Building Your Pro Forma Test Bank Zacharakis Ch.9

Questions for Chapter 9

True/False

1. It is better to let your accountant articulate the numbers of your business idea to potential investors. (pg. 276)

2. Entrepreneurs who claim their estimates are “conservative” are usually overly optimistic about their ventures’ future. (pg. 276)

3. When we graph costs over time, we see them decreasing exponentially. (pg. 276)

4. An optimistic attitude about your business’s future helps achieve positive cash flow sooner.

(pg. 276)

5. Typically, a business begins to generate revenue within the first two months after it launches.

(pg. 277)

6. Investors often predict the market share of startups as 3% after Year 3, because of the ease with which 3% can be captured. (pg. 277)

7. The income statement shows the standing of a company at any given point of time. (pg. 277)

8. The expenses that a business incurred appear on a different financial document than the amount of cash that it spent. (pg. 278)

9. Many noncash transactions are represented in the balance sheet. (pg. 278)

10. It is possible to have positive earnings on the income statement and a negative statement of cash flows. (pg. 278)

11. For an asset to appear on the balance sheet it must generate revenue. (pg. 278)

12. In the build-up method, you look at the revenue you might generate and the cost you might incur in a typical day. (pg. 279)

13. Scientific findings suggest that people make better decisions by decomposing problems into

smaller decisions. (pg. 279)

14. The first step in Revenue Projections is to calculate the median revenue of your products in the product mix. (pg. 280)

15. Revenue projections help you to understand the company’s revenue drivers. (pgs. 280–281)

16. For a bookstore, COGS is the cost of employee wages that is incurred in that period. (pg. 281)

17. Most pro-forma projections for new companies show monthly income figures for the first two years. (pg. 281)

18. Gross profit margin can be calculated by dividing the Cost of Goods Sold by Total Revenues.

(pg. 282)

19. In addition to direct expenses, businesses incur operating expenses, such as marketing, salaries

and general administration (SG&A), rent, interest expenses, and so forth. (pg. 282)

20. You should attempt to calculate your operating costs before you start a business. (pg. 282)

21. Financial analysis is simply the mathematical expression of an overall business strategy.

(pg. 283)

22. The process of examining and reexamining your assumptions over and over is a waste of time

(pg. 283)

23. In financial analysis, the step that follows forecasting revenues and expenses is formulating a cash flow statement from those forecasts. (pg. 284)

24. In the comparable method, you look at how your company compares to industry averages and benchmark companies. (pg. 284)

25. Different companies may calculate COGS differently, even if their actual costs are identical.

(pg. 285)

26. Pro-forma financials often project sales occurring 5 years in the future. (pg. 287)

27. Businesses should expect to build their sales and start operating efficiently within a five-year period. (pg. 287)

28. Seldom are revenues in retail spread evenly across the calendar year. (pg. 288)

29. It is critical to show the first two years of pro-forma projections on a monthly basis because this is when a company is most vulnerable to failure. (pg. 288)

30. By closing your sales for credit, you can increase your company’s cash flow. (pg. 290)

31. The expense of acquiring land should appear in full on your annual income statement. (pg. 290)

32. If, after all calculations, your balance sheet does not balance, you should adjust retained earnings accordingly. (pg. 290)

Multiple Choice

1. Which of the following represent the most common mistake(s) in an entrepreneur’s business proposal, according to the professional equity investors?” (pgs. 276-277)

1. Not understanding the revenue drivers
2. Underestimating costs
3. Lack of comparables
4. Underestimating time to secure financing
5. All of the above

2. Which of these describes how well a company conducted its business over a recent period of time—typically, a quarter (three months) or a year? (pg. 277)

1. Income statement
2. Balance sheet
3. Cash flow statement
4. Liability statement
5. Accounts payable

3. Which of these enumerates all the company’s assets, liabilities, and shareholder equity? (pg. 278)

1. Income statement
2. Balance sheet
3. Cash flow statement
4. Liability statement
5. Accounts payable

4. An income statement will never include a line for: (pg. 278)

1. Depreciation
2. COGS
3. SG&A costs
4. Taxes on profits
5. Accounts payable

5. The bottom line of the income statement states the company’s _______. (pg. 278)

1. net size
2. net income
3. revenue less expenses
4. net assets value
5. gross profit margin

6. The statement of cash flows starts with which of the following? (pg. 278)

1. Net Income
2. Costs
3. Expenses
4. Net Assets
5. Net Liabilities

7. Which of the following equations is true about the Balance Sheet under GAAP? (pg. 278)

1. Assets = Liabilities
2. Shareholder Equity + Assets = Liabilities
3. Assets = Liabilities + Shareholder Equity
4. Liabilities + Assets = Shareholder Equity
5. None of the above

