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1 | P a g e
Festus Eligbo & Young Okezie
2 | P a g e
Course Outline
1. Introductions
2. Executive Summary
3. Company Description
4. Industry Analysis
5. Market Ana...
3 | P a g e
The Approach to taking this course will be practical. The envisaged learning
outcome is for each ...
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Module 15

  1. 1. 1 | P a g e MODULE 15: PRACTICAL INSTRUCTIONS ON HOW TO WRITE BUSINESS PLAN By Festus Eligbo & Young Okezie
  2. 2. 2 | P a g e Course Outline 1. Introductions 2. Executive Summary 3. Company Description 4. Industry Analysis 5. Market Analysis 6. Production and Technical Considerations 7. Management and Labour Requirement 8. Project Cost & Financing 9. Commercial Viability 10. Project Management Issues 11. Exit Strategy 12. Recommendations
  3. 3. 3 | P a g e INTRODUCTION The Approach to taking this course will be practical. The envisaged learning outcome is for each and every one of you to be able to produce a bankable business plan at the end of the course. There is no clear cut outline for preparing a business plan. However, there are basic elements that are expected to be covered in a business plan. This course covers all these elements. Strong emphasis and time will be devoted to the commercial viability section of the business plan because this is the meat and flesh of the business plan. A complete real life Business Plan (Feasibility Study) is included in this manual for your consultation and guide. 1. Definition What is a Business Plan? There is no specific definition of a business plan. Generally, a business plan is a plan or roadmap produced to summarize the operational and financial objectives of a business enterprise for the near future. It essentially serves as a blueprint to guide the firm's policies and strategies to aid the smooth running of the enterprise as well serves as a tool for fund raising. A business plan is a living document; it is continually modified as conditions change and new opportunities and/or threats emerge. From the definition above we can deduce the following: i. A business plan is a document demonstrating the feasibility of a prospective new business and providing a roadmap for its first several years of operation. ii. A business plan is a formal statement of business goals, reasons they are attainable, and plans for reaching them. It may also contain background information about the organization or team attempting to reach those goals. iii. Business plans are an important part of creating new businesses, whether as a startup or an offshoot of an existing business. iv. Business plans have varying target audience. Business Plans for startups are often shared with funding agencies and potential investors to obtain the necessary funding. For the purpose of this course and audience, we will limit ourselves to business plans for startups. So we are going to build business plans that are aimed at
  4. 4. 4 | P a g e convincing potential investors and financing agencies on why they should invest or fund the proposed business.
  5. 5. 5 | P a g e WHY DO YOU NEED A BUSINESS PLAN?  To map the future A business plan is not just required to secure funding at the start-up phase, but is a vital aid to help you manage your business more effectively. By committing your thoughts to paper, you can understand your business better and also chart specific courses of action that need to be taken to improve your business. A plan can detail alternative future scenarios and set specific objectives and goals along with the resources required to achieve these goals. By understanding your business and the market a little better and planning how best to operate within this environment, you will be well placed to ensure your long-term success.  To support growth and secure funding Most businesses face investment decisions during the course of their lifetime. Often, these opportunities cannot be funded by free cash flows alone, and the business must seek external funding. All prospective lenders will require access to the company’s recent Income Statements/Profit and Loss Statements, along with an up-to-date business plan (financial projections). Income Statements/Profit and Loss Statements help investors to understand the past, whereas the business plan gives them a window peep into the future. To help the prospective investor see the future, it is important to clearly describe the business opportunity and its prospects, as investors will want to know:  Why they would be better off investing in your business, rather than leaving money in a bank account or investing in another business?  What the Unique Selling Proposition (USP) for the business arising from the opportunity is?  Why people will part with their cash to buy from your business? A well-written business plan can help you convey these points to prospective investors, helping them feel confident in you and in the thoroughness with which you have considered future scenarios. The most crucial component for them will be clear evidence of the company’s future ability to generate sufficient cash flows to meet debt obligations, while enabling the business to operate effectively.
  6. 6. 6 | P a g e  To help manage cash flow Careful management of cash flow is a fundamental requirement for all businesses. The reason is quite simple–many businesses fail, not because they are unprofitable, but because they ultimately become insolvent (i.e., are unable to pay their debts as they fall due). Cash flow management is vital when businesses pursue investment opportunities where there are significant cash out flows, in advance of the cash flows coming in. These opportunities need to be assessed against any seasonal variations in the business and the timing of the flows. If you are a “cash- only” business, you can bank the income immediately; however, if you sell on credit, you receive the cash in the future and hence may need to pay some of your own expenses before that income hits your account. This will put a further strain on the company’s solvency and hence a well-structured business plan will help you manage funding requirements in advance.
