Tag Archives: the Financial decision

What kind of business investors seek

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high quality revenue

Investors simply like high quality revenue, that is it :)…

In business valuation, high quality revenue—the kind of earnings that investors seek—is defined by three essential characteristics: Predictability, Profitability, and Diversity.

Predictability is the most important, so we will take about it the last.

High Quality revenue2

Profitability:

It defines what is your gross margin, which is (net sales – net cost). investors usually likes business that generates gross margin of 70% and more !!!

Diversity:

When we evaluate companies we look closely at revenue concentration. Investors do not like a business with main revenue stream coming from one product or one customer. It could be accepted for a company in its early stages, but they should have a plan on how to diversify their revenue stream.

Predictability:

This the most critical and important factor, we can define it by the following sentences:

  • How many paying customers you have from the last year.
  • How much cash you can confirm that you going to earn this year or the next year.
  • how many customers you lose each year.

Investors look for the bushiness with recurring revenue.

As an example, if you are in the IT business and have a cloud application where each customer pay 100$ per month. You are at the end of 2014 with 100 customers. You usually lose 10% of your customers each year (churn rate), then we can easily predict that you going to have recurring revenue of 9000$ per month during the next year. If you know your growth rate just like you know your churn rate, then this will be better.

You can count on recurring revenue month over month and year over year. Cash flow is steady and improving all the time. You don’t have to stress about payroll and other expenses, so you can put your energy toward more strategic business-building activities. Having a steady income stream liberates you to take risks and get more aggressive with your business plan. Move into a new market. Go after larger, harder-to-land clients. If you miss a sales target one month, your cash flow remains unaffected.

Recurring revenue builds a valuable legacy for whenever you decide to exit your business. Increasing the amount of monthly recurring revenue coming into your business raises the quality of your earnings and the overall value of your business.

Some professionals estimate that a business with recurring revenue is worth 16 times more than a one-time revenue model (such as rip and replace). Another recent article estimated that an owner can expect to receive 4 to 6 times EBITDA [earnings before interest, taxes, depreciation, and amortization] for a company on a one-time sales model, while owners with recurring revenue can expect a payday of 6 to 8 times EBITDA

Focus on growth and growth alone is always a temporary strategy. Over time, a company’s value becomes a function of both growth and cash flow. Superior earnings eventually lead to superior value creation.

It’s a simple enough framework, but often difficult to achieve. High-quality revenue requires predictability, profitability and diversity. Do you have highly predictable revenue with high gross margins and without revenue concentration? …

Think about it

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How to Rock your start-up project Financial plan – Part.3. (Financial decision criterions)

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financial decisions

How can you impress your investor if he is not in your business domain and can’t understand your idea… the only way is to talk with the money language. Financial decision criterion’s are the alphabetic of the money language in this area.

Here i will talk about three important criterion’s, Breakeven point, Pay Back period, and Net present value.
In my business plans, i usually go far for more criterion just like the profitability index PI and Internal rate of return IRR. I encourage the reader to take any free course on financing from any MOOC sites like Coursera.

Breakeven point…

This is the point in time when your project revenues start to cover your expenses.
When you start your project, you will cover your expenses from your own personal savings or some kind of investment till the project starts to make revenues that can cover your expenses.

In the template we built together in part.1 and part.2, it is the point in time where your gross profit converts from negative to positive value.

why it is important, simply because it gives a clear message on how much time you need till your project becomes independent of any external financial support.

Pay Back period…

It is the point in time where your project net profits reach a value similar to the amount of money invested.
why it is important, simply because it gives the investor some insights about the time needed to get back his investment.

Net Present Value…

If you have a 1000$ now, and you invested it in a project with interest of 10% per year. Then 1000$ today will be 1100$ after a year. and hence to know the present value of a future value, you should discount it with the same interest rate. So the present value of a 1100$ future value after a year with discount rate 10% is 1000$.

npv1

But in real life, we have projects that extend over time, may be several years, so we need to discount these values over time to have what we name the net present value.

NPV is the value of specific stream of future cash flows presented in today’s dollars

npv2

NPV is based on the concept that money now is more valuable than money later on. … Why, because you can use the money to make more money.

