This document provides an overview of key financial concepts for new venture finance including how to prepare and interpret balance sheets, income statements, cash flow statements, and various financial metrics and ratios. It discusses calculating and analyzing metrics like net cash burn rate, liquidity ratios, conversion periods, leverage ratios, and comparing company performance to industry peers. The document uses an example company to illustrate how to apply these concepts to a real-world case.

1. New Venture Finance Concepts
TOPIC 4
1

2.  Describe and prepare a
balance sheet and an income
statement
 Prepare a cash flow
statement and explain how it
helps monitor a venture’s
cash position
 Describe operating
breakeven analysis in terms
of breakeven revenues
 Identify major drivers on the
amount of revenues needed
to survive
 Describe how financial ratios
are used to monitor a
venture’s performance
 Identify cash burn rate
measures and liquidity ratios
and explain how they are
calculated and used
 Identify specific leverage
ratios and explain their usage
by lenders and creditors
 Identify and describe
measures of profitability and
efficiency that are important
to the entrepreneur and
equity investors
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3.  Generally Accepted Accounting Principles (GAAP):
 guidelines that set out the manner and form for
presenting accounting information
 Accrual Accounting:
 the practice of recording economic activity when
recognized rather than waiting until realized
 Depreciation:
 reduction in value of a fixed asset over its expected life
intended to reflect the usage of wearing out of the asset
 Accumulated Depreciation:
 sum of all previous depreciation amounts charged to fixed
assets
3

4.  Balance Sheet:
financial statement that provides a snapshot of a venture’s
financial position as of a specific date
 Balance Sheet Equation:
Total Assets = Total Liabilities + Owners’ Equity
 Assets:
financial, physical and intangible items owned or controlled by
the business
 Owners’ Equity:
equity capital contributed by the owners of the venture is shown
after listing all liabilities
4

5.  Current Assets:
cash & other assets that are expected to be converted
into cash in less than one year
 Cash:
▪ amount of coin, currency, and checking account balances
 Receivables:
▪ credit sales made to customers
 Inventories:
▪ raw materials, work-in-process, and finished products which
the venture hopes to sell
 Fixed Assets:
 assets with expected lives of greater than one year
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6.  Current Liabilities:
 Payables:
▪ short-term liabilities owed to suppliers for purchases made on
credit
 Accrued Wages:
▪ liabilities owned to employees for previously completed work
 Bank Loan:
▪ interest-bearing loan of one year or less from a commercial bank
 Long-Term Debts:
 loans that have maturities of longer than one year
 Capital Leases:
 long-term, noncancelable leases whereby the owner
receives payments that cover the cost of the equipment
plus a return on investment in the equipment
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7.  Income Statement:
 financial statement that reports the revenues generated
and expenses incurred over an accounting period
 Sales or Revenues:
 funds earned from selling a product or providing a service
 Gross Earnings:
 net sales (after deducting returns and allowances) minus
the cost of production
 Net Income (or Profit):
 bottom line measure after all operating expenses,
financing costs, and taxes have been deducted from net
sales
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8.  Statement of Cash Flows:
 shows how cash, reflected in accrual accounting,
flowed into and out of a firm during a specific
period of operation
 Can be used to determine if a venture has
been building or burning cash
 “Net Cash Burn” occurs when the sum of cash
flows from “operations” and “investing” is
negative
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9.  Assume:
 Company started business on January 1, began
production on July 1, and sold first unit in August
▪ Sold 1,200 units @ $100/unit during the year
▪ Sold 100 units each in August and September; Sold 250 units each in
October and November; and Sold 500 units each in December
▪ All sales on credit, payable by customer in 30 days
 Other expenses include:
▪ Rent – $500/month
▪ Marketing – $12,500 (for the year)
▪ Other administrative expenses – $1,500/month
▪ Depreciation expense – assume 20 year useful life
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10.  Assume:
 Company produced 1,600 units
▪ Produced 200 units each in July and August and Produced 300
units each in September, October, November and December
 Cost to produce each unit:
▪ Cost of parts, materials, etc. – $50/unit
▪ Cost of direct labor – $15/unit
 All materials for production were purchased at the
beginning of the month they were used
▪ All materials were purchased on credit, payable to supplier in
30 days
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11.  Other assumptions:
 Company applied for and received two credit
cards totaling a $30,000 line of credit with an
introductory rate of 0% for the first 12 months
▪ Two cards held a $25,000 balance as of December 31
 $3,000 of administrative wages incurred in
December were paid the next month (in January)
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12. 12
Assume the following beginning Balance Sheet as of January 1

13. 13
Income Statement as of December 31

14. 14
Basic Production Schedule as of December 31

15. 15
Cash Flow Statement as of December 31

16. 16
Balance Sheet as of December 31

17.  Financial Ratios:
 show the relationship between two or more financial
variables
 Trend Analysis:
 used to examine a venture’s performance over time
 Cross-sectional Analysis:
 used to compare a venture’s performance against
another firm at the same point in time
 Industry Comparables Analysis:
 used to compare a venture’s performance against the
average performance in the same industry
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18. 18
Measures of Financial Performance by Life Cycle Stage

