ASSESSING A NEW VENTURE'S FINANCIAL STRENGTH AND VIABILITY

Introduction to Financial Management

Financial management deals with two activities, raising money and managing a company's finances in a way that achieves the highest rate of return. A firm is successful doesn't mean that it doesn't face financial challenges. As a company grows, its cash demands often increase to service a growing clientele. 

Financial Objectives of a Firm
There are four main financial objectives of entrepreneurial ventures :
👉 Profitability : the ability to earn a profit.
👉 Liquidity : a company's ability to meet its short-term financial obligations.

👉 Efficiency : how productively a firm utilizes its assets relative to its revenue and its profits.
👉 Stability : the strength and vigor of the firm's overall financial posture.

The Process of Financial Management
To assess whether its financial objectives are being met, firms rely heavily on analyses of :
🙆 Financial statement : a written report that quantitatively describes a firm's financial health. This is include the income statement, the balance sheet, and the statement of cash flows.

🙆 Forecasts : an estimate of a firm's future income and expenses, based on its past performance, its current circumstances, and its future plans.
🙆 Budgets : itemized forecasts of a company's income, expenses, and capital needs and are also an important toll for financial planning and control. 

Financial Statements
⇰ Historical financial statements reflect past performance and are usually prepared on a quarterly and annual basis.
⇰ Pro forma financial statements are projections for future periods based on forecasts and are typically completed for two to three years in the future. In fact, most companies consider their pro forma statements to be confidential and reveal them to outsider, such as lenders and investors, only on a "need-to-know" basis.

Historical Financial Statements
If a firm goes to banker or investor to raise funds, the banker or investor will invariably ask for copies of past financial statements to analyze the firm's financial history.
💧 Income Statement
The income statement reflect the results of the operations of a firm over a specified period of time. It records all the revenues and expenses for the given period an shows whether the firm is making a profit or is experiencing a loss. There are three numbers that receive the most attention when evaluating an income statement :
- Net sales : total sales minus allowances for returned goods and discounts.
- Cost of sales : includes all the direct costs associated with producing or delivering a product or service, including the material costs and direct labor.
- Operating expenses : include marketing, administrative costs, and other expenses not directly related to producing a product or service.

An increasing profit margin means that a firm is either boosting its sales without increasing its expenses or that is is doing a better job of controlling its costs.
💧 Balance Sheet
A balance sheet is a snapshot of a company's assets, liabilities, and owners' equity at a specific point in time. A balance sheet must always "balance", meaning that a firm's assets must always equal its liabilities plus owners' equity. (A = L + E)
💧 Statement of Cash Flows
The statement of cash flows summarizes the changes in a firm's cash position for a specified period of time and details why the change occurred. The statement of cash flows is divided into three separate activities : operating, investing, and financing activities
💧 Ratio Analysis
- Profitability ratios : associate the amount of income earned with the resources used to generate it.
- Liquidity ratios : measure the extent to which a company can quickly liquidate assets to cover short-term liabilities.
- Overall financial stability ratio : measures the overall financial stability of a firm.
💧 Comparing a Firm's Financial Results to Industry Norms
It helps a firm determine how it stacks up against its competitors an if there are any financial "red flags" requiring attention. 

Forecasts
Forecasts are predictions of a firm's future sales, expenses, income, and capital expenditures. A well-developed set of pro forma financial statements helps a firm create accurate budgets, build financial plans, and manage its finances in a proactive rather than a reactive manner.
💨 Sales Forecast (basis of the other forecast)
A sales forecast is a projection of a firm's sales for a specified period, though most firms forecast their sales for two to five years into the future. A sales forecast for an existing firm is based on:
- its record of past sales
- its current production capacity and product demand
- any factor that will affect its future production capacity and product demand

Sophisticated tools are available to help firms project their future sales, usually it use regression analysis which is a statistical technique used to find relationships between variables for the purpose of predicting future values.
💨 Forecast of Costs of Sales and Other Items
The common way to do this is to use the percent-of-sales method, which is a method for expressing each expense item as a percentage of sales. Once a firm completes its forecast using the percent-of-sales method, it usually goes through its income statement on an item-by-item basis to see if there are opportunities to make more precise forecasts. In addition to computing sales forecasts, when a company considers opening a new branch or producing a new product, it often calculates a break-even analysis to determine if the proposed initiative is feasible.

Pro Forma Financial Statements
A firm's pro forma financial statements are similar to its historical financial statements except that they look forward rather than track the past. The preparation of pro forma statements helps firm rethink their strategies and make adjustments if necessary. A firm's pro forma financial statements should be created in conjunction with the firm's overall planning activities.

💦 Pro Forma Income Statement
In the pro forma income statement, the constant ratio method of forecasting is used to forecast the cost of sales and general and administrative expenses, meaning that these items are projected to remain at the same percentage of sales in the future as they were in the past.
💦 Pro Forma Balance Sheet
- provides a firm a sense of how its activities will affect its ability to meet its short-term liabilities and how its finances will evolve over time.

- quickly show how much of a firm's money will be tied up in accounts receivable, inventory, and equipment.
- used to project the overall financial soundness of a company.
💦 Pro Forma Statement of Cash Flows
The pro forma statement of cash flows shows the projected flow of cash into and out of the company during a specified period. The most important function is to project whether the firm will have sufficient cash to meet its needs.
💦 Ratio Analysis
This work is completed so the firm can get a sense of how its projected financial performance compares to its past performance and how its projected activities will affect its cash position and its overall financial soundness. It is extremely important for a firm to understand its financial position at all times and for new ventures to base their financial projections on solid numbers.

"If you don't understand what's happening in your business factually and you're making business decisions based on anecdotal data or gut instinct, you'll eventually pay a big price." - Bill Gates-