MBA Notes: Finance

Key Topics:
- Where business gets its money
- The difference between debt and shareholders' investment
- Understanding the role of private equity
- Floating on a stock market
- Calculating the cost of capital
- Budgeting for the future

The dividing line between accounting and finance is blurred. In basic terms accounting is considered to be everything concerned with the process of recording financial events and ensuring that such recordings are in compliance with the prevailing rules. Finance is the area concerned with where the money to run a business actually comes from in order to be accounted for. In order to be able to understand and interpret the accounts using such tools as ratios you need a reasonable grasp of both these areas, though the ratios themselves are generally considered to be in the accounting domain. 

The syllabus: In many business schools you will find an array of options in addition to the core elements of this discipline- asset pricing, corporate finance, hedge funds, corporate governance, investments, mergers and acquisitions, capital markets and international finance. There are options on options on behavioural finance, dealing with financial crime, and derivatives.

Sources of funds
There are many sources of funds available to businesses; however, not all of them are equally appropriate to all businesses at all times. These different sources of finance carry very different obligations, responsibilities and opportunities for profitable business. Having some appreciation of these differences will enable managers and directors to make an informed choice.
Most businesses initially, and often until they go public, floating their shares on a stock market, confine their financial strategy to bank loans, either long term or short term, viewing the other financing methods as either too complex or too risky. In many respects the reverse is true. Almost every finance source other than banks will to a greater or lesser extent share some of the risks of doing business with the recipient of the funds.

Debt vs equity
Despite the esoteric names – debentures, convertible loan stock, preference shares – businesses have access to only two fundamentally different sorts of money. Equity, or owner's capital, including retained earnings, is money that is not a risk to the business. If no profits are made, then the owner and other shareholders simply do not get dividends. They may not be pleased, but they cannot usually sue, and even where they can sue, the advisers who recommended the share purchase will be first in line.
Debt capital is money borrowed by the business from outside sources; it puts the business at financial risk and is also risky for the lenders. In return for taking that risk they expect an interest payment every year, irrespective of the performance of the business. High gearing is the name given when a business has a high proportion of outside money to inside money. High gearing has considerable attractions to a business that wants to make high returns on shareholders' capital.

Figure below shows the funding appetite of various sources of funds. VCs, business angels and indeed any source of share capital will only be attracted to propositions that combine high growth potential with a high risk/reward potential. Banks and other lenders will be attracted to almost the opposite profile, looking instead to a stable less risky proposition that at least offers some security to the capital sum they are putting up.
 

FIGURE: Funding appetite


 

How leverage/gearing works
Table shows an example of a business that is assumed to need $/£/€60,000 capital to generate $/£/€10,000 operating profits. Four different capital structures are considered. They range from all share capital (no gearing) at one end to nearly all loan capital at the other. The loan capital has to be 'serviced', that is, interest of 12 per cent has to be paid. The loan itself can be relatively indefinite, simply being replaced by another one at market interest rates when the first loan expires.

TABLE: The effect of leverage/gearing on shareholders' returns
 

Following the tables through, you can see that return on the shareholders' money (arrived at by dividing the profit by the shareholders' investment and multiplying by 100 to get a percentage) grows from 16.6 to 30.7 per cent by virtue of the changed gearing. If the interest on the loan were lower, the ROSC, the term used to describe return on shareholders' capital, would be even more improved by high gearing, and the higher the interest, the lower the relative improvement in ROSC. So in times of low interest, businesses tend to go for increased borrowings rather than raising more equity, that is, money from shareholders.

At first sight this looks like a perpetual profit-growth machine. Naturally, shareholders and those managing a business whose bonus depends on shareholders' returns would rather have someone else 'lend' them the money for the business than ask shareholders for more money, especially if by doing so they increase the return on investment. The problem comes if the business does not produce $/£/€10,000 operating profits. Very often a drop in sales of 20 per cent means profits are halved. If profits were halved in this example, the business could not meet the interest payments on its loan. That would make the business insolvent, and so not in a 'sound financial position'; in other words, failing to meet one of the two primary business objectives.

Bankers tend to favour 1 : 1 gearing as the maximum for a business, although they have been known to go much higher. As well as looking at the gearing, lenders will study the business's capacity to pay interest. They do this by using another ratio called 'times interest earned'. This is calculated by dividing the operating profit by the loan interest. It shows how many times the loan interest is covered, and gives the lender some idea of the safety margin. The ratio for this example is given at the end of Table below . Once again rules are hard to make, but much less than 3× interest earned is unlikely to give lenders confidence. (See this for comprehensive explanation of the use of ratios.)

Borrowed money
Towards the lower-risk end of the financing spectrum are the various organizations that lend money to businesses. They all try hard to take little or no risk, but expect some reward irrespective of performance. They want interest payments on money lent, usually from day one, though sometimes they are content to roll interest payments up until some future date. While they hope the management is competent, they are more interested in securing a charge against any assets the business or its managers may own. At the end of the day they want all their money back. It would be more prudent to think of these organizations as people who will help you turn a proportion of an illiquid asset, such as property, stock in trade or customers who have not yet paid up, into a more liquid asset such as cash, but of course at some discount.

Any decisions about gearing levels have to be taken with the level of business risk involved. Certain categories of venture are intrinsically more risky than others. Businesses selling staple food products where little innovation is required are generally less prone to face financial difficulties than, say, internet start-ups, where the technology may be unproven with a short shelf life and the markets themselves uncertain. See Figure below.

FIGURE: Risk and leverage/gearing


Banks
Banks are the principal, and frequently the only, source of finance for 9 out of every 10 unquoted businesses. Firms around the world rely on banks for their funding. In the UK, for example, they have borrowed nearly £55 ($86/€62) billion from the banks, a substantial rise over the past few years. When this figure is compared with the £48 ($75/€54) billion that firms have on deposit at any one time, the net amount borrowed is around £7 billion.
Bankers, and indeed any other sources of debt capital, are looking for asset security to back their loan and provide a near-certainty of getting their money back. They will also charge an interest rate that reflects current market conditions and their view of the risk level of the proposal; usually anything from 0.25 per cent to upwards of 3 or 4 per cent for more risky or smaller firms.

