This case was prepared by Donna Kelley, Professor of Entrepreneurship at Babson College. It was developed as a basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. It is not intended to serve as an endorsement, source of primary data or illustration of effective or ineffective management.

Copyright © 2018 Babson College and licensed for publication to Harvard Business Publishing. All rights reserved. No part of this publication can be reproduced, stored or transmitted in any form or by any means without prior written permission of Babson College.

BAB466 / NOVEMBER 2018

A Guide to Creating Financial Statements for Entrepreneurs Donna Kelley, Babson College1 November 2018 The creation of financial projections in the feasibility stage of entrepreneurship can help you think about the financial consequences of the work you have done so far to develop your opportunity. Projections are useful for anticipating cash needs and when you will need to secure financing. They can also help you determine whether the business model is viable and potentially profitable, whether effort and money should be invested in developing it further, and which aspects may need to be rethought. The financials that are common in the business world are those that track past performance. With these statements, if we know past performance, we can better predict future performance. For a prospective business that has not previously existed, on the other hand, preparing financial statements is much more difficult. There is no past history to build on, there are no real numbers to start with, and it is not certain how the venture will materialize. It is not likely the numbers will be correct, so why do this? The main reasons for creating financials fall into internal and external arguments:

1. Your numbers reflect your positioning and business model. They can inform you about the viability of your business and help you determine whether and how to move forward. While some numbers are likely to be wrong, your initial approach to the business is also likely to be wrong in some aspects. If these numbers can help put you on a more viable path (sooner rather than later), this information is undeniably valuable.

2. Investors and other stakeholders will want to understand the viability of your business and how you intend to pursue the opportunity. They want to know that you have thought through the economic representation of your business model and that you have done your homework in crafting logical financials. While most sophisticated investors and

1 The author would like to acknowledge Janice Bell, Professor Emeritus of Accounting, Babson College, for her constructive comments on an early draft of this note.

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other experts often believe entrepreneurs are overly optimistic with financial projections, they also want to see how ambitious you are in your thinking about launching the business.

Most business people have at least a basic understanding of financial statements, but creating them from scratch is a difficult task. The complexity of the exercise increases when entrepreneurs feel they need to create detailed, comprehensive statements with items such as unearned revenue, prepaid rent, and allocated overhead. Don’t do this. Start simple, at least for the first pass. Get the basics down and, more importantly, understand the relationships between the numbers on the statements and how they link to your business model. Using Templates A template can serve as an easy solution for an entrepreneur who does not have substantial finance expertise and has little time to devote to this task. Working with a template can be better than ending up with no financials at all, or with poorly constructed ones. However, be aware of the limitations. First, plugging in numbers and having the statements generate on their own can limit your understanding of the relationships between elements within and across the different statements. In addition, you want to have in-depth knowledge of your financials when dealing with sophisticated investors and other financially savvy stakeholders. In many ways, templates can help you do this. However, you need to understand the reasoning behind your inputs to the statements and what the results tell you. Similarly, if you have a team member with financial expertise or an accountant working with you on this, make sure you know the numbers and their implications. Second, every business is unique, and generic templates are often limited in their ability to help specific types of business, or they are overly complex in an attempt to be relevant to all businesses. A similar issue arises with adapting financials from an established company in your industry. This latter exercise is very useful and will be discussed later in this note. But financials from an ongoing business may have more detail than you need to consider early on. Also, adapting financials needs to be done with careful consideration of the startup context and how your business differs. With regard to templates, if you can find a template that serves your industry well, and if these templates allow for adaptation to your unique business model, this can be very helpful, especially in establishing a base-level set of financials. This note will guide you through the process of building basic financials that reflect the approach of your prospective business. This will provide a foundation for you to evaluate the viability of, and make changes to, the business model, and communicate the opportunity to key stakeholders. This early set of financials can then serve as a launching pad for identifying metrics and for ongoing assessment of the venture startup and growth process. Understanding the Relationship Between the Three Statements Let’s first take a basic look at the financial statements and their interrelationships. Each serves a critical role in exhibiting particular dimensions of your business. The income statement tells you about the profitability of your business, while your cash flow statement indicates how cash will Do

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flow into and out of the business (like a checking account register). The balance sheet shows assets and liabilities and, by subtracting the liabilities from the assets, it reflects your equity in the business. Here is an oversimplified example, meant to illustrate in very basic terms the differences, and relationships, between the three statements. Let’s assume you decide to start a business called Orthopawdic, selling orthopedic dog beds. Month 1: You paid your supplier for your first shipment of 10 dog beds at $50 each. Your grandmother gave you a loan of $500 to cover this inventory. Your statements would look like this below. Look at these for a few minutes before you read further. Think about the activities that have taken place and how they are represented in the numbers below.

Income Statement Cash Flows Balance Sheet Month 1 Month 1 Month 1

Revenues 0 Operating activities -500 Accounts Receivable less: COGS2 0 Investing activities Inventory 500 Gross Margin 0 Financing activities 500 Total Assets 500 Net Cash Flow 0 less: SG&A3 0 Beginning balance 0 Liabilities 500 Net Income 0 Ending balance 0 Equity

Total Liabilities and Equity 500

You’ve probably noticed a few things:

1. There is a lot of cash and product changing hands, but no sales, so the income statement shows nothing (for simplicity, we’re assuming no SG&A).

2. On the cash flow statement, the cash paid for the inventory is reflected in operating activities. The money from Grandma shows up in financing activities on the balance sheet. You now have inventory, which is an asset that will create value when you sell it. But you owe Grandma $500, and that shows up as a liability on the other side, balancing out the statement.

Month 2: Congratulations! You made your first sale. Kiki has bought a bed for $125 for her dog Max and will pay you next month. Your statements below reflect this month’s activities. Again, look at this before you read further, and think about how this month’s activities are reflected in the three statements, especially compared to the first month. What has changed? 2 Cost of Goods Sold 3 Selling, General and Administrative Expenses Do

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Income Statement Cash Flows Balance Sheet

Month 2 Month 2 Month 2 Revenues 125 Operating activities 0 Accounts Receivable 125 less: COGS 50 Investing activities Inventory 450 Gross Margin 75 Financing activities 0 Total Assets 575 Net Cash Flow 0 less: SG&A 0 Beginning balance 0 Liabilities 500 Net Income 75 Ending balance 0 Equity 75

Total Liabilities and Equity 575

Some observations you’ve made probably include the following:

1. You’ve made a sale, so the income statement shows revenue. One dog bed comes out of inventory and goes into COGS on the income statement. You’ll notice that inventory on the balance sheet is now $450.

2. You’ve also made a profit of $75 (the amount that Kiki paid, less the cost of the bed) which shows up in the income statement as net income and also in equity on the balance sheet. Essentially, you’ve added $75 of value to the business.

3. You’ll notice that no cash changed hands. Kiki will not pay you until next month, and you already paid for the inventory last month. So the $125 sale is recorded as an account receivable on the balance sheet, and there is no activity recorded on the cash flow statement.

