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  • 1. Terence Westgate 2014 Business Capital Definition and Acquisition
  • 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 Business Capital Returns cost of money Investment alternatives Risk and Return Loss lenders’ risk owners’ risk
  • 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 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 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 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 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 Business Capital What is profit? Revenue – Expenses Depreciation Valuation adjustments Profits aren’t Cash
  • 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 Business Capital Direct Investment Cash flow is the vital element for survival
  • 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 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 Values Asset values - break-up values ‘fire sales’ - goodwill of a going concern - value to competitors Business Valuation for Direct Investment Decisions
  • 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 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 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 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 Investor considerations Direct investors share risks Their shares are not liquid Business Valuation for Direct Investment Decisions
  • 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 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 Valuing a direct investment Accrual accounting methods Business Valuation for Direct Investment Decisions
  • 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 Business Capital Returns cost of money Investment alternatives Risk and Return Loss lenders’ risk owners’ risk
  • 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 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 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 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 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 Business Capital What is profit? Revenue – Expenses Depreciation Valuation adjustments Profits aren’t Cash
  • 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 Business Capital Direct Investment Cash flow is the vital element for survival
  • 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 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 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 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 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 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