Exam Two

Mission Statement Impact

- Founders must be clear about where and how they will compete. - The mission statement should help by: Clearly specifying in which market the firm will compete The major ways in which it will compete.

Capabilities

- Resources that combine to allow a firm to do things better than its competitors. - The resources of the firm are constrained. - It is critical the new business focus on areas with the potential to maximize success.

Current Assets

Assets such as cash or those assets that can easily be converted to cash, such as accounts receivable and notes receivable.

Current Ratio (Liquidity)

Assets that can be quickly turned into cash and used to pay for immediate liabilities.

Fixed Assets

Assets that have a physical presence, including land, buildings, office equipment, machinery, and vehicles.

Nonsubstitutable

Cannot be easily replaced. Will newer, cheaper parts work on antique cars?

Cash Flow vs. Budgets

Don't confuse a cash flow statement with a budget. A cash flow statement does the exact opposite of a budget. Budgets are helpful, but knowing the amount of cash you need to pay the bills is reality.

Equity Funding

Evaluate before admitting investors. Investors can be: - Active or passive, majority or minority, - Other companies, and/or suppliers. Use an attorney to clearly specify how ownership, and profit, will be managed. Sources include other firms, venture capitalists, and business angels.

Importance of Solid Financial Foundation in an Entrepreneurial Business

Evaluation of the firm starts with the mission. Key measures should focus on aspects giving a competitive advantage. If the mission is low-cost, then control of expenses is the focus, with outcomes measured daily.

Step 3: Evaluate Competitiveness of Extraordinary Resources

Examine extraordinary resource list. - Are any a source of competitive advantage? Some capabilities on the list may not be the best on which to center a business. Focus efforts on those areas that provide the greatest competitive advantage.

Rare

Few firms have it. Only four businesses on a busy intersection.

Economic Rents

Financial gains garnered from an asset or capability that are in excess of the ordinary returns in that particular industry.

Applying the Strategy

Implementing a strategy is about fit and alignment within the business. The business must be built on a consistent set of activities around its mission and strategy. This helps focus the business clearly on its strengths and gives it the best opportunity to make economic rents.

Intangible Assets

Industry experience Contacts Previous start-up experience Education Unique knowledge of the industry (usually from previous research) Skill set of founders (presentation, innovation, etc.) Name branding

Strategy

Michael Porter suggests there are three broad strategies, which can be combined: - Low cost, - Differentiation, and - Focus. Most new firms pursue a combination of the three, resulting in a value strategy.

Valuable

Outperform competitors in price, costs and new customers. If your service is unique, customers will pay more.

Quick Ratio (Liquidity)

Removes the ability to sell inventory and examines the pure cash position.

Grants

Special funds that do not require repayment and are designed to aid businesses in specific areas.

Budgets

Statement that projects all the costs that will be incurred by the organization over a period of time and allocates those expenses evenly over the relevant time period.

Survey Data

Survey data can be tabulated and examined with simple statistics, such as percentages. With slightly more sophisticated analysis techniques, much more can be learned. - Cross tabulation, and Simple regression.

Balance sheet definition

The assets minus the liabilities in the balance sheet should total to zero. - Thus, the assets and liabilities balance each other. A balance sheet is a snapshot of a business at one point in time. The current assets minus the current liabilities are referred to as the working capital.

First-mover advantage

The benefit of gaining customer loyalty by being the first firm to the market.

Key Financial Issues Involved with Starting a Business

The financial issues are intertwined. The funding level of the firm, The establishment of an accounting system, and Attention to the flow of information.

Time value of money

The value of money over time at a given rate of inflation or other type of return. Calculated as the value of your investment in time and money if you did not do the proposed venture.

Building a Competitive Advantage

There are other ways a new business can build a competitive advantage: - You can have a special relationship with suppliers. - Location - access, parking, etc. - There is a wide range of options available. Your competitive advantage must be defensible. - Not easily substituted or matched by competitors.

Importance of Having a Measurement Focus

There are two aspects to any business: - The standard, and the extraordinary. Routinely manage the 'standard' parts of the business, with very little analysis. Focus on areas providing competitive advantage. Concentrate analysis efforts on 'extraordinary' areas of the business.

