4.3 Financial planning

Introduction

The task of financial planning is to determine the capital requirements of a company and to ensure the procurement of capital. The determination of the company's goals must be harmonised with the goals of financial planning.

Capital requirements arise from the fact that the company has to make investments and expenditures that are not directly matched by any income, or at least not by income of the same amount. The capital requirement calculation determines to what extent and at what time capital is required.

Financing and raising capital is a complex challenge for many entrepreneurs. For a start-up, it is as much about initial investment as it is about liquidity management.

Funding includes:

• The financial plan determines what the capital is to be used for and how it is to be raised (use of capital, investments, etc.).
• The capital requirements calculation, it determines how much capital is needed.
• The use and raising of capital is also referred to as financing.

4.3.1 Capital appropriation

Every company needs capital. This involves raising capital for operational occasions. These can be:

• Start-up capital to finance a start-up or the establishment of a company,
• Capital for financing a business acquisition or business succession,
• Capital to finance investments,
• Capital to pre-finance the first stock of goods,
• capital to finance liquidity.

The capital appropriation must state what capital is needed for. The amount of capital must be calculated and justified. Finally, the raising of capital must ensure that sufficient equity and debt capital is available. 

The inappropriate use of capital is a burden on every company. 

What needs to be financed, for example:

• Start-up financing: When founding a start-up, a distinction must be made between a) investments before the start-up and b) investments after the start of the business activity, c) reported start-up costs.
• Business sector: Capital requirements differ significantly between different business sectors and industries. A manufacturing company or a construction firm need significantly more capital than an individual management consultant or sales representative. The type and amount of capital required depends on the industry.
• Company size: The amount of capital usually depends on the size of the company or the individual business. More capital is needed to start a shop than to start an internet company. 
• Turnover rate : It indicates how often a company sells goods within a defined period. To achieve an annual turnover of goods of € 120,000, a monthly turnover of € 10,000 is needed 12 times; if the turnover is twice, it is twice as much. If the goods have to be financed in advance, the capital requirement increases accordingly. If the company did not have enough capital for this, business expansion would not be possible. 
• Payment terms and delivery credits: They act like credit transactions. The longer the payment term, the higher the capital requirement for the seller and the lower the capital requirement for the buyer. 

4.3.2 Raising capital

Capital and assets balance each other out in a company's balance sheet. The capital side is contrasted with the assets in which the capital is tied up in the company. Capital is considered the sum of the values on a balance sheet. The operating assets denote the value of the property of a company.

 

 

 

 

The source of funds asks about the origin of the required capital. A distinction must be made between equity and debt capital.

Equity makes the company independent of external influences. The company is not threatened by the withdrawal of operating funds as a result of a loan termination. It is crisis-proof. High equity capital makes it easier to obtain loans. Equity capital should be at least as high as the fixed assets (e.g. business equipment) that form the basis of the enterprise.

When founding a company, equity should not be less than 10 - 20 % of the total capital.

 

Sources of equity are:

• Cash, bank deposits, securities;
• Entrepreneurial capital can be granted through ERP loans;
• Relatives and friends can provide capital;
• Partners and shareholders can also join a company as partners. In return, they may want a say and an interest on the capital invested.
• Equity investment companies enter the market as private or publicly funded investment companies. They provide capital to (young) enterprises that they cannot raise from their own savings or cannot obtain from banks due to a lack of collateral. Participations can be granted by state-owned companies under certain conditions from € 50,000. Private investors, such as "venture capital" are usually more interested in investments in "millions". They want to earn much higher returns.

 

Debt capital is to be procured in the form of loans. A loan is the temporary transfer of money or material assets in exchange for money (interest) between an investor (creditor) and a borrower (debtor). The capital provider trusts in the debtor's future willingness and ability to pay.

Credit is the external capital provided to a company in the form of money or material goods, e.g. from a bank.

There are favourable start-up loans from public funding programmes for start-ups. These can be applied for at the house bank. They are granted by the "Deutsche Ausgleichsbank".

The financing of debt capital:

• Start-up loan
  

The start-up loan is the most important form of financing for start-ups. There are separate funding programmes for this.