  7. 7. 7 | P a g e ELEMENTS OF A BUSINESS PLAN A well written business plan must contain some basic information which if not provided will make the business plan incomplete and ineffective. The areas of emphasis in a business plan depends on the target audience. The audience of a start-up is different from that of an existing business and the information that is expected in the business plan for a start-up is therefore, slightly different from what an existing enterprise will be required to provide. While for instance, an existing business will be required to provide historical facts about its operations, a start-up is only required to provide realistic projections (forecast) that are based on reliable and verifiable data (assumptions) because no investor will want to risk money on conjectures. The number of chapters and their titles in a business plan vary from project to project as well as the objectives the business plan is aimed at achieving. Irrespective of the project type and the objective of the business plan, there are some specific elements that must be included in the business plan. Some of these elements are outlined below. 1. Executive Summary. The Executive Summary provides a succinct synopsis of the business plan, and highlights the key points raised within. The Executive Summary must communicate to the prospective investor the size and scope of the market opportunity, the venture’s business and profitability model, and how the resources/skills/strategic positioning of the Company’s management team make it uniquely qualified to execute the plan. The Executive Summary must be compelling, easy-to-read, and no longer than 2-4 pages. 2. Company Analysis. This section provides a strategic overview of the company and describes how the company is organized, what products and services it offers/will offer, and goes into further detail on the company’s unique qualifications in serving its target markets. 3. Industry Analysis. This section evaluates the playing field in which the company will be competing, and includes well-structured answers to key market research questions such as the following:
  8. 8. 8 | P a g e  What are the sizes of the target market segments?  What are the trends for the industry as a whole?  With what other industries do your services compete? 4. Analysis of Customers. The Customer Analysis section assesses the customer segment(s) that the company serves. In this section, the company must convey the needs of its target customers. It must then show how its products and services satisfy these needs to an extent that the customer will pay for them 5. Analysis of Competition. This section defines the competitive landscape of your business. It identifies who the direct and indirect competitors are, assesses their strengths and weaknesses and delineates your company’s competitive advantages. 6. Marketing Plan. The marketing plan details your strategy for penetrating the target markets. Key components include the following:  A description of the company’s desired strategic positioning  Detailed descriptions of the company’s product and service offerings and potential product extensions  Descriptions of the company’s desired image and branding strategy  Descriptions of the company’s promotional strategies  An overview of the company’s pricing strategies  A description of current and potential strategic marketing partnerships/ alliances 7. Management Team. The Management Team section demonstrates that the company has the required human resources to be successful. The business plan must answer questions including:  Who are the key management personnel and what are their backgrounds? What management additions will be required to make the business a success?  Who are the other investors and/or shareholders, if any?  Who comprises the Board of Directors and/or Board of Advisors?  Who are the professional advisors (e.g., lawyer, accounting firm)?
  9. 9. 9 | P a g e 8. Financial Plan. The Financial Plan involves the development of the company’s revenue and profitability model. It includes detailed explanations of the key assumptions used in building the model, sensitivity analysis on key revenue and cost variables. In addition, the financial plan assesses the amount of capital the firm needs, the proposed use of these funds, and the expected future earnings. It includes Projected Income Statements, Balance Sheets and Cash Flow Statements, broken out monthly for the first year, and annually for years 1-5. Importantly, all of the assumptions and projections in the financial plan must flow from and be supported by the descriptions and explanations offered in the other sections of the plan. The Financial Plan is where the entrepreneur communicates how he/she plans to “monetize” the overall vision for the new venture. 9. Appendix. The Appendix is used to support the rest of the business plan. Every business plan should have a full set of financial projections in the Appendix, with the summary of these financials in the Executive Summary and the Financial Plan. Other documentation that could appear in the Appendix includes technical drawings, partnership and/or customer letters, expanded competitor reviews and/or customer lists, proforma invoices for equipment.
  10. 10. 10 | P a g e Commercial Viability Assumption on which the Financial Projections is based. Realistic assumptions form the bedrock of a sound financial projection especially for a start-up. To achieve this: i. Ensure that you are conservative with your sales and revenue estimates. Be cautiously optimistic. ii. Capture all envisaged expenses as realistic as possible. i. Project Cost ii. Finance Cost (Cost of fund) iii. Salaries & Wages iv. Working Capital v. Production Plan vi. Depreciation Please note that any financial projection that is based on conjectures will not stand the scrutiny of potential investors. The only thing most investors are interested in is the bottom-line (ROI). For a start-up, the only tool you have at your disposal to convince a potential investor, to entrust hard earned resources to you, is your business plan. Most investors really do not care so much about the technical details you have in the business plan as much as they care about your financial projection. Most Investors after reading the executive summary will skip every other details and move straight to your financial projections, the heart of the business plan. Your financial projection will tell the potential investor a story about the future of his resources. Will they yield fruits and “how much” fruit will the resources yield and for how long? Thus, your financial projection must provide the investor these answers. These required answers can only be deduced from a well-articulated and realistic assumption based upon which the financial projections are made. It is after the investor is convinced that there is a business case that he will take time to study the rest of the plan to gain insight into the proposed industry sector and your marketing plan for the product or service you propose to engage in.
  11. 11. 11 | P a g e In the next sections of this course we will focus on each critical element that make up the assumptions and then move on to forecast our financials.
