To raise capital for your new business, you should be able to first
determine how much capital you will realistically need. Others evaluate
your proposal based on the ability of the business to generate profits.
Minimizing total capital requirements, shortening time to break even,
long-term growth potential, etc., all relate to how quickly and how high
you can grow profits; these functions include holding down costs, growing
‘‘smartly,’’ and seizing opportunities.
Forecasting a company’s profits, and for many, determining when it will
achieve a break-even point, is a critical component of the financial proposal,
basically an income statement perspective. Equally important is the amount
of assets required to create the infrastructure to generate these profits, the
corresponding balance sheet perspective.
1. In most cases the firm’s financial needs forecast, as expressed in the pro
forma financial statements, depends on the sales forecast. How would
you go about forecasting sales for a new venture? What steps can you
take to improve the accuracy of your foreca st?
2. Banks will typically impose covenants, restrictions on a firm’s behavior,
before granting a loan to reduce their risk. What types of covenants might
a bank impose? Are there costs to the firm associated with these co venants?
3. What are the pros and cons of financing a start-up with debt? With
equity? Does one source of financing seem to dominate the other?
4. Calculate the cost of trade credit with the followi ng terms: 3/10 net 6 0. Do
you think the firm should forego the discount as a source of credit? Why
or why not?
CASE 2.1 NEW TECH (B): HOW MUCH DO THEY NEED?
How much growth capital will New Tech Distributors need to finance its
Stuart Chip, founder and owner of New Tech Distributors Corp., wants
to take his company to a higher level. He is very optimistic about New
Tech’s expansion program and its capability for producing power modules.
He realizes that the key to New Tech’s future growth and success is to
produce and sell a new line of highly profitable power modules that can
provide New Tech with higher margins and improved financial per-
formance. He feels that the market for power modules is growing rapidly
Alternatives in Venture Financing—Debt Capital 75
and this is the right time to expand. However, Stuart needs growth capital
to build new production facilities, market the new line, and fund ongoing
See Appendix 2.1 for projected financial statements and other forecasts.
THE CHALLENGE:DETERMINING NEEDS
Stuart asks Elizabeth Pratt (New Tech’s in-house accountant) to take the
lead in this project. However, because of the importance and complexity of
this proposal, he wants Elizabe th to get as much information as possible
from the company’s management team to help her in preparing the first
draft of the investment prop osal. Elizabeth turns to you for assistance in
developing the initial forecasts.
Elizabeth realizes that potential investors will be asking questions about
the assumptions used in producing the financial projections. Investors will
also want to explore the assumptions used by management to determine
their sales revenue and expenses. She produces a list of key assumptions (see
THE CHALLENGE:FINANCIAL PROJECTIONS
Cost of a New Production Facility
New Tech will need to build a new pro duction facility to house the new
product line. Building a production facility for the new line will cost
$1,100,000 in 2001.
The company will also need $225,000 in marketing funds to launch the
new product line successfully in 2001.
Working Capital Requirements
Elizabeth calculates that the 30% increase in sales revenue in 2001 would
require additional investments in working capital of $200,000. As the table
below shows, the working capital requirements break down this way:
$100,000 will be invested in accounts receivable, $75,000 in inventory, and
$75,000 in other current assets. This $250,000 will be partly financed by a
$50,000 increase in accounts payable, leaving a requirement of $200,000.
Accounts receivable $100,000
Other current assets $75,000
Increase in current assets $250,000
Less: accounts payable $50,000
Net change in working capital $200,000
76 Alternatives in Venture Financing—Debt Capital