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Lecture 6

BU121 Lecture Notes - Lecture 6: Quick Ratio, Nopat, Profit Margin

Course Code
Laura Allan

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Week 6 - Entrepreneurial Finance (Part 2)
Evaluating Financial Performance
Why evaluate financial performance?
Principle 1 of entrepreneurial finance:
Real human, and financial capital must be ‘rented’ from owners.
Want return on their investment
Principle 5 of entrepreneurial finance:
A venture’s financial objective is to increase value.
Different analytical measures are important to different users at different stages…
Analytical Measures
Development and Startup Issues:
How quickly the venture uses cash
Need to know how fast using cash as will need more (Cash Burn Rate)
The venture’s ability to meet short-term financial obligations (pay bills)
How liquid you are shows how fast you can pay bills
The length of the operating/working capital cycle
Operating Cycle: How long does it take to convert inventory to recievables to
cash, how quickly can stay liquid
Working Cycle: The capital we work with to operate business
Additional Survival Issues:

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The venture’s potential to employ and repay debt
When we can take on more risk to earn a bigger return (bigger fixed costs)
Borrow assets to make more profit, risky as need to make more to cover
Taking on debt to try and make a bigger return on equity, debt less expensive
The venture’s ability to provide a return on invested capital?
Return/Profitability and Efficiency
How quickly and effectively you are using given assets to make a return
Cash Burn Rates and Liquidity
Burn and Build balance each other; Liquidity is balance
Cash Burn Rate
How quickly a venture ‘burns through’/uses cash
Determine weeks of cash remaining
Cash Build Rate
How quickly a venture builds cash balances through collections on sales
The ability of the venture to maintain a build rate high enough to meet its obligations as
they come due
Measuring Burn and Build Rates
Cash Burn = the cash a venture expends on its operating and financing expenses and its
investments in assets
Cash Burn
= Cash Operating Expenses + Interest + Taxes
+ increase in Inventories
changes in Payables and Accruals
+ Capital Expenditures

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Cash Burn Rate =
(380,000+65000+39,000+27000+20000+8000) +
45,000 (27,000+1,000) + 50,000 = $606,000
Cash Build = what the venture receives on its sales
Cash Build
= Net Sales Increase in Receivables
=$575,000 30,000 = 545,000
Net Cash Burn when cash burn exceeds cash build
= 606,000 545,000 = $61,000
Monthly Burn Rate
Monthly cash burn rate = $606,000/12= 50,500
Monthly cash build rate = 545,000/12 = $45,417
= Monthly net cash burn rate = $61,600/12 = $5083
Given that the company has $5,000 in cash at the end of 2010, it has <1 month until it runs
out of cash
Burn and Build Rates can also be determined using the Cash Flow Statement
Cash flow from operating activities and investing activities
Cash flow from operating and investing activities is negative, therefore net cash burn
=$11,000 + $50000 = $61,000
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