Homework 7.0


The chapter includes a schedule that is specific to entrepreneurial startups, called a Source and Use of Funds Statement.  Do not confuse this with the customary Cash Flow Statement.  The template for this schedule has been attached as an excel file at the bottom of this instruction. 

This is the format for the Financial Plan chapter:


     7.1       Expansion Plan Source and Use of Funds Statement

     7.2      Financial Statement Assumptions Sheet

     7.3      Pro Forma Income Statement

     7.4      Pro Forma Balance Sheet

     7.5      Pro Forma Cash Flow Statement

     7.6      Key Financial Ratios and Analysis of Trends over Time

Proforma means looking ahead, into the future and estimating the expected results.  The reason we do it is to provide a picture of how we expect the plan to turn out.  We look forward not just for one year, but for a realistic period into the future – typically five years.  Beyond five years, things are so fuzzy that the predictions are not reliable.  

Why not just use a shorter period – say three years?   If we try to shorten the planning horizon, the growth of a new startup business can’t be properly described and the financial ratios won’t show clear trends.  It’s like watching a rocket launch and only seeing the first 10 seconds.  Will it make it to the moon?  Or will it simply fall back into the sea?  You need to watch for a longer period to be able to make that prediction.   And so too with a new business, you need to watch it perform for a longer period (five years) to predict whether it will be successful.  

And always start your proforma schedules with a column indicating your most recent actual results. Presume youve been in business (at a low volume) for 12 months and show the actual results for that period (pre-expansion plan).  It demonstrates where you are coming from and enables the reader to better judge the impact of your expansion plan.  Show the actual results as the left-hand column on a multi-year schedule.

The Financial Plan should include the following proforma financial statements:

  • expansion plan source and use of funds statement
  • assumptions sheet
  • income statement
  • balance sheet
  • cash flow statement
  • ratio analysis

The Expansion Plan Source and Use of Funds Statement is a document that 1) itemizes the cash needs of the business to pay for the expansion project and fund the companys working capital needs until the project will be self-sustaining, and 2) identifies the sources of cash presently available to the business.  The difference between needs and sources shows how much extra cash will be required.  The difference between the needs and the sources thus equals the amount of funding being requested from investors.

This is NOT the classic financial cash flow statement which is also required further into the chapter.  Instead, it is a simple chart that lays out the expected start-up costs, and funding sources, until such time as the business will be self-sufficient from a cash flow perspective.  Thus, the period of time it covers will differ from case to case.  It begins when you need fresh investment money to start paying for the expansion plan and operating the business at the higher volume levels.  It ends when the business is earning sufficient profit to be self-supporting. There is no timing in the chart, just a total. 

Most of the investment funds will obviously be used to fund the physical part of the expansion plan new equipment, facilities, manpower, marketing, etc. And some of the money will be needed to fund the marketing expense of getting your product recognized in the marketplace.  And finally, some of the funds will likely be needed to fund working capital and profitability shortfall for the business until it starts generating sufficient cash inflows from sales and collections to be self-sufficient.  This represents the uses of funds.  The sources of funds represent any money you may have available to help pay for these uses.  It can include any residual paid-in capital from the promoters, any newly contributed capital from relatives, and angel investors and any grants/loans you might receive from various agencies.    The difference between the two subtotals equals the funding you are looking to obtain from the equity investors.

Make sure that the source and use of funds statement numbers match those that you have posted in other chapters.  Go back and adjust the prior chapters data if the numbers just dont make sense, now that you see them all together.

Here is an example of a Source and Use of Funds Statement.  Figures have been left in the example, to permit you to follow the logic of the schedule. 

Expansion Plan – Source and Use of Funds Statement  Company:    Source of Funds SourceAmountManagement Team Investment $      700,000Line of Credit from Bank $         75,000Total Funds Committed $      775,000Total Funds Required $   1,225,000Total Funds Needed from an Equity Investor $      450,000  Use of Funds Cost ItemAmountOffice Facilities $      210,000Office and Computer Equipment $        75,000Staffing $        30,000Sales and Marketing $        50,000Attorney Fees $        15,000Initial Inventory $     645,000Other (R&D and General Expenses) $        50,000Cash for Working Capital $        50,000Shortfall on Profitability During Initial Operations $      100,000Total Required Funds $   1,225,000  

In this particular schedule, there is more to it than simple in and outflows of cash at the end of the year.  Instead, the period the chart covers is the entire duration of the project, up to the point that it can self-fund from internal cash flow.    The flows are describing the funding availability and needs for the growth project that you are proposing.  The Sources are funds that are available to fund the growth project and the Uses are the budgeted expenditures on the growth project plus expected working capital needs until the project has sufficient traction to be self-funding through cash flows from operations.  