Durable

Time before competitors match the product. Do competitors want to match you? Can they?

Break-even analysis

Tool for the estimation of when a business's income exceeds its expenses.

Chart of Accounts

a financial organizational tool that provides a complete listing of every account in an accounting system. An account

Inventory Turnover (Activity)

a measure of the number of times inventory is sold or used in a time period such as a year.

Petty Cash

a small amount of cash on hand that is used for paying small amounts owed, rather than writing a check.

Times Interest Earned (Leverage)

estimates the number of times that the firm could repay the current interest owned on its debts.

Return on Assets (ROA) (Profitability)

examines the ability of the firm to return an overall profit compared to the amount of assets that the firm has invested into the effort.

Accounts payable

money owed by a company to its creditors.

Check register

record of transactions in a checking account.

Mission Statement Function

- As a business grows, it gets progressively more difficult to change its direction. - It must be concise and understood by all. - Keeps the focus on activities offering competitive advantage.

Managing Data Flow

- The time frames needed to obtain data may differ from one business to another. - New firms do not have the complex data measurement methods of large firms - The key is obtaining data in a timely manner that is tied to the strategic needs of the firm.

Key issues with Cash Flows

A cash flow statement for a new business is much different from one generated by a public company. The cash flow statement shows the flow of cash during a specific time period. A history of cash flow statements assists in: - Loans or credit lines, - Infusions of equity capital, and - Valuation if the owners choose to sell the company.

Deviation Analysis

A chart tracking various performance measures from one time period to the next. The chart has two additional columns, one showing actual change and the other showing percentage. A chart should be maintained for all important metrics.

Asset leasing

A form of lease tied to a particular asset used by a business to conserve cash and maintain the latest versions of whatever equipment is available.

Venture Capital Fund

A fund that is organized to make significant equity investments in high-growth new ventures.

Debt

A generic term to describe any type of non-equity funding tied to the business. Any form of capital infusion that must be paid back with interest. Most common forms: Loans from Banks or finance companies, Individuals, Founders, Credit cards, and/or Supplier credit.

Asset-based lending

A loan provided for the purchase of a necessary asset for the business. - Family is another source. - Founder(s) may choose to loan to the business.

Ratio Analysis

A series of ratios along four areas of company performance (liquidity, activity, leverage, profitability) that provides a picture of the health of the company.

Balance sheet

A summary of the assets and liabilities of the entrepreneurial business.

Pro Forma

A term describing estimates of what the balance sheets and income statements will look like in the future. "As a matter of form".

Factoring

Accounts receivable that are sold at a discount to another company to receive immediate cash.

Credit Cards

Card entitling one to revolving credit that is not tied to any particular asset, does not have a set repayment schedule, typically has a set upper limit, and is usually tied to a much higher interest rate than that of a bank loan.

What is cash flow

Cash flow is not the same as profit. Carrying inventory results in cash flowing out long before any cash from product flows in. Negative cash flow. The cash crunch worsens when sales grow. You must forecast your real cash flow to prevent the crunch.

Key accounting reports

Chart of accounts, petty cash register, check register, expense accounts, inventory accounts, accounts payable, and payroll.

Other terms for mission statement

Company mission, vision, overall strategy, goals, simple rules, and statement of purpose.

Loans

Contractual agreements whereby the firm receives some amount of money that must be repaid over a specified period of time at a specified interest rate.

Fixed costs

Costs that must be paid no matter how many goods are sold, such as rent for the building.

Variable costs

Costs that vary according to how many goods are produced.

Equity Investment

Funds received by a business in exchange for a percentage ownership of the business.

Businesses as Equity Investors: Looking to buy

Least expensive means for new ideas/products/methods. Developing ideas in-house detracts from core business. Investing in start-ups does not. Successful start-ups are purchased and brought into the core organization.

Current Liabilities

Liabilities or debts that the entrepreneurial business has to pay within one year. These include accounts payable, notes payable such as bank notes, and accrued payroll.

Long-term liabilities

Liabilities that are owed by the business and are ultimately due more than a year from the current date. These include mortgages payable, owners' equity, and stockholders' equity (the latter two are the investment by these individuals in the business).

