Entrepreneurial Financial Management

An Applied Approach

Jeffrey R. Cornwall, David O. Vang, Jean M. Hartman

• Publisher: Routledge
• Year: 2016
• ISBN:
  9781317502937
• Edition: 4
• Topic: Commerce
• Subtopic: Commerce Général

This new edition presents an applied, realistic view of entrepreneurial finance for today's entrepreneur. The book provides an integrated set of concepts and applications, drawing from entrepreneurship, finance, and accounting. The book's contents are designed to follow the life cycle of a new business venture. Topics are presented in a logical order, as entrepreneurs will likely face them as they begin the process of business start-up and move into growing the business.

A comprehensive financial statements template is included with the book. This tool allows for the application of many of the concepts to actual businesses, and will be a valuable supplement to the process of developing a full business plan. The templates are available for unlimited free downloads at www.drjeffcornwall.com.

1	Introduction

THE IMPORTANCE OF KNOWING THE NUMBERS

Imagine moving to a foreign country where the people speak a different language from your own. While you may be able to get by for a while without learning the language of this country, you will be severely hampered. Asking for and receiving simple information will be a tedious and frustrating task. For example, assume you want to find a coffeehouse with a wireless hotspot. How do you get to the coffeehouse? If you make it there, how do you order an espresso? How do you get a connection to the Internet? More complex tasks are an even bigger challenge. Imagine trying to rent an apartment. What does the landlady expect from you as a tenant? The contract she is requiring you to sign is completely unintelligible to you. Even an interpreter will help only so much. He can translate, but the process is slow and certain issues in the contract lose their precise meaning during the translation. And it would be impossible to rely on an interpreter all of the time.

Accounting is called the “language of business.” Much of what is communicated about a business is done in this financial language. And, yet, to many entrepreneurs this is a language as foreign to them as the language of a foreign country is to a traveler. Accountants who work with entrepreneurs often report that most entrepreneurs know very little about accounting or finance. And many of those accountants have not been trained to work effectively with entrepreneurs and their private businesses. Most accountants’ training focuses on working for large publicly traded companies. The application of accounting and financial principles to entrepreneurial ventures creates unique challenges. The success of new ventures often depends on entrepreneurs having the skills and knowledge necessary to manage this aspect of their businesses.

Financial statements reveal the general financial condition of a business. How profitable is the business? Can it pay its bills on time? Can it pay its loans? What is the value of the business? All these and many more questions can be answered by the financial statements of a company. This is critical information for outsiders, such as bankers and creditors, and for insiders, such as owners and managers.

Financial reports also can give crucial insight into the operating effectiveness of a business. They are often critical to making the right decisions. Which products make money? Should the company add a new type of service? When should management add more employees? Can the company afford to expand right now? These are questions that are answered through the language of accounting and finance. It is a myth that entrepreneurs can answer such questions simply based on intuition or gut feel.

The language of numbers in business is also the one used to communicate with those entities and people who provide funding for businesses. Bankers, venture capitalists, and investment angels all speak this language and expect the entrepreneurs with whom they work to be fluent in the language as well. None of these sources of funding will be satisfied with reports generated by a computer. All will want to have conversations with the entrepreneur about where the business has been and where it is going, using the language of business: financial data.

Some entrepreneurs believe that they can get by with a good accountant who can speak this language for them—an interpreter, if you will. However, because this language of business is so fundamentally important to understanding any business venture, it is critical that entrepreneurs learn to speak it fluently themselves. Entrepreneurs will not have credibility with investors if they do not know the language of business. More important, they will not be able to manage their business effectively as it grows unless they understand its financial condition.

MEASURING SUCCESS

The language of business can help answer the fundamental question: How successful is the business? The language of business can assess the profitability of the business, the strength of its cash flow, its market share, and its overall financial health. All these are important measures that help ensure the survival and sustainability of an entrepreneurial venture. They are all a part of how entrepreneurs measure the success of a business (Cornwall and Naughton 2003).

However, financial measurements are not the only ways entrepreneurs assess the success of their ventures. Other measures are required in order to understand what success truly means to each entrepreneur. This is not as simple as it may first appear.

Certainly success means the ability to earn a living from a business. For most entrepreneurs, success also is measured by the ability to earn a profit from the business. Profits are important to sustain the business, to create additional income for the owners, to pay off debt, and to create value in the business (see Chapter 15 for a more thorough discussion of business valuation). Other entrepreneurs measure success through the jobs they are able to create. For many entrepreneurs, success also is measured by the ability to create balance between work and family, work and leisure, or work and community activities such as volunteering. For example, Paul Orfalea, founder of Kinko’s, says, “Success in life is having kids who want to come back to visit you when they’ve grown up.” Every entrepreneur has a unique assessment of success.

