PREPARING FOR THE NEW VENTURE LAUNCH: EARLY MANAGEMENT DECISIONS (Continued….)

<< PREPARING FOR THE NEW VENTURE LAUNCH: EARLY MANAGEMENT DECISIONS (Continued….)

PREPARING FOR THE NEW VENTURE LAUNCH: EARLY MANAGEMENT DECISIONS (Continued….) >>

Entrepreneurship MGT602

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.

Entrepreneurship MGT602

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.

Entrepreneurship MGT602

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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