8. Under the Build-Up Method, you should start with the: (pg. 279)

1. Income statement
2. Balance Sheet
3. Statement of Cash Flows
4. Industry averages
5. None of the above

9. The build-up method drills down revenue projections to a typical ______. (pg. 279)

1. hour
2. day
3. month
4. quarter
5. year

10. Which of the following columns is not included in the revenue worksheet? (pg. 280)

1. Product/Service Description
2. Price
3. Units Sold
4. Units Ordered
5. Total Revenue

11. Which of the following can be used to strengthen your assumptions? (pgs. 280 – 281)

1. Industry research
2. Competitor analysis
3. Own observations
4. Surveying customers
5. All of the above

12. In the build-up method, after you identify all your revenue sources, what is the next step?

(pgs. 280)

A) Identify all your costs

B) Think about how much revenue you can generate in a year

C) Determine operating expenses by the most appropriate time frame

D) Break down revenue into a typical day

E) Write a two- to three- page description of financial statements

13. The chapter recommends that you should construct monthly income and cash flow statements for the first: (pg. 281)

1. 1 year
2. 2 years
3. 3 years
4. 4 years
5. 5 years

14. Gross margin is calculated with the formula (pg. 282)
A) Revenue plus COGS

B) Gross Profit times COGS
C) Price plus Gross Profit

D) Revenue minus COGS

E) Revenue times profit

15. The following are examples of operating expenses, except: (pg. 282)

1. Property purchases
2. Rent expenses
3. Interest expenses
4. Salaries
5. Administrative expenses

16. A financial statement that displays each item as a percentage of a common-base figure is called:

(pg. 284)

1. A Keynesian statement
2. A common-size statement
3. A statement of residuals
4. A comparable statement
5. A matching statement

17. What does the Comparable Method help an entrepreneur to do? (pg. 284)

1. Estimate project cost
2. Research the industry
3. Benchmark competitors
4. Calculate operating expenses
5. Validate projections

18. Under the Comparable Method, you can see how the model changes overall when you: (pg. 285)

1. Increase your revenues
2. Leverage your drivers
3. Tweak your inventories
4. Change one of the assumptions
5. Decrease your costs

19. What is the best way to validate costs? (pgs. 285-286)

A) Validating costs is not necessary.

B) Adjust your business model.

C) Ask your customers.

D) Compare your balance sheet with your competitors’ balance sheets.

E) Compare your common-sized income statement with the industry averages or some benchmark companies.

20. An entrepreneur must be able to ___________, if his income statement does not match the industry average? (pg. 286)

1. remove any information that deviates from the average
2. adjust and refine your metrics accordingly
3. understand and explain the differences
4. change the metrics to more appropriate ones
5. rewrite your projections from scratch

21. The standard term for most business plans is: (pg. 287)

1. 2 years
2. 4 years
3. 5 years
4. 8 years
5. Until the break-even date

22. If a business is profitable and growing, which of the following is most likely to be a reason for failure? (pg. 287)

1. High COGS
2. Low clientele
3. Strong competition
4. Failure to estimate the size of the market
5. Insufficient financing

23. According to the chapter, it takes time to: (pgs. 287-288)

1. Build up your clientele
2. Learn to operate efficiently
3. Develop track record
4. Understand seasonality
5. All of the above

24. It is critical to show the pro-forma projections on a monthly basis when a company is: (pg. 288)

1. Experiencing negative cash flow
2. Not earning any revenue
3. Most vulnerable to failure
4. Facing strong competition
5. Managing an inventory-to-asset ratio of 10% or higher

25. Seasonality is important because it affects which of the following: (pg. 288)
A) Product or service demand

B) Financial decisions

C) Key operations and decisions such as hiring

D) A & C

E) All of the above

26. What effect can selling on credit have on your business? (pg. 290)

1. Reduce assets
2. Decrease accounts payable
3. Delay cash inflows
4. Reduce liabilities
5. Increase inventory

27. An accumulated depreciation line item on your balance sheet shows how much of the asset has been: (pg. 290)

1. Used up
2. Acquired
3. Written-off
4. None of the above
5. All of the above

28. How long should the explanation of the financial statements be? (pg. 292)

1. 1 page
2. 2 - 3 pages
3. 10 - 15 pages
4. Approximately 20 pages
5. 25 - 30 pages

29. Approximately how many subsections in the section of the planning process should your explanation of the financial statements have, if you follow the model in the chapter?