• Loans from banks, savings banks or Volksbanks are granted at any time at standard market conditions. They can be used by any company for financing - provided the company is creditworthy. 
• Overdraft facility
  

Current account credit is also colloquially called "overdraft credit". It is the credit that the credit institution grants to the current account holder as an overdraft credit, taking into account his previous banking transactions. The amount depends on the current income and expenditure and the creditworthiness of the account holder. Overdrafts are relatively expensive; they range from 10%-18% per year. They can be used to balance short-term liquidity fluctuations. They are hardly suitable as a long-term means of payment. The credit line can be agreed with the house bank. The usual amount is one to two months' income or monthly turnover of the credit holder or company.

• Supplier credit

Supplier credit, as the name suggests, is granted by the supplier of the goods. The credit depends on the respective payment term granted by the supplier. In this sense, each entrepreneur is a creditor until the goods or services have been paid for by his customer. Contractually, payment variants can be freely agreed. Some examples:

• The goods are payable immediately upon delivery without deduction.
• The goods are payable after delivery within 7 days with 2% discount.
• The goods are payable after delivery within 30 days without deduction.

• The goods will only be delivered against advance payment.
• Supplier and buyer agree on a term of payment. Even if immediate payment is agreed, time delays in banking transactions are to be expected. The time until payment for the goods must be pre-financed by the entrepreneur. Those who are liquid should make use of cash discounts, because that is how quickly cash can be earned. 
• Bill of exchangeThe

bill of exchange is a means of payment. In the bill of exchange (deed), an obligation
 is assumed,
detached from the reason for the
debt, to pay a certain sum of money to the legitimate holder of the deed. Bills of exchange are issued, for example, to pay for goods at a later date. At the same time, the bill of exchange can be used to pay one's own debts. The supplier does not ask for money at first, but for a bill of exchange. It contains the name, the amount and the period of validity. It can be honoured within the period of validity to settle own debts to another creditor. The bill of exchange must be paid to the last creditor noted, i.e. the owner of the bill of exchange, on the due date.

Creditworthiness plays a prominent role in business life and especially in a start-up. Credit involves trust in the will and ability of a person or company to properly fulfil its obligations (psychological level); on the other hand, performance (material level), which is made in the confidence that the consideration will be properly provided at a later date. Creditworthiness serves to monitor and examine the personal and material criteria of a company seeking credit. The legal, personal and economic circumstances are examined. Loans are only granted if there is a "calculable" certainty that the loan can be repaid. Today, the risk is examined for many companies according to the provisions of Basel II. Loans are always associated with risk.

Guarantees constitute collateral for loans. A guarantor is a person who undertakes vis-à-vis the creditor of a third party, the principal debtor, to vouch for the third party's obligations. This, for example, in the case of insolvency. A distinction can be made between private and public guarantees.

In the case of a loan guaranteed by a company, the owner, for example, undertakes to be liable with his personal assets by means of a personal guarantee. For example, a loan is usually only granted to a limited liability company if the shareholder assumes personal liability. In addition to the borrower (the company), another person is liable for interest and repayment (redemption). The same requirements are placed on the guarantor's ability to pay as on the borrower. The guarantee amount is usually higher than the loan amount so that interest and other costs can be paid from it.

Public guarantees are granted by guarantee banks. A guarantee bank stands surety for a borrower. They can provide deficiency guarantees if the available capital is not sufficient. Indemnity guarantees are fully-fledged guarantees for credit institutions or banks. However, they are usually only issued for up to 80% of the amount for which a guarantee is requested. A guarantee loan costs interest. Guarantee programmes are available from KfW Mittelstandbank.

Equity capital

Start-ups and entrepreneurs often encounter the fact that banks do not want to give loans for a business idea. This is the case when the prospects of success are difficult to assess. Investment companies or private investors can help here.

Equity capital is often also regarded as venture capital. From the point of view of a capital company, venture capital is to be treated like equity capital, because the financier participates directly in the start-up or the company.

There are currently about 200 private equity companies in Germany. Information on this is provided by the Bundesverband Deutscher Kapitalbeteiligungsgesellschaften (BVK) in Berlin.

Lease financing

In lease financing, medium and long-term rights of use to movable and immovable assets and goods are acquired by means of rental or lease agreements. The lessor who rents out a leasing object remains the legal and economic owner of the object. Use is transferred to the taker in return for a rent.