Techniques for Measuring Performance

Limit analysis to those areas critical to profit. Move from the general to the specific. Four classic analysis techniques: - Ratio analysis, - Deviation analysis, - Sensitivity analysis, and - Short surveys.

Step 2: Split the List into Standard and Extraordinary Assets

Most assets are standard for the industry. - An office, computer systems, telephones, etc. Most capabilities or skills of founders and employees is also standard. - Excellent customer service is a customer expectation. There will also be extraordinary assets and capabilities. - A source of competitive advantage.

Importance of Proper Accounting When Starting a Business

Most new entrepreneurs can meet their accounting needs with available software. The entrepreneur must determine if they will use cash- or accrual-basis accounting.

Summary of Ratios

Ratios are valuable tools to the firm. Owners use one or two ratios from each category. - Understand the broad indicators in order to choose intelligently. A good data collection system is necessary. Interpreting ratios means comparing them over time or to another firm.

Leverage Ratios

Ratios that are used to examine the relative level of indebtedness of the entrepreneurial business. High levels of debt are dangerous when the economy turns down. Three ratios of interest: - Debt-to Equity, - Debt-to-Assets, and - Times Interest Earned.

Profitability Ratios

Ratios that examine the performance of the firm and its ability to make economic rents over and above its costs. The outcome of the business's other activities. Five ratios of interest: - Gross profit margin, - Operating profit margin, - Net profit margin, - Return on assets (ROA) - Return on equity (ROE).

Activity Ratios

Ratios that measure the efficiency with which the entrepreneur is handling the resources of the business. Three specific ratios: - Inventory Turnover, - Account Receivable Turnover, and - Total/Fixed Asset Turnover.

Liquidity Ratios

Ratios that measure the short-term ability of the firm to meet its obligations. Financial liquidity is critical for success. Two ratios: Current ratio & Quick ratio

Income Statement

Revenue of the firm minus expenses. - The focus is profit. - One key is predicting sales. - Another key is to be conservative. Provides both the gross and net profit. - Gross profit equals sales minus cost of goods sold. - Gross profit minus all expenses equals net profit before taxes. - Subtract estimated taxes for net profit after taxes.

Expenses

Salaries. Basic benefits. Taxes/Fees. Payroll, income, local, state, business, licenses. Cost of goods sold. Manufacturing, packaging, direct labor, shipping. Utilities and Security. Tools/Machinery. Etc.

Resource-Based Perspective

Strategists use the resource-based perspective to analyze the list of competitive advantages. Subject each resource to the following four criteria: - Is it rare? - Is it easily substituted? - Is it durable? - Is it valuable?

Businesses as Equity Investors: Looking to sell

Supplier investment is simpler. Restriction is the issue with this type of equity investment. - The deal usually involves an exclusivity agreement. Use care not to lose future needed flexibility.

Step 1: Develop a List of Your Business's Assets and Capabilities

Tangible assets & Intangible assets - While this may seem mundane, it is critical to the later steps. - This list will be long and should include everything the company has now or will have at its opening.

Importance of Cash flow analysis

The cash flow statement during this stage of the new venture differs from one generated by an established, ongoing firm. For a proposed business, the focus is on its ability to generate positive cash flow in the shortest possible time. - Again, cash flow, not profitability. - Profit is desirable, but cash pays the bills.

Float

The difference between when the money goes out and when it comes in. - For example, if you deposit a check today in payment for some good, you typically do not receive cash when you deposit it. - Instead there is a period of float before it is credited to your account.

Initial Funding

To calculate maximum amount of outside financing needed: - Multiply 150 percent by lowest ending cash balance on the cash flow statement. - Resulting balance is initial equity needed. - Connect this with the percentage of the firm available to investors. - These are your investment parameters.

Entrepreneurial breakeven

When a new venture's net cash flows exceed the initial investment plus the time value of the money invested.

Gross Profit Margin (Profitability)

determine the overall profit that is obtained from all sales during the period being evaluated.

Total/Fixed Asset Turnover (Activity)

is the ratio of sales to the value of fixed assets. It indicates how well the business is using its fixed assets to generate sales.

