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FW12 - First sketch
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FW15 - Marketing mix
FW16 - Operations
FW17 - Organization
FW18 - Accounting
FW19 - Financial statements
FW20 - Financial analysis
FW21 - Cash flow
1. Starting the company
2. Survival potential
3. Do it yourself
4. Author
FW22 - Business name
FW23 - Decision making process
FW24 - Check up point
FW25 - Communication
FW26 - Negotiation
FW27
- Raising money
FW28 - Project management
FW29 - Management
FW30 - Strategy
FW21-MANAGING
YOUR CASH FLOW
CASE STUDY
YOUR POSITION
Look at the map
MAP
192 days before opening
1. Starting the company 2. Survival potential 3. Do it yourself 4. Coaching
INTRODUCTION
This module cash flow is not a classic course. It's a case study. It will enable you to use all that you have learnt in the previous financial modules.
Right now, our objectives are the following:
-You are starting a company. You need to use the ratios that are useful for the creation of your business.
-As your company becomes active, you will use the financial knowledge's and ratios that are useful for the management.
- According to your first results, you must determine the immediate measures to be taken.
We shall use a case study based on the John tourism project.
Real case study:
This project is quite simple:
- You are living in El Calafante, Patagonia, near by one of the most beautiful glaciers in the world, the Périto Moreno.
-You want to organize excursions for tourists to the glacier.
-The tourists will be picked up at their hotel(s) in the morning, then they will be taken to the glacier where a picnic is served, and after the visit you will take them back to their hotel(s).
Duration
Case study: 1,5 hours
Do it yourself: 1,5 hours
Total: 3 hours
Objectives
We shall study the different ratios necessary for this project and the measures that must be taken:
-To start up the company
-To preserve its survival potential.
1. Starting the company 2. Survival potential 3. Do it yourself 4. Coaching
1-STARTING THE COMPANY
Firstly, you have to define your costs, your selling price and the amount of money you need.
For this purpose, You need only two tools:The break even point and the cash flow projection.
11-Costs and selling price: The break even point.
First, you have to determine your fixed and variable costs
111-Fixed costs.
You will need:
-An office: rent 30 $ per month------------ 360 $ per year
-An insurance:----------------------------- 40 $ per year
-A computer:with equipment:------------- 1 000 $ to invest
-Office supplies:--------------------------- 600 $ per year
-Telephone:-------------------------------- 500 $ per year
TOTAL:------------------------------------ 2 500 $ per year
Then you determine how much profit you want to make.
You do not create an enterprise for the fun. If you are employed by a company in El Calafante, you are probably paid around 6 000 $ per year. Your goal in starting up your own business is to raise your living standard and to gain as much as a middle class North American, let’s say 30 000 $ per year.
Finally you determine the number of tourists you can reach per year.
This is quite simple. By consulting the statistics of the El Calafante airport, you can see that 10 000 tourists are coming in every year. 10 % of this number means 1 000 tourists per year for your business.
Based upon these statistics, you know your fixed costs, you know your target profit and you know the number of tourists you can get. According to these figures you can set the following formula:
or
that gives:
According to your fixed costs, expected profit, and maximum tourists your selling price minor variable cost per unit must be equaled to $32,5
Consequently, you have now to determine the variable cost per unit.
112-Variable costs per unit.
We target 1000 tourist per year. What 's the number per day?
We will count 200 days per year, taking into account bad weather, week-ends and your days off.
You will guide 5 tourists per day.
To transport these 5 tourists, you will need a Land Rover Station Wagon, a driver and 30 liters of fuel per day. You have to split these costs per tourists and per day. It's quite easy:
-Cost of a second hand Station Wagon: 20 000 $
Actual lifetime 3 years: 6 700 $ per year
Its cost per day will be 6 700 $ : 200 days: 33,5 $ per day
Its cost per tourist will be 33,5 $ : 5 tourists: 7 $ per tourist per day.
-The chauffeur’s salary will be $170 per month, that means 2 000 $ per year all charges included.
The calculation is the same: 2 000 $ : 200 = 10 $
10 $ : 5 tourists = 2 $ per tourist per day
-For the fuel:
30 liters per day = 6 l per tourist at a cost of 0,5 $ = 3 $ per tourist per day.
-For picnic and unforeseen events:
Let’s say that each tourist will cost 8 $ per day
TOTAL: Your variable cost per unit is then 20 $ (7 + 2 + 3 + 8).
