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FinanceBasics

Dr.AmandaThompson

Financeinoneslide

– Whenislater?– Howcertain islater?

InvestorYourCo

Invest$$Now

$$ReturnLater

$Return > $Invest+RiskCompensation

CF Risk

• Whataretheimportantquestionsaninvestor(ormanager)wouldaskinthistransaction?– Howmuch$now?– Howmuch$later?

•Investif….

Howmuch$requirednow??• Easiesttoestimatebecausenearterm,tangibleoperationalneeds

• Drivenby:– Typeofinnovation– Distancetonextmajormilestone

• Howtoestimate:– Beasactivityfocusedasyoucan,whatspecificpeopleandresourcesdoIneed?

– CanIestimatearelationshipbetweenacostandadriverofcosttolinkmyestimatestomyactivities?

Example• Activityexample:Onlineeducationcompany

– Eachpossiblestudentrequiresabouta15minute(0.25hr)chatwithadmissioncounselors– Counselorsareonthephoneabout50%oftheir8hr day.– 5%ofstudentsreachedactuallyenroll

• Howmanystudentscanonecounselorrecruitina5dayweek?– Onphone50%x40hrs =20hrs perweek– Recruit5%ofthe(20hrs perweek/0.25hr perstudent)

=5%x80students/wk =4students/wk percounselor

• Howmanyadmissioncounselorswillyouneedifyoutarget100newstudentspertrimester(16wks)?– 4students/wk x(16wk/tri)=64stud/counselor/tri– 100studenttarget/64=1.5counselors

• Salary=$40,000/yr whatisthecostperenrolleejustforrecruitment?– (1.5coun x$40,000)/(3tri*100students)~$208/enrollee

BuildingaModel

Time 2017 T1 2017T2 2017T3 2018T1

Targetenroll 100 110 125 140

Counselors 1.56 1.72 1.95 2.19

SalaryCost $20,833 $22,916 $26,042 $29,167

Assumptions Salary Conversion Time(hr)/prospective

% phone

AdmissionCounselor $40,000 5% 0.25 50%

StudentTechsupport …

Professors

GeneralAssumptions

Workinghrs/tri 640

64enrolled/counselor

Exercise• Exercise:Thinkandshare– Canyouspecifyyourmajormilestones?– Whatmajoractivitieswillberequiredtoreachthem?– Whataresomeactivityratios?

• 1studentenrolledper10hoursofcounselortime• Howmanyprofessorhoursperstudent?• What%dropout?

– Canyouestimatethecapitalrequiredtogettoeachmilestone?

• Forourexample:Neednow=$3M

Whatisthereturnlater?

Invest Time??

SellCompany/IPO

??

$3MAsk

Whatisthereturnlater?Invest

…

t=¥

MaterialsSUPPLIERS CUSTOMER

MGMT&LABOR

+

-

EquipmentSUPPLIERS

Building yourbusinessmodel

GOV’T

Price>Costs = Profit!!!!

YourCo

INVESTOR

MaterialsSUPPLIERS CUSTOMER

MGMT&LABOR

+

-

EquipmentSUPPLIERS

Thisiseasy…right??

GOV’T

Revenue>Costs = Profit!!!!

MaterialsSUPPLIERS CUSTOMER

LABOR

+

-

EquipmentSUPPLIERS

Thisiseasy…right??

Revenue>Costs = Profit!!!!

$600/machinelasts12months

$6materialsfor$10sale

$2.50laborfor$10sale

25%

100units AprilSales $1,000Costs $850Equipment $50Profitbeforetax $100Tax $25Profitaftertax $75

100unitsat$10each

HappensLAST!!!

GOV’T

Raw WIP

Payables:60days

Inventoryshelf:90days Collection:30days

ReceiveMaterials

ReceivePayments

PayforMaterials

SellProduct

FundingGapcreatesCashFlowProblem!

Example:Manufacturing

Finished

Profitv.CashFlowJanuary February March April

Sales $1,000Costs $850Equipment $50Profitbeforetax $100Tax $25Profitaftertax $75

MaterialsReceived $850

CashInCashOutforCosts $850CashOutforEquipment $600CashFlow -$600 $0 -$850 $0

Profitv.CashFlowJanuary February March April May

Sales $1,000Costs $850Equipment $50Profitbeforetax $100Tax $25Profitaftertax $75

MaterialsReceived $850

CashIn $1,000CashOutforCosts $850CashOutforEquipment $600CashFlow -$600 $0 -$850 $0 $1,000

Profitv.CashFlowJanuary February March April May June July August

Sales $1,000 $1,000 $1,000 $1,000 $1,000Costs $850 $850 $850 $850 $850Equipment $50 $50 $50 $50 $50Profitbeforetax $100 $100 $100 $100 $100Tax $25 $25 $25 $25 $25Profitaftertax $75 $75 $75 $75 $75

MaterialsReceived $850 $850 $850 $850 $850 $850 $850 $850

CashIn $1,000 $1,000 $1,000 $1,000CashOutforCosts $850 $850 $850 $850 $850 $850CashOutforEquipment $600CashFlow -$600 $0 -$850 -$850 $150 $150 $150 $150

Butwhatifsalesgrowby20%?

Profitv.CashFlow

-$4,000

$0

$4,000

$8,000

Profitvs.CashFlow

Sales20% Profitaftertax CashFlow

+

-

MaterialsSUPPLIERS CUSTOMER

MGMT&LABOR

+

-

EquipmentSUPPLIERS

Thetimingissue

GOV’T

INVESTORSOperatingstrategyWhattobuy?