Important note: The Source And Use of Funds Statement is different from the Cash Flow Statement that will be described later.

The Financial Statement Assumptions Sheet is an explanation of the most critical assumptions that your financial statements are based on.  These always include assumptions on inflation and price escalation for multi-year forecasts.  Forecasters developing proforma schedules always precede the schedules with detail of all the assumptions they made to construct the schedules.  The method for constructing a forecast is just as important as the forecast results.  It enables the readers to validate the methodology of the forecast and thus to develop confidence in the results of the forecast.

The Income Statement reflects the projected results of the operations for a firm for a given period of time. It records all the projected sales and expenses for the given period and shows whether the firms will be making a profit or experiencing a loss.

This financial schedule has a standardized format.  The first section displays the expected sales revenue.  The next section is the cost of production and sales.  The difference between revenue and cost is the expected profit (or loss) and appears in the next section of the Income Statement.

Financial statements are to be multi-year for 5 forecast years.  In addition, show the actual results from your first 12 months of operations.  This will permit a comparison of the before and after expansion results and will also “seed” the future years with beginning balances in the case of the Balance Sheet and Cash Flow Statement.

Financial people sometimes get caught up in a problem.  They believe they are constructing the actual plan, and they go to work inventing all the assumptions behind the financial forecast results.  The financial schedules aren’t the actual plan.  They are a way to describe the results of the plan we have presented in all the other chapters.    So, you MUST make certain that your financial results tie back to the estimates that you included in the prior chapters.

It started way back when you estimated your expected future sales volume back in Chapter 3.  That sales volume then gets translated into financial figures in Chapter 7.  You also recall that we calculated the weighted average selling price of our product or service in Chapter 4.   So now, in the income statement, we compute the revenue, by multiplying the volume figures in Chapter 3 by the weighted average selling price in Chapter 4.  That gives us the first line in the Income Statement.  Whew, almost finished, right?  Not quite…   

Now we need to compute the costs of the business.  In the operations chapter, you provided a high-level overview of the facilities, equipment, and staffing you will require for your business.  Now its the moment when you translate that vision into cost elements that are used in the financial schedules.  For example, if you need a facility, then you will estimate the expected depreciation that will be recorded for the facility.  There are depreciation formulas that enable you to do this with precision.  The staffing requirements can be translated into wages, salaries, and benefits. And so you estimate each individual line of the financial statement until you have reached the bottom.  Subtracting the cost from the revenue yields net income.  And thus you have completed the income statement schedule.

The Balance Sheet is where the value of the assets and liabilities are reported.  Each of the tangible assets has value for example, land, buildings, and equipment.  Material is valued based on the expected inventory that will be on hand at any point in time. Cash and accounts receivable are also assets. Liabilities such as accounts payable and loans are reported, based on their average value.  The difference between assets and liabilities is the Owners equity, consisting of original paid-in capital and retained earnings.

It should start with your balance sheet position at the beginning of your proforma period.  This will include your original capital contribution as original paid-in capital, along with any minor assets and liabilities that youve incurred during your brief period of operation to date.  That is the jumping-off point for computing your balance sheet at the end of the first proforma year.  You will build from there, with the addition of assets such as land, buildings, equipment, furniture, etc.  It would also show liabilities such as accounts payable and loans.  And each year, the original paid-in capital would be supplemented or diminished by the “retained earnings” (or losses) that the business incurred that year.  Additionally, (many student submissions miss this point) the original paid-in capital will increase to reflect the new equity contribution that is anticipated from the investor.  Your schedules should reflect that you are successful in securing the funding necessary to pay for the expansion plan, just the same as they reflect the addition of assets and revenues as the result of implementing the plan.

The Cash Flow Statement shows how the cash flows into and out of the business during each year. It is divided between Operations flows and Investing flows.  It again starts with the inflow of the original investment capital.  Then it has outflows and inflows from the Business Operations.  The way that flows from Operations are displayed is by starting with the retained earnings that were the bottom line on the Income Statement, and then adding or subtracting changes in the balance sheet line items (since it cost or added cash for them to have changed) and by reversing non-cash charges on the Income Statement (such as depreciation).  Then the Cash Flow considers changes in investing items and financing items, such as bank loans and new capital injections.  This then shows what the cash balance is at the end of the period being estimated.  Hopefully, it’s not a negative number.  Thats because a negative number means that sometime during the year the business ran out of funds and likely went bankrupt.  Yes, its possible for even profitable businesses to run out of funds.  And when that happens, the business goes bankrupt and closes.  This is the biggest threat to entrepreneurs and what you need to carefully plan for in your Sources and Uses of Funds calculation.  Be sure you have enough working capital in your Uses projection to carry you through to the point that the business is bringing in more cash than its spending (the break-even point).

