Plan
Capture
Copyright © 2011 Business Performance Group, Inc.

You should have a good understanding of the following at this point:



• Accounting > General Ledger Accounts > Closing > Financial
Statements
• How to read and interpret financial statements – Balance Sheet,
Income Statement, and Statement of Cash Flows
• How to analyze financial statements – Horizontal, Vertical and Ratios
 • Return on Investment vs. Cost of Capital
 • Working capital management > Cash, Receivables, Inventory
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8. Which of the following is a real cost of doing business that gets ignored by accounting and financial statements?
a. Purchases b. Cost of Capital c. Non Operating Expenses d. Non Cash Flow Expenses
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9. The most common benefit stream used to assign value to a private business is: a. Net Income or Profits b. Current Cash on Hand c. Cash + Accounts Receivable d. EBITDA
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Module
10 Forecasting
Title
11
12
13
Risk Analysis
Economic Analysis
Ratio Models and
Economic Value Added
Purpose
Recognize the key steps for preparing a financial forecast
Understand the risk analysis process and how finance quantifies risk into estimates
Apply three indicators for evaluating long term investments
Identify 3 Ratio Models and how they can be used; Calculate Economic Value Added and apply it for measuring value
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Module
14
15
16
17
18
Title
Recap All Topics
Purpose
Private Capital
Intellectual Capital
Distinguish Public vs. Private Capital. Identify different transfer channels and how they differ in valuing a company
Recognize the importance of Intellectual Capital and its influence on value. Apply a 3M approach to 3 components
Performance Measurement Apply techniques for developing performance measurements
Non Financial Analysis Identify and apply several analytical models to analyzing a business
Recap key takeaways from this workshop
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Learning Objectives
• Identify the sequential steps with preparing a financial forecast
• Distinguish quantitative analysis from qualitative analysis
• Identify what an underlying driver behind a forecast is
• Calculate a forecast based on past historical data and assumptions (Exercise 14)
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127

1. Start with Sales – Volume of Expected Business (What is the under-lying driver?)
2. Establish Relationships – Quantitative Analysis
(Correlations are very important)
3. Qualitative Analysis – Confirm Changes with Experts
4. Convert Forecasts to Plans and Budgets
5. Execution of Financial Plan - Monitor and Adjust
Try to be flexible and iterative with this process since things will change!
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1. Start with Sales – How much volume of business do you expect to do?
2. Distinguish Cost – Variable vs. Fixed
3. Estimate Your Cost – Percent of Sales Method
4. For purposes of preparing Pro Forma or Forecasted Financial
Statements:
1. Forecasted Income Statement
2. Estimate your resources / assets to support the sales forecast
3. Forecasted Balance Sheet
4. External Financing Requirements
5. Forecasted Cash Flow
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Quantitative Analysis – Follow the numeric trend forward
Year Sales Percent
Change
2010
2011
2012
2013
2014
Forecast 2015
$ 1,230,000
$ 1,261,980
$ 1,297,315
$ 1,329,748
$ 1,364,321
?
+ 2.6%
+ 2.8%
+2.5%
+ 2.6%
Error on the conservative side and say 2015 will be 2.5% higher than 2014
$ 1,364,321 x 1.025 = $ 1,398,429 Forecasted Sales for 2015
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Sales
Variable Operating Cost
Fixed Operating Cost
Operating Income
Variable Non Operating
Fixed Non Operating
Net Income
$ 1,398,429
783,120
293,600
321,709
55,937
111,000
$ 154,772
Start here and work your way down!
Use Percent of
Sales Method for
Variable Cost
Look at your Horizontal and Vertical Analysis to confirm some of the relationships.
For example, suppose your Return on Sales has been 12% each year for the last
5 years, then Forecasted Net Income is $ 167,811
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Balance Sheet
Current Assets
Sales
$ 1,398,429
Percent
16%
Long Term Assets $ 1,398,429
Total Assets
Current Liabilities
Long Term Liabilities
Total Liabilities
$ 1,398,429
(Existing Balances in Place)
29%
11%
Retained Earnings
Other Equity
Total Equity
Additional Financing
(Ending Balance + Net Income)
(Ending Balances in Place)
$ 629,250 - $ 263,800 - $ 332,000
Amount
$ 223,750
$ 405,500
$ 629,250
$ 153,800
$ 110,000
$ 263,800
$ 255,000
$ 77,000
$ 332,000
$ 33,450
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Certain types of work may have relationships that you can use to forecast your costs. In the example below, we are using the Source Lines of Code as a key driver behind the cost to develop a new system:
Cost Estimate - Develop new Security System for Ajax Corporation
Sub System or
Module
SLOC
(thousands)
Level of
Complexity
Hours per
SLOC
Total Est
Hours
Avg Prog
Cost per Hour
Total
Cost
Inspection
Detection
Monitoring
Ad Hoc Reports
6,500
3,750
4,650
Low
Low
Low
2,090 Moderate
Key Parametric Relationships per past projects:
8.00
9.00
11.00
52,000
33,750
51,150
$
$
$
95.00
105.00
110.00
15.00
31,350 $ 145.00
Total Developmental Costs
Testing and Sign Off's 12% of Total Developmental Cost
Training and User Documentation 8% of Total Developmental Cost
SLOC = Source Lines of Code Total ROM Estimate
4,940,000
3,543,750
5,626,500
4,545,750
18,656,000
2,238,720
1,492,480
22,387,200
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You currently work as a Competitive Analyst for a retail drug chain.