The term depends on the useful life of the item. For example, car leasing is common for three years. Equipment and machines are leased for 3 to 5 years. If the use is still economical after that, the contract can be extended with a lower lease rate.

The rental rate depends on the respective object and the competitive situation in the market. Different financing models (with partial down payments, residual payments) are common. The costs for leasing are between 1% - 5% of the respective purchase price. There is also 0 % leasing in car leasing.

Financing through leasing is advantageous because the company does not have to take out bank loans for it, which have to be secured by guarantees or other collateral. The leasing costs are directly operating expenses. Leasing thus creates liquidity.

A profitability calculation can show whether borrowing is worthwhile. Borrowing costs interest and fees. Capital costs are all expenses that have to be incurred in order to be able to draw on financial resources as equity or borrowed capital. The return on the use of borrowed capital should be higher than the cost of the respective loan.

 

Forms of financing

Source of funds   Rights of the Capital provider	External financing (via Financial Markets)	Internal financing (from turnover processes)
Equity	Equity in the form of a contribution or participation	Self-financing - Asset reallocation - Retention of profits from releases of funds such as provisions such as depreciation
Debt capital	Debt capital in the form of credits, loans, grants, (leasing, franchising)	-Asset reallocation, - Sale of property

Table 21: Forms of financing

 

In internal financing, the financial resources arise from the business activity. It is surpluses or sales revenue, which is also called cash flow financing. Depreciation of assets (Afa) as well as reserves from profits or provisions (capital that is temporarily invested or pension provisions) also belong to the area of internal financing. In addition, internal financing takes place through asset restructuring, e.g. sale of property. Rationalisations can also constitute internal financing.

4.3.3 Cost of capital

The cost of capital is also called the cost of financing.

General borrowing costs

Anyone who raises capital must pay money market costs for it. This is usually interest. Interest is granted for the provision of a loan. Interest is income for the creditor and expenditure for the debtor.

The repayment of a loan takes place through redemption.

The discount is a reduction by which the loan is brought below the nominal value of the loan.

 

Overview of capital costs and types of capital

Cost of capital	Types of capital	Examples
One-off capital costs (start, end)	Procurement costs	Commissions Processing fees Discount (markdown) Issuing costs Collateral costs
	Repayment costs	Repayment Fees Repayment discount Costs for restitution of collateral
Current capital costs	Capital utilisation costs Debt service costs Market maintenance costs	Interest Overdraft commissions Profit distributions Commitment fees Income tax Corporation tax Trade tax Coupon redemption costs Costs for stock exchange publicity Costs for market cultivation

Table 22: Cost of capital

 

 

 

 

 

 

The following example shows the calculation of a loan.

Example loan conditions: Nominal value €25,000; discount 10%; n = term, 3 years; t (tempus) = year; percentage rate = 7%; annual fees 0.5% of nominal committed

After deducting the discount, the company has a loan amount with a nominal value of € 22,500 at its disposal. The repayment amount is fixed. The annual debt service results from the payment sequence. It is to be taken into account in the cost accounting or P&L.

Loans for start-ups

Start-ups can take advantage of special funding programmes. Funding requires that the applicant has sufficient technical, commercial and personal competence to set up a business. Founders of an Ich-AG will have to provide evidence of a business plan.

• Entrepreneurial capital becomes: ERP capital for start-ups (0-2 years)
• StartMoney, Microloans
• Advisory support, business development, employment office, IHK, HWK, advisory centres
• Investment allowances for the new federal states in the east and Berlin
• KfW Entrepreneur Loan (Kreditanstalt für Wiederaufbau, Deutsche Ausgleichsbank)
• Special depreciation allowances and savings depreciation allowances for the promotion of SMEs pursuant to § 7 g EStG (Income Tax Act),
• Investment grants as a joint task for the improvement of the regional economic structure
• ERP programmes for investments and innovations
• Equity capital for small technology companies
• ESF funding for SMEs

The funding programmes are constantly being changed. They can be viewed in the internet database of the Federal Ministry of Economics and Labour: www.bmwa.bund.de or BMWA-Gründerportal: www.existenzgruender.de

 

Deadlines

Meeting deadlines is a key parameter for financing. Usual terms are:

• Short-term loans should only be used for the procurement of current assets. Maturity of up to approx. 1 year; In the case of an overdraft, the current account is drawn down by overdraft. The interest rates are very high. Goods credits are used until an invoice is paid.
• Medium-term and long-term loans enable the company to plan far-sightedly and secure it against short-term capital withdrawal. Medium-term 1 to 5 years, e.g. credit for equipment investments. Long-term 5 years or more, e.g. debentures, depreciation for buildings.