NPV could be the most important decision criteria. it is used to know the approximate value of the project and is also used to compare between two projects.

I will not go in mathematical details on how to calculate the NPV. I Just want you to feel the meaning of it. Rather i will show you how to calculate it using excel on the template we discussed in the Part.1 and Part.2

In part.1 and part.2 we learned together how to build the template and then how to build different scenarios of it. Now i want you to make a summary for each plan you have just like what i did in the figure below:

cash flow summary

Y0: represents the first day in your project.
Accumulated cash: represents the cash in hand at the end of each year after deducting all expenses and taxes. you can say it is the net profit of each year.The accumulated cash at Y0, represent the cash in hand at the project start date which is your finance or investment.

The NPV is calculated with the npv formula in excel as in the figure below:

npv calculation in excel

The question here is how to chose the discount rate… actually there is no certain way to calculate it. It could be affected by many factors such as inflation rate, interest rate of another competing project, interest rate on treasury assets, and so on.

So this will depend on the project nature, and the country you live in.

I just finished my series on how to build a financial plan for a start-up that can rock. if you have any questions or suggestion for any enhancements, please mail me or leave your comments.

In a later article, i will talk about “how to valuate your project” especially if you don’t have any assets and the project will result in an intangible assets.

How to Rock your start-up project Financial plan – Part.2 (Make different scenarios)

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different scenarios

In part.1, we talked about how to build a flexible template that will allow you to forecast your cash flow.
Before you  go working on this template, you probably have a business plan that describes the market you are targeting, and your capabilities in acquiring a certain market share. The business plan also probably describes your expectations of the economy in the few coming years.

We all know that, no business grows linearly, because markets and economics do not do . … right ?!!!
Nowadays, a lot of surprises happen…

company growth patterns

  • Financial crises in 2008 caused a major economic recession worldwide especially in USA, and Europe.
  • Revolutions and the political instability in the middle east affected the market there and a lot of surrounding and dependent markets.
  • Any price move in oil causes a lot of sequences in the whole world.
  • A natural disaster in the far east can affect computer components prices worldwide!.

These above are sample issues that we can hardly expect. But on the other hand you can also face the following cases:

Black swan

When you present your project to an investor, he might dig into these details. You should expect that, and be able to discuss it. Expect the worst.  Read about the Black Swan effect.

When you first start with the template, start working on the optimum plan. Optimum plan is the plan based on the current given assumptions for the Economy and business risks. If numbers are working good with this plan, you have a chance to convince an investor, and if not, i encourage you to stop and rethink of your idea. And see what it takes to enhance your numbers. Please read about “lean start-ups“.

Then go plan for the Conservative case, where you over estimate risks, and plan even for things that are unlikely to occur. If you have a good idea, then this plan will show how much your business is immune for economical disasters.

Finally go plan for the optimistic case, where you show what would happen to numbers if things go better than our expectations.

Also another reason for having three plans is that in a good business, things starts slow and then accelerate.

exponential growth

As an example, I work in the Cloud business domain. In a good cloud business, revenues grow exponentially, as shown in the figure. So when i made my three scenarios (Conservative, Optimum, and Optimistic) financial plans for the project i am working on, the three scenarios was not only to show how much the business is immune and promising at the same time, it was also to simulate three different periods.
The 1st period where revenues are growing very very slowly. The investment will be used to cover expenses in this period.
The 2nd period where revenues are growing good.
The 3rd period where revenues are booming.

Although you may make a one plan with three different scenarios over three periods of time, but i prefer to do three different plans…

3 different plans

Note the following.

  • The conservative plan, will be the plan that needs the biggest investment, because the period where you need cash to cover your expenses will increase. So you have to think in which plan you going to ask for investment.
  • when you move between the different scenarios, do not alter the revenues only, think also about the expenses. It is logically that when sales figures are doing good, is that you spend more in marketing.

when you finish your plans, please draw the following graphs so you can feel how your business is going to perform.

