ENTREPRENEURIAL FINANCE Fifth Edition

1. ENTREPRENEURIAL FINANCEFifth Edition Chapter 1 Financial and Economic Concepts

2. Buffett and Gates • Buffett and Gates Section 5 http://www.youtube.com/watch?feature=player_detailpage&v=_4_jj843x2Q • Buffett and Gates Section 6 http://www.youtube.com/watch?feature=player_detailpage&v=_4_jj843x2Q • Buffett and Gates Section 7 http://www.youtube.com/watch?feature=player_detailpage&v=g3e3RFx0D_c • Buffett and Gates Section 8 http://www.youtube.com/watch?feature=player_detailpage&v=Ez_pjiIy0sY

3. What is it? • Finance is essentially any transaction in which money or a money- like instrument is exchanged for other money or another money- like instrument. • Tasks • Cash management • Investing • Financing • Implementation of strategic plans

4. Cash Management • Critical task for managers • Obviously need cash to operate • Cannot exist very long with poor cash management • What do we manage • Inflow of cash • From customers • From investors • Outflow of cash • To suppliers • To creditors • To owners

5. Investing • Managers invest in two basic asset types • Invest in the securities of other companies • Strategies followed are identical to the strategies of individual investors • Invest in plant and equipment • Processes are very similar to individuals • Ultimate goal is to maximize the value of the firm

6. Financing • Where do managers get funds to enable the firm to grow and operate. • Sources of funds • Their own assets • Friends, family, other people • Banks and insurance companies • Bonds • Stocks • Profits of the firm • The size and type of the firm will determine which of these can be used.

7. Source: www.bizstats.com

8. Implementation of the strategic plan • The overall outcome of financial management is to provide the mechanism and tools to implement the plans of the company. • A secondary activity is providing data for understanding how the plan is functioning. Also, data for the creation of the plan is provided through the tools available from financial management.

9. Economic concepts • In the US, basic principle is that individuals can achieve their own objectives within a free enterprise system. • Market economy – individuals and institutions exchange goods and services freely • Real estate • Retail • Commodities • Financial instruments • Who gains when we perform transactions? • Both sides (buyers and sellers) believe they gain from a transaction.

10. Economic Concepts • Scarce resources – scarce because people want more than they have. • Types • Natural resources • Human resources • Capital resources • Economic • Financial • Entrepreneurial resources • http://www.youtube.com/watch?feature=player_detailpage&v=VttAbSYYIsw

11. Economic Concepts • Opportunity costs • The highest value that is surrendered when a decision to invest funds is made. • http://www.youtube.com/watch?feature=player_detailpage&v=pWE7WDZC-lQ

12. Income, Expenditures, and Taxes • Gross income is all of the money received from all sources during the year. • Wages • Tips • Interest earned on savings and bonds • Income from rental property • Profits to entrepreneurs

13. Taxes • Progressive taxes: larger percentage of tax paid as income increases. • Regressive taxes: larger percentage of tax paid as income decreases. • Proportional taxes: percentage of tax paid remains the same at all levels of income.

14. Example of Progressive Tax • Formula for tax percentage paid: • Income tax is progressive:

15. Example of Regressive Tax • Sales tax is regressive: • Income = $20,000; savings = 0; sales tax = 5% • Sales tax paid = $20,000 x 0.05 = 1,000 • Income = $60,000; savings = $10,000; sales tax = 5% • Sales tax paid = $20,000 x 0.05 = $1,000

16. Example of Proportional Tax • Formula for tax percentage paid: • Medicare tax is 1.45% • Annual income $30,000 • Medicare tax = $30,000 x 0.0145 = $435 • Annual income $500,000 • Medicare tax=$500,000 x 0.0145 = $7,250

17. Basic Income Calculations • Gross income - taxes = Disposable income • For most of us, disposable income is take-home pay. • Disposable income - Fixed expenses = Discretionary income • Fixed expenses are contractual obligations like rent, utilities, insurance, and car payments. • Discretionary income is that we can spend or save. • Does this include debt?? NO • Would the government want to find a way to increase disposable income? Why?? • Would the government rather you spend or save your disposable income??

