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Lecture 6

BU121 Lecture Notes - Lecture 6: Accounts Payable, Promissory Note, Income Statement

Course Code
Laura Allan

of 4
Week 6 February 11th 15th
Lecture Notes
What do you need to know?*
7 Principles of Entrepreneurial Finance
1. Real human, and financial capital must be ‘rented’ from owners.
2. Risk and expected reward go hand in hand: don’t risk something that
won’t be rewarding
3. While accounting is the language of business, cash is the currency:
Liquidity of assets and cash on balance is important!!
4. New venture financing involves search, negotiation, and privacy.
5. A venture’s financial objective is to increase value.
6. It is dangerous to assume that people act against their own self-interests:
People only do what is good for them!
7. Venture character and reputation can be assets or liabilities.
Financing vehicles used at different stages
Development stage: Seed Financing
Start-up Stage: Startup financing
Survival stage: First-round financing
Rapid-growth stage: Second-round financing,
Mezzanine financing, Liquidity-stage financing
Early-maturity stage: Obtaining bank loans, issuing
bonds and issuing stock
Measures of financial performance statements
Balance Sheet (Statement of Financial Position):
Provides a ‘snapshot’ of the venture’s financial position on a specific date
Assets listed in order of liquidity (how fast they can be converted to cash)
Current Assets: converted to cash within 12 months (funds used to pay bills) Cash,
marketable securities, accounts receivable, notes receivable, inventory
Fixed Assets: long-term assets used in production (except for land, they usually wear
out through amortization/depreciation) buildings, land, equipment, furniture,
In-tangible Assets: long-term assets with no physical existence (patents, copyrights,
trademarks, etc.)
Owners’ Equity: Records financing obtained by owners
Retained earnings: amount left over from profitable operations (total profits
Liabilities: Financing obtained by lenders
Current Liabilities: must be paid within 12 months Accounts payable, notes
payable, accrued expenses (accumulated expenses such as wages & taxes which must be
paid, but no bill was received by the firm), income taxes payable, current portion of long-
term debt (repayment on debt due within the year)
Long-term Liabilities: ex. Mortgage, company’s bonds sold to others, bank loans, etc.
Income Statement:
Shows firms revenues and expenses total profit/loss over a period of time
Revenue-Expenses= Net Profit/Loss
Revenue: dollar amount of firms sale (plus any other incomes interest,
dividends, rents)
o Determined with Gross Sales (total amount of sales)- returns and
allowances (merchandise returned because it was damaged/defected) =
Net Sales
Expenses: cost of generating revenue
o Cost of Goods Sold (COGS): total expense of buying/producing
Beginning Inventories + Inventory Purchases = Inventories
available for sale ……. – ending inventories = COGS
o Operating Expenses: expenses of running the business (administrative,
advertising, etc.)
Statement of Cash Flows:
To ensure company does not go bankrupt: remember, just because it is profitable,
does not mean it won’t go bankrupt!!
Impact on Cash
Operating Activities (related to production):
Start with Net Income
Add back Depreciation/Amortization
+ Decrease / - Increase in Receivables
+ Decrease / - Increase in Inventory
+ Increase / - Decrease in Payables
+ Increase / - Decrease in Accrued Liabilities
Investing Activities (Related to purchase/sale of assets):
+ Decrease / - Increase in Gross Fixed Assets
Financing Activities (related to debt and equity financing):
+ Increase / - Decrease in Loans
+ Increase / - Decrease in Stock
- Cash Dividends paid
Survival/cash breakeven
Some new ventures show profitability during the startup stage, but…
It is more common for a new venture to have losses survival stage
need to know level of sales necessary to cover costs break even
Therefore need to compare revenues to cash operating and financing costs…
Two types of expenses/costs:
a. Variable
i. Costs of directly providing a product or delivering a service
therefore vary with sales
ii. For example cost of goods sold
b. Fixed
i. Expected to remain constant over a range of revenues for a
specific time period
Breakeven is when EBDAT = 0
o Sales when total revenue = total cost
o EBDAT = Revenues (R) Variable costs (VC) Cash Fixed costs (CFC)
o Price (volume) = VC (volume) + CFC
Breakeven Drivers
Most important influence/driver on venture breakeven is its variable cost revenue
ratio (VCRR) and hence its contribution margin
For example, let’s say that in year 2, due to volume discounts, PSA could lower
production costs to $60 per unit (60% of $100 revenue per unit)
Survival revenue (SR)
At higher contribution margin of 40%, the level of survival revenue
needed to breakeven drops to $1 million or 10,000 units
A highly leveraged venture can turn a small increase in revenues into a major
increase in EBDAT
For example, a firm can choose to pay higher up-front fixed costs to gain lower
variable costs
Each additional unit of revenue will result in a higher EBDAT once FC are covered,
because VC per unit is lower
Higher contribution margin
So, with greater leverage, the contribution margin is higher and therefore the
return (EBDAT) is higher above breakeven
40% contributes from every sale to cover fixed costs vs 35%
But, breakeven is higher and therefore you have to sell more to reach it the risk