Now, before reading further, recall the purpose of each of the three financial statements. What does each tell you about your business? The income statement tracks your business activities (regardless of the flow of cash). There are two main categories of expenses: (1) COGS is tied to sales. So when Orthopawdic made a sale to Kiki, one bed came out of inventory and went into COGS;4 (2) SG&A are expensed in the period in which they are incurred; they are not costs associated with a particular sale. If, for example, Orthopawdic did some advertising in Month 1, that expense would go under SG&A. Your income statement thus tells you about the flow of business activities and whether the enterprise can be profitable. It should reflect your business model. For example, if you are introducing an innovative or otherwise highly differentiated product, you should expect higher margins, particularly to cover expenses associated with communicating its unique advantages, and perhaps other costs like product development. With this example, you will likely project losses for the first year or more, given that you are incurring expenses such as marketing and product development5 that you expect will generate substantial future sales. 4 Notice how the dog bed went from being classified as an asset on the balance sheet, to an expense on the income statement. Before it was sold, the bed was sitting in inventory, offering future economic value for your business. That value was created when the bed was sold, and it then became an expense (COGS) associated with the revenue generated on the income statement. 5 R&D/product development costs are expensed when incurred, under SG&A on the income statement. If you have a patent, however, the cost associated with applying for, or acquiring, the patent will become an asset on the balance sheet that is expensed over time on the income statement (as amortization). Do

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The cash flow statement tracks your flow of cash. Cash flows fall into three categories:

1. Operations: actual cash received and paid out for items on the income statement. 2. Investing: assets that go on the balance sheet. For example, equipment, property, or

temporary investments in stocks of other companies. 3. Financing: money that comes in or is paid out to finance the business, whether debt

or equity. This includes dividends, but interest is typically an operating cash flow. You may already recognize the importance of the cash flow statement for entrepreneurs, particularly when considering that what happens in the income statement does not necessarily match what’s going on relative to cash flows. You can be hugely profitable but cash poor; cash flow projections can therefore help you determine when you will be short on funds. The balance sheet essentially shows the asset base you are leveraging and the capitalization of your business. It can provide a lens into how you are building and managing your asset base, and how you are choosing to finance your business. While the income statement is a financial representation of the business activities that have taken place over time, and the cash flow statement reflects cash flows over a period, the balance sheet is unique in providing a snapshot of your financial picture. The balance sheet is akin to a still photo, while the income statement and cash flow statement are like videos. Making Informed Assumptions Given the high uncertainty characterizing the early stages of planning a venture, financial projections are often seen as unreliable, like pulling numbers out of thin air. What is more important than arriving at precise figures, however, is the set of assumptions and reasoning applied to derive the numbers. There are three basic sources you can use to determine your inputs to the financials:

1. Published (secondary) sources. These are cheap and plentiful. You can access a range of information such as company and industry data, trade and business information, media articles and so forth. Secondary data is compiled for a particular purpose, not all of which is relevant to your needs. And what is relevant often needs to be adapted somehow. The overall challenge is to sort through all of this, and to figure out what applies to your business and how. Be selective in what you use to support your numbers and the reasoning you use in applying this data to your business. Then, continue your search through the vast amount of information out there, and incorporate new information into your financials as they evolve.

2. Advice and feedback from experts or customers you contact. It is increasingly critical to talk to people about your business and use their feedback to adjust your approach. You will impress your audience when you show evidence of having reached out to experts and customers.

3. Results of experiments and primary research you conduct. This will surely wow an

investor or other interested party—stating that you stood at an intersection for two hours Do N

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at a time over each day of the week for one week and counted how many cyclists there were, and how many wore helmets. Or, you rented a table at a farmer’s market, and 50% of the people who stopped in front of your table bought your brownies.

When using any of these sources, make sure you sound as objective as possible. Avoid biased information, like saying you told 50 people about your new cat-tracking device and 90% said they loved it, even if they didn’t have a cat. Seeing how passionate you are, or neither understanding it nor feeling invested in what you’re doing, they may just say what you want to hear. Think deeply about how you can gather and present information in the most objective way. For example, you talked with 60 men and women aged 45-65 in the Boston area, and 30% are currently members of a health club, but of these, half have not visited their club at all in the prior two weeks. In the early stages of building an opportunity, particularly an innovative one, actual behavior is much more reliable than expressed intentions. Your numbers may represent a guess, an informed estimate, or an exact number. As you move forward with your business, you’ll have some exact numbers (financing raised, sales orders received, marketing costs incurred). In the beginning, it may seem that you have mostly guesses. Nonetheless, you want to move quickly toward informed estimates. Continually refine your numbers as you collect more information and steer your venture onto more viable paths. Keep a running list of the sources used to develop your assumptions and any interpretation you applied. These increase your confidence in your numbers and signal to investors that you have reasonably thought through this exercise. Building Your Financial Statements Typically, entrepreneurs provide five years of financial projections for all three statements, and then a monthly breakdown for the first two years with the income statement and cash flow statement. The reasons for this monthly breakdown are straightforward. For the income statement, monthly detail shows your ramp-up and seasonality. Monthly detail on cash flows shows when you’ll have a cash deficit, and when you’ll need funding and how much. For the first two years, you may find it useful first to create annual income statements and cash flow statements for the full five years and take a high-level approach to what this looks like. Then, you could divide the first two years into monthly detail, considering both the initial ramp- up period and any seasonality. But, particularly when applying the bottom-up method described in this note, you may find it useful to estimate what sales look like on a daily and weekly basis, and build this out to monthly and annual numbers as you progress through the initial year or two. Do

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The Income Statement Revenue Projections Let’s first take a look at three ways you can estimate revenues: top-down, bottom-up, or comparables. Top Down With this method, you identify the total size of the market segment you could serve and estimate your share of the market. Of all customers who are reachable with your concept, you can estimate what proportion is likely to buy. You may be able to find market data expressed in total dollar amounts, which includes both numbers of people and the amount they purchase per year. You could calculate market share and revenue data from this. Another way is to calculate numbers of customers and then apply pricing and purchase frequency. First, consider the proportion of your market that can reasonably become aware of, and access, your product. It is often said, for example, that people will drive no more than 15 minutes to a health club. Given the demographics of the market for a health club, one could identify the number of people in the target market area and adjust for demographic and behavioral characteristics. Building on this example, say you want to open a fitness business in Welltown, Massachusetts. Your market research and business model indicate a target market segment of older males and females, 45-65 years of age, who exercise regularly.

a. Population statistics reveal that there are 30,000 people living in Welltown and 30% are between the ages of 45 and 65 years old. This gives you 9,000 people.

b. A magazine published a survey showing that 50% of people in the region around Welltown engage in regular exercise. Applying this information reveals a market size of 4,500 people.

c. There is one health club in Welltown, a national franchise, which a source says has 1,800 members. Industry statistics reveal that about half of health club members in the United States are over the age of 44, so you estimate that they have 900 members over 44 or 20% market share in the segment you are targeting. There are also four niche fitness businesses (cycling studio, pilates, personal training, and a weight gym) that have smaller market shares. Your concept is a multi-offering facility targeting the older population, so you project you can achieve 10% market share, or 450 members, after an initial ramp-up period, eventually increasing to 30% by the end of five years. You then apply your pricing information to generate revenue projections.

