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Entreprenuerial finance

Entreprenuerial finance. Measuring & evaluating performance Financial planning. Objectives. Describe and calculate operating breakeven analysis in terms of EBTDA and NOPAT. Describe how financial ratios are used to monitor a venture’s performance.

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Entreprenuerial finance

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  1. Entreprenuerial finance Measuring & evaluating performance Financial planning

  2. Objectives • Describe and calculate operating breakeven analysis in terms of EBTDA and NOPAT. • Describe how financial ratios are used to monitor a venture’s performance. • Identify and calculate conversion period ratios • Discuss the entrepreneurial perspective on financial statement analysis

  3. Objectives • Understand the concept of sustainable sales growth rate • Understand the process of identifying additional funds needed (AFN) • Model the effect of varying sales growth rates on AFN • Prepare LT financial plans • Prepare ST financial plans

  4. 4.4 Statement of cash flows • Remember “sources” and “uses” of funds

  5. R.E.C. Inc.Statement of Cash Flows

  6. R.E.C. Inc. Statement of Cash Flows For fiscal years ending December 31, 2006, 2005, 2004

  7. R.E.C. Inc. Statement of Cash Flows For fiscal years ending December 31, 2006, 2005, 2004

  8. R.E.C. Inc. Statement of Cash Flows For fiscal years ending December 31, 2006, 2005, 2004

  9. R.E.C. Inc. Statement of Cash Flows For fiscal years ending December 31, 2006, 2005, 2004

  10. Assessing Cash Burn/Cash Build • Add Cash flow from operating activities and Cash flow from investing activities • Cash Burn if CFopns+ Cfinvesting is negative • Cash Build if CFopns+ Cfinvesting is positive • Cash Burn/Cash Build for R.E.C. Inc. • Calculate cash burn/cash build for 2004, 2005, and 2006

  11. Cash Burn/Cash Build for R.E.C. Inc. • Calculate cash burn/cash build for 2004, 2005, and 2006 • 2004 • 2005 • 2006

  12. Cash Burn/Cash Build for R.E.C. Inc. • Calculate cash burn/cash build for 2004, 2005, and 2006 • 2004 • 5,629 + (3,982) = 1,647 Build • 2005 • (3,767) + (4,773) = (8,540) Burn • 2006 • 10,024 + (13,805) = (3,781) Burn

  13. 4.5 Operating breakeven analyses • Survival breakeven • EBTDA (or cash flow) breakeven • SR = [CFC / (1-VCRR)] • Where SR is Survival Revenue, CFC is Cash Fixed Costs, and VCRR is Variable Cost Revenue Ratio • SR is the level of sales required for EBTDA=0

  14. PSA Corporation

  15. Survival breakeven • COGS is the only variable cost in this example, VCRR is 65% • Cash Fixed Costs include both fixed operating and fixed financing costs. In this case: • $200,000+180,000+20,000 = $400,000 • SR = $400,000/(1-.65) = $1,142,857

  16. NOPAT breakeven • NOPAT breakeven is the amount of revenues needed to cover a venture’s total operating costs. • NR = TOFC / (1-VCRR) • Where NR is NOPAT breakeven revenue and TOFC is Total Operating Fixed Costs = Cash Operating Fixed Costs + Interest Expenses + Depreciation • NR = ($200+180+25)/(1-.65) = $1,157 • Depreciation expense in this case is $25

  17. EVA breakeven • EVA breakeven would extend NOPAT breakeven to include the financing cash flows expected by the investors • EVA = NOPAT – WACC(Invested Capital) • Setting EVA=0, the breakeven point would be the level of revenue that sets NOPAT = WACC(Invested Capital)

  18. Breakeven drivers • Level of fixed costs and variable costs • Degree of operating leverage • Sales price • Industry sales growth vs company sales growth expectations

  19. 5.2 Cash burn rates • Cash burn (short cut) Net cash flows from financing - net change in cash excluding cash account Net cash burn • The burn rate is the (Net Cash Burn)/12 • Compare the burn rate to the cash balance to assess short term survivability

