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Boot Camp 1
Entrepreneurship Boot Camp
“Running the Numbers”
Jim NolenFin 394 – Harvest, Finance &
Negotiation
Boot Camp 2
Entrepreneurship Boot Camp1. If you do not have a strong accounting and
finance background, find a study group with members who do, as much of the case study method occurs in the study groups.
2. Take Managerial Accounting or Financial Statement Analysis to improve your understanding of financial statements.
3. When analyzing a case, use the analytical frameworks provided in your course such as Porter and SWOT analysis and FIT framework
Boot Camp 3
Entrepreneurship Boot Camp Put yourself in the position of the
case’s decision-maker. Try to determine what the central issues are to the decision to be made and prioritize what is urgent and what is important.
Try to link these central issues to the financial statements and sort out the relevant data.
Boot Camp 4
Entrepreneurship Boot Camp Examine the historical financial
information. Compound Annual Growth Rate (CAGR) Gross and Net Margins Common Form Balance Sheet Ratios
Liquidity, Leverage, Coverage, Turnover, Profitability, and Return
The DuPont equation is a good tool to use.
Boot Camp 5
Entrepreneurship Boot Camp Look at trends in these ratios
(intracompany) and benchmark them against the industry or comparable firms (intercompany).
Compare the forecasted data to the historical data and look for inconsistencies
Look at the cash flow statement. Where are the sources of funds being generated and are they sustainable. What are the uses of funds. Follow the Money.
Boot Camp 6
Entrepreneurship Boot Camp Is the cash flow of the company
capable of servicing existing debt and to cover increases in working capital and capital expenditures to support the projected sales increase.
Assets are a function of sales and increase represent a use of funds
Capital requirements are a function of asset requirements and profitability and represent a source of funds.
Boot Camp 7
Entrepreneurship Boot Camp Boil the numbers down to their smallest
elements (unit economics) and use common sense. Look at revenue per employee or sales per sq. ft. Does this seem reasonable?
What growth rate would you have to assume to get to this market value?
What percent share of market would they have to have to make the projections?
Why is the seller selling and is there some window dressing going on?
Read the footnotes in the tables and look at the exhibits that would put a twist on the decision.
Boot Camp 8
Return on Assets (ROA) Relates profitability to the assets
(capital) employed. Uses some measure of Profitability divided by Total Assets. It can be calculated before or after taxes.
Net ProfitROA = Total Assets
Boot Camp 9
Return on Equity (ROE) Relates profitability (usually after
tax) to the amount of owner’s capital employed and is affected by the level of debt used in the company.
Net Profit ROE = Owner’s Equity
Boot Camp 10
DuPont Formula - ROA
Return on Assets
Profit Margin X Asset Turnover
NET PROFIT SALES SALES X ASSETS
Boot Camp 11
RETURN ON EQUITY
Profit Investment Financial Margin X Turnover X Leverage
NET INCOME X SALES X ASSETS SALES ASSETS EQUITY
Dupont Formula - ROE
Boot Camp 12
Short Term Cash Cycle
Cash
Raw MaterialsInventory
WIPInventory
Finished GoodsInventory
AccountsReceivable
FixedAssets
Boot Camp 13
Short-Term Cash Cycle
Production Cycle
Cash CycleDays inA/P
OrderMaterials
(lag time, order vs carrying
costs)
Raw MaterialsInventory
Work-In-Process
Inventory
Finished Goods
Inventory
Collectionof A/R
Sale ofGoods orServices
MaterialReceipt
Inventory CostsPmt. for Materials
Conversion CostsLabor, Equip. & Mfg. Overhead
Inventory CostsCarrying Costs
Selling & Credit
Expenses
Pmt. ofA/P
Boot Camp 14
Cash Conversion Cycle
Days in Raw Materials Inventory Avg. Raw Materials Inventory x 365
Cost of Raw Materials DaysLess: Days in Accounts Payable
Avg. Accounts Payable x 365 Cost of Goods Sold - Labor Days
Plus: Days in WIP Inventory Avg. WIP Inventory x 365
Cost of Goods Sold DaysPlus: Days in Finished Goods Inventory
Avg. Finished Goods Inventory x 365 Cost of Goods Sold Days
Plus: Days in Accounts Receivable Avg. Accounts Receivable x 365
Credit SalesDays
Boot Camp 15
Value Drivers Managers can directly affect the firm’s
returns and firm value by: Increasing Operating Profits (increasing revenues,
decreasing costs, or employing operating leverage)
Increasing Asset Turnover - Improved working capital management and fixed asset utilization
Judicious use of financial leverage Decrease Risk - maintaining liquidity and lowering
variability through planning and diversification
Boot Camp 16
Valuation Models
Book Value Appraised Book Value
Market Value Prior Sales of Stock/Transaction Analysis Comparable Market Value
Capitalization Models Constant Growth Model Discounted Cash Flow Model Excess Earnings Model
Boot Camp 17
Comparable Market Value
Surrogate Market Value based on valuation benchmarks of similar publicly traded companies.
