Mod 1 - Business plan and modeling Flashcards
Learn
Valuators must have comprehensive knowledge of
- Co. strategic direction
- Process to determine amount and type of financing
- Financing sources available
- Appropriate financing structure to meet needs
Before deciding what type of financing is required mgmt must determine?
- strategic direction of the company
- prepare business plan (defines next 3 to 5 years)
10 pieces of info business plan should include:
1) executive summary - visions & strategic direction
2) Business purpose- mission statement, history, summary of services
3) Co. customers- who they are, value, opportunities
4) Competitive environment - strengths and weakness of competitors
5) Company suppliers: who they are, strengths, weaknesses, reliance
6) Marketing plan - sales channels
7) Key staff- who they are background, experience
8) Financial forecast- cash flow model, projected financial statements incorporating financing
9) Valuation of co. - includes amount, assumptions, rationale, comparables
10) Sources and uses - outline of proposed sources and uses of financing
Define: Offering memorandum
A legal document that may be required under provincial securities law when raising debt and equity privately.
Define: Confidential Information Memorandum
In M&A rather than offering memorandum a Confidential Information Memorandum (CIM) is used to market the company. subject to confidentiality agreement
Define: Business Plan
Far less formal document that is used both as planning and summary. Used simply to describe the company, and typically not to offer others the opportunity to invest in the company.
Define: Financing proposal
A written doc created by a business to solicit primary interest of investors and lender in providing financing to the company. It’s for “selling”
Information to be included in the financing proposal
a) description of the business
b) analysis of the industry environment
c) resumes of the co. mgmt
d) description of business assets
e) action-oriented business plan - builds on s&o deals with w&t
f) forward budgets
g) relevant financial, product and corporate documents
Strong financing proposal
Financing amount: Clearly states amount
Financial forecast: effects of inflows and outflows
sensitivity analysis: multiple sensitivity analysis on variables
supporting financial statements: address questions, relevant financial info
readability and credibility: concise, detailed relevant info
Weak financing proposal
Financing amount: vague or wide range
Financial forecast: no effects of inflows and outflows
sensitivity analysis:none or irrelevant
supporting financial statements: waits for request
readability and credibility: lengthy / irrelevant
Financiers perspective
Asset based - future cash flows, quality of assets
mezzanine - good story, growth plans, cash flow, mgmt
equity: strategic, growth plans, good story, mgmt
In selecting forecast technique or model what items should be considered
- time period: dependent on nature bus/ industry, cycles, and needs
- data patterns: whether historics consider month, quarterly, yearly and patterns
- costs: labour and other costs with preparation
- accuracy and reliability: balance ease of understanding with realistic results
Mgmt can determine funding requirement by?
Calculating the difference between the cost of the assets required to support the forecasted sales and the cash flows that will be generated from the forecasted sales.
Items on which to judge plausibility of forecast?
- Preparer knowledge
- Assumptions reasonability
- Growth rate realistic - with past
- Support for projected revenues
- Previous forecasts accuracy
Two cash flow approaches to utilize in financial modelling
1) using rev and costs from P&L to make a single working capital adjustment (represents net effect of timing lag to determine net operating cash flow)
2) including operating cash received and paid explicitly on the cash flow statement
Nominal vs. Real approaches
Nominal: Cash flow forecasts are increased to include inflation (they are indexed)
Real: Cash flows are projected inflation free( un-indexed)
Granted like terms are used the same result should be achieved
Nominal vs. Real formula
Real rate =[ (1+ Nominal rate) / (1 + inflation)]-1
Valuator can assess financial stability through use of ratio and trend analysis including
- Leverage ratios - financial risk
- Liquidity ratios - short term solvency
- Efficiency ratios - effectiveness of mgmt use of assets
- Profitability ratios - expense control / shl returns
Leverage ratios
Debt Ratio: (LT debt + leases)/ (LT debt+ equity + leases)
Debt to equity: D/E
Times interest earned: EBITDA/ interest
Debt servicing: (income before tax+ interest+ dep) / (interest +principal)
Liquidity ratios
Current ratio: CA/ CL
quick ratio: (current assets - inventories- prepaids)/ CL
Efficiency ratios
Inventory turnover: COGS/ Avg Inv
Average collection: Average AR/ Average daily sakes
Profitability ratios
ROA : (EBIT - Tax) / Average Total Assets
ROE: Earning available to common shareholders / Average equity
Gross Margin Ratio: Gross Margin / Net Sales
Define covenant:
A promise from debtor to a lender that certain activities will not be carried out. Most common are financial covenants that require debtor to maintain certain level for leverage and working capital ratios.
When developing projections management should consider?
•How much does the expansion, acquisition or project cost?
• How much money is required to maintain healthy liquidity ratios?
• How much money is required on a long-term loan basis to maintain healthy leverage
ratios?
• At which frequency are these cash inflows required?
• For what horizon do these needs run?
Business financing needs:
- Near term needs
- Long term, high priority needs
- Low priority needs
Near term financing needs:
Short term financial situations for day to day operations.
Match with short term financing because can be reversed or changed quickly
Long term financing needs:
Part of long term goals, some form of increasing competitive edge such as purchase and or expansion.
Match with long term financing such as lease, LT secured bank to match life. Also include equity and mezzanine lenders.
Two important factors to consider when assessing company’s capacity to issue debt or raise equity?
1) Balance sheet
2) Nature of assets owned
additional considerations:
- are assets tangible
- can these assets be used as collateral or can they be sold
- what ratios can bet met given ratios of A/L and L/E
- what feeds co.’s cash flow are they sustainable
Issues related to balance sheet
- change in inventory levels
- potential understated liabilities
- consider whether there are any overstated liabilities
- consider the value of marketability of assets in the targets portfolio
- any intangible assets
Issues related to income statement
- inventory accounting method
- method to recognize revenue
- consider the quality of earnings
- beware of inclusion of personal expenses
- window dressing with deferral of expenses
Capital budgeting decision tools
- IRR
- Profitability index
- NPV
- Payback period
- Discounted payback period
Internal rate of return
The discount rate that equates investment to the cash flows stream
0 = -CF + CF1/ (1+irr) + CF2/ (1+irr)^2+…..
NPV
Difference between the pv of inflows and outflows discounted by the opportunity to cost of capital
Discrepancy between IRR and NPV
Irr is sensitive to timing
Cash flows can have a higher irr then projects with larger NPV if cash flows occur earlier. In doubt use NPV
Profitability index
Present value of projects future cash flows divided by initial investment.
PI = PV of future cash flows/ Initial investment or
PI = (NPV/ initial investment ) +1
Payback period vs. Discounted Payback Period
Payback period: length of time to recover costs of investment. No time value of money
PP= costs of investment/ period cash flow
Discounted payback period: cost of investment / PV of period cash flow
Holding period returns
Holding period return measure the total return generated from holding an asset over a period. Expressed as a percentage - higher the better
HPR= (income + (ending - initial)) / initial value
Annualized HPR= (HPR+1)^1/t - 1
Return of capital employed
a profitability ratio that measures how efficiently a firms capital is employed. Higher means more efficient use should be higher then cost of capital.
ROCE = EBIT / D+E
