Case Study: Forecasting revenues and Cash Flow

NEWTECH (Part I)

NewTech is a company that aims to develop innovative products based on Galileo, the European global satellite-based navigation system that accurately locates moving objects worldwide through satellites. The following Table lists the assumptions underlying the forecast.

Given that the expected development time and sales lead-time together are expected to take 21 months, the venture is expected to generate its first sales after 22 months, for a total value of 15,000. After that, the company anticipates a monthly growth rate of 10 per cent for a period of two years, given its deployment of sales and marketing resources.

The Serviceable Obtainable Market is expected to mature thereafter, with an assumed growth rate equal to the average growth rate of the overall economy (estimated to be 3 per cent).

It is assumed throughout the case that the company is all equity financed. This is not a crucial assumption, however, as a startups financial plan focuses in the first place on the cash from operations.

Table: NewTechs assumptions under the most likely scenario

1. The entrepreneur invests 50,000 in cash and another 30,000 in kind (a testing machine) when the venture is founded. The machine is depreciated over a period of 5 years. This is the only capital expenditure at startup.

2. The development and first sales process takes 21 months.

3. First sales are expected in month 22 for a total amount of 15,000.

4. Sales will grow at a monthly rate of 10 per cent for a period of two years. After this period, sales growth is assumed to be equal to the growth of the overall economy (3 per cent annually).

5. The gross margin is 50 per cent of sales revenue.

6. In month 20, a production facility is bought with a total value of 360,000. The facility is depreciated over a period of 30 years.

7. Selling, general and administrative expenses are expected to amount to a yearly fixed cost of 60,000 plus 5 per cent of monthly sales.

8. The company sells on credit. 60 per cent of sales in a given month is collected in the next month, 30 per cent is collected after 2 months and 10 per cent is collected after 3 months.

9. Accounts payable are 20 per cent of costs of sales.

10. The company plans to keep an inventory buffer of 10 per cent of sales expected in the next month.

11. The company is subject to a corporate tax rate of 33 per cent, but losses can be carried forward indefinitely.

Questions for Discussion

1. Given the business plan of NewTech, what is its expected monthly EBIT after taxes?

2. What is NewTechs expected monthly free cash flow?

3. Assuming no additional financing is raised, what is the expected cash shortage after four years of operations?