Bottom Up You can also count the number of customers you expect to serve, along with how much they will buy. You may be able to get data on customer behavior from various sources. You can talk to reliable informants, such as store owners, sales reps, suppliers, or other industry experts. Or you can physically observe this—counting people entering and exiting a store, tabulating how many buy, and if possible, what and how much. Think reasonably about how many people would buy Do

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your product or use your service. Given the hours the business is open, what might a typical day be like, including peak or slow hours? How much does a typical customer spend? From this approach, you can build out to weekly, and then monthly and annual sales projections. Comparables A third approach is to obtain revenue numbers from comparable businesses, drawing on a company (or companies) selling a similar offering, and adjusting for differences in elements such as stage of business and your source of differentiation. You may not have concrete numbers for your closest competitors, especially if they are private, but you can obtain data on industry averages and public firms. Particularly for large companies with multiple product offerings, revenues are often aggregated, and you will again have to make assumptions. For example, if you are opening a retail store and you have located a comparable company that reveals the number of stores it has, you can divide total sales by the number of stores to determine average revenue per store. As another example, say you know a company’s total sales for the year. You may be able to locate information showing what proportion of these sales contains the product category that matches your offering. You can draw on published sources such as press releases, journal articles, or the Management Discussion and Analysis (MDA) section and footnotes in annual reports, even expert opinion. With the information available, consider how you can make informed estimates. In projecting revenues, your price and sales volume should reflect your strategy. If you have a premium product or service, pricing should be relatively higher. Comparisons to the alternatives presented in your competitive analysis are helpful here, so collect good data on pricing for competing products or services. Summarize the logic behind your pricing in your assumptions. Expenses Like revenues, expenses may also be approximated in multiple ways. You can obtain data on actual rent costs where you plan to locate, for example, or on average salaries for the types of employees you would need to hire. In addition, you can draw on industry averages or actual expenditures of similar businesses to estimate certain expense categories. To estimate cost of goods sold, you may be able to determine what it would cost to purchase or produce your product or service.6 You can get quotes from suppliers, or ask those purchasing similar products what they pay. You can also look at gross margins for similar alternatives. Industry averages or comparisons may also be helpful. Again, try several different methods and arrive at a reasonable figure, making adjustments for your particular concept. Document your reasoning in your assumptions. 6For entrepreneurs, the lower risks and capital requirements of buying a product from a supplier or outsourcing production to a contract manufacturer generally outweigh the advantages of in-house production. Depending on your business, you may be able to start with small-batch production in-house. But when ramping up your operations, consider the implications of doing it yourself: investments you would need to make in equipment and facilities, and the capital requirements, as well as other considerations such as human resources and compliance issues. Having control, and the ability to leverage fixed costs and increase margins, can be attractive, but you also want some flexibility as you establish your product and test the market. Do

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For SG&A costs, you can use comparables or consult experts. Be careful not to underestimate how much it will cost to attract and convince customers, even beyond ramp-up. You are just starting out, and people may not be aware of, or think they need, your concept. They may be happy with competing alternatives, and there may be costs associated with switching to your solution, such as a learning curve, complementary products, or network effects. Triangulate, Triangulate, Triangulate In building your income statement, it is useful to try multiple ways to estimate both revenues and expenses and see how they compare. You may find that the various methods reveal different results. In this case, revisit your assumptions and seek additional evidence to revise your numbers. You can make adjustments to your results until the methods triangulate. When they do, you have stronger support for your projections. You can take into consideration whether one method might be more accurate for your purposes than others, depending on the nature of your business and the availability of relevant information. At the same time, you may find it helpful to combine the most useful aspects of different approaches. Remember, there is a high level of uncertainty associated with estimating revenues and expenses at this point. While acknowledging this, you want nonetheless to project confidence that you have thought about what drives your numbers and that you have evidence to support your assumptions. Additionally, beware the tendency to overestimate revenues and/or underestimate expenses. Entrepreneurs are inherently optimistic — some would say naïve — when it comes to estimating sales, the speed at which sales ramp up, and the level of expenses required to generate projected sales. Investors and other sophisticated stakeholders will see right through this. Make informed assumptions and back these up with sound evidence. Startup Costs The startup phase includes three additional considerations relative to the financial picture. First, what startup costs will you incur, and how many months will you be spending money before generating sales? Second, what would the sales ramp-up time look like? Third, how long will it take for the business to break even, when sales cover your expenses? The income statement should start with the first expense incurred, even if you have not yet made a sale. Realistically, you will need to spend money to get operations up and running before you generate revenues. Detail the amount it will take to get started. This affects the amount of financing needed to launch the business. In fact, it clarifies for your investors where the money will go. Here, you can think resourcefully (but also realistically) about what you will need at the time of launch. For example, this can include: investments in fixed assets, a budget for your market launch, website development, upfront legal expenses, R&D/design/engineering, and consulting. Adjusting for the Startup Context Remember that for both revenues and expenses, it is vitally important to take into account your particular context. This includes the fact that you are a startup, and the extent to which you have a particular source of differentiation, both of which will affect the rate of market acceptance. Do

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Revenues should reflect a reasonable ramp-up period. You do not have the same track record as established competitors, and this will impact your initial sales. It may take several months or longer for your concept to take hold, depending on industry conditions and other external factors. In addition, the greater your uniqueness, the longer it might take customers to become aware of your solution and understand its value. You might be serving a small niche market of likely users in the beginning, before expanding more broadly. Ramp-up time may also be influenced by choices made around aspects such as sales efforts, marketing expenditures, or location. For example, if your concept will rely heavily on marketing, your sales level may be higher (along with operating costs). Also remember to build in any seasonality that may characterize your business. Keep it Simple Keep it simple is the theme of the day. If you are selling a product for which you contract out production, or which you buy from a supplier, the price you pay to the producer or supplier goes into COGS. However, if you are producing a product in-house, it may be relatively easy to track costs for materials, components, ingredients, and so forth. However, attempting to allocate labor and overhead can be complex. For now, put your material costs into COGS, and labor and items that might be considered overhead into SG&A — you could even call the category SG&A and Operations. The same goes for a service business. Cost of services, like labor for a product company, can be hard to track in a service business, unless you use contract laborers to provide services and pay according to services provided. Unless this situation exists in your service company, try starting with revenues and put all your costs in SG&A and Operations. You can refine this later, but the simpler the better for now. Breakeven Point Another key aspect to highlight is the breakeven point. When do you project revenues will cover expenses, and what sales level does this represent? Given that you have a reasonable set of monthly projections for the first two years, you can calculate the breakeven sales level. This is important because it shows what you will need to sell in a month to cover your costs. You can then weigh whether this is feasible: for instance, can you attain the market share required to break even? You may consider changes to your approach, such as taking on more or fewer value chain activities. To calculate breakeven sales requires an estimate of total fixed costs and variable costs. Fixed costs are those that do not change with short-term variations in sales. For example, rent will be the same whether you sell one more or one fewer unit. Of course, if sales increase to a level for which a larger space is needed, fixed costs will need to be adjusted. The main point, however, is that short-term variations in sales do not affect the level of these costs. Often people think that fixed costs are all the operating costs, but this is not true. If you pay sales commissions, for example, these are variable. So go through your expenses and determine which are likely to stay the same over moderate variations in sales, and which are expected to change with different sales levels. Do

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Breakeven sales can be calculated as follows.

1. Take your average per unit selling price and subtract your per unit variable cost. This is your per unit contribution (toward fixed costs).