You have been asked to provide some insights into prescription drug sales.
Senior leadership wants to know:
1. How much sales are attributable to prescription drugs?
2. What is the future outlook for growth with prescription drugs?
3. What factors are influencing prescription drug sales?
4. If you were to forecast prescription revenues for 2008 based on the average percentage increase for the last 3 years (2005 to
2007), what would this be?
HANDOUT: Use the 10-K Filing for Walgreens
Take ten minutes to complete this exercise
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See if you can answer the following questions about Kraft Foods:
1. What products seem to contribute most to sales revenues?
[see Page 3]
2. What contributes the most to the cost of coffee? [see 4 th paragraph on Page 6]
3. What are some of the factors that influence the prices paid for raw materials? [see 1 st paragraph on Page 7]
4. How do companies compete against one another? [see 2 nd paragraph on Page 12]
HANDOUT: Use the 10-K Filing for Kraft Foods
Take ten minutes to complete this exercise
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Find your template for Exercise 14 – Jacobs Engineering.
Sum up the components that derive your forecasted sales
Look at the trends and relationships described in Steps 2 and 3, apply these and complete the Forecasted Income
Statement template for Step 4
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Learning Objectives
• Distinguish a single point cost estimate from a three point or triangular distribution type estimate
• Identify the two important dimensions for rating risk
• Recognize how to setup a risk rating or scoring matrix
• Calculate the values for each point in a Triangular Distribution
• Recognize how to extract a budget value from a distribution table at different confidence intervals
• Identify some software tools that you can use for risk modeling
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4.0
4.1
4.2
4.3
3.0
3.1
3.2
3.21
3.22
3.23
3.3
3.4
3.5
3.6
WBS No.
1.0
1.1
1.2
1.3
WBS Description
Define Concept and Requirements
Process Study & Gap Analysis
User / Functional Requirements
Detail Requirements
2.0
2.1
2.2
2.21
2.22
2.23
2.24
2.3
Design Solutions
Preliminary Design
Prototype Testing and Refinement
Design Prototype Model
Conduct Testing
Design Demonstrations
Design Changes
Final Design
Develop Solutions
Software Programming
Hardware Installation
Mainframe Servers
Storage Devices
Switches & Network Equipment
Testing
Vulnerability Assessment
Demonstration
Final Release
Amount
110,000
45,000
35,000
30,000
77,000
26,000
36,000
10,000
6,000
8,000
12,000
15,000
75,500
30,000
17,000
8,500
4,600
3,900
6,500
4,000
8,000
10,000
Start with your best estimate of future cost and/or revenues. In this example, we have estimated next year’s project cost in terms of a work breakdown structure. These estimates have not been adjusted for risk.
Implement Solutions
Deploy to Critical Sites
Training and Support
Final Deployment
76,000
16,000
35,000
25,000
TOTAL PROJECT COSTS
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338,500
138

Module 10 –
Risk Analysis
We want to quantify risk into our cost estimate based on a rating assigned to each major component of cost
0
0
0
4
3
2
8
6
4
12
9
6
16
12
8
0
0
1
0
2
0
3
0
4
0
< - - - - - - - - - - - - - - - Impact - - - - - - - - - - - - - - - - >
None Low Moderate High Very High
0 1 2 3 4
Very High
High
Moderate
Low
None
4
3
2
1
0
No Risk Adjustment is Made
Low Risk Adjustment (scores of 1 to 2)
Medium Risk Adjustment (scores of 3 to 4)
High Risk Adjustment (scores of 6 to 9)
Very High Risk Adjustment (scores of 12 to 16)
Adjust the Cost Estimate: no adjustment is made range between -10% and +10% range between -10% and +50% range between -10% and +100% range between -10% and +200%
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Our best guess is that we will invest $ 338,500 in a new technology system. The investment is broken down into 4 major cost elements. We assessed risk using 5 weighted criteria.
Weighting >
Schedule Resources Technical
15% 25% 20%
Organiz
25%
Complex
15%
Major Cost Category Amount < - - - - - - - - - - - - - - - - - - Risk Scores - - - - - - - - - - - - - - - - >
Composite
Score
2
2
2
1
2
2
3
2
3
1
0
2
2
1
3
2
2
2
2
3
2.10
2.00
2.20
1.55
Define Concept and Requirements
Design Solutions
Develop Solutions
Implement Solutions
110,000
77,000
75,500
76,000
338,500
Composite
Score Adjust the Cost Estimate:
2
3
0
1
4 no adjustment is made range between -10% and +10% range between -10% and +50% range between -10% and +100% range between -10% and +200%
Low
10%
10%
10%
10%
High
10% These percentages are used to calculate the
50% ranges. The wider the range, the higher the
100% uncertainty.
200%
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The risk ratings establish a possible range of values:
Lowest Most Highest
Major Cost Category Value Likely Value
Define Concept and Requirements
Design Solutions
Develop Solutions
Implement Solutions
Total Project Cost
99,000
69,300
67,950
68,400
304,650
110,000
77,000
75,500
76,000
338,500
165,000
115,500
113,250
83,600
477,350
Next step is to run a simulation with these ranges. We will use Crystal Ball to run a Monte Carlo Simulation. Crystal Ball is an Excel Add On Program used for risk analysis and forecasting. The inputs are highlighted in Green and the
Output is highlighted in Blue.
