Terence Westgate 2014
Business Capital
Definition and Acquisition
2
Business Capital
Capital is finance used in acquiring assets employed in
the establishment and day to day running of a b...
3
Business Capital
Returns
cost of money
Investment alternatives
Risk and Return
Loss
lenders’ risk
owners’ risk
4
Business Capital
Balance sheet representation
Assets Liabilities
Non Current Assets Non Current Loan Capital
Current Ass...
5
Business Capital
Example
Assets Liabilities
Non Current Assets $100 25 Non Current Loan Capital
Current Assets 50
(Curre...
6
Business Capital
Balance sheet representation
Assets Liabilities
Non Current Assets
Less Depreciation
Non Current Loan C...
7
Business Capital
Revaluation of Non-Current Assets to Net Realisable Value
Assets Liabilities
Non Current Assets $ 50 25...
8
Business Capital
Example
Assets Liabilities
Non Current Assets $100 25 Non Current Loan Capital
Cash [overdraft] (10)
In...
9
Business Capital
What is profit?
Revenue – Expenses
Depreciation
Valuation adjustments
Profits aren’t Cash
10
Business Capital
Direct investment
Owner risk
Investment is non liquid
Shared responsibilities
Value in performance
Inv...
11
Business Capital
Direct Investment
Cash flow is the vital element for survival
12
What is Direct Investment?
Shares not listed on stock exchanges bought directly from
owners of company
Business Valuati...
13
Direct investment means direct risks if the company is not
listed – i.e. It’s shares are not in a stock market
Therefor...
14
Values
Asset values
- break-up values ‘fire sales’
- goodwill of a going concern
- value to competitors
Business Valuat...
15
Equity Capital
Ownership of business
Non – refundable
Preference shares may be convertible
Ordinary shares have voting ...
16
Bonds and Loans vs equity
No ownership of business
Repayable
May be convertible
No voting rights
Fixed or floating inte...
17
Dividend values of ordinary shares
Dividends are a share of the after-tax profits of a company.
They are paid at the di...
18
Direct investors’ decision criteria
1 How much money am I likely to make and when?
2 How much money can I possibly lose...
19
Investor considerations
Direct investors share risks
Their shares are not liquid
Business Valuation for Direct Investme...
20
RISKS
Market risk
Business risk
Currency risk
Political risk
Environmental risk
Economic risk
Legal
Criminal risk
Busin...
21
Exit from investment
Investors can sell shares in a restricted market – not public
at a profit
at a loss
If the company...
22
Valuing a direct investment
Accrual accounting methods
Business Valuation for Direct Investment Decisions
23
Business Capital
Capital is finance used in acquiring assets employed in
the establishment and day to day running of a ...
24
Business Capital
Returns
cost of money
Investment alternatives
Risk and Return
Loss
lenders’ risk
owners’ risk
25
Business Capital
Balance sheet representation
Assets Liabilities
Non Current Assets Non Current Loan Capital
Current As...
26
Business Capital
Example
Assets Liabilities
Non Current Assets $100 25 Non Current Loan Capital
Current Assets 50
(Curr...
27
Business Capital
Balance sheet representation
Assets Liabilities
Non Current Assets
Less Depreciation
Non Current Loan ...
28
Business Capital
Revaluation of Non-Current Assets to Net Realisable Value
Assets Liabilities
Non Current Assets $ 50 2...
29
Business Capital
Example
Assets Liabilities
Non Current Assets $100 25 Non Current Loan Capital
Cash [overdraft] (10)
I...
30
Business Capital
What is profit?
Revenue – Expenses
Depreciation
Valuation adjustments
Profits aren’t Cash
31
Business Capital
Direct investment
Owner risk
Investment is non liquid
Shared responsibilities
Value in performance
Inv...
32
Business Capital
Direct Investment
Cash flow is the vital element for survival
33
Return on Equity (ROI) criteria and factors
Business Valuation for Direct Investment Decisions
Forecast Balance Sheet 1...
34
Return on Equity (ROI) criteria and factors
Business Valuation for Direct Investment Decisions
Forecast income statemen...
35
Return on Equity (ROI) criteria and factors
Business Valuation for Direct Investment Decisions
NOTE
On 1 Jan 2015 NRV o...
36
Business Valuation for Direct Investment Decisions
Cash based investment appraisal
Cash flows mirror bank statements
Ig...
37
Cash based investment appraisal
Business Valuation for Direct Investment Decisions
Forecast cash flow 2015 -2015 Jan Fe...
38
Business Valuation for Direct Investment Decisions
Westgate ROCE method answers the questions
How much of my money is t...