  12. 12. 12 | P a g e FINANCIAL ASSUMPTIONS We will present some samples of assumptions used for business plans in some industry sectors Sample Assumption 1. Used for a printing press business plan. BASIS AND ASSUMPTIONS ON WHICH THE FORECASTS ARE PREDICATED General 1. There will not be any significant changes in the general political and economic climate that will adversely affect the operations of the Company 2. Changes in the Federal Government of Nigeria’s monetary and fiscal policies will not be significant enough to seriously affect the Company's operations 3. The Company will continue to enjoy the goodwill and confidence of present and future customers; and demand from customers will continue to grow at least at current industry rates. The Company will experience sustainable growth in its customer base and lines of products. 4. The quality of the Company's management and personnel will be at least sustained if not improved steadily over the period. 5. The Accounting policies being used by the Company to prepare these forecasts will not materially change during this forecast period 6. Average Inflation rate and increases during the period will not exceed 20% 7. Diesel and motor fuels costs is expected to increase by 20% per annum 8. Overhead costs are projected to increase by 20% per year and are paid for in the month they are incurred 9. Taxation of 30% of Net Profit to be provided for at year end but payable in the following year 10.20% of Net Profit to be paid as dividends from 3rd year but payable in the following year while a provision of 5% is made for year 2. 11.Staff Cost is projected to increase by 15% annually and an annual staff welfare package of 10%.
  13. 13. 13 | P a g e 12.Raw material purchases is done on a need basis hence no provision for stock is made 13.Long Term Loan with tenure of 5 years was obtained at an all-inclusive interest of 10% per annum. The Loan Appraisal and Commitment Fees was 2% flat. 14.Sales cost is 2% of Sales 15.Biz Dev is 1.5% of Sales 16.Maintenance is 2.5% of equipment cost Specific to the Company The printing industry has certain months in the year where there is greater production/sales of the product. The 5 months of August to December are thus considered to be the active production months in the year. DIARIES i. Sales of Diaries are only realized in the active months. ii. Sales of Diaries in the active months are realized in the following ratio: Aug Sept Oct Nov Dec 10% 15% 30% 30% 15% iii. Advance payment of 25% of the monthly sum/order value is collected in the month of the contract and the remaining 75% is collectible 60 days later. The cost of production of diaries is 74% of sales. COMMERCIAL PRINTING & CORPORATE GIFT ITEMS i. For commercial printing 30% of the sales are realized in the 7 non-active months and 70% in the active 5 months ii. Sales of these items in the 5 active months are realized in the following ratio:
  14. 14. 14 | P a g e Aug Sept Oct Nov Dec 14% 14% 24% 24% 24% iii. The remaining 30% realized in the non-active months are realized evenly from January to July iv. Gross profit margin is expected to be 40% v. The revenue from this line is expected to grow at 25% year on year Sample Assumption 2. Used for a Concrete products factory business plan. Evaluation of the commercial viability of XYZ concrete products factory is based on the following assumptions: Production Plan The production split between the 6 inches hollow block, 9 inches hollow block and 9 inches special hollow block envisages 50% production of the 6 inches hollow blocks, as compared with 45% of the 9 inches hollow block and 5% of the 9 inches special hollow block reflecting market demand. It should be noted however, that production plan of the Daphman plant on daily basis will reflect actual market demand from customers. Thus, if the market requires only 6 inches solid blocks, that product will be produced and if the market shifts to only 9 inches special hollow block, that is what will be produced by the plant. Daily production planning and scheduling will be carried reflecting market demand. Machine Capacity: Number of Blocks per cycle 8.00 Machines Capacity: Number of Cycles / Minute 3.00 Machines Number of Cycles / Hour 180.00 Number of Blocks /Hour 1,440.00
  15. 15. 15 | P a g e Operational Hours / Day 9 hours Break Period / Day 1 hour Number of Man Month Day 25.00 Production Computation’ assumption is as shown below: Machine Capacity: Number of Blocks per cycle 8 Machines Capacity: Number of Cycles / Minute 1 Machines Number of Cycles / Hour 60 Number of Blocks /Hour 480 Operational Hours / Day 8 Number of Man Month Day 25 Number of Blocks / Day 480 X 8 = 3840 Number of Blocks / Month 3840 X 25 = 96,000 Production Split: 6 Inches Hollow Block 50% 9 Inches Hollow Block 45% 9 Inches Special Hollow Block 5% Quantity Produced / Month:
  16. 16. 16 | P a g e 6 inches Hollow Block @ 50% of capacity 96,000 X 0.5 = 48,000.00 9 inches Hollow Block @ 45% of capacity 96,000 X 0.45 = 43,200.00 9 inches Special Hollow Block @ 5% capacity 96,000 X 0.05 = 4,800.00 Total Numbers of Blocks Produced / Month 96,000.00 Capacity Utilization Capacity utilization has been deliberately set at below the machine installed capacity from 3 cycles per minute to 1 cycle per minute. Capacity utilization of the 1 cycle per minute was set at 60% in year 1, 65% in year 2 and 70% in year 3. The machine installed capacity is expected to ramp up to 80% and 90% by year 4 and 5 respectively. Sample Assumption 3. Our Sample business plan for Water Bottling Plant. The first thing to do once you have made up your mind to invest in any industry sector to carry out a study on the industry sector. During the course of the study, you want to find out: i. The dynamics in that industry ii. Trends in the industry as a whole iii. Current products offering iv. Players in the industry as well as the strength of their brand v. The market size vi. Supply and Gap analysis vii. Factors influencing consumer’s preferences in buying a particular brand
