Owner: Ask Jon Paul URL:http://askjonpaul.com/ Join Date: Tue, 02 Jan 2007 17:54:07 -0600 Rating:0 Site Description: As a business finance expert for 25 years, I have helped many businesses turn the finance area at their firm into a resource for the rest of the company and helped propel their growth with strategic and tactical guidance. My blog will look at various pro Site statistics:Click here
Have a Range of Valuations Ready 2007-03-25 19:21:00
I usually don’t advise putting valuation in on a business plan. The valuation could lock you in. It might be possible that a prospective buyer or investor might be prepared to offer an even higher valuation that what you would’ve thought of and you just might be selling yourself short by putting a number in. Conversely, you might scare some people away before they’ve had a chance to really fully understand the value that you have to offer with your company.
However, that does not mean don’t bother thinking about valuations. Instead that means to go ahead and think about it and be prepared, but just don’t have it put down in the particular business plan.
I would generally suggest there be some information that you have available off to the side that you could use in a face to face meeting. But, sooner of later, it’s going to come to the time where you’re going to be sitting down face to face with the particular investor. This is where having the valuations handy at your f Read more:Range
Beware the Incremental Pricing Trap 2007-03-24 18:14:00
It can feel very seductive, especially for professional service firms. I can make $10 or so per hour on this person, so why not go for it. This can be especially true for firms that place people on projects on an interim basis.
That’s what I call incremental pricing, making a small amount on a particular job. After all, the incremental amount will be gravy, additional income coming into the bottom line.
The major problem with incremental pricing is that it can be leaving serious money on the table. Rather than saying what you could pick up in small amounts on additional work, what if instead you could raise your margin slightly on a lot of your existing business. And besides, you could also pick up some incremental business at the higher price point. Pulling that off could be much more valuable than the benefits from some incremental small work.
Another problem with incremental pricing is that it can become too successful without adding much to the bottom line. You could suddenly fi Read more:Pricing
, Beware
, Incremental
Try Alternative Valuations 2007-03-23 18:06:00
Next time you calculate a valuation on your equity, consider taking multiple paths. The different valuations could help re-enforce each other and give you more credibility to your audience.
So, what would be some of the different ways that you could value the equity?
1. Multiple of earnings or EBITDA. Take your most recent EBITDA earnings and the multiply it times a multiple that you think is realistic for your market. Alternative
ly, you could go several years out and then discount that number back to the present.
2. Multiple of revenues. In some situations a multiple of revenues would be a more accepted factor for the industry. You could do it based on your current revenues or, again, go several years out, determine the value, then discount it back to the present.
3. Product/Service lifetime value. This is a method you don’t see commonly use, but can be a very powerful way. What this does is look at lifetime value of certain products, service or customer classes. The calculation is
The Lifetime Value Approach to Valuations 2007-03-22 15:43:00 Here is an alternative method to valuing a company that you don’t often see, but can be very insightful and powerful.
You calculate the lifetime value of either:
- Your product or service lines
- Your customer base
To calculate this you need the combination of several numbers:
1. The annual expected revenues.
2. The cost of servicing these revenues on an annual basis. These could include marketing costs, cost of goods or services, technology cost, shipping cost or other cost related to the sales of the particular products or services.
3. The difference between the two is the annual contribution.
4. The number of years you expect to keep the product or service or customer.
5. The net present value of the annual contribution. This is taking the annual contribution for the number of years that the product or service will be in place and then discounted back to a present value.
6. The cost of acquisition. This would be what does it cost to acquire the customer in the first place.
7. Life Read more:Lifetime
, Value
Streamlining the journal entries 2007-03-21 15:38:00
There’s another step to making your month end process faster and simpler. That next step is to streamline some of the journal entries.
Take a look at the journal entries that you have with the month end closing process. Which of these journal entries could be more automated?