(pg. 292)

1. 1
2. 3
3. 4
4. 7
5. 8

Open ended

1. Explain why it is important to construct pro forma financial statements for new ventures. (pgs. 276 – 277)
   1. Building pro forma statements helps a lead entrepreneur to understand the numbers.
   2. Financial statements serve to bridge the entrepreneur’s great idea and what that idea amounts to, in terms of dollars and cents.
   3. A startup does not have any past trends in revenue and costs. Therefore, you cannot use the past as a basis to project future revenues and costs; you need to forecast them.
2. What is a “hockey stick” projection and what is so unrealistic about it? (pg. 276)
   1. A “hockey stick” graph is a projection of costs and revenues, when revenues skyrocket over time while costs slowly progress upward.
   2. This faulty projection means that the entrepreneur underestimates the infrastructure needed in terms of employees and physical assets to achieve the projected level of sales.
   3. Poor projections lead to cash shortages and, ultimately, to failure.
3. What is the difference between the respective purposes of the balance sheet and the income statement? (pgs. 277 – 278)
   1. The balance sheet enumerates all the company’s assets, liabilities and shareholder equity. It reflects a company’s state of affairs at a given point of time.
   2. The income statement describes how well a company conducted its business over a period of time.
   3. Both of them form a basis that helps you to understand the company and how it is doing
4. Briefly describe the principle of the build-up method and its advantages. (pgs. 279 – 280)
   1. Identify all your sources of revenues and determine your revenues for a “typical day”
   2. Understand your revenue drivers and validate driver assumptions, multiply the typical day by the number of days in a year
   3. Determine Cost of Goods Sold (COGS) for typical day, multiply COGS by number of days in a year
   4. Determine operating expenses by most appropriate time frame and refine operating costs
   5. Create preliminary income statement

The build-up method gives you a better understanding of the business and how it functions every day, its cycles, etc. This method allows you to overcome the often intimidating task of building a pro-forma financial statement by reducing the task to small, easily understood pieces.

1. What are examples of revenue drivers? (pg. 280)

a. How many customers you will serve

b. How much product they will buy

c. How much they will pay for each product

d. How often they will buy

1. When building a revenue worksheet, an entrepreneur has to begin with certain assumptions. What are three ways for an entrepreneur to later strengthen those initial assumptions? (pgs. 280 – 281)
   1. Observe the behavior of customers of similar businesses.
   2. Learn about customer needs through analytical and empirical research (surveys, market reports, articles, etc.).
   3. Benchmark your competitors.
2. What is the purpose of creating a headcount table? (pg. 283)

A headcount schedule is an important step in refining your labor projections. It allows you to break down a day into hours and predict peaks and lulls in intraday customer activity. The table also helps you to identify how many employees you will need, when you will need them, and thereby project salary expenses.

1. Explain the comparable method. (pgs. 284 – 285)
   1. In the comparable method, you look at how your company compares to industry averages and benchmark companies.
   2. First, gauge whether your revenue projections and your cost structure are reasonable.
   3. Then run some scenario analysis. By going through scenario analysis and understanding your business model, you should be able to explain why your firm differs
2. What is the importance of building integrated financial statements? (pgs. 287 – 288)
   1. The income statement, cash flow, and balance sheet are the core statements for managing any business.
   2. Integrated financial statements answer the questions of when you expect to start making revenue, run out of cash, and become profitable, and how you are going to grow your business through the most dangerous stages of any venture’s life.
   3. The integration among the statements helps you to find out how a change in one affects the others.
   4. Additionally, monthly statements open new perspectives, ones that you might have otherwise missed.
3. Explain what a “brief description of your financial spreadsheets” should include.

(pg. 292)

• 1. It should be a two to three page explanation of the financial spreadsheets.
  2. This section of the planning process should include a description of the key drivers that affect your revenues and costs.
  3. The first subsection should discuss the income statement.
  4. The next subsection should discuss the cash flow statement.
  5. The final subsection explains the balance sheet.

11. The chapter says financial statements are obsolete immediately after they come off the printer. Why? (pg. 292)

1. Once the business is operating, the nature of your financial statements changes.
2. Your operations will not match your predictions.
3. There may be some factors you did not take into account or some that you were ultimately wrong about.
4. Also, since business environment is very flexible, you will have to constantly adjust your financial statements accordingly.
5. Financial statements cover specific periods of points in time. That relevant moment in time is over before the statements are read.