  17. 17. 17 | P a g e viii. Consumer segmentation ix. Your proposed target market segment x. Competition within that market segment xi. Your positioning in the market xii. The proposed market share The answers you provide to the above is what will help to determine the size of your proposed operations and it is from this that every other thing about your financials will flow – project cost, funding requirements, calibre of and staff strength, etc. We shall now take a step by step approach using the life data from our sample Business Plan for the Water Bottling Project. Step 1: Quantify Demand and Supply Gap. Demand Based on the respective population data, estimates of the demand for bottled water in Nigeria (144.62 million), Edo State (3.32 million) and in Rivers State (5.36 million) are: Global Average Consumption per capita in 2005… = 25.3 litres Global Average Annual Growth Rate …………. = 8.7% Demand for Bottled Water in Nigeria (2007) …... = 4.32 billion litres Of which: Demand in Edo and Rivers State (2007)….. = 259.5 million litres Supply Gap Matched against the demand for bottled water derived above, the national supply/demand gap is as below. Demand for Bottled Water (2007)….………= 4.32 billion litres/annum
  18. 18. 18 | P a g e Supply of Bottled Water (2007)……………= 1.89 billion litres/annum Supply Gap ………………………………… = 2.43 billion litres/annum From the above, we have seen that there is a supply gap of about 2.43 billion litres per annum in the industry. The big question now is: do you want to establish your Water Bottling Plant to fill this HUGE supply gap? The answer is obvious; you cannot muster the capacity to this. In order for you to determine what market share you need to aim at, you want to estimate how much resources you can muster plus other logistics issues. Consider the following: i. Location – is your location in an area with high concentration of high networth individual who consume bottled water or they consume pure water? ii. The logistic challenge in the bottling industry is a big issue. In fact, bottling is logistics. A good number of single use input plus distribution of finished products poses a lot of logistics challenge which if not well managed will lead to the failure of the company. iii. Available of sufficient funding. iv. Quality of the ground water in your location Having consider all of the above, you decide to satisfy a small percentage of the computed supply gap. You are now able to envisage the size of your operations. This takes us to the next step. Manpower need! Step 2: Manpower – Salaries / Wages.
  19. 19. 19 | P a g e You need to know your direct cost of production at the end of the day so it is good for you to separate your direct from indirect cost. Direct costs refer to materials, labour and expenses related to the production of a product. Other costs, such as depreciation or administrative expenses, are more difficult to assign to a specific product, and therefore are considered indirect costs. Step 3: Production Plan to help determine how much working capital is required. Refer back to Page 10 to see the sample production plan for a concrete block factory Let’s look at our Water Bottling Plant. SALARIES & WAGES S/N POSITION NO REQUIRED SCALE/ANNUM TOTAL COST No Required 4 Y2 YEAR 2 1 Production/Quality Control Manager 1 600,000.00 600,000.00 1.00 660,000.00 2 Marketing/Sales Manager 1 600,000.00 600,000.00 1.00 660,000.00 3 Admin/Finance Manager 1 600,000.00 600,000.00 1.00 660,000.00 4 Sales Supervisor 1 300,000.00 300,000.00 2.00 660,000.00 5 Accounts Supervisor 1 360,000.00 360,000.00 1.00 396,000.00 6 Admin Supervisor 1 360,000.00 360,000.00 1.00 396,000.00 7 Sales Representatives 4 180,000.00 720,000.00 8.00 1,584,000.00 8 Drivers 4 180,000.00 720,000.00 6.00 1,188,000.00 9 Office Clerks 3 216,000.00 648,000.00 3.00 712,800.00 4,908,000.00 6,916,800.00 10 Quality Control/Laboratory Supervisor 1 360,000.00 360,000.00 2.00 792,000.00 11 Purchasing Supervisor 1 360,000.00 360,000.00 1.00 396,000.00 12 Storekeeper 1 360,000.00 360,000.00 2.00 792,000.00 13 Production Operators 6 240,000.00 1,440,000.00 12.00 3,168,000.00 14 Electricians 2 216,000.00 432,000.00 2.00 475,200.00 15 Plumbers 2 216,000.00 432,000.00 2.00 475,200.00 16 Packers 5 180,000.00 900,000.00 5.00 990,000.00 17 Security Guards 5 180,000.00 900,000.00 5.00 990,000.00 TOTAL 40 5,184,000.00 55.00 8,078,400.00 51 12,110,400.00 17,994,240.00 YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5 Direct Labour Cost 5,184,000.00 8,078,400.00 8,886,240.00 9,774,864.00 10,752,350.40 Indirect Labour Cost 4,908,000.00 6,916,800.00 7,608,480.00 8,369,328.00 9,206,260.80 Direct Labour Costs with 20% Welfare 6,220,800.00 9,694,080.00 10,663,488.00 11,729,836.80 12,902,820.48 Indirect Labour Costs with 20% Welfare 5,889,600.00 8,300,160.00 9,130,176.00 10,043,193.60 11,047,512.96 As a result of increase in capacity, additional workers would be recruited in year 2 hence wages will increase for subsequest years. Computation 4 year 2 is: X basic by 1.1 2 account for annual inrease. Multiply operators & Packer wages by 1.1 add this to over all direct wages basic to get new direct basic. add yearly welfare to get true wage 4 year 2. Increase this 4 year 3,4 & 5. Increase sales force 4 year 2 and also drivers. Increase production staff for year 2 Management & Labour Costs plus 20% Welfare