For example, one area could be with payroll. There could be several entries that feed off a payroll number, such as:
1. Payroll taxes.
2. Medical insurance.
3. Other fringes.
4. Unemployment taxes.
5. Payroll allocations.
All these entries could be linked to a particular payroll number. So, what you could do is setup a spreadsheet where the payroll numbers are either downloaded or input from the payroll for the month or the last payroll of the period, depending upon which triggered the entry. This can then be used as a base for all the other entries in the payroll area. From there, you could setup another sheet that would have all these other payr
The Real Test of a Financial Model 2007-03-20 15:32:00 You’ve done your financial model going several years out. You’ve got some nice assumptions laid out that are documented well. You have the full set of financials, profit and loss, balance sheet and cash flow. Plus, you’ve got various supporting schedules to support your revenues and various departmental expenses.
So, are you done at this point? How do you know if your model will work correctly going forward?
I am a big believer in looking forward, but this can be one example where looking back can be very meaningful.
Here is a test that I would want you to take. Suppose you have a model going out three years covering 2007, 2008 and 2009. You’ve got the assumption laid out for those different years, which drive this model. Now, we want you to do this test. Create another column to the left of 2007 for the entire model. This column will be for 2006. What we want you to do is to put an assumption for 2006 and see how the Read more:Financial
Deferred Revenues – What Should the Balance Be? 2007-03-19 15:29:00 If you have a business where you collect money upfront from customers, like a magazine subscription or an annual software license or some other type of annual service paid upfront, then you probably have to face the issue of estimating the deferred revenue liability on your balance sheet.
Deferred revenues, that sounds like some accounting jargon. What that means is you have to match your revenues with the period that you earned the revenues in. A 12 month magazine subscription is earned one month at a time. So, if somebody subscribed to your magazine in July, they would still have six months remaining at the end of the year and your deferred revenue liability for that customer would be half a year’s subscription of 50% of the total subscription price received. If you offer multi-year plans, you can see that the liability is even more significant.
So, this is a pretty important number to be estimating on the balance sheet. For some companies, it can be t Read more:Revenues
, Balance
Stock Options - Assume Exercise 2007-03-18 15:21:00 One question sometimes comes up when doing a cap table of the equity in a company. Should you assume that the stock options are exercised or not assume it? Do you base it upon what will be at the present time and let future stock option exercises dilute the equity at a later point in time?
I’ve heard cases made for either way, but I think it’s much better to assume full exercise of the stock option. You want to give the investors that hold the other stock the most conservative view on their holdings. By not including the stock exercise, you show a higher percentage of ownership for them in the shorter term. Then when the shares from the options are exercised there could be disappointment on their part, could they even realize they could get diluted down to such a lower level.
If you have other stock options planned in the near future, over the next couple years, you might want to also put them into the capitalization plans. Get them approv Read more:Stock
, Options
, Assume
, Exercise
, Stock Options
The Net Cash Balance 2007-03-17 15:15:00 The balance sheet’s all done, but there might be some missing information down below the end of the balance sheet.
What might that be? The net cash balance.
This applies only in certain situations. This will be when your company has deposits from customers or deferred revenue liability. The latter can happen when you receive money from customers for subscriptions or licenses that cover an extended period of time, such as 12 months, and the revenue needs to be recognized over a period of time. This money you receive from the customer first goes into the deferred revenue liability account.
The net cash balance would be a memo line down below the balance sheet. It represents the difference between what you show on cash, less the customer deposits and deferred revenue liability. So, for example, if you had $100,000 in the bank and you had deferred revenue liability of $50,000, your net cash position would be $50,000.
Why show this? Because this n Read more:Balance
Exit Strategy 2007-03-16 15:08:00 One thing sometimes left out in business plan narratives is the exit strategy. The plan looks very enticing, the numbers look good going forward. There appears to be some nice growth in the valuation of the company. Revenues are growing and ebitda is at a nice level.
That’s fine for the company, but what about the investor. One of their primary questions is, “How will I get my money out?” They want to make sure their getting into an investment that will have some liquidity at some point. They’re not looking for money in that’s going to be around for several generations.
