Forecasting the need for capital, whether debt or equity, has already been
discussed.

The capital to finance a business has two major forms: debt and equity.
Creditor money (debt) comes from trade credit, loans made by financial
institutions, leasing companies, and customers who have made prepayments on
larger–frequently manufactured–orders. Equity is money received by the
company in exchange for some portion of ownership. Sources include the
entrepreneur’s own money; money from family, friends, or other
non-professional investors; or money from venture capitalists, Small
Business Investment Companies (SBICs), and Minority Enterprise Small
Business Investment Companies (MESBICs) both funded by the SBA.
Debt capital, depending upon its sources (e.g., trade, bank, leasing
company, mortgage company) comes into the business for short or
intermediate periods. Owner or equity capital remains in the company for
the life of the business (unless replaced by other equity) and is repaid
only when and if there is a surplus at liquidation of the business–after
all creditors are repaid.
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Identifying the actual cost of doing business requires careful and accurate
analysis. No one is expected to calculate the cost of doing business with
complete accuracy. However, failure to calculate all actual costs properly
to ensure an adequate profit margin is a frequent and often overlooked
cause of business failure.

Establishing Selling Prices
The costs of raw materials, labor, indirect overhead, and research and
development must be carefully studied before setting the selling price of
items offered by your business. These factors must be regularly
re-evaluated, as costs fluctuate.
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If there is anything more important to the successful financial management
of a business than the thorough, thoughtful preparation of Pro Forma Income
Statements, it is the preparation of the Cash Flow Statement, sometimes
called the Cash Flow Budget.

The Cash Flow Statement

The Cash Flow Statement identifies when cash is expected to be received and
when it must be spent to pay bills and debts. It shows how much cash will
be needed to pay expenses and when it will be needed. It also allows the
manager to identify where the necessary cash will come from. For example,
will it be internally generated from sales and the collection of accounts
receivable–or must it be borrowed? (The Cash Flow Projection deals only
with actual cash transactions; depreciation and amortization of good will
or other non-cash expense items are not considered in this Pro Forma.)
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“Break-Even” means a level of operations at which a business neither makes
a profit nor sustains a loss. At this point, revenue is just enough to
cover expenses. Break-Even Analysis enables you to study the relationship
of volume, costs, and revenue.

Break-Even requires the business owner/manager to define a sales
level–either in terms of revenue dollars to be earned or in units to be
sold within a given accounting period–at which the business would earn a
before tax net profit of zero. This may be done by employing one of various
formula calculations to the business estimated sales volume, estimated
fixed costs, and estimated variable costs. Read More→

Leverage Ratio
This Debt/Worth or Leverage Ratio indicates the extent to which the
business is reliant on debt financing (creditor money versus owner’s
equity):
Debt/Worth Ratio = Total Liabilities
—————–
Net Worth

Generally, the higher this ratio, the more risky a creditor will perceive
its exposure in your business, making it correspondingly harder to obtain
credit. Read More→