2. Express this as a percentage of sales by dividing it by the unit selling price. This is your contribution margin ratio.7

3. Take your monthly fixed costs and divide that by your contribution margin ratio.

Breakeven Sales = Fixed Costs / Contribution Margin Ratio The contribution margin ratio represents the percentage of sales remaining after variable costs are covered, and which contributes to covering fixed costs. For example, for every dog bed that Orthopawdic sells for $125, $75 is left over after covering the $50 cost of the bed (contribution margin ratio of 60%). If Orthopawdic had monthly fixed costs of $7,500, 100 dog beds would need to be sold to cover this amount, i.e., to break even. Above this point, every unit Orthopawdic sells “contributes” to bottom-line profit. Depreciation Before we construct cash flow statements and balance sheets, let’s review how depreciation is handled. For items that will be used within a year, or assets of relatively small value (like $2,000 for a laptop), just expense these. If you are purchasing assets such as furniture, equipment, vehicles, leasehold improvements, or other large ticket items that will be used over a longer period, these will be depreciated on your income statement. In this manner, they are expensed gradually over the length of time that your business benefits from them. You can easily look up estimates of the useful life of certain categories of fixed assets. Use the straight-line method, where you expense the cost over the number of years of useful life. For example, if you buy a set of weight machines for your health club for $50,000 and this category has a useful life of 10 years, you could expense it at a rate of $5,000 per year. Yes, there is such a thing as salvage value, but you can keep it simple for now and depreciate down to zero. Here is how a fixed asset purchase and depreciation figure in your statements:

x Income statement: you expense a portion of the asset as depreciation expense each period.

x Balance sheet: record the full cost of the asset under fixed assets, and deduct accumulated depreciation from this amount to find the net value. Note that accumulated depreciation is additive—you add the amount of depreciation expense to the prior year’s accumulated depreciation.

x Cash flow statement: recall that depreciation is not a cash flow; when you paid for the asset, you should have recorded the cash outflow under cash flows from investing activities. Under cash flows from operating activities in your cash flow statement, you need to remember to add back depreciation expense to net income, since it is a non-cash item.

7 Alternatively, you can take total sales revenue and subtract your total variable costs, and then divide by total sales revenue. Do

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x Drawing on the previous example, the $50,000 you paid for the line of weight machines

will be recorded as a cash outflow in cash flows from investing activities when you paid for it. The $5,000 in depreciation expense from your annual income statement will be added back to net income in cash flows from operating activities.

As a side note, consider the tradeoffs associated with leasing versus buying fixed assets. Leasing may seem expensive, but it can reduce your need for large amounts of financing early on, as well as provide flexibility. The Balance Sheet Let’s start with a very basic balance sheet. You do not need all the items you see in balance sheets of publicly traded companies. Keep it simple on this first pass. Here are the typical categories you place on the asset (left) side:

1. Cash: you can keep this blank and fill in when you complete the cash flow statement. 2. Current Assets

a. Accounts Receivable: this assumes your customers will not always pay in cash. If payment terms are 30 days, you could take the last month sales revenue number and place it here (for example, you assume December sales will be paid in January). If your customers pay with credit cards, it may take a few days to receive the cash from the credit card company, but for the sake of simplicity, you can treat this the same as a cash sale.

b. Inventory: if you are holding inventory, you can determine how much you need to have on hand. You want to balance tying up cash with avoiding stockouts. Industry practices, agreements with suppliers (small-batch or on-demand production), and products that are perishable or prone to obsolescence, are among factors that can influence this. You might, for example, maintain inventory equal to the next month’s COGS, assuming you want to keep 30 days of inventory on hand.

3. Fixed Assets: here is where you put the cost of your large depreciable assets, then subtract accumulated depreciation to get a net value.

On the liabilities and equity side (right side), you have the claims against your assets.

1. Current liabilities: if you have inventory, you could assume you will pay cash on delivery (suppliers often require this for new businesses). In this case, you do not need to include current liabilities on your balance sheet. Obviously, this is also the case if you have a business that does not carry inventory. However, if you have inventory, and if you project something like 30-day terms, you may assume inventory purchases in the current period will be paid in the following period. This amount could thus go into accounts payable.

2. Debt: if you think you will use debt financing, leave this blank until you complete the cash flow statement and calculate the amount needed.

3. Equity has two basic components: a. Equity financing: again, if you think you will raise equity funds, leave this blank

until you calculate financing needs in the cash flow statement. b. Accumulated earnings (losses): add the current net income (loss) from the

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This document is authorized for educator review use only by MUHAMMAD ATHER ELAHI, Institute of Business Administration until Sep 2021. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860

A Guide to Creating Financial Statements for Entrepreneuers BAB466- November 2018

13

Cash Flow Statement Let’s assume you use the indirect method to create the cash flow statement, which is the method that starts with results from the income statement. Although this is not always intuitive, it can be easier to reconcile with the other two statements, and this method is used more commonly. Whether you use the indirect or direct method (tracking actual cash flows for operating activities), the only difference between these methods is in the first category, Cash Flows from Operating Activities. Here is how you set this up:

1. Cash Flows from Operations a. First, take net income and add back depreciation expense. Remember,

depreciation is not a cash flow; the cash flow occurs when you made payment on the fixed asset, which goes under investing activities below.

b. Look at the difference in your current assets and current liabilities from the last period.

i. If you increase current assets (accounts receivable, inventory), you are tying up cash, so subtract that. Decreases are added to cash flows.

ii. If you increase current liabilities (accounts payable), you are delaying a cash outlay, so add this. Decreases are subtracted.

2. Cash Flows from Investing: here is where you put the cash outlay for fixed assets, investments in suppliers, or purchases of stock of other companies.

3. Cash Flows from Financing: leave this blank for now until you identify how much cash you will need to cover shortfalls.

4. Add the above three together to get your net change in cash. 5. Input the cash balance from the end of the last period. 6. Add #4 and #5 above to get your ending cash balance.

Given that you have created a monthly cash flow breakdown for the first two years, look at where you find big cash deficits. You will likely need money even before you make a sale, depending on big-ticket purchases and the amount of pre-revenue costs you incur. You also want a cushion so you do not run out of cash if things do not go as you expect. You can determine a minimum level of cash to maintain as a reserve, an amount below which you will not go. This may include several months of expenses, so you can pay employees and bills even if you do not have revenues. You want to strike a balance between securing too much money too early, which is generally more expensive, and risking cash outages. You can examine the amount needed, and whether you have access to some quick or temporary sources of financing. Just remember that it often takes time to raise money, sometimes several months. Once you fill in the financing amount on your cash flow statement, this can go into the debt or equity section of the balance sheet. With your financing in place, you now have your ending cash balance and can put this on the asset side of the balance sheet. The asset side of the balance sheet, and the liabilities and equity side of the balance sheet, should display the same bottom line. Do

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A Guide to Creating Financial Statements for Entrepreneuers BAB466- November 2018

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Presenting the Financials in Your Business Plan Your financial statements should go into an appendix in your business plan. You can include additional spreadsheets that break down some key components, but do not overload the appendix with a lot of subsidiary ledgers. Rather than show every last detail, just describe how you calculated certain numbers. A list of assumptions should accompany your financial statements. Provide as much evidence as you can to support your numbers; cite published or primary sources where possible. In the main text of your business plan, highlight key results and insights derived from your financials. Discuss your financial model; put into words what you see in the spreadsheets. For example, identify the length of the pre-revenue period and list major upfront expenditures. Describe the ramp-up period, any seasonality, and how your source of differentiation is reflected in the financials. Identify when you will break even. A final reminder: once you complete reasonable financial projections, you may recognize that the route you have chosen is not viable or attractive. You may need to cycle back and rethink the product or market. Use the numbers to inform, not just impress.