So check your plan out. Does it have an exit strategy section? If not, add one in. It doesn’t have to be too long. It may only be a couple paragraphs, but make sure you cover some of the bases in terms of what some of the alternatives might be. Here are a few that you might consider:
1. Acquisition by a strategic party. A strategic Read more:Strategy
Showing Your Passion 2007-03-16 15:05:00 It’s time for the meeting with that prospective investor. You have your PowerPoint ready. You’ve got your numbers down. The business plan is all ready. So, what might be most important in the presentation?
Probably none of the above.
What they may be really looking for can be summed up in one word. Passion
.
Biggest thing investors look for in a company to invest in is the management. And, perhaps, the biggest thing they’re going to look for in the management is passion. They know they’ll be some bumps along the road during the venture. Not everything will travel on a straight line. They’ll need a leader who can weather the storms and make the appropriate adjustments.
They also know it might take longer to get the venture off the ground and to be profitable and read to be sold. They want to see an executive leader who will be in there for the long haul not just in there for a quick run.
What can really sum it up? Pass
Ready for the Auto Race 2007-03-15 14:58:00 NASCAR’s getting pretty popular these days. My oldest son, Brad, has become quite an auto racing fan.
So, what does this have to do with business and finance? Plenty. There are a number of parallels to run an effective business and being successful in NASCAR. While my knowledge of auto racing is pretty minute, I think I can draw some parallels. Here are some key things that your company needs to be ready to run the race of business and be in it for the long haul.
1. Road Map. You need to have a sense on where you’re going. Okay. (Inaudible) on NASCAR you’re just going around the loop, but in most instances when you’re taking a long trip of 500 miles, you want to have a map to get you going in the right direction. Someone good in the financial area can be a tremendous help to you in the strategic direction, and help give you suggestions on how to change your course and help keep you on track.
2. Fuel. You wo
What’s Your Real Carrying Cost? 2007-04-03 20:46:00
As you go to price out some of the costs of your product lines, one cost often overlooked is the carrying cost required to finance a product line.
However, it’s also possible when it is calculated that it could be very well overstated too.
One method says to look at some of the different components and say what would be the average days accounts receivable for that particular product line and multiple that cost times your average cost to capital and secondly, what the average days of inventory and multiple that times the average cost to capital.
However, are your costs really quite that much? A better way could be to take a closer look at your working capital cycle and see just exactly what are you out of pocket for. This can especially apply if say, for example, you’re not borrowing on your accounts receivable.
Here’s how it can work. First, you look at the raw materials you have to purchase. Then consider how long you have to pay for them. The meter doesn’t really start runn
What level of finance are you operating at? 2007-04-04 20:48:00
There are different level
s of finance
operation ranging from those that just barely get by or perhaps don’t even do that well, all the way to ones that are really strategic and add tremendous value to the organization. Take this test and let’s see what level is your particular finance department operating at.
Level 0. This is the finance department that is really struggling. Numbers take a long time to be generated. Results can change dramatically from month to month. Financials often have to be restated. Cash flow is tight. It can be a scramble to keep up with payroll or to keep vendors happy with payments.
Level 1. Just the basics are getting done, but not terribly well. The financials are getting created and perhaps somewhat accurate, but they take a long time to get together may be even up to 30 days. Cash flow is okay, but there’s not a log of cushion within the operation.
Level 2. Doing better, getting the basics done. Financials are done on a more timely fashion, perhaps
Everybody has Competition 2007-04-07 17:25:01
Sometimes I see business plans that mention that there is no competition. I don’t buy that, nor is it likely that a potential investor will buy that either.
Everybody
has competition.
If there isn’t any competition, that might mean one of two things. One is that the market is dead and it’s long past gone by. Okay. Perhaps, if you manufacture buggy whips, you may not have any competition, but is that a good thing? The second thing could be it, perhaps, that the market is not yet established. That can be a scare to the potential investor as well.
So rather than say there is no competition, perhaps, think more broadly and put down some different sources:
1. Doing nothing. Sometimes the competition can be the alternative of doing nothing.
2. Doing it the existing way. If you’re coming out with the first airplane company, you could say there was no competition for airplanes, but in a broader market sense the market was really travel. So, the competition could be trains, automobiles
When the Attachment is Too Big 2007-04-07 17:04:00
Sometimes you’ll run into a situation when you have an attachment that is just too big to send through your regular email carrier. For example, I have Comcast and I know anything greater than five megabytes through Comcast will not get through.
