Small Business Management: A Planning Approach

Small Business Management:A Planning Approach Joel Corman Suffolk University, Emeritus Robert Lussier Springfield College Lori Pennel Bunker Hill Community College

PART 4Controlling and Evaluating Performance CHAPTER 12The Financial Function

12-1 The Interrelationship between the Financial Function and the Other Business Plan Components • All resources need finance • Production requires material, equipment, and personnel. • Marketing needs to advertise and promote new and old products. • The finance function finds and taps sources for the funds required by all the functions.

12-2 Determining Financial Need • Entrepreneurial/small business activities start with an idea and the thought that purchasing this idea will provide both pleasure and profit. • Small business provides a lifestyle as well as independence and monetary returns. • Pro forma’s are guidelines against which you can measure how assumptions relate to reality. • Capital requirements indicates how much money you need to go into business. • Cash flow pro forma statement translates your business plan into future or projected dollars of income and expenses.

12-2Determining Financial Need (contd.) • Pro forma income statements and balance sheets can also be determined. • Two methods to determine the pro forma cash flow statement: • Using your present knowledge of the business operation and it’s operating history to determine all the expense categories and their interrelationships • Use of standard industry ratios • Standard industry ratios are developed from data reported to trade associations or governmental units. • SIC/NAICS codes are used to classify businesses.

12-2Determining Financial Need (contd.) • Cash deficit occurs when cash expenditures are greater than cash income. • Operational results occur when the operation of the business results in income being greater than expenditures on a cash basis.

12-2aBreak-Even Analysis • Break-even occurs when the volume of sales is sufficient to cover all fixed and variable costs. • Break-even point (BEP) is the point at which revenue equals costs. • At break-even point sales revenues equals the costs necessary to generate them. • As long as forecasted sales are greater than the break-even point, you must stay in business, if they drop below it, you may decide against starting or continuing it.

12-2b Determining the Break-Even Point • BEP shows the relationship between cost and volume. • The components of break-even analysis are: • Revenue • Determined by multiplying unit sales by unit price • Fixed costs • Expenses that do not vary with the level of production or sales • Variable costs • Costs that vary directly with the level of production or sales.

12-2b Determining the Break-Even Point(contd.) Graphic depiction of break-even point

12-2c Break-Even Analysis as a Management Tool • Contribution margins (CM) are the amount of money generated by sales volume after fixed costs are covered. • Enables us to predict a break-even point at various described profit levels. • It is possible to calculate break-even point by individual products in a multi-product company too.

12-3Types of Capital Financing • Three major types of capital financing: • Short-term capital • Early-stage capital • Long-term capital

12-3aShort-Term Capital • Short-term capital is funds that are borrowed for less than one year. • Used when companies have expended their initial capital • Occurs when one has neglected the task of preparing a projected cash flow budget statement • Trade credit obtained from creditors is commonly used.

12-3bEarly-Stage Capital • Early-stage capital (intermediate capital) is funds to be paid back within a period of five years. • Need arises as need for working capital increases. • Business must be at break-even point. • Used for small expansion activities

12-3cLong-Term Capital • Covers long-term projects lasting longer than five years • Used for fixed assets and real estate purchases, expensive machinery, and franchise financing • Used for major expansions or the acquisition of expensive equipment

12-3dCapital Requirements • A good assessment of capital needs and resources is an essential step for the small business owner. • The three basic questions before initiating a search for capital: • How much capital will I need? • What type of capital is required? • Where can I get the funds?

