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CREATING SHAREHOLDER VALUE

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CREATING SHAREHOLDER VALUE Course 101 January 2010 John A. Boquist Edward E. Edwards Professor of Finance Indiana University Kelley School of Business What ... – PowerPoint PPT presentation

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Title: CREATING SHAREHOLDER VALUE


1
CREATING SHAREHOLDER VALUE
  • Course 101 January 2010
  • John A. Boquist
  • Edward E. Edwards
  • Professor of Finance
  • Indiana University
  • Kelley School of Business

2
  • What distinguishes financially successful
    Rep/Broker firms? Shareholder value is the
    result of clearly defined strategies with strong
    financial results. An important part of any
    strategic plan, financial strategies must be
    designed for the long term health of the
    organization. This session involves a briefing
    and development of such strategies.

3
  • Objectives
  • Understand your firms financial performance
  • Understand cash flows
  • Be able to determine your firms value
  • Sharpen your firms strategic plans
  • Financial Planning
  • Value creation
  • Competitive barriers
  • Projections and budgets
  • Exit plans

4
  • Outline
  • Basic Financial Statements
  • Income Statement
  • Balance Sheet
  • Cash Flow
  • Tax vs. GAAP vs. Managerial Accounting
  • Valuation
  • Reasons for valuations
  • Methods and Models
  • Application

5
THE MECHANICS TODAY
Balance sheet (beginning of year)
Income statement
Balance sheet (end of year)
Assets
Liabilities plus Owners equity
Revenue less Expenses Income
Assets
Liabilities plus Owners equity
1 ACCOUNTING CYCE (1
FISCAL YEAR )
6
The Financial Statements
  • How much did we earn last year?
  • The Income Statement
  • Discusses the flow of past events
  • How much are we worth?
  • The Balance Sheet
  • Gives a picture of the corporate financial
    position
  • How much cash flow was generated?
  • Statement of cash flows
  • Analyzes sources and uses of cash

7
Key concepts in accrual accounting
  • REVENUE RECOGNITION RULES
  • Earnings process complete
  • Revenue known
  • Amount can be estimated
  • Collection reasonably assured
  • EXPENSE RECOGNITION RULES
  • Match expenses to revenues
  • Logical, systematic allocation
  • Amortization over time vs. immediate write-off
  • IF CASH ACCOUNTING
  • Revenue when received
  • Expense when paid

8
Statement of cash flows
Opening cash balance /- Cash flow from
Operations /- Cash flow from Investing
Activities /- Cash flow from Financing
Activities Ending cash balance
9
  • CASH FLOW HOW TO GO BROKE... WHILE MAKING A
    PROFIT
  • As the year started, Mr. Jones of the ABC Co.
    was in fine shape. His company made widgets --
    just what the consumer wanted. He made them for
    .75 each, sold them for 1. He kept a 30-day
    supply in inventory, paid his bills promptly, and
    billed his customers 30-day net. Sales were
    right on target, with the sales manger predicting
    a steady increase. It felt like his lucky year,
    and it began this way
  • Dec. 31 CASH 1,000 INVENTORY 750
    RECEIVABLES 1,000
  • In January, he sold 1,000 widgets shipped them
    at a cost of 750 collected his
    receivables--winding up with a tidy 250 profit
    and books like this
  • Jan. 31 CASH 1,250 INVENTORY 750
    RECEIVABLES 1,000
  • This month sales jumped, as predicted, to 1,500.
    With a corresponding step-up in production to
    maintain his 30-day inventory, he made 2,000
    units at a cost of 1,500. All receivables from
    January sales were collected. Profit so far
    625. Now his books looked like this
  • Feb. 28 CASH 750 INVENTORY 1,125
    RECEIVABLES 1,500
  • March sales were even better 2,000 units.
    collections On time. Production, to adhere to
    his inventory policy 2,500 units. Operating
    result for the month 500 profit. Profit to
    date 1,125. His books
  • Mar. 31 CASH 375 INVENTORY 1,500
    RECEIVABLES 2,000
  • In April, sales jumped another 500 units to
    2,500--and Jones patted his sales manager on the
    back. his customers were paying right on time.
    Production was pushed to 3,000 units, and the
    months business netted him 625 for a profit to
    date of 1,750. He took off for Florida before
    he saw the accountants report.

