Fu Da Mentals of Entrepreneurship

FUNDAMENTALS OF ENTREPRENEURSHIP
(ETR300/ENT300)
MODULE 11 :
FINANCIAL PLAN
Entrepreneurship Dept, FBM ETR/ENT300 MODULE 11 : Financial Plan 1

(2009)
LEARNING OUTCOMES
At the end of the session, students should be able to:
• Understand the importance of preparing a financial plan

• Understand the process of developing a financial plan
• Identify the components of a financial plan
• Analyse the financial position of the proposed business
• Prepare a financial plan for a small business

(2009)
INTRODUCTION
A financial plan incorporates all financial data derived from

the operating budgets i.e. the marketing, production (or
operations) and administration budgets. Financial
information from the operating budgets is then translated or
transformed into a financial budget.
Based on the financial data, projections are prepared via the

following pro forma statements:
 Cash flow
 Income (or profit and loss) statement
 Balance sheet.
(2009)
THE IMPORTANCE OF A FINANCIAL PLAN
A financial plan is crucial to the overall business plan that is

developed for a particular business or project. Its importance
can be summarised as follows:
 To determine the size of investment

 To identify and propose the relevant sources of finance
 To ensure that the initial capital is sufficient
 To analyse the viability of the project before actual investment is
committed
 To be used as a guideline for project implementation

(2009)
THE PROCESS OF DEVELOPING A FINANCIAL PLAN
To develop a workable and meaningful financial plan, the

entrepreneur has to follow these steps:
 Step 1: Gather all financial inputs

 Step 2: Determine the project implementation cost
 Step 3: Determine the sources of finance
 Step 4: Prepare the pro forma cash flow statement
 Step 5: Prepare the pro forma income statement
 Step 6: Prepare the pro forma balance sheets
 Step 7: Perform basic financial analysis
(2009)
Step 1: Gather the Financial Input (contd.)
• The process of developing a financial plan for a

specific project begins with the accumulation of
financial information from the marketing,
operations and organizational plans.
• The financial requirements for each plan are

presented in the form of budgets known as
operating budgets (i.e. marketing, operations and
organisation budgets)

(2009)
Step 1: Gather the Financial Input (contd.)
• In addition, the monthly or annual sales

forecast derived earlier in the marketing plan is
a very important input for the financial plan.
• After gathering all information the financial

plan is prepared in terms of financial budget.

(2009)
Marketing Plan Organizational Plan
Sales Forecast Administrative Budget
Marketing Budget Financial Plan
Project implementation cost
Sources of financing
Pro forma cash flow statement
Pro forma income statement
Pro forma balance sheet
Financial Analysis
Operations Plan
Operations Budget

(2009)
Step 2: Determine the Project Implementation
Cost
• A project implementation cost incorporates both long-

term and short-term expenditure needed to start a
project.
• Long-term expenditure refers to such expenditure as the

procurement of plant, machinery, equipment, vehicles
and other fixed assets needed by the new business.

(2009)
Step 2: Determine the Project Implementation Cost
(contd.)
• Short-term expenditure, such as payments of utilities,

salaries and wages, factory overheads, purchase of raw
materials or inventories, represent the amount of initial
working capital required to finance the daily operation until
the business gets its first sale.
• Components of project implementation cost:

 Capital expenditure
 Working capital
 Other expenditure
 Contingency cost
(2009)
(2009)
Step 3: Determine the Sources of Finance
• Sources of finance refers to the sources where funds

to finance a particular project’s implementation costs
can be secured.
• These can be categorised into internal and external

sources. The internal sources mainly come in the
form of equity contributions from the entrepreneurs.
These contributions can either be in the form of cash
or other assets.

(2009)
(contd.)
• External sources of finance are mainly derived from

commercial banks, finance companies and
government agencies. It may come in the form of
term loans, hire purchase or grants.
• The total amount of funds that has to be sourced

should equal the total project implementation cost
calculated earlier. This is to ensure that the project is
fully funded and to avoid the risks of under-financing.

(2009)
(contd.)
Components of sources of finance:

 Contingency cost
 Internal sources
 Equity contributions (cash and/or assets)
 External sources
 Term loan
 Hire purchase
 Others

(2009)
(2009)
Step 4: Prepare Pro Forma Cash Flow Statement
• Pro forma cash flow statement refers to the projected

statement of cash inflow and outflow throughout the
planned period.
• Under normal circumstances, the pro forma cash flow

statement is prepared for three consecutive years,
detailed by month for the first year and by year for the
second and third years. However, longer periods are
sometimes needed depending upon the projects
undertaken.

