2.1 Feasibility Studies

دوره: Essentials of Entrepreneurship- Thinking & Action / فصل: Feasibility Studies / درس 1

2.1 Feasibility Studies

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I'm not gonna use the reduced common cash flow statement format that you see published in financial reports. My cash flow statement is gonna have more or less the same line items of income, you know, of revenue. I teach it for an entire term, and my students come back and they bring me, you know, quarterly or annual, right?

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Welcome back to the essentials of entrepreneurship. This is module two, and we’re gonna talk about entrepreneurial finance. Okay you’ve got your first person opportunity, you’re ready to move into the, the formal evaluation of this. And what we’re gonna have to do now is, we’re gonna have to do a feasibility study. Okay? So you’re gonna sit down, open up Excel, and start plugging in some numbers. Now, what are we going to produce? On Excel, we’re going to produce an income statements, we’re gonna produce a projective income statement. Well, how do you produce a projective income statement for a business that doesn’t exist? Well we’re gonna, we’re gonna use research, we’re gonna use best guesses, we’re going to use hopefully conservative projections, hopefully. But we’re gonna produce a income statements. We’re also gonna produce a cash flow statement because we need cash in order to evaluate our opportunity, we need cash flows. Okay. So, were, income statements, cash flow statements. How about a balance sheets? Now I hope you’re not sitting there looking at me going, what’s a balance sheet? In fact, I hope you’re not saying what’s an income statement, what’s a cash flow statement? But don’t worry if you don’t know what they are right now we’ve, we’ve got a quick fix for that. Balance sheets, some people ask for them, some people don’t. Balance sheets, because of the nature of what a balance sheet is. It can be very ambiguous, or ambiguous, I’m sorry. It can be very ambiguous for a projected business. So you may not want to do a balance sheet. I only do balance sheets in my financial projections if the client asks for it. If a client says I want a balance sheet, I give them a balance sheet. Otherwise, cash flow income statement, that’s really what we wanna use. Okay so our financial statements. Now, do you wanna start with the ca, with the cash flow statement? Or the income statements? The answer is, it depends. It really depends on the nature of your business. Sometimes it’s easier to do the cash flow statement first, just look at the flows of cash and how they’re gonna come in and out of the business, and that one is a lot easier. Sometimes it’s easier to start with income statements. Now, my income statements and cash flow statements are gonna look very similar. Okay? I’m not gonna use the reduced common cash flow statement format that you see published in financial reports. No. My cash flow statement is gonna have more or less the same line items of income, you know, of revenue. The same line items of expenses that my income statement does. And I wanna do this monthly. I wanna do this monthly. Okay. And I say this all the time. I teach this in class. I teach it for an entire term, and my students come back and they bring me, you know, quarterly or annual, right? This doesn’t help me as an entrepreneur. Okay. I need to know, especially when I get to my cash flow, where is my cash flow monthly? The fact that my cash flow is positive at the end of each quarter does not necessarily mean I have the cash to pay my salaries in month one and month two of that quarter. If that cash all came in in month three, well then it’s never gonna happen cause my employees are probably gonna walk out in month one or month two and they don’t get paid. Do it monthly. Reason for this, another two reason for this, is that you’re on Excel. It’s easy, right? You’re dragging and dropping. You’re dragging formulas across. To do 60 months is as easy as to do 5 years, it’s the same, it’s just dragging it out. Okay? Also, when you wanna make it quarterly or annually. Right? It’s easy to do it from a monthly, whereas if you’ve done quarterly or yearly, and now you need monthly, that’s difficult. Do it monthly. Monthly income statement, monthly cash flow statements, okay? We’re gonna do them monthly. These are gonna show us how our business is gonna perform, what we’re expecting, and in terms of the cash flow statement, the cash flow is gonna tell us, how much cash do we have? How much cash do we need? When do we need it? It’ll also tell us about break even. Now this break even, if any of you have, have ever performed break even analysis before, there’s a couple different kinds of break even out there. Right? There’s break even that we perform in business all the time where we talk about a product. Or, or how, or how many units, or how many sales that this business needs to, to perform to break even. This is not what we’re talking about here. We’re talking here about investment break even. Right? You are gonna put money into this company. If not, somebody else is gonna put money into this company. When are they gonna get their money out of the company? Okay, that’s a break even. There’s another kinda break even that, that’s on the, the, the same the same scheme, basically, the same cash flow statement. We can also calculate what I call operational break even, right? Which is, at what point is the business running without further injections of cash? So when is the business able to sustain itself? And then, when does all the money originally invested into this business? When does it start growing and come out the other side? And finally, have paid back more then what was put into it so that’s investment break even. And we’re gonna see this all in the cash flow statement and that’s why the cash flow statement is so extremely important. So we use the cash flow statement for a lot of operational things and seeing how our business is gonna, is gonna do operationally. How about the income statement? Well the income statement really is gonna