18. What do we learn? • We have a progressive tax system. • Fixed expenses decrease as a percentage of income, as income increases. • Discretionary income increases as wealth increases.

19. Economic Concepts • Factors Affecting Interest Rates • The supply of money saved is primarily the total money that is placed in demand deposit (checking) accounts, savings accounts, and money market mutual funds. • law of supply relates to the price paid and the quantity of a resource that is provided at that price. • The demand for borrowed funds is all of the money that is demanded in our economy at a given price. • The law of demand states that as the price of an item de-creases, people will demand a larger quantity of that item,

20. As interest rates increase, all people would desire to save more money, but at a decreasing rate.

22. Economic Concepts • Factors Affecting Interest Rates • The supply of money saved is primarily the total money that is placed in demand deposit (checking) accounts, savings accounts, and money market mutual funds. • law of supply relates to the price paid and the quantity of a resource that is provided at that price. • The demand for borrowed funds is all of the money that is demanded in our economy at a given price. • The law of demand states that as the price of an item de-creases, people will demand a larger quantity of that item,

26. Factors Affecting Interest Rates (continued) • In a totally free market supply and demand will determine interest rates. We do not have a totally free market. • Federal Reserve Policy • The Federal Reserve is the central bank of the United States. • Monetary policy is the government’s action to alter the supply of money. • Goals of monetary policy • Economic growth • Price stability • Full employment

28. Factors Affecting Interest Rates (continued) • Inflation is a primary concern for the FED. • A primary goal is to assure that inflation remains in check to create stability in prices. • How do they attempt to control inflation? • Open market operations • Discount rate • Reserve requirements

29. Factors Affecting Interest Rates (continued) • Risk • Systematic Risk: Risk associated with economic, political, and sociological changes that affect all participants on an equal basis. • Frequently referred to as market risk • This risk is not diversifiable • Unsystematic Risk: Risk unique to an individual, firm, or industry. • Frequently referred to as company specific risk • This risk is diversifiable

30. Chapter 2 Financial Management and Planning

31. What is management? • The process of working with or through others to achieve an individual or business goal by efficiently and effectively using resources. • Five basic functions • Planning • Organizing • Staffing • Directing • Controlling operations. • http://www.youtube.com/watch?feature=player_detailpage&v=b_slep81F4E

32. Management Functions • Planning is a systematic process that takes us from some current state to some future desired state. • Strategic planning involves establishing an overall plan for the business. • Where do we want our business to be at some time in the future? • Functional planning is driven by strategic plans and is related to specific functional areas of a business such as accounting, marketing, or human resources. • Financial planning • The reason so many businesses fail is because of a lack of adequate financial planning. • Nobody begins a business with a plan for failure, but too many businesses have been started with a failure to plan.

33. Management Functions (continued) • Goal setting is precursor to establishing a plan. • Goals must be measurable, achievable, and have a time frame. • Basic financial goals of a for-profit organization: • To maximize the wealth of the business owners (investors) over the life of the business • To meet interest payments on debt • To grow • Goals vs Objectives • Goals are normally considered to be long term • Objectives are intermediate goals that measure progress toward the overall long- term goal.

34. Management Functions (continued) • Organizing is the second function of the manager and defines the structure of the business. • Who will do it? • What skills do they need? • What is the time frame that we have set in which to have it accomplished? • Where will it be accomplished? • How do we get it accomplished?

35. Management Functions (continued) • Staffing requires that the manager obtain the most capable personnel to implement the business plans. • Determine job requirements. • Develop a job description. • Directing (leading). Providing proper guidance and direction to others to accomplish the organization’s mission.

36. Management Functions (continued) • Controlling is a three-step process: • Establishing a standard of measurement • Measuring actual performance against the standard • Taking corrective action when actual performance varies from the established standard

37. Forms of Business Ownership

38. Forms of Business Ownership (continued) • A sole proprietorship is operated by an individual for profit. • A partnership is an association of two or more persons who carry out a business as co-owners for a profit. • A corporation is a legal entity with most of the rights of individuals • A limited liability corporation is a hybrid of a partnership and a corporation.