  20. 20. 20 | P a g e PRODUCTION PLAN The production split between the 50cl, 75cl and the 150cl bottles on the small bottles line envisages 45% production of the 75cl bottle, as compared with 35% of the 50cl bottle and 20% of the 150cl bottle reflecting market demand. Thus, with a filler speed of 2,200-2,500bph, the following quantities will be produced at 60% capacity on one 8- hour shift in the starting year: 50cl bottle 2,200bph X 8hrs X 300days X 0.35 X 0.6 46,200 ctns of 24 75cl bottle 2,200bph X 8hrs X 300days X 0.45 X 0.6 118,800 wraps of 12 150cl bottle 2,200bph X 8hrs X 300days X 0.2 X 0.6 105,600 wraps of 6 From the above table, revenue estimates are computed as well as the cost of raw material. Refer to the production plan on the attached sample business plan. Year 1 production plan, sales revenue and raw material cost is shown below. YEAR 1 Nos of Cartons Selling Price Sales Value 1 Month Raw- Mat Cost Direct material 46,200.00 550.00 25,410,000.00 1,478,400.00 17,740,800.00 118,800.00 550.00 65,340,000.00 2,376,000.00 28,512,000.00 105,600.00 330.00 34,848,000.00 1,372,800.00 16,473,600.00
  21. 21. 21 | P a g e The major raw material here is the packaging – pet bottles, labels, cartons and shrink- wrap material. As at the time of the study, the cost of pet bottle was about N11.00. The cost of labels, cartons or shrink-wrap was placed at N5.00 per bottle. This was done across board for all sizes to arrive at the raw material cost. Working Capital Estimates In the computation of working, you make provision for 1 month of raw material and 1 month of finished goods. What this does is that Step 4: Project Cost and Finance Recall that from your Supply /Demand analysis you have decided on your factory size. This dictated the size of plan and equipment you need. Next step is to look for equipment suppliers and get the costings of the equipment. Get the equipment supplier to give a prorforma invoice – quotation specifying every associated cost – shipping if buying from overseas, clearing, transportation, installation/commissioning and training of staff. YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5 50cl bottles at N16 each X 24 bottles X 46,200ctns/12 = 1,478,400.00 75cl bottles at N20 each X 12 bottles X 118,800ctns/12 = 2,376,000.00 150cl bottles at N26 each X 6 bottles X 105,600ctns/12 = 1,372,800.00 Raw Material/Packaging Material Requirement 5,227,200.00 Working Capital Requirement is thus: Wages and Salaries (3 Months) 3,027,600.00 4,498,560.00 4,948,416.00 5,443,257.60 5,987,583.36 Raw- and Material Requirement for 1 month 5,227,200.00 11,325,600.00 12,196,800.00 13,068,000.00 13,939,200.00 Finished Goods/Debtors for 1 month 10,466,500.00 22,677,416.67 24,421,833.33 26,166,250.00 27,910,666.67 Total Working Capital Required 18,721,300.00 38,501,576.67 41,567,049.33 44,677,507.60 47,837,450.03 Change in Working Capital 19,780,276.67 3,065,472.67 3,110,458.27 3,159,942.43
  22. 22. 22 | P a g e ITEM UNIT COSTS TOTAL COST (=N=) LAND & BUILDINGS Land 5,000,000.00 Site Development 3,000,000.00 Factory/Office Building 15,000,000.00 23,000,000.00 PLANT & MACHINERY Borehole & Water Treatment Plant 5,000,000.00 Purification Plant with Reverse Osmosis System 6,550,000.00 Ozonator 1,300,000.00 Automatic Bottling Plant - Small Bottles 3,500,000.00 20 Litre Bottling Plant Automatic Online Inkjet Coding Machine 1,100,000.00 Pet Blowing Machine 4,400,000.00 Moulds for 50cl, 75cl & 150cl bottles 900,000.00 Automatic Shrink Packing & Wrapping machine 1,350,000.00 Servo Stabilizer 15KVA - 3 Phase 185,000.00 Servo Stabilizer 5KVA - Single Phase 55,000.00 Installation 950,000.00 25,290,000.00 OTHER CAPITAL COST
  23. 23. 23 | P a g e 250 KVA Generator/Transformer etc 5,000,000.00 Motor Vehicles 14,130,000.00 Furniture & Fittings 2,500,000.00 Pre-operating Costs 4,000,000.00 25,630,000.00 Initial Working Capital 18,721,300.00 TOTAL PROJECT COST 92,641,300.00 Project Financing Now that you have arrived at your project cost. How do you finance it? Usually, projects are financed through a combination of debt and equity. Working capital is usually not a long term loan but taken as Bank Overdraft. PROJECT FINANCE Nature Source Amount % Equity Shareholders 23,160,325.00 25.00% Long Term Loan Commercial Bank 50,759,675.00 54.79% Working Capital Bank Overdraft 18,721,300.00 20.21% 92,641,300.00 100.00%
  24. 24. 24 | P a g e Cost of Finance Step 5: Depreciation of Plant and Equipment Depreciation is the systematic reduction in the recorded cost of a fixed asset. Examples of fixed assets that can be depreciated are buildings, furniture, and office equipment. The only exception is land, which is not depreciated. For accounting purposes, depreciation indicates how much of an asset's value has been used up. For tax purposes, businesses can deduct the cost of the tangible assets they purchase as business expenses. Depreciation is used in accounting to try to match a portion of the cost of a fixed asset to the revenue that it generates; this is mandated under the matching principle, where you record revenues with their associated expenses in the same reporting period in order to give a complete picture of the results of a revenue-generating transaction. The net effect of depreciation is a gradual decline in the reported carrying amount of fixed assets on the balance sheet. In our sample, we will depreciate factory building, plant & machinery, motor vehicles, generators and office equipment. Here is the depreciation schedule We have successfully built enough assumptions to make our financial projections reliable. We will now