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This document is authorized for educator review use only by MUHAMMAD ATHER ELAHI, Institute of Business Administration until Sep 2021. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860

Content

1.1	Cash flow
1.2	Cash flow
2.1	Annuity
2.2	Annuity
2.3	Annuity
3.1	NPV Using Constant Discounting
3.2	NPV Using Constant Discounting
4.1	NPV Using General Discounting
4.2	NPV Using General Discounting
5.1	Loan Amortization
5.2	Loan Amortization
9.1	Firm and project Val
9.7	Firm and project Val
15.1	Break Even Analysis
15.2	Break Even Analysis

&"Arial"&10&K000000&1#

&1#&"Arial"&10&K000000Saudi Aramco: Company General Use

Sheet1

Location Evaluation
Criteria	Khobar suopr foam car wach
population density (15)	15
purshusing power and social class (10)	8
possibility of obtaining licenses (5)	5
transferring materials to the site (5)	3
clossness to vital places (5)	5
labor accommedation (10)	10
easy access (10)	10
capacity (10)	10
rent (10)	9
compititors (10)	8
total (90)	83
Foundation expenses
	qty	unit price	total
transfer kfala fees	19	2000	38,000.00 [$ر.س.‏-401]
visa and imgration	19	1750	33,250.00 [$ر.س.‏-401]
waterpumps	4	5500	22,000.00 [$ر.س.‏-401]
water hose	7	500	3,500.00 [$ر.س.‏-401]
air compressor	2	6000	12,000.00 [$ر.س.‏-401]
steam machine	1	27000	27,000.00 [$ر.س.‏-401]
car vacuum	4	3500	14,000.00 [$ر.س.‏-401]
washing tools and supplies	1	5000	5,000.00 [$ر.س.‏-401]
logo and sinages	1	26000	26,000.00 [$ر.س.‏-401]
decorations	1	60000	60,000.00 [$ر.س.‏-401]
rent for 6 month	0.5	100000	50,000.00 [$ر.س.‏-401]
labor accomodation	1	10000	10,000.00 [$ر.س.‏-401]
other			25,000.00 [$ر.س.‏-401]
needed capital			325,750.00 [$ر.س.‏-401]
Operational Expenses
Column1	monthly	yearly
salary	44300	531600
advertismnets	700	8400
stationary	100	1200
food expenses	1600	19200
transportation	600	7200
safty equipments	200	2400
rent	8333	99996
internet	500	6000
hospitality	100	1200
electriciety	2000	24000
water	3000	36000
medical	500	6000
maintenance	700	8400
commission	500	6000
tools	500	6000
extra labor	1200	14400
total	64833	777996
Labor costs
job	qty	position	skill	nationalty	salry	ministiry of labor fees	monthly for 1	total month	total year
manager	1	A	exelant	saudi	4000	0	4000	4000	48000
supervisor	1	B	very good	indian	1600	900	2500	2500	30000
labor	18	C	good	bangladishi	1200	900	2100	37800	453600
الاجمالي	20					1800	8600	44300	531600
Incom
Column1	car per day	avreg incom per car	daily incom	monthly incom	yearly incom
year 1	60	35	2100	63000	756000
year 2	70	35	2450	73500	882000
year 3	80	40	3200	96000	1152000
year 4	90	40	3600	108000	1296000
year 5	100	40	4000	120000	1440000
Resultes
Column1	Column2	monthly	yearly	Column3
year 1	incom	63000	756000
	cost	64833	777996
	result	-1833	-21996	-6.75%
year 2	incom	73500	882000
	cost	64833	777996
	result	8667	104004	31.93%
year 3	incom	96000	1152000
	cost	64833	777996
	result	31167	374004	114.81%
year 4	incom	108000	1296000
	cost	64833	777996
	result	43167	518004	159.02%
year 5	incom	120000	1440000
	cost	64833	777996
	result	55167	662004	203.22%

1.1

SINGLE CASH FLOW	Present Value
Inputs
Single Cash Flow	$1,000.00	20
Discount Rate / Period	6.0%	6
Number of Periods	5	5
Present Value using a Time Line
Period	0	1	2	3	4	5
Cash Flows
Present Value						$747.26
Present Value using the Formula
Present Value	$747.26
Present Value using the PV Function
Present Value	$747.26

&"Arial"&10&K000000&1#

&1#&"Arial"&10&K000000Saudi Aramco: Company General Use

Single Cash Flow - Present Value

Cash Flows 0 1 2 3 4 5 Present Value 0 1 2 3 4 5 747.25817286605684

Period

1.2

SINGLE CASH FLOW	Future Value
Inputs
Single Cash Flow	$747.26	14
Discount Rate / Period	6.0%	6
Number of Periods	5	5
Future Value using a Time Line
Period	0	1	2	3	4	5
Cash Flows	$747.26
Future Value	$1,000.00
Future Value using the Formula
Future Value	$1,000.00
Future Value using the FV Function
Future Value	$1,000.00

&"Arial"&10&K000000&1#

&1#&"Arial"&10&K000000Saudi Aramco: Company General Use

Single Cash Flow - Future Value

Cash Flows 0 1 2 3 4 5 747.26 Future Value 0 1 2 3 4 5 1000.0024451173764

Period

2.1

ANNUITY	Present Value
Inputs
Payment	$80.00	8
Discount Rate / Period	6.0%	6
Number of Periods	5	5
Present Value	$336.99	6
Annuity Present Value using a Time Line
Period	0	1	2	3	4	5
Cash Flows	$80.00	$80.00	$80.00	$80.00	$80.00	$80.00
Present Value of Each Cash Flow		$75.47	$71.20	$67.17	$63.37	$59.78
Present Value	$336.99
Annuity Present Value using the Formula
Present Value	$336.99
Annuity Present Value using the PV Function
Present Value	$336.99

&"Arial"&10&K000000&1#

Annuity

Cash Flows 0 1 2 3 4 5 80 80 80 80 80 80 Present Value of Each Cash Flow 0 1 2 3 4 5 75.471698113207538 71.199715201139185 67.169542642584133 63.367493059041635 59.780653829284553

Period

2.2

ANNUITY	Future Value
Inputs
Payment	$80.00	8
Discount Rate / Period	6.0%	6
Number of Periods	5	5
Annuity Future Value using a Time Line
Period	0	1	2	3	4	5
Cash Flows		$80.00	$80.00	$80.00	$80.00	$80.00
Future Value of Each Cash Flow		$101.00	$95.28	$89.89	$84.80	$80.00
Future Value						$450.97
Annuity Future Value using the Formula
Future Value	$450.97
Annuity Future Value using the FV Function
Future Value	$450.97