(2009)
(contd.)
• The total amount of funds that has to be

sourced should equal the total project
implementation cost calculated earlier. This is to
ensure that the project is fully funded as well as
to avoid the risks of under-financing.

(2009)
(contd.)
The pro forma cash flow statement must be able to show

the following information:
 Cash inflows – the projected amount of cash flowing
into the business
 Cash outflows – the projected amount of cash
flowing out of the business.
 Cash deficit or surplus – the difference between cash
inflows and outflows
 Cash position – the beginning and ending cash
balances for a particular period
(2009)
(contd.)
Elements of cash inflows:

 Equity contribution (cash)
 Term loan
 Cash sales
 Collection of receivables
 Others

(2009)
(contd.)
Elements of cash outflows:
 Marketing expenditure
 Operations expenditure
 Administrative expenditure
 Term loan repayment
 Hire purchase repayment
 Purchase of fixed assets
 Pre-operating expenditure
 Payments for deposits
 MiscellaneousETR/ENT300
Entrepreneurship Dept, FBM
(2009)
expenditure
MODULE 11 : Financial Plan 20
Example: Pro Forma Cash Flow Statement

(2009)
Example: Pro Forma Cash Flow Statement (contd.)

(2009)
Step 5: Prepare Pro Forma Income Statement
• The next step in developing a financial plan is to

prepare the pro forma income statement which shows
the expected profit or loss for the planned period,
usually for three consecutive years.
• The pro forma income statement consists of the

following elements:
• Sales
• Gross Income
• Net Income Before Tax

(2009)
Step 5: Prepare Pro Forma Income Statement
(contd.)
• Net income before tax is derived as follows:
Sales - Cost of Sales = Gross Profit

Gross Profit - Operating Expenses = Net Income before tax

(2009)
Example: Pro Forma Income Statement
Year 1Year 2Year 3

Sales240,000276,000317,400
Cost of sales94,600103,900108,940
Gross profit145,400172,100208,460
Less: Operating Expenses

Marketing expenses18,00018,90019,845
Administrative expenses96,000100,800105,840
Depreciation charges7,2007,2007,200
Miscellaneous 2,700 600600
123,900127,500133,485
Operating income21,50044,60074,975
Less: Financing expenses:
Interest on term loan4,5003,6002,700
Interest on hire-purchase1,6001,6001,600
6,100 5,200 4,300
Net profit before tax15,40039,40070,675
(2009)
Step 6: Prepare Pro Forma Balance Sheet
• While the pro forma income statement shows the

financial performance of the business for the planned
period, the pro forma balance sheet shows the financial
position of the business at a specific point in time in
terms of assets owned and how those assets are
financed.
• The pro forma balance sheet is normally prepared for a

period of three years.

(2009)
Step 6: Prepare Pro Forma Balance Sheet (contd.)
• The pro forma balance sheet consists of the following

elements:
 Assets
 Owners’ equity
 Liabilities
• The balance sheet shows the following equation:
Assets = Owners’ equity + Liabilities

(2009)
• Assets are the economic resources of a business that are

expected to be of benefit in the future. Assets reported in the
balance sheet are generally categorised into two categories:
non-current and current assets.
• Non-current assets include fixed assets and other assets that

are owned and usually held to produce products or services.
These assets are not intended for sale in the short term.
Examples: property, plant, machinery, equipment, vehicles,
major renovations and long-term investments. For fixed assets,
the values shown in the balance sheet are the book value i.e.
the original cost less the accumulated depreciation.

(2009)
• Current assets are short-term assets that can be

converted into cash within a year. Examples: cash,
inventories (raw materials, work-in-process and/or
finished goods), receivables and other short-term
investments.
• Owners’ equity refers to capital contributions from the

owners or shareholders in terms of cash or assets plus
the accumulated amount of net income. However, if the
business suffers a loss, the amount of loss will be
deducted from the capital contributions.

(2009)
• Liabilities are the amounts owed by the business to outsiders.

They are categorised as non-current (long-term) and current
liabilities.
• Non-current or long-term liabilities refer to the long-term

obligations of the business that mature in a period of more
than one year. They usually include long-term loans as well as
hire purchase.
• Current liabilities refer to the short-term obligations of the

business that mature within a period of less than a year. The
most common forms of current liabilities are accounts
payable and accrued payments
(2009)
• Liabilities are the amounts owed by the business to

outsiders. They are categorised as non-current (long-
term) and current liabilities.
• Non-current or long-term liabilities refer to the long-term

obligations of the business that mature in a period of
more than one year. They usually include long-term
loans as well as hire purchase.

