Business at every stage of its development needs to express its activity in financial data which are used either for external or internal (managerial) purposes.  This financial data are contained in three financial statements from which we can obtain the raw material for further financial analysis. These are:

• The balance sheet,
• The income statement/ Profit and loss account / Income - expenses statement
• The cash flow statement
• The start up costs budget

The balance sheet is “snapshot “of the assets used by the company and of the funds that are related to those assets. It is a static document related to one point of time  - end of months, quarters, years.   In other words, the balance sheet puts what the firm owns versus what it owes at any point in time.  What differentiate balance sheets is the net worth (NW) or shareholders /owner equity (OE)which is the difference between total assets (TA) and total liabilities (TL). The basic accounting equation is:                TA = TL + OE.

The income statement (Profit and loss account/ Income – expenses statement) measures the gains or losses from both ordinary and extra ordinary activities over period of time bounded by the two balance sheets (from the two subsequent periods). It shows the firm´s financial position over a period of time (months, quarters, year) through the comparison between the in-resources (revenue and income) and the out-resources (costs ).  Similar as the balance sheet which presents the net worth as differentiating component, the income statement is identified by the net profit (NP) which is the difference between total revenue (TR) and total costs (TC).  Based on that the income statement equation is:                                         TR – TC = NP

 The Cash flow statement

The cash flow statement describes the actual net cash that flows into (cash inflow) and out

of (cash outflow) a firm through its operation and finances. It would also show if would be any need for additional financing and which way would be possible to get them: through equity, loans, short-term line of credit and how and under which conditions they would be paid back.

There are four separated components of the flow of cash and its equivalents:

• Operating activities
• Investing activities
• Financing activities.

As far as operating activities are cash has to be spent in order for the firm to carry out production. When products are sold, they either bring immediate cash or delayed cash through the accounts receivable if they are sold on credit.

Investing activities – company can gives out or takes in cash when buy and sell fixed assets.

Financing activities – company would can get cash in  from loans raised from banks and issuing new equity. Cash out related to financing activities is  paying interests and instalments for loans, taxes and dividends. Cash in is receiving of interests from deposits, or cash back from tax returned.

Start-up costs budget

This is important part for a business plan written for  start-ups. It contains all of the expenses incurred to initiate the business, develop and run it. As each business is different there is no universal method for estimating start-up costs. It is important to take into consideration:

• What type of business you are? There are businesses that need smaller budget and the other ones ask for huge investment in inventory or equipment.
• how much starting capital or seed money is needed to start business? It is important to estimate the costs of doing business for the first months. Some expenses will be one-time costs (like buy building), some will be on-going costs like cost of utilities, inventories etc.
• Which costs are essential and which are optional? Only essential costs it means those that are necessary to start a business should be included in budget. Essential costs can be divided into two categories: fixed and variable. Fixed costs are costs of rent, utilities, administrative costs, insurance etc. Variable costs are costs of material, shipping and packaging costs, sales commissions etc.
• The most effective way to calculate startup costs is to use a worksheet that lists both one-time and ongoing costs. If this worksheet is extended by key sources of funds for dedicated time period is possible to calculate whether there is excess or  shortage of funds for start- up business in particular periods.

Data in financial statements are raw materials for financial analysis. Its results are used for external and internal analysis to report  financial position and different financial aspects of company . There are several ways to do financial statement analysis. The most applied are:

• Vertical or common size analysis
• Horizontal/change/dynamic analysis
• Ratios analysis
• Break – even analysis.

• Vertical or common size analysis

This analysis is based on comparison of one item of balance sheet or income statement to selected common ground like value of  total assets or net sales if we calculate these percentages for each item of balance sheet and income statement we receive structure of assets and liabilities and cost structure. These “structural” ratios  can be further analysed e.g. through comparative analysis or time series analysis etc.   This analysis is very useful in forecasting of balance sheet or income statement of companies with history.

