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Lecture

Entrepreneurial Finance 2.doc

6 Pages
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Department
Business
Course Code
BU121
Professor
Roopa Reddy

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Description
Entrepreneurial Finance Monday, March 04, 2013 1:06 PM Liquidity • Compares assets that can be quickly converted to cash with liabilities that represent near-term needs for cash • Addresses long-term trends • Cash burn helps us see if we're in immediate need Year end accounting figures -> gives sense of long term trend, won't • tell you tomrrow and issue is short term • Evaluates working capital management issues • Handling current assets and liabilities, things we deal with on daily basis to operate buiness • Current Ratio = average current assets/ average current liabilities • Rule of thumb: >2, <4 - holding too much current assets when you could be investing it to earn a higher return • Acid Test/Quick Ratio = average current assets – average inventories average current liabilities • Rule of thumb: >1 • NWC (net working capital) to total assets ratio = average current assets – average current liabilities average total assets • higher the percentage, greater the liquidity Interpreting Cash-Related Trends • Critical factor: how many months of cash do you have? • Current ratio, quick ration, NWC are going down -> has to do with burn rate • Receivables, inventories = money tied up (not coming back to cash) Conversion Period Ratios • Measure average time in days required for non-cash current assets and selected current liabilities to create/demand cash • Faster assets can be converted into cash, greater the liquidity • Tells you the actual time it's taking Operating cycle: measures time it takes to purchase raw materials, assemble • a product, book the sale and collect on it Selling on credit: increases pool of customers Measuring Conversion Times • Inventory-to-Sale Conversion Period = average inventory (cost of goods sold/365) • Measures speed of inventory • Sale-to-Cash Conversion Period = average receivables (net sales/365) • Days of sales outstanding or average collection period (speed of receivables) • How many days does it take to collect your receivables • Inventory to sale + Sale to Cash conversion period = average operating cycle • Purchase to Payment Conversion Period = average payables + average accrued liabilities (cost of goods sold/365) • Care about speed because while that's happening, you still have to pay payables and accruals • When operating cycle is going on (outside cycle) you still have to pay the inside  Want to balance them • Cash Conversion Cycle = Inventory to Sale + Sale to Cash - Purchase to Payment Conversion Period • Number of days of operation that must be externally financed  Number of days that you don't have enough cash • Should be as close to 0 as possible Inventory Conversion Trends • Inventory sale went up: more money tied up in inventory (not a good thing- stocking too much so need better relationship with supplier or not selling quickly enough), don't want it to be too fast because you'll lose sales if you don't have anything to sell • Net cash burn: if inventory is going up because sales are going up, you'll have a build with the burn • Cash conversion cycle going up means spending more cash than bringing in (relating back to net cash burn) Leverage • Considers how firm acquired external financing (to support longer cash conversion cycle) • Measures extent to which firm has used debt and its ability to meet debt obligations • Benefit of using debt vs equity? (borrow or get from shareholders) • Interest (cheaper than dividends but higher return & risk) vs. dividends (not obligated to pay)  Expense for borrowing is less than equity because of tax savings (lower cost of capital, return is higher) • Risk/return tradeoff  Higher the return, higher the risk • Control vs. legal recourse  If you sell more stock, you're diluting interest (takes away some of control, give up equity = less control) but doesn't happen for debt  Could be pushed into bankruptcy if you don't pay debt  Control vs bankruptcy • Low degree of leverage: lower risk but higher cost of capital = lower return • High degree of leverage: higher risk but lower cost of capital = higher return Leverage: multiplying/magnifying the return, if above 2, there's a • multiplied impact from leverage • Total Debt to Total Assets = average total debt / average total assets • Good indication of how much debt was funded in investment of assets • Equity Multiplier = average total assets / average owners' equity = 1 / (1 - total debt to total assets) • How much is debt or supported by equity • Another way to look at debt to assets • Debt to Equity = average total debt / average owners' equity • How are you financing • Current liabilities to total debt = average current liabilities / average total liabilities • Interest coverage = EBITDA / interest • Fixed Charges Coverage = EBITDA + lease payments interest + lease payments + (debt repayments/(1-tax rate) • If you have to borrow more to pay off debt and interest, it's ba
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