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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

Entreprenuerial finance

Measuring & evaluating performance

Financial planning

objectives
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
objectives1
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 statement of cash flows
4.4 Statement of cash flows
  • Remember “sources” and “uses” of funds
r e c inc
R.E.C. Inc.

Statement of Cash Flows

For fiscal years ending December 31, 2006, 2005, 2004

r e c inc1
R.E.C. Inc.

Statement of Cash Flows

For fiscal years ending December 31, 2006, 2005, 2004

r e c inc2
R.E.C. Inc.

Statement of Cash Flows

For fiscal years ending December 31, 2006, 2005, 2004

r e c inc3
R.E.C. Inc.

Statement of Cash Flows

For fiscal years ending December 31, 2006, 2005, 2004

assessing cash burn cash build
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
cash burn cash build for r e c inc
Cash Burn/Cash Build for R.E.C. Inc.
  • Calculate cash burn/cash build for 2004, 2005, and 2006
  • 2004
  • 2005
  • 2006
cash burn cash build for r e c inc1
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
4 5 operating breakeven analyses
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
survival breakeven
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
nopat breakeven
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
eva breakeven
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)
breakeven drivers
Breakeven drivers
  • Level of fixed costs and variable costs
    • Degree of operating leverage
  • Sales price
  • Industry sales growth vs company sales growth expectations
5 2 cash burn rates
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
r e c inc revisited
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
r e c inc revisited1
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
5 3 conversion periods
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
6 1 financial planning throughout the venture s life cycle

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

forecasting sales for seasoned firms
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
forecasting sales for early stage ventures
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
estimating sustainable sales growth rates
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
the afn formula
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)
factors that affect external financing requirements
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)
afn formula
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%.
forecasting when balance sheet ratios change
Forecasting when Balance Sheet ratios change
  • Economies of scale
  • Lumpy Assets
  • Excess assets due to forecasting errors
    • Linear regression (+ reality checks)
    • Excess capacity adjustments
pro forma statements and ratios
Pro Forma Statements and Ratios
  • Cumberland Industries
short term cash planning
Short term cash planning
  • Ace Manufacturing Company
review
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