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McGuire + Farry
Financial Projections
Keith McManusPartner McGuire + Farry Tel: 028 908137447th November 2008
Email:[email protected]
Agenda
• How to measure the performance of your business ?
- Review of key profitability, liquidity and leverage ratios
- Worked example
- Invest NI ratio analysis
Agenda
• The Importance of Cash
- causes of business failure
– defining cashflow
– link between profit and cash
– worked example
– how to establish the funding requirement
Agenda
• Funding Requirements / Sources
– difficulties faced when seeking initial funding
– sources of funding
– what do Banks look for
– repayment capacity
Agenda
• The Business plan process
– different uses of the business plan
– a walkthrough of the key contents of a business plan
McGuire + Farry
Measuring the Performance of your Business
- business financial ratios
Business Financial Ratios
Simple example – Gross Profit Margin (GPM)
A Sales are £500,000
B Cost of sales are £350,000
C Gross Profit is £150,000 (A minus B)
D GPM margin is 30% (C as % of A)
Business Financial Ratios
• Main Ratio Categories– Profitability – Liquidity and solvency– Leverage (Gearing)
Profitability – how successfully is the business being run?
(1) Sales Growth Current Year SalesPrior Year Sales x 100 = %
(2) GPM Gross Profit x 100 = % Sales
(3) Net Profit Margin Profit before Tax x 100 = % Sales
(4) Return on Capital Profit before Tax x 100 = %Employed (ROCE) Shareholders Funds
Liquidity – Can the company meet current obligations when they fall due?
(1) Current Ratio Current Assets =Ratio
Current Liabilities
(2) Quick Ratio Current Assets-Stocks = RatioCurrent Liabilities
(3) Debtors days
Debtors x 365 = days
Sales
Liquidity – Can the company meet current obligations when they fall due?
(4) Creditor days Trade Creditors Purchases x 365 = days
(5) Stock turnover Average stock x 365 = days
Cost of sales
Leverage – Dependency on external debt ?
(1) Gearing Ratio Total External Debt Shareholders funds x 100 =
%
Business financial ratios
• Interpretation of ratios– Banks / HP and finance companies– Investors
Widgets NI Ltd
2004 2005 2006
Profit & Loss £ £ £
Sales 2,652,000 2,754,000 2,856,000
Cost of goods sold 2,121,000 2,203,200 2,284,800
Gross profit 531,000 550,800 571,200
General admin & selling 204,000 224,400 244,800
Depreciation 81,600 102,000 122,400
Miscellaneous 41,400 85,700 122,400
Total Overheads 327,000 412,100 489,600
Net profit before tax 204,000 138,700 81,600
Widgets NI Ltd
2004 2005 2006
Balance Sheet £ £ £
FIXED ASSETS
Land and buildings 49,000 130,600 122,400
Machinery 151,000 118,300 102,000
Motor vehicles 28,600 8,200 6,100
228,600 257,100 230,500
CURRENT ASSETS
Stock 306,000 550,000 876,600
Debtors 245,000 306,400 448,000
Cash 61,000 28,600 20,000
612,000 885,000 1,344,600
Widgets NI Ltd
2004 2005 2006
Balance Sheet (cont’d) £ £ £
CURRENT LIABILITIES
Bank - 102,000 286,000
Creditors 98,000 155,000 306,000
Accruals 49,000 57,000 77,500
147,000 314,000 669,500
NET CURRENT ASSETS 465,000 571,000 675,100
Creditors>1 year – Loan 45,000 40,800 36,700
NET ASSETS 648,600 787,300 868,900
SHARE CAPITAL 365,000 365,000 365,000
Reserves 283,600 422,300 503,900
SHAREHOLDERS FUNDS 648,600 787,300 868,900
Performance ratios - Profitability
2004 2005 2006
Sales growth 3.8% 3.7%
Gross profit margin % 20% 20% 20%
Net profit margin % 7.7% 5.0% 2.8%
Return on Capital Employed 31.5% 17.6% 9.4%
Performance Ratios -Liquidity & Gearing
2004 2005 2006
Current Ratio 4.16:1 2.82:1 2.0:1
Quick ratio 2.08:1 1.1:1 0.69:1
Debtors days 34 41 57
Creditors days 17 26 49
Stock Turnover days 71 114
Gearing 7% 18% 37%
Invest NI
Invest NI – Ratio Analysis • ROCE• GPM• Current ratio• Quick ratio• Stock turnover• Debtors days• Creditors days• Gearing ratioOther; • Value added per employee
McGuire + Farry
The Importance of Cash
Contents
• Causes of business failure
• What is the cashflow?
• Relationship of profit to cash
• Example
• Establishing the funding requirement
Causes of business failure
• Poor cashflow management
• Poor business planning
• Market failure
• Inadequate or inappropriate financing
What is cashflow?
• Links the Profit & Loss Account to the Balance Sheet
• Shows how much cash was physically received/spent during the period
• Shows whether the organisation had a net inflow or outflow of cash
PROFIT DOES NOT EQUAL CASH !