19. 19
Company ABC Income Statement for Years Ended 2009 and 2010

20. 20
Company ABC Balance Sheet for Years Ended 2008, 2009, and 2010

21. 21
Company ABC Statement of Cash Flows for Years Ended 2009 and 2010

22.  Net Cash Burn Rate:
 represents the amount of cash expended on the
venture’s operating and financing expenses and
its capital investments in assets net of the cash
generated from operations (sales) and financing
 = Cash burn rate – Cash build rate
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23.  Cash Burn Rate:
 cash expended by a venture on its operating and
financing expenses and its investments in assets
 = Inventory-related expenses + Admin expenses +
Marketing expenses + R&D expenses + Interest
expenses + Change in prepaid expenses – (Change in
accrued liabilities + Change in payables) + Capital
investment + Taxes
 For 2010, Cash Burn:
 = 425,000 + 65,000 + 39,000 + 27,000 + 20,000 + 0 –
(1,000 + 27,000) +50,000 + 8,000 = 606,000
▪ Note 425,000 = 380,000 (COGS) + 45,000 (Change in Inv.)
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24.  Cash Build Rate:
 Cash build for a fixed period of time, typically a
month
 = Net Sales – Increase in Receivables
 For 2010, Cash Build:
 = 575,000 - 30,000 = 545,000
 Net Cash Burn
= Cash burn – Cash build
= 606,000 - 545,000 = 61,000
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25.  Liquidity Ratios:
Indicates the ability to pay short-term liabilities when
they come due
 Current Ratio:
= Average current assets/Average current liabilities
= ((250,000+180,000)/2) ÷ ((204,000+110,000)/2)
= 1.37
 Quick Ratio =
(Average current assets –Average inventories)/Average current
liabilities
(= (250,000 +180,000)/2 – (140,000+95,000)/2) ÷ ((204,000 +
110,000)/2)
= .62
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26. 26
Operating Cycle
Operating Cycle –
time required to purchase,
produce, and sell the
venture’s products plus
the time needed to collect
receivables if the sales are
on credit

27.  Cash Conversion Cycle:
 sum of the inventory-to-sale conversion period
and the sales-to-cash conversion period less the
purchase-to-payment conversion period
 Conversion Period Ratio:
 indicates the average time it takes in days to
convert certain current assets and current liability
accounts into cash
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28.  Inventory-to-Sales Conversion Period:
 is the period required to convert purchased
materials into the sale of finished costs and
represents the amount of cash tied up in
inventories
= Average Inventories/(CoGS / 365)
= ((140,000 + 95,000)/2) ÷ (380,000/365)
= 112.9 days
 What drives this number?
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29.  Sales-to-Cash Conversion Period:
 measures the average days of sales committed to
the extension of trade credit
= Average Receivables/(Net Sales/365)
= ((105,000 + 75,000)/2) ÷ (575,000/365)
= 57.1 days
 What is the significance of this measure?
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30.  Purchase-to-Payment Conversion Period:
 measures the average time from a purchase of
materials and labor to actual cash payment and
represents the days of production costs financed
by trade credit and accrued wages/liabilities
= (Average Payables + Average Accrued Liabilities) /
(COGS / 365)
= ((84,000+57,000)/2 + (10,000+9,000)/2) ÷
(380,000/365)
= 76.8 days
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31.  Cash Conversion Cycle (C3)
 C3 indicates the average time it takes a venture to
complete its operating cycle less a deduction for days
supported by trade credit and delayed payroll
financing
 Goal is to keep C3 as close to ~0 days as possible
= Inventory-to-Sale Conversion Period + Sale-to-Cash
Conversion Period – Purchase-to-Payment Conversion
= 112.9 days + 57.1 days – 76.8 days
= 93.2 days
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32. 32
Interpreting Changes in Conversion Times

33.  Leverage Ratio:
 indicates the extent to which the venture is in
debt and its ability to repay its debt obligations
 Loan Principal Amount:
 dollar amount borrowed from a lender
 Interest:
 dollar amount paid on the loan to a lender as
compensation for making the loan
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34.  Leverage (Total-Debt-to-Total-Asset) Ratio:
 indicates the amount of assets “pledged” to debt
holders and other creditors and also indicates the
percentage of the assets left for equity holders
= Average total debt / Average total assets
= ((204,000 +110,000)/2 + (80,000 +90,000)/2) ÷
((446,000 + 343,000)/2)
= .6134 or 61.34%
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35. 35
How Does Company ABC ‘s Performance in 2010 Compare with Industry Peers?

36. 36
How Does Company ABC Compare with Industry Peers? (cont.)