New Venture Development

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New Venture Development

Exam 2 content

Spring 2013

Working Capital


Working capital

consists of the current
assets and the current liabilities of a
business.


Current assets are
gross working capital
.


Cash, marketable securities, accounts
receivable, and inventory


Net working capital

is the difference
between a business’s total current assets
and its total current liabilities.

Working Capital Management



Working capital management

is our ability to
effectively and efficiently control current
assets and current liabilities in a manner that
will provide our firm with maximum return on
its assets and will minimize payments for its
liabilities.

Current Asset Management


Cash management


Marketable securities management


Accounts receivable management


Inventory management


Cash Management


The goal of cash management is to obtain the
highest return possible on cash. Cash consists
of:


Petty cash


Cash on hand


Cash in bank, checking


Cash in bank, savings


Marketable Securities Management


Marketable securities

normally are those
investment vehicles that include U.S. treasury
bills, government and corporate bonds, and
stocks.


Excess cash should be placed in the above
vehicles because they increase in value more
than cash itself.

Accounts Receivable Management


The goal of
accounts receivable management

is to increase sales by offering credit to
customers.


Options to offering credit include:


The business issuing its own credit card or line of credit.


Factoring

selling accounts receivable to another firm
at a discount off of the original sales price.

Accounts Receivable Management
(continued)


The 3 C’s of credit:


A customer’s
character

is favorable if that
customer has paid his or her bills on time in
the past and has favorable credit references
from other creditors.


Capacity

to pay refers to whether the customer
has enough cash flow or disposable income to
pay back a loan or pay off a bill.


Collateral

is the ability to satisfy a debt or pay
a creditor by selling assets for cash.


Accounts Receivable Management
(continued)


Credit terms

are the requirements that our
business establishes for payment of a loan
(the use of credit by a customer).


To speed up collections, cash discounts are
often offered to a business customer. An
example would be 2/10 net 30. If the customer
pays the bill within 10 days of the invoice a 2
percent discount is given. Otherwise the entire
net is due 20 days later or at the 30th day.

Accounts Receivable Management
(continued)


Analyzing accounts receivable:


Accounts receivable turnover:




Example:




Collection days is 365 days in a year divided by
accounts receivable turnover:

receivable

Accounts
Sales

Credit


turnover

recievable

Accounts

6


$50,000
$300,000


turnover

recievable

Accounts
days
days
61
833
.
60



6
365


days

Collection

Use of collection days:


If collection days exceed our credit terms, then
we have to speed up collections.


Example: If we give terms of 30 days and we collect
in 61 days as previously shown, then we have to
speed up collections in order to better manage
accounts receivable. We may also have to re
-
evaluate our credit policies.


If collection days are less then our terms, then
we have increased our liquidity. May also
consider loosening credit policy.

Accounts Receivable Management
(continued)


Aging of accounts receivable

is accomplished
by determining the amounts of accounts
receivable, the various lengths of time for
which these accounts have been due, and the
percentage of accounts that falls within each
time frame.


Related: See Joe D. Plummer forecasting and
budgeting

Accounts Receivable Management
(continued)

Customer


Outstanding Balance

Days Outstanding

< 30

< 60

<90

> 90

1


$ 5,000

30

5000

2


7,000

45

7000

3


15,000

30

5000

4


12,000

70

12000

5


8,000

90

8000

6


15,000

60

15000

7


6,000

120

6000

8


10,000

100

10000

9


13,000

45

13000

10


9,000

90

9000

9000

Total


$ 100,000


$ 10,000


$ 35,000


$ 29,000


$
25,000

Aging of accounts receivable

Weighted average days outstanding = 64.9 days

Apple’s Current Asset Management

Apple’s Current Asset Management

Inventory Management


The overall goal of inventory management
is to minimize total inventory costs while
maximizing customer satisfaction.


Two primary decisions must be made:


Establish the reorder quantity (the number of
items to order)


Establish the reorder point (that level of
inventory at which a new order will be placed).



Economic Order Quantity Formula:


Attempts to balance ordering costs against
storage costs and provide us with the most
economic quantity to order to minimize overall
inventory costs.