Relationship of Profit to Cash
ProfitAdd Back:DepreciationTax= Profit from operating activities
Movement in working capital assets:(Increase)/Decrease in stock(Increase)/ Decrease in debtorsIncrease/(Decrease) in creditorsIncrease/(Decrease) in accruals(Loan repayments) / New loans(Capital expenditure)= Net Operating Cashflow
Widget NI Ltd
2005 £ £
Profit 138,700
Add Back – Depreciation 102,000
Profit from operating activities 240,700
Movement in working capital assets
Increase in stock (244,000)
Increase in debtors (61,400)
Increase in creditors & accruals 65,000
Loan repayments (4,200)
Capital expenditure (130,500) (375,100)
Net Operating Cashflow (192,600)
Widget NI Ltd
2006 £ £
Profit 81,600
Add Back – Depreciation 122,400
Profit from operating activities 204,000
Movement in working capital assets
Increase in stock (326,600)
Increase in debtors (141,600)
Increase in creditors & accruals 171,500
Loan repayments (4,100)
Capital expenditure (95,800) (396,600)
Net Operating Cashflow (134,400)
Establishing the Funding Requirement
• Establish the three year funding requirement
- Capital expenditure
- Working capital
• Peak funding requirement
McGuire + Farry
Sources of Funding
Overall Perspective of the Finance Market
• Initial funding is most difficult• Combination of funding sources• Capital grants have reduced• NI is generally a favourable place to borrow.
Equity Capital
• Capital introduction
- Own capital
- Business Angels
- Venture capital
Finance - Who are the debt providers?
• Main tier (4 Clearing Banks)• Second Tier- Anglo Irish Bank- Bank of Scotland- Barclay's Bank- HSBC Bank plc- Internet banks
Bank Products – Short Term
- Extension of overdraft facility
- Invoice discounting
- Stock financing
- Forward contracts
Bank Products – Medium term
- Fixed rate loans
- Variable term loans
- Hire purchase / leasing
- Small Firm's Loan Guarantee Scheme
Approach to lending
Three major areas of importance:
1. The borrower
2. Capacity to repay
3. Security
The Borrower
Key issues:
Track record Integrity Management ability Quality of MIS Can they successfully carry the project through?
Repayment Capacity
• The adequacy and stability of cash generation to meet:– working capital needs– capital expenditure needs– dividends– tax– debt reduction
while keeping leverage at acceptable levels
• Demonstrating satisfactory repayment capacity
Security
If all else fails -
• Receivership/liquidation/bankruptcy costs• Personal guarantees• Guarantors
Other Sources of Funding
• Invest NI• Business Angels• Venture Capitalists• Going public
Invest Northern Ireland
• focussing on stimulating entrepreneurship
• target grants in high growth sectors
• target exporting, R&D, mktg & training
Business Angels
PATRON ANGELS• invest £1million • little involvement in day to day affairs
ENTREPRENEURIAL ANGELS• invest between £50,000 - £1million• provide 'hands-on' support
OCCUPATIONAL• up to £50,000 to invest• seeking full time employment
Venture Capitalists
• Generally for investment over £1 million
• venture capitalists look for a high return
• expect demanding targets
• will have knowledge of your industry
• experience in how to realise their investment
• specific interest in growing your business quickly
What do Venture Capitalist's and Business Angels look for?
• Attractive market
• ability to sustain a competitive edge
• strong growth opportunities
• strong management
Going Public
• Key markets
• Full Listing on the LSE
• AIM (Alternative Investment Market)
• Others
AIM
• Junior Stock Market launched 1995
• no set requirements for size
• generally market capitalisations of £1 - £10 million
• used primarily to raise money to grow rather than payout existing shareholders
• must appoint NOMAD to advise
Full Listing
• demands strict admission criteria
• requires three year track record
• directors and senior management with expertise
• market capitalisation of at least £700,000
• 25% of shares must be in public hands
• publish a comprehensive prospectus including financial information
McGuire + Farry
The Business Plan Process
Uses of a Business Plan
Internal• as a plan for the business
• as a means of measuring performance
• as a way of communicating with employees
• as a way to detect adverse trends early and to be able to correct them
Uses of a Business Plan (contd)
External
• to be used to raise finance
• to demonstrate control of the business
• to provide information about the business
Contents of a Business Plan
• Executive Summary• Background• Ownership, management and control• Market and marketing strategy• Product and production • Historical financial information• Projected financial information• Funding proposal
Background & Terms of Reference
• Brief overview of business
- When business will start
- Core business / core products / services
- Market trends
- Market share / competitors
Background & Terms of Reference
• Purpose of the business plan
- Business objectives
- Key business issues to meet
- Management resources
- Production / product development
- Sales / marketing etc
Ownership, Management & Control
Ownership• - Status of Business• - Identify owners / directors / partners
Ownership, Management & Control
Management
- Planned organisational chart
- Identify key functional managers (Sales / production / technical / finance)
- Identify any resource gaps
- Require job specifications / job descriptions
Ownership, Management & Control
• Control
- Describe accounting and control system(Sales / purchases / overheads / stock /payroll / computer system)
- Detail management information system
Marketing
• Market overview
• Sales / marketing resource
• Target customers / markets
• Competition
Marketing (contd)
• Pricing
• SWOT analysis
• Marketing strategy / tactics
• Promotion / selling methods
• Action plan and budget
Production
• Product / service range
- Competitive advantage
• New product development
• Premises
• Materials
Production (contd)
• Labour
• Quality control
• Cost control
• Capital equipment
Financial Projections
• Source of business comparison
• Key business ratios
- Profitability
- Liquidity
- Leverage
Financial Projections
• Three year financial projections:– Balance Sheet– Profit & Loss– Cashflow
• Detail out assumptions
• Funding proposal falls out of this
• Failing to plan is planning to fail
• “Prediction is very difficult, especially about the future” (Niels Bohr)