113-Selling price
You now have all elements to set the selling price:
-Selling price — variable cost per unit = 32,5 $
-X — 20 $ = 32,5 $
RESULT: X = 52,5 $
Your selling price must be 52 $ per tourist per day, which is a reasonable price. You verify if your calculations are correct on establishing a small yearly working account:
-Sales
1 000 tourists per year at $52,5 :-------------------$52 500
-Costs
| Chauffeur: | $2 000 |
| Fuel (30 l per day x 200) | $3 000 |
| Sundry
expenses (8 $ per tourist per day) (8 $ x 5 x 200) |
$8 000 |
| Redemption of the vehicle | $6 700 |
| $20 700 | |
| Gross income: | $31 800 |
| fixed costs: | $2 500 |
| Net income: | $29 300 |
As you former salary amounted $6 000 per year, the difference between your earlier situation and today will be around $24 000 (29300-6000).
12-The amount of money you need: The cash flow projection.
Right now, you have to calculate how much money you need for starting your project
For this purpose, you just have to establish your cash flow projection for the 15 months to come (we will use 5 quarters to simplify).
Let’s suppose that when you bought the Station wagon you paid 50 % of the amount in cash. The rest is to be paid within 6 months.
Let’s also suppose a delay of 3 months between the start up of your company and the appearance of your first clients. According to these hypothesis, your cash flow projection should be the following:
|
1st quarter |
2nd quarter |
3rd quarter |
4th quarter |
5th quarter |
Total |
|
|
Cash receipt |
||||||
|
Number of tourists |
- |
250 |
250 |
250 |
250 |
1000 |
|
Sales (52 $ per tourist) |
_ |
13125 |
13125 |
13125 |
13125 |
52500 |
|
Cash expenditures |
||||||
|
Fixed costs: |
||||||
|
Computer |
1000 |
1000 |
||||
|
Office supplies |
400 |
200 |
600 |
|||
|
Telephone |
100 |
100 |
100 |
100 |
100 |
500 |
|
Insurance |
40 |
40 |
||||
|
Rent |
90 |
90 |
90 |
90 |
90 |
450 |
|
Manager’s salary |
1500 |
1500 |
1500 |
1500 |
1500 |
7500 |
|
Variable costs: |
||||||
|
Station wagon |
10000 |
10000 |
20000 |
|||
|
Chauffeur |
500 |
500 |
500 |
500 |
2000 |
|
|
Fuel |
750 |
750 |
750 |
750 |
3000 |
|
|
Sundry expenses |
|
2000 |
2000 |
2000 |
2000 |
8000 |
|
Total |
13130 |
5140 |
14940 |
4940 |
4940 |
43090 |
|
Net cash flow |
-13130 |
+ 7985 |
- 1815 |
8185 |
8185 |
9410 |
|
Cumulative net cash flow |
-13130 |
- 5145 |
- 6960 |
+ 1225 |
9410 |
As you can see, you will need an initial capital of 13 500 $ to cover the negative cash flow of 13130 $.
With an initial capital of 13 500 $ the cumulative net cash flow at the end of the 5th quarter will be:
9410 + 13500 = $22910
1. Starting the company 2. Survival potential 3. Do it yourself 4. Coaching
2-SURVIVAL POTENTIAL
According to the previous calculations, your company has been created and is currently active during fifteen months.
Now, you have to analyze your results
21-First results analysis
The first thing to do is to establish the balance sheet and the income statement at the end of the 1st exercise of 15 months (5 quarters x 3)
211-Balance sheet and income statement
|
BALANCE SHEET |
||
|
Assets: |
||
|
Cash |
22 910 |
(positive cumulative cash flow at the end of the 5th quarter) |
|
Property and equipment |
20 000 |
|
|
- depreciation |
- 6 700 |
(redemption of the station wagon over 3 years) |
|
13 300 |
||
|
Total |
36 210 |
|
|
Liabilities: |
||
|
Taxes |
9 084 |
look at the income statement |
|
Initial equity |
13 500 |
|
|
Net income |
13 626 |
look at the income statement |
|
Total |
36 210 |
|
INCOME STATEMENT |
||
|
Sales |
52 500 |
|
|
Cost of goods sold |
13 000 |
(chauffeur, fuel and sundry expenses) |
|
Gross income |
39 500 |
|
|
fixed costs |
10 090 |
Computer,office,manager salary,tel |
|
Depreciation |
6 700 |
station wagon |
|
Operating income |
22 710 |
|
|
Taxes 40 % |
9 084 |
|
|
Net income |
13 626 |
As you can see, your net income (13126) is added to your initial equity in your balance sheet. You have doing well because you have doubled your owner equity. The taxes (9084) appears in the liabilities in the balance sheet because it's a debt that you will have to paid within a short term.
212-Ratio analysis
The second thing to do is to set up a ratio analysis. You have two fundamental ratios: The ROE and the Acid test.