Bankers like to speak of the 'five Cs' of credit analysis, factors they look at when they evaluate a loan request. When applying to a bank for a loan, be prepared to address the following points:

- Character: Bankers lend money to borrowers who appear honest and who have a good credit history. Before you apply for a loan, it makes sense to obtain a copy of your credit report and clean up any problems.
- Capacity: This is a prediction of the borrower's ability to repay the loan. For a new business, bankers look at the business plan. For an existing business, bankers consider financial statements and industry trends.
- Collateral: Bankers generally want a borrower to pledge an asset that can be sold to pay off the loan if the borrower lacks funds.
- Capital: Bankers scrutinize a borrower's net worth, the amount by which assets exceed debts.
- Conditions: Whether bankers give a loan can be influenced by the current economic climate as well as by the amount.

Types of bank funding
Banks usually offer three types of loan:

- Overdrafts: Though technically short-term money as they can be called in at a moment's notice, these tend to form a part of the permanent capital of a business, albeit a fluctuating one.
- Term loans: Offered for set periods.
- Government-backed loans: These are available to some types of business, usually small or new ventures, where the banker's normal criteria might not be met, but the government would like to encourage the sector.

Overdrafts/notes payable
The principal form of short-term bank funding is an overdraft, secured by a charge over the assets of the business. A little over a quarter of all bank finance for small firms is in the form of an overdraft. If you are starting out in a contract cleaning business, say, with a major contract, you need sufficient funds initially to buy the mop and bucket. Three months into the contract they will have been paid for, and so there is no point in getting a five-year bank loan to cover this, as within a year you will have cash in the bank and a loan with an early redemption penalty!
However, if your bank account does not get out of the red at any stage during the year, you will need to re-examine your financing. All too often companies utilize an overdraft to acquire long-term assets, and that over-draft never seems to disappear, eventually constraining the business.

The attraction of overdrafts is that they are very easy to arrange and take little time to set up. That is also their inherent weakness. The key words in the arrangement document are 'repayable on demand', which leaves the bank free to make and change the rules as it sees fit. (This term is under constant review, and some banks may remove it from the arrangement.) With other forms of borrowing, as long as you stick to the terms and conditions, the loan is yours for the duration. It is not so with overdrafts.

Term loans
Term loans, as long-term bank borrowings are generally known, are funds provided by a bank for a number of years.
The interest can either be variable, changing with general interest rates, or fixed for a number of years ahead. The proportion of fixed-rate loans has increased from a third of all term loans to around one in two. In some cases it may be possible to move between having a fixed interest rate and a variable one at certain intervals. It may even be possible to have a moratorium on interest payments for a short period, to give the business some breathing space. Provided the conditions of the loan are met in such matters as repayment, interest and security cover, the money is available for the period of the loan. Unlike in the case of an overdraft, the bank cannot pull the rug from under you if circumstances (or the local manager) change.

Just over a third of all term loans are for periods greater than 10 years, and a quarter are for 3 years or less.

Government backed finance
One of the most notable initiatives has been the Enterprise Finance Guarantee scheme (EFG), which has offered a total value of £1.88 billion to over 18,000 economically viable small businesses.
Although established small- and mid-sized companies have benefited the most from the scheme, start-ups in the first three years of business account for 37 per cent of all loans offered, with 17 per cent attributed to businesses within their first three months.

You can find more information on the Enterprise Finance Guarantee scheme on the GOV.UK website (www.gov.uk/government/publications/enterprise-finance-guarantee).

The Enterprise Finance Guarantee Scheme operated by the banks at the behest of the UK government is typical of such interventions. This is aimed at businesses with a turnover up to £25 million with viable business proposals that have tried and failed to obtain a conventional loan because of a lack of security. Loans are available for periods between two and 10 years on sums from £1,000 ($1,500/€1,126) to £1 ($1.5/€1.1) million.

The government guarantees 75 per cent of the loan. In return for the guarantee, the borrower pays a premium of 1–2 per cent per year on the outstanding amount of the loan. The commercial aspects of the loan are matters between the borrower and the lender. You can find out more about the details of the scheme at www.gov.uk/government/publications/enterprise-finance-guarantee.

Bonds, debentures and mortgages
Bonds, debentures and mortgages are all kinds of borrowing with different rights and obligations for the parties concerned. For a business a mortgage is much the same as for an individual. The loan is for a specific event: buying a particular property asset such as a factory, office or warehouse. Interest is payable and the loan itself is secured against the property, so should the business fail the mortgage can substantially be redeemed.
Companies wanting to raise funds for general business purposes, rather than as with a mortgage where a particular property is being bought, issue debentures or bonds. These run for a number of years, typically three years and upwards, with the bond or debenture holder receiving interest over the life of the loan with the capital returned at the end of the period.
The key difference between debentures and bonds lies in their security and ranking. Debentures are unsecured and so in the event of the company being unable to pay interest or repay loans they may well get little or nothing back. Bonds are secured against specific assets and so rank ahead of debentures for any payout.
Unlike bank loans, which are usually held by the issuing bank, though even that assumption is being challenged by the escalation of securitization of debt being packaged up and sold on, bonds and debentures are sold to the public in much the same way as shares. The interest demanded will be a factor of the prevailing market conditions and the financial strength of the borrower.

Categories of bond
There are several general categories of bond that companies can tap into:

- Standard bonds pay interest, a coupon, half-yearly on the principal amount, known as the face or par value. At the maturity date the principal is repaid. The value of bonds fluctuates dependent on market conditions, the length of time to maturity and the likelihood of the borrower defaulting. None of these matters are of immediate concern to the recipient of the funds, as long as they can service the interest. The risk is for the bondholder who can see the value of their investment alter over time.
- Zero coupon bonds pay no interest over their life but pay a lump sum at maturity equivalent to the value of the interest such an investment would normally bear. The buyer of the bond receives a return by the gradual appreciation of the bond's price in the marketplace. This could be an attractive financing strategy for a business making an investment which itself will not bear fruit for a number of years.
- Junk bonds are bonds usually subordinated to, that is, put below others in the pecking order of who gets paid in tough times, other regular bonds. Such bonds carry a higher interest burden.
- Callable bonds are used when an issuer wants to retain the option to buy back their bonds from the public if general interest rates fall sharply after the issue date. The issuer notifies bondholders that after a certain date no further interest will be paid, leaving the holders with no reason to keep the bond. The company issuing the bond can then go out to the market and launch a new bond at a lower rate of interest and so lower its cost of capital. This process is also known as refinancing.

Asset-backed financiers
The banks are more covert when it comes to looking for security for money lent. Two other major sources of funds are less circumspect; indeed their whole prospectus is predicated on a precise relationship between what a business has or will shortly have by way of assets, and what they are prepared to advance. Both groups play an important role in financing growing businesses.