&"Arial"&10&K000000&1#

Annuity

Cash Flows 0 1 2 3 4 5 80 80 80 80 80 Future Value of Each Cash Flow 0 1 2 3 4 5 100.99815680000003 95.281280000000024 89.888000000000005 84.800000000000011 80

Period

2.3

ANNUITY	System of Four Annuity Variables
Inputs
Payment	$80.00	8
Discount Rate / Period	6.0%	6
Number of Periods	5	5
Present Value	$336.99	6
Annuity Present Value using a Time Line
Period	0	1	2	3	4	5
Cash Flows	$80.00	$80.00	$80.00	$80.00	$80.00	$80.00
Present Value of Each Cash Flow
Present Value
Annuity Present Value using the Formula
Present Value
Annuity Present Value using the PV Function
Present Value
Payment
Payment using the Formula	$80.00
Payment using the PMT Function	$80.00
Discount Rate / Period
Discount Rate / Per using the RATE Func	6.0%
Number of Periods
Num of Periods using the NPER Function	5

&"Arial"&10&K000000&1#

Annuity

Cash Flows 0 1 2 3 4 5 80 80 80 80 80 80 Present Value of Each Cash Flow 0 1 2 3 4 5

Period

3.1 - 3.2

NPV USING CONSTANT DISCOUNTING				Nominal and Real Rates
(in thousands of $)
Inputs
Inflation Rate	3.0%	3
Real Discount Rate	4.854%	4
Outputs
Nominal Discount Rate	8.0%
Net Present Value using a Time Line
Period	0	1	2	3	4	5
Cash Flows	($100.00)	$21.00	$34.00	$40.00	$33.00	$17.00				10	2	3	4	3	1
Present Value of Each Cash Flow	($100.00)	$19.44	$29.15	$31.75	$24.26	$11.57
Net Present Value	$16.17
Net Present Value using the NPV Function
Net Present Value	$16.17

&"Arial"&10&K000000&1#

NPV Using Constant Discounting

Cash Flows 0 1 2 3 4 5 -100 21 34 40 33 17 Present Value of Each Cash Flow 0 1 2 3 4 5 -100 19.444512860323027 29.149725017594321 31.753624816778299 24.256326525817492 11.570117896511826

Period

4.1 - 4.2

NPV USING GENERAL DISCOUNTING				Nominal and Real Rates
(in thousands of $)
		0
Inputs
Period	0	1	2	3	4	5			Add to All Periods
Inflation Rate		3.0%	2.8%	2.5%	2.2%	2.0%			0.0%		2	2	2	2	2	5
Real Discount Rate		4.854%	4.669%	4.683%	4.697%	4.902%			0.0%		4	4	4	4	4	5
Outputs
Period	0	1	2	3	4	5
Nominal Discount Rate		8.0%	7.6%	7.3%	7.0%	7.0%
Net Present Value using a Time Line
Period	0	1	2	3	4	5
Cash Flows	($100.00)	$21.00	$34.00	$40.00	$33.00	$17.00				10	2	3	4	3	1
Cumulative Discount Factor	0.0%	8.0%	16.2%	24.7%	33.4%	42.8%
Present Value of Each Cash Flow	($100.00)	$19.44	$29.26	$32.08	$24.73	$11.91
Net Present Value	$17.42

NPV Using General Discounting

Cash Flows 0 1 2 3 4 5 -100 21 34 40 33 17 Present Value of Each Cash Flow 0 1 2 3 4 5 -100 19.444512860323027 29.258058235727582 32.079423041604514 24.734057380908478 11.908207824613447

Period

5.1 - 5.2

LOAN AMORTIZATION		Basics and Sensitivity Analysis
Inputs
Present value	$300,000	30
Interest rate / year	8.00%	8
Number of years	30	30
Outputs
Year	1	2	3	4	5	6	7	8	9	10	11	12	13	14	15	16	17	18	19	20	21	22	23	24	25	26	27	28	29	30	31
Beg. Principal Balance	$300,000	$297,352	$294,492	$291,403	$288,067	$284,464	$280,573	$276,370	$271,832	$266,930	$261,636	$255,919	$249,744	$243,076	$235,873	$228,095	$219,694	$210,622	$200,823	$190,241	$178,812	$166,469	$153,138	$138,741	$123,192	$106,399	$88,262	$68,675	$47,521	$24,674
Payment	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648	$26,648
Interest Component	$24,000	$23,788	$23,559	$23,312	$23,045	$22,757	$22,446	$22,110	$21,747	$21,354	$20,931	$20,474	$19,980	$19,446	$18,870	$18,248	$17,576	$16,850	$16,066	$15,219	$14,305	$13,317	$12,251	$11,099	$9,855	$8,512	$7,061	$5,494	$3,802	$1,974
Principal Component	$2,648	$2,860	$3,089	$3,336	$3,603	$3,891	$4,202	$4,539	$4,902	$5,294	$5,717	$6,175	$6,669	$7,202	$7,778	$8,401	$9,073	$9,798	$10,582	$11,429	$12,343	$13,331	$14,397	$15,549	$16,793	$18,136	$19,587	$21,154	$22,847	$24,674
Data Table: Sensitivity of the Interest Component to the Interest Rate / Year
Input Values for		Output Formula: Interest Component
Interest rate / year	$24,000	$23,788	$23,559	$23,312	$23,045	$22,757	$22,446	$22,110	$21,747	$21,354	$20,931	$20,474	$19,980	$19,446	$18,870	$18,248	$17,576	$16,850	$16,066	$15,219	$14,305	$13,317	$12,251	$11,099	$9,855	$8,512	$7,061	$5,494	$3,802	$1,974
7.00%	$21,000	$20,778	$20,540	$20,285	$20,013	$19,722	$19,410	$19,076	$18,719	$18,337	$17,928	$17,491	$17,023	$16,522	$15,987	$15,413	$14,800	$14,144	$13,442	$12,690	$11,886	$11,026	$10,105	$9,120	$8,066	$6,939	$5,732	$4,441	$3,060	$1,582
8.00%	$24,000	$23,788	$23,559	$23,312	$23,045	$22,757	$22,446	$22,110	$21,747	$21,354	$20,931	$20,474	$19,980	$19,446	$18,870	$18,248	$17,576	$16,850	$16,066	$15,219	$14,305	$13,317	$12,251	$11,099	$9,855	$8,512	$7,061	$5,494	$3,802	$1,974
Data Table: Sensitivity of the Principal Component to the Interest Rate / Year
Input Values for		Output Formula: Principal Component
Interest rate / year	$2,648	$2,860	$3,089	$3,336	$3,603	$3,891	$4,202	$4,539	$4,902	$5,294	$5,717	$6,175	$6,669	$7,202	$7,778	$8,401	$9,073	$9,798	$10,582	$11,429	$12,343	$13,331	$14,397	$15,549	$16,793	$18,136	$19,587	$21,154	$22,847	$24,674
7.00%	$3,176	$3,398	$3,636	$3,891	$4,163	$4,454	$4,766	$5,100	$5,457	$5,839	$6,248	$6,685	$7,153	$7,653	$8,189	$8,762	$9,376	$10,032	$10,734	$11,486	$12,290	$13,150	$14,071	$15,056	$16,109	$17,237	$18,444	$19,735	$21,116	$22,594
8.00%	$2,648	$2,860	$3,089	$3,336	$3,603	$3,891	$4,202	$4,539	$4,902	$5,294	$5,717	$6,175	$6,669	$7,202	$7,778	$8,401	$9,073	$9,798	$10,582	$11,429	$12,343	$13,331	$14,397	$15,549	$16,793	$18,136	$19,587	$21,154	$22,847	$24,674

