Financial Mgmt Day 2 (2015-08-29) r1

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Plan
Capture
Finance for Non Financial Managers
Perform
Copyright © 2011 Business Performance Group, Inc.
Any Questions from Day 1?
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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Multiple Choice Question 8
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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Multiple Choice Question 9
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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Day 2 Agenda
Module
Title
Purpose
10
Forecasting
Recognize the key steps for preparing a
financial forecast
11
Risk Analysis
Understand the risk analysis process and how
finance quantifies risk into estimates
12
Economic Analysis
Apply three indicators for evaluating long term
investments
13
Ratio Models and
Economic Value Added
Identify 3 Ratio Models and how they can be
used; Calculate Economic Value Added and
apply it for measuring value
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Day 2 Agenda – continued
Module
Title
Purpose
14
Private Capital
Distinguish Public vs. Private Capital. Identify
different transfer channels and how they differ
in valuing a company
15
Intellectual Capital
Recognize the importance of Intellectual Capital
and its influence on value. Apply a 3M approach
to 3 components
16
Performance Measurement Apply techniques for developing performance
measurements
17
Non Financial Analysis
Identify and apply several analytical models to
analyzing a business
18
Recap All Topics
Recap key takeaways from this workshop
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Module 10 - Financial Forecasting
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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Keys to
Financial Forecasting
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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Some Basic Steps - Forecasting
1.
2.
3.
4.
Start with Sales – How much volume of business do you expect to do?
Distinguish Cost – Variable vs. Fixed
Estimate Your Cost – Percent of Sales Method
For purposes of preparing Pro Forma or Forecasted Financial
Statements:
1.
2.
3.
4.
5.
Forecasted Income Statement
Estimate your resources / assets to support the sales forecast
Forecasted Balance Sheet
External Financing Requirements
Forecasted Cash Flow
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5 Year Look Back –
Good Starting Point
Quantitative Analysis – Follow the numeric trend forward
Year
Sales
Percent
Change
2010
$ 1,230,000
2011
$ 1,261,980
+ 2.6%
2012
$ 1,297,315
+ 2.8%
2013
$ 1,329,748
+2.5%
2014
$ 1,364,321
+ 2.6%
Forecast 2015
?
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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Fill in the Blanks –
Forecasted Income Statement
Sales
Variable Operating Cost
$ 1,398,429
783,120
Fixed Operating Cost
Operating Income
Variable Non Operating
293,600
321,709
55,937
Fixed Non Operating
Net Income
Start here and work
your way down!
Use Percent of
Sales Method for
Variable Cost
111,000
$ 154,772
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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Next Step –
Forecast Asset Requirements
Balance Sheet
Sales
Percent
Amount
Current Assets
$ 1,398,429
16%
$ 223,750
Long Term Assets
$ 1,398,429
29%
$ 405,500
Total Assets
Current Liabilities
$ 629,250
$ 1,398,429
Long Term Liabilities
11%
(Existing Balances in Place)
Total Liabilities
$ 110,000
$ 263,800
Retained Earnings
(Ending Balance + Net Income)
Other Equity
(Ending Balances in Place)
Total Equity
Additional Financing
$ 153,800
$ 255,000
$ 77,000
$ 332,000
$ 629,250 - $ 263,800 - $ 332,000
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$ 33,450
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Drivers behind IT project costs
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
Inspection
Detection
Monitoring
Ad Hoc Reports
SLOC
(thousands)
6,500
3,750
4,650
2,090
Level of
Complexity
Low
Low
Low
Moderate
Hours per
SLOC
8.00
9.00
11.00
15.00
Total Est
Hours
Avg Prog
Cost per Hour
52,000 $
95.00
33,750 $
105.00
51,150 $
110.00
31,350 $
145.00
Total Developmental Costs
Total
Cost
4,940,000
3,543,750
5,626,500
4,545,750
18,656,000
Key Parametric Relationships per past projects:
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
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ROM = Rough Order
of toMagnitude
2,238,720
1,492,480
22,387,200
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Exercise 12 – 10-K Filing
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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Exercise 13 – 10-K Filing
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 4th
paragraph on Page 6]
3. What are some of the factors that influence the prices paid for
raw materials? [see 1st paragraph on Page 7]
4. How do companies compete against one another? [see 2nd
paragraph on Page 12]
HANDOUT: Use the 10-K Filing for Kraft Foods
Take ten minutes to complete this exercise
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Exercise 14 – Forecast Income Statement
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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Module 11 – Risk Analysis
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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Single Point Estimate
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
77,000
26,000
36,000
10,000
6,000
8,000
12,000
15,000
3.0
3.1
3.2
3.21
3.22
3.23
3.3
3.4
3.5
3.6
Develop Solutions
Software Programming
Hardware Installation
Mainframe Servers
Storage Devices
Switches & Network Equipment
Testing
Vulnerability Assessment
Demonstration
Final Release
75,500
30,000
17,000
8,500
4,600
3,900
6,500
4,000
8,000
10,000
4.0
4.1
4.2
4.3
Implement Solutions
Deploy to Critical Sites
Training and Support
Final Deployment
76,000
16,000
35,000
25,000
TOTAL PROJECT COSTS
Amount
110,000
45,000
35,000
30,000
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.