• Horizontal / change/ dynamic analysis

                While in vertical analysis we compare several items of balance sheets or income statement to the selected common ground like total assets or net sales, in horizontal/ change or dynamic analysis we compare these items across time, especially a comparison to a selected base time.    

• Ratio Analysis

The major purpose of ratio analysis is to analyse the company financial statement by the way of constructing and calculating different ratios which can be used as general indictors to assess the company´s performance. The most typical categories of ratios are liquidity, profitability, operational activity, debt and market- based ratios. For each of those categories numerous ratios have been developed.

• • Liquidity ratios show the firm´s ability to handle and pay for its short term liabilities.

The higher liquidity ratio is the easier and smoother the entire performance would be. The most frequently used are the current ratio, the quick ratio, the net working capital ratio and the cash ratio.

• • Profitability/ efficiency  ratios  have major objective to assess how efficiently firm

utilize their assets. Key profitability ratios are net profit margin which shows how much operating profit (EBIT) is generated by each monetary unit (EUR, Pound, CZK, USD etc.) of net sales; return on assets which relates net profit (profit after taxes) to total assets of the company; return on equity in which net profit after taxes is related to shareholder´s equity. The higher is value the better is efficiency of the company.

• • Operational activity ratios which deals with the extent to which the firm is able to

convert various accounts into cash or sales.  These includes inventory turnover ratio; accounts receivable ratio, accounts payable ratio, fixed and total assets turnover.

• • Debt/leverage ratios which indicate the extent to which the company´s assets are

tied to the creditor´s claim and , due to that, the company´s ability to meet the fixed payments that are due to pay off debt. The most common ratios in this category are: total debt ratio, times interest earned ratio, long term debt ratio and debt/equity ratio.

• Break-even analysis / cost-volume-profit analysis in generally means to calculate the point

 that equates the costs with revenues. 

Break-even point  is calculate either as minimum quantity of product (BEQ) or revenue (BER).

• • BEQ = Fixed costs/(price per unit of product minus variable operating cost per unit of product)
  • BER = Fixed cost /( 1 – (variable cost per unit/price per unit)).

By knowing BEQ and BER start-up company can determine and control its operations in order to sustain the proper level of output to cover all operating costs and also assess and control its ability and timing to earn profits at different level of production and volume of sales.

Financial forecasting is the process of predicting the future state and value of financial and economic indicators and their changes based on current knowledge and current and past data.  There are the following key steps that guide the forecasting process and the creation of financial model:

a/ build and support an assumptions that may come from fundamental analysis of the opportunity, information on comparable companies, or expert judgment.

b/ start with a forecast of revenue as most other aspects of the financial model are related to revenue.

c/ decide whether to develop the forecast in real or nominal terms which means to decide how inflation would be included into forecast.

d/ integrate the financial statements it means through spreadsheet formula to integrate the pro forma balance sheet, income statement end cash flow statement to be able to da/ test sensitivity to formulated assumptions, db/ to do scenario analysis, dc/ to simulate impact of uncertainty on future performance.

e/ determine an appropriate time span for forecast which depends on purpose of the forecast. The forecast used for determining financial needs should cover period long enough at the end of which the venture has its track record based on which is able to attract follow-on financing.

f/ determine an appropriate forecasting interval which depends on planning period of the venture. If we assess the financial needs of the new venture than interval of one year is too long as entrepreneurs must assess their cash needs on more frequent basis. Therefore, monthly period is the most relevant from time and reliability points of view.

g/ assess the assumptions of the model across the financial statements. “What if” analysis and stress tests are techniques that are usually used.

