1. EUROPEAN COURSE IN ENTREPRENEURSHIP FOR THE CREATIVE INDUSTRIES
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Financial Plan
2. EUROPEAN COURSE IN ENTREPRENEURSHIP FOR THE CREATIVE INDUSTRIES
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Financial plan
Sources:
Harold L. Vogel, “Entertainment Industry Economics”, Sixth Edition, John
Wiley & Sons, Inc., 2001
Alan B. Albarran, “The Media Economy”, Routledge, 2010
Richard A. Brealey & Stewart C. Myers, “Principles of Corporate Finance”,
MacGrawHill, 1998
To finance a viable project
Purposed objectives and review of internal resources determine needs of investment,
in fixed assets and working capital. The financial plan aggregates cost/benefit
calculations that fix amounts in investment needs, break-even point, profit, return on
investment (return of total assets involved in the project) and return on equity
(shareholders return). Decisions must be made to access project viability (enough, e.g.,
if it is worth taking the correspondent risk) and, if so, how will it be financed, either
through equity capital, funding or both.
With the exception of rare cases of notoriety pursuit or philanthropy, the investor’s
choice depends on which available project is likely to provide a higher return at a
reasonable risk. Entrepreneurs need to bear in mind that they should go through with
their strategic decisions only if they are profitable, or if, at the very least, there will be
no unrecoverable financial losses, even when those losses are only theirs. Cost and
revenue projections should be as accurate and objective as possible, and final
feasibility indicators should be recalculated at risk-adjusted present value (taking into
account inflation, interest, minimum required return and risk associated with the
endeavour).
Basic financial concepts
In its simplest form, finance refers to the funds that flow in and out of a business
entity. Most businesses fail as a result of poorly managed finance. Financial
management refers to the systematic process of budgeting, monitoring, and
controlling the flow of funds in an organization.
Equity refers to the ownership of the firm or business
Assets represent things that have value and can ultimately be converted into
cash
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Fixed assets are long-term tangible piece of property that the firm owns and
uses in the production of it’s income and is not expected to be consumed or
converted into cash any sooner than at least one year’s time.
Depreciation is the allocation of cost of a fixed tangible asset over its useful
time
Current assets are short term tangible piece of property that are likely to be
converted into cash no later than one year’s time. Examples: inventory (stock),
accounts receivables (credit to clients or other entities)
Liabilities refer to debt or money that is owed
Fixed costs (also known as overhead or structure costs): existing costs
independent of sales
Variable costs (cost of goods sold): related to sales (usually raw materials used
in product sold or number of personnel hours in services sold)
Working Capital = current assets – current liabilities
o In a project corresponds to the value of cash funds + permanent stocks
+ receivables (credit to clients) minus accounts payable (credit from
suppliers)
Payback period or Break-even point (BEP) represents the moment where there
is no loss or gain. Total revenues minus total costs = 0.
Revenues
2400
1800
.BEP
1200
600
600 1.200 1800 2400
Costs
Balance sheet A firm’s balance sheet shows its assets (what it owns) and its
liabilities (what it owes) at a point in time.
Income Statement summarizes the profitability of the firm over a period of
time, in this case a year. Income, profits and earnings all mean the same thing –
the difference between revenues and expenses.
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Risk assessment and management
Examples of business risk
External risks
Environmental causes: areas often subject to natural disasters
Regulations, taxes and subsidies: political swaps in government can
cause sudden change of legal and fiscal regulations
Macro-economics: growth versus recession, inflation rates, interest
rates, exchange rates
Price risk of inputs: supplies prices change unpredictably
Price risk of outputs: sudden change in demand or competitors can
cause prices to fall
Internal risks
Production risks: break down of machines, workers do not show up for
work, new technologies make the companies equipment obsolete
Time frame in which a certain project is undertaken. Risks increases as
the project takes more time
Risk transfer
Hedging: reducing exposure to risk, for example selling future
production at a fixed price (forward contract) or negotiating fixed
exchange rates with banks; eliminates potential loss but give up the
potential gain
Insuring: paying a premium (to the insurance) to avoid losses. For
example making an insurance for a film release
Diversifying: holding many risk assets at lower price instead of
concentrating in just one big investment.
Introducing a time frame
Time units could be quarter, semester, and year, usually related to interest rate. Time
frame is the shortest of the following:
Product/service life
Lifespan of facilities (lease contract) or equipment
Entrepreneurs decision
The excel model used in the below example of a film production will be provided to
students.
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Sales forecast Sales forecast is connected with market research (number of
service users expected, or quantity of product expected to be sold) and
installed capacity. It should never be considered 100% capacity usage due to
probable down time in equipment maintenance, malfunction or breakdown. In
the case of a theatre a reasonable but not excessive percentage of total seats
capacity should used. Unreasonable optimism should be avoided since it leads
to overestimating sales projections. This is a recurrent error in this type of
analysis which brings disastrous results. A sensitivity analysis should be made in
sales projections (best case, expected case and worst case scenarios).