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338,500
138
Module 10 –
Risk Analysis
Higher Risk = Wider Range
Probability
We want to quantify risk into our cost estimate based on a
rating assigned to each major component of cost
0
4
8
12
16
0
3
6
9
12
0
2
4
6
8
0
1
2
3
4
0
0
0
0
0
< - - - - - - - - - - - - - - - Impact - - - - - - - - - - - - - - - - >
None
Low
Moderate
High
Very High
0
1
2
3
4
Very High
High
Moderate
Low
None
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)
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4
3
2
1
0
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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Example of how this works
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.
Schedule Resources Technical
Organiz
Complex
Weighting >
Major Cost Category
Define Concept and Requirements
Design Solutions
Develop Solutions
Implement Solutions
Composite
Score
0
1
2
3
4
15%
Amount
110,000
77,000
75,500
76,000
338,500
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%
25%
20%
25%
15%
Composite
Score
< - - - - - - - - - - - - - - - - - - Risk Scores - - - - - - - - - - - - - - - - >
2
1
2
2
3
2
2
2
Low
10%
10%
10%
10%
0
2
3
1
3
2
2
1
2
3
2
2
2.10
2.00
2.20
1.55
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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Distribution of Possible Values
The risk ratings establish a possible range of values:
Major Cost Category
Define Concept and Requirements
Design Solutions
Develop Solutions
Implement Solutions
Total Project Cost
Lowest
Value
99,000
69,300
67,950
68,400
304,650
Most
Likely
110,000
77,000
75,500
76,000
338,500
Highest
Value
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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Simulation Results
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
End of Forecasts Total Cost . . . . . $ 338,500
Unadjusted
Risk Adjusted Total Cost . . . $ 383,241
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Software Programs and
White Paper
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.
2.
3.
4.
Oracle Crystal Ball
@RISK – Palisade (http://www.palisade.com/risk/) (1)
Vose (http://www.vosesoftware.com/)
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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Module 12 – Economic Analysis
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 vs. Finance
Accounting
Finance
Historical Value (Looks Back)
Future Values (Looks Forward)
Input = Transactions
Input = Financial Statements,
Estimates, Analysis
Output = Financial Statements
Output = Forecasts, Budgets, etc.
Not Analytical (Process
Transactions)
Very Analytical
Advocates Profits
Advocates Creating Value
Enforce Rules and Comply
Few Rules / More Creative
Short Term Focus
Long Term Focus
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Present and Future Values
Accounting
Historical
Values
Finance
Constant Dollars –
does not change
over time
Present
Values
What is the value
today?