So, are you stuck? Not necessarily so.
Here’s a great tool that I use in such circumstances. It’s an online virtual vault. It’s called Big Vault. To check it out go to www.bigvault.com.
This site has been very handy for me for when I have files greater than five megabytes in size, files that just won’t dip down to a size below that limit. It’s also a great way to get files over to a client when they might be having trouble with their email system, but do have access to a web browser.
Big Vault works like this. You go ahead and setup an account. Now, within that account, you can setup folders. With each folder then, you can setup a particular password for that folder and setup some characteristics for that folder, such as how much fi Read more:Attachment
The Three Legs of Cash Flow 2007-04-06 16:56:00
Perhaps, the most overlooked financial statement in the financials is the cash flow statement. Often it’s not there as part of the reporting package.
This statement can be very critical to understanding how the cash is flowing in your business. Cash is king. Cash is the life blood of your company.
The cash flow statement has three main legs to it. This can give you insight in terms of how your company is really doing. It could be more meaningful than the profit and loss statement and the balance sheet. Let’s look at the three:
1. Cash from operations. This looks at how much cash flow is your company generating during the month. It goes beyond your net income because it also looks at some of the working capital required to support that income. You might have positive net income, but on the other hand your receivables are growing just as fast. So rather than cash being generated from operation, all you’re doing is moving it from one hand to the other. The net income is going into Read more:Three
A Test of Any Number - So What? 2007-04-05 16:44:00 Just because a number’s calculated doesn’t mean it should be. Sure, there are certain things you have to do for the financial statement, but what about numbers for dashboards or other supplemental management reports. This is a good question to ask about any particular number.
So what?
So what will you do differently as a result of seeing the number? Will any action really be taken? What if the number’s two or three times what it is? What if the number is half? Will any of these lead to any changes?
If not, maybe it’s a number that shouldn’t be calculated.
Perhaps, there’s a better number that should be put in its place.
Let me use an example from the personal side. I know somebody who has a booklet in his car and he records the gallons of gas and the miles per gallon for each tank of gas. He takes a minute or two to pull that out, put it down and put it back in the glove compartment of his car, after each fill-up.
So, what is he going to do with that information? Is he Read more:Number
Prove your Sales Batting Average 2007-04-09 05:30:00
One of the biggest things a sharp investor, particularly an institutional investor, is going to check out is your batting average on meeting your sales forecast. Don’t leave it to chance; know where it stands ahead of time.
At a simple level, they may look at it overall, from a high level. What has been your sales forecast for the past three years and how did it match up against your actual sales? They’ll be some variances there. How would you explain them? Would there be factors such as:
1. Delays in the timing of introduction of new products.
2. Inability to close on some new customers that you had expected.
3. Shifts in the market.
4. Delays in your product introduction or service offerings.
5. Insufficient funds to ramp up the sales force.
6. Geographic differences affecting your conversions to buyers.
It’s even better if you can do this analysis, breaking it down into more detail, covering by product line and do by geographic territory or by sales person. Show that it’s a Read more:Prove
, Sales
, Average
Spell out the Assumptions 2007-04-11 06:04:00
One of the best practices to have with your financial model, something not often done, is to spell out your assumption separately, in its own assumption sheet in the file. Two things I generally see with assumptions in financial model:
1. The assumptions are buried in the individual cells. The reader has to dig through the model to pull out all the various individual assumptions.
2. Assumptions may be spelled out, but they're listed on individual sheets where the calculations are done. This forces the read to go through many sheets to see the various assumptions.
Neither of these is as good as having all the key assumption laid out in one page. It makes it much easier to review when they're all together. It provides a check and balance, for you can see where certain assumptions out here out of sync with each other.
However, there's an even greater blessing - two great additional benefits I see:
1. You can make all your assumption changes right from one particular sheet.
2. It is
Know your Bank's Performance 2007-04-10 05:55:00
Sometimes bank loans get called and you are told to get your company loan from another bank.