SALES FORECAST
Year 2013 2014 2015 2016 2017
Local distributor 600.000
TV Sales 400.000
DVD duplication 150.000 100.000
Distribution other territories 200.000
Others
TOTAL 0 0 600.000 750.000 100.000
Territory: North America, Latin America, South East Asia, Middle East, Western
Europe (U.K., Germany, France, Italy, Spain), Smaller Western Europe (Benelux,
Scandinavia, Greece, Portugal, Switzerland, Iceland), Eastern Europe, Africa
Cost analysis Costs should never be underestimated; either in quantity used
neither in unit price.
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VARIABLE COSTS
VARIABLE OR PRODUCTION COSTS
Year 2013 2014 2015 2016 2017
Copyrights - author 10.000
Screenplay writers 2.000 2.000
Director 5.000
Producers 10.000
Actors 500.000
Director of photography 12.000
Editor 6.000
Sound-track
Make-up 1.000
Assistants 3.000
Shootage costs 20.000
Location costs 10.000
Wardrobe 15.000
Travelling 10.000 30.000
Hotels, food and beverage 5.000 20.000
Others 1.000 1.000
TOTAL 43.000 620.000 0 0 0
FIXED (overhead) COSTS
Year 2013 2014 2015 2016 2017
# months 13 13 13 13 13
Annual increment 2,0% 2,0% 2,0% 2,0%
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Other Costs
Food allowance 1239,04 3.717 3.717 3.717 3.717 3.717
Work Insurance 1,00% 377 385 392 400 408
Training 0 0 0 0
Comissions 0 0 0 0
Health Insurance 0 0 0 0
Car and fuel 0 0 0 0
Mobile phone 0 0 0 0
Others 0 0 0 0
Total Benefits 4.094 4.102 4.109 4.117 4.125
Total Payroll Taxes+benefits 12.556 12.733 12.914 13.098 13.285
TOTAL OFFICE SALARIES 50.256 51.187 52.137 53.105 54.093
Year 2013 2014 2015 2016 2017
Annual
increment 2,0% 2,0% 2,0% 2,0%
OFFICE SUPPLIES 2013 2014 2015 2016 2017
Stationery 1.200 1.224 1.248 1.273 1.299
Office supplies 600 612 624 637 649
Comunication 2.400 2.448 2.497 2.547 2.598
Others 300 306 312 318 325
TOTAL Office Supllies 9.090 9.272 9.457 9.646 4.871
Year 2013 2014 2015 2016 2017
Annual increment 2,0% 2,0% 2,0% 2,0%
LEGAL AND PROFESSIONAL SERVICES 2013 2014 2015 2016 2017
Layers 1.440 1.469 1.498 1.528 1.559
Accountants 1.440 1.469 1.498 1.528 1.559
Network assistance 360 367 375 382 390
Other Office equipment assistance 240 245 250 255 260
Others 0 0 0 0
TOTAL Legal and professional services 3.480 3.550 3.621 3.693 3.767
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FIXED OR OVERHEAD COSTS
Year 2013 2014 2015 2016 2017
Office Salaries 37.700 38.454 39.223 40.008 40.808
Employee Benefits 4.094 4.102 4.109 4.117 4.125
Payroll Taxes 8.462 8.632 8.804 8.980 9.160
Advertising 5.000 5.000 5.000
Stationery, Office Supplies & Postage 9.090 9.272 9.457 9.646 4.871
Legal and Professional Services 3.480 3.550 3.621 3.693 3.767
Dues & Subscriptions 500 500 500 500 500
Data Processing 200 200 200 200 200
Rent or Mortgage 6.000 6.000 6.000 6.000 6.000
Building Maintenance 600 600 600 600 600
Interest on Loans or Mortgages 300 300 300 300 300
Insurances & Taxes 1.500 1.500 1.500 1.500 1.500
Depreciation 1.400 1.400 1.400 400 400
Utilities 100 100 100 100 100
TOTAL 73.426 79.609 80.814 81.044 72.331
Financial evaluation
Operating free cash flow Corresponds to earnings before depreciation and
after taxes, e.g., available funds for investment and return.
