CHAPTER 15

CAPITAL REQUIREMENTS AND STRATEGY

Reporters:
Mark Joseph Biteng
Jonnalyn Orpilla
Giselle Inigo
Christine Joy Galutan
 Most new business are established without raising extensive
amounts coming from external source of capital. They are created
with small infusions of cash from the founders, augmented by
support from relatives or rich individuals.
The financing strategy is bootstrapping in stages based on
iterative phases of success and only doing what must be done to
get to the next phase with minimal capital.
This is a resourceful and practical approach:
1. Establish the critical path items for at least the first stage of the
company or project
2. Start with customer.
3. Define what it takes to validate the market and prove the
company’s ability.
4. Develop a list of where and from who to get the resources needed
(i.e who has reason to care about the company’s success)
5. Assess how to bridge the gap with friends and family and personal
investment.
CAPITAL BUDGETING- it’s important to plan out the capital budget
before opening one’s own business. Capital budget expenses cannot
to be deducted as a business that’s under-capitalized
DISCOUNTED PAYBACK- A capital budgeting procedure used to
determine the profitability of a project. Contract to a Net Present Value
(NPV) analysis, which provides the overall value of an projects, a
discounted payback period gives the number of years it takes to break
even from undertaking the initial expenditure. Future cash flows are
considered are discounted to time “zero” This procedure is similar to
payback period; however, the payback period only measure how long
 it takes for the initial cash outflow to be paid back, ignoring the
time value of money.
For calculating discounted payback period (DPP), calculate the
present value (PV) of each cash flow (CF) starting from the first
year as zero point. For said purpose, the management is required
to set a suitable discount rate. The discounted cash flow (DCF) for
each period is to be calculated using this formula:
DCF= Actual Cash Flows /[1+i]^n
Where,
I is the discount rate;
n is the period to which the cash flow belongs.
 The two components used are actual cash flows and PV factor
i.e. (1/(1+i)^n) in this formula. Thus CDF is the product of actual
cash flows and PV factor. While calculating Discounted Payback
Period similar procedure will be used for calculating simple
payback period except the use of the discounted cash flows
instead of actual cash flows.

Sample Problem
An initial capital investment of Php1,550,000 is expected to generate
Php 300,000 per year for next 5 years. Calculate the DPP of the
investment if the discount rate is 12% calculate first the DCF for
each period by multiplying the actual cash flows. With PV factor.
After that work out cumulative discounted cash flows.
 Table 32 Discounted Payback Computation

Year N CF PV Factor DCF=CF  Cumulative

PV$1 = 1 PV$1 DCF
(1+i) ^n
0 (1,550,000) 1.000000 (1,550,000) (1,550,000)
1 300,000 0.89285 267,857.14 (732,142.86)
2 300,000 0.79719 239,158.16 (492,984.69)
3 300,000 0.71178 213,534.07 (279,450.62)
4 300,000 0.63551 190,655.42 (88,795.20)
5 300,000 0.56742 170,228.06 81,432.86
Discounted Payback Period =X+Y/Z
X=Last Period with –ive DCC
Y=Last value of DCC at the end of period X
Z=DCC during the period after X
Discounted Payback period= 4+ -88795.2 / 190655.42= 4.47 years
Decision Rule for DPP
Push the startup business if the discounted payback period is less
than the specified period, otherwise reject it.
Advantage: Since this technique considers Time Value Of Money
therefore, business analysts rely more on discounted payback period
than on simple payback period. If the startup business has Negative
NVP, it would not payback the initial capital value that will be invested
in this business
Net Present Value

Net present value is a numerical calculation that shows the

present value of an investment based on expected income from
that investment in future years minus the cost of the project. Net
present value is calculated by dividing the expected income of a
project in each future year by a term equal to one plus a discount
rate raised to a power equal to the year. The totals for each year
then are added together, and the initial cost of the project is
subtracted from that sum to arrive at the net present value. The
discount rate represent the time value of money: the amount that
could be made by committing the money to other opportunities.
 The purpose of net present value is to help analyst and managers decide whether or
not now new projects are financially viable. Essentially, net present value measures the total
amount of gain or loss a project will procedure compared to the amount that could be
earned simply by saving the money in a bank or investing it in some other opportunity that
generates a return equal to the discount rate. If a long term project has a positive net
present value, then it is expected to produce more income than what could be gained by
earning the discount rate, which means the company should go ahead with the project.
if a certain project has a net present value of zero, then the company neither gains nor
loses money by pursuing the project. When net present value is less than zero, the projects
is expected to lose money. Projects with a negative net present value should be avoided.
The formula is:

𝑵
𝑪𝒏
𝐍𝐏𝐕 = ෍ =𝟎
(𝟏 + 𝒓)𝒏
𝒏=𝟎
To effectively demonstrate how NPV works, imagine the new
business made an investment of Php1,000 in the stock market
with a discount rate of 10 percent. The new owner then expect to
receive Php1,200 by the start of the second year and have a total
balance of Php1,200 by the start of the third year. Calculating the
NPV would then equate to the following:
Year 1 cash flow: -Php1,000
Year 2 present value cash flow: Php110/1.10=Php100
Year 3 present value cash flow:
Php1,200/(1.102)=Php1,200/1.21= Php991.74
Final NPV: -Php1,000 + Php100 + 991.74= Php91.74
The owner received Php 200 in return to the investment that
money equates to present value of Php91.74 Based on the fact
that this scenario returns a positive value; it is considered a good
investment opportunity and will return a significant amount of
money to the new owner.

Internal Rate of Return

Internal rate of return (IRR) is the discount rate at which the net
present value of an investment becomes zero. In other words,
IRR is the discount rate which equates the present value of the
future cash flows of an investment appraisal.
Decision Rule for IRR
A project should only be accepted if its IRR is NOT less than
the target internal rate of return. When comparing two or more
mutually exclusive projects, the project having highest value of
IRR should be accepted.
the calculation of IRR is a bit complex than other capital
budgeting techniques. Note that IRR, Net Present Value (NPV) is
zero, thus:
NPV = 0; or
PV of future cash flows – Initial Investment = 0; or
 CF1 + CF2 + CF3
(1+r)1 (1+r)2 (1+r)3
Where,
r is the internal rate of return;
CF1 is the period one net cash inflow;
CF2 is the period two net cash inflow,
CF3 Is the period three net cash inflow, and so on …
But the problem is, we cannot isolate the variable r(=internal rate
of return) on one side of the above equation. However, there are
alternative procedures which can be followed to find IRR. The
simplest of them is described below:
1. Guess the value of r and calculate the NPV of the project at that
value.
2. If NPV is closet zero then IRR is equal to r.
3. If NPV is greater than 0 then decrease r and jump to step 5
4. If NPV is smaller than 0 then decrease r and jump to step 5
5. Recalculate NPV using the new value of r and go back to step 2

Example:
Find the IRR of an investment having initial cash outflow $213,000.
The cash inflows during the first, second, third and fourth years are
expected to be $65,200,$96,000,$73,100 and $55,400 repectively.
Solution:
Assume that r is 10%
NPV at 10% discount rate=$18,372
Since NPV is greater than Zero we have to increase discount rate,
thus NPV at 13% discount rate= $4,521
But it is still greater than zero we have to further increase the
discount rate, thus
NPV at 14% discount rate= $204
NPV at 15% discount rate= ($3,975)
Since NPV is fairly close to zero at 14% value of r, therefore
IRR+14%
Supporting Schedules
the supporting documents that follow are important in the
preparation of the projected financial statements.
Sale Budget
Sales budget is the first and basic components of master budget
and it shows the expected number of sales units of a period and the
expected price per units. It also shows total sales which are simply
the product of expected sales units and expected price per units. It
also shows total sales which are simply the product of expected
sales units and expected per units. Sales Budget influences many
of the other components of master budget either directly or
indirectly. This is due to the reason that the total sales figures
provided by sale budget is used as a base figure in other
components budgets. For example the schedule of receipts from
customers, the production budget, pro forma income statement, etc.
 Table 36 Sample Sales Budget
Company A
Sales Budget
For the Year Ending December 30,2010