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Forecast: Total Project Cost (cont'd)
Percentiles:
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Forecast values
323,460
346,848
355,332
361,753
366,424
371,590
377,372
383,241
390,971
400,741
439,205
Average or Mean Total Cost is $ 371,590
70% certain that our Total
Cost will be $ 383,241
Risk Adjusted Total Cost . . . $ 383,241
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Microsoft Excel lacks the capability for Monte Carlo Simulation, the technique used for Risk Analysis. Most finance professionals will use a program that facilitates Monte Carlo Simulation such as:
1.
Oracle Crystal Ball
2.
@RISK – Palisade ( http://www.palisade.com/risk/ ) (1)
3.
Vose ( http://www.vosesoftware.com/ )
4.
GoldSim ( http://www.goldsim.com/Home/ )
(1): Used in the Advanced Risk Management Class
Also see White Paper in your course notebook: Basic Cost Risk Analysis:
Using Crystal Ball on Government Life Cycle Cost Estimates
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Multiple Choice Question 10
10. An investment has estimated installation and fabrication cost of $ 600,000. The Cost Analyst has assigned a risk rating of 4 to this cost category. An uncertainty range for this risk rating is – 5% to + 50%. This implies that the lowest and highest possible values for this estimate are:
Lowest Highest a. $ 600,000 $ 700,000 b. $ 570,000 $ 900,000 c. $ 300,000 $ 900,000 d. $ - 0 $ 700,000
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Learning Objectives
• Distinguish Accounting from Finance
• Recognize the difference between Historical Value, Present Value and Future Value
• Identify the three economic criteria used for evaluating long-term investments
• Apply the concept of discounting for arriving at present values
• Calculate the Net Present Value of an investment
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Accounting
Historical Value (Looks Back)
Input = Transactions
Output = Financial Statements
Not Analytical (Process
Transactions)
Advocates Profits
Enforce Rules and Comply
Short Term Focus
Finance
Future Values (Looks Forward)
Input = Financial Statements,
Estimates, Analysis
Output = Forecasts, Budgets, etc.
Very Analytical
Advocates Creating Value
Few Rules / More Creative
Long Term Focus
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Historical
Values
Accounting
Constant Dollars – does not change over time
Present
Values
Future
Values
Finance
What is the value today?
What is the value tomorrow?
Why the differences in value (Accounting vs. Finance)?
1. Risk – I promise to pay you $ 100,000 five years from now!
2. Inflation - $ 100,000 five years from now will lose purchasing power!
3. Opportunity Cost – If you had $ 100,000 now (not five years from now), you could do something with it – lost opportunity!
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Three important economic indicators in finance:
1. Return on Investment – We discussed this earlier > Investors must earn a rate higher than the cost of capital; otherwise the investment is not attractive. [ We already covered this ]
2. Net Present Value – Discount the cash flows of both the costs and the benefits of the investment. The more positive the value, the more attractive the investment.
3. Discounted Payback Period – How long does it take for the investor to recover his investment. The shorter the payback, the more attractive the investment.
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You will need to estimate both your cost (cash outflows) and benefits (cash outflows) over the life cycle of the investment. These amounts need to be discounted to a Present Value. You can use tables for the discount factors:
Cash Outflow in Year 2 = $ (60,000)
Discount Factor @ 4% = x .925
Present Value Outflow $ (55,500)
Cash Inflow in Year 3 = $ 80,000
Discount Factor @ 4% = x .889
Present Value Inflow $ 71,120
Net Present Value $ 15,620
Period 1%
1 0.990
2 0.980
3 0.971
4 0.961
5 0.951
6 0.942
7 0.933
8 0.923
2% 3%
0.980
0.971
0.961
0.943
0.942
0.915
0.924
0.888
0.906
0.863
0.888
0.837
0.871
0.813
0.853
0.789
4%
0.962
0.925
0.889
0.855
0.822
0.790
0.760
0.731
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An investment in a new software program will eliminate over 100 hours per month of manual work. This investment requires an initial payment of $ 100,000 and $ 10,000 per year to maintain over a five year life:
End of
Year
2
3
4
5
0
1
Constant
Dollars
(Accounting)
$ (100,000)
$ (10,000)
$ (10,000)
$ (10,000)
$ (10,000)
$ (10,000)
Present Value
Factor
1.000
.909
.826
.751
.683
.621
Present
Dollars
(Finance)
$ (100,000)
$ (9,090)
$ (8,260)
$ (7,510)
$ (6,830)
$ (6,210)
1. Estimate your cost in constant dollars
2. Discount the constant dollars using a discount factor based on your cost of capital. Cost of Capital in example is 10%
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Based on cost savings from less time, we have quantified the benefits below over the life cycle of the investment:
0
1
2
3
4
5
End of
Year
Constant
Dollars
(Accounting)
$ 0
$ 35,000
$ 45,000
$ 50,000
$ 50,000
$ 50,000
Present Value
Factor
1.000
.909
.826
.751
.683
.621
Present
Dollars
(Finance)
$ 0
$ 31,815
$ 37,170
$ 37,550
$ 34,150
$ 31,050
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Now calculate the Net Present Values of the Cash Outflows and Inflows
End of
Year
2
3
4
5
0
1
Present Value
Outflows
$ (100,000)
(9,090)
(8,260)
(7,510)
(6,830)
Present Value
Inflows
$ 0
31,815
31,170
37,550
34,150
(6,210) 31,050
Net Present Value of Investment
Net
Present
Value
$ (100,000)
22,725
22,910
30,040
27,320
24,840
$ 27,835
If NPV is positive, adds value. If negative the investment destroys value for the company
$ 27,835 / $ 137,900 P.V. Cost = 20.2% ROI
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A simple economic indicator – when will I recover my investment and start to realize a return?
