Module 7

DEVELOPMENT OF A BUSINESS PLAN: FINANCIAL PLAN

The financial plan translates into monetary terms what you have learned after
completing the first three major components of your business plan. In doing the
marketing plan, you learned things related to sales generation, whereas in the
production and organizational plans, you learned about things related to expenses. The
financial plan translates all of this information into monetary figures, and from these data
you will be able to assess whether the profit that you expect the business to earn is
greater than the cost of setting it up and operating it.

START-UP COSTS

Startup costs are expenses incurred while establishing a new business. They can be
divided into two categories: pre-opening and post-opening. Once the business is operational,
these costs can be broadly categorized into pre-opening and ongoing or operating expenses.

 Pre-opening costs may include expenses for developing a business plan, market
research, securing a location, and initial marketing.
 Ongoing costs typically involve operational expenses like employee salaries, utilities,
and inventory replenishment.

FINANCIAL STATEMENT
Financial statements are documents that convey a company’s business activities and
financial performance. As the U.S. Securities and Exchange Commission (SEC) succinctly put
it, “They show you where a company’s money came from, where it went, and where it is now.”

Types of Financial Statements

1. Income Statement
STATEMENT OF COMPREHENSIVE INCOME – Also known as the income
statement. Contains the results of the company’s operations for a specific period of time
which is called net income if it is a net positive result while a net loss if it is a net negative
result. This can be prepared for a month, a quarter or a year (Haddock, Price, & Farina,
2012).

TEMPORARY ACCOUNTS – Also known as nominal accounts are the accounts

found under the SCI. They are called such because at the end of the accounting period,
balances under these accounts are transferred to the capital account, thus having only
temporary amounts and resulting to zero beginning balances at the beginning of the
following year (Haddock, Price, & Farina, 2012). Examples of temporary accounts
include revenues, sales, utilities expense, supplies expense, salaries expense,
depreciation expense, interest expense among others.

The different parts of an Income Statement:

a. Heading
i. Name of the Company
ii. Name of the Statement
iii. Date of preparation (emphasis on the wording – “for the”)
b. Revenue/Sales
 Sales Revenue is the company’s revenue from sales or services,
displayed at the very top of the statement. This value will be the gross of the
costs associated with creating the goods sold or in providing services. Some
companies have multiple revenue streams that add to a total revenue line.
Accounts under Revenue are the following:

● Sales Revenue: Income from selling goods or services.

● Service Revenue: Income from providing services.
● Interest Revenue: Income from interest earned on investments.
● Dividend Revenue: Income from dividends received from
investments.
● Rent Revenue: Income from renting out property.
● Gain on Sale of Assets: Profit from selling assets.
c. Cost of Goods Sold (COGS)
Cost of Goods Sold (COGS) is a line-item that aggregates the direct
costs associated with selling products to generate revenue. This line item
can also be called Cost of Sales if the company is a service business. Direct
costs can include labor, parts, materials.
d. Gross Profit
Gross Profit Gross profit is calculated by subtracting Cost of Goods
Sold (or Cost of Sales) from Sales Revenue.
e. Selling, General and Administrative Expenses
SG&A Expenses include the selling, general, and administrative
section that contains all other indirect costs associated with running the
business. This includes salaries and wages, rent and office expenses,
insurance, travel expenses, and sometimes depreciation and amortization,
along with other operational expenses. Entities may, however, elect to
separate depreciation and amortization in their own section.
● Advertising Expense: Costs incurred for advertising and marketing.
● Salaries and Wages Expense
● Rent Expense
● Utilities Expense
● Insurance Expense
● Depreciation Expense
● Legal and Professional Fees
f. Depreciation & Amortization Expense
Depreciation and amortization are non-cash expenses that are created
by accountants to spread out the cost of capital assets such as Property,
Plant, and Equipment (PP&E).

Depreciation= Purchase price - Scrap Value

Estimated useful life
Scrap Value/ Residual Value is the amount at which the asset can be sold at the
end of its estimated useful life.

g. Net Income
Net Income is calculated by deducting income taxes from pre-tax
income. This is the amount that flows into retained earnings on the balance
sheet, after deductions for any dividends.
2. Cash Flow Statement
CASH FLOW STATEMENT – Provides an analysis of inflows and/or outflows of cash
from/to operating, investing and financing activities (Deloitte Global Services Limited,
2015). This statement shows cash transactions only compared to the SCI which
follows the accrual principle.

The cash flow statement (CFS) measures how well the company generates cash
to pay its debts and fund its operating expenses and investments. It helps investors see
whether or not the company is on strong financial ground by showing where its money
comes from and how it’s being spent. Detailing the exchange of money between the
company and the outside world also over a period of time, the CFS can be useful when
compared to the income statement, especially when the amount of reported profit or loss
does not reflect the company’s cash flows.

Parts of the Cash Flow Statement

a. Heading
i.Name of the Company
ii.Name of the Statement
iii.Date of preparation (emphasis on the wording – “for the”)
b. Operating Activities – Activities that are directly related to the main revenue-
producing activities of the company such as cash from customers and cash paid
to suppliers/employees (Deloitte Global Services Limited, 2015).
c. Investing Activities – Cash transactions related to purchase or sale of non-current
assets (Deloitte Global Services Limited, 2015).
d. Financing Activities – Cash transactions related to changes in equity and
borrowings.
e. Net change in cash or net cash flow (increase/decrease) – The net amount of
change in cash whether it is an increase or decrease for the current period. The total
change brought by operating, investing and financing activities.
f. Beginning Cash Balance – The balance of the cash account at the beginning of
the accounting period.
g. Ending Cash Balance – The balance of the cash account at the end of the
accounting period computed using the beginning balance plus the net change in
cash for the current period.

