Chapter 9: Creating a
Successful Financial Plan
Objectives |
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Upon completion of this chapter, you will be able to:
- Understand the importance of preparing a financial plan.
- Describe how to prepare the basic financial statements and use them to
manage a small business.
- Create projected (pro forma) financial statements.
- Understand the basic financial statements through ratio analysis.
- Explain how to interpret financial ratios.
- Conduct a breakeven analysis for a small company.
Chapter 9: Creating a
Successful Financial Plan
Chapter Overview
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- Understand the importance of preparing a financial plan.
- Launching a successful business requires an entrepreneur to create a solid
financial plan. Not only is such a plan an important tool in raising the capital
needed to get a company off the ground, but it also is an essential ingredient
in managing a growing business.
- Earning a profit does not occur by accident; it takes planning.
- Describe how to prepare the basic financial statements and use them
to manage the small business.
- Entrepreneurs rely on three basic financial statements to understand the
financial conditions of their companies:
- The balance sheet - Built on the accounting equation: Assets =
Liabilities + Owner's Equity (Capital), it provides an estimate of the company's
value on a particular date.
- The income statement - This statement compares the firm's revenues
against its expenses to determine its net profit (or loss). It provides
information about the company's bottom line.
- The statement of cash flows - This statement shows the change in the
company's working capital over the accounting period by listing the sources and
the uses of funds.
- Create projected (pro forma) financial statements.
- Projected financial statements are a basic component of a sound financial
plan. They help the manager plot the company's financial future by setting
operating objectives and by analyzing the reasons for variations from targeted
results. Also, the small business in search of startup funds will need these pro
forma statements to present to prospective lenders and investors. They also
assist in determining the amount of cash, inventory, fixtures, and other assets
the business will need to begin operation.
- Understand the basic financial statements through ratio analysis.
- The twelve key ratios described in this chapter are divided into four major
categories: liquidity ratios, which show the small firm's ability to meet
its current obligations; leverage ratios, which tell how much of the
company's financing is provided by owners and how much by creditors;
operating ratios, which show how effectively the firm uses its resources;
and profitability ratios, which disclose the company's profitability.
- Many agencies and organizations regularly publish such statistics. If there
is a discrepancy between the small firm's ratios and those of the typical
business, the owner should investigate the reason for the difference. A below
average ratio does not necessarily mean that the business is in trouble.
- Explain how to interpret financial ratios.
- To benefit from ratio analysis, the small company should compare its ratios
to those of other companies in the same line of business and look for trends
over time.
- When business owners detect deviations in their companies' ratios from
industry standards, they should determine the cause of the deviations. In some
cases, such deviations are the result of sound business decisions; in other
instances, however, ratios that are out of the normal range for a particular
type of business are indicators of what could become serious problems for a
company.
- Conduct a breakeven analysis for a small company.
- Business owners should know their firm's breakeven point, the level of
operations at which total revenues equal total costs; it is the point at which
companies neither earn a profit nor incur a loss. Although just a simple
screening device, breakeven analysis is a useful planning and decision-making
tool.
Chapter 9: The Foundations of
Entrepreneurship
Small Business
Assignments |
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Answer all of the following questions:
1. Why is developing a financial plan so important to an entrepreneur
about to launch a business?
2. How should you use the 12 ratios discussed in this chapter?
3. Outline the key points of the 12 ratios. What signals do each
ratio give to you the manager?
4. What are pro forma financial statements and why are they important
to the financial planning process?
5. How can the break-even analysis help you plan to launch a business?
Chapter 9: Creating a
Successful Financial Plan
Small Business Links
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