Leasing companies
Physical assets such as cars, vans, computers, office equipment and the like can usually be financed by leasing them, rather as a house or flat may be rented. Alternatively, they can be bought on hire purchase. This leaves other funds free to cover the less tangible elements in your cash flow.
Leasing is a way of getting the use of vehicles, plant and equipment without paying the full cost all at once. Operating leases are taken out where you will use the equipment (for example a car, photocopier, vending machine or kitchen equipment) for less than its full economic life. The lessor takes the risk of the equipment becoming obsolete, and assumes responsibility for repairs, maintenance and insurance. As you, the lessee, are paying for this service, it is more expensive than a finance lease, where you lease the equipment for most of its economic life and maintain and insure it yourself. Leases can normally be extended, often for fairly nominal sums, in the latter years.
Hire purchase differs from leasing in that you have the option to eventually become the owner of the asset, after a series of payments. You can find a leasing company via The Finance and Leasing Association (www.fla.org.uk/asset/members), which gives details of all UK-based businesses offering this type of finance. The website also has general information on terms of trade and code of conduct.

Discounting and factoring
Customers often take time to pay up. In the meantime you have to pay those who work for you and your less patient suppliers. So, the more you grow, the more funds you need. It is often possible to 'factor' your creditworthy customers' bills to a financial institution, receiving some of the funds as your goods leave the door, hence speeding up cash flow.
Factoring is generally only available to a business that invoices other business customers, either in its home market or internationally, for its services. Factoring can be made available to new businesses, although its services are usually of most value during the early stages of growth. It is an arrangement that allows you to receive up to 80 per cent of the cash due from your customers more quickly than they would normally pay. The factoring company in effect buys your trade debts, and can also provide a debtor accounting and administration service. You will, of course, have to pay for factoring services. Having the cash before your customers pay will cost you a little more than normal overdraft rates. The factoring service will cost between 0.5 and 3.5 per cent of the turnover, depending on volume of work, the number of debtors, average invoice amount and other related factors. You can get up to 80 per cent of the value of your invoice in advance, with the remainder paid when your customer settles up, less the various charges just mentioned.
If you sell direct to the public, sell complex and expensive capital equipment, or expect progress payments on long-term projects, then factoring is not for you. If you are expanding more rapidly than other sources of finance will allow, this may be a useful service that is worth exploring.
Invoice discounting is a variation on the same theme where you are responsible for collecting the money from debtors; this is not a service available to new or very small businesses. You can find an invoice discounter or factor through The Asset Based Finance Association (www.abfa.org.uk/public/membersList.asp), the association representing the UK's 41 factoring and invoice discounting businesses.

Equity
Businesses operating as a limited company or limited partnership have a potentially valuable opportunity to raise relatively risk-free money. It is risk-free to the business but risky, sometimes extremely so, to anyone investing. Essentially this type of capital, known collectively as equity, consists of the issued share capital and reserves of various kinds. It represents the amount of money that shareholders have invested directly into the company by buying shares, together with retained profits that belong to shareholders but which the company uses as additional capital. As with debt, equity comes in a number of different forms with differing rights and privileges.
Ordinary shares form the bulk of the shares issued by most companies and are the shares that carry the ordinary risks associated with being in business. All the profits of the business, including past retained profits, belong to the ordinary shareholders once any preference share dividends have been deducted. Ordinary shares have no fixed rate of dividend; indeed over half the companies listed on US stock markets pay no or virtually no dividend. These include high-growth companies such as Google and Microsoft, which argue that by retaining and reinvesting all their profits they can create better value for shareholders than by distributing dividends. A company does not have to issue all its share capital at once. The total amount it is authorized to issue must be shown somewhere in the accounts, but only the issued share capital is counted in the balance sheet. Although shares can be partly paid, this is a rare occurrence.
Preference shares get their name for two reasons. First, they receive their fixed rate of dividend before ordinary shareholders. Second, in the event of a winding up of the company, any funds remaining go to repay preference share capital before any ordinary share capital. In a forced liquidation this may be of little comfort, as shareholders of any type come last in the queue after all other claims from creditors have been met.
Class A and Class B shares are cases where categories of shareholder are singled out for more or less favourable treatment. For example, class A shares are often given up to five votes per share, while class B gets one. In extreme cases class B shareholders can get no votes at all. Companies will often try to disguise the disadvantages associated with owning shares with fewer voting rights by naming those shares. One of the most famous examples was their use by the Savoy Hotel Group to ward off an unwanted takeover by Trusthouse Forte. While Trusthouse was able to buy 70 per cent of Savoy shares on the open market, they could secure only 42 per cent of the voting rights as they were only able to buy class B shares, the A shares being in the hands of the Savoy family and allies.
Reserves, a typically misleading term in all accounting, means profits of various kinds that have been retained in the company as extra capital. Also important is what the term reserves does not mean. It does not mean actual money held back in reserve in bank accounts or elsewhere. Reserves come from retained profits over many years but are reinvested in buildings, equipment, stocks or company debts, just like any other source of capital, and are rarely held in cash.

The main categories of reserves are as follows:
- Profit and loss account, ie cumulative retained profits from ordinary trading activities.
- Revaluation reserves, being the paper-profit that can arise if certain assets are revalued to current price levels without the assets concerned being sold.
- Share premium account, ie the excess over the original par value of a share when new shares are offered for sale at an enhanced price. Only the original par value is ever shown as issued share capital.

Sources of equity capital
There are two broad sources of equity: private equity, usually put in by individuals or small groups of individuals who for the prospects of greater returns will take on greater risks; or public capital through a share issue on a stock market.

Private equity
There are three main sources of private equity: business angels, venture capital firms and corporate venture funding.

Business angels
One likely first source of equity or risk capital will be a private individual with his or her own funds, and perhaps some knowledge of your type of business. In return for a share in the business, such investors will put in money at their own risk. They have been christened 'business angels', a term first coined to describe private wealthy individuals who back a play on Broadway or in London's West End.
Most angels are determined upon some involvement beyond merely signing a cheque and may hope to play a part in your business in some way. They are hoping for big rewards – one angel who backed Sage with £10,000 ($15,700/€11,230) in its first round of £250,000 ($392,000/€280,800) financing saw his stake rise to £40 ($63/€45) million.
These angels frequently operate through managed networks, usually on the internet. In the UK and the United States there are hundreds of networks, with tens of thousands of business angels prepared to put up several billion pounds each year into new or small businesses.