Quarter

1 2 3 4 Year
Sales 1,320 954 1,103 1,766 5,143
Units P3,958.5 P4,002 P4,219.5 P4,872
 Price per
unit
Total P5,225,22 P3,817,90 P4,654,10 P8,603,95 P22,301,1
Sales 0 8.5 8.5 2 88.5
Production Budget
a schedule showing planned production units which must be
made by manufacturer during a specific period to meet the expected
demand and sale and planned finished goods inventory. The
required production is determined by subtracting the beginning
finished goods inventory from the sum of expected sales and
planned ending inventory of the period. Thus:
Planned production in Units
=Expected Sales in Units
+Planned ending Inventory in units
- Beginning Inventory in Units
Production budget prepared after sales budgets since it needs
the expected sales units’ figure which is provided by the sales
budgets. It is important to note that only a manufacturing business
needs to prepare the production budgets.
 Table 37 Sample Production Budget
Company A
Production Budgets
For the Year Ending December 30, 2010

1 2 3 4 Year

Budgeted sales 1,320 954 1,103 1,766 5,143

Units
+Planned
Ending Units 210 168 213 225 225
-Beginning
Units

-196 -210 -168 -213 -196

Planned 1,334 912 1,148 1778 5,172

Production in
units
 Direct Materials Purchases
Purchase budget shows budgeted beginning and ending direct material
inventory, the quantity of direct material that will be used in production,
the amount of direct material that must be purchased and its cost during
a specific period. Direct material purchases budgets is a component of
master budget and it is based on the following formula:
Budgeted Direct Material Purchases in Units
=Budgeted Beginning Direct Material in Units
+Direct Material in Units Needed for Production
-Budgeted Ending Direct Material in Units
In the above formula, the direct material in units that is needed for
production is calculated as follow:
Budgeted Production during the Period
Units of Direct Material Required per Units
=Direct Material in Units Needed for production
Since the budgeted production figure is provided by the production
budget, the direct material purchases budget can be prepared only
after the preparation of production budget.
Direct labor/Payroll
Direct labor budget shows the total direct labor cost and number
of the direct labor hours needed for production budget because the
budgeted production in unit figure provided by the production budget
serves as starting point in direct labor budget.
Following are the calculation involved in the direct labor budget:
Planned Production in units
Direct Labor hours Required per Units
=Budgeted Direct Labor Hours Required
Cost per Direct Labor Hours
=Budgeted Direct Labor Cost
Table 38 Sample Material Purchases Budget
Company A
Direct Material Purchases Budget
For the Year ending December 30, 2010
1 2 3 4 Year
1,334 912 1,148 1778 5,172
4.00 4.00 4.00 4.00 4.00
5,336 3,648 4,592 7,112 20,688
547 689 1,068 961 961
-800 -547 -689 -1,068 800
5,038 3,790 4,971 7,005 20,849
P134.85 P139.20 P152.25 P174.00 .
P685,445.55 P527,568 P756,834.75 P1,18.870 P3,188,715.3
 Table 39 Sample Direct Labor Budget
Company A
For The Ending December 30, 2010

1 2 3 4 Year
1,334 912 1,148 1,778 5,172
3.5 3.5 3.5 3.5 3.5
4,669 3,192 4,018 6,223 18,102
P174 P217.5 P217.5 P217.5
P812,706 P694,260 P873,915 P1,353,50 P3,734,38
2.5 3.5
Factory overhead
Factory overhead budget shows all the planned manufacturing costs which are
needed to produce the budgeted production level of a period, other than direct
costs which are already covered under direct material budget and direct labor
budget. The overhead budget is an operational budget contained in the master
budget of a business. It was two sections, one for variable overhead costs and
other for fixed overheads costs.
Total variable overhead may be calculated as the product of estimated variable
cost per units (also called variable overhead rate) and the budgeted production
units (obtained from production budget). However most businesses will prefer to
prepare a detailed overhead budget showing individual variable costs such as
electricity, fuel, supplies etc. The fixed overhead costs are calculated as the sum
individual fixed overheads costs for example rent, depreciation, etc. which are
planned for the period. It is also useful to calculate the expected cash
disbursement for factory overhead costs at the end of overhead budget.
Table 40 Sample Factory Overhead Budget
Company A
Factory Overhead Budget
For the Year Ending December 30, 2010
1 2 3 4 Year