39. Forms of Business Ownership (continued) • A sole proprietorship is operated by an individual for profit. • Advantages • No formal legal requirements • Title to property is in owner’s name • No formal organizational style • All that is needed to start is an idea and a desire • Disadvantages • Capital structure limited • Unlimited liability • Life of business = life of business owner • May lack managerial skills • May be difficult to hire long-term employees or employees with specific skill sets • Accountant

40. Forms of Business Ownership (continued) • A partnership is an association of two or more persons who carry out a business as co-owners for a profit. • Advantages over sole proprietorship lies in the number of people involved. • General partnership • Limited partnership • Requires one general partner • “silent partners” • Cannot participate in business

41. Terms • Liability • Who pays? • Where does the money come from? • Taxes • Who pays? • What rate? • Buy-sell agreements • Stops the sale of interest to unknown people • Important because of liability issues

42. Forms of Business Ownership(continued) • The corporation is a legal entity according to U.S. law. • Incorporated in one of the fifty states or territories of the United States. • Public Corporation: stock is sold to the public. • Private Corporation: Stock is not sold to the public. • All corporations are formed as C corporations unless they meet the requirements of and request Subchapter S tax status. • Subchapter S corporation: Private corporation with special tax status granted by Internal Revenue Service (IRS) • Maximum of 100 shareholders • No double taxation • Taxes • Who pays? What rate?

43. Forms of Business Ownership (continued) • A Limited Liability Company (LLC) is a hybrid business entity having features of both partnerships and corporations. • Taxed as a partnership • Has limited liability for all owners • Flows through income and losses to individual owner’s tax returns • Not legal in all states

44. Forms of Business Ownership (continued) • Franchise not an actual form of ownership. A franchise is a business in which the buyer, who is the franchisee, purchases the right to sell the goods or services of the seller, who is the franchiser. • http://www.youtube.com/watch?feature=player_detailpage&v=uhSEVjTciA0

45. Forms of Business Ownership (continued) • What form to choose? • Liability • tax advantages • financial support • the owner’s desires • the type and location of the business. • Three types of business owners • http://www.youtube.com/watch?feature=player_detailpage&v=uhSEVjTciA0 • Where to form the business • http://www.youtube.com/watch?feature=player_detailpage&v=gRV6xx4BftQ

46. Starting a Business • Run a SWOT analysis • Strengths are the core competencies of a business. They are those factors that will make your business succeed because you perform in these areas better than your competitor. • Weaknesses are those areas of your company that definitely need improvement. • Opportunities are factors that exist outside of your business, but that if taken advantage of, will help your business to grow and prosper (e.g., low interest rates for business loans). • Threats are factors that exist in the environment that may impede the growth of your business, directly or indirectly (e.g., new competition).

47. Development of a Business Plan • Executive summary: Part of business plan that investors review to determine if they want to read further. Two pages or fewer, the executive summary should contain: • Business strategy for success • Brief description of the market and what makes your business unique • Brief description of the product or service • Brief description of management teams’ qualifications • Summary of revenue and expense projections • Estimate of how much money is needed and how it will be used

48. Development of a Business Plan (continued) • General Company Description: • Mission Statement: • Company goals • Company objectives • Business philosophy • Form or forms of business ownership • Products and services • Marketing plan • 4 Ps: Price, Product, Promotion, Place. • Government contracts as source of revenue • Operational plan • Management and organization • Personal financial statement of each owner or major stockholder • Startup expenses and capitalization • Financial plan; a 4-year projection of profit

49. Development of a Business Plan (continued) • Appendices • Brochures, advertising materials, business cards • Industry studies • Maps and photos of location • List of equipment owned or purchased • Copies of leases or contracts • Letters of support from suppliers and future customers • Market research studies • List of assets available for a loan

50. Business Succession Plans • Determine who will take the business if owner is unable to function. • Succession Planning • Buy-sell agreement is overt • Owner and spouse on same page • Heirs receive ownership rights directly, or in trust • Ownership by family members only or do we include non-family members? • Gather information from spouse and children when formulating a buy-sell agreement or succession plan. • Consult with attorney and other professionals. • http://www.youtube.com/watch?feature=player_detailpage&v=vITv-jjve9Y