Finding a business angel: The World Business Angels Association (www.wbaa.biz/?page_id=58) provides links to angels and angel associations around the globe. The UK Business Angels Association (www.ukbusinessangelsassociation.org.uk) has an online directory of UK business angels. The European Business Angels Network (eban) has directories of national business angel associations both inside and outside of Europe at (www.eban.org > About EBAN > Members Directory) from which you can find individual business angels.

Venture capital
Venture capital (VC) providers are investing other people's money, often from pension funds. They have a different agenda from that of business angels, and are more likely to be interested in investing more money for a larger stake.
In general, VCs expect their investment to have paid off within seven years, but they are hardened realists. Two in every 10 investments they make are total write-offs, and six perform averagely well at best. So, the one star in every 10 investments they make has to cover a lot of duds. VCs have a target rate of return of 30 per cent plus, to cover this poor hit rate.
Raising venture capital is not a cheap option and deals are not quick to arrange either. Six months is not unusual, and over a year has been known. Every VC has a deal done in six weeks in its portfolio, but that truly is the exception.
Finding venture capital The British Venture Capital Association (www.bvca.co.uk) and the European Venture Capital Association (www.evca.com) both have online directories giving details of hundreds of venture capital providers. Ernst & Young (www.ey.com/GL/en/Services/Strategic-Growth-Markets) provide an overview of the risk capital market on this website. The National Venture Capital Association in the United States has directories of international venture capital associations both inside and outside the United States (www.nvca.org > Resources).

You can see how those negotiating with or receiving venture capital rate the firm in question at The Funded website (www.thefunded.com) in terms of the deal offered, the firm's apparent competence and how good they are managing the relationship. There is also a link to the VC's website. The Funded has 2,500 members.

Corporate venturing
Venture capital firms often get their hands dirty taking a hand in the management of the businesses they invest in. Another type of business is also in the risk capital business, without it necessarily being their main line of business. These firms, known as corporate venturers, usually want an inside track to new developments in and around the edges of their own fields of interest. For example, Microsoft, Cisco and Apple have billions of dollars invested in hundreds of small entrepreneurial firms, taking stakes from a few hundred thousand dollars up to hundreds of million.
And it's not just high-tech business that takes this approach. McDonald's held a 33 per cent stake in Prêt à Manger while it worked out where to take its business after saturating the burger market. British sugar and artificial sweetener maker Tate & Lyle launched a £30 million venture capital fund in January 2013 to help develop food science start-ups and develop new ingredients, as well as opening a Commercial and Food Innovation Centre in Chicago. HM Revenue and Customs (www.hmrc.gov.uk/guidance/cvs.htm) has a useful guide entitled 'The Corporate Venturing Scheme', explaining the scheme, tax implications and sources of further information.
Recent research into corporate venturing by Ashridge (www.ashridge.org.uk > Research and Faculty) Business School concluded that less than 5 per cent of corporate venturing units created new businesses that were taken up by the parent company. Moreover, many failed to make any positive contribution whatsoever.

CASE STUDY  Meraki: Corporate venture multi-million dollar pay day

Meraki (may-rah-kee), a Greek word that means doing something with passion and soul, could soon stand for how to make a billion in under a decade. Meraki was formed in 2006 by three PhD candidates from MIT, Sanjit Biswas, John Bicket and Hans Robertson, all currently on leave from their degree programme.
Meraki, according to its website, 'brings the benefits of the cloud to edge and branch networks, delivering easy-to-manage wireless, switching, and security solutions that enable customers to seize new business opportunities and reduce operational cost. Whether securing iPads in an enterprise or blanketing a campus with WiFi, Meraki networks simply work'. With over 10,000 customers worldwide ranging from the English public school Wellington College to fast-food chain Burger King, Meraki was initially backed by Californian venture capital firm Sequoia Capital and Google, two early venture investors. Rajeev Motwani, the Stanford University professor who taught Google co-founders Larry Page and Sergey Brin made the necessary introductions.
Payday came on 19 November 2012 when Cisco, who had been in exclusive talks since September with Meraki bought the company for US $1.2 billion (£754 million). The founders had been considering a flotation and at first rejected Cisco's overtures. Analysts think Cisco has overpaid, but with their greater market presence and cash resources the company is confident it will be able to expand Meraki's technology using their global networks. Cisco has included a retention package to keep Meraki's co-founders at Cisco to consummate the deal. Sujai Hujela, an executive at Cisco, also stated: 'We are making sure we want to preserve and pollinate the culture (at Meraki) into Cisco.'

Private capital preliminaries
Two important stages will be gone through before a private investor will put cash into a business. The emphasis put on these stages will vary according to the complexity of the deal, the amount of money and the legal ownership of the funds concerned. For example, a business angel investing on their own account can accept greater uncertainty than, say, a venture capital fund using a pension fund's money.

Due diligence: Usually, after a private equity firm signs a letter of intent to provide capital and you accept, it will conduct a due diligence investigation of both the management and the company. During this period the private equity firm will have access to all financial and other records, facilities, employees etc to investigate before finalizing the deal. The material to be examined will include copies of all leases, contracts and loan agreements in addition to copious financial records and statements. It will want to see any management reports, such as sales reports, inventory records, detailed lists of assets, facility maintenance records, aged receivables and payables reports, employee organization charts, payroll and benefits records, customer records and marketing materials. It will want to know about any pending litigation, tax audits or insurance disputes. Depending on the nature of the business, it might also consider getting an environmental audit and an insurance check-up. The sting in the due diligence tail is that the current owners of the business will be required to personally warrant that everything they have said or revealed is both true and complete. In the event that proves not to be so, they will be personally liable to the extent of any loss incurred by those buying the shares.

Term sheet:A term sheet is a funding offer from a capital provider. It lays out the amount of an investment and the conditions under which the new investors expect the business owners to work using their money.
The first page of the term sheet states the amount offered and the form of the funds (a bond, common stock, preferred stock, a promissory note or a combination of these). A price, either per $/£/€1,000 unit of debt or per share of stock, is quoted to set the cost basis for investors 'getting in' on your company. Later that starting price will be very important in deciding capital gains and any taxes due at acquisition, IPO (initial public offering) or shares/units transferred.
Another key component of the term sheet is the 'post-closing capitalization'. That is the proposed cash value of the venture on the day the terms are accepted. For example, investors may offer $/£/€500,000 in Series A preferred stock at 50 pence per share (1 million shares) with a post-closing cap of $/£/€2 million. This translates into a 25 per cent ownership stake in the firm ($/£/€500,000 divided by $/£/€2 million).
The next section of the term sheet is typically a table that summarizes the capital structure of your company. Investors generally start with preferred stock in order to gain a priority of distribution, should the enterprise fail and the liquidation of assets occur. The typical way to handle this is to have the preferred stock be convertible into common stock on a 1 : 1 ratio at the investors' option, such that the preferred position is essentially a common stock position, but with priority of repayment over the founders' own common-stock position.
Other terms included on the sheet could cover rents, equipment, levels of debt vs equity, minimum and maximum time periods associated with the transfer of shares, vesting in additional shares, and option periods for making subsequent investments and having 'right of first refusal' when other rounds of funding are sought in the future.

