THOSE FINANCIALS AGAIN 293
Those financials again
Remember how you looked out of the window and compared yourself with other compa-
nies in your industry (see Chapter 5). Recall how you valued capital projects and assessed
your rate of return (see Chapter 11). This is exactly how others – bosses, bankers and
backers – will crawl over the financials in your business plan. You know how you did the
analysis so it should not be too hard to visualise how others will do it to you. They will:
review your break even position to ensure you have comfortable safety margins;
look at the state of your profit and loss account and compare costs and revenues;
analyse your balance sheet, checking for liquidity and valuable assets;
examine your cash flow to ensure that it is healthy;
compare you against other companies in similar industries.
None of this should hold any terrors for you – you have already worked through these
details. However, as promised earlier, now is a good time to run through the measure-
ments that are taken during your health check.
Why plans fail after passing the first glance
If business plans are rejected after passing the first glance, it is usually because they
do not answer the questions in Figures 12.1 and 12.3. The most common omission
is failing to reassure the reader that marketing and sales will bring home the
silver. The second most frequent problem is lack of operational detail – how it will
happen. Both of these boil down to a weakness in (explaining) the strategy. Beyond
these factual details, the major hurdle for new ventures is conveying your vision –
as shown by the quotations scattered throughout this chapter.
t
If you go to a doctor for a medical check-up, you will be measured
exhaustively. A nurse will check your age, height, weight, blood pressure,
pulse, take a blood sample and so on. Interesting stuff, but so what if your
red blood count is 4 million/ml? This is meaningless unless explained and compared
against some measure. You do not want to be in good shape for a 60-year-old if you
are only 32. This is exactly how it is with many of your financials.
294 CHAPTER 12 GETTING IT APPROVED
Everybody
1 Can the management adequately describe their ideas? Do they have good communication
skills?
2 If it is an existing business, how has it been managed up to now?
3 What is the quality of the management?
4 Do they understand their business? Do they have a penetrating understanding of critical
factors such as costs per item, break even, sales per product?
5 Do they understand the market? Who will buy? Why?
6 Do they understand the competition? Who are the key competitors? What is their market
share?
7 Where is the action plan? How will theory be turned into action?
Fussy equity investors Easy-to-please bankers!
Funding requirements
8 How much funding is required? 8 Is there adequate
9 What will the money be used for? security for loans?
10 What will we be buying – in terms of fixed assets,
intellectual property, dreams?
The history 9 Will there be adequate
11 How much money has gone in already? cash flow to pay interest
12 How much came from the existing owners?* and repay principal?
13 Where else did it come from?
14 How was it used?
15 With what results?
The future
16 How will further expansion be funded?
17 How will our investment grow and how will it be diluted
by further share issues?
The deal
18 What percentage of the company is on offer?
19 At what price?
20 What sort of shareholders are required? Passive
or active. With specific skills, expertise, contacts?
21 How will investors unlock future value?
22 What will be the return on equity?
23 What are the risks of losing the investment?
* Yes, I know that the owners, logically, own 100% of the issued capital. However, a founder presenting
a plan might have spent his entire savings and mortgaged his house in return for 10% of the equity, or
he might have risked almost nothing in return for 90%. A big difference in perceived commitment.
Figure 12.1 The things that they want to know!
THOSE FINANCIALS AGAIN 295
Take an obvious example. A high proportion of overdue accounts receivable might be
normal for a company selling household appliances on credit, but it would be very odd
for a clothing retailer with a cash-based business.
There is a message here. I can show you some of the figures that bankers and other
investors will look at, but you have to use your own knowledge of your industry to know
whether yours look good, bad or indifferent.
Of course, you have to compare like with like. If you assemble computers from compo-
nents sourced overseas, your balance sheet will look very different from another computer
company that itself manufactures the main boards. They will use more machinery and
equipment than you. They probably have more fixed assets – and this means that the ratio
of their sales to assets will be smaller than yours if you have the same market share.
What will readers look at? Some key indicators are shown on the following pages. You will
find that the names, constituent parts and arithmetic vary from country to country – and
indeed from analyst to analyst. For example, the receivables turnover ratio – sales divided
by accounts receivable – in the US is turned upside down in the UK and called the trade
debtors to sales multiple – trade debtors (that is, accounts receivable) divided by sales.
Different name. Different way of expressing the relationship. Same message.
Incidentally, try to use the terms familiar to your readers.
However, from the information given, you should be able to cope with the indicators
whatever guise they are wearing when you meet them. I have written the commentary as if
you were the one interpreting the indicators, because this is how I want you to look at your
business plan right now. You do not need to worry too much about the arithmetic – just
look at what is being compared with what. When you have glanced through these exam-
ples, I will show you a delightful relationship that will help clarify the meaning of it all.