OPERATING FREE CASHFLOW Year 2013 2014 2015 2016 2017
Sales + 0 0 600.000 750.000 100.000
Variable Costs - 43.000 620.000 0 0 0
Gross margin = -43.000 -620.000 600.000 750.000 100.000
Fixed costs - 73.426 79.609 80.814 81.044 72.331
Operating income = -116.426 -699.609 519.186 668.956 27.669
Income tax (25%) - 0 0 0 93.026 6.917
Operating income after tax = -116.426 -699.609 519.186 575.929 20.752
Depreciation costs of fixed assets + 1.400 1.400 1.400 400 400
OPERATING FREE CASHFLOW = -115.026 -698.209 520.586 576.329 21.152
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Investment needs
o Total fixed assets purchase cost: price of property facilities, equipments
and other fixed assets.
o Working capital: amount of retained cash in stocks and credit.
INVESTMENT - FIXED ASSETS
Description # Unit price Amount
Camera 2 700 1400
Mainframe 1 1000 1000
Desktop 2 600 1200
Software 1 800 800
Office furniture 1 600 600
Others 0 0 0
TOTAL 5000
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DEPRECIATION OF FIXED ASSETS
Year 2013 2014 2015 2016 2017
Cameras
Expenditure 1400
Useful life Years 5
Depreciation 20% 280 280 280 280 280
Acumulated depreciation 280 560 840 1120 1400
Hardware
Expenditure 2200
Useful life Years 3
Depreciation 33% 733 733 733
Acumulated depreciation 733 1467 2200
Software
Expenditure 800
Useful life Years 3
Depreciation 33% 267 267 267
Acumulated depreciation 267 533 800
Office furniture
Expenditure 600
Useful life Years 5
Depreciation 20% 120 120 120 120 120
Acumulated depreciation 120 240 360 480 600
Total Depreciation per Year 1400 1400 1400 400 400
Acumulated depreciation 1400 2800 4200 4600 5000
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Calculation of working capital:
WORKING CAPITAL Year 2013 2014 2015 2016 2017
Clients (credit given to clients) + 0 0 20.000 115.000 115.000
Stocks (permanent stock) + 0 0 0 0 0
Suppliers (credit from suppliers) - 22.626 115.855 134.770 52.816 42.414
Working Capital = -22.626 -115.855 -114.770 62.184 72.586
WORKING CAPITAL VARIATION -22.626 -93.229 1.085 176.954 10.402
Working Capital Variation = WC(n+1) - WC (n)
The amount to be considered is working capital variation, or the amount to be
increased or decreased from the initial amount.
Project net cash flow. Total earnings at constant prices.
PROJECT NET CASFLOW Year 2013 2014 2015 2016 2017
Sales + 0 0 600.000 750.000 100.000
Variable Costs - 43.000 620.000 0 0 0
Gross margin = -43.000 -620.000 600.000 750.000 100.000
Fixed costs (OVERHEAD) - 73.426 79.609 80.814 81.044 72.331
Operating income = -116.426 -699.609 519.186 668.956 27.669
Income tax - 0 0 0 93.026 6.917
Operating income after tax = -116.426 -699.609 519.186 575.929 20.752
Depreciation + 1.400 1.400 1.400 400 400
OPERATING FREE CASHFLOW = -115.026 -698.209 520.586 576.329 21.152
Investment in fixed assets - 5.000 0 0 0 0
Investment in working capital - -22.626 -93.229 1.085 176.954 10.402
PROJECT NET CASHFLOW = -97.400 -604.980 519.501 399.375 10.750
ACCUMULATED PROJECT CASFLOW = -97.400 -702.380 -182.880 216.495 227.245
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Internal Rate of Return (IRR): measures the profitability of the project
It is the interest rate at which the net present value of all the cash flows (both
positive and negative) from a project or investment equal zero
= − +
(1 + )
= 0
Co = initial investment
Cn = cashflows
r = IRR
IRR = 19%
IRR can be calculated in a scientific calculator or excel (function IRR)
Net present value (NPV)
Corresponds to total earnings at market value at a certain time (current prices).
It compares the value of the euro today with the value of the same euro in the
future. It is determined using a discount rate. Condition for project feasibility is
NPV > 0. Highly profitable projects have high NPV’s.
= − +
(1 + )
Co = initial investment
Cn = cashflows
i = discount rate
Discount rate: includes inflation, interest rate (for financed projects) and risk-
adjusted return rate (also called investor’s rate and should include return for
investor + risk). Discount rates should differ throughout the project periods
according to inflation and interest rate projections for each of those periods.