Debt-to-Equity (Leverage)

provides information on the portion of the business owned by lenders and portion owned by founder.

Sustainable Competitive Advantage

- An advantage that other's can not immediately copy. - All individual competitive advantages disappear as industries change and adapt. - A key to competitive advantage is in having a deep understanding of customers' needs. - Personal relationships with customers can be a great source of sustainable advantage. - Before developing a mission statement, the business must list its competitive advantages.

Mission Statement

A brief statement that summarizes how and where a firm will compete.

Sensitivity Analysis

A chart using current cash flow statement, income statement, or balance sheet to create a pro forma projection based on a dramatic increase in sales, a dramatic decrease in sales, or the complication of a major change in the business.

Cash Flow

Actual cash that flows into the firm, minus the cash that goes out of the firm.

Sensitivity Analysis

An examination of the best- and worst-case cash flow scenarios.

Deviation Analysis

Analysis of the differences between the predicted and the actual performance. This will assist the entrepreneur in: - Developing realistic forecasts, and - Point out differences between actual and predicted performance at a point in time. Allows maximum flexibility during growth.

Tangible Assets

Building location Equipment (list) Initial financing (equity or debt) Inventory Patents or patents pending Software and systems for business Build-out of facility (list detail)-walls, fixtures, built-ins, etc.

Non-equity Funding

Debt from: Banks, Credit cards, Asset leasing companies, Individuals, and/or Suppliers. Grants.

Followers

Firms that enter a market after the first mover.

Revenues (Cash Inflows)

For maximum insight, divide into categories. A lawn care service found they made more money planting flowers and landscaping for businesses. - They got these jobs due to their mowing contracts. - So, they began pricing their mowing low in order to get the contracts.

Basics of Funding a Business

Funding starts with the founder(s) and his or her personal resources. The firm may need other sources of funds. - Sources may be small. - Sources may or may not be tied to an ownership interest.

Crowdfunding

Funds received by a business by soliciting a large number of very small investors usually via the Internet.

Business Angeles

High-net-worth individuals who invest in businesses not as a business, but as an individual. Seek those with relevant knowledge. Relatively new way of raising capital. Sites such as: - Kickstarter.com, - EquityNet.com, and - Indiegogo.com, Streamlined the process. Could be an equity investment, or a gift.

Designing a Mission Statement

Keep it short. Keep it simple. Make it applicable. Be specific. Establish measurable goals.

Use of Short Surveys in Business

Ratios analyze financial information. Short surveys gather more contextual information that is subject to interpretation. Surveys can be given to anyone transacting with your business. There will be some bias. The questions should relate directly to the mission or strategy of the company.

Identifying a Sustainable Competitive Advantage

Step 1 - Develop a list of assets and capabilities. Either existing or proposed. Step 2 - Break that list into two groups:Standard and extraordinary/unique. Step 3 - Evaluate the extraordinary resources/capabilities.

Developing a Strategy

Step 1: the mission statement specifies where and how the firm is to compete. Step 2: a plan showing capabilities used to meet each part of the mission and strategy. Step 3: confirm the strategy is defendable and will provide above average economic returns. Step 4: constantly reevaluate the strategy.

Supplier credit

Suppliers often will provide credit on both physical assets (refrigerators, molding equipment, etc.) and the actual supplies provided.

Expense account

an arrangement under which sums of money spent in the course of business by an employee are later reimbursed by their employer.

Net Profit Margin (Profitability)

bottom-line calculation from the income statement. A picture of the relative margin earned after all obligations and expenses are considered.

Inventory accounts

dealing with assessing and accounting for changes in inventoried assets.

Account Receivable Turnover (Activity)

how fast the company turns credit sales into cash.

Debt-to-Assets (Leverage)

measures the percentage of the assets of the firm that are actually owned by the creditors.

Payroll

the total amount of wages and salaries paid by a company to its employees.

Operating Profit Margin (Profitability)

used to calculate the percentage of profit a company produces from its operations, prior to subtracting taxes and interest charges.

Return on Equity (ROE) (Profitability)

used to provide all investors with an evaluation of how much each dollar of their investment is generating in profit.