Future
Values
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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Economic Analysis – Three Indicators
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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Discount Factor –
Convert $ to Present Values
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%
2%
3%
4%
1
0.990
0.980
0.971
0.962
2
0.980
0.961
0.943
0.925
3
0.971
0.942
0.915
0.889
4
0.961
0.924
0.888
0.855
5
0.951
0.906
0.863
0.822
6
0.942
0.888
0.837
0.790
7
0.933
0.871
0.813
0.760
8
0.923
0.853
0.789
0.731
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Example –
Start with Cash Outflows
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
Constant
Dollars
(Accounting)
Present Value
Factor
Present
Dollars
(Finance)
0
$ (100,000)
1.000
$ (100,000)
1
$ (10,000)
.909
$ (9,090)
2
$ (10,000)
.826
$ (8,260)
3
$ (10,000)
.751
$ (7,510)
4
$ (10,000)
.683
$ (6,830)
5
$ (10,000)
.621
$ (6,210)
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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%
150
Step 2 – Discount the Benefits
Cash Inflows
Based on cost savings from less time, we have quantified the benefits below
over the life cycle of the investment:
End of
Year
Constant
Dollars
(Accounting)
Present Value
Factor
Present
Dollars
(Finance)
0
$0
1.000
$0
1
$ 35,000
.909
$ 31,815
2
$ 45,000
.826
$ 37,170
3
$ 50,000
.751
$ 37,550
4
$ 50,000
.683
$ 34,150
5
$ 50,000
.621
$ 31,050
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Step 3 – Calculate the
Net Present Values
Now calculate the Net Present Values of the Cash Outflows and Inflows
End of
Year
Present Value
Outflows
Present Value
Inflows
Net
Present
Value
0
$ (100,000)
$0
$ (100,000)
1
(9,090)
31,815
22,725
2
(8,260)
31,170
22,910
3
(7,510)
37,550
30,040
4
(6,830)
34,150
27,320
5
(6,210)
31,050
24,840
Net Present Value of Investment
$ 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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Discounted Payback
A simple economic indicator – when will I recover my
investment and start to realize a return?
End of
Year
Net
Present
Value
Cumulative
NPV
0
$ (100,000)
$ (100,000)
1
22,725
(77,275)
2
22,910
(54,365)
3
30,040
(24,325)
4
27,320
2,995
5
24,840
27,835
In this example, we reach
payback in Year 4
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Exercise 11 - Net Present Value
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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Module 13 – Ratio Models and EVA
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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ROI and the Root Drivers
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):
ROI
Capital
Turnover
Invested
Capital
Long
Term
Assets
Working
Capital
Profit
Margin
Sales
Net
Income
Revenues
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Expenses
156
Sustainable Growth Rate
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)
10.5%
(.73) - (.055) (1 - .33) (1 +.88)
Source: Analysis for Financial Management by Robert Higgins
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Z Score
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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Exercise 15 – DuPont Ratio Model
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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Economic Income vs. Net Income
• 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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Key Points with EVA
• 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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Step 1 – Calculate Capital Employed
Per the Balance Sheet:
Current Assets – Current Liabilities or Net Working Capital
Long Term Fixed Assets net of Depreciation
Sub Total – Capital Employed Reported
$ 120,000
640,000
760,000
Not Recognized on the Balance Sheet:
Research and Development – New Products
135,000
Leadership Development Program
38,000
Global Marketing Program
55,000
Leased Assets not reported on the Balance Sheet
26,000
Sub Total – Capital Employed Adjustments
254,000
TOTAL CAPITAL EMPLOYED
$ 1,014,000
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Step 2 - Calculate Capital Charge
Next, calculate a charge for your Capital Employed:
Total Capital Employed
$ 1,014,000
Weighted Average Cost of Capital
Cost of Capital Charge
12.5%
$ 126,750
Expense recognized by Economic Value
Added, but not recognized in Accounting!
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Step 3 – Deduct Capital Charge from NOPAT
Operating Revenues
$ 580,000
Operating Expenses
(362,000)
Operating Income
Less Taxes @ 22%
218,000
(47,960)
Net Operating Profits After Taxes (NOPAT)
Less Cost of Capital Charge
ECONOMIC VALUE ADDED
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170,040
(126,750)
43,290
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Exercise 16 – Calculate EVA
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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Module 14 – Private Capital
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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Public Capital vs.