(2009)
Example: Pro Forma Balance Sheet
Year 1Year 2Year3

Non-Current Assets (book value)
Land & building45,00045,00045,000
Machinery & equipment18,40013,8009,200
Furniture & fixtures5,6004,2002,800
Renovation3,2002,4001,600
Vehicles20,00015,00010,000
Deposit 800 - -
93,00081,20069,400
Current Assets
Inventory of raw materials3,0003,5004,000
Inventory of finished goods3,0004,000 5,000
Cash40,90077,600145,575
46,90085,100154,575
Total Assets139,900166,300223,975
Owners’ Equity
Capital72,50072,50072,500
Accumulated profit15,400 54,800125,475
87,900127,300197,975
Long-term Liabilities
Term loan36,00027,00018,000
Hire-purchase 16,00012,000 8,000
52,000 39,000 26,000
Total Owners’ Equity & Liabilities139.900166,300223,975
(2009)
Step 7: Perform Basic Financial Analysis
• Financial analysis is a technique of examining financial

statements to help the entrepreneur analyse the
financial position and performance of the business.
• Financial analysis involves two basic steps: generating

the information from the financial statements and
interpreting the results.
• The most common form of financial analysis is “ratio

analysis”.
(2009)
Step 7: Perform Basic Financial Analysis (contd.)
• Financial ratios are normally used to compare figures

from the financial statement with other figures, so that the
true meaning of financial pictures can be obtained.
• There are various financial ratios that the entrepreneur

can look at. However, the most commonly considered
ratios in small business decision-making fall into four
categories: liquidity, efficiency, profitability and solvency.
• For illustrative purposes, financial data presented in pro

forma financial statements in the next slides will be used.

(2009)
Pro Forma Income Statement
Year 1Year 2Year 3

Sales576,000662,400794,880
Cost of sales 227,000254,600278,460
Gross profit349,000407,800516,420
Less: Operating Expenses

Marketing expenses56,50062,15068,365
Administrative expenses226,000248,600273,460
Depreciation charges21,00021,00021,000
Other operating expenses 5,000 4,000 4,000
308,500335,750366,825
Operating income 40,500 72,050149,595
Less: Financing expenses:
Interest on term loan16,50013,200 9,900
Net income before tax24,00058,850139,695

(2009)
Pro Forma Balance Sheet
Year 1Year 2Year3

Non-Current Assets (book value)
Land & building100,000100,000100,000
Motor vehicles64,00048,00032,000
Office equipment5,6003,0002,000
Renovation16,00012,0008,000
Machinery32,00024,00016,000
Other assets (deposits) 1,000 1,000 1,000
217,000188,000159,000
Current Assets
Inventory of raw materials2,0003,0004,000
Inventory of finished goods5,0006,000 8,000
Cash 46,500105,350244,645
53,500114,350256,645
Total Assets270,500302,350415,645
Owners’ Equity
Capital105,500105,500105,500
Accumulated profit24,000 82,850222,545
129,500188,350328,045
Long-term Liabilities
Term loan132,00099,00066,000
Current Liabilities
Accounts payable 9,000 15,000 21,600

Total Owners’ Equity & Liabilities270.500302,350425,645
(2009)
• Liquidity Ratios
 The term liquidity refers to the availability of liquid

assets to meet short-term obligations. Thus,
liquidity ratios measure the ability of the business
to pay its monthly bills.
 The most widely used liquidity ratios are current

ratio and quick ratio.

(2009)
 Current ratio can be determined by dividing total

current assets by total current liabilities. Generally,
this ratio shows the business’ ability to generate cash
to meet its short-term obligations.
Current ratio = Total current assets Total current
liabilities
Year 1 Year 2 Year 3
Current assets RM53,500 RM114,350 RM256,645
Curent liabilities RM 9,000 RM15,000 RM 21,600
Current Ratio 5.94 7.62 11.88

(2009)
 If the business’ current ratio falls below 1, it means

that the business is in a serious liquidity situation. In
most cases, the comfortable current ratio for most
businesses is ‘2’.
 Quick ratio, also known as the acid test ratio,

measures the extent to which current liabilities are
covered by liquid assets.
 To determine quick ratio, the calculation of liquid

assets does not take into account inventrories since
it is sometimes difficult to convert them into cash
quickly.
(2009)
Quick ratio=Total current assets-inventories

Total current liabilities

Current assets RM53,500 RM114,350 RM256,645
Inventories RM 7,000 RM 9,000 RM 12,000
Current liabilities RM 9,000 RM15,000 RM 21,600
Quick Ratio 5.17 7.02 11.33
In most cases, the comfortable quick ratio is ‘1’.