  20. R.E.C. Inc. Revisited • Net cash flows from financing activities • 2006 2,728 • Net change in cash excluding the cash account • CFopns + CFinvesting + CFfinancing = • Cash Burn is CFfinancing – Net Change in cash = • With Cash & Marketable Securities of $1,933, REC would run out of cash in____ months

  21. R.E.C. Inc. Revisited • Net cash flows from financing activities • 2006 2,728 • Net change in cash excluding the cash account • CFopns + CFinvesting + CFfinancing = 10,024 + (13,805) + 2,778 = (1,003) • Cash Burn is CFfinancing – Net Change in cash = 2,778 - (-1,003) = 3,781 • 3,781/12 = $315.08 per month • With Cash & Marketable Securities of $1,933, REC would run out of cash in 6.1 months

  22. 5.3 Conversion periods • Inventory conversion period • Inventories /(COGS/365) • AR Days Sales Outstanding • Receivables / (Sales/365) • Accounts Payable Deferral Period • Payables / (COGS/365) • Cash Conversion Cycle • Inventory conversion + DSO – AP deferral

  23. Cash Conversion Cycle example

  24. Cash Conversion Cycle example

  25. DEVELOPMENT STAGE Screen business ideas Prepare business plan Obtain seed funding 6.1 Financial planning throughout the venture’s life cycle STARTUP STAGE Choose organizational form Prepare initial financial statements Obtain startup financing SURVIVAL STAGE Monitor financial statements Project cash needs Obtain first round financing LIQUIDATE Private liquidation Legal liquidation RESTRUCTURE Operations restructuring Asset restructuring Financial restructuring RAPID GROWTH STAGE Create and build value Obtain additional financing Examine exit opportunities GO PUBLIC IPO SELL OR MERGE MATURITY STAGE Manage ongoing operations Maintain and add value Obtain seasoned financing

  26. Forecasting sales for seasoned firms • 1. Use average of most recent five years sales data • 2. Top-down “reality check” • Economy and industry growth • 3. Bottom-up “reality check” • Customer check • 4. Company specific issues • R&D expenditures, changes in credit policy

  27. Forecasting sales for early stage ventures • Little or no historical basis • Use top-down, market-driven approach • Estimate overall market demand for next five years • Estimate new venture’s anticipated share of that market • How big could we be? • How big must we be? • Considerably more risk in these estimates

  28. Estimating sustainable sales growth rates • The rate at which the venture can grow using internally generated funds. • g=RR x ROE; • Where RR is the retention rate (1-Div/NI) and ROE is the Return on Equity • Can be extended into DuPont model to see the impact of profit margin, asset turnover and equity multiplier

  29. Financial Statement Forecasting

  30. The AFN Formula • A* = Assets tied directly to sales • L* = Liabilities that increase spontaneously • AP and accruals – not bank loans or bonds • A*/S0 and L*/S0 – percentage of sales • S0=Sales last year • S1=Sales this year • S = change in sales • M = profit margin • RR = retention ratio (1-dividend payout)

  31. Factors that Affect External Financing Requirements • Sales growth (S) • Capital intensity (A*/S0) • Spontaneous liabilities-to-sales ratio (L*/S0) • Profit margin (M) • Retention ratio (RR)

  32. AFN Formula • Carter Corporation’s sales are expected to increase from $5 million in 2006 to $6 million in 2007, or by 20 %. Its assets totaled $3 million at the end of 2006. Carter is at full capacity, so its assets must grow at the same rate as projected sales. At the end of 2006, current liabilities were $1 million, consisting of $250,000 AP; $500,000 notes payable, and $250,000 accruals.The after-tax profit margin is forecasted to be 5% and the forecasted payout is 70%.

  33. Use AFN formula to forecast Carter’s additional funds needed for the coming year.

  34. Forecasting when Balance Sheet ratios change • Economies of scale • Lumpy Assets • Excess assets due to forecasting errors • Linear regression (+ reality checks) • Excess capacity adjustments

  35. Pro Forma Statements and Ratios • Cumberland Industries

  36. Short term cash planning • Ace Manufacturing Company

  37. Review • CASH IS KING! • Cash burn and cash burn rate • Cash conversion cycle • Short-term cash forecasting • Breakeven concepts • AFN and LT financial statement forecasts • Beware of sales forecasts

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