2
3
0
1
4
5
End of
Year
Net
Present
Value
Cumulative
NPV
$ (100,000) $ (100,000)
22,725 (77,275)
22,910
30,040
27,320
24,840
(54,365)
(24,325)
2,995
27,835
In this example, we reach payback in Year 4
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Refer to the Net Present Value template to complete this exercise. You will also need the Present Value of Lump Sum Amount Table for the discount factors.
1. Read and understand the investment as described on the template
2. Discount the Net Amounts back to a present value by finding the appropriate discount factors from the table.
3. Multiply the discount factors by the Net Amounts to arrive at present values.
4. Sum up the present values to arrive at Net Present Value
Take ten minutes to complete this exercise
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Learning Objectives
• Calculate key ratios that drive ROI per the Dupont Ratio Model
• Calculate a sustainable rate of growth for a business
• Calculate a score that indicates if a company is on the verge of bankruptcy
• Recognize why Economic Value Added is superior to Net Income in the world of finance
• Calculate Economic Value Added
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In order to understand what drives financial performance, you have to understand relationships. Many of these relationships can be expressed into a Ratio Model (DuPont Model):
R O I
Capital
Turnover
Invested
Capital
Sales
Profit
Margin
Net
Income
Long
Term
Assets
Working
Capital
Revenues Expenses
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Four key financial metrics are needed to calculate the
Sustainable Growth Rate (SGR):
P = Profit Margin on Sales after Taxes
R = Percent of Profits Returned Back to Owners
L = Debt to Equity Ratio
A = Asset to Sales Ratio
(P) (1-R) (1+L)
The SGR formula is:
A – (P) (1-R) (1+L)
Example:
P = .055
R = .333
L = .88
A = .73
(.055) (1 - .33) (1 + .88)
(.73) - (.055) (1 - .33) (1 +.88)
10.5%
Source: Analysis for Financial Management by Robert Higgins
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157

Very predictive of financial distress and bankruptcy:
Z Score = (1.2 x A) + (1.4 x B) + (3.3 x C) + (.6 x D) + (1.0 x E)
A = Working Capital / Total Assets
B = Retained Earnings / Total Assets
C = Earnings Before Interest & Taxes / Total Assets
D = Value of Equity / Book Value of Debt
E = Sales / Total Assets
Z Scoring Scale:
3.0 and Above = Company is OK for the next 12 months
Below 3.0 and Above 1.8 = Company is somewhat weak
Below 1.8 = Company is near bankruptcy
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54

Let’s go back to the Jacobs Financial Statements and our lesson on
Ratio Analysis.
Complete the Ratio Model template starting from the bottom and working your way up to the top
Key Point > The lower level drives the financial results above
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159

• Real Income of the Business is Economic
• Assets change in value over time
• Expenditures may provide future benefits (such as training or R & D)
• Economic Value Added (EVA) is the most popular approach to measuring economic income
• Economic Income or EVA correlates more closely with the value of a business vs. Net Income
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• Accounts for Cost of Capital as an Expense
• Measures the Value Added above your Cost of Capital
Rate
• Certain expenses, such as Research are not expensed, but capitalized over several years
• Certain investments not on the Balance Sheet, such as leased assets are included
• Economic Value Added (EVA) = Net Operating Profit after Taxes − (WACC × Capital Employed)
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161

Per the Balance Sheet:
Current Assets – Current Liabilities or Net Working Capital
Long Term Fixed Assets net of Depreciation
Sub Total – Capital Employed Reported
Not Recognized on the Balance Sheet :
Research and Development – New Products
Leadership Development Program
Global Marketing Program
Leased Assets not reported on the Balance Sheet
Sub Total – Capital Employed Adjustments
TOTAL CAPITAL EMPLOYED
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$ 120,000
640,000
760,000
135,000
38,000
55,000
26,000
254,000
$ 1,014,000
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Next, calculate a charge for your Capital Employed
:
Total Capital Employed
Weighted Average Cost of Capital
Cost of Capital Charge
$ 1,014,000
12.5%
$ 126,750
Expense recognized by Economic Value
Added, but not recognized in Accounting!
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Operating Revenues
Operating Expenses
Operating Income
Less Taxes @ 22%
Net Operating Profits After Taxes (NOPAT)
Less Cost of Capital Charge
ECONOMIC VALUE ADDED
$ 580,000
(362,000)
218,000
(47,960)
170,040
(126,750)
43,290
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Find the Exercise 16 Template – Economic Value Added
Complete the 2 Step Process:
1.
Calculate the Total Capital Deployed and the Cost of
Capital Charge
2.