1,334 912 1,148 1,778 5,172

P 522 P652.50 P696 P826.50
P 696.348 P595,080 P799,008 P1,469,517 P3,559,953

391,500 391,500 391,500 391,500 1,566,000

326,250 326,250 326,250 326,250 1,305.000
P717,750 P717,750 P717,750 P717,750 P2,871,000
P1,414,098 P1,312,830 P1,516.758 P2,187.267
391,500 391,500 391,500 391,500 1,566,000
P1,022,598 P921,330 P1,125,258 P1,795,767 P4,864,953
Selling and Administrative Expense
Selling and administrative expense budget is a schedule of
planned operating expenses other than manufacturing costs. It is a
components of master budget and it is divided in two sections: the
selling expenses and the administrative expenses. .Both selling
expenses and administrative expense may be fixed or variable. For
example sales commission and freight cost on sales are variable
selling expenses where as sale salaries are fixed selling expenses.
Similarly depreciation and rent on office building are fixed
administrative expenses whereas office supplies and utilities expense
are variable administrative expenses. Different variable selling and
administrative expenses vary with different types. Example sales
commission vary with number of units sold, entertainment expenses
with number of employees in the organization etc., therefore an
accurate selling and administrative expenses budget can be made by
using activity costing.
 Table 41 Sample Selling and Administration Budget
Company A
Selling and Administration Expense Budget
For the Year Ending December 30, 2010
1 2 3 4 Year
Budgeted Selling
Expenses:
Sales P113,970 P103,530 P104,835 P156,165 P478,500
Commission

Freight out 169,215 152,685 132,675 218,805 673,380

Budgeted Admin.
Expenses:
Office Rent 348,000 348,000 348,000 348,000 1,392,000

Office Salaries 435,000 435,000 435,000 435,000 1,740,000

Office Supplies 48,720 44,805 67,860 103,095 264,480

Miscellaneous 30,450 30,450 30,450 30,450 121,800

Expenses

Total Selling & 1,145,355 P1,114,470 P1,118,820 P1,291,515 P4,670,160

Admin. Expense
Cost of Goods Manufactured
Cost of goods manufacturing budget is an operational
component of master budget. It is prepared to calculate the
manufactured budget is based on direct material purchases budget,
direct labor cost budget and factory overhead budget.
The figures from direct labor budget and overhead budget are
directly used in the preparation of cost of goods manufactured
budget but the direct material purchase cost needs to be adjusted
as shown below:
Direct Material Purchase
+Direct Material Beginning Inventory
-Direct Material Ending Inventory
=Cost of Direct Material Used in Production
The next step is to calculate the budgeted cost of goods
manufactured as follows:

Cost of Direct Material used in Production

+Direct Labor Cost
+Factory Overhead Cost
=Manufacturing Cost
+Beginning Work in Process
=Cost of Goods Manufactured
 Table 42 Sample Cost of Goods Manufactured Budget
Company A
Cost of Goods Manufacturing Budget
For the Year Ending December 30, 2010
1 2 3 4 Year

Direct Material P685,429.50 P527,568 P756,813 P1,218,870 3,188,724

Purchases
Beginning Direct 104,400 73,776 95,917.50 162,603 104,400
Material
Ending Direct -73,776 -95,917.50 -162,603 -167,214 -167,214
Material
Direct Material P716,053.50 P505,426.50 P690,127.50 P1,214,259 P3,125,910
Cost
Direct Labor Cost 812,406 694,260 873,915 1,353,503.50 3,734,083.50

Manufacturing 1,0225,598 921,330 1,125,258 1,795,767 4,864,953

Overhead
Total P2,551,051.50 P2,121,016 P2,689,300.50 P4,363,528.50 P11,724,946.50
Manufacturing
Costs
Beginning Work in 0 0 0 0 0
Process
Budgeted Cost of -0 -0 -0 -0 -0
Goods
Manufactured P2,551,057.50 P2,121,016.50 P2,689,300.50 P4,363,528.50 P11,724,946.50
Product Costing and Pricing
Costing is the way entrepreneur calculates or works out how
much each individual product( goods or service) costs produce or
sell. Costing is important to be able to set the price of the product
fairly and competitively. There are two components of costing
which are:
1. Direct or Variables costs: Vary directly with the number of
items made or sold. Include all money spend supplies and
materials to make the product or to provide the service. For
example the cost of raw materials, packaging and labor.
2. Indirect or fixed costs: Are the business expenses or
overheads that must be paid weather or not its products are
sold. Indirect costs include items such as rent, electricity,
telephone, salaries, insurance and depreciation.
Pricing is deciding what to charge for your goods or service. The
following factors affect pricing:
1. How the competition prices the good and service you plan to
provide.
2. Expectations about sale and expenses
3. How much money the owner wants or needs to make
4. Market service
5. Supplier pricing terms and inventory costs.
The price amount decided on must meet the following:
1. High enough to cover all costs of production
2. Enable the entrepreneur to earn reasonable return.
3. Low enough to encourage persons to keep on buying and to tell
others about the product.
Four factors to focus on when setting price:
1. Knowledge of what your costs are.
2. Knowledge of the prices your competitors are selling at.
3. What customers are willing to pay
4. How the prices of new goods or services compare with that of
existing ones.
Table 43 Sample Costing and Pricing per Unit