But, it might not be due to your performance. It could be due to your bank. They may have to reduce some of their credit risk, so even though you have performed like you said you would, there could be external reasons that force them to call in your loan.
Now, you can't always tell when that would happen. Fortunately, it's pretty unlikely that it would. But, when it does happen, it seems to have a habit of happening at the most inopportune time.
So, how can you protect yourself against it?
Know how your bank is doing, get their annual reports, get their quarterly reports, and keep track of their performance. Your metropolitan area might have a publication that will do an annual ranking of the banks by performance, such as Crain's Chicago in the Chicagoland metro area.
Talk with your banker too. If you're not sure how to understand the bank financials, which can be a little bit differen Read more:Performance
Keep the Outlook File Small. Lose the Attachments. 2007-04-12 06:17:00
I’d only been using Outlook
for about a year. Previously, I’d used a very good email program called Eudora. However, I thought Outlook was getting better and it was time to jump on the Microsoft platform.
In the course of a year’s time, I had grown my Outlook file to nearly four gigabytes. It would get sluggish at times. No wonder!
I checked with one of my technical gurus and he mentioned that anything over two gigabytes and you’re asking for trouble. Now, I found out the archives weren’t working as automatically as I needed to have done, so I did some manual archiving and that helped. However, there was another big step that I was missing, that I since have incorporated into my daily practice.
What was it? Moving out the attachments.
I realized Eudora operated differently than Outlook. Eudora would keep the attachments separately from the Eudora database. Outlook, on the other hand, puts everything into one large file. As a result, in this day of large attachments, it does Read more:Small
Breaking Down the Sales Projection 2007-04-14 06:44:00
One of the biggest complaints that is often heard about business plans is that the sales projection is unrealistic. One of the greater shortcomings of financial forecasts in falling short of what was projected is not hitting the sales forecast.
Here’s one way to sort that out and test the sales forecasts for reality.
One way to do it is to take a look at the sales cycle and build that into the forecast. Among the elements of the sales cycle that can be put in are:
1. How many prospects would be contacted?
2. What percentage of prospects will turn into sales visits? This will lead to the numbers projected sales visits.
3. What percentage of sales visits will turn into customers? This will lead to the total number of new customers.
4. Expected order size from the new customers. This can lead to the total expected orders.
That covers some of the info from the new customers. Next then, we have a parallel side from existing customers if we look at what type of business will come in from Read more:Breaking
, Sales
, Projection
Business Plans – Grab Them at the Start 2007-04-13 06:29:00
A crucial part of the business plan is the start to your executive summary. In other words, the summary in the summary.
This is the moment of truth. You can lose your audience very quickly or you can really whet their appetite.
Depending upon where you’re going to, the reader could very well be someone who sees hundreds of these a month and has a very short attention span. If you don’t grab them quick, you’re going to lose them.
So, what do you need in that summary part of your summary to get them juiced?
It should be pretty clear to them what you’re about. It shouldn’t be hard work for them to sort out what is going on. To make that happen cover the following points:
1. What is the pain out there that your customers are experiencing? Make it emotional. Get your reader to feel the pain. Make it something they can relate to, if at all possible.
2. How large is the market? You want to establish that this something large enough for them to be interested in.
3. Why are you the Read more:Business
, Start
, Business Plans
Handling the Credit Reference 2007-04-17 08:36:00
From time to time, you may have a new supplier that you want to do business with, but now it’s got to go through their credit department. They’re going to call for a credit reference. How should the accounting department handle it? I’d like to give them core information that they need, but not any more.
They probably will ask for a full set of financial statements, but I think when you let the financials out to outsiders you can lose control of the information. I prefer to leave it to more summary type of information and balance sheet data on a selective basis.
For example, it could be just a high level balance sheet and say that the profit and loss is confidential. They’ll get a feel for the profitability though the balance sheet with the positive retained earnings that you’re showing.