Calculate Net Operating Profits After Taxes (NOPAT) and Economic Value Added
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Learning Objectives
• Distinguish Public vs. Private Capital Markets
• Identify different sources of capital for private companies
• Recognize how risk gets magnified and impacts the Cost of
Capital for a private company
• Recognize different valuations associated with transfer channels
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166

Public Capital
• Well organized, central market that is highly efficient
• Ready access to information and financials about the company
• Highly liquid market – easy to cash out the investment in a company
• Easy to assign value –
Market Capitalization =
Shares x Price of Stock
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Private Capital
• Not well organized, very decentralized
• Information and financials about the company is not readily available
• Not very liquid – unable to sell your ownership interest
• Value assigned depends upon the transfer channel
(see next slide)
167

Private business owners can sell their businesses different ways and each has its own value:
• Buy/Sell Asset Market Value
• MBO Investment Value
• ESOP
• Recap
Fair Market Value
Financial Market Value
$ 2.4 MM
$ 7.5 MM
$ 9.2 MM
$12.0 MM
• Auction Synergy Market Value $16.6 MM
• IPO Public Value $36.8 MM
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1. Friends and Family – Just starting the business; by far the most popular source of capital for new business owners
2. Angel Investors – Wealthy individuals who seek to invest in startups. Can also be useful as mentors to ensure success.
3. Venture Capital – For businesses that have high growth potential. Can be very expensive source of capital.
4. Mezzanine Financing – Debt financing that converts to equity. Usually can be obtained from equity type investors when a bank will not lend money.
5. Private Equity – Groups of investors who pool resources and help fund growing companies
6. Bank Loans – Stable, healthy businesses should establish lines of credit or seek loans to finance a specific project whose returns > cost debt
7. Asset Backed Financing – Borrow against the asset you are purchasing such as equipment
8. Factoring – Pledge highly marketable assets or receivables that are highly collectable to raise cash to meet increasing demand
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Wide Difference in Cost of Capital
Small vs. Mid Size vs. Large Public Companies: There is a wide difference in what each pays for equity financing since the risks vary so much
Small
Middle
50%
40%
30%
20%
10%
0%
Large
Debt Equity
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 Private Capital is much more diverse and dynamic compared to what everyone teaches in finance
 Private Companies must work hard to reduce risk to lower their Cost of Capital
 Private Companies should plan ahead for a potential exit and consider various transfer channels
 Where to learn more about Private Capital:
Private Capital Markets by Robert T. Slee
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Karl Miller owns a small private company. Karl is nearing 70 years old and needs to transfer his ownership. The business is run and managed by the employees, all of whom are very capable of operating the company. Karl trusts that these employees can continue to run the business. Which of the following transfer channels seems to fit best for transferring ownership?
a. Initial Public Offering of stock for the company b. Sell off all marketable assets of the business to outside parties c. Setup an Employee Stock Ownership Plan d. Attract and secure new equity investors to grow the company
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You are having trouble obtaining a loan from the bank to grow your business.
Your business has solid growth and can take on more debt which keeps your cost of capital low. You have an appointment to talk to a group of venture capitalist, but you would prefer to not give up any equity at this point in time.
Which of the following financing options should you consider arranging?
a. Management Buyout b. Mezzanine Financing c. Equity Recapitalization d. Auction Sale of the Business
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Learning Objectives
• Distinguish various definitions used, such as Intellectual Capital vs. Intellectual Property
• Identify specific components of Intellectual Capital
• Identify three common categories that can used to identify
Intellectual Capital
• Identify three comprehensive models that companies can use to measure and develop Intellectual Capital
• Distinguish the four layers that comprise the Balanced Scorecard
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Intellectual Capital – The total knowledge and expertise of a company. Often includes all non-physical / tangible assets not recognized on the financial statements
Intellectual Property – Legal rights obtained by creating something: Patents, Copyrights, and Trademarks. May not carry much value on the financial statements.
Intangible Assets – Includes Intellectual Property, but also includes Branding, Trade Secrets and Goodwill. May get assigned a fair value for financial reporting.
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Component
Loyal Customers
Motivated Workforce
Strong Leadership
Ability to Innovate
Efficient Processes
High Quality Service
Strategic Execution
Speed to Market
Know How
Description
Ability to retain and not lose customers
Your people are extremely productive
Company has direction and can change
New ideas are brought to market to increase sales
Extremely lean and efficient processes
Superior service compared to the competition
Company can execute at very high levels
Quick turn around on improvements – Market Share
Knowledge of markets, customers, trends,
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• Difficult to measure, not recognized in the Financial
Statements
• Unlike tangible / physical assets, very hard for the competition to replicate
• Unlike tangible / physical assets, can appreciate in value as opposed to depreciate
• All kinds of sources – People, Reputation, Creativity, etc.
• Increasingly, it is the biggest source of market value for companies
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Identify and Measure
Intellectual Capital
Three major components of Intellectual Capital (IC):
Major IC
Category
Human Capital
IC Description
Value of a business that is contained in the skills, abilities and talents of its people.
Measure to Grow
(Appreciate IC)
Level of Competency,
Level of Experience,
Advanced Certifications
Organizational
Capital
Value of a business that is contained in the processes, systems, patents, trademarks, reputation, innovation, etc.
Process Turn Around
Times, % of Innovative
Ideas Implemented, # of
Patents Licensed, etc.
Relational Capital Value of a business contained in its relationships with customers, suppliers, other businesses, government, etc.
Customer Retention
Rate, Satisfaction
Surveys, Supply Chain
Metrics with Vendors,
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Balanced Scorecard – Four Perspectives: Financial, Customer,
Process, and Internal Growth
Intangible Assets Monitor – Three Indicator Areas: External
Structure (Supply Chain, Customer Relationships), Internal Structure
(IT Systems, Org Structure, Culture), and Individual Competencies
(Leadership, Skills, Experience)
Skandia Navigator – Five Focus Areas: Financial, Customer, Human
Resource, Process, and Renewal & Development
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Module 11 –
Advanced
Concepts
Culture – Denison Model Leadership – LPI Model www.denisonconsulting.com
www.leadershipchallenge.com
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Find the Annual Supplement for Skandia titled: Value Creating Processes
Read the following pages and see if you can answer these questions:
1. Per Page 4, other than human capital, what are some of the other major categories of intellectual capital for Skandia?
