Unit 5 - Fun with Finance
Learning Target 3: I can explain the process of business planning
When you want to start a business chances are you are going to require substantial financing to get started. Even if you start a lawn mowing business you are going to need a mower which is close to $2000 and a truck and trailer to get that mower to each and every job site which will be at least $10,000 and up. The amount of money needed to start a business is directly related to what kind of business you are starting. Read this article on how to estimate your startup costs for your new business.
How does a business acquire the cash (capital) to get started? The obvious answer is loans from a credit union or bank. This is correct but are their other ways. You could get a personal loan from a relative or use a credit card or you could get a third party investor also known as a venture capitalist who could provide you the money needed to open or expand your business.
When deciding to acquire cash it is important for a business to differentiate between working capital management and capital management decisions. Work capital management deals with the company’s current balance of its assets and liabilities as well as who they owe money to (accounts payable), who owes them money (accounts receivables), inventory and cash. Capital investment decisions involves what projects will be financed and how it will be financed as well as the amount of dividends should be paid to shareholders.
A key component of working capital management is the cash conversion cycle. A business will use its cash to purchase inventory and then pay its suppliers so it can manufacture its products in order to sell to its customers who may pay them at a later date. As you can see the cash conversion process is not a cycle that happens all at once, in fact there may be significant time gaps between each step. The goal of a financial manager is the shorten the time between each step of the cash conversion cycle in order for the business to have more working capital. This is an important component of a business because when a business asks for more money for some capital management decisions its cash conversion cycle is often evaluated by potential investors as well as other items.
Digging deeper into capital investment decisions, mangers have to make some tough decisions such as how much cash do they want to use to finance a project. More times than not a business will not use all of its cash to invest in a new project because it knows it will need working capital for day to day operations. Companies have to determine their capital structure or in other words how much money do they want to borrow (debt) as compared to using the assets they already own (equity). Every business has different ideas on what that mix should be and there is no one correct answer. The only wrong answer is one in which the project invested in does not make money.
In order to get financing capital investment decisions a business needs to prove to the capital provider that their business will be successful and they will get their money back plus interest or equity. In order to do this, you need to create proforma financial statements. The three proforma financial statements usually needed to acquire capital for startups are the income statement, balance sheet and statement of cash flows.
Watch these videos for a brief overview of each of the financial statements.