Private Capital
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
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)
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Different Values for Private Company –
Exit Transaction
Private business owners can sell their businesses
different ways and each has its own value:
•
•
•
•
•
•
Buy/Sell
MBO
ESOP
Recap
Auction
IPO
Asset Market Value
Investment Value
Fair Market Value
Financial Market Value
Synergy Market Value
Public Value
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$ 2.4 MM
$ 7.5 MM
$ 9.2 MM
$12.0 MM
$16.6 MM
$36.8 MM
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Wide Range of
Sources for Capital
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
Expected Returns
50%
Middle
40%
30%
20%
Large
10%
0%
Debt
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Equity
170
Start with the motives of the business owner . .
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In Summary - Key Points
 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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Multiple Choice Question 11
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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Multiple Choice Question No. 12
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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Module 15 – Intellectual Capital
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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Overlapping Terminology
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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Intellectual Capital =
All Types of Intangibles
Component
Description
Loyal Customers
Ability to retain and not lose customers
Motivated Workforce
Your people are extremely productive
Strong Leadership
Company has direction and can change
Ability to Innovate
New ideas are brought to market to increase sales
Efficient Processes
Extremely lean and efficient processes
High Quality Service
Superior service compared to the competition
Strategic Execution
Company can execute at very high levels
Speed to Market
Quick turn around on improvements – Market Share
Know How
Knowledge of markets, customers, trends,
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Characteristics of
Intellectual Capital
• 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
IC Description
Measure to Grow
(Appreciate IC)
Human Capital
Value of a business that is
contained in the skills, abilities
and talents of its people.
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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Comprehensive Models for
Measuring Intellectual Capital
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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Balanced Scorecard
Very Popular Framework
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Module 11 –
Advanced
Concepts
Models for Growing IC Components
Culture – Denison Model
www.denisonconsulting.com
Leadership – LPI Model
www.leadershipchallenge.com
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Exercise 17 – IC Annual Report
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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Module 16 –
Developing Performance Measurements
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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Inputs, Outputs and Outcomes
Three types of performance measurements: Inputs, Outputs and
Outcomes:
1. Inputs – What
you need
(money, people,
location, startup
conditions, etc.)
3. Outcomes –
What are our
results? (happy
customers,
increasing
profits, etc.)
2. Outputs –
What we deliver
(products and
services)
Inputs
Outcomes
Outputs
Percentage of funds raised
Percentage of Open Positions Filled
Location has been Secured
Percentage of Startup Conditions Met
Timing is Right
Number of deliveries made
Percentage of Orders Filled
Percentage of Calls Answered < 5 min
Percentage of Capacity Used
Volume of Products Produced
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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Making the Connection Cause Effect Analysis
Lead
Inputs
Lag
Lead
Lag
Outputs
Outcomes
% of Staff Positions filled
Total hours billed out
Project Revenue
# of proposal teams
# of proposals submitted
New Contract Awards
# of applications submitted
# of applications processed
Applicants Hired
# of trouble tickets called
in per day
# of tickets closed per day
% of problems resolved first
time < 30 minutes
# of marketing flyers
distributed
# of inquiries logged by
Sales Rep’s
% 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
Outcome
Enabler
Internal Processes Perspective - Select objectives from three categories:
Innovation Process
- New products and services
- New features existing products
- Unique solutions
- Fast turnaround to market
_________________________
Operating Process
- Efficient production
- Timely delivery
- Quality products
- Cost management
_________________________
Service Process
- Service after the sale
- Resolve problems first time
- Proactive & Timely Followup
- Flexibility / Personal Touch
_________________________
Outcome
Enabler
Learning & Growth Perspective - Select objectives from three categories:
Employee Competencies
- Improve employee satisfaction
- Retain key personnel
- High employee productivity
- Continuous training
Knowledge & Technology
Company Culture
- Leverage technologies
- 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
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Weighting the Metrics
Performance measurements are not considered equal:
Easy to Measure
and Execute
(Important)
Inputs
Easy to Measure
and More Difficult
(Very Important)
Outputs
Difficult to Measure
and Execute (Most
Important)
Quantitative
Qualitative
Specific, Quantifiable
Numbers (Hard)
Descriptive,
Revealing (Soft)
5%
Least Significant
14 %
9%
19 %
Most Significant
Outcomes
24 %
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29 %
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Three Criteria for
Developing Good Metrics
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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How to Express Performance
Numeric
Percentages
Ratios
Easy to Measure and
Report
Relatively easy to Measure
and Report
Relatively easy to Measure
and Report
May not be very insightful
in understanding
performance
More insightful in
understanding performance
Very meaningful and useful
for comparative
benchmarking
Used for inputs, outputs, and
Commonly used for inputs outcomes
and outputs
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
% of association members
renewing
Total Funds Raised to Total
Costs
Average Donation per
Donor
Volunteer to Donor Ratio
Total Funds Raised to Total
Days Required
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Standard Template
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
research
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Multiple Choice Question 13
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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Multiple Choice Question 14
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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Module 17 - Non Financial Analysis
(Business Analysis)
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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The Analysis Big Picture
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
SWOT
Vertical
Analysis
Ratio
Analysis
Porter’s
Five Forces
Non
Financial
PEST /
STEEP
Boston
Growth
Share
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Previously
Discussed
Cost of
Capital
GE
Business
Screen
Pareto
Chart
195
Answering Critical Questions
6 Useful Techniques
What are you trying to solve?