2. Per Pages 4 to 5, what role does technology play in helping Skandia develop its intellectual capital?
3. Per Page 9, how does Skandia measure the efficiency of reaching out and contacting customers?
4. Per Page 13, how does Skandia use Activity Based Costing?
5. Per Page 14, how does Skandia use Economic Value Added?
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Learning Objectives
• Identify the three major types of performance measurements
• Identify the cause effect relationship between different measurements
• Distinguish the relative importance or weight of different measurement types
• Identify three criteria you can use to help develop a good performance measurement
• Identify three different ways of expressing performance
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Three types of performance measurements: Inputs, Outputs and
Outcomes:
1. Inputs – What you need
(money, people, location, startup conditions, etc.)
2. Outputs –
What we deliver
(products and services)
3. Outcomes –
What are our results? (happy customers, increasing profits, etc.)
Inputs
Percentage of funds raised
Percentage of Open Positions Filled
Location has been Secured
Percentage of Startup Conditions Met
Timing is Right
Outputs
Number of deliveries made
Percentage of Orders Filled
Percentage of Calls Answered < 5 min
Percentage of Capacity Used
Volume of Products Produced
Outcomes
Customer Satisfaction Rating
Employee Retention Rate
Percentage Change in Profits
Sales Margin by Product
Brand Recognition Survey Results
Percent of Market Share
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Inputs
Lead
% of Staff Positions filled
# of proposal teams
Lag
Outputs
Total hours billed out
# of proposals submitted
Lead Lag
Outcomes
Project Revenue
New Contract Awards
# of applications submitted
# of trouble tickets called in per day
# of marketing flyers distributed
# of applications processed
# of tickets closed per day
# of inquiries logged by
Sales Rep’s
Applicants Hired
% of problems resolved first time < 30 minutes
% of inquiries converted into paying customers
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Balanced Scorecard –
Cause Effect
Financial Perspective - Select measurements based on one of three stages:
Early Stage Company (High
Growth)
Revenue Growth
Positive Earnings
Sales Growth Rate
_______________________
_______________________
Sustainable Stage Company
(Modest Growth)
Operating Income
Return on Capital
Gross Margins
_______________________
_______________________
Mature Stage Company (Slow
Growth)
Cash Flows
Economic Value Added
Cash Value Added
_______________________
_______________________
Outcome
Enabler
Customer Perspective - Select objectives based on values provided to customers:
< - - - - - - - Value Attributes - - - - - - - >
Quality Price Time Function
Image Relationships
Internal Processes Perspective - Select objectives from three categories:
Innovation Process
- New products and services
Operating Process
- Efficient production
- New features existing products - Timely delivery
- Unique solutions - Quality products
- Fast turnaround to market - Cost management
Service Process
- Service after the sale
- Resolve problems first time
- Proactive & Timely Followup
- Flexibility / Personal Touch
_________________________ _________________________ _________________________
Learning & Growth Perspective - Select objectives from three categories:
Employee Competencies Knowledge & Technology
- Improve employee satisfaction - Leverage technologies
- Retain key personnel
- High employee productivity
- Continuous training
Company Culture
- Empower the workforce
- Implement best practices - Set accountability standards
- Protect critical assets - Align employees to objectives
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- Easy access to information - High morale & motivation
Outcome
Enabler
Outcome
Enabler
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Easy to Measure and Execute
(Important)
Performance measurements are not considered equal:
Quantitative Qualitative
Specific, Quantifiable
Numbers (Hard)
Descriptive,
Revealing (Soft)
Inputs 5 %
Least Significant
9 %
Easy to Measure and More Difficult
(Very Important)
Outputs 14 % 19 %
Difficult to Measure and Execute (Most
Important)
Outcomes 24 %
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Most Significant
29 %
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Regardless of what type of performance measurement you are dealing with, all performance measurements should:
1. Relevant
Does the measurement fit with the performance objective?
Objective : Need to have five volunteers in place by October 1st
Measure : Number of volunteers in place
2. Measurable
Can you collect the data and report a measurement that makes sense?
3. Actionable
Can you act on the measurement in a timely way to correct and improve what is happening?
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Numeric
Easy to Measure and
Report
Percentages
Relatively easy to Measure and Report
May not be very insightful in understanding performance
More insightful in understanding performance
Commonly used for inputs and outputs
Used for inputs, outputs, and outcomes
Ratios
Relatively easy to Measure and Report
Very meaningful and useful for comparative benchmarking
Used for inputs, outputs, and outcomes
EXAMPLES:
EXAMPLES:
EXAMPLES:
# of volunteers available
# of workshops conducted
# of donors solicited
# of grant applications submitted
% of participants who made pledges
% of budget used for outside help
Total Funds Raised to Total
Costs
Average Donation per
Donor % of association members renewing
Volunteer to Donor Ratio
Total Funds Raised to Total
Days Required
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You may want to use a template to organize and catalog all of your performance measurements:
Step 1: Define a measurement for each strategic objective:
Strategic Objective =>
Measurement to be used =>
Description of Measurement =>
Units of Measurement ($,%,etc)
Update Frequency => ___ Monthly ___ Quarterly ___ Yearly ___ Other
Step 2: Define the sources for the measurement:
Internal documents / reports
External documents / reports
Special studies
Programs
Databases
Other ______________________________________
Step 3: Define how the measurement is derived and reported:
Calculation Required: _______________________________________________
Assumptions in Calculation: _________________________________________
Availability of Data:
Currently Available
Requires some research
Not Available at this time
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It’s OK to measure inputs and outputs, but ultimately you want to measure what type of performance?
a. Throughput b. Outcome c. Variance d. Average
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14. An online mail order company has the following strategic objective: All orders will be shipped within 5 days of the order receipt date.