attempt to make the projections. YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5 Working Capital 18,721,300.00 14,977,040.00 11,232,780.00 7,488,520.00 3,744,260.00 Long Term Loan 50,759,675.00 40,607,740.00 30,455,805.00 20,303,870.00 10,151,935.00 Bank Charges 25% Interest on Working Capital 4,680,325.00 3,744,260.00 2,808,195.00 1,872,130.00 936,065.00 25% Interest on Long Term Loan 12,689,918.75 10,151,935.00 7,613,951.25 5,075,967.50 2,537,983.75 1% as Other Bank Charges 694,809.75 555,847.80 416,885.85 277,923.90 138,961.95 Total Bank Charges 18,065,053.50 14,452,042.80 10,839,032.10 7,226,021.40 3,613,010.70 VALUE @ COST DEPRECIATION RATE / ANNU M (%) YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5 Factory Buildings 15,000,000.00 2.50% 375,000.00 375,000.00 375,000.00 375,000.00 375,000.00 Plant & Machinery 25,290,000.00 10% 2,529,000.00 2,529,000.00 2,529,000.00 2,529,000.00 2,529,000.00 Motor Vehicles in year 1 14,130,000.00 25% 3,532,500.00 3,532,500.00 3,532,500.00 3,532,500.00 - Motor Vehicles in year 2 6,000,000.00 25% - 1,500,000.00 1,500,000.00 1,500,000.00 1,500,000.00 Generator etc 5,000,000.00 20% 1,000,000.00 1,000,000.00 1,000,000.00 1,000,000.00 1,000,000.00 Furniture & Fittings 2,500,000.00 20% 500,000.00 500,000.00 500,000.00 500,000.00 500,000.00 TOTAL 67,920,000.00 7,936,500.00 9,436,500.00 9,436,500.00 9,436,500.00 5,904,000.00
  25. 25. 25 | P a g e You may be required to make monthly projection or quarterly projections. The yearly projection is the sum of the monthly projection. Usually, most financials may want to see a five-year projection. Please bear in mind that no matter how good your financial projections are, they remain projections (estimates). Scarcely, do they eventually correlate to exact actual figures during implementation. Some slight variation does occur but if you have done a good job at the projections and with your assumptions, the financials provides a very good guide during implementation. For instance, from your cashflow, you know which month or which time you are going to have cashflow challenges, this helps you to make alternative arrangement for cash to finance your operations. Step 6: Income Statement or P&L The income statement is a simple and straightforward report on a business' cash- generating ability. It's an accounting scorecard on the financial performance of your business that reflects quantity of sales, expenses incurred and net profit. It draws information from various financial categories, including revenue, expenses, capital (in the form of depreciation) and cost of goods. By combining these elements, the income statement illustrates just how much income your company makes or loses during the year by subtracting cost of goods and expenses from total revenue to arrive at a net result, which is either a profit or a loss. An income statement differs from a cash flow statement, because unlike the latter, the income statement doesn't show when revenue is collected or when expenses are paid. It does, however, show the projected profitability of the business over the time frame covered by the plan. For a business plan, the income statement should be generated on a monthly basis during the first year, quarterly for the second and annually for the third. Income statement is the same as profit and loss statement. An income statement lists financial projections in the following format: i. Income. Includes all the income generated by the business and its sources. ii. Cost of goods. Includes all the costs related to the sale of products in inventory.
  26. 26. 26 | P a g e iii. Gross profit margin. The difference between revenue and cost of goods. Gross profit margin can be expressed in dollars, as a percentage, or both. As a percentage, the GP margin is always stated as a percentage of revenue. iv. Operating expenses. Includes all overhead and labor expenses associated with the operations of the business. v. Total expenses. The sum of all overhead and labor expenses required to operate the business. vi. Net profit. The difference between gross profit margin and total expenses, the net income depicts the business's debt and capital capabilities. vii. Depreciation. Reflects the decrease in value of capital assets used to generate income. Also used as the basis for a tax deduction and an indicator of the flow of money into new capital. viii. Net profit before interest. The difference between net profit and depreciation. ix. Interest. Includes all interest derived from debts, both short-term and long- term. Interest is determined by the amount of investment within the company. x. Net profit before taxes. The difference between net profit before interest and interest. xi. Taxes. Includes all taxes on the business. xii. Profit after taxes. The difference between net profit before taxes and the taxes accrued. Profit after taxes is the bottom line for any company. Let us proceed to our Sample Business plan to build the income statement based on the above assumptions. Step 7: Cashflow Statement The cash-flow statement is one of the most critical information tools for your business, showing how much cash will be needed to meet obligations, when it is going to be required, and from where it will come. It shows a schedule of the money coming into the business and expenses that need to be paid. The result is the profit or loss at the end of the month or year. In a cash-flow statement, both profits and losses are carried over to the next column to show the cumulative amount. Keep in mind that if you run a loss on your cash-flow statement, it is a strong indicator that you will need additional cash in order to meet expenses.
