Upon completing the first three parts of the pre-feasibility study, the entrepreneur should now be able to proceed in constructing his or her enterprise’s financial forecasts for the business. The financial forecasts refer to the monetary transactions that the business is expected to engage in. Ultimately, the end result of the financial forecasts will indicate the feasibility of the enterprise.
Financial forecasting calls for the creation of the four critical financial statements: namely, (1) income statement; (2) balance sheet; (3) cash flow statement; and (4) funds flow statement. The marketing strategy and action program should translate into revenue or sales forecasts. The operations strategy and the production or service delivery program should translate into forecasts of costs of goods produced. The rest of the Enterprise Delivery System should translate into forecasts of operating and non-operating expenses. Together, they comprise the income statement forecasts. The resources mobilized and held by the enterprise are translated into forecasts of the balance sheet (which show the investments in the form of assets and their corresponding financing in the form of liabilities). The flow of resources should be translated into funds and cash flow statements. For a better understanding, this discussion will concentrate on preparing a simple income statement and balance sheet.
The income statement is a financial statement that measures an enterprise’s performance in terms of revenue and expenses over a certain period. Simply put, the formula is:
REVENUES – EXPENSES = INCOME OR PROFIT (LOSS)
From revenues forecasted (quantities sold times the prices they are sold for), the entrepreneur must subtract the estimated cost of goods sold corresponding to the forecasted sales. This should give the gross profit. From the gross profit, the operating expenses must be deducted to arrive at the operating profit. Then, the taxes due are subtracted to derive the net profit after taxes. If the enterprise has non-operating revenues and expenses, these should be added or subtracted from the operating profit before the taxes are computed. An example of a simple income statement is shown in Table 1.
Table 1. Monthly Income Statement of Mang Juan’s Manufacturing
Less: Cost of Goods Sold*
Less: Operating Expenses
Net Profit After Taxes
* Note that cost of goods sold refers to the materials, labor costs, and overhead of making a product. For service establishments, the entrepreneur can compute the costs of servicing the customers directly as cost of services rendered.
Creating the balance sheet is a bit more complicated because one has to look at three different things: assets, liabilities, and equities.
Assets represent all the investments in the enterprise including the initial investments that you considered in the pre-feasibility study (investment requirements). These include cash (on hand and in bank), accounts receivable, inventory of goods, equipment and machinery, facilities, vehicles, etc.
Financing the assets or investments are the liabilities and equity. Liabilities represent the enterprise’s debts to suppliers, to banks, to government, to employees, and other financiers. Stockholders’ equity represents the investors’ investments in the stock (or shares) of the business.
The balance sheet equation is:
ASSETS = LIABILITIES + EQUITY
The above equation means that the resources invested into the enterprise in the form of liabilities and stockholders’ equity must be equal to the total value of the assets or the enterprise itself. An example of a simple balance sheet is shown in Table 2.
Table 2. Balance Sheet of Mang Juan’s Manufacturing
* Retained Earnings are the accumulated profits or losses of the enterprise over the years, which have not yet been given back to investors as dividends.
Financial Ratios and Measurements
In any business endeavor, the investor or the entrepreneur himself or herself will always be interested in knowing the payback period or how long will it take for him or her to get back what he or she has invested in the enterprise.
However, payback period is just one of the many financial computations one can take a look at in considering a particular business opportunity. But this will only be possible if the entrepreneur can come up with financial statements. The income payback period can be computed as follows:
To compute for the income payback period based on ABC Company’s financial statements, which specify investments of $1,500,000 and net income after taxes of $500,000 a year, we can conclude that it would take around 3 years for the company to recover the investment.
In the Cash Payback Period, the entrepreneur should add back the non-cash deductions from the income statement, which is the depreciation expense. Thus, if the depreciation expense is $250,000 a year, the net income after taxes plus depreciation would amount to $750,000 a year. This would then represent a cash payback period of two years only.
In effect, the faster you are able to earn back the money invested, the better it is for the entrepreneur and the more attractive the business opportunity becomes.
There is also the return on sales (ROS) ratio where the entrepreneur calculates how much profit the enterprise is earning for each peso sold. The formula is as follows:
Substituting the variables into ABC Company’s estimated figures:
Furthermore, if the entrepreneur is interested to know the return on the investments made, which come in the form of assets, then he or she can compute for the return on assets (ROA) or return on investments (ROI) shown by the formula:
Again, substituting the variables using ABC Company’s estimated figures:
The above ratios are but a few of the frequently used financial measurements. Should the resulting figures for all three ratios be favorable, this means that the business 1 opportunity is quite promising.