• Forecasting the revenue of an established business

There are five simple (naïve) approaches often used for revenue forecasting:

• Forecasting based on the historical nominal growth rate of sales. This approach takes into consideration extrapolation based on the last period sales level which is multiplied by the average historical growth rate of sales (e.g. calculated based on the last five years nominal growth rate of sales).
• Forecasting based on the historical real growth rate of sales. This approach is also  based on extrapolation but taking into consideration real growth rate of sales which means its each year  inflation- adjustment  (annual sales growth rate minus inflation rate).
• Weighting the historical growth rates of sales. This method is based on weighting of historical data so that more recent annual growth rate of sales is multiplied by the greater weight.  Average weighted growth rate of sales is calculated as an average of each year weighted growth rates. The logic behind is that the future will probably be more like the recent past than the more distant path.
• Exponential smoothing is an alternative weighting scheme that brings more accurate results the previous methods when historical data are limited.
• Forecasting based on fundamentals takes into consideration influence of macroeconomic development on sales growth.  One way how to get forecasted real growth rate of sales is based on historical data of real GDP growth and real sales growth to estimate relationship (ratio) between GDP real growth and real sales growth and multiply this ratio by expected real growth rate of GDP in forecasted year.

• • Forecasting revenue of a new venture

Forecasting of revenue for a venture with no previous historical data where are many uncertainties like product is doesn´t exist  and customers are not known, behaviour of competitors is unknown etc. is much more difficult than for established companies.

There are two approaches  used for this forecasting:

a/ Yardsticks

b/ Fundamental analysis

a/ Yardsticks

If for some new ventures exists reasonable comparable yardsticks companies than their public or non-public data are used for forecasting.  Comparable dimensions important for forecasting are:

.  product/customer attributes,

.  distribution channels,

.  manufacturing technology etc.

Data sources  are publicly disclosed reports, IPO prospectus, mainly for newly public ventures and other data sources which depends on concrete countries/regions.

All these data sources usually contain historical data needed for forecasting .  Then techniques used for forecasting are the same as for established businesses described above.

b/ Fundamental analysis

There are different approaches to fundamental analysis.

• For simple new venture like opening coffee shops empirical data gathering through talking to customers, observations of traffic, prices etc. is sufficient.
•  For innovative new ventures analysis must be more complex   and should start with estimation of the size of the relevant market. Then demand and supply approaches are applied.
  • Demand – side approach assess consumer willingness and ability to buy the product assuming that new venture has sufficient capacity to produce it. It should take into consideration such factors as geographic market which should be served, estimation of number of customer in this market, growth rate of this market, quantity of purchase of a typical customer during a forecast period, expected average price. Based on these inputs sales growth rate is forecasted.
  • Supply-side approach seeks to determine how fast the venture can growth taking into consideration resources constraints ( access to raw material, financial, human, managerial etc.). This means even if demand grows rapidly sales growth rate of the venture is limited by supply side.
  • Combination of  demand – supply sides means to choose expected sales growth rate which is lower.
    • Integrated financial modelling

Goal of the of integrated financial modelling is to create set of integrated financial statements that  capture interactions between pro forma statements, reflect assumption changes across all statements  and add time dimension to accommodate growth.

Pro forma statement is financial statement (income statement, balance sheet, cash flow)the items of  which are projected values based on a specific forecasting method and a certain set of assumptions. 

The pro forma analysis is one of the most common and practical ways to predict the feasibility and worth of a firm in the near future. It is useful for established companies  but especially for new venture.

For start up majority of variables for the pro forma statements have to be estimated. When company pass through the first year of production and sales in the real market, then actual figures can be used for pro forma statements forecasting.

Key steps of the integrated financial modelling:

• Starting point for integrated financial modelling is forecasting revenue  which we have discussed above and is a basis for pro forma balance sheet, income statement and cash flow.
• Cash conversion cycle  presents flow the venture´s operations and describes the relationships between cash flow and income statement and balance sheet accounts.
• Working capital, growth and financing needs projection.  The most important components of gross working capital (which is also name for current assets) are inventory, accounts receivable and cash.  Additional key item for net working capital (= current assets – current liabilities) are accounts payable.  There are three major financing strategies for working capital:
  • Aggressive approach means the company would match the permanent financial need to the long-term debt and match the temporary capital to the short-term borrowing, where each financing would be taken at its own market cost of capital.
  • In the conservative approach company would drop the short-term financing altogether, and rely on the long-term debt to finance almost all of its capital needs.
  • In the balanced approach the company would compromise the previous two approaches.