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Okay, now we've talked a little bit about the kind of basic financial statement, and
given you a very high-level overview of that.
Let's get into some more specifics.
I like this cartoon that says, our books are balanced.
Half of our numbers are real and half of them are made up.
I appreciate that, from having worked in that field a long time ago.
So let's talk about what you need if you're going to put together
an internal investment proposal for your corporate finance group.
You want to have a detailed income statement, but only really detailed for
the first year.
Very high level, and maybe years two and
three you can kind of do summary, growth rates and stuff.
Because you're starting out in a new business or a new product line,
and you really don't have much data to go on.
And then you want to show sales, okay?
You want to show sales or revenues by product or service.
And you want to show cost of sales,
and that can be a significant number or it can be a very small number,
depending upon whether it's a manufactured product or a software developed product.
But you have to generate an understanding of what is the cost, incremental cost to
the corporation of generating the revenues that you're showing in your proposal.
And that shows you the gross margin, okay?
And so sales less cost of sales is gross margin.
And generally, as I've said in my previous lectures,
that may be where you stop because of shared expenses.
You don't have to create a new marketing company, the new marketing group.
You don't have to create a new human resources group.
You can utilize your accounting group.
So they're really interested in,
what additional gross margin are you going to contribute to the organization?
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Now, the cash flow statement.
Now what's the purpose of the cash flow statement, okay?
The purpose of it is to take the income statement and convert it into cash.
And why do we do that?
Well, because the income statement is generally on an accrual basis,
as I said, again, said earlier.
But when it comes down to it, the most important part of a company is cash flow.
So it converts the income statement from a accrual basis to the cash basis.
And that shows you whether or not you're self financing or not,
if your project's self financing or not.
And so again, you want to have a fairly significant amount of detail
in the first year, then very high-level, maybe, for years two and three.
And so there're three basic parts of the cash flow statement.
The first one is cash flow from operations,
and that's maybe the most important one.
That is, what cash are you generating from the operations of your project?
That would be revenues less cost of goods sold, okay?
The next thing would be, what investing activities are required for my project?
Meaning, do I need to make asset purchases to support the project?
Do I need to buy new equipment?
How much of the investment itself, okay?
And then thirdly, you're talking about cash flow from financing activities.
That means, are you going to
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need incremental funds, something other than the limited capital budget you
already have to use, in order to finance this project?
So those three things are important, and
those are what the cash flow statement shows you.
Okay, then the balance sheet, okay?
Again, if you're a project, you probably won't have a full-blown balance sheet.
But let's talk about what a full-blown balance sheet does for you.
It shows current assets, and
current assets are any assets that can be converted into cash in one year or less.
It shows fixed assets like property, plant, and equipment.
They are not readily converted into cash.
They are generally depreciated over some time frame.
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Current liabilities are those amounts, so, very similar to current assets, right?
Current assets are assets that are converted to cash in one year.
Liabilities are liabilities that must be paid within the next year.
So they kind of match up against each other.
And the current assets less current liabilities are something we call
working capital.
And hopefully, if you're doing well, you have positive working capital.
If you have negative working capital, that means that the company's
going to have to finance you for that working capital deficit, okay?
Long-term liabilities are long-term debt that you may acquire.
Again, a project's not going to have long-term debt, or maybe it will.
Maybe they'll decide to issue some type of a bond or
something to finance the project.
If it's a big project, it could have long-term debt.
But generally, they don't.
And then reserves or equity, in a typical standalone company,
the equity basically is the cumulative amount of profits and
loss of the company since the beginning of time.
If you're a project, it may simply be an accounting of all the positive and
negative cash flows of the organization.
That generally will run through what they call an intercompany accounting system.
And then there are a number of financial ratios that you can create, or
not create, but calculate from the balance sheet.
A current ratio is, how much do my current assets cover my current liabilities?
Hopefully it's more than 1.
Let's say, a current ratio would be good if it was 2 or 3 to 1.
A quick ratio means, how much do my readily
liquid assets pay my liabilities?
Because current assets can include things like prepaid insurance or other assets
that are basically used up in the first year, but they're not generally liquid.
So liquid assets are like cash and marketable securities.
So the quick ratio gives you a better understanding of,
how well can I pay my current liabilities?
And then we can calculate return on capital employed as well.
So when you put together these financial statements,
you want to have a comprehensive list of all the assumptions you've used.
Hopefully they're reasonable assumptions.
You should be prepared to discuss those with the people that are analyzing your
project.
And you should always have in your back pocket, somewhere, in an appendices or
something, a what if analysis that says, okay,
somebody's going to ask you this, right?
They'll say to you, what if I give you $10 million to spend versus 5 million?
Or what if you only get 2.5, what happens then?
So you need to be prepared to answer those questions,
by having something you have already thought through.
So you can pull out and say, well, here's what happens if we only get 2.5 million.
You want to talk about growth rates.
You want to talk about interest rates, if you are using those.
You basically want to have all your assumptions in a way which you can
demonstrate that you've thought things through well and
they're reasonable assumptions.
So I hope that this has been helpful.
I don't think you're going to become financial accounting people that
are going to develop a bunch of internal financial statements.
But at least you'll have a feel for
how these statements will impact on how people look at your project.
Michael R. PrattLecturer of Technology Entrepreneurship
