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.