The meaning of success often is derived from the entrepreneur’s personal values and personal goals. For example, Bob Thompson, founder of a highway paving business in the upper Midwest, never felt real success in his business in spite of incredible growth in sales and profits over many years. It was not until he sold his paving business and gave huge bonuses (many over $1 million) to many of his employees that he finally felt he had achieved real success. For him, success came from the ability to share the wealth from his business with those who had helped him achieve that wealth. Jake Jorgovan launched a highly successful video production agency, as well as a thriving freelance web design business. However, after a few years of managing these rapidly growing ventures, he decided to become a freelance developer. He exited his ventures and began to work remotely and travel the world. Over the period of about a year, Jorgovan visited 13 countries and had countless experiences.

To be sure, some entrepreneurs measure success solely by the profits they can put directly into their own pockets. Many of the dot-com businesses of the 1990s were criticized for this approach. Their only goal was to create enough hype to take their business public and realize a quick financial windfall. Many never created profits, and some never even created revenues, yet they were able to create wealth for themselves through a quick turn of their businesses. Likewise, the disasters of Enron, Global Crossing, and the subprime mortgage meltdown of 2007–2008 represent what can occur when people in an organization are not well versed in the language of accounting and finance and have maximization of short-term returns as their only goal.

Those in the millennial generation have two primary measures of success. The first is lifestyle. Millennials view entrepreneurship as a career path that gives them more control over their lives and as a way to create balance between their careers and their families. This is particularly true among female millennials. They also seek personal fulfillment from their entrepreneurial careers, which they do not believe they will find in a more traditional business career. It also should be noted that many in the millennial generation see entrepreneurship as a tool to help enact social change. Success for them is not measured in terms of financial outcomes but rather outcomes that reflect improvement in social conditions.

Chapter 2 will present a process of self-assessment that is used to help entrepreneurs understand what success really means to each of them. With this understanding, they are better able to know how to measure success for each unique business.

WHAT IS ENTREPRENEURIAL FINANCIAL MANAGEMENT?

Entrepreneurial finance is typically defined simply in terms of raising funds for a business. How can an entrepreneur raise funds to support a business venture as it grows? How does the entrepreneur attract venture capital? What is the process of taking a business public? All these can be critical questions that an entrepreneur may need to address for his or her business. However, when the topic is broadened to entrepreneurial financial management, many other critical issues emerge.

Entrepreneurial financial management is defined in terms of six general activities and functions in the business. First, entrepreneurial financial management includes setting clear financial goals for the business that are consistent with the aspirations of the entrepreneur who owns the venture. What are the income and wealth goals that the entrepreneur is pursuing through the business? How will the business need to perform in order to allow the entrepreneur to realize these financial goals? As will be discussed, the focus should not be on simply growing revenues as high and as quickly as possible. Instead, the focus should be on the profit goals that help the entrepreneur reach their aspirations from the business venture. The process of setting financial goals and engineering these goals into the planning of the business will be examined in Chapter 2.

Second, using financial statements and reports to manage a growing business and to make informed decisions is a key element of entrepreneurial financial management. This is the process of becoming fluent in the language of business and being able to specifically apply this language to the unique circumstances found in each business venture. Chapter 3 will introduce the basic concepts of financial reporting, and Chapter 7 examines the process of monitoring financial performance.

Third, entrepreneurial financial management includes forecasting. The entrepreneur and their team use forecasts as a guide to assess the progress of the business and to determine how well it is meeting expected results. Forecasts also are used to communicate the potential of a business venture to outside funding sources such as banks and venture capitalists. Forecasting future financial results has been described as more art than science. However, there are tools and techniques that can drastically improve the accuracy of forecasts. Revenue forecasts (Chapter 4) should be developed hand-in-hand with the financial goals of the owners (what revenues will be required to reach the profit goals established for the business). Also, revenue goals should be consistent with data obtained through the marketing plan. Expense forecasts are discussed in Chapter 5. Chapter 6 presents a spreadsheet model for forecasting financial statements that integrates the principles of effective revenue and expense forecasting.

Fourth, entrepreneurial financial management includes effective managing of what can be the most precious resource: cash. Cash flow often is described as the lifeblood of a business. Cash flow management includes both long-term planning for cash needs as well as day-to-day cash flow management. Chapter 8 examines various techniques and critical issues associated with cash flow management.

Fifth, entrepreneurial financial management does include raising funds for entrepreneurial ventures. However, before racing off to obtain external funds, the entrepreneur must examine the impact of debt and equity on her ability to reach their goals throughout the life of the business. There are some creative first steps toward financing. Chapters 9 and 10 explore these issues of financing over the life of a business and start-up financing using the entrepreneur’s own resources and the resources of family and friends. Additionally, if managed properly, growing businesses can often generate funds internally through the creative application of critical business functions such as marketing, staffing, operations, and so forth. Chapter 11 examines how a colle...