show us the book profitability of of, of, this venture. It’s also like the cash flow statement gonna help us control expenses. And it helps us with scenario evaluation, okay? Now we’re gonna do scenarios in, in both and the way that we’re gonna put this, we’re gonna put these together, is you’re gonna use one Excel file and one sheet of Excel will be your cash flow statement and one sheet will be your income statement. And their gonna be linked, and this is one of the best pieces of advice I can give you. Link everything. Link everything. Because when you’re evaluating your business, you go well, what if we charge a little bit more for this product? Or what if we think no, we’re gonna sell, we thought we were gonna sell more of this but now we’re gonna sell more of this. Or what if we can actually get this supplied at a, at a lower cost? You go in and you change the one thing, and it changes everything, right? Cuz you, you, create your your income statement, and your cash flow statement, and they’re linked. So what I like to have, is I actually like to have, you know, tab one on my Excel will simply be basic info. Right, and I start putting assumptions in there. And that’s the only point, place, where I ever change those assumptions. Okay, and as I change them there, they get linked over to other tabs in Excel and they update everything. So make sure as you’re putting together your feasibility study that you, you link it up that you have as few open cells, loose cells as possible so that. And, and that you have one page somewhere that shows you kind of the main the main variables and the main data points that you’re working with, so you can see it all in one glance. And what I often do is when it’s, I’m ready to present that to someone, I I clean it up and basically just call it my basic info sheet. In which ca, it, that you can look at and you can see this is, you know, this is what I’m sell, this is how many I think I’m gonna sell month one. Which equates to this year one, this is the prize, this is the number of customers, has all that information kinda right up front. And that’s very nice and clean for investors. So you get these sheets together, and you can now start running some graphs. And investors love graphs cuz now they don’t have to look at, you know, sales and sales and sales full of numbers. They can start looking at the visualization of things. So you can do something like you see here. You’ve got 5-year projected net income. Okay. And here you also see some scenarios, right? You can see that there’s a probable case, there’s a best case, there’s a worst case scenario. Scenarios are, are good for you and they’re very good for an investor because we’re predicting the future here. And we want to use a base case scenario, based on what the market research, what the market data indicates we should, we should have. In fact, once you become very experienced in it, like myself, what you really do is, what the market predicts is really your best case scenario. Then you throw some flies in the ointment as we say, you throw in some, well what if something happens and we don’t start off as quick as we thought. Or we, we run into a problem here or there, and we, and then, that’s the base case. And then we throw something even worse into it. Well, what if there’s a, there’s a, a shortage in the supply of a certain element that we need to get this done. And you create a worst case scenario. And so, you have something very strong and robust to present. Because you’ve actually studied different cases and what will happen in different scenarios. And you have a plan for how you’re gonna deal with each scenario. You can then take this information. And you know, you know now know how much you’re gonna need. Okay. How much investments is this company gonna require? How much is this company worth? Cuz once I’ve got a cash flow statement, I can discount my cash flows by, by a determined discount rate, and I can come up with a value. This is important if I want investors. Cuz if I want investors, I need $50,000. Well what is $50,000 worth? If any of you have watched that that program Shark Tank, right? Where people, uninformed entrepreneurs just kinda walk in and they say, I will, you know, I need $50,000 and I’ll give you 5% of my company. Well basically, you’re saying that, that $50,000 is, is what 5% of your company is worth. Okay so what is that is that $2 million is what your saying that company is worth? Well show me that, that company is worth $2 million. You see if I if I ask, if I say I want $50,000 and my projected cash flows show that my company is worth $100,000. Then, just to be fair, $50,000 is half of my company. That is what it comes out to. That’s the way it is, right? Determining how much of our company we give for how much, equity is not an arbitrary thing, especially not to an investment. An investor. They wanna know that they’re getting their fair share for what they’re paying. Okay so we have all this put together once we’ve got our income statement and our projected cash flows. We can get an actual value of that business. The other thing that the cash flows show us especially on a month to month basis is that they show us when we need that cash. You see we could determine that we’re gonna need $50,000 worth of cash. But you don’t need a month one or month zero. You maybe need 10,000 to get up and running. And then when you hit a benchmark, you’re gonna need another 10,000. And then, and another benchmark that’s when you’ll need another 10,000. Right? And people are much more willing to invest smaller amounts of money at a time seeing the progress that you’re making. Right? Then they are investing a bunch of money up front. Also, the more that your business progresses, the more your business will actually be worth. So maybe they get 10% of your company for the first 10,000 they give but on the second 10,000, maybe they only get 9% now because we can see that your company is worth more money. All right. So it’s also a way of maximizing the money you can get and minimizing the equity that you have to give.

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