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Help to the Financial Plan

4.1 What is the total capital requirement?

Total capital requirement, also known as total project cost or total investment requirement, is composed of three items: fixed assets, pre-operating expenses and working capital.

Fixed assets is the sum total of all costs of land and improvements, building, machinery, furniture and fixtures, vehicle, etc. (step 2.2)

Pre-operating expenses are those necessary expenses which are incurred before the business starts operating. These include registration fees and licenses, training costs, cost of preparing business plan, trips to raw material and equipment suppliers, etc. (step 3.5)

Working capital is the amount of money permanently needed in cash or in kind to keep the business operating while it is awaiting full payment for goods sold to customers.

Working capital can be calculated by adding five factors:

1) the cost of maximum raw material stocks that will have to be stored to ensure continuous production. In some cases this may be three to six months worth, if the raw material is difficult to obtain or has to be imported, whereas in other cases (where raw materials are readily available) only one or two weeks worth may be needed;

2) the cost of finished goods which will be kept in stock awaiting distribution to the customers;

3) the cost of work-in-process which are on the factory floor but have not yet been converted into a final product or finished goods;

4) the cost of goods already distributed to customers but which have not yet been paid for (accounts receivable);

5) the amount of ready cash needed to pay workers and overheads.

• To determine the cost of raw material stocks, simply multiply the quantity needed by its purchase price;

• To determine the cost of finished goods stock, multiply the number of units to be kept by the unit production cost (step 2.18)

• To determine the cost of work-in-process, first estimate the number of days it takes to convert the raw material into finished goods, then multiply this by the daily production level (step 2.6), then multiply the figure obtained by the unit production cost determined in (step 2.18). Finally divide this figure by 2.

• To determine the cost of goods already distributed but not yet paid for, estimate the quantity that will be given on credit and multiply this number by the unit production cost (step 2.18)

• To determine the amount of cash needed in the business, add the monthly          labour cost in step 2.14 and overheads (step 2.17) to the monthly      marketing expenses (step 1.12) and the administrative expenses (step 3.7)

Add these five cost elements together to arrive at the total working capital requirement.

To calculate the total capital requirement, add the following:

            + Fixed Assets (step 2.2, step 3.6)

            + Pre-Operating Expenses (step 3.5)

            + working capital (step 4.1)

            = Total Capital Requirement (Project Cost)

4.2 Is a loan needed? What will be the equity contribution of the entrepreneur? And how much?

How the total capital requirement is going to be sourced is called the financing plan. Bankers want to know these sources and what different project cost components are being funded by these various financial sources. After determining the total capital requirement, the next step is to see whether the amount required is too much for you to finance on your own, or beyond your capability to finance. If this is the case, then a loan will be needed.

The entrepreneur is almost always expected to make an equity (owner’s capital) contribution to the project. For example, if the project costs LC50,000, the bank may require the entrepreneur to put up at least LC10,000, or 20%. The LC10,000 constitutes the owner’s equity. 

To arrive at the amount of loan needed, subtract the equity from the total capital requirement. List these as follows (using our CEFE Soap Manufacturing example):

It is also possible to borrow from other sources like family members, friends, raw material and equipment suppliers in addition to banks. Hence, your financing plan (although given here in a very simplified manner) may look like the one above.

4.3 What security (collateral) can be given to the bank?

In addition to equity, the bank will want to know what kind of security the entrepreneur can offer the bank to ensure that the loan is really repaid. Normally land and building (the title of ownership has to be certified by the appropriate government authority) are used for security purposes. Be aware that if your building or house is valued by the bank at LC100,000, the bank may only accept 60% of its full value, or LC60,000, for security purposes.

In many countries, a titled land has a collateral value from 80 to 100%. Likewise, the machinery, vehicles or building which the loan will finance can also be used as collateral.  For example, machinery and equipment have a collateral value of 60% of its purchase cost in many countries.  

Some credit institutions, especially those catering to small loans, accept personal property (e.g., jewellery, private car, refrigerator, sewing machine, etc.) as collateral.

If the entrepreneur does not have enough security to cover the loan needed, he must then raise this security from friends and relatives or reduce the size of his project until the loan size matches the security requirement of the bank.  

4.4. What does the Profit and Loss Statement indicate?

We now have all the data for preparing a profit and loss statement, also known as income statement.

Start with sales which are derived from multiplying the unit selling price by the volume of expected sales during  the year (step 1.9). From the annual sales revenue figure, step by   step, subtract all the yearly expenses. They are as follows:

1) Raw Material Cost - This is the sum of all raw materials used to produce the products that were sold.

2) Labour Cost - This is the sum of all direct labour costs for the whole year.

3) Factory Overhead - This is the sum of all miscellaneous costs such as minor raw materials, indirect labour,  maintenance and repair cost, depreciation of production machinery, electricity, water, supplies, etc. associated in producing the product for the whole year.

The three items above are known as Cost of Goods Sold. Sales minus these three items results in Gross Profit.

4) Marketing Cost - This is the sum of all selling and promotional costs, including distribution cost to retail shops, commissions, etc. (See step 1.12)

5) Administrative Cost - This is the sum of all administrative costs, including office supplies, security guard's salary, accountant/bookkeeper’s salary, telephone bills, entertainment expenses, and depreciation of office equipment and furniture, etc. (see step 3.7)

Gross Profit less marketing and administrative costs results in Operating Profit.

6) Financial Cost - This is the sum of interest paid to  banks on the amount of borrowing.

Operating Profit less financial cost results in Net Profit Before Tax. Net Profit Before Tax less the relevant business income tax results in Net Profit After Tax. 

If you are borrowing money from the bank, the latter would usually require you to project your profit and loss statement (and other figures) corresponding to the life of  the loan. That is, if you intend to pay the loan in five years, the bank will ask you to project your figures (e.g., sales forecast, profit and loss statement, cash flow  statement, balance sheet, loan repayment schedule, etc.) for five years.

Determination of Selling Price and Profit Margin

                                                                                                                                    Monthly Cost

Raw Material      26,070

Direct Labour     1,600

Overhead Expenses  2,333

Total Monthly Production Cost    30,003

Marketing and Administrative Cost    550
Interest    583.50
Total Monthly Product Cost    31,136.50

                                        LC 31;136.50
Unit Product Cost =
                                      120 kg x 20 days

Total Cost per kg =          LC12.97
Profit Mark Up per kg       =          LC 1.03
Factory Selling Price=     LC14.00

4.5 What does the Cash Flow Statement indicate?

In this part of the business plan, the Cash Flow Statement is calculated and included. While the profit and loss statement gives the results of financial transactions of a business during a certain period (e.g. month or year), the cash flow statement shows the sources (inflows) and applications (outflows) of the cash in the business during the year. The example below is drawn from the business plan of the CEFE soap manufacturing project.

Cash Flow Statement (first year)

 4.6 What does the Balance Sheet indicate?

The balance sheet is the statement of assets and liabilities and gives the financial picture of the business as of a certain date, for example, at the end of the year. 

Balance Sheet as at the end of first year

4.7 What is the loan repayment schedule?

After determining the annual net profit, prepare the Loan Repayment Schedule. An example is given below. For a loan of LC120,000 at the cost of 10% for six years, the repayment schedule is shown in the table below: 

4.8 What is the break-even point (BEP)?

Three kinds of break-even point (BEP) are commonly referred to, namely: 

1) BEP Sales (LC)

2) BEP Prod