Public capital
Stock markets are the place where serious businesses raise serious money. It's possible to raise anything from a few million to tens of billions; expect the costs and efforts in getting listed to match those stellar figures. The basic idea is that owners sell shares in their businesses that in effect bring in a whole raft of new 'owners' who in turn have a stake in the businesses' future profits. When they want out, they sell their shares on to other investors. The share price moves up and down to ensure that there are as many buyers as sellers at any one time.
Going public also puts a stamp of respectability on you and your company. It will enhance the status and credibility of your business, and it will enable you to borrow more against the 'security' provided by your new shareholders, should you so wish. Your shares will also provide an attractive way to retain and motivate key staff. If they are given, or rather are allowed to earn, share options at discounted prices, they too can participate in the capital gains you are making. With a public share listing you can now join in the takeover and asset-stripping game. When your share price is high and things are going well you can look out for weaker firms to gobble up – and all you have to do is to offer them more of your shares in return for theirs. You do not even have to find real money. But of course this is a two-sided game and you also may now become the target of a hostile bid.
You may find that being in the public eye not only cramps your style but fills up your engagement diary too. Most CEOs of public companies find that they have to spend up to a quarter of their time 'in the City' explaining their strategies, in the months preceding and the first years following their going public. It is not unusual for so much management time to have been devoted to answering accountants' and stockbrokers' questions that there is not enough time to run the day-to-day business, and profits drop as a direct consequence.
The City also creates its own 'pressure' both to seduce companies onto the market and then by expecting them to perform beyond any reasonable expectation. There have been a number of high-profile examples of companies that have floated their shares on a stock market then changed their minds and withdrawn, buying out all outside shareholders. The rationale for taking a company private is that the buyer feels that they can run the company better without the need to justify their decisions to other shareholders, or the complex and burdensome regulations that public companies must comply with.

CASE STUDY  Ocado: cash box placing
Ocado, which sells food sourced from supermarket operator Waitrose (part of John Lewis), launched an initial public offering (IPO) in 2010 putting a value of between £1 billion and £1.1 billion on the business. Not bad for a business showing losses in the preceding three years of £22.5 million, £43.5 million and £45.5 million, an improving trend, albeit a fairly shallow one.
It was long known that the company's strategy called for a voracious consumption of cash and in various rounds of fundraising the company had already raised just short of £300 million, more than any other European internet start-up.
By November 2012 Ocado's business model had not delivered the goods.
Shareholders grabbing a slice of the action in July 2010's 180p-a-share float had lost almost two-thirds of their money. Financial engineering to the rescue: the business urgently needed another £35 million or so to keep the show on the road and there was no chance of existing shareholders or their bankers stumping up more cash. Goldman Sachs came to the rescue with a little known money spinner, Cash Box Placing, a strategy that neatly skirts past the pre-emption requirements of Companies Act 2006 requiring all shareholders to be treated equally and allowing the use of a special purpose unlisted vehicle to warehouse the funds.

The only asset of the special purpose vehicle, in this case Weir Developments, is cash. The cash is generated by a subscription of shares by Goldman who are then able to finance their commitment to fund the subscription price on the shares out of the proceeds of placing the company's shares at a highly preferential price – in this case 64p. The net result is that shareholders who are not invited by Goldman or joint-bookrunner Numis Securities to take part in the placing get their shareholding diluted by the addition of new shareholders. Worse still they get no say in the matter yet have to fund £1 million of fees to engineer the deal.

Initial public offer (IPO) – criteria for getting a stock market listing
The rules vary from market to market but these are the conditions that are likely to apply to get a company listed on an exchange:

- Getting listed on a major stock exchange calls for a track record of making substantial profits with decent seven-figure sums being made in the year you plan to float, as this process is known. A listing also calls for a large proportion, usually at least 25 per cent, of the company's shares to be put up for sale at the outset. In addition, you would be expected to have 100 shareholders now and be able to demonstrate that 100 more will come on board as a result of the listing.

- As you draw up your flotation plan and timetable you should have the following matters in mind:

– Advisers: You will need to be supported by a team which will include a sponsor, stockbroker, reporting accountant and solicitor. These should be respected firms, active in flotation work and familiar with the company's type of business. You and your company may be judged by the company you keep, so choose advisers of good repute and make sure that the personalities work effectively together. It is very unlikely that a small local firm of accountants, however satisfactory, will be up to this task.

– Sponsor: You will need to appoint a financial institution, usually a merchant banker, to fill this important role. If you do not already have a merchant bank in mind, your accountant will offer guidance. The job of the sponsor is to coordinate and drive the project forward.

– Timetable: It is essential to have a timetable for the final months during the run-up to a float – and to adhere to it. The company's directors and senior staff will be fully occupied in providing information and attending meetings. They will have to delegate and there must be sufficient backup support to ensure that the business does not suffer.

– Management team: A potential investor will want to be satisfied that your company is well managed, at board level and below. It is important to ensure succession, perhaps by offering key directors and managers service agreements and share options. It is wise to draw on the experience of well-qualified non-executive directors.

– Accounts: The objective is to have a profit record which is rising but, in achieving this, you will need to take into account directors' remuneration, pension contributions and the elimination of any expenditure which might be acceptable in a privately owned company but would not be acceptable in a public company, namely excessive perks such as yachts, luxury cars, lavish expense accounts and holiday homes.

Accounts must be consolidated and audited to appropriate accounting standards and the audit reports must not contain any major qualifications. The auditors will need to be satisfied that there are proper stock records and a consistent basis of valuing stock during the years prior to flotation. Accounts for the last three years will need to be disclosed and the date of the last accounts must be within six months of the issue.