  1. comparison between the three different plan revenues.
  2. for each plan, draw a graph for the following:
    1. Revenues.
    2. Expenses.
    3. Revenue – Expenses (which is almost the gross profit).
    4. Accumulated cash (which is the net profit, that can be distributed to share holders).

Below are examples for these graphs from a project i am working on (any one need to invest 🙂 )

sales comparison

Conservative

Optimum

Optimistic

Now go do it yourself and feel the numbers….

waiting your comments

How to Rock your start-up project Financial plan – Part.1 (Build the template)

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Cash Flow

Want to rock your business plan to impress an investor, then have a good financial plan. Most of investors first look at numbers, or more specifically the Financial decision criterion’s, and then will go deep with you into more details on how you gonna achieve these numbers. But first you have to influence them with numbers.

This article will be in three parts:
Part.1: Build the template: in this part you will learn how to build your financial cash flow plan. Financial data in this cash flow plan will be used to calculate the Financial decision criterion’s.
Part.2: Have different scenarios. No business grows linearly, in the first stages you may make small profits, in a later phases you make bigger profits. in this part of the article i will give you some hints on how to build different scenarios. …Read part.2
Part.3: what are the financial decision criterion’s and how they are calculated and presented…. Read part.3

Plan for your cash flow by building the following template in any spread sheet program.

Cashflow 1

1- “Time Line” which is the template header. You going to build your cash flow forecast over 3 or 5 years divided into months.

2- “Monthly Sales” This is where you list the sales done in each month. In the template we can see that sales in the first two months are zero, and 6000$ in the third month. Of course you can extend your sales rows into your different sales channels such as online sales, sales through partners, direct sales, …etc and sum them all in the “monthly sales” row.

3- “Monthly Expenses”  where you write your monthly expenses. Also you can detail the expenses, so you list salaries, office expenses, Marketing expenses,..etc. then sum them all in the “Monthly Expenses” row.

4- “Monthly Gross profit” This is the monthly profit (each month sales – each month expenses). You can see that in the first two months we don’t have sales but have expenses, and hence the monthly gross profit is in negative value.

5- “Investment needed” or the cash needed to fund the project. wither it is a loan, fund, or money savings, this is the money which will cover your expenses. When you first start building your template put it with zero value. lets name it (X).

6- “Available Cash (Balance)” each time you spend money on expenses, your cash balance decrease. And each time you make sales, you cash balance increase.
the balance of the 1st month = the Gross profit of the 1st month + Investment needed.
the balance of the 2nd month = the gross profit of the 2nd month + the balance of the 1st month.
the balance of the 3rd month = the gross profit of the 3rd month + the balance of the 2nd month.
….
the balance of the any month = Gross profit of this month + the balance of the last previous month.

7- “year summary” this is something like a simple income statement for the year.
Total sales: is the sales summation of all monthly sales.
Gross profit: is the sum of gross profits of all months in the year.
Tax: depends on your country and state laws.
Net profit: Gross profit – Tax.

 Example

example

In this example, we did not have any sales in the first two months, and hence the “available cash” is in negative value. In the third month we had a 10000$ sales, and hence we have 1000$ cash in hand.
Again, how we get the 1000$.
Sales in the 3rd month: 10,000$  |   Expenses in the 3rd month: 4000$
Then gross profit of the third month: 10000 – 4000 = 6000.
Available cash of the third month = available cash from the previous month + Gross profit of this month.
= -5000 + 6000
= 1000$

So can you tell me the investment needed to cover this project !!!
simply, it is the summation of all negative values in the monthly gross profit row, which is the summation of all losses…Sound logic 🙂

see the same example with value of 5000$ as fund.

example2

See what happened. The 5000$ is the amount that will cover you till you can make money that can cover your expenses. This point in time is named “the breakeven point“. So, the breakeven point of this project is two months.

remember this factor because it is one of the financial decision criterion.

Now try to practice this template with yourself. once you start in it, you will add more details and enhancements. the figure below shows a financial plan for a project i am working on. Just look how much details are presented. i started with this simple template and the work extended with me to this.

example3

If you have any questions please leave it in the comments.

Please follow the blog so you get an email when i publish part.2 and part.3.