  27. 27. 27 | P a g e Like the income statement, the cash-flow statement takes advantage of previous financial tables developed during the course of the business plan. The cash-flow statement begins with cash on hand and the revenue sources. The next item it lists is expenses, including those accumulated during the manufacture of a product. The capital requirements are then logged as a negative after expenses. The cash-flow statement ends with the net cash flow. The cash-flow statement should be prepared on a monthly basis during the first year, on a quarterly basis during the second year, and on an annual basis thereafter. Items that you'll need to include in the cash-flow statement and the order in which they should appear are as follows: i. Cash sales. Income derived from sales paid for by cash. ii. Receivables. Income derived from the collection of receivables. iii. Other income. Income derived from investments, interest on loans that have been extended, and the liquidation of any assets. iv. Total income. The sum of total cash, cash sales, receivables, and other income. v. Material/merchandise. The raw material used in the manufacture of a product (for manufacturing operations only), the cash outlay for merchandise inventory (for merchandisers such as wholesalers and retailers), or the supplies used in the performance of a service. vi. Production labor. The labor required to manufacture a product (for manufacturing operations only) or to perform a service. vii. Overhead. All fixed and variable expenses required for the production of the product and the operations of the business. viii. Marketing/sales. All salaries, commissions, and other direct costs associated with the marketing and sales departments. ix. Admin Cost: All the labor expenses required to support the administrative functions of the business. x. Taxes. All taxes, except payroll, paid to the appropriate government institutions. xi. Capital. The capital required to obtain any equipment elements that are needed for the generation of income.
  28. 28. 28 | P a g e xii. Loan payment. The total of all payments made to reduce any long-term debts. xiii. Total expenses. The sum of material, direct labor, overhead expenses, marketing, sales, Admin, taxes, capital and loan payments. xiv. Cash flow. The difference between total income and total expenses. This amount is carried over to the next period as beginning cash. xv. Cumulative cash flow. The difference between current cash flow and cash flow from the previous period. As with the income statement, you will need to analyze the cash-flow statement in a short summary in the business plan. Once again, the analysis statement doesn't have to be long and should cover only key points derived from the cash-flow statement. Let us proceed to our Sample Business plan to build the cashflow statement based on the above assumptions. Step 8: Balance Sheet The last financial statement you'll need to develop is the balance sheet. Like the income and cash-flow statements, the balance sheet uses information from all of the financial models developed in earlier sections of the business plan; however, unlike the previous statements, the balance sheet is generated solely on an annual basis for the business plan and is, more or less, a summary of all the preceding financial information broken down into three areas:  Assets  Liabilities  Equity To obtain financing for a new business, you may need to provide a projection of the balance sheet over the period of time the business plan covers. As mentioned, the balance sheet is divided into three sections. The top portion of the balance sheet lists your company's assets. Assets are classified as current assets and long-term or fixed assets. Current assets are assets that will be converted to cash or will be used by the business in a year or less. Current assets include:
  29. 29. 29 | P a g e  Cash. The cash on hand at the time books are closed at the end of the fiscal year.  Accounts receivable. The income derived from credit accounts. For the balance sheet, it's the total amount of income to be received that is logged into the books at the close of the fiscal year.  Inventory. It's the inventory of material used to manufacture a product not yet sold.  Total current assets. The sum of cash, accounts receivable, inventory, and supplies. Other assets that appear in the balance sheet are called long-term or fixed assets. They are called long-term because they are durable and will last more than one year. Examples of this type of asset include:  Capital and plant. The book value of all capital equipment and property (if you own the land and building), less depreciation.  Investment. All investments by the company that cannot be converted to cash in less than one year. For the most part, companies just starting out have not accumulated long-term investments.  Miscellaneous assets. All other long-term assets that are not "capital and plant" or "investments." E.g. art works, prepayments etc.  Total long-term assets. The sum of capital and plant, investments, and miscellaneous assets.  Total assets. The sum of total current assets and total long-term assets. After the assets are listed, you need to account for the liabilities of your business. Like assets, liabilities are classified as current or long-term. If the debts are due in one year or less, they are classified as current liabilities. If they are due in more than one year, they are long-term liabilities. Examples of current liabilities are as follows:  Accounts payable. All expenses derived from purchasing items from regular creditors on an open account, which are due and payable.  Accrued liabilities. All expenses incurred by the business which are required for operation but have not been paid at the time the books are closed. These expenses are usually the company's overhead and salaries.