Risk-adjusted return rate also differs from year to year (the longest the project
the higher the risk)
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Risk-adjusted capital return rate = (1+Re) x (1+Ri) – 1
Re - return rate
Ri - risk associated to the project
Discount rate = (1+I) x (1+R) – 1
I – interest rate (for financed projects)
R – risk-adjusted return rate
NET PRESENT VALUE
Year 2013 2014 2015 2016 2017
n 1 2 3 4 5
Discount rate 12% 12% 12% 12% 12%
PROJECT CASHFLOW -97.400 -604.980 519.501 399.375 10.750
NET PRESENT VALUE -86.965 -482.286 369.770 253.810 6.100
ACCUMULATED NET PRESENT VALUE -86.965 -569.251 -199.481 54.330 60.429
NPV = 60.429 (NPV should be as high as possible)
Example:
NPV4 =399375/(1+12%)^4
Payback period or Break-even point (BEP)
Corresponds to the moment (n) where revenues = costs
= − +
(1 + )
= 0
Co = initial investment
Cn = cashflows
i = discount rate
The project is not viable if BEP > Project period
BEP in the example = 4 – (54330/253810) = 3,79 years = 3 years, 9 months and 48 days
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Financing a project
The ability/possibility of financing a project depends upon the investors trust on the
project (good returns, objective analysis and projections) and on the entrepreneurs’
(their previous experience and background, their personality and behaviour. Various
possibilities of funding are presented in chapter 12.
Financial leverage Total earnings of the project can be increased using financial
leverage. Financial leverage in financed endeavours is savings in income taxes
due to financing costs (interest paid for financed amounts). In effect financial
costs reduce operating earnings thus reducing income tax amount. In previous
analysis income tax was calculated over operating income, disregarding the
way the project would be financed. Total project earnings are then NPV + AV.
Adjusted value (AV) is the amount of savings in income tax at market value at a
certain time.
LONG TERM LOAN 5% 25%
Discount
rate
n Loan debt
Loan
amortization
Interest
Savings in
income tax
Interest x
Inc.Tax
Adjusted
value
12% 1 50.000 0 2.500 625 558
12% 2 50.000 10.000 2.500 625 498
12% 3 40.000 10.000 2.000 500 356
12% 4 30.000 10.000 1.500 375 238
12% 5 20.000 10.000 1.000 250 142
Total adjusted value AV1 1.650
SHORT TERM LOAN 4% 25%
Discount
rate
n Loan debt
Loan
amortization
Interest
Savings in
income tax
Interest x
Inc.Tax
Adjusted
value
12% 1 0 0 0 0 0
12% 2 650.000 500.000 32.500 8.125 6.477
12% 3 150.000 150.000 7.500 1.875 1.335
12% 4 0 0 0 0 0
12% 5 0 0 0 0 0
Total adjusted value AV2 7.812
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TOTAL ADJUSTED VALUE AV1+AV2 9462
NPV AV
NET PRESENT VALUE: 60.429 + 9462 = 69.892
Financial Statements
INCOME STATEMENT 2013 2014 2015 2016 2017
Sales revenue 0 0 600.000 750.000 100.000
Cost of goods sold 43.000 620.000 0 0 0
Gross margin -43.000 -620.000 600.000 750.000 100.000
General, selling ,administrative expenses 72.026 78.209 79.414 80.644 71.931
Depreciation costs 1.400 1.400 1.400 400 400
Operating Income -116.426 -699.609 519.186 668.956 27.669
Interest expense 2.500 35.000 9.500 1.500 1.000
Taxable Income -118.926 -734.609 509.686 667.456 26.669
Income tax - 25% 0 0 0 80.901 6.667
Net Income -118.926 -734.609 509.686 586.554 20.002
Allocation of net income:
Dividends 0 0 0 250.000 0
Retained earnings -118.926 -734.609 509.686 336.554 20.002
(1)
Accumulated income -118.926 -853.535 -343.850 323.606 N/A
Income tax 0 0 0 80.901
Per Portuguese law one is allowed to recover previous losses (up to 4 years) for income tax purposes
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BALANCE SHEET
Assets 2013 2014 2015 2016 2017
Property, plant and equipment (PP&E) 5.000 5.000 5.000 5.000 5.000
Accumulated depreciation 1.400 2.800 4.200 4.600 5.000
Net PP&E 3.600 2.200 800 400 0
Current assets
Inventories 0 0 0 0 0
Receivables 0 0 20.000 115.000 115.000
Cash and marketable securities 100 120 120 120 120
Total current assets 100 120 20.120 115.120 115.120
Total Assets 3.700 2.320 20.920 115.520 115.120
Liabilities and Stokholders' Equity 2013 2014 2015 2016 2017
Paid-in capital 50.000 50.000 50.000 50.000 50.000
Retained earnings -118.926 -853.535 -343.850 -7.296 12.706
Stockholders' equity -68.926 -803.535 -293.850 42.704 62.706
Long term debt 50.000 40.000 30.000 20.000 10.000
Current liabilities
Short-term debt 0 650.000 150.000 0 0
Accounts payable 22.626 115.855 134.770 52.816 42.414
Total current liabilities 22.626 765.855 284.770 52.816 42.414
Total liabilities and stockholders' equity 3.700 2.320 20.920 115.520 115.120