(2009)
• Efficiency Ratios
 The efficiency ratios measure how efficient the

business uses its assets to generate sales.
 The most widely used efficiency ratio for planning

purposes is inventory turnover ratio.

(2009)
 Inventory turnover (or stock turnover) measures the

number of times inventories have been converted into
sales and indicates how liquid the inventory is. All
other things being equal, the higher the turnover
figure, the more liquid the business is.
 This ratio divides the cost of sales (or cost of goods

sold) by the average value of inventory. The average
value of inventory is derived by adding the opening
and closing balance of and dividing the total by two.
Inventory turnover =Cost of sales Average inventory
(2009)

Cost of sales RM227,000 RM254,600 RM278,460
Average inventory RM 7,000 RM8,000 RM 10,500
Inventory turnover 32.42 times 31.83 times 26.5 times

(2009)
• Profitability Ratios
 Profitability ratios are important indicators of the

business’ financial performance. Investors will
particularly be interested in these ratios since they
measure the performance and growth potential of
the business.
 Some of the commonly used profitability ratios are

gross profit margin, net profit margin, return on
assets and return on equity.

(2009)
 Gross profit margin give a good indication of financial

health of the business. Without an adequate gross
margin, the business will be unable to pay its
operating and other expenses.
 Gross profit margin is calculated by dividing the

business gross income by sales.
Gross profit margin =Gross profit Sales

(2009)

Gross profit RM349,000 RM407,800 RM516,420
Sales RM576,000 RM662,400 RM794,880
Gross profit margin 60.59% 61.56% 64.97%
 Net profit margin is an indication of how effective

the business is at cost control. The higher the net
profit margin, the more effective the business is at
converting sales into actual profit.

(2009)
 Net profit margin is calculated by dividing the business

net income by sales.
Net profit margin =Net profit Sales

Net profit RM 24,000 RM 58,850 RM139,695
Sales RM576,000 RM662,400 RM794,880
Net profit margin 4.16% 8.88% 17.57%

(2009)
 Return of assets measures the overall return that the

business is able to make on its assets.
 This ratio is derived by dividing the business net profit

by total assets.
Return on assets =Net profit Total assets

Net profit RM 24,000 RM 58,850 RM139,695
Total assets RM270,000 RM302,350 RM415,645
Return on assets 8.89% 19.46% 33.61%

(2009)
 Return of equity shows what the business has earned

on its owners’ investment in the business.
 This ratio is derived by dividing the business net profit

by total equity.
Return on equity =Net profit Total equity

Net profit RM 24,000 RM 58,850 RM139,695
Total equity RM129,500 RM188,350 RM328,045
Return on equity 18.53% 31.25% 42.58%

(2009)
• Solvency Ratios
 This final category of ratios is designed to help the

entrepreneur measure the degree of financial risk that
his business faces. By referring to this ratio, the
entrepreneur can assess his level of debt and decide
whether it is appropriate for the business.
 The most commonly used solvency ratios are total
debt (liabilities) to equity (also known as leverage or
gearing), total debt to total assets, and times interest
earned (also known as interest coverage).

(2009)
 The total debt to equity ratio indicates what

proportion of equity and debt that the company is
using to finance its assets.
 This ratio is calculated by dividing the the total debt by

total equity.
Debt to equity ratio =Total debt Total equity
Total debt RM141,000 RM114,000 RM 87,600
Total equity RM129,500 RM188,350 RM328,045
Debt to equity ratio 1.09 : 1 0.61 : 1 0.27 : 1

(2009)
 The debt to asset ratio measures the percentage of

the business’ assets financed by creditors relative to
the percentage financed by the entrepreneur.
 This ratio is calculated by dividing the total debts by

total assets.
Debt to equity ratio =Total debts Total assets
Total debts RM141,000 RM114,000 RM87,600
Total assets RM270,500 RM302,350 RM415,645
Debt to total assets ratio 52.13% 37.70% 21.08%
(2009)
 Times interest earned ratio measures the number of

times interest expense can be covered by profit
before interest and tax.
 This ratio is calculated by dividing total interest

expense by profit before interest and tax.
Time interest earned = Profit before interest & tax
Interest expense Year 1 Year 2 Year 3
Profit before interest RM40,500 RM72,050 RM149,595
Interest expense RM16,500 RM13,200 RM 9,900
Time interest earned 2.45 times 5.46 times 15.11 times

(2009)
SUMMARY
• The financial plan is an important part of the business

plan. It incorporates all financial data derived from the
operating budgets, i.e. marketing, operations and
administrative budgets.
• Based on this financial data, several financial

projection tools are prepared to provide the
entrepreneur with a clear picture of the amount of
money needed to start a business, sources of finance,
the amount of cash available and the financial
performance and position of the business.
(2009)
SUMMARY (contd.)
• The output of a financial plan covers project

implementation cost schedule, sources of financing
schedule, pro forma cash flow statement, pro forma
income statement , and pro forma balance sheet.
• The business financial data gathered in the financial

statements are analysed in order to obtain an overall
financial picture of the business. The financial ratios are
used to analyse the financial performance of the
business.

