Learn about a situation in which a company has to expand its infrastructure to handle increased demand.
- You've seen some really quick ways to use top line revenue to create predictions for your new sporting goods store. Before we delve into more complex analyses of balance sheets and income statements, let me set the stage a little bit. Imagine that your sporting goods store called Richards, recently opened its first location. Things are going okay, and you're definitely anticipating some growth. To keep up you'll have to create some proforma statements to show to your investors. Why? Because you want capital to fund the expansion of the business.
What do your finances look like currently? Well let's take a look at your statement of cash flows to see where your cash is coming and going. Please recognize that this is a very simplified version. In your startup phase, you'll have to buy inventory. Supplies, invest in equipment and buildings. And you'll also need to invest in marketing an sales to make sure you can bring in customers and therefore revenue. So if you're looking at your operating section in the statement of cash flows things are going to look pretty bleak.
You may have little positive cash flow or even negative cash flow. This is especially true if you have a longer cash collection period than the time required to pay your suppliers. For example, you could stuff on credit for 45 days, but have to pay your suppliers every 30 days. In this situation even if the business has a positive gross profit and net income, it could still have a negative cash flow from operations. Hey, that's okay, you're growing, and that's what matters.
All businesses spend at least some time in this space. You may even spend years. Your investing section is likely going to be negative as well. Remember you're purchasing stuff. Equipment, inventory, buildings, and on top of that you're not selling any of it back, so you won't have any positive cash inflow. When a business has negative or low cash flow from operations and from investments it needs a source of cash to fund both of these activities to help it grow and become profitable.
This money is going to come from financing activities. A lot of this financing is going to come in the form of equity investments. You'll have to woo investors into putting money into your business for a share of it. So why equity? Why not just get a loan from the bank? Well it depends on your philosophy as a business owner. Maybe the investors will be more active if they have a stake in how well the business does. But you're a growing company and you haven't proved anything yet.
Since you're just getting started a bank maybe hesitant to give you a large loan. In any case, because you're acquiring some money through investments, your financing section cash flow is more than likely going to be positive. So you have a couple of things to keep in mind. The most important is that you're a growing business. Don't freak out over low cash flows. Second, and this might be a little contradictory to what I just said, but you're going to need cash and this cash is more than likely going to come from investors, therefore you need to create documentation that will show your investors your company's trajectory.
One option is to show them proforma statements.
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- Explain the four different types of financial statements.
- Distinguish between the types of moving averages.
- Determine a seasonal adjusted trend.
- Break down pro-forma financial statements.
- Identify cash flows, and what increased liabilities and decreased earnings generally indicate.
- Tell what a regression is.
- Outline the naive approach.