  30. 30. 30 | P a g e  Taxes. These are taxes that are still due and payable at the time the books are closed.  Total current liabilities. The sum of accounts payable, accrued liabilities, and taxes. Long-term liabilities include:  Bonds payable. The total of all bonds at the end of the year that are due and payable over a period exceeding one year.  Mortgage payable. Loans taken out for the purchase of real property that are repaid over a long-term period. The mortgage payable is that amount still due at the close of books for the year.  Notes payable. The amount still owed on any long-term debts that will not be repaid during the current fiscal year.  Total long-term liabilities. The sum of bonds payable, mortgage payable, and notes payable.  Total liabilities. The sum of total current and long-term liabilities. Once the liabilities have been listed, the final portion of the balance sheet-owner's equity-needs to be calculated. The amount attributed to owner's equity is the difference between total assets and total liabilities. The amount of equity the owner has in the business is an important yardstick used by investors when evaluating the company. Many times it determines the amount of capital they feel they can safely invest in the business. In the business plan, you'll need to create an analysis statement for the balance sheet just as you need to do for the income and cash flow statements. The analysis of the balance sheet should be kept short and cover key points about the company. Let us proceed to our Sample Business plan to build the balance sheet based on the above assumptions. Step 9: Discounted Cash Flow Analysis discounted cash flow (DCF) analysis is a method of valuing a project, company, or asset using the concepts of the time value of money. All future cash flows are estimated and discounted by using cost of capital to give their present values (PVs).
  31. 31. 31 | P a g e The sum of all future cash flows, both incoming and outgoing, is the net present value (NPV), which is taken as the value or price of the cash flows in question. The most widely used method of discounting is exponential discounting, which values future cash flows as "how much money would have to be invested currently, at a given rate of return, to yield the cash flow in future." Other methods of discounting, such as hyperbolic discounting, are studied in academia and said to reflect intuitive decision-making, but are not generally used in industry. The discount rate used is generally the appropriate weighted average cost of capital (WACC), that reflects the risk of the cashflows. The discount rate reflects two things: Time value of money (risk-free rate) – according to the theory of time preference, investors would rather have cash immediately than having to wait and must therefore be compensated by paying for the delay Risk premium – reflects the extra return investors demand because they want to be compensated for the risk that the cash flow might not materialize after all he discounted cash flow formula is derived from the future value formula for calculating the time value of money and compounding returns Let us proceed to our Sample Business plan to build the balance sheet based on the above assumptions. The DCF helps us to compute the internal rate of return (IRR) Internal rate of return (IRR) is the interest rate at which the net present value of all the cash flows (both positive and negative) from a project or investment equal zero. IRR is used to evaluate the attractiveness of a project or investment. If the IRR of a new project exceeds a company’s required rate of return, that project is desirable. If IRR falls below the required rate of return, the project should be rejected. IRR concept does not take into consideration external factors.
  32. 32. 32 | P a g e The calculation of IRR is a bit complex than other capital budgeting techniques. We know that at IRR, Net Present Value (NPV) is zero, thus: NPV = 0; or PV of future cash flows − Initial Investment = 0; or PV of future cash flows − Initial Investment = 0; or CF1 + CF2 + CF3 + ... − Initial Investment = 0 ( 1 + r )1 ( 1 + r )2 ( 1 + r )3 Where, r is the internal rate of return; CF1 is the period one net cash inflow; CF2 is the period two net cash inflow, CF3 is the period three net cash inflow, and so on ... Step 9: Sensitivity Analysis using Financial Ratios i. Payback Period The payback period is the time required for the amount invested in an asset to be repaid by the net cash outflow generated by the asset. Unlike net present value method and internal rate of return method, payback method does not consider the present value of cash flows. Under this method, an investment project is accepted or rejected on the basis of payback period. Payback period means the period of time that a project requires to recover the money invested in it. The payback period of a project is expressed in years and is computed using the following formula: According to this method, the project that promises a quick recovery of initial investment is considered desirable. If the payback period of a project computed by the above formula is shorter than or equal to the management’s maximum
  33. 33. 33 | P a g e desired payback period, the project is accepted otherwise it is rejected. For example, if a company wants to recoup the cost of a machine within 5 years of purchase, the maximum desired payback period of the company would be 5 years. The purchase of machine would be desirable if it promises a payback period of 5 years or less. ii. Current Ratios Current ratio is a financial ratio that measures whether or not a company has enough resources to pay its debt over the next 12 months by comparing firm's current assets to its current liabilities. iii. Debt to equity ratio Debt/Equity Ratio is a debt ratio used to measure a company's financial leverage, calculated by dividing a company’s total liabilities by its stockholders' equity. The D/E ratio indicates how much debt a company is using to finance its assets relative to the amount of value represented in shareholders’ equity. iv. Return on Equity (ROE) Return on equity (ROE) measures the rate of return for ownership interest (shareholders' equity) of common stock owners. It measures the efficiency of a firm at generating profits from each unit of shareholder equity; ROE shows how well a company uses investments to generate earnings growth. v. Return on Investment (ROI) Return on investment (ROI) is the benefit to the investor resulting from an investment of resources. A high ROI means the investment gains compare favourably to investment cost. ROI is a performance measurement tool used to
  34. 34. 34 | P a g e evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. This is one way of considering profits in relation to capital invested. ROI = 𝐸𝑟𝑎𝑛𝑖𝑛𝑔𝑠𝐵𝑒𝑓𝑜𝑟𝑒𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡𝑎𝑛𝑑𝑇𝑎𝑥 ÷ 𝐼𝑛𝑖𝑡𝑖𝑎𝑙𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑚𝑒𝑛𝑡 Final Words Having concluded your financials, you provide a short analysis in the business plan and add the financials as annexures or insert them in the appropriate place locations in the business plan. Conclude the business plan. Let us look at our sample business plan.