39
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Session1 introduction

  1. 1. Terence Westgate 2014 Business Capital Definition and Acquisition
  2. 2. 2 Business Capital Capital is finance used in acquiring assets employed in the establishment and day to day running of a business Working Capital is the value of assets bought and sold in the course of trade.
  3. 3. 3 Business Capital Returns cost of money Investment alternatives Risk and Return Loss lenders’ risk owners’ risk
  4. 4. 4 Business Capital Balance sheet representation Assets Liabilities Non Current Assets Non Current Loan Capital Current Assets (Current Liabilities) Owners’ Equity Capital
  5. 5. 5 Business Capital Example Assets Liabilities Non Current Assets $100 25 Non Current Loan Capital Current Assets 50 (Current Liabilities) -25 75 Subscribed Equity Capital Net Assets 125 25 Retained Earnings 125 Capital
  6. 6. 6 Business Capital Balance sheet representation Assets Liabilities Non Current Assets Less Depreciation Non Current Loan Capital / Owners’ Equity Capital x 100 = Gearing % Current Assets - Current Liabilities = Working Capital
  7. 7. 7 Business Capital Revaluation of Non-Current Assets to Net Realisable Value Assets Liabilities Non Current Assets $ 50 25 Non Current Loan Capital Current Assets 50 (Current Liabilities) -25 75 Subscribed Equity Capital Net Assets 75 (25) Retained Earnings 75 Capital
  8. 8. 8 Business Capital Example Assets Liabilities Non Current Assets $100 25 Non Current Loan Capital Cash [overdraft] (10) Inventory 35 Receivables 25 (Current Liabilities) -25 75 Subscribed Equity Capital Net Assets 125 25 Retained Earnings 125 Capital
  9. 9. 9 Business Capital What is profit? Revenue – Expenses Depreciation Valuation adjustments Profits aren’t Cash
  10. 10. 10 Business Capital Direct investment Owner risk Investment is non liquid Shared responsibilities Value in performance Investment through stock market Owner risk reduced Investment is liquid Reduced responsibilities No choice of ownership
  11. 11. 11 Business Capital Direct Investment Cash flow is the vital element for survival
  12. 12. 12 What is Direct Investment? Shares not listed on stock exchanges bought directly from owners of company Business Valuation for Direct Investment Decisions
  13. 13. 13 Direct investment means direct risks if the company is not listed – i.e. It’s shares are not in a stock market Therefore the shares are NOT liquid assets As the investor will share directly the fortunes of the investee, his interest is in performance and profitability This changes the style of investment document for an IPO prospectus. Cash based performance measurement becomes important Business Valuation for Direct Investment Decisions
  14. 14. 14 Values Asset values - break-up values ‘fire sales’ - goodwill of a going concern - value to competitors Business Valuation for Direct Investment Decisions
  15. 15. 15 Equity Capital Ownership of business Non – refundable Preference shares may be convertible Ordinary shares have voting rights Non-interest bearing Dividends paid after tax at discretion of managers Transferable – subject to shareholders’ agreement Ordinary shareholders last to be paid in event of liquidation – so high risk – but limitable Business Valuation for Direct Investment Decisions
  16. 16. 16 Bonds and Loans vs equity No ownership of business Repayable May be convertible No voting rights Fixed or floating interest rate Interest paid before tax (deductible) at fixed dates Transferable Repayable before equity in the event of liquidation May be secured against assets to reduce lender risk Business Valuation for Direct Investment Decisions
  17. 17. 17 Dividend values of ordinary shares Dividends are a share of the after-tax profits of a company. They are paid at the discretion of the directors They cannot be paid if there are no profits They are usually paid in cash Business Valuation for Direct Investment Decisions
  18. 18. 18 Direct investors’ decision criteria 1 How much money am I likely to make and when? 2 How much money can I possibly lose? 3 What is the likelihood of loss? 5 What are the exit choices? Business Valuation for Direct Investment Decisions
  19. 19. 19 Investor considerations Direct investors share risks Their shares are not liquid Business Valuation for Direct Investment Decisions
  20. 20. 20 RISKS Market risk Business risk Currency risk Political risk Environmental risk Economic risk Legal Criminal risk Business Valuation for Direct Investment Decisions
  21. 21. 21 Exit from investment Investors can sell shares in a restricted market – not public at a profit at a loss If the company is profitable or shows potential for growth an equity investor may sell to another interested party If an investor wants to guarantee a sale, he should write a ‘put’ option into the original shareholders’ agreement Investors and management may opt for an IPO if the shares and the business are suitable Business Valuation for Direct Investment Decisions
  22. 22. 22 Valuing a direct investment Accrual accounting methods Business Valuation for Direct Investment Decisions
  23. 23. 23 Business Capital Capital is finance used in acquiring assets employed in the establishment and day to day running of a business Working Capital is the value of assets bought and sold in the course of trade.