Where

Inventory Management
(continued)

IP
DS
EOQ
2

Inventory Management
(continued)


EOQ and Quantity Discounts


If the business is large or uses items in
quantity, then quantity discounts may override
the EOQ formula. We will determine this by
use of both the EOQ formula previously given
and the total cost formula which is:



Q
DS
QIP
DP
TC



2
Inventory Management
(continued)


Determining EOQ with quantity discounts requires
the following procedures:


Compute EOQ for each discounted price.


If the computed EOQ falls within the discounted
quantity area, then order the EOQ.


If the EOQ does not fall within the discounted quantity
area, then compute total inventory costs.


Order the minimum quantity that provides the lowest
overall total inventory costs.


Warehouse storage cost (I) =
0.40
Ordering cost (S) =
10.00
$

Annual demand (D) =
16,000
Price
Discount
Quantity
EOQ
Quantity
to Order
Total Cost
20.00
$

0–500
200.00
200
321,600.00
$

19.00
$

501–1,000
205.20
501
306,223.16
$

18.90
$

Over 1,000
205.74
1,001
306,343.62
$

Table 7-2 EOQ with Quantity Discounts
Total costs for each quantity
20
.
205
)
19
)($
40
.
0
(
)
10
)($
000
,
16
)(
2
(
2



IP
DS
EOQ
16
.
223
,
306
$
501
)
10
)($
000
,
16
(
2
)
19
.$)($
0
)(
501
(
)
19
)($
000
,
16
(
2







TC
Q
DS
QIP
DP
TC
Inventory Management
(continued)


Reorder Point Calculations


The reorder point (ROP) has three factors that
are used in determining the quantity of an item
that exists when we actually place an order:


Lead
-
time

(L) is the time that lapses from order
placement to order receipt.


Daily demand

(d) is the quantity of a product that is
used per day.


Safety Stock
(ss) the quantity of stock you keep for
variations in demand.

ss
Ld
ROP


Current Liabilities Management


Current liabilities management

consists of
minimizing our obligations and payments
for short
-
term debt, accrued liabilities, and
accounts payable. It consists of:


Short
-
term debt management


Accrued liabilities management (servicing long
-
term debt)


Accounts payable management



Current Liabilities Management
(continued)


Short
-
term debt management


Short
-
term debt

consists of business
obligations that will be paid within the current
accounting period. They consist of the
following:


Current payments on long
-
term debt


Bank lines of credit


Notes payable


Accounts payable


Short
-
term loan for one year or less

Current Liabilities Management
(continued)


Lines of credit:


A
line of credit

is similar to a credit card.


With it, we obtain a credit limit, but we are not
obligated to make payments unless we actually borrow
the money.


A line of credit is normally obtained from our primary
bank.


A line of credit is used when our cash outflow exceeds
our cash inflow.

Accrued Liabilities Management
(continued)


Accrued liabilities

are those obligations of the
firm that are accumulated during the normal
course of business and are primarily payroll
taxes and benefits, property taxes, and sales
taxes.


Accounts Payable Management


Accounts payable
are the debts of a business
which are owed to vendors. Vendors offer
several types of discounts. They are:


Trade discounts


Cash discounts


Quantity discounts

Accounts Payable Management
(continued)


Trade discounts

are amounts deducted from
list prices of items when specific services are
performed by the trade customer.


Trade discounts may be expressed as a single
amount, such as 30 percent, or in a series, such as
30/20/10.


Accounts Payable Management
(continued)


Trade discount examples


2/10 net 30
-

buyer must pay within 30 days of the invoice date, but will
receive a 2% discount if they pay within 10 days of the invoice date.


3/7 EOM
-

buyer will receive a cash discount of 3% if the bill is paid within 7
days after the end of the month indicated on the invoice date.


3/7 EOM net 30
-

buyer must pay within 30 days of the invoice date, but will
receive a 3% discount if they pay within 7 days after the end of the month
indicated on the invoice date


2/15 net 40 ROG
-

buyer must pay within 40 days of receipt of goods, but will
receive a 2% discount if paid in 15 days of the invoice date.


