Financial decision making frameworks and applications

Business Planning/Financial Decision Making

One of the popular axioms about American history is that the country was made by the small entrepreneur- after all; Microsoft and Apple were both garage projects before launching into multi-million dollar businesses. However, the sad fact is that most small businesses fail, and many people who have a passion for a particular product or service simply do not know how to run their passion as a money making entity. In fact, small business opportunities are so important to the American economy because they represent 99% of all employer firms and employ just over half of the private sector. In general, small businesses pay 44% of U.S. total payroll, and have generated almost 70% of net new jobs over the past two decades. Small businesses are innovative, too, making up about 97% of exporters producing 1/3 U.S. export volume; in addition, they produce 13 times more patents per employee than even the large patenting firms (U.S. Small Business Administration, 2011).

Investing in a Small Business- We now know how important small businesses are to the overall American economy. Without investment, it is unlikely that there would be as many small business opportunities as there are, nor would small innovators have the money to change the economy through their innovations. Still, most financial advisors say the basic principle of investing is: never invest more than you can afford to lose. In the same light, always understand that any investment, no matter how well planned, is risky. Small businesses especially are notoriously non-liquid -- even though they may have paper security. There are, however, several things that on can do to minimize risk and make investing a win-win situation for companies in which the investor believes will see a return on investment:

Check details; length of expertise of owners or time in business.

What is the salary structure? Are owners taking unreasonably large salaries with benefits in view of the company's stage of development?

What percentage are the owners willing to risk (are they taking 80% of the profits while offering 20% of the shares?)

What is the trend in the industry? Is this a hobby business or something that has real fiscal potential for the medium and long-term?

Does the company have a realistic marketing plan and the funding to execute that plan?

What are the chances the company will go public or sold? (State of Wisconsin, 2009).

Company Analysis- The following three organizations are looking for investors and have presented their business plans for consideration. Highlights of each are as follows:

Acme Consulting -- Start up; consulting company specializing in marketing of high-technology products for the international market. They will offer high-tech manufacturers a reliable, high-quality alternative to in-house resources for business development, market development, and channel development on an international scale.

Owners -- Founders are former marketers of consulting services, personal computers, and market research, all in international markets.

Sales -- Projected just over 1/2 million first year growing to $1 million by year 3.

Finances -- Needing $50, 350 to start; asking for three investors, two at $20K, one at $10K

Competitive issues -- Several high-level services for major corporations, few that work with smaller concerns; challenge will be in convincing U.S. firms the need for help when dealing in the international marketplace

Market segmentation -- vast potential in the U.S. high tech market, showing 10% annual growth; target market will be larger corporations that need particular expertise in international areas.

Staff -- 3 to 5 partners, flat at the beginning, at least one based in Europe, possibly one based in Asia. Salaries of $144,000 for first year growing to $200,000 total for all partners in 1998; payroll expenses of almost $200K first year to mid-$400 range in third year.

Interstate Travel Center -- Start up; travel center based in Dallas, Texas. Consisting of a convenience store, gas/diesel islands, at least one restaurant, and amenities for truckers and travelers off the major highways around the Dallas area.

Owners -- Founders are husband and wife team; husband has extensive experience within automotive repair, wife who has over 20 years financial and bookkeeping experience.

Sales -- Projected $8.2 million Year 1; $8.6 million Year 2, $9 million year 3; profits include a 26% margin.

Finances -- Need $325,000 in revenue per month for breakeven; monthly fixed costs are just under $85K; industry profile shows 11% growth, Interstate's figures are based on 1/2 of that. Asking for $2.5 million in loan to purchase and develop land and construct a 6,000-foot travel center.

Competitive issues -- Center will be located between Hwy 45 and 635; there is high visibility, good access, limited competition, good traffic potential.

Market segmentation -- Will offer gas, convenience store items, restrooms, showers, game rooms, trucker lounge, scales, parking -- meant to be a regular stop for truckers on busy U.S. route.

Staff -- Initially run by management team; with supplemental hourly wage staff for check out, cooking, dining, hotel maintenance, etc. Owners to take $50K each for salary, total payroll just under $500,000 per annum.

Silvera and Sons Coffee Export -- Prepares green Arabia coffee beans grown in Brazil for export to the U.S. (specialty roasters) and then sell to Brazilian wholesalers. Asking for investment to expand from 72,000 bags per year to 120-160 bags per year. Coffee differentiates because it is high end, currently demand exceeds the ability to supply, causing the company to refuse shipments and orders.

Owners -- Family owned business in its 7th year of operation; the plant has been in operation for 12 years under one of the owner's managerial expertise. Past performance shows steady sales growth, from $16.2 million to $18.4 million, 15% margin fairly steady.

Sales -- Projected $26.3, $33, and $46 million for years 1-3 forward, moving gross margin to 17.5%. Need $2.7 to $3 million to expand.

Finances -- Finance through LT Debt and increased cash flow; purchase of larger facility will require 80% debt;

Competitive issues -- Top level coffee trends are showing high-growth; key indicator for the company is inability to fill orders for past several years. Numerous coffee producers and roasters of low-mid range product; very few on high end.

Market segmentation -- vast potential in the U.S.; new relationships with high-end producers through phone selling and trips to Brazil, print advertising in trade publications, and Web based information.

Staff -- Current staff, especially management in place, key gap is controller or staff member who can analyze the changing legal and financial aspect of the business; more cost effective to plan this in house; other staff are experts in their jobs, with salaries ranging from $37-50K/annum.