AIM
London's Alternative Investment Market (AIM) was formed in the mid-to-late 1990s specifically to provide risk capital for new rather than established ventures. AIM raised £15.7bn in 2007 – a 76 per cent leap from the previous year – and a record number of companies floated on the exchange, bringing the total to 1,634.
AIM is particularly attractive to any dynamic company of any size, age or business sector that has rapid growth in mind. The smallest firm on AIM entered at under £1 million capitalization and the largest at over £500 million. The formalities are minimal, but the costs of entry are high and you must have a nominated adviser, such as a major accountancy firm, stockbroker or banker. The survey showed that costs of floating on the junior market is around 6.5 per cent of all funds raised and companies valued at less than £2m can expect to shell out a quarter of funds raised in costs alone. The market is regulated by the London Stock Exchange (www.londonstockexchange.com > For companies and advisers > AIM).

You can check out all the world stock markets from Australia to Zagreb on Stock Exchanges World Wide Links (www.tdd.lt/slnews/Stock_Exchanges/Stock.Exchanges.htm), maintained by Aldas Kirvaitis of Lithuania, and at World Wide Tax.com (www.worldwide-tax.com > World Stock Exchanges). Once in the stock exchange website, almost all of which have pages in English, look out for a term such as 'Listing Center', 'Listing' or 'Rules'. There you will find the latest criteria for floating a company on that particular exchange.

PLUS – a market fails
One rung down from AIM was PLUS-Quoted Market whose roots lie in the market formerly known as Ofex. It began life in November 2004 and was granted Recognised Investment Exchange (RIE) status by the Financial Services Authority (FSA) in 2007. Aimed at smaller companies wanting to raise up to £10 million it draws on a pool of capital primarily from private investors. The market is regulated, but requirements are not as stringent as those of AIM or the main market and the costs of flotation and ongoing costs are lower. Keycom used this market to raise £4.4 million in September 2008 to buy out a competitor to give them a combined contract to provide broadband access to 40,000 student rooms in UK universities. There are 174 companies quoted on PLUS with a combined market capitalization of £2.3 billion. Even in 2009/10, a particularly bad period for stock market activity, 30 companies applied for entry to PLUS and 18 were admitted. But in 2012 after a fruitless attempt to sell up, the exchange closed leaving shareholders and companies in a less than desirable position. The lesson here is that there is only so far up the risk curve you can go and still have sufficient buyers and sellers to create a market.

Share buyback
Companies can buy back their shares, which reduces the number of shares outstanding, giving each remaining shareholder a larger percentage ownership of the company. This is usually considered a sign that the company's management believes its share price is undervalued. Other reasons for buybacks include putting unused cash to use, raising earnings per share and obtaining stock for employee stock option plans or pension plans.

Hybrids
A number of financing methods straddle the debt and equity boundary. These try to mitigate taking a bit more risk for the potential of a bit more return than would be usual with debt financing. But they also limit the upside that might be expected from pure equity, which would retain all of any increase in value from the outset:

- Convertible preference shares operate like preference shares, in that their holders rank before ordinary shareholders for dividend payment, or return of funds in the case of failure. They also have the option, at some specified date in the future, to convert to ordinary shares and so enjoy all of any increase in value.
- Mezzanine finance has one or all of these characteristics: it ranks after other forms of debt, but before equity, for any payout in the event of a business failing; it pays higher, often significantly higher, interest than other debt; it can be held for up to 10 years; it can be converted into ordinary shares. It is popular with VCs for management buyouts.


Crowdfunding
Crowdfunding business finance is a new game-changing concept that puts the power firmly into the hands of entrepreneurs looking to raise finance. Instead of one large investor putting money into a business, larger numbers of smaller investors contribute as little as £10 each to raise the required capital. 
Crowdcube was the first crowdfunding website in the world to enable the public to invest in and receive shares in UK companies. 

Grants
Government agencies at both national and local government level as well as some extra-governmental bodies such as the EU offer grants, effectively free or nearly free money in return for certain behaviour. It may be to encourage research into a particular field, stimulate innovation or employment or to persuade a company to locate in a particular area. Grants are constantly being introduced (and withdrawn), but there is no system that lets you know automatically. You have to keep yourself informed.
You can find out about international grants and funding at Proposalwriter.com (www.proposalwriter.com/intgrants.html), as well as advice on writing a proposal.
Grants.Gov (www.grants.gov) is a guide to how to apply for over 1,000 federal government grants in the United States.

Cost of capital
A business needs to keep track of how much it is paying for the capital it uses, as that is the minimum hurdle rate for any investment it may make. Also, it needs to be aware that if new money being raised is more costly than that already in the business, it will only be profitable if it raises the hurdle rate for new projects accordingly.

Cost of debt
This can be very straightforward. If a company takes out a bank loan at a fixed rate of interest of say, 8 per cent, then this is the cost before any tax relief. Taking tax relief at 40 per cent into account, the net cost of debt comes down to 4.8 per cent. In the case of a public offer for bonds or debentures, the rate of interest which has to be paid on new loans to get them taken up by investors at par can be regarded as the cost of borrowed capital.

Cost of equity
Put simply, the cost of equity is the return shareholders expect the company to earn on their money. It is their estimation, often not scientifically calculated, of the rate of return that will be obtained both from future dividends and an increased share value.

Dividend valuation model
One approach to finding the cost of equity is to take the current gross dividend yield for a company and add the expected annual growth.
Example For example, XYZ plc has forecast payment of a gross equivalent dividend of 10p on each ordinary share in the coming year. The company's shares are quoted on the Stock Exchange and currently trade at $/£/€2.00. Growth of profits and dividends has averaged 15 per cent over the past few years.

The cost of equity for XYZ plc can be calculated as:

With this method, dividends are assumed to grow in the future at the constant rate achieved by averaging the last few years' performance.

Capital asset pricing model (CAPM)
Before turning to the next method, we need to clarify some aspects of risk. There are two broad types of risk:

- Specific risk: This applies to one particular business. It includes, for example, the risk of losing the chief executive; the risk of someone else bringing out a similar or better product; or the risk of labour problems. Shareholders are expected not to want compensation for this type of risk as it can be diversified away by holding a sufficient number of investments in their portfolios.
- Systematic risk: This derives from global or macroeconomic events that can damage all investments to some extent and therefore holders require compensation for this risk to their wealth. This compensation takes the form of a higher required rate of return.

A slightly more complicated approach to the cost of equity tries to take the systematic risk element into account. It is known as the capital asset pricing model or CAPM for short. Put simply, CAPM states that investors' required rate of return on a share is composed of two parts: a risk-free rate similar to that obtainable on a risk-free investment in short-term government securities; and an additional premium to compensate for the systematic risk involved in investing in shares.