If you look poor against an industry average, but good against a specific
competitor, make sure that you are compared with the company not the
average. You could make specific reference to this by identifying the best
comparison, or by including some helpful figures that do the work. Take care to
explain it well, or a naïve reader stumbling upon the poor comparison might think
that you had deliberately tried to mislead.
t
Do you need a summarised plan? Sometimes commentators suggest
sending the executive summary only to your targets, and following up with
the full plan in due course. I am not enthusiastic about this. If you decide
that you do need a summary, extract the appropriate information from your full
plan to create a short version (with its own executive summary). Make it lighter –
closer to magazine format – and indicate that a detailed plan is available.
t
296 CHAPTER 12 GETTING IT APPROVED
What do I get for my money?
Where possible, include in your business plan a table showing how you will use the
funds. If you can demonstrate increasing value at the same time you will make your
backers feel much more comfortable.
The following schedule shows how the funds will be applied. By the end of July,
total outlays of $500,000 will have secured assets and inventory with a book value
of $485,000 (value will be added by manufacturing process). We will also have an
exclusive sales licence for Africa which we value at. …
Date Item Amound
payable
Running
total
Comment
1 June Deposit for machine 10,000 10,000 Refundable
15 June Legal fees 15,000 25,000 Exclusivity for Africa
25 June Deposit for prototype 25,000 50,000 Refundable
1 July Machine delivered 90,000 140,000 100% increase in capacity
12 July Inventory delivered 200,000 340,000 Basic inputs for production
18 July …
t
Indicators of liquidity
Liquidity ratios indicate whether the business is likely to be able to meet its
financial obligations as they fall due.
Indicator Comment
Current ratio
Current assets
divided by
Current liabilities
If the answer to this simple sum is less than 1, current
liabilities exceed current assets. It looks as if you cannot
meet your daily commitments. A figure of 2 used to be
a safe rule of thumb (current assets are twice current
liabilities) but 1.5 is often acceptable.
Acid test (quick ratio)
Cash,
marketable securities
and accounts receivable
divided by
Current liabilities
This is similar to the current ratio but it excludes
inventory and other current assets that are likely to
be difficult to turn into cash. It is a better measure
of current liquidity. A result of 1 is a useful rule of
thumb – but businesses that buy on credit and sell
for cash (e.g. food retailing) may have acid test ratios
as low as 0.2. This shows how careful you have to be
interpreting ratios.
THOSE FINANCIALS AGAIN 297
‘This “telephone” has too many shortcomings to be seriously considered as a means of
communication. The device is inherently of no value to us.’
WESTERN UNION INTERNAL MEMORANDUM, 1876
‘We don’t like their sound and guitar music is on the way out.’
DECCA RECORDING COMPANY, REJECTING THE BEATLES IN 1962
Debt indicators
Indicators of debt reveal whether a business is borrowing too much (in which
case it might have to look to equity for additional funding), or whether the
company could borrow more.
Indicator Comment
Leverage (US) or
gearing (UK)
Debt (liabilities)
Divided by Equity
This indicates the extent to which a company is
dependent on debt or equity. Low leverage (low
gearing) indicates a low reliance on debt – finance is
mainly equity – which suggests less risk of a cash flow
crisis and a greater likelihood of borrowing if required.
Debt to net worth
Total debt (liabilities)
divided by
Tangible net worth
(owners’ equity less
intangible assets)
This compares what is owned with what is owed. A
high ratio (e.g. if it was 2 then liabilities would be twice
tangible net worth) indicates that creditors’ claims
exceed those of the owners. In this case a business
is borrowed up and its ability to raise more debt is in
question – equity might be the only way to go.
Debt-service
coverage Cash flow
from operations
(profit before interest
and tax)
divided by
Annual interest
payments
This is a measure of a company’s ability to meet its
interest on borrowings. The higher the ratio the more
likely it is that the business will be able to pay interest
on (i.e. service) its debt. A figure of at least 3 is usually
considered safe, and would be a good sign for a
company wanting to borrow more. A figure of below 1
indicates a high risk of default or bankruptcy.
Contingent
liabilities Contingent
liabilities divided by
Owners’ equity
Recall from Chapter 10 that contingent liabilities are
probable or possible liabilities that do not show as
actual liabilities on the balance sheet. Contingent
liabilities that are large in relation to equity could
seriously undermine financial stability if they
materialised into payments due.
..................Content has been hidden....................
You can't read the all page of ebook, please click here login for view all page.