Financial Functions and Business Viability in Startups

Posted on Dec 16, 2024 in Economy

**Financial Function**

It is one of the basic functions of a company. It involves making decisions that will integrate the appropriate actions to achieve the means of payment (financing decision) and its use (investment decision). It is always directed to the objectives of the company. So, to solve this function, there will be two big decisions: choosing the productive assets to be acquired by the company (investment decision) and determining the sources of resources to invest, given the optimal combination for the least cost (funding decision), (i.e., where they are listed).

**Average Collection Period (ACP)**

The Average Collection Period is the average number of days in the trade cycle, i.e., the average time it takes for the cash flow to complete the turn, from buying raw materials until we collect from customers. In the economical ACP, it is the average time the company takes to recover the money invested in working capital (from approval, manufacturing, and sales collection to approval and billing). The financial ACP is the number of days in the operating cycle that the company has to finance because part of the cycle you can finance with providers [Financial ACP – Payment Period = Economical ACP]. It is inversely proportional to the rotation because it allows shorter operating cycle times to be repeated more times during the year and increases profitability. To reduce it and increase the rotation, you can improve purchasing policy (increase approval rotation), improve stock control (lower average stock), improve company productivity (increase manufacturing rotation), improve sales (increase sales rotation), reduce the collection period from customers (increase customer rotation), and lower the payment period.

**Necessary Working Capital**

Current assets that must be financed by permanent capital. This is the amount in fixed assets for the year in safety stocks, debt available to customers, or to keep pace with the normal activity of the company. These are healthy financial resources for permanent capital. To maintain the financial balance of the company, the basics are:

Working Capital = Average balance of inventory + Average customer credit rating needed + Average cash – Credit rating of providers.

In general terms, the working capital must be positive, but what working capital exactly does a company need? It depends on the rotation and the ACP. If the ACP is high, the working capital will be high. If the rotation is low, the working capital will be high.

Rotation = Flow / Average balance = Average balance: Flow / Rotation.

  • Approval of raw materials = ROT consumption (purchases of raw materials – (Initial Stock – Final Stock)) / Average balance of raw materials (Initial Stock + Final Stock / 2 (of raw materials)) = PM = 365 / Rotation of approvals.
  • Manufacturing Rotation = Cost of manufacturing (consumption of raw materials + other manufacturing costs) / Average balance of products in progress.
  • Sales Rotation = Consumption of raw materials + Manufacturing costs + Other costs / Finished goods.
  • Collection Rotation = Sales / Average balance of customers.
  • Payment Rotation = Purchases (Approvals) / Average balance of suppliers.

**Economic Viability: The Threshold of Profitability**

This is to check whether the activity of the company will generate profits or not. This must have a clear idea of what will be the costs and revenues of the company, in addition to fixed and variable costs, and the price of the product. With this information, we can apply the deadlock, a tool that allows us to know the minimum amount of product to be sold to start getting benefits.

**Affordability**

First, we make a forecast of the needs that the company will need, and expound on the investment plan, a document that outlines and quantifies the resources needed to start the new activity.

**The Business Plan**

The Business Plan must be recorded to quantify the funding needed to determine the type of funding source (public or private).

  • The quantification and forecast of annual funding needs: Through funding, we need to get the resources necessary to carry out investments. To obtain these resources, the company may resort to various sources (loans, leasing, capital increases, etc.), and these can be public or private:
    • Public: Public Administration provides funding for particular projects of new creation through non-refundable funding (no obligation to return), loans with interest below the current market, and the provision of advisory services to developers, administrators, local, etc., without cost.
    • Private: To grant loans to developers, demand information. The information to be presented is variable depending on the entity, and also the form requesting the submission of the annual business plan forecasts.
  • Before starting the activity of the company, promoters must include a series of forecasts for the business plan to know the financial structure of the company’s ability to meet payments on time and the profitability of the project:
    • Balance of foresight: This will show the company’s equity structure, the relationship between investment and financing to ensure financial balance.
    • The result of the exercise: What are the aims of the expected results over several periods.
    • Cash budget: It is not expected to arise in which the company is not currently able to meet the payments. This is a document containing, for each time period, what is the expected flow of payments and receipts, and determines what the cash position of companies is at each moment.
    • Project Profitability: Once cash flows are defined, determine what the expected profitability of the project is. You can proceed to its calculation using the methods of Net Present Value (NPV), payback period, and Internal Rate of Return (IRR).

**The Project Report Business**

Once found to have sufficient elements to decide whether to create a viable business, you must initiate the process for the draft entrepreneurship. Getting ready to start typing the project report containing a business in which a description is orderly and legitimate entrepreneurship project, which is essential to know the characteristics and inform those who may be concerned (potential investors, banks, etc.).

The general structure:

  1. Introduction and presentation of the business project (business description, fundamental characteristics of the business idea).
  2. Promoters of the projects: personal and curriculum of the people who are part of the company.
  3. Government shape and legal bodies of the company: description and justification of the kind of company that is created.
  4. Location: comment and argumentation on the location.
  5. Market research: explanation about the viability of the project.
  6. Analysis of areas of operation: description of the different functional areas of the company.
  7. Investment plan and financing: the justification of the investment will be made, the budget for this, and how to finance it.
  8. Calendar of steps for the creation of the company.
  9. Description of documentary and administrative procedures necessary.
  10. Comments on the draft as a global conclusion.

**Choice of Legal Form**

One of the most important decisions, as derived from a set of rights and obligations. There are a number of factors that influence the choice: invested capital, number of promoters, liability, taxation, and costs of establishment. There is no great way for all companies in general, but each must choose which best suits their circumstances.

**The Procedures Established**

Once decided the type of independent legal entities, you need to plan the process of administrative procedures and documents needed to complete the formal constitution of the company:

  1. Certification of the negative name of the company: The selected name for the company is verified by a procedure in the Commercial Register, ensuring there is no company with the same name.
  2. Execution of the deed of incorporation: The statutes governing the company and the agreements that determine the relationships among partners are drafted before a notary.
  3. Applications to finance: The tax identification number is requested. A census statement is made according to which the activity of the company has started. The tax on economic activities is paid, and the official books required are legalized.
  4. Social Security procedures: The company is registered with Social Security. The start of the activity is communicated, and the process for enrolling hired workers is carried out.
  5. Proceedings before the City Council: A license to start the activity is requested, as well as a work permit if necessary.