This systematic risk for a company's shares is measured by the size of its beta factor. A beta the size of 1.0 for a company means that its shares have the same systematic risk as the average for the whole market. If the beta is 1.4 then systematic risk for the share is 40 per cent higher than the market average. A company's share beta is applied to the market premium that is obtained from the excess of the return on a market portfolio of shares over the risk-free rate of return.

The formula to calculate cost of equity capital using CAPM is:
Ke = Rf + B(Rm – Rf)
Where: Ke = cost of equity, Rf = risk-free return, Rm = return on market portfolio of shares and B = beta factor.

Example: If the risk-free rate of return is 5.5 per cent and the return on a market portfolio is 12 per cent, then for a company with a beta of 0.7 for its ordinary shares calculate its cost of equity.


Of the two methods described for finding the cost of equity for a company, the latter CAPM method is the more scientific. Ideally, the risk-free and market rates of return should reflect the future, but current rates of return are used as substitutes. Beta factors measure how sensitive each company's share price movements are relative to market movements over a period of a few years.
The weakness of CAPM is that it assumes all investors are rational and well informed, that markets are perfect and that there is an unlimited supply of risk-free money. There are even more complex models for calculating the cost of equity capital, but none are without their critics.

Weighted average cost of capital
Having identified the cost of equity and the cost of borrowed capital (and that of any other long-term source of finance such as hire purchase or mortgages), we need to combine them into one overall cost of capital. This is primarily for use in project appraisals as justification of those that yield a return in excess of their cost of capital.
An average cost is required because we do not usually identify each individual project with one particular source of finance. Because equity and debt capital have very different costs, we would make illogical decisions and accept a project financed by debt capital only to reject a similar project next time round when it was financed by equity capital. Generally businesses take the view that all projects have been financed from a common pool of money except for the relatively rare case when project-specific finance is raised. The weightings used in the calculations should be based on the market value of the securities and not on their book or balance sheet values.

Example: Assume your company intends to keep the gearing ratio of borrowed capital to equity in the proportion of 20 : 80. The nominal cost of new capital from these sources has been assessed, say, at 10 per cent and 15 per cent respectively and corporation tax is 30 per cent. The calculation of the overall weighted average cost is as follows:

The resulting weighted average cost of 13.4 per cent is the minimum rate that this company should accept on proposed investments. Any investment that is not expected to achieve this return is not a viable proposition. Risk has been allowed for in the calculation of the beta factor used in the CAPM method of identifying the cost of equity. This relates to the risk of the existing whole business. If a company embarks on a project of significantly different risk, or has a divisional structure of activities of varying risk levels, then a single cost of equity for the whole company is inappropriate. In this situation, the average beta of proxy companies operating in the same field as a division can be used.
Investment decisions
The cost of capital is an important figure as it is in essence the threshold for future investments. Taking the figures shown above, if our weighted average cost of capital is 13.4 per cent then taking on any new activity that makes a lower profit ratio will be lowering the performance, hardly an MBA type of activity.
Investment decisions, where the decisions have cost and revenue implications for years, perhaps even decades, fall into a number of categories:

- Bolt-on investments: These are where an investment will be supporting and enhancing an existing operation. For example, if part of a production process is being slowed down for want of some new equipment to eliminate a bottleneck.
- Standalone single project: This involves a simple accept or reject decision.
- Competing projects: This requires a choice of which produces the best results, either because only one can be pursued or because of limited finance. In the latter case this is described as capital rationing.

CASE STUDY  Cobra Beer
In 1990, Cambridge-educated and recently qualified accountant Karan Bilimoria started importing and distributing Cobra beer, a name he chose because it appeared to work well in lots of different languages. He initially supplied his beer to complement Indian restaurant food in the UK. Lord Bilimoria, as he now is, started out with debts of £20,000, but from a small flat in Fulham and with just a Citroen CV by way of assets he has grown his business to sales of over £100 million a year. Three factors have been key to its success. Cobra was originally sold in large 660ml bottles and so were more likely to be shared by diners. Also, as Cobra is less fizzy than European lagers, drinkers are less likely to feel bloated and can eat and drink more. The third factor was Bilimoria's extensive knowledge, through his training as an accountant, of sources of finance for a growing business. He was fortunate in having an old-style bank manager who had such belief in Cobra that he agreed a loan of £30,000, but since then he has had to tap into every possible type of funding (see Figure below), including selling a 28 per cent stake in his firm in 1995.

FIGURE: Cobra Beer's financing strategy

What follows is an examination of the financial aspects of investment decisions. There may well be other strategic reasons for taking investment decisions, including those that might be more important than finance alone. For example, it could be imperative to deny a competitor a particular opportunity; or if part of achieving a national or global strategy calls for disproportionate expenses in one or more areas. However, there are NO circumstances when any investment decision should not be subjected to proper financial appraisal and so at least see the cost of accepting a lower return than required by the cost of capital being used.
Also, it's important to note that any methodology for appraising investments requires that cash is used rather than profits, for reasons that will become apparent as the techniques are explained. Profit is not ignored; it is simply allowed to work its way through in the timing of events.

Payback period
The most popular method for evaluating investment decisions is the payback method. To arrive at the payback period you have to work out how many years it takes to recover your cash investment. Table below shows two investment projects that require respectively $/£/€20,000 and $/£/€40,000 cash now in order to get a series of cash returns spread over the next five years.

TABLE: The payback method

Although both propositions call for different amounts of cash to be invested, we can see that both recover all their cash outlays by year 4. So we can say these investments have a four-year payback. But as a matter of fact Investment B produces a much bigger surplus than the other project and it returns half our initial cash outlay in two years. Investment A has returned only a quarter of our cash over that time period.
Payback may be simple, but it is not much use when it comes to dealing with the timing or with comparing different investment amounts.

Discounted cash flow
We know intuitively that getting cash in sooner is better than getting it in later. In other words, a pound received now is worth more than a pound that will arrive in one, two or more years in the future because of what we could do with that money ourselves, or because of what we ourselves have to pay out to have use of that money (see Cost of capital above). To make sound investment decisions we need to ascribe a value to a future stream of earnings to arrive at what is known as the present value. If we know we could earn 20 per cent on any money we have, then the maximum we would be prepared to pay for a pound coming in one year hence would be around 80p. If we were to pay one pound now to get a pound back in a year's time we would in effect be losing money.
The technique used to handle this is known as discounting. The process is termed discounted cash flow (DCF) and the residual discounted cash is called the net present value.
The first column in Table below shows the simple cash-flow implications of an investment proposition; a surplus of $/£/€5,000 comes after five years from putting $/£/€20,000 into a project. But if we accept the proposition that future cash is worth less than current cash, the only question we need to answer is how much less. If we take our weighted average cost of capital as a sensible starting point, we would select 13.4 per cent as an appropriate rate at which to discount future cash flows. To keep the numbers simple and to add a small margin of safety, let's assume that 15 per cent is the rate we have selected (this doesn't matter too much, as you will see in the section on internal rate of return).