COSTING TEMPLATE
Recipe for Scrambled Eggs ala Ready to be Rich
Yield: 4 servings
Ingredients Quantity Equivalent Measure Peso Cost
Cooking oil 2 tablespoons 30 ml 1.60
Eggs 4 pieces 4 pieces 16.00
Salt ½ teaspoon 2 grams 0.26
Total Recipe Cost 17.86
Cost Per Yield 4.47
130% Profit Margin 5.80
SUGGESTED RETAIL PRICE 10.27
The following are pricing strategies that could be employed by
the startup business:
1. Cost- plus pricing: determining price by adding a
percentage for profit to the total price of the product.
2. Pricing to the market: setting a price for the product based
on the price changed by competitors.
3. Discount pricing: the use of promotions, sale, etc. often to
introduce a new product or service.
4. Penetration pricing: reducing the price of the product to
attract and or keep customers.
5. Prestige pricing: charging more than the competitors to sell
product of high quality and to maintain image or status.
6. Demand-oriented pricing: setting a price for good and
service bases on an estimate of what customers are willing to
pay.
Statement of Stockholders’ Equity/Capital Statement
Changes comprise capital, drawings and the profit for the
period.
Just like income statement, this statement normally covers a
twelve-month period.
Table 44 Sample Statement of Changes in Equity

Statement of changes in equity for the period ending 31st of December 2010

Balance at the beginning of the year P 2,653,500

Capital contributed during the year 1,087,500
Profits for the year 1,514,670
Drawings (87,000)
Balance at the end of the year 5,168,670
Business Model/s
This is the plan that implemented by a company to produce
revenue and make profit from operation. The model includes the
components and functions of the business, as well as the
revenues it generates as and the expenses it acquires.
A business model can be simple or very multifaceted.
There are various types of business model that most companies
fall into. Many of those operate under the basic categories of
manufacturer, distributor, retail or franchise.
In order to develop a good feasibility study, the first thing needed
is to determine which business model is to be followed.
1. Manufacturer
2. Distributor
3. Retail Outlet
4. Franchise Model
Funding Needed and it’s Sources
The hardest part of starting a business is raising the money to get going. Raising
finance for startup requires careful planning.
The startup business owner needs to decide:
1.How much finance is required?
2.When and how long the finance is needed for?
3.What security(if any) can be provided?
4.Wheater the entrepreneur is prepared to give up some control(ownership) of
the start-up in return for investment?

The finance needs of a start-up should take account of these key areas:
1) Set-up costs
2) Starting investment in capacity
3) Working capital
4) Growth and development
Main Internal sources of finance for a start-up are as follows:
1. Personal sources these are the most important sources of
finance for a start-up, and we deal with them in more detail in a
later section.
2. Retained profits this is the cash that is generated by the
business when it trades profitably; another important sources of
finance for any business, large or small.
3. Share capital

While the external sources are the following:

1. Loan capital- this can take several forms, but the most
common are a bank loan or bank overdraft.
a) Bank loan
b) Bank overdraft
2. Share capital- These are outside investors for a startup business;
the main sources of outside (external) investor in the share capital
of a company are friends and family of the startup business owner.
Opinion differ on weather friends and family should be encouraged
to invest in a startup company.

Break-even Analysis
Break-even point is a techniques to determine the required number
of units and required sales of the business to be able to say that it is
able to survive. Here is a sample computation:
Variable Cost P176.67 per units
Fixed Cost P928,208.00
Selling Price P295.00 per units

Break Even (units) = P928,208.00/118.33=7,844 units

Breakeven (sales)= 7,844  P295.00= P2,313,980.00