Ratio Analysis is computed by taking numbers out of financial statements and forming ratios with them. Once the financial statements are developed, then ratios can be computed that show how well (or badly) the business is being operated.  There are a number of standard ratios that are used by investors to measure business performance.  For example, inventory turnover ratio measures how quickly a business takes in and consumes inventory.   Ratios cannot be analyzed by themselves.  They must be compared with industry averages to determine whether this business is doing better or worse than expected.   Also, ratios can show trends when the ratios for several years are plotted in a line graph.  The trend can show improvements or worsening situations.  These need explanation in the business plan. 

Each ratio has a particular meaning in regard to the potential of a business.  Most importantly, ratio analysis looks at the trend over time, to see whether conditions are improving or worsening.  Ratios should always be explained in the report commentary and never left for the reader to interpret.

There are a lot of standard ratios and this section is very important to flesh out with lots of details.  The ratios should cover multiple years just like the statements.  Graphs showing some of the trends in the ratios over time are very helpful.

Identify any trends from the data (you will probably be best to compute this since you aren’t likely to find trends already computed for your schedule examples.)  How to compute ratios is explained in numerous places on the net.  But computing the ratios is only the first step.  What is important is the trend analysis of the ratios over time and analytic comments about the trend.  For example, you might analyze the inventory turnover ratio and discover that over time the trend is deteriorating. You would show the trend and offer remarks about why this is occurring and what management intends to do to correct the situation.   Bottom line is that investors like to see three things – the raw data, the analysis of the data to point out important trends, and commitments from management how any problems revealed by the data are going to be corrected.

Appreciate that the computation of ratios and analysis of those ratios is very meaningful to investors who use the results to gauge the financial strength of the business. Students should research into the development of ratios, and understand how to look for trends in ratios over time (e.g.  Is the inventory turnover improving or deteriorating from year to year? and; Why is it changing?)  They should see how displaying the trends in graphs can yield some useful information about the expected success (or lack of success) that the business is forecast to experience.

General Instructions:

Now, in reality, most business owners would have a professional accountant prepare the financial schedules in the business plan.  Perhaps the accountant would already be on staff, or else a CPA would be retained to do this.    In this class, you don’t have that “luxury” and many students do not have the accounting background to be able to compute these difficult schedules.   

Students should do their best to understand the purpose behind the various financial schedules.  

But students in this class are not expected to become overnight accountants.  If they haven’t had the necessary accounting training beforehand, they won’t be able to develop these schedules.  In such instances, it is ok to include representative examples of the schedules as a copied picture in the business plan.  Of course, being a picture, the numbers can’t be changed and they won’t correspond to your actual business.  But that, unfortunately, is the best low-budget alternative we have available for this classroom exercise.  If you use a copied picture rather than constructing your own schedule, be sure to describe the insertion as a representative example and properly cite its source.

 In past classes, some students had the skills to build the schedules while others included copied examples.  The grading was equal, with the emphasis on whether the student appeared to understand the concepts.  This isn’t an accounting class so I’m not looking for you to be able to be professional accountants.  But it is a class that rewards critical thinking, so what I am more looking for is your commentary accompanying the respective schedules

Here’s the Key Requirement

Be sure to offer some analytic commentary about the financial schedules that shows that you have looked at the data and have drawn some conclusions about it. (This is what managers are expected to understand about financial schedules they could most likely never construct one, but they do know what the schedules are trying to say.)

Don’t simply throw raw data at the reader, in the form of complex schedules.  That’s completely dissatisfying to a reader.  You are expected to tell the reader what is important about the reams of data that you are presenting.

If you prepare your financial statements in Excel, dont submit the Excel sheets.  Instead, copy and paste the Excel charts into your word document as an integral part of your report.  If the excel schedule is massive, you can construct a condensed version of the schedule for inclusion in the body of the report and include the full schedule in an appendix but in all cases, as a word document. 

Dont just display the statements alone, without explanation.  Include a brief introductory paragraph before each schedule.  And, offer commentary after each schedule highlighting any key points that you would like investors to notice.  This is particularly important in the ratio analysis subsection. 

Wrap up the Financial Plan with a brief concluding paragraph that sums up the trend indicated by the financial statements.  (Hopefully, this will be a favorable trend that will impress investors.)

An example of a Source and Use of Funds Statement has been attached as an excel file at the bottom of this instruction. 


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