In our example the acid test will be:
22-Management decisions
221-The decisions
Because of your brilliant results, you take several decisions:
-You recruit a secretary: $4 000 per year.
-You buy a small vehicle paid cash: $20 000
-You recruit a 2nd chauffeur: $2 000 per year
To cover these new costs, you anticipate to receive 2 000 tourists per year but in fact:
-You will peak at 1 000 because of a new company operating in the same field.
-During the 4th quarter the airport is closed for bad weather, and for the three last months of the year you have no tourists, so no income.
222-The results
Now let’s take a look at your cash flow over the year:
|
RECEIPT |
1st |
2nd
|
3rd
|
4th
|
|
|
Sales |
13 125 |
13 125 |
13 125 |
39 375 |
|
|
Beginning cash flow |
22 910 |
22 910 |
|||
|
36 035 |
13125
|
13125
|
62 285 |
||
|
FIXEDCOSTS |
|||||
|
Management |
1 500 |
1 500 |
1 500 |
1 500 |
6 000 |
|
Office supplies |
400 |
200 |
600 |
||
|
Telephone |
100 |
100 |
100 |
100 |
400 |
|
Insurance |
40 |
40 |
|||
|
Rent |
90 |
90 |
90 |
90 |
360 |
|
Secretary |
1 000 |
1 000 |
1 000 |
1 000 |
4 000 |
|
3 130 |
2 890 |
2 690 |
2 690 |
11 400 |
|
|
VARIABLE COSTS |
|||||
|
Vehicle |
20 000 |
20 000 |
|||
|
1st chauffeur |
500 |
500 |
500 |
500 |
2 000 |
|
2nd chauffeur |
500 |
500 |
500 |
500 |
2 000 |
|
Fuel |
750 |
750 |
750 |
750 |
3 000 |
|
Income tax |
- |
9 084 |
- |
- |
9 084 |
|
Sundry expenses |
2 000 |
2 000 |
2 000 |
2 000 |
8 000 |
|
23 750 |
12 834 |
3 750 |
3 750 |
44
084
|
|
|
Total Cost |
26 880 |
15 724 |
6 440 |
6 440 |
55 484 |
|
Net cash flow |
+ 9 155 |
- 2 599 |
+ 6 685 |
- 6 440 |
|
|
Cumulative cash flow |
+ 9 155 |
+ 6 556 |
+13241 |
+ 6 801 |
In spite of your positive report of $22 910 (the cash on the last balance sheet) the 2nd quarter’s cumulative cash flow is weak. The situation is still weak in the 4th quarter. What will happen if the airport is still closed for the first quarter of the next year?
Let’s study your income statement by the end of the year.
|
Sale |
39 375 |
|
|
Cost of goods sold |
15000 |
(2 chauffeurs, fuel and sundry expenses) |
|
Gross income |
24 375 |
|
|
Fixed costs |
11 400 |
|
|
Depreciation of 1 vehicle |
6 700 |
|
|
Depreciation of 2 vehicle |
6 700 |
|
|
24 800 |
||
|
Operating margin |
- 425 |
|
|
Income tax |
0 |
|
|
Net income |
- 425 |
|
Thanks to your decisions, you are now in the red!
Now let’s take a look at the balance sheet compared to the former one:
Let’s have a look at our two ratios:
-Your cash has been reduced from 22 910 to 6 801 .
-The ROE is negative:
-To diagnose the problem, we must consult the Gross Margin Ratio and the Operating Margin Ratio.
As we can see, decrease of sales is not the cause of your bad situation. The Gross Margin goes from 75 to 62 %, and this is acceptable.
The Operating Margin on the other hand goes from 43 % to 0. This is where you have a problem:
-Fixed costs and depreciation raises from 16 790 $ the first year to 24 800 $ the second year.
-You should not have recruited a secretary and bought a second vehicle!
23-Measures to adjust the situation
The measures you must take to adjust this situation are obvious:
-Sell the 2nd vehicle
-Lower your salary
-Fire your secretary and your 2nd chauffeur
According to this example, the measures you are taking agree with the arguments you can read from the ratios.
1. Starting the company 2. Survival potential 3. Do it yourself 4. Coaching
DO IT YOURSELF
You must now revise all the financial projections that you have included in your business plan.
This chapter of your business plan, called "Financial Projection", is the most important one. Potential associates will carefully scrutinize this chapter.
Remember that your Balance sheet, Income statement and the Cash flow projections must be established for a period of 5 years.
The cash flow projections must be presented each week for the first year (Starting period + one year of regular running period) and each month for the four next years.
1. Starting the company 2. Survival potential 3. Do it yourself 4. Coaching
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