(2009)
END OF MODULE 11

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FUNDAMENTALS OF ENTREPRENEURSHIP

Entrepreneurship Dept, FBM ETR/ENT300 MODULE 11 : Financial Plan 1

At the end of the session, students should be able to:

• Understand the importance of preparing a ﬁnancial plan

Entrepreneurship Dept, FBM ETR/ENT300 MODULE 11 : Financial Plan 2

A ﬁnancial plan incorporates all ﬁnancial data derived from

Based on the ﬁnancial data, projections are prepared via the

A ﬁnancial plan is crucial to the overall business plan that is

 To determine the size of investment

Entrepreneurship Dept, FBM ETR/ENT300 MODULE 11 : Financial Plan 4

To develop a workable and meaningful ﬁnancial plan, the

 Step 1: Gather all ﬁnancial inputs

• The process of developing a ﬁnancial plan for a

• The ﬁnancial requirements for each plan are

Entrepreneurship Dept, FBM ETR/ENT300 MODULE 11 : Financial Plan 6

• In addition, the monthly or annual sales

• After gathering all information the ﬁnancial

Entrepreneurship Dept, FBM ETR/ENT300 MODULE 11 : Financial Plan 7

Entrepreneurship Dept, FBM ETR/ENT300 MODULE 11 : Financial Plan 8

• A project implementation cost incorporates both long-

• Long-term expenditure refers to such expenditure as the

Entrepreneurship Dept, FBM ETR/ENT300 MODULE 11 : Financial Plan 9

• Short-term expenditure, such as payments of utilities,

• Components of project implementation cost:

• Sources of ﬁnance refers to the sources where funds

• These can be categorised into internal and external

Entrepreneurship Dept, FBM ETR/ENT300 MODULE 11 : Financial Plan 12

• External sources of ﬁnance are mainly derived from

• The total amount of funds that has to be sourced

Entrepreneurship Dept, FBM ETR/ENT300 MODULE 11 : Financial Plan 13

Components of sources of ﬁnance:

Entrepreneurship Dept, FBM ETR/ENT300 MODULE 11 : Financial Plan 14

• Pro forma cash flow statement refers to the projected

• Under normal circumstances, the pro forma cash flow

Entrepreneurship Dept, FBM ETR/ENT300 MODULE 11 : Financial Plan 16

• The total amount of funds that has to be

Entrepreneurship Dept, FBM ETR/ENT300 MODULE 11 : Financial Plan 17

The pro forma cash flow statement must be able to show

Elements of cash inflows:

Entrepreneurship Dept, FBM ETR/ENT300 MODULE 11 : Financial Plan 19

Entrepreneurship Dept, FBM ETR/ENT300 MODULE 11 : Financial Plan 21

Entrepreneurship Dept, FBM ETR/ENT300 MODULE 11 : Financial Plan 22

• The next step in developing a ﬁnancial plan is to

• The pro forma income statement consists of the

Entrepreneurship Dept, FBM ETR/ENT300 MODULE 11 : Financial Plan 23

• Net income before tax is derived as follows:

Sales - Cost of Sales = Gross Proﬁt

Entrepreneurship Dept, FBM ETR/ENT300 MODULE 11 : Financial Plan 24

Year 1Year 2Year 3

Less: Operating Expenses

• While the pro forma income statement shows the

• The pro forma balance sheet is normally prepared for a

Entrepreneurship Dept, FBM ETR/ENT300 MODULE 11 : Financial Plan 26

• The pro forma balance sheet consists of the following

• The balance sheet shows the following equation:

Assets = Owners’ equity + Liabilities

Entrepreneurship Dept, FBM ETR/ENT300 MODULE 11 : Financial Plan 27

• Assets are the economic resources of a business that are

• Non-current assets include ﬁxed assets and other assets that

Entrepreneurship Dept, FBM ETR/ENT300 MODULE 11 : Financial Plan 28

• Current assets are short-term assets that can be

• Owners’ equity refers to capital contributions from the

Entrepreneurship Dept, FBM ETR/ENT300 MODULE 11 : Financial Plan 29

• Liabilities are the amounts owed by the business to outsiders.