Principal And Interest Payments Over Time

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 21000.000000000004 20777.685526266669 20539.809039372001 20285.281198394707 20012.936408548998 19721.527483414095 19409.719933519744 19076.085855132791 18719.097391258754 18337.119734913533 17928.403642624144 17491.0774238745 17023.138369812379 16522.443581965908 15986.700158970189 15413.454696364766 14800.082051376965 14143.773321240018 13441.522979993482 12690.115114859693 11886.108699166536 11025.821834374858 10105.314889047764 9120.3724575477718 8066.4840558427804 6938.8234660184407 5732.2266349063966 4441.1680256165091 3059.73531367633 1581.6023119003378 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 3175.9210533333535 3398.2355270666885 3636.1120139613558 3890.6398549386504 4162.9846447843593 4454.3935699192625 4766.2011198136133 5099.8351982005661 5456.8236620746029 5838.8013184198244 6247.5174107092134 6684.8436294588573 7152.782683520978 7653.4774713674487 8189.2208943631686 8762.4663569685908 9375.8390019563922 10032.147732093339 10734.398073339875 11485.805938473664 12289.812354166821 13150.099218958499 14070.606164285593 15055.548595785585 16109.436997490577 17237.097587314915 18443.69441842696 19734.753027716848 21116.185739657027 22594.31874143302 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 24000 23788.141598705464 23559.334525307368 23312.222886037423 23045.34231562588 22757.111299581415 22445.821802253395 22109.62914513913 21746.541075455723 21354.405960197644 20930.900035718922 20473.5136372819 19979.536326969919 19446.040831832976 18869.865697085079 18247.596551557352 17575.545874387404 16849.73114304386 16065.851233192834 15219.260930553726 14304.94340370349 13317.480474705233 12251.020511387116 11099.243751003551 9855.3248497893001 8511.8924364779086 7060.9854301016057 5494.0058632151995 3801.6679309778801 1973.9429641615754 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 2648.2300161816893 2860.088417476225 3088.8954908743217 3336.0071301442658 3602.8877005558097 3891.1187166002746 4202.4082139282946 4538.6008710425594 4901.6889407259659 5293.8240559840451 5717.3299804627677 6174.7163788997896 6668.6936892117701 7202.1891843487138 7778.3643190966104 8400.6334646243376 9072.6841417942851 9798.4988731378289 10582.378782988855 11428.969085627963 12343.286612478199 13330.749541476456 14397.209504794573 15548.986265178139 16792.905166392389 18136.337579703781 19587.244586080084 21154.22415296649 22846.562085203808 24674.287052020114

Time (Years)

Principal And Interest Components

Loan Amortization

Payment 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 26648.230016181689 Interest Component 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 24000 23788.141598705464 23559.334525307368 23312.222886037423 23045.34231562588 22757.111299581415 22445.821802253395 22109.62914513913 21746.541075455723 21354.405960197644 20930.900035718922 20473.5136372819 19979.536326969919 19446.040831832976 18869.865697085079 18247.596551557352 17575.545874387404 16849.73114304386 16065.851233192834 15219.260930553726 14304.94340370349 13317.480474705233 12251.020511387116 11099.243751003551 9855.3248497893001 8511.8924364779086 7060.9854301016057 5494.0058632151995 3801.6679309778801 1973.9429641615754 Principal Component 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 2648.2300161816893 2860.088417476225 3088.8954908743217 3336.0071301442658 3602.8877005558097 3891.1187166002746 4202.4082139282946 4538.6008710425594 4901.6889407259659 5293.8240559840451 5717.3299804627677 6174.7163788997896 6668.6936892117701 7202.1891843487138 7778.3643190966104 8400.6334646243376 9072.6841417942851 9798.4988731378289 10582.378782988855 11428.969085627963 12343.286612478199 13330.749541476456 14397.209504794573 15548.986265178139 16792.905166392389 18136.337579703781 19587.244586080084 21154.22415296649 22846.562085203808 24674.287052020114

Year

9.1-9.7

FIRM AND PROJECT VALUATION			Five Equivalent Methods
Inputs
Valuation Object		1
Date 0 Proj Investment or Firm Cap	$800.00									50
Tax Rate	40.0%									40
Unlevered Cost of Equity Capital	10.0%									100
Riskfree Rate=Cost of Riskfree Debt	3.0%									30
Infinte Horizon Growth Rate	5.0%									50
Include Infinite Horizon?		1
Cash Flows							2nd Stage:
		First Stage: Finite Horizon					Infin Horiz
Date	0	1	2	3	4	5	6
Revenues		$650.00	$690.00	$720.00	$755.00	$775.00	$840.00				50	50	50	50	50	55
Expenses		$410.00	$435.00	$445.00	$470.00	$470.00	$475.00				50	50	50	50	50	50
Gross Earnings
Depreciation		$60.00	$60.00	$60.00	$60.00	$60.00	$60.00				50	50	50	50	50	50
Earnings Bef Interest & Tax (EBIT)
Interest Expense
Earnings Before Tax
Taxes
Earnings
Add Back Depreciation
Cash Flow from Operations
New Invest in Plant and Equipment		($60.00)	($60.00)	($60.00)	($60.00)	($60.00)					50	50	50	50	50
After-Tax Salvage Value						$0.00									50
New Invest in Working Capital		($10.00)	($10.00)	($10.00)	($10.00)	($10.00)	($10.00)				50	50	50	50	50	50
Cash Flows from Investments
New Borrowing (Repayment)		$5.00	$5.00	$5.00	$5.00	$5.00					50	50	50	50	50
Free Cash Flow to Equity (FCFE)
= Dividends
Interest
Less New Borrowing (Repayment)
Cash Flow to Debtholders (CFD)
Tax Shield Benefit
Free Cash Flow to the Firm (FCFF)
Alternative Way to get FCFF
Earnings
After-tax Interest Expense
Net Oper. Profit After Tax (NOPAT)
Depreciation
Cash Flows from Investments
Free Cash Flow to the Firm (FCFF)
Debt (D)	$250.00									50
Book Value of Equity
Total Capital
Economic Profit
Net Oper. Profit After Tax (NOPAT)
Capital Charge
Economic Profit
(1.) Adjusted Present Value (APV)							2nd Stage:
		First Stage: Finite Horizon					Infin Horiz
Date	0	1	2	3	4	5	6
Free Cash Flow to the Firm (FCFF)
Value of the Unlevered Firm
Tax Shield Benefit
Value of the Tax Shield Benefit
Value of the Firm (APV Method)
- Date 0 Firm Capital
Value Added by Firm (APV Method)
(2) Free Cash Flow to Equity (FCFE)							2nd Stage:
		First Stage: Finite Horizon					Infin Horiz
Date	0	1	2	3	4	5	6
Debt + Equity (D+E)
Equity (E)
Levered Cost of Equity Capital
Free Cash Flow to Equity (FCFE)
Value of Equity (E)
Value of Debt (D)
Value of the Firm (FCFE Method)
- Date 0 Firm Capital
Value Added by Firm (FCFE Method)
(3) Free Cash Flow to the Firm (FCFF)							2nd Stage:
		First Stage: Finite Horizon					Infin Horiz
Date	0	1	2	3	4	5	6
Equity Weight (E / (D+E))
Debt Weight (D / (D+E))
Cost of Firm Capital (WACC)
Free Cash Flow to the Firm (FCFF)
Value of the Firm (FCFF Method)
- Date 0 Firm Capital
Value Added by Firm (FCFF Method)
(4) Dividend Discount Model (DDM)							2nd Stage:
		First Stage: Finite Horizon					Infin Horiz
Year	0	1	2	3	4	5	6
Dividend
Value of Equity (E)
Value of Debt (D)
Value of the Firm (DDM Method)
- Date 0 Firm Capital
Value Added by Firm (DDM Method)
(5) Residual Income (RI)							2nd Stage:
		First Stage: Finite Horizon					Infin Horiz
Year	0	1	2	3	4	5	6
Economic Profit
Economic Profit on Salvage Value
Value of the Economic Profit
+ Date 0 Book Value of the Firm
Value of the Firm (RI Method)
- Date 0 Firm Capital
Value Added by Firm (RI Method)

(13) Free Cash Flow to Equity Enter =C34 and copy across

Firm

Project

Valuation Object

Yes

No

Infinite Horizon

15.1

BREAK-EVEN ANALYSIS		Based On Accounting Profit
Inputs
Fixed Costs	$30,000	30
Sales Revenue / Unit	$6.00	6
Variable Costs / Unit	$4.00	4
Calculate the Break-even Point using the Formula
Break-even Point (Unit Sales)	15,000
Back solve for the Break-even Point using the Income Statement
Unit Sales	15,000
Sales Revenue	$90,000
Variable Costs	$60,000
Gross Margin	$30,000
Fixed Costs	$30,000
Accounting Profit	$0
Data Table: Sensitivity of Costs, Revenues, and Acct. Profit to Unit Sales
		Input Values for Unit Sales
Output Formulas:		0	5,000	10,000	15,000	20,000
Total Costs	$90,000	$30,000	$50,000	$70,000	$90,000	$110,000
Sales Revenue	$90,000	$0	$30,000	$60,000	$90,000	$120,000
Accounting Profit	$0	($30,000)	($20,000)	($10,000)	$0	$10,000

Break-Even Point Based On Acct. Profit = 0

Total Costs 0 5000 10000 15000 20000 30000 50000 70000 90000 110000 Sales Revenue 0 5000 10000 15000 20000 0 30000 60000 90000 120000 Accounting Profit 0 5000 10000 15000 20000 -30000 -20000 -10000 0 10000

Unit Sales

15.2

BREAK-EVEN ANALYSIS		Based On NPV
(in thousands of $)
	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7
Key Assumptions
Sales Growth Rate			55.0%	40.0%	25.0%	5.0%	-20.0%	-50.0%
Change in Sales Growth Rate				-15.0%	-15.0%	-20.0%	-25.0%	-30.0%
Inflation Rate		2.0%	2.5%	3.0%	3.5%	4.0%	4.0%	4.0%
Real Cost of Capital		11.0%	11.2%	11.4%	11.6%	11.8%	12.0%	12.2%
Tax Rate		35.0%	35.0%	35.0%	35.0%	35.0%	35.0%	35.0%
Discounting
Discount Rate = Cost of Capital		13.2%	14.0%	14.7%	15.5%	16.3%	16.5%	16.7%
Cumulative Discount Factor	0.0%	13.2%	29.0%	48.1%	71.0%	98.9%	131.6%	170.3%
Price or Cost / Unit
Unit Sales		1,875	2907	4070	5087	5342	4273	2137
Sales Revenue / Unit		$9.70	$9.94	$10.24	$10.60	$11.02	$11.46	$11.92
Variable Cost / Unit		$7.40	$7.59	$7.81	$8.09	$8.41	$8.75	$9.10
Cash Fixed Costs		$5,280	$5,412	$5,574	$5,769	$6,000	$6,240	$6,490
Cash Flow Forecasts
Sales Revenue		$18,192	$28,903	$41,678	$53,921	$58,881	$48,989	$25,474
Variable Costs		$13,879	$22,050	$31,796	$41,135	$44,920	$37,373	$19,434
Gross Margin		$4,314	$6,853	$9,882	$12,785	$13,962	$11,616	$6,040
Cash Fixed Costs		$5,280	$5,412	$5,574	$5,769	$6,000	$6,240	$6,490
Depreciation		$1,421	$1,421	$1,421	$1,421	$1,421	$1,421	$1,421
Total Fixed Costs		$6,701	$6,833	$6,996	$7,191	$7,422	$7,662	$7,911
Operating Profit		($2,388)	$20	$2,887	$5,594	$6,540	$3,954	($1,871)
Taxes		($836)	$7	$1,010	$1,958	$2,289	$1,384	($655)
Net Profit		($1,552)	$13	$1,876	$3,636	$4,251	$2,570	($1,216)
Add Back Depreciation		$1,421	$1,421	$1,421	$1,421	$1,421	$1,421	$1,421
Operating Cash Flow		($131)	$1,434	$3,298	$5,058	$5,672	$3,992	$205
Investment in Plant & Equip	($11,350)							$1,400
Cash Flows	($11,350)	($131)	$1,434	$3,298	$5,058	$5,672	$3,992	$1,605
Present Value of Each Cash Flow	($11,350)	($115)	$1,111	$2,227	$2,957	$2,852	$1,723	$594
Net Present Value	($0)
Data Table: Sensitivity of Net Present Value to Year 1 Unit Sales
and Year 2 Sales Growth Rate
Output Formula:		Input Values for Year 1 Unit Sales
Net Present Value	($0)	1,700	1,900	2,100	2,300
	45.0%	($6,767)	($4,692)	($2,618)	($543)
Input Values for Year 2	50.0%	($4,673)	($2,352)	($31)	$2,290
Sales Growth Rate	55.0%	($2,283)	$319	$2,921	$5,523
	60.0%	$442	$3,365	$6,288	$9,210
	65.0%	$3,548	$6,836	$10,124	$13,412

NPV Break-Even Contour (Based On NPV = 0) Across Year 1 Unit Sales And Year 2 Sales Growth Rate

1,700 0.45 0.5 0.55000000000000004 0.6 0.65 -6767.0836670711742 -4672.9277187851812 -2283.1385032181506 442.23187178181001 3547.5606264680082 1,900 0.45 0.5 0.55000000000000004 0.6 0.65 -4692.4891514404444 -2351.9619151207999 318.97897286588602 3364.9811566893713 6835.6427060445294 2,100 0.45 0.5 0.55000000000000004 0.6 0.65 -2617.8946358097064 -30.996111456413871 2921.0964489499165 6287.7304415969229 10123.724785621049 2,300 0.45 0.5 0.55000000000000004 0.6 0.65 -543.30012017896979 2289.9696922079647 5523.2139250339442 9210.4797265044799 13411.806865197566

Year 2 Sales Growth Rate

Net Present Value

Year 1 Unit Sales

NPV Break-Even Contour

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