TABLE: Using discounted cash flow (DCF)

The formula for calculating what a pound received at some future date is:

Present Value (PV) = $/€/£P × 1/(1 + r)n
where $/£/€P is the initial cash cost, r is the interest rate expressed in decimals and n is the year in which the cash will arrive. So if we decide on a discount rate of 15 per cent, the present value of a pound received in one year's time is:

Present Value
= $/€/£1 × 1/(1 + 0.15)1
= 0.87 (rounded to two decimal places)
So we can see that our $/£/€1,000 arriving at the end of year 1 has a present value of $/£/€870; the $/£/€4,000 in year 2 has a present value of $/£/€3,024 and by year 5 present value reduces cash flows to barely half their original figure. In fact, far from having a real payback in year 4 and generating a cash surplus of $/£/€5,000, this project will make us $/£/€4,358 worse off than we had hoped to be if we required to make a return of 15 per cent. The project, in other words, fails to meet our criteria using DCF but might well have been pursued using payback.

Internal rate of return (IRR)
DCF is a useful starting point but does not give us any definitive information. For example, all we know about the above project is that it doesn't make a return of 15 per cent. In order to know the actual rate of return we need to choose a discount rate that produces a net present value of the entire cash flow of zero, known as the internal rate of return. The maths is complex but Microsoft has a neat template (http://office.microsoft.com/engb/templates/internal-rate-of-return-irr-calculator-TC001234202.aspx) that will crunch the numbers for you. They also have a whole host of other templates that you can reach by typing their name – payback period, present value, discounted cash flow and so forth.
Using this spreadsheet you will see that the IRR for the project in question is slightly under 7 per cent, not much better than bank interest and certainly insufficient to warrant taking any risks for.

Budgets and variances
Budgeting is the principal interface between the operating business units and the finance department. As a staff function, the finance department will assist managers in preparing a detailed budget for the year ahead for every area of the organization and is in effect the first year of the business plan. MBAs are invariably expected to play a role in facilitating the process within their departments. Budgets are usually reviewed at least halfway through the year and often quarterly. At that review a further quarter or half year can be added to the budget to maintain a one-year budget horizon. This is known as a 'rolling quarterly (half yearly) budget'.

Budget guidelines
Budgets should adhere to the following general principles:

- The budget must be based on realistic but challenging goals. Those goals are arrived at by both a top-down 'aspiration' of senior management and a bottom-up forecast of what the department concerned sees as possible.
- The budget should be prepared by those responsible for delivering the results – the salespeople should prepare the sales budget and the production people the production budget. Senior managers must maintain the communication process so that everyone knows what other parties are planning for.
- Agreement to the budget should be explicit. During the budgeting process, several versions of a particular budget should be discussed. For example, the boss may want a sales figure of $/£/€2 million, but the sales team's initial forecast is for $/£/€1.75 million.
- After some debate, $/£/€1.9 million may be the figure agreed upon. Once a figure is agreed, a virtual contract exists that declares a commitment from employees to achieve the target and commitments from the employer to be satisfied with the target and to supply resources in order to achieve it. It makes sense for this contract to be in writing.
- The budget needs to be finalized at least a month before the start of the year and not weeks or months into the year.
- The budget should undergo fundamental reviews periodically throughout the year to make sure all the basic assumptions that underpin it still hold good.
- Accurate information to review performance against budgets should be available 7 to 10 working days before the month's end.

Variance analysis
Explaining variances is also an MBA-type task so performance needs to be carefully monitored and compared against the budget as the year proceeds, and corrective action must be taken where necessary. This has to be done on a monthly basis (or using shorter time intervals if required), showing both the company's performance during the month in question and throughout the year so far.
Looking at Table below, we can see at a glance that the business is behind on sales for this month, but ahead on the yearly target. The convention is to put all unfavourable variations in brackets. Hence, a higher-than-budgeted sales figure does not have brackets, while a higher materials cost does. We can also see that, while profit is running ahead of budget, the profit margin is slightly behind (–0.30 per cent).

TABLE: The fixed budget ($/£/€000's)

This is partly because other direct costs, such as labour and distribution in this example, are running well ahead of budget.

Flexing the budget
A budget is based on a particular set of sales goals, few of which are likely to be exactly met in practice. Table shows a company that has used $/£/€762,000 more materials than budgeted. As more has been sold, this is hardly surprising. The way to manage this situation is to flex the budget to show what, given the sales that actually occurred, would be expected to happen to expenses. Applying the budget ratios to the actual data does this. For example, materials were planned to be 22.11 per cent of sales in the budget. By applying that to the actual month's sales, a materials cost of $/£/€587,000 is arrived at.
Looking at the flexed budget in Table below, we can see that the company has spent $/£/€19,000 more than expected on the material given the level of sales actually achieved, rather than the $/£/€762,000 overspend shown in the fixed budget.

TABLE: The flexed budget ($/£/€000's)

The same principle holds for other direct costs, which appear to be running $/£/€94,000 over budget for the year. When we take into account the extra sales shown in the flexed budget, we can see that the company has actually spent $/£/€4,000 over budget on direct costs. While this is serious, it is not as serious as the fixed budget suggests.
The flexed budget allows you to concentrate your efforts on dealing with true variances in performance.
The following website, SCORE (www.score.org/resources/sales-forecast-1), has a downloadable Excel spreadsheet from which you can make sales and cost projections on a trial and error basis. Once you are satisfied with your projection, use the profit and loss projection (www.score.org/resources/3-year-profit-and-loss-projection) to complete your budget.

Seasonality and trends
The figures shown for each period of the budget are not the same. For example, a sales budget of $/£/€1.2 million for the year does not translate to $/£/€100,000 a month. The exact figure depends on two factors:

- The projected trend may forecast that, while sales at the start of the year are $/£/€80,000 a month, they will change to $/£/€120,000 a month by the end of the year. The average would be $/£/€100,000.
- By virtue of seasonal factors, each month may also be adjusted up or down from the underlying trend. You could expect the sales of heating oil, for example, to peak in the autumn and tail off in the late spring.