BU121 Study Guide - Final Guide: The Ventures, Critical Success Factor, Canada Labour Code

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17 Apr 2013
School
Department
Course
Professor
BU121 Final Exam Review
Finance 26 Marks
Textbook pg. 170: “Using Financial Information and Accounting
Lab Manual Readings (pg. 226-230 and 236-248)
Lab Manual Exercises (pg. 262-266, 286-291, and 304-305)
Lecture Material
Evaluating Financial Performance analytical measures at different stages of the life cycle
Evaluate financial performance because of principle 1 of entrepreneurial finance (real
human and financial capital must be „rented‟ from owners) and principle 5 (a venture‟s
financial objective is to increase value)
Different analytical measures are important to different users at different stages
Development and Start-up Issues
o How quickly the venture uses cash (cash burn rate), their ability to meet short-
term financial obligations like pay bills (liquidity), and the length of the
operating/working capital cycle (conversion periods)
Additional Survival Issues: the venture‟s potential to employ and repay debt (leverage)
and their ability to provide a return on invested capital (profitability and efficiency)
Analytical Measures financial ratios
o Liquidity: ability to maintain a build rate high enough to meet obligations;
compares assets that can be quickly converted to cash with liabilities that
represent short-term needs for cash, addresses long-term trends, and deals with
working capital management issues
o Conversion Period: the amount of time (days) to convert assets into cash; the
faster, the greater liquidity (note: cash = accounts payable + accrued liabilities)
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o Leverage: considers how the firm will finance (to support a longer C³) and
measures the extent to which a firm uses debt to meet debt obligations
Debt
Leverage
Interest: provides a discount in tax because
it is counted as an expense but can also
accumulate and cause higher expenses
Higher risk and higher return (due to lower
cost of capital)
More control
Dividends that are paid after taxes
Lower risk but lower return (higher cost of
capital)
Gives up control through legal recourse
o Profitability and Efficiency: ability to provide a return on investment and profit;
how well a company controls expenses and uses assets
Analytical techniques
o Industry Comparable Analysis: compare against average
o Cross-Sectional Analysis: compare to specific firms
o Trend Analysis: compare over time
Process of Ratio Analyses
Cash Burn Rate: how quickly a venture “burns through” /uses cash; determine weeks of
cash remaining; the cash a venture spends on 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
= (COGS + marketing + general/admin) + interest + taxes + increase
in inventories changes in payables and accruals + (change in net
fixed assets + depreciation)
Cash Build Rate: how quickly a venture build cash balances through collections on sales
Cash Build = net sales increase in receivables
Burn and build rates can also be determined using the Cash Flow Statement
o Cash flow from operating and investing activities if negative = cash BURN
o Net Cash Burn: cash burn cash build
o Monthly Net Cash Burn Rate = monthly cash burn rate monthly cash build rate
How long before more external financing is needed?
o Calculate monthly net cash burn to determine months of cash remaining?
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Ratios
Ratio Name/Issue
Calculation
Comparisons
Interpretation
Liquidity Ratios
Current Ratio
- used to measure a firm‟s
liquidity


Rule of thumb
2 < x < 4
Should have at least
2x current assets than
liabilities
> 2 for risk
< 4 for return
If stronger than Acid Test,
look at inventory-to-sales
conversion period
Acid Test/Quick Ratio
- measures a firm‟s
liquidity excluding
inventory since it is less
liquid than other assets

 


Rule of Thumb
x > 1
If much lower than current
ratio, too dependent on
inventory (ex. retail
stores)
Net Working Capital to
Total Assets
- analyze the extent to
which assets are tied up in
WC or the amount of
assets req‟d to run daily
operations



Rule of Thumb
The higher the %, the
greater liquidity
A high NWC to total
assets ratio shows the
company‟s ability to
match its A/P obligations
on time and low means
cash flow difficulties
Conversion Period Ratios
Inventory-to-Sale
- measures # of
times/period that a
business sells and replaces
all inventory



Higher ratio indicates better performance (but
could be accompanied by a loss of sales due to
inventory shortage) and a lower value means
inefficiency in controlling inventory levels
Sale-to-Cash
- ability to convert sales to
cash



Indicates productivity
higher indicates
growth due to
sufficient cash flow
to finance
“Days of sale
outstanding,” the average
collection period
Average Operating Cycle
- # of days from cash to
inventory to accounts
receivable to cash
Inventory-to-Sale + Sale-to-Cash
Reveals how long
cash is tied up in
receivables and
inventory
Long cycle means less
cash is available to meet
short-term obligations
Purchase-to-Payment
- how many times/period
you pay suppliers A/P




Short-term liquidity
Higher means business
was able to repay
suppliers quickly (better)
Cash Conversion Cycle
(C³)
Inventory-to-Sale + Sale-to-Cash
Purchase-to-Payment
Rule of Thumb as
close to zero as
possible
The # of days of operation
that must be externally
financed
Leverage Ratios
Total-Debt-to-Total-Assets
- measure of financial risk


The % of a company‟s assets financed by debt
Lower is better
Debt-to-Equity
- indicates how much
equity is financing the
company`s assets




High means a company has been aggressive in
financing its growth with debt which can result in
volatile earnings because of interest expenses
Current Liabilities to
Total Debt


Interest Coverage
- the actual cash you are
able to pay on outstanding
debt


Rule of Thumb
x > 1.5
< 1 means not
generating enough
revenue to pay
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Document Summary

Evaluating financial performance analytical measures at different stages of the life cycle. Evaluate financial performance because of principle 1 of entrepreneurial finance (real human and financial capital must be rented from owners) and principle 5 (a venture s financial objective is to increase value) Different analytical measures are important to different users at different stages. Development and start-up issues: how quickly the venture uses cash (cash burn rate), their ability to meet short- term financial obligations like pay bills (liquidity), and the length of the operating/working capital cycle (conversion periods) Additional survival issues: the venture s potential to employ and repay debt (leverage) and their ability to provide a return on invested capital (profitability and efficiency) Interest: provides a discount in tax because it is counted as an expense but can also accumulate and cause higher expenses. Lower risk but lower return (higher cost of capital) Higher risk and higher return (due to lower.

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