2. 2
Business Capital
Capital is finance used in acquiring assets employed in
the establishment and day to day running of a business
Working Capital is the value of assets bought and sold in
the course of trade.
4. 4
Business Capital
Balance sheet representation
Assets Liabilities
Non Current Assets Non Current Loan Capital
Current Assets
(Current Liabilities)
Owners’ Equity Capital
5. 5
Business Capital
Example
Assets Liabilities
Non Current Assets $100 25 Non Current Loan Capital
Current Assets 50
(Current Liabilities) -25
75 Subscribed Equity Capital
Net Assets 125
25 Retained