3. Statement of Financial Position (Balance Sheet)

STATEMENT OF FINANCIAL POSITION – Also known as the balance sheet.
This statement includes the amounts of the company’s total assets, liabilities, and
owner’s equity which in totality provides the condition of the company on a specific date
(Haddock, Price, & Farina, 2012). The balance sheet adheres to the accounting equation
below:

Assets = Liabilities + Owners’ Equity

PERMANENT ACCOUNTS – As the name suggests, these accounts are

permanent in a sense that their balances remain intact from one accounting period to
another. (Haddock, Price, & Farina, 2012) Examples of permanent account include
Cash, Accounts Receivable, Accounts Payable, Loans Payable and Capital among
others. Basically, assets, liabilities and equity accounts are permanent accounts. They
are called permanent accounts because the accounts are retained permanently in the
SFP until their balances become zero. This is in contrast with temporary accounts which
are found in the Statement of Comprehensive Income (SCI). Temporary accounts unlike
 permanent accounts will have zero balances at the end of the accounting period.

CONTRA ASSETS – Contra assets are those accounts that are presented under the
assets portion of the SFP but are reductions to the company’s assets. These include
Allowance for Doubtful Accounts and Accumulated Depreciation.

● Allowance for Doubtful Accounts is a contra asset to Accounts Receivable.

This represents the estimated amount that the company may not be able to
collect from delinquent customers.
● Accumulated Depreciation is a contra asset to the company’s Property,
Plant and Equipment. This account represents the total amount of
depreciation booked against the fixed assets of the company.

Parts of a Balance Sheet

a. Heading
i. i. Name of the Company
ii. ii. Name of the Statement
iii. iii. Date of preparation (emphasis on the wording – “as of”)
b. Asset
Current Assets – Assets that can be realized (collected, sold, used up) one year
after year-end date. Examples include Cash, Accounts Receivable, Merchandise
Inventory, Prepaid Expense, etc.
 Cash and Cash Equivalents-Cash on hand and Checking and savings
accounts
 Accounts Receivable-Money owed to the company by customers
 Inventory- Products that the company has for sale, Raw materials and
work-in-progress, supplies
 Prepaid Expenses- Expenses paid in advance, such as rent or insurance
Noncurrent Assets – Assets that cannot be realized (collected, sold, used up)
one year after year- end date. Examples include Property, Plant and Equipment
(equipment, furniture, building, land), Long Term investments,Intangible Assets etc.
 Property, Plant, and Equipment (PP&E)- Land, Buildings, Machinery and
equipment, Vehicles
 Intangible Assets- Patents, Copyrights, Trademarks, Goodwill

c. Liabilities
Current Liabilities – Liabilities that fall due (paid, recognized as revenue) within
one year after year- end date. Examples include Notes Payable, Accounts Payable,
Accrued Expenses (example: Utilities Payable), Unearned Income, etc. Common
examples of current liabilities include:

● Accounts Payable: Money owed to suppliers for goods or services

received.
● Short-Term Notes Payable: Short-term loans that must be repaid within a
year.
● Accrued Expenses: Expenses that have been incurred but not yet paid,
such as salaries, wages, taxes, and interest.
● Current Portion of Long-Term Debt: The portion of a long-term debt that
is due within the next year.
 Noncurrent Liabilities – Liabilities that do not fall due (paid, recognized as
revenue) within one year after year-end date. Examples include Loans Payable,
Mortgage Payable, etc. Common examples of non-current liabilities include:

 Long-Term Notes Payable: Long-term loans that must be repaid over

a period of more than one year.
 Bonds Payable: Debt securities issued by a company to raise capital.
 Deferred Taxes: Taxes that have been accrued but not yet paid.
 Lease Liabilities: Obligations arising from long-term lease
agreements.

d. Owner’s Equity

Owner's Equity refers to the amounts invested by the owner/owners in the

business and includes profits retained in the business.

FINANCIAL ANALYSIS
1. Break-even Point
The break-even point is the point where a company's revenues equals its
costs. The calculation for the break-even point can be done one of two ways; one is
to determine the amount of units that need to be sold, or the second is the amount of
sales, in peso, that need to happen.
The break-even point allows a company to know when it, or one of its
products, will start to be profitable. If a business’s revenue is below the break-even
point, then the company is operating at a loss. If it’s above, then it’s operating at a
profit.
The break-even point sales is derived through the formula shown below:

BEP Sales = Monthly Sales x Monthly Operating Expenses

Monthly Sales – Monthly Cost of Goods Sold

2. Return on Investment
Return on Investment (ROI) is a performance measure used to evaluate the
efficiency of an investment or compare the efficiency of a number of different
investments. ROI tries to directly measure the amount of return on a particular
investment, relative to the investment’s cost. To calculate ROI, a formula is given
below.

RETURN ON INVESTMENT (ROI)= Net Income

Long-term Liabilities + Owner’s Equity

3. Payback Period
The payback period refers to the amount of time it takes to recover the cost of
an investment. Simply put, the payback period is the length of time an investment
reaches a break- even point.

The desirability of an investment is directly related to its payback period.

Shorter paybacks mean more attractive investments. Payback period is computed
using the formula below.
PAYBACK PERIOD = Total Start-up Cost
Monthly Net Income