Price/Book Value Price/Earnings Price/Cash Flow Price/Revenues Price/EBITDA
Boot Camp 18
Comparable Market Value
Comparable Firms should be similar in: Industry and Products Management Size and Geographic area Accounting Methods Risk and Return Usually only publicly traded firm’s
information can be found and do not meet the requirements above.
Boot Camp 19
Capitalization of Earnings
The Present value of $300 into Perpetuity at a 20% required rate of return is equal to:
$300PV = .20 = $1,500
Boot Camp 20
Earning’s Adjustments
Normalization of Earnings Excessive Compensation Tax Strategies
Excessive lease expense paid to owners Personal expenses paid by the business
Non-Recurring Income or Expenses Extraordinary Income or Expenses
Boot Camp 21
Capitalization Models
Constant Growth Model
Projected Earnings Year 1Equity Cap. Rate - Growth Rate
All valuation models would add back surplus cash or undeveloped assets to the value of the cash flows.
Boot Camp 22
Constant Growth Model
What is the value of an equity stream projected to be $100 in year 1 and expected to grow at 10% per year assuming the investor’s required rate of return is 20%?
PV = $100 = $1,000 .20 - .10
Boot Camp 23
Equity Capitalization Rate
Required Rate of Return (Opportunity Cost) Risk Free Rate
Treasury Bill or Treasury Bond + Market Risk Premium + Unique Risk of the Company
Variability of Sales and Income, Small Firm Size Key Man, Lack of Succession, Concentration of
Sales Market and Financial Risk
Boot Camp 24
Equity Capitalization Rate
Risk Premium is based upon the analysis and experience of the appraiser. Assuming a risk free rate of 6%, then the equity cap rate with the risk premium would range:
Low risk 15% - 20% Medium Risk 20% - 30% High Risk 30% - 50%
Boot Camp 25
Discounted Cash Flow (DCF)
Firm FCF1 FCF2 FCF3 FCFn
Value = (1+r)1 + (1+r)2 + (1+r)3 +.... (1+r)n
Where FCF is “free cash flow and “r” is the required rate of return (weighted average cost of capital)
Market value of the debt is then subtracted from this firm value to arrive at the value of the equity of the company.
Boot Camp 26
Free Cash FlowT
NOPAT (EBIT x (1-T))+ Depreciation and Amortization- Increase in Net Working Capital*- Capital Expenditures
Free Cash FlowT
* Increase in W/C is the spontaneous assets and liabilities only (A/R, Inv, A/P and Acc. Exp), not CA-CL.
Boot Camp 27
Discounted Cash Flow Projected earnings or cash flow
Usually forecast 5 years into the future. Assume a residual value at the end of year 5
Can use the constant growth model or comparable value
YR 1 2 3 4 5 ResidualFCF $100 $200 $300 $400 $500 $5,500PVIF@20% .833 .694 .579 .482 .402 .402PV = $83 $139 $174 $193 $201 $2,211
DCF Firm Value = $3,001
Boot Camp 28
Residual Value
Residual Value was calculated as follows:
Year 5 FCF x (1+g) $ 500 x (1+.10) WACC - g .20 - .10
Residual Value = $5,500
Boot Camp 29
Discounts
Lack of Marketability Minority Interest Liquidity
Boot Camp 30
Lack of Marketability/Liquidity Discounts range from 10% to over 50%,
but studies of court cases found the average discount for lack of marketability is 35%. Thus, if the surrogate market value or capitalized value of the company were $1 million, the value after this discount would be $650,000 at 35% discount.
Do not use for book value technique.
Boot Camp 31
Minority Interest Discount
A minority block of stock is worth less than controlling interest since the minority stockholder can not influence the decisions of the company.
Conversely, a majority interest has more value than a minority interest and a control premium may be appropriate.
An additional discount (on top of the marketability discount) for minority shares should be applied.
Boot Camp 32
Minority Interest Discount
The discount for minority interest can range from 10% to 25%.
The combined discount for lack of marketability and a minority block of stock often total 50% to 60%.
This explains why publicly traded companies trade at higher multiples than small firms as they exhibit liquidity.
Boot Camp 33
Minority Interest Discount
When using comparable market value, the valuation benchmarks of public companies already assume a minority block of stock is trading so no discount is applied to comparable market value technique, but is applied to the capitalization of income technique.
Boot Camp 34
Venture Capital Method
Venture Capitalists generally will apply a comparable or industry price/earnings multiple (p/e ratio) to projected earning in year 5 (the exit point) to get a surrogate market value, then discount that value to the present at their required return (30-60+%).
This present value is the pre-money value and when added to the capital raised, produces the post-money valuation.