FinancingStrategyWhowillpay?

Financefundamentals

INVESTORYourCo

$Invest

$Return

Whattobuy? Whowillpay?

Whyyou?

Price>Costs

CUSTOMER

$

Value

WhathastobetrueabouttherelationbetweenPriceandValue??

Value > Price>Costs??

Financefundamentals

INVESTORYourCo

$Invest

$Return

• Howwouldyoudecideifyouwanttoinvest?– If$Return>$Invest+riskcompensation

• Whattypesofinvestorsarethere??

Debtinvestors

Equityinvestors

Profit

YourCo

DebtFinancing

FundamentalIdea

DEBT

EQUITYRetainedEarnings

EquityFinancing

Interest

Tax

Differenttypesofinvestorsfacedifferentrisks,why???

DIV

Thetsunami• Debtinvestors– don’tcarehowbigthebottleisaslongastheirglasswillbefull

• Equityinvestors– benefitfromthetsunami!!

Debtinvestors

YourCoPmts

PriceLoan time

Interest

Interest&Princ

Interest

Interest

Interest

Interest

Debtinvestors

DefinedpaymentsLegalteeth

Equityinvestors

Pmts

PriceInvest time

SellCompany

Dividend

Div

DividendEquity

investorsYourCo

ResidualpaymentSeatatthetable

Financefundamentals

INVESTORYourCo

$Invest

$Return

Debtinvestors

Equityinvestors

Fundingyourbusiness

INVESTORYourCo

$Invest

$Return

Debtinvestors

Equityinvestors

• Estimate:HowdoyouthinkmostAmericanbusinessesarefunded?– AveragebusinessisfundedbyX%debt

Fundingovertime

RetainedEarnings

Debt

Equity

Fundingoptions

• WhataboutallthosebigNYSElistedfirms?

Yourfundingoptions?

$ Risk Speed Effort Control Cost Other

Grant Rules

Lineofcredit

Unreliable

Debt InterestCFPro/Con

Conv.Debt

Complex

FounderEquity

Highrisk

AngelsEquity

Finding

VentureCapital

Latestage

Othersources

• Franchisorfunding– Loansfor:equipment,thefranchisefee,operationalcostsorany/allofabove

• Leasingassets• Personalsources– Homemortgagesandequity,creditcards,friends/family,yourcash(max75%)

• Governmentloans

SBALoans• Criteria

– Soundbusiness,trustworthycharacter,abilitytorepaywithsomeskininthegame

• Size– Median$130,000- $140,000withhighestaround– Range$5,000(microloans)to$5M– Averageloanaround$371,000

• Help– SBADistrict/BranchOffices– atleastoneineverystate– SBDCs – SmallBusinessDevelopmentCenters;(~900withhigher

educationinstitutions)– WBCs- Women’sBusinessCenters(~100educationalcenters

nationwide)

FinancingSources

time

$

IPO

Venture

Angels

Family

RetainedEarnings

Seed Early Expansion/Late

Idea

InitiateDividends!

Global Mature

• Doyouthinkfundingchoicesdifferbyindustry?INDUSTRY Debt% INDUSTRY Debt%

Maritime Steel

Energy Retail(Food)

Automotive Chemical

Utilities Pharma/Biotech

PaperandForest E-comm/Software

Fundingbyindustry

• Doyouthinkfundingchoicesdifferbyindustry?INDUSTRY Debt% INDUSTRY Debt%

Maritime 63% Steel 31.69%

Energy 60% Retail(Food) 29.25%

Automotive 57% Chemical 21.47%

Utilities 46% Pharma/Biotech 12.5%

PaperandForest 37.45% E-comm/Software 6.02%

MarketAverage 31.81%

Fundingbyindustry

Howdoinvestorsvalueyou?

• FinancialPlanning– Liquidityplan– Salesplan– Costsplan– Profitability

• Allboilsdownto…– Timingandsizeofprofits– Riskandprobabilityofsuccess

Value

InvestmentDecision

PV0 CFt

Invest

Value<InvestmentReject!!

𝑉𝑎𝑙𝑢𝑒 = '()(*+-*./0)12(45*)2

time

Value

time

PV0 CFt

Invest

FutureProfits>InvestmentAccept!

InvestmentDecision

𝑉𝑎𝑙𝑢𝑒 = '()(*+-*./0)12(45*)2

Howbigabite?• Determinedbyriskandtimingofthe

profitsyouforecast!!

Marketforcapitaliscompetitive,sotheinvestorconsidersthereturntheycouldearninothersimilarlyriskyprojectsandrequiresthatofYOU!

*Youcanfindcostofcapitalbyindustry:Aswath Damodaran NYUSternwebsite

VCrequiredreturns

Financefullcircle

INVESTORYourCo

$Invest

$Return

• Howwillyoudecideifyouwanttoinvest?– Investif$Return>$Invest+riskcompensation

Insummary• Value>Price>Costs– Modeltheseusingassumptionslinkedtotheactivitiesrequired

– Neartermmodelhelpsestimateamountneedednow– Longtermmodelhelpsestimatethevalueofthebusiness

• Costsincludetherequiredreturnpaidtoinvestorsfortakingontheriskofyourbusiness– Debt– Equity– Marketforcapitaliscompetitive