10
This example indicates that even successful firms
may not neglect their planning responsibilities.
Too much growth can spell disaster to the
undercapitalized business. A funds flow
statement, prepared while Mr. Jones returns from
Florida, may point out exactly what has
happened. Mr. Jones has made the mistake
of paying more attention to his profits than to
his liquidity. A simple cash budget based on
projected sales could have alerted Mr. Jones to
the potential problem before it occurred. For
example Based on this cash budget,
then, Mr. Jones would have made arrangements for
additional capital before he left for
Florida. Notice again the use for which funds
flow statements and cash budgets are intended.
Funds flow data is provided as a supplement to
the financial statements and gives information
which is not always readily available from a
quick examination of the balance sheet and income
statement. Its purpose, then, is in detecting
trends after they occur. the cash budget, on the
other hand, is a device for future planning. Its
prime purpose is to point out problems resulting
from too much or too little cash before they
occur. Loans are seldom negotiated overnight.
ABC Company may lose some profits from their
shortsightedness.
11

Sources and Uses of Funds
  • Income
  • Revenue
  • Expense
  • Profit
  • Sources of Funds
  • Profitable operations
  • Decrease Assets
  • Increase Liability
  • Balance Sheet
  • Assets
  • Current
  • Fixed
  • Liabilities
  • Owners Equity
  • Uses of Funds
  • Losses
  • Increase Assets
  • Decrease Liabilities

Depreciation
Retained Earnings
12
The Cash Conversion Cycle
Product Sales
Inventory Conversion Period
Receivables Conversion Period
Cash Received
Resource Purchase
Operating Cycle
Cash Conversion Period
Payables Conversion Period
Cash Outlay
13
Generalized Break-Even Chart
14
Present Value Techniques
  • The Time Value of Money
  • Compound Interest
  • Discount Rate k
  • - Interest Rates
  • -Risk Factors
  • -Opportunity Cost
  • Future Value Formula
  • FnP (1k)
  • Present Value Formula
  • P Fn/(1k)

n
n
15
  • Present Value Shortcuts
  • Annuity Flows
  • Use of Tables
  • Use of Calculators
  • Use of PCs

16
Valuation of Manufacturers Rep Business
Terminal Value?
200,000 per Year
Annual After-tax Cash Flows
50,000
Execute
Now
5 Years
11 Years Economic Life
Start-up
Expand
Growth
Required Return 10
60,000
40,000
100,000
17
Perpetuity Models
  • No Growth Value FCF WACC
  • Growth Value
  • WACC - Growth

FCF
18
Valuation Adjustments
  • Value of Liabilities
  • Lawsuits
  • Pensions, etc.
  • Control Premium
  • Discount for Lack of Marketability
  • Prior Comparable Transactions
  • Multiples of Sales, Earnings, Cash Flow, Book
    Value
  • Form of Payment
  • Cash
  • Seller Financing

19
Distribution of Value Created
  • Use a Model of Economic Value
  • Reinvest or Distribute?
  • Is Value Being Added?
  • Recipient of Distribution
  • Owners
  • Customers
  • Employees
  • Capture Value Transferred Upon Exit From Business
  • Family Members
  • Employee
  • Third Party

20
Elements of Industry Structure
New Entrants
Industry Competitors Our Firm
Suppliers
Buyers
Substitute Services or Products
21
Valuation References
  • The Classic for small, private business
    valuation Shannon Pratt Valuing a Business
    Dow Jones-Irwin, 1988.
  • The bible for investment bankers Copeland,
    Koller, and Murrin Valuation Second Edition
    John Wiley, 1996.
  • The best text solely devoted to the financial
    management of the small firm Walker and Pretty
    Financial Management of the Small Firm
    Prentice-Hall, 1986.
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