Legal status of the creditor

The legal status of the creditor plays a role in financing that should not be underestimated. It becomes important when it comes to liability and security issues. In addition, the legal form tells who can assert which property and capital claims. While in the case of a partnership, the individual is liable with his or her entire private and company assets, in the case of a corporation, e.g. a limited liability company (GmbH), the liability risk is limited to the amount of the capital contribution - which is at least € 25,000. At the same time, the distribution of profits or the allocation of losses in the case of corporations is made in the amount of the capital shares.

4.3.4 Financial management objectives

The management of the company's development must be based on measurable criteria. These include profitability, liquidity, economic efficiency and, for example, productivity in manufacturing companies. The planned key figures are the basis of financial planning.

 

Profitability target

Profitability is defined by the ratio of profit to capital employed.

Most companies are financed through debt and equity capital. Interest must be paid to the lender for the debt capital. The invested equity capital must also "yield" interest, in the form of the profit or the annual surplus. If the profit meets expectations, the profitability target is achieved.

Return on equity =	Profit	* 100
	Equity

 

If the equity and debt capital are taken as a basis and the interest expense for the debt capital is added to the profit, the result is the return on total capital or corporate profitability.

 

 

In the case of a partnership, the entrepreneur's salary must first be deducted from the profit.

Return on assets =	Profit + interest expense	* 100
	Total capital

 

Return on sales determines the ratio of profit to sales revenue.

Example:

Total capital

Equity                                     300.000 €             

Debt capital                                           200.000 €             

Profit                                                        40.000 €

Interest                                    10.000 €

• Return on equity:

e.g.: 40.000 € : 300.000€ * 100 = 13,3 %

• Return on total capital:

e.g.: 40.000 € + 10.000 € : 500.000 € * 100 = 10 %

Return on sales =	Profit	* 100
	Sales proceeds

 

Information on profitability comparisons is published, for example, for the retail trade by the "Institute for Trade Research", University of Cologne. Comparative data on sectors is also available from the chambers of commerce. Profit margins for small traders are determined by the regional tax offices with the help of reference rate collections.

Target liquidity

Liquidity means being solvent at all times. This is one of the most essential foundations of any business activity. In other words, insolvency and over-indebtedness threaten the continued existence of the company and usually lead to insolvency. 

Building on short- and medium-term financial planning, the capital structure should be aligned in such a way that financial imbalances are avoided. In this context, finance speaks of the financial equilibrium of the company. The financial equilibrium of a company is established through the careful coordination of four factors:

• Amount of capital required,
• Source of capital raising,
• required capital utilisation period,
• Repayment agreement (capital transfer period).

Long-term capital commitments (fixed assets) should be financed through long-term financing (equity and long-term debt). The so-called floor of current assets (inventories and outstanding receivables) should also be financed on a long-term basis.

As a rule of thumb, at least one, preferably several months' sales should be available as liquidity.

 

Goal Economic efficiency

Profitability is defined as the ratio of income to expenditure.

 

 

Productivity target

Productivity is largely due to technical progress. Productivity determines the productivity of economic activity. It is measured by the quantitative output per day, per hour, per employee, per machine, per unit.

Economic considerations play no role in determining productivity. It says nothing about profitability.

 

4.3.5 Financing errors

Typical financing mistakes should be avoided. These include:

• too little equity capital,
• no timely negotiations with the house bank,
• Use of the overdraft facility to finance investments,
• high debts to suppliers,
• inadequate planning of capital requirements,
• public financial aid is not applied for, even though it is cheaper,
• Payments and deadlines are not met,
• financial overload due to seemingly favourable loans.