Which of the following performance measurements is the best fit with this strategic objective?
a. Number of Orders Shipped per Day b. Percent of Orders Processed in under 24 hours c. Percent of Orders Shipped in under 5 days d. Ratio of Orders Shipped to Orders Received
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Learning Objectives
• Identify six analytical models that can help answer critical business questions
• Distinguish the four components of SWOT
• Identify techniques that can help with portfolio management of the business
• Identify two techniques that can be used to help identify the root cause of a problem
• Identify a simple three step approach you can take for solving any type of problem and then plug in the analytical models that fit
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Try to become proficient with analysis below the financial area since non-financial activities drive the financial results. It helps to know how to analyze the non financial parts of the business.
Financial
Horizontal
Analysis
Vertical
Analysis
Ratio
Analysis
Cost of
Capital
Previously
Discussed
Non
Financial
SWOT
PEST /
STEEP
Porter’s
Five Forces
Boston
Growth
Share
GE
Business
Screen
Pareto
Chart
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What are you trying to solve?
What is our current situation?
What is external factors influence our business?
How does my industry work?
How well do we manage our products / services?
What are the most important issues?
What is causing this problem?
Appropriate Analytical
Model to Use:
1. SWOT
2. PEST / STEEP
3. Porter’s Five Forces
4. Boston Growth Matrix
5. Pareto Analysis
6. Root Cause Analysis
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Most popular analytical model for assessing your situation – very useful for strategizing. Easy to understand & comprehensive.
Internal Assessment of the organization, its people, services, competencies, etc.
Strengths
Client has a global infrastructure to service all types of customers
Services are in high demand in most parts of the world
Weaknesses
Client has limited resources for expanding its global reach
Key processes are not very cost competitive when compared to other service providers
External Assessment of direct and indirect forces, social, economic, political, etc.
Opportunities
Untapped demand exists in almost half of the World
New Technologies make it possible to expand service reach
Threats
Other clients are investing in newer technologies
Some clients are entering into strategic partnerships to expand their global footprint
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Overall scan of the environment that you operate in – these outside forces can have big impacts on your company.
Political – Pressure and changes brought on by government and elected officials.
Economic – Economic variables such as economic supply and demand, inflation, interest rates, economic conditions, exchange rates, and economic policies.
Social – Social beliefs, values, lifestyles, demographics, and other social factors impact the organization.
Technology – Changes brought on by technology such as the internet, new production methods, high-tech products, and other innovations.
A much broader model called SPECTACLES is explained in the book:
Mastering the Business Environment. Additions include Customer,
Culture and Aesthetics.
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If you understand these forces, then you understand your industry!
1.
New Entrants – High profitability attracts new entrants.
Every industry has its own unique barriers to entry. High barriers keeps competition out. Example: Manufacturer of
Computer Chips vs. Gift Shop.
2.
Power of Suppliers – Source for raw materials, labor, and tangible property. Usually has very limited power or influence unless the supplier has very specialized resources such as medical devices.
3.
Power of Buyers – Customers can exert influence by pushing prices down. You lose power when you are captive to a single or few number of customers.
4.
Substitutes – Degree to which you can substitute for another product from another company, such as when you buy food or gasoline. Not easy to substitute if the product is very unique such as iPod or Swatch.
5.
Competition – The other four forces shape the existing competition and your competitors can exert influence within the industry. They can advertise why their products are better or copy and improve on what you are offering.
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Very popular model for evaluating your product or service offerings. Goal is to maximize market share for high growth products and not waste resources on products that have no potential future.
1. Stars – Products with high growth rates and strong market position. Want to invest heavily and grow these aggressively.
2. Question Marks – Products with high growth rates, but market share is small.
Invest heavily, but monitor closely to see if you can secure solid market share. Goal is to move these to the Star category.
3. Cash Cows – Products are mature and not growing, but they have a very secure and steady market. Invest modestly to sustain.
4. Dogs – Products with low market share and very low growth. Hard to sustain
–
Unless you can grow and improve, you
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Quantifies what is most important onto a graph. Need to group problems or issues (Categories) and then plot the frequency
(Measure). Helps improve focus:
Allocate your limited resources to this for maximum impact
Categories
Causes, Products, Mfg. Lines, Operators
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Five Whys refers to the practice of asking, five times, why the problem exists in order to get to the root cause of the problem
Employee turnover rate has been increasing
Why?
Why?
Why?
Why?
Why?
Employees are leaving for other jobs
Employees are not satisfied
Employees feel that they are underpaid
Other employers are paying higher salaries
Demand for such employees has increased in the market
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The value of the Fishbone Diagram is that it provides a method for categorizing the many potential causes of problems or issues in an orderly way and in identifying root causes
Cause Cause
Detail Detail
Result (Problem)
Detail
Cause Cause
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Past Present
1
Situational
Analysis
Future
2
Problem
Analysis
Why is this happening?
