000 111,000
Total liabilities 289,600 184,900 165,500
Shareholders’ equity Blank Blank Blank
Common stock (100,000 shares) 10,000 10,000 10,000
Retained earnings 430,000 299,000 216,000
Total shareholders’ equity 440,000 309,000 226,000
Total liabilities and shareholders’ equity 729,600 493,900 391,500
 Historical Statement of Cash Flows (1 of 2)
Statement of Cash Flows for New Venture Fitness Drinks, Inc.

Dec 31, 2018 Dec 31, 2017

Cash flows from operating activities
Net income $131,000 $83,000
Additions (sources of cash)
Depreciation 13,500 5,900
Decreases in accounts receivable 9,300 1,300
Increase in accrued expenses 1,900 3,900
Decrease in inventory 1,200 1,000
Subtractions (uses of cash) Blank Blank
Decrease in accounts payable (16,700) (3,500)
Total adjustments 9,200 8,600
Net cash provided by operating activities 140,200 91,600
Cash flows from investing activities Blank Blank
 Historical Statement of Cash Flows (2 of 2)
Statement of Cash Flows for New Venture Fitness Drinks, Inc.

Blank Dec 31, 2018 Dec 31, 2017

Purchase of building and equipment (250,500) (112,500)

Net cash flows provided by investing activities (250,500) (112,500)
Cash flows from financing activities
Proceeds from increase in long-term debt 119,500 19,000
Net cash flows provided by financing activities 119,500 19,000
Increase in cash 9,200 (1,900)
Cash and cash equivalents at the beginning of each year 54,600 56,500

Cash and cash equivalents at the end of each year 63,800 54,600
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 stacks up against its competitors and if there are any financial “red flags”
requiring attention.
Historical Ratio Analysis
Ratio Formula 2018 2017 2016
Profitability ratios:
Return on assets ROA = net income/average total assetsa 21.4% 18.7% 14.7%
ROE = net income/average shareholders’
Return on equity 35.0% 31.0% 24.9%
equityb
Profit margin Profit margin = net income/net sales 22.3% 17.9% 13.6%
Liquidity ratios:
Current Current assets/current liabilities 3.06 2.26 2.35
Quick Quick assets/current liabilities 2.58 1.89 1.96
Overall financial stability ratio:
Debt Total debt/total assets 39.7% 37.4% 42.3%
Debt to equity Total liabilities/owners’ equity 65.8% 59.8% 73.2%
Forecasts
Figure 8.3 Historical and Forecasted Annual Sales for New Venture Fitness Drinks

Insert new Figure 8.3