FINANCE TO FEED THE DRAGON

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FINANCE TO FEED THE DRAGON
THURSDAY 14TH JULY

• HECTOR DOUGLAS

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• ARE YOU WINNING THE FINANCIAL GAME?
• WHAT CAN WE LEARN FROM WHAT THE CHAMPIONS DO?

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THE DRAGONS
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Deliver Investors an IRR of 20 or more
Doug Richard
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• Deliver Investors
• an IRR of 20 or more

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• Deliver Investors
• an IRR of 20 or more

Compound Annual Growth Rate
Internal Rate of Return
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• Deliver Investors
• an IRR of 20 or more

EXTERNAL
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As An Investor

• 1m into each of 10 coys for 5years
• IRR of 20
• Total fund must double in 5years
• 6 of 10 fail
• 2 make 20
• 2 must make 140, worth 8m in 5years

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Net Present Value

• Maximise the NPV
• of projected cash flows
• at the cost of capital

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• Maximise the NPV
• of projected cash flows
• at the cost of capital

Internal
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External
Internal
The Cost of Capital
Identify Opportunities Assess likely
returns Deploy as appropriate
Identify sources of funds Assess expected
rewards Employ as appropriate
Projected Cash Flows
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Finance Cycle
FINANCING
ASSETS
Growth
Retentions
PROFITS
DISTRIBUTIONS
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• THE STRATEGIES OF CHAMPIONS
• WHAT THE FASTEST GROWING INDEPENDENT COMPANIES DO
  TO GET AND STAY IN THE FAST LANE
• Kingston Smith and Cranfield School of Management

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Champions and Statics

• Champions
• Fast growing successful businesses
• Doubled turnover and profit over four years
• Statics
• Treading water or declining
• Turnover and profit either static or declined
  over four years

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Financial Factors and Strategic Decisions that
Impact Small Business Performance

• Have a business plan AND follow it
• Stick to your knitting
• Exercise financial discipline
• Maintain financial flexibility

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Business Plan

• 45 of Champions
• 6.5 of Statics
• Worked closely to a Business Plan prepared within
  the last 12 months

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Stick to Your Knitting

• 53 of Champions
• Primary source of growth derived from existing
  products and services to existing markets
• Statics
• More likely to derive growth from
• New products/foreign markets (15/6)
• New products/existing markets (20/10)
• All businesses that reported moving into new
  business areas were Statics

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Financial Discipline

• 89 of Champions
• 54 of Statics
• Produce cash flow forecasts
• 72 of Champions
• 37 of Statics
• Employ financially qualified staff
• High correlation between cash flow
  forecast/financial knowledge and Champion/Static

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Financial Flexibility

• 48 of Champions
• 77 of Statics
• Rely on one source of funds
• 43 of Champions
• 18 of Statics
• Use 2 or 3 sources of funds
• 8 of Champions
• 5 of Statics
• Use 4-5 sources of funds

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• Champions are more likely to have changed banks
  in the last 10 years
• 24 Champions
• 10 Statics

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Pulling it Together
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OBJECTIVE

• Maximise the net present value of projected cash
  flows discounted at the cost of capital

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External
Internal
The Cost of Capital
Identify Opportunities Assess likely
returns Deploy as appropriate
Identify sources of funds Assess expected
rewards Employ as appropriate
Projected Cash Flows
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Cost of Capital

• Weighted average cost of all sources of capital

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Cost of Capital

• Weighted average cost of all sources of capital
• EG
• Loans 25
• Equity 75

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Cost of Capital

• Weighted average cost of all sources of capital
• EG
• Loans 25 at 6
• Equity 75 at 15

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Cost of Capital

• Weighted average cost of all sources of capital
• EG
• Loans 25 at 6 1.5
• Equity 75 at 15 11.25

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Cost of Capital

• Weighted average cost of all sources of capital
• EG
• Loans 25 at 6 1.5
• Equity 75 at 15 11.25
• Weighted average 12.75

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Hurdle Rate

• Cost of Capital
• Allowance for non-profitable projects
• Risk Premium

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External
Internal
The Cost of Capital
Identify Opportunities Assess likely
returns Deploy as appropriate
Identify sources of funds Assess expected
rewards Employ as appropriate
Projected Cash Flows
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What To Discount?

• Only Cash Flow is Relevant

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Discounted Cash Flow( DCF)

• CASH
• 100 cash this year is worth more than 100 cash
  next year
• DCF equalises the value of future cash flows

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DCF

• Invest 1,000 today
• 100 back in each of years 1 to 5
• 500 in year 6
• A Good Investment?
• Return Required 15

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Sum is NPV
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negative
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Opportunity

• You are thinking about buying a digitally
  controlled machine tool for 4,000. The
  investment will generate 2,000 and 4,000 in
  cash flows for two years.
• A Good Opportunity?

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NPV Formula
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Rate where NPV 0 is IRR
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IRR Formula
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Internal Rate of Return
IRR28
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IRR/ Multiple Rates of Return

• Certain cash flows can generate NPV0 at two
  different discount rates.
• This illustrates a cash flow which generates
  NPV0 at both 50 and 15.2.

NPV
1000
IRR50
500
Discount Rate
0
-500
IRR15.2
-1000
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MIRR Formula
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Internal Rate of Return

• Reasonably easy to calculate using spreadsheet
• Intuitive to understand
• Can give misleading indication

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Net Present Value

• Technically, the accepted basis for evaluating
  projects

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Championship Winners

• Maximise the net present value of projected cash
  flows discounted at the cost of capital

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THANK YOU AND QS
hector_at_2know.co.uk