  24. 24. 24 Business Capital Returns cost of money Investment alternatives Risk and Return Loss lenders’ risk owners’ risk
  25. 25. 25 Business Capital Balance sheet representation Assets Liabilities Non Current Assets Non Current Loan Capital Current Assets (Current Liabilities) Owners’ Equity Capital
  26. 26. 26 Business Capital Example Assets Liabilities Non Current Assets $100 25 Non Current Loan Capital Current Assets 50 (Current Liabilities) -25 75 Subscribed Equity Capital Net Assets 125 25 Retained Earnings 125 Capital
  27. 27. 27 Business Capital Balance sheet representation Assets Liabilities Non Current Assets Less Depreciation Non Current Loan Capital / Owners’ Equity Capital x 100 = Gearing % Current Assets - Current Liabilities = Working Capital
  28. 28. 28 Business Capital Revaluation of Non-Current Assets to Net Realisable Value Assets Liabilities Non Current Assets $ 50 25 Non Current Loan Capital Current Assets 50 (Current Liabilities) -25 75 Subscribed Equity Capital Net Assets 75 (25) Retained Earnings 75 Capital
  29. 29. 29 Business Capital Example Assets Liabilities Non Current Assets $100 25 Non Current Loan Capital Cash [overdraft] (10) Inventory 35 Receivables 25 (Current Liabilities) -25 75 Subscribed Equity Capital Net Assets 125 25 Retained Earnings 125 Capital
  30. 30. 30 Business Capital What is profit? Revenue – Expenses Depreciation Valuation adjustments Profits aren’t Cash
  31. 31. 31 Business Capital Direct investment Owner risk Investment is non liquid Shared responsibilities Value in performance Investment through stock market Owner risk reduced Investment is liquid Reduced responsibilities No choice of ownership
  32. 32. 32 Business Capital Direct Investment Cash flow is the vital element for survival
  33. 33. 33 Return on Equity (ROI) criteria and factors Business Valuation for Direct Investment Decisions Forecast Balance Sheet 1-1-15 Fixed assets cost 10,000 Depreciation for year -2,000 8,000 Current assets Cash 1,000 Debtors less creditors 1,000 Inventory 1,000 3,000 Net Assets 11,000 Long term loans 5,000 Equity 5,000 Retained earnings 1,000 11,000
  34. 34. 34 Return on Equity (ROI) criteria and factors Business Valuation for Direct Investment Decisions Forecast income statement 1-1-15 Sales 50,000 Cost of sales 20,000 Gross Profit 30,000 Operating expenses 24,000 Interest 1,000 Depreciation 2,000 Net Profit before tax 3,000 Taxation 1,000 Net profit after tax 2,000 Dividend 1,000 Retained earnings 1,000
  35. 35. 35 Return on Equity (ROI) criteria and factors Business Valuation for Direct Investment Decisions NOTE On 1 Jan 2015 NRV of assets is estimated to be £5,000 fixed and £2,000 current Return on investment of £10,000 NPAT 2,000/10,000 = 20% ROI of book value assets 2,000/8,000 = 25% EBIT/Net assets = 4,000/11,000 = 36% Cash surplus / Asset NRV 1,000/7,000 = 14%
  36. 36. 36 Business Valuation for Direct Investment Decisions Cash based investment appraisal Cash flows mirror bank statements Ignore debtors and creditors Include only: Payments Receipts Show an available cash balance
  37. 37. 37 Cash based investment appraisal Business Valuation for Direct Investment Decisions Forecast cash flow 2015 -2015 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec £000's Capital received 10 Sales receipts 1 2 3 4 5 5 5 5 5 5 5 5 TOTAL 11 2 3 4 5 5 5 5 5 5 5 5 Capital expenditure 10 Inventory 1 1 1 2 2 2 2 2 2 2 2 2 Operating expenses 2 3 3 3 3 2 2 2 2 2 2 2 TOTAL 13 4 4 5 5 4 4 4 4 4 4 4 MONTHLY BALANCES -2 -2 -1 -1 0 1 1 1 1 1 1 1 BALANCE B/FORWARD 0 -2 -4 -5 -6 -6 -5 -4 -3 -2 -1 0 BALANCE C/FORWARD -2 -4 -5 -6 -6 -5 -4 -3 -2 -1 0 1 NOTE Negative balances funded by overdraft, repayable on demand
  38. 38. 38 Business Valuation for Direct Investment Decisions Westgate ROCE method answers the questions How much of my money is tied up in this investment? What is the fire-sale value of the assets employed? What is the annual free cash surplus available for distribution?
  39. 39. 39

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