What is happening now?
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Decision
Analysis
What are our alternatives and what is the best decision?
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15. If you want to better understand your respective industry, a good analytical model to use is: a. SWOT – Strengths Weaknesses Opportunities Threats b. Pareto Analysis c.
Porter’s Five Forces d. Root Cause Analysis
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One easy way of conducting root cause analysis is to simply: a. Use some form of simulation modeling b. Initiate an environmental scan using PEST or STEEP c. Ask why five times d. Apply a SWOT to the situation
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Quadrant Systems is a small minority owned business that provides vulnerability assessments of IT systems in the private sector. Quadrant would like to secure new business in the federal public sector space. Quadrant has a good reputation with its existing customers, but lacks a contract vehicle (such as a GSA MOBIS
Schedule). Quadrant also has a very highly trained and loyal workforce. The level of competition is extremely intense and winning proposals must be both low price and technically acceptable (LPTA). The company is in good financial condition, well managed, but has no partnerships with other companies in the Washington D.C. area. The demand for vulnerability type work is growing rapidly in the federal public sector. Additionally, the world of contract vehicles is under a lot of change as various agencies stand up their own contract vehicles and the GSA continues to evolve how contracts are structured and awarded.
What strengths, weaknesses, opportunities, and threats do you see for
Quadrant Systems?
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• Economic Analysis
1.
Applies to long term investments – new systems, new marketing program, acquire another business, etc.
2.
Estimate cash inflows and outflows over life of investment
3.
Apply three economic criteria:
1.
Net Present Value – How much is this investment worth
2.
Return on Investment – What return do we earn
3.
Discounted Pay Back – When do I recover my investment and start to earn a pay back
4.
Use present values – Discount future estimates back to the present, use a discount rate that reflects the rate of financing the investment or if internally funded, then use your Cost of Capital for the company
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Sequential Steps for Financial Forecasting
1.
Look back and estimate your future sales for the next period. Five Year
Trends provide an element of truth.
2.
Qualify your estimate
– get confirmation from senior management, marketing and other people
3.
Prepare a Forecasted Income Statement
4.
Estimate all resources required to support your Sales Forecast
• Good forecasting is based on key drivers behind your Revenues and
Expenses
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• Monte Carlo Simulation – Used to estimate values at different confidence intervals per Triangular Distribution
• Assign risk ratings to what you are estimating – More risk equates to wider range of values
• Select at least the 50% Confidence Level to start with
• Difference between your Single Point Cost Estimate and
Selected Value = Contingency Reserve (Risk Adjusted
Estimate)
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• DuPont ROI Model – Gives you insights into what financial levers will increase the ROI for investors / owners in the business
• Sustainable Growth Model – Based on the financial, grow sales revenues at this rate to sustain the growth over time
• Z Score – Apply this model if the company is experiencing financial distress
• Economic Value Added – Removes distortions that are present in the Accounting Model
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• Private Companies should plan ahead for an exit or transfer of ownership well in advance
• Several exit channels and each has its own valuation
• Private Companies have very high cost of capital which many business owners are not aware of
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• Very important driver of value now (Google, Apple, etc.).
This is what investors are looking for
• IC has many forms – leadership, talent, reputation, knowledge, etc.
• Measure to Manage to Maximize the Value
• Start with the three major types of IC: Human (People),
Organizational (Systems, Process), and Relational
(Customer)
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• 3 Types: Inputs, Outputs and Outcomes. Try to put focus on outcomes with outputs and inputs as the lead or driver
• Understand cause effect relationships – Build a tight model for measuring performance
• Percentages are a good way of expressing performance
(such as % increase in Sales)
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• SWOT – Most popular analytical model for analyzing a business. Straight forward and easy to use.
• Don’t forget environmental scans – companies are often too internally focused. Common frameworks are PEST /
STEEP. Also attend trade shows and other events.
• Look at your business through a Portfolio View: Boston
Consulting Matrix and GE Matrix
• Root Cause Analysis to Solve Problems . Do the 5
Whys
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The Guide to Understanding Financial Statements by S. B. Costales and
Geza Szurovy
How to Use Financial Statements: A Guide to Understanding the Numbers by James Bandler
Annual Reports 101 by Michael C. Thomsett
Financial Statements: A Step by Step Guide to Understanding and
Creating Financial Reports by Thomas Ittelson
Finance and Accounting for Non Financial Managers by Samuel C.
Weaver and J. Fred Weston
Essentials of Finance and Accounting for Non Financial Managers by
Edward Fields
The Accounting Game: Basic Accounting Fresh from the Lemonade Stand by Darrell Mullis and Judith Orloff
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Sources for Financial Analysis : www.onesource.com
– Combines over 20 sources to generate company profiles and financial reports www.capitaliq.com
– Provides a set of tools to conduct financial analysis on over
500,000 companies.
Quick Learning Sites : www.accountingcoach.com
www.accountingaide.com
www.simplestudies.com
http://www.almaris.com/fact/fact-contents.htm
- Financial Accounting Tutor http://bizzer.com/images/Financial/index.html
- Understanding Financial
Statements http://www.mcisaac.co.uk/downloads/Web-Financial-Statements.pdf
-
Understanding Annual Reports
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Please complete the course evaluation before you leave!
I will now go get your Certificates of
Completion – please take this as you leave!
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