They may also ask for some trade references and I’m fine with those. You should have a list of trade references that you would give out, but rotate it around so you’re not always relying Read more:Handling
Having Cash for Next Month 2007-04-16 08:34:00
There are some businesses out there that are living practically payroll to payroll. That’s a tough way to go at it. One little speed bump can create a significant crisis, like not being able to make payroll.
It doesn’t have to be that way.
Consider the alternative, having enough cash on hand to cover the next month. Think what a relief that can be to have that set and then be able to focus on other things during the month. Wouldn’t it be great to not have that distraction looming in the back of your mind?
So, what are some things you can do to build some buffer on the cash flow:
1. Banking. Your banking relationship might be able to provide some buffer for you. Do you have a line of credit setup? If not, that might be able to give you some cushion there? Does your company have receivables? Do you have inventory? If so, you could have the collateral that a bank could use to support giving you a line of credit. That just might be what you need to give yourself a buffer.
2. Revenue Read more:Having
, Month
Keep a Watch on these Numbers 2007-04-15 08:27:00
Microsoft Excel is loaded with features that are often ignored. Here’s a terrific feature that very few people use that can be extremely powerful and a great timesaver for you. It can eliminate a lot of going back and forth. It can make it easier for you to get to the values and the results that you want to achieve in the spreadsheet.
I can’t recall if this was available in the prior version of Excel, but in Excel 2007, it’s out there as an icon and easy to use and put in place. What is the feature?
The watch feature.
This feature allows you to keep a watch on how a particular value changes as you make changes in formula. For example, maybe you want to track the change in net income based on changes in your financial plan. To do so you would setup a new watch tracking that net income value. This would then be captured in a small window that would reside on top of your spreadsheet. You can move around this window and resize it to meet your pleasure.
The beauty is now this window Read more:Numbers
Facing a Down Round 2007-04-19 06:42:00
Sometimes there are bumps along the road in the path to becoming a successful company. One of those bumps could be the change in stock price, even as a private company. When you’re going out to raise one round of capital, you might find that the next valuation is down from your previous one. In other words, you have the down round.
Usually, down rounds are caused by one or two situations or both:
1. Company circumstances have changed and the company has not delivered like they thought they would. They’ve had to pull back and retrench before going forward.
2. The early rounds were overvalued. This can often happen with shifts from going from an individual investor, such as friends and family or angels, to more professional investors, such as a private equity firm.
There could be one option though to the down round and this would be to keep the valuation up, but make it subject to hitting certain targets down the road. If the targets are not hit, then the investors in this new round Read more:Facing
Getting an Open Account 2007-04-18 06:39:00
One thing that can help your cash flow, especially when you’re a younger company getting up and going, is to get as many open accounts as much as possible with your suppliers.
Sometimes that can be easier than it sounds.
You may reach that point sooner or later, what you have to get something from a larger company. Depending upon the company, you might run into a rather rigid credit department. They might require so many years of financial statements or they might require a certain level of credit score. Perhaps, they might even be at the point where they just don’t start up anybody on open account terms, but want you to build up a little bit of history with them.
So what can you do, when you run into somebody that’s playing the hard-line and not being as flexible? Here are a few thoughts:
1. Have your own credit references set. Be proactive, have your own set of credit references developed. Be establishing some good relationships with certain suppliers that will back you up a Read more:Account
Checkout the Investor 2007-04-21 06:46:00 Checkout
the investor; they’re going to be checking out you. It’s a two-way street.
After all, where you get the money from can be even more important than how much money do you get. Getting a lot of money, but coming from the wrong party, could make your business life a nightmare over the next few years.
So, what kind of things might you checkout in order to qualify the investor?
1. What industries have they invested in? Is it similar to your industry? Will they be able to add value through your industry experience?
2. What is their style? Are they a financial investor or do they like to get actively involved? If you think you are going to get a financial investor and it turns out to feel like the second coming of your mother-in-law, you could be in for a tough go.
3. What kind of contacts could they bring in? Are you looking for an investor who can help open doors for you?
4. Who is involved in their firm? Who sits on the board?
5. What stage do they typically get in to an inves Read more:Investor
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