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Entrepreneurship
MGT602
VU
Lesson
41
PREPARING
FOR THE NEW
VENTURE
LAUNCH: EARLY MANAGEMENT
DECISIONS (Continued....)
LONG-TERM
VS. SHORT-TERM
DEBT
The
entrepreneur may need to borrow funds to
finance assets and meet
cash needs. Fixed assets
are usually
financed
by long-term debt borrowed
from a bank. Alternatives include
borrowing from family
members,
having
partners contribute more funds or
selling corporate stock. Many of
these options require
the
entrepreneur
to give up some equity.
MANAGING
COSTS AND PROFITS
An
interim income statement
helps to compare the actual
with the budgeted amount for
that period.
The
most effective use of the interim
income statement is to establish
cost standards and compare
the
actual
with the budgeted amount for
that time period. Costs are
budgeted based on percentages of
net
sales.
These percentages can be
compared with actual
percentages to see where tighter
cost controls may be
necessary.
This lets the entrepreneur manage
and control costs before it is
too late. In later years, it is
also
helpful
to look back on the first
year of operation and make
comparisons month-to-month.
When
expenses
or costs are much higher than
budgeted, the entrepreneur may need to
determine the exact cause.
Comparison
of actual and budgeted
expenses can be misleading
for ventures with multiple
products or
services.
For financial reporting purposes, the
income statement summarizes
expenses across all
products
and
services. This does not
indicate the marketing cost for each
product nor should the most
profitable
product.
Allocating expenses over
product lines be done as effectively as
possible to avoid arbitrary
allocation
of costs.
TAXES
The
entrepreneur will be required to withhold
federal and state taxes
for employees and make
deposits to
the
appropriate agency. Federal taxes,
state taxes, social
security, and Medicare are
withheld from
employees'
salaries and are deposited
later. The entrepreneur should be careful
not to use these funds.
The
new
venture may also be required to pay
state and federal unemployment
taxes. Federal and
state
governments
will require the entrepreneur to file end-of-the-year
returns of the business.
RATIO
ANALYSIS
Calculations
of financial
ratios can
also be valuable as an analytical
and control mechanism. These
ratios
serve
as a measure of the financial strengths
and weaknesses of the venture, but should
be used with
caution.
There are industry rules of thumb
that the entrepreneur can use to
interpret the financial data.
Liquidity
Ratios
Current
ratio is commonly
used to measure the short-term solvency
of the venture or its ability to meet
its
short-term
debts. The current liabilities
must be covered from cash or
its equivalent.
The
formula is:
Current
ratio =
current
assets
current
liabilities
While
a ratio of 2:1 is generally
considered favorable the entrepreneur should also
compare this ratio
with
industry
standards.
Acid
test ratio is a
more rigorous test of the short-term
liquidity of the venture.
It
eliminates inventory, which is the
least liquid current
asset.
The
formula is:
Acid
test =
current
assets - inventory
ratio
current
liabilities
Usually
a 1:1 ratio would be
considered favorable.
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Entrepreneurship
MGT602
VU
Activity
Ratios
Average
collection period indicates
the average number of days it takes to
convert accounts receivable
into cash.
This
ratio helps gauge the
liquidity of accounts receivable or the
ability of the venture to collect from
its
customers.
The
formula:
Average
collection = accounts
receivable
period
average
daily sales
This
result needs to be compared to
industry standards.
Inventory
turnover measures
the efficiency of the venture in managing and
selling its inventory. A
high
turnover
is a favorable sign indicating the venture is
able to sell its inventory
quickly.
The
formula:
Inventory
=
cost
of goods sold
turnover
inventory
Leverage
Ratios
Debt
ratio helps
the entrepreneur assess the firm's
ability to meet all its
obligations. It is also a measure
of
risk
because debt also consists
of a fixed commitment.
The
calculation:
Debt
ratio =
total
liabilities
total
assets
Debt
to equity ratio
assesses the firm's capital
structure. It provides a measure of risk by
considering the
funds
invested by creditors and
investors. The higher the percentage of
debt, the greater the degree of
risk
to
any of the creditors.
The
calculation:
Debt
to
=
total
liabilities
equity
ratio
stockholder's
equity
Profitability
Ratios
Net
profit margin represents
the venture's ability to translate
sales into profits. You
can also use gross
profit
as
another measure of profitability. It is
important to know what is reasonable in
the particular industry as
well
as to measure these ratios
over time.
The
calculation:
Net
profit =
net
profit
margin
net
sales
Return
on investment measures
the ability of the venture to manage its
total investment in assets. By
substituting
stockholders' equity for
assets, you can also
calculate a return on
equity.
The
calculation:
Return
on =
net
profit
investment
total
assets
The
result of this calculation will also
need to be compared to industry
data. As the firm grows it
will be
important
to use these ratios in
conjunction with all other
financial statements to provide an
understanding
of
how the firm is
performing.
RAPID
GROWTH AND MANAGEMENT
CONTROLS
Rapid
growth may result in
management problems. Before rapid
growth occurs, the new venture is
usually
operating
with a small staff and
limited budget. Rapid growth
may also dilute the
leadership abilities of the
entrepreneur.
The entrepreneur's unwillingness to
delegate responsibility can lead to
delays in decision-
making.
The
entrepreneur can avoid these
problems through preparation and
sensitivity. It may be necessary
to
limit
the venture's growth if the future
financial well being of the venture means a
more controlled
growth
rate.
The limits to the growth of
any venture will depend on the
availability of a market, capital,
and
management
talent. Too rapid growth can
stretch these limits and
lead to serious financial
problems.
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Entrepreneurship
MGT602
VU
CREATING
AWARENESS OF THE NEW VENTURE
In
the early stages, the entrepreneur should
focus on developing awareness of the
products offered
through:
Publicity
Internet
Advertising
Trade
Shows
Selecting
an Advertising Agency
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