12-4 Traditional Sources of Venture Capital • The traditional paths of financing: • Seed financing • Relatives and friends • Partnerships • Commercial banks • Sale of capital stock • Venture capital companies • Government-sponsored agencies • State and regional development companies • Trade credit • Equipment loans and leases

12-4aSeed Financing • The initial investment amount that an owner has invested in the business • This initial capital could also include some debt. • The owner should have at least two-thirds of this amount. • Many firms fail because of the lack of ownership equity. • Seek the “right” investor who is aware of: • The funding required • Aware of risks involved • Ability to provide additional funds that may be needed • The nature of the business and offer guidance

12-4bRelatives and Friends • Most frequently sought by most entrepreneurs • Troubles frequently arise from this type of loan: • Interference in business decisions cannot be avoided as they may seek an active role in the business. • Demand of early repayment of the loan leads to misunderstanding and confusion. • Rules must be laid out before the whole process takes place. • Should be repaid in the shortest possible time

12-4cPartnerships • Business ventures are started with one or more partners in order to meet capital requirements. • A limited partner has interests with the investment only and not with the daily activities of the business. • However, limited partners should have some voice in the decisions that affect the business’s viability.

12-4dCommercial Banks • Banks that receive funds for depositors and lend funds to businesses • Do offer a limited source when initial capital is needed against personal guarantees • Offer only short-term loans to small businesses rather than long-term loans • Qualified applicants could seek many special types of financing. • Establishing a good relationship with banks is to the benefit of the entrepreneur.

12-4eSale of Capital Stock • The sale of stock as a device for raising capital is not limited to large businesses. • Capital stock is stock, or ownership shares, issued in exchange for funds needed to operate the business. • Private sale stock helps avoid compliance with the laws of the Security Exchange Commission. • As owners, equity holders may also share in the earnings of the company. • Private placements are direct sales of stock positions to private investors without SEC registration and with minimal restrictions.

12-4fVenture Capital Companies • Venture capital refers to funds that are invested in new or higher risk enterprises, usually in return for an equity position. • Good source for rapid growth businesses • They seek higher rate of return as they subject themselves to higher risk. • Appear to be an excellent source of readily available capital

12-4fVenture Capital Companies (contd.) • Advantages: • Heightened credibility with customers and bankers • Expert managerial assistance • Continuing source of financing • Smaller burden of risk • Disadvantages: • Loss of substantial equity • Investor makes most of the decisions • Risk of takeover

12-4gGovernment-Sponsored Agencies • The government has developed sources that sponsor the small business owner. • Small Business Administration • An agency of the government founded to help small businesses, offer the most assistance with financial help and professional advice. • SBA Loan Guarantee program • Small Business Institute (SBI) • Service Corps of Retired Executives (SCORE), an organization of people who donate their time to assisting business (affiliated with the SBA) in making business plans and facilitate obtaining of loans.

12-4gGovernment-Sponsored Agencies (contd.) • Minority Enterprise Small Business Investment Company (MESBIC) • Special financing for minorities • A private concern that combines financing sources of the company itself, banks, and the SBA. • Provide managerial assistance and perform market studies • Invest in banks, high-tech firms, service companies, franchisees, and other diverse ventures • Small Business Investment Company SBIC • Evolved out of the Small Business Equity Act of 1958 • Principal funding comes from insurance companies, pension funds, bank trust departments, and wealthy individuals. • In 1979, 40% of start-ups were financed. • Needs a reasonable amount of owners equity and a thoroughly developed business plan.

12-4h State and Regional Development Companies • Privately owned companies sponsored by the state • Private companies develop suppliers and customers through this medium. • Backed by large manufacturing companies, and utility and transportation companies

12-4i Trade Credit • Trade credit is credit extended by a supplier. • Inventory is one of the largest investments. • Excellent source of capital comes from vendors with whom the business has dealings. • Involves unsecured, open-book account • Terms of credit are usually 30 days with a discount if paid early. • “2/10, net 30” would mean 2% discount if paid before 10 days, the remainder due within 30 days.

12-4jEquipment Loans and Leases • Vendors routinely offer attractive installment plans against which equipment can be bought. • 25–35% down payment is usually required with an intermediate loan period of 3–5 years. • The advantages of leasing are: • Flexibility with equipment needs and payment schedules • Smaller capital requirements • Equipment maintenance service offered by the leasing company • A way to beat the obsolescence problem • The disadvantage would be the absence of depreciation and a higher total cost of purchase.

Small Business Management: A Planning Approach