Appropriate Analytical
Model to Use:
What is our current situation?
1. SWOT
What is external factors influence our business?
2. PEST / STEEP
How does my industry work?
3. Porter’s Five Forces
How well do we manage our products / services?
4. Boston Growth Matrix
What are the most important issues?
5. Pareto Analysis
What is causing this problem?
6. Root Cause Analysis
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SWOT Analysis
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
Weaknesses
Client has a global infrastructure to
service all types of customers
Client has limited resources for
expanding its global reach
Services are in high demand in most
parts of the world
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
Threats
Untapped demand exists in almost half
of the World
New Technologies make it possible to
expand service reach
Other clients are investing in newer
technologies
Some clients are entering into strategic
partnerships to expand their global
footprint
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PEST / STEEP / SPECTACLES
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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Porter’s Five Forces Model
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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BCG Growth Matrix
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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should divest and remove
these
products.
200
Pareto Chart (80/20 Rule)
Quantifies what is most important onto a graph. Need to group
problems or issues (Categories) and then plot the frequency
(Measure). Helps improve focus:
Downtime, Errors,
# of Employees, etc.
Allocate your limited resources to
this for maximum impact
Categories
Causes, Products, Mfg. Lines, Operators
Machines,
Defect
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Root Cause Analysis
Five Whys
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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Root Cause Analysis
Fishbone Diagram
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
Detail
Detail
Result (Problem)
Cause
Cause
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Overall Approach to
Problem Solving
Past
Present
Future
Situational
1
Analysis
2
Problem
Analysis
Why is this
happening?
3
What is happening
now?
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Decision
Analysis
What are our
alternatives and
what is the best
decision?
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Multiple Choice Question 15
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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Multiple Choice Question 16
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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Exercise 18 –SWOT
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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Module 18
Recap Day 2 Topics
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Recap – Economic Analysis (Module 10)
• Economic Analysis
1.
2.
3.
4.
Applies to long term investments – new systems, new marketing
program, acquire another business, etc.
Estimate cash inflows and outflows over life of investment
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
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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Recap – Financial Forecasting (Module 11)
Sequential Steps for Financial Forecasting
1.
2.
3.
4.
•
Look back and estimate your future sales for the next period. Five Year
Trends provide an element of truth.
Qualify your estimate – get confirmation from senior management,
marketing and other people
Prepare a Forecasted Income Statement
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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Recap – Risk Analysis (Module 12)
• 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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Recap – Ratio Models and EVA (Module 13)
• 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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Recap – Private Capital (Module 14)
• 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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Recap – Intellectual Capital (Module 15)
• 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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Recap –
Performance Measurement (Module 16)
• 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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Recap – Business Analysis (Module 17)
• 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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Recommended Reading
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
217
Licensed to Business Performance Group, Inc., from Matt H. Evans
Recommended Web Sites
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
Licensed to Business Performance Group, Inc., from Matt H. Evans
218
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Licensed to Business Performance Group, Inc., from Matt H. Evans
219
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