Trade discounts may be expressed as a single amount, such as 30 percent, or in
a series, such as 30/20/10.


Accounts Payable Management
(continued)


Cash discounts

are offered to credit customers to
entice them to pay promptly.


The seller views a cash discount as a sales discount.


The customer views it as a purchase discount.



The terms of a cash discount play an important role in
determining how the invoice will be paid.



“Preferred payment”

method discount


Some retailers (particularly small retailers with low
margins) offer discounts to customers paying with
cash, to avoid paying fees on credit card transactions.

Accounts Payable Management
(continued)


Cash discounts will normally appear on an invoice
in terms such as 2/10 n30.


This means that the customer may deduct 2 percent
off of the invoice price if he or she pays within 10
days.


If the customer does not pay within 10 days, he has
the use of 98% of the money owed for the next 20
days.


If the customer pays within 30 days, the net, or total
amount, of the invoice is due.


If he or she pays after 30 days, the credit agreement
with the seller normally stipulates that a monthly
interest charge be added to the unpaid balance.

Accounts Payable Management
(continued)


Calculations used in cash discounts:


A $10,000 invoice with terms of 2/10 n30


Option 1: Pay off the $10,000 with a payment
of $9,800 within 10 days of the invoice date.


This is computed by multiplying the invoice price by
1 minus the discount (1
-

0.02 = 0.98, and $10,000 x
0.98 = $9,800).


Or by taking the invoice price times the discount
and subtracting it from the invoice price ($10,000 x
0.02 = $200, and $10,000
-

$200 = $9,800).

Accounts Payable Management
(continued)


Calculations used in cash discounts
(continued)
:


A $10,000 invoice with terms of 2/10 n30


Option 2: P
ay the invoice price of $10,000 on
the 30th day after the invoice date. If this
option is chosen, he will pay the equivalent of
36.7 percent annual interest because of his
delaying payment. The logic is shown on the
following page.


Accounts Payable Management
(continued)


Calculations used in cash discounts
(continued)
:


$200 is the cost paid on $9,800 for 20 days, or
an interest rate of 2.04 percent ([$200


$9,800] x 100).


This will result in an effective annual interest
rate of 36.7 percent (2.04 x [360


20days]).


The effective annual interest rate is obtained
by multiplying the time period interest rate by
the number of time periods in an accounting
year (360


20)
.

Accounts Payable Management
(continued)


Quantity discounts

are offered by vendors
to increase their own cash flow when they
offer discounts to customers who purchase
items in large quantities.

Item Number
Quantity
Unit Cost
10010
1–99
15.00
$

100–499
14.50


500–999
14.00


Table 7-5 Quantity Discounts
The working capital cycle

A negative working capital cycle is a good thing; Owen must borrow $ to maintain WC

Trade discounts

The offer


Your supplier offers you a
trade discount of 2/10n30


What does this mean?


You get a 2% discount if you
pay within 10 days


Otherwise, pay full amount
within 30

Implications








But you are essentially
borrowing $200 at an
effective annual interest
rate of 37%

Forecasting



A
forecast

is a quantifiable estimate of future
demand.


Forecasting
in business is the process of
estimating the future demand for our
products and services.


Forecasting

for the financial manager also
requires estimates of future interest
rates
.

Practical Sales Forecasting for

Startup Businesses


Steps to take for a sales forecast:


Listing what you know:


Expertise, experience, knowledge of charges and fees.


Previous revenue and cost information based on experience.


Research similar companies via EDGAR competing
company annual reports, or industry
-
specific
publications.


List three types of expenses:


Startup


Fixed


Variable


Develop a revenue forecast


Forecast of Revenue for a Startup
-

Autoshop

Pro Forma Financial Statements


A
pro forma financial statement

is a projected
statement based on the forecast.


The three basic pro forma statements are:


Pro forma income statement


Pro forma cash budget


Pro forma balance sheet


Pro Forma Balance Sheet Using
Percentage of Sales


Percentage of sales method

is based on the
fact that assets and liabilities historically vary
with sales.


Thus any increase in sales will cause a subsequent
buildup in both assets and liabilities.


Both profit margins and dividend (owner) payout
ratios determine the amount of internal financing
that can be applied to support increased asset
buildup.


See examples Chapter 6 Adelman & Marks and
Vermont Teddy Bear Company Forecasting

Percentage of sales method


forecasting balance sheet

Financial

Statements

Income

Statement

Balance

Sheet

Statement

Of

Cash Flows

Building Integrated Financial Statements


BUILDING YOUR PRO FORMA FINANCIAL STATEMENTS

Build
-
up Method

Comparable Method

Final Steps

BUILD
-
UP METHOD


Revenue


Projections


COGS


Operating


Expenses


Revenue Worksheet

COGS Worksheet

Operating Expense Worksheet

Preliminary

Income Statement

COMPARABLE METHOD

Choose industry metrics

Compare your projections to other

companies and industry average

Benchmark other companies


in the industry

BUILDING INTEGRATED


FINANCIAL STATEMENTS

INTEGRATED


FINANCIAL
STATEMENTS

Income Statement

Monthly forecasts

for years 1 and 2

Adjust monthly
forecasts

according to
seasonality

Annual forecasts

for years 3
-
5

Balance Sheet

Consider


Accounts
Receivable

Show outflow and

depreciate PP&E

Consider

Accounts Payable

Statement of


Cash Flows


Focus on major infusions of cash



describe the nature of your



accounts receivables and payables



Mention PP&E expenses

PUTTING IT ALL TOGETHER

2
-
3 page explanation of your

Financial Spreadsheets


Talk about revenue drivers



Talk about seasonality



Discuss the expense categories


Focus on major infusions of cash



Describe the nature of your cash flows



Accounts receivables and payables



Mention PP&E expenses


Talk about major asset


categories, and any


Liabilities that aren’t


clear from the previous


discussion


Discuss the


Income Statement

Discuss the Cash

Flow Statement

Discuss the

Balance Sheet

Reduced

survival

chance



Underestimating


time to

secure


financing



Top
-
down


versus

bottom
-
up


forecasting



Lack of


comparables



Underestimating


time to generate


revenues



Underestimating


costs



Not


understanding


the revenue


drivers


Common mistakes entrepreneurs make

Joe D. Plummer budgeting


71% of Joe’s
revs are on
credit


His COGS
seems a bit
high…


He has
substantial
fixed costs


Help him!

The Campaign to Raise Capital

New venture financing

The campaign to raise capital

The
vast majority of funded deals using venture capital follow
this course of events:

1.
Set funding objectives

2.
Prepare the plan to attract investors

3.
Pick the best capital
-
raising strategy

4.
Assign tasks

5.
Launch the campaign

6.
Make presentations

7.
Incorporate
feedback from presentations

Crown Semiconductor


A by
-
the
-
numbers
approach to raising capital


Hired a household
-
name veteran CEO


Added 3 friends with strong industry experience
from 2 seed VC firms


made them advisers to the
board of directors


Consistently presented start
-
up as “blue chip” of all
companies in this new technology


Used well
-
known law firm to get introductions to 5
-
7 top VC sources

Crown Semiconductor


A by
-
the
-
numbers
approach to raising capital


Negotiated for $10M in first round, expected to get only
$6M


Set minimum ownership dilution point for owners at 30%
by projected IPO time


Gave up only one more board seat to investors in first
round


Presented an extremely focused sales pitch: “top CEO!” “5
months from shipping first product!” “You better get in
now, because there is no tomorrow”

The Road Show


Definition:
a presentation by an issuer of securities to
potential buyers



The term “road show” applies to the presentations
management gives to analysts, fund managers, and
potential investors around the country when they want to
issue securities or do an initial public offering (IPO)


The road show is intended to generate excitement and
interest in the issue or IPO, and is often critical to the
success of the offering.


Also known as a "dog and pony show."

1994: Netscape’s Road Show


Netscape files to go public on June 23, 1994


Overwhelming reception on the road suggests a bubble
psychology is taking over the investment community


Instead of meeting with 3
-
4 analysts from a given
institutional investor in each city, Netscape got 50
-
75 at
their presentations


most wanted to understand the
Internet


Investors didn’t want to miss “the next Microsoft”

The campaign to raise capital

The vast majority of funded deals using venture capital
follow this course of events (
continued
):

9.
Modify plan but maintain vision

10.
Due diligence

11.
The lead VC says “We will invest!”

12.
Closing the VC contract

13.
Closing week

14.
C
ash in the bank

Chips and Technologies Financing

Chips and Technologies Equity Ownership

Chips and Technologies Equity Ownership

Conclusions


Raising capital is a very time
-

and effort
-
intensive activity


it never ends for the start
-
up firm


Professional management, experience, time until first
sales, and attractive cash flows and ROI are essential


There are many routes to the IPO


you can be creative
with raising capital (see Chips and Technologies) or
disciplined (Crown Semiconductor)

Bigfoot Networks

1.
What is the business model presented in the
business plan? Do you think it is viable?

2.
Imagine you are an Angel investor who is going
to be sitting in the audience during Bigfoot
Networks business plan presentation in April of
2005:

a)
Would you be willing to offer to buy a $50,000 unit
of the $200,000 being sought for the seed money
investment?

b)
Assume you decide to invest. What concerns would
you have and what due diligence would you perform
to address them before writing the check?

Letter Logic valuation

𝑉𝑎



𝑖 
=
𝑃 𝑖𝑐
𝐸𝑎 𝑖
𝑋
𝐸𝑎 𝑖
𝑅   
𝑋𝑅   

Letter Logic valuation

2003


In 2003,
LetterLogic

has annual revenues of $2,500,000.
They would like to grow their revenues to approximately
10x this value over the next several years.


Despite the company's success with revenue generation,
no banks or equipment suppliers would agree to provide
the company with a line of credit. All the company had
was founder Sherry
Deutschmann's

business credit card
with a $5,000 limit.


Later that year, she met a venture capitalist who offered
to invest $350,000 in her company in exchange for an
equity stake of 25%. Importantly, he also guaranteed a
$500,000 line of credit.


With this line of credit,
Deutschmann

was able to grow
here business to annual revenues of $21,000,000 by
2011. Banks routinely contact her with offers to provide
loans and new lines of credit.


To understand the valuation exercise in the spreadsheet,
we first have to examine how the initial VC investment
affected the company's valuation.


Getting 25% of a company for $350,000 means that the
company was worth $1,400,000 ($350,000/0.25)

2011


In 2011 with annual revenues of $21,000,000, we
know what the top of the income statement looks
like, but not the new valuation.


Using the same pre
-
money valuation ratio from
2003, a company that makes $2,500,000 and is
worth $1.4M would hypothetically be worth around
$11.8M in 2011 when it is making $21 M. ($1.4M X
$21M/$2.5M).


Another way to determine the value of
LetterLogic

in 2011 is to use market
comparables
.
Deluxe
Corporation

had a net income to revenues ratio of
10.2% and a P/E ratio of 8.67. Using this market
comparable, the value of
LetterLogic

should be
$21M X 10.2% X 8.67 = $18.571.167.


By logical extension, the value of the venture
capitalist's investment of $350,000 in 2003 is now
worth $4,642,792, which represents an internal rate
of return of 1,227%!


By providing the right financing for growth AND a
line of credit for working capital needs, both the
company and the venture capitalist realized high
returns from this venture.


Proof Eyewear


Do the math for the first year. $433,000 in total
revenues brought $150,000 in profits. They have great
gross profit margins (300% for wholesalers, 600% for
retailers). The boys "don't take any salary." What's
going on with operating expenses?


The brothers think the company is worth $1.5 million.
The Sharks think the company is worth $600,000. Who
is right and why? (consult the revenue numbers and
growth projections for your answer)


How much does Kevin's demand for an up
-
front royalty
payment affect Proof's ability to grow organically
through revenues?