The University of Sydney Page 1FINC6025ENTREPRENEURIAL FINANCEWEEK 4Key ideas from Chapter 7Chapter 9 Projecting FinancialStatementsPresented byJoakim WesterholmcrunchbaseThe University of Sydney Page 22The University of Sydney Page 3Schedule for Session 410 min Types and Costs of Financial Capital – Key topics relevant for this UoS20 min Adjusted Growth Rates, Sustainable Growth Rates and Additional Funds Needed50 min Projected Financial Statements10 min START PREPARING FOR STARTUP BUSINESS PLAN AND PITCHThis moduleThe University of Sydney Page 4Types & Costs of Financial Capital– Implicit Versus Explicit Financial Capital Costs– Formal historical accounting procedures include explicit records of debt(interest and principal) and dividend capital costs– However, no provision is made to record the less tangible expenses ofequity capital (i.e., required capital gains to complement the lack ofdividends)4The University of Sydney Page 5Determining Market Interest Rates for New Venture DebtFINC5001, Fixed Income Classes– rd = RR + IP + DRP +LP +MP– Suppose:– Real interest rate = 3%– Inflation expectation = 3%– Default risk = 5%– Liquidity premium = 3%– Maturity premium = 2%– Then:– rd = 3% + 3% + 5% + 3% + 2% = 16%5The University of Sydney Page 6Public Corporation Cost of EquityFINC5001– Expected Return on Venture’s Equity (re) using theSecurity Market Line (SML):– re = rf + [MRP] β– MRP:– market risk premium =excess average annual return of common stocksover long-term government bonds6The University of Sydney Page 7Private Venture Cost of Equity– Venture Hubris:– optimism expressed in business plan projections that ignore thepossibility of failure or underperformance– What do we do with such projections? Use– rv = re + AP + LP + HPP– where: » rv» re= rate of return for venture investors= cost of common equity » AP = advisory premium» LP = liquidity risk» HPP = hubris projections premium– This is how we come up with Target Returns7The University of Sydney Page 8main “result” from the Chapter 7 Types and Cost ofFinancial Capital: Target Return Comparison8The University of Sydney Page 99The University of Sydney Page 10Chapter 9: Learning Objectives– Explain the differences in forecasting sales for seasoned firmsversus early-stage firms– Understand the concept of sustainable sales growth rate– Understand the process of identifying the quantity and timingof additional funds needed to support the venture’s salesforecasts– Connect sales growth rates to the amount and timing ofadditional funds needed– Describe the percent-of-sales method for preparing financialplans10The University of Sydney Page 11The University of Sydney Page 12The University of Sydney Page 13The University of Sydney Page 14Projecting Financial Statements: Adjusted Growth RatesSeasoned Firm Forecasting14The University of Sydney Page 15Early-Stage Forecasting15The University of Sydney Page 16Knocking Back Those Growth Rates (Venture Capitalists)16The University of Sydney Page 17Sustainable Sales Growth Rates– Internally Generated Funds: Net income or profits after taxesearned over an accounting period– Sustainable Sales Growth Rate: Rate at which a firm can growsales based on the retention of profits in the business17The University of Sydney Page 18Sustainable Sales Growth Rates18Don’t worry Accountants like to break down their measuresinto its components to see what drives them!The equations will given IF used in the exams.WHAT IS IMPORTANT?Last slide says: “Sustainable Sales Growth Rate: Rate at which a firm can grow sales,based on the retention of profits in the business“ > there is a limit to how much a companyCan grow with internally generated funds!The University of Sydney Page 19Sustainable Sales Growth Rates19ROE = Net Profit Margin x Asset Turnover x Equity Multiplierg ROA x FPg Operating Performance x Financial Policiesx RRCETAxTANSxNSNIgCETAxTANSxNSNICENIROEbeg= = == =More breakdown of accounting ratios…The University of Sydney Page 20Additional Financing Needed (A quick way to determinefinancing needs -next year- and see where they come from)– Financing Capital Needed (FCN): financial funds needed toacquire assets necessary to support a firm’s sales growth– Spontaneously Generated Funds: increases in accountspayables and accruals (wages and taxes) that occur with asales increase20The University of Sydney Page 21Additional Funds Needed– Additional Funds Needed (AFN): gap remaining between thefinancial capital needed and that funded by spontaneouslygenerated funds and retained earnings, or,– AFN = Required Increase in Assets – Spontaneously GeneratedFunds – Increase in Retained Earnings21The University of Sydney Page 22AFN EquationRR Retention RateNI Net IncomeAL Accrued liabilitiesAP AccountspayableNS Change in net sales between next year and current yearNS Net saleswhere :TA Total assets(RR )NSNI( NS) – (NS )NSAP AL( NS) –NSTAAFN oo o1oo oo o== = = ==== + 22The University of Sydney Page 2323$68,000.625($480,000) -.05($480,000) – $2,080,000(.10)(1.00)(1.00)$1,600,000$160,000($480,000) – ($2,080,000)$1,600,000$80,000($480,000) –$1,600,000$1,000,000AFN= = ==The University of Sydney Page 24Projecting Financial Statements– Percent of Sales Method: make projections based on theassumption that certain costs and selected balance sheet itemsare best expressed as a percentage of sales– Constant Ratio Method: variant of the percent of sales methodthat projects selected cost and balance items at the samegrowth rate as sales24The University of Sydney Page 25Projecting Financial Statements– Financial Forecasting Process To Project Financial Statements1. Forecast sales – See recorded lecture: Top Down vs. Bottom Up2. Project income statement3. Project balance sheet4. Project statement of cash flows25The University of Sydney Page 26Projected Income Statements26The University of Sydney Page 27Projected Balance Sheets27The University of Sydney Page 28Projected Statements of Cash Flow28The University of Sydney Page 29START: STARTUP BUSINESS PLAN AND PITCH– Business Model Generation• What tools do we have out our disposal?• The Business Model Canvas• Others? Do a web search! Many sites provide businessplans but do not help with the idea generation.–Cash Flow Projections• Generate credible cash flow projections for three yearsforward based on the business model design.• Use cash flow pro forma in Financial Projections:Blank.xlsx–What is the aim?• To prepare for the Group Assignment Report• To prepare for the Group Pitch29The University of Sydney Page 30The business model canvas30The University of Sydney Page 31Cash flow projections in assignment– Extract from the assignment description (coming up soon)– 2. Cash Flow Projections (20 Marks): Generate credible cash flow projections for three yearsforward (month-by-month for the first year) based on thebusiness model design. See cash flow pro forma in Financial Projections –Blank.xlsx and fill in worksheet 6b-CashFlowYrs1-3. Pastea screenshot of this sheet in landscape mode into yourreport. Use multiple pages to improve readability ifnecessary. (MODEL SPREADSHEET TO BE UPLOADED)–Suggested methods:– a. Utilize peer analysis to generate values and providerationale for input values.– b. You may use approaches such as unit forecasting,costing or others.– The Tools Needed for Business Model Generation areDiscussed in separate “Bonus Lectures”, Part 1 and 2 ofBusiness Model Canvas, already uploaded.31The University of Sydney Page 32Takeaways from this Fourth lectureThree New Tools1. Target Returns2. Adjusted Venture Growth Rates and Sustainable growth rates3. Additional Funds Needed!4. Beginning of projecting full financial statements– XERO will current statements for you but you need understandhow the statements are generated– Then you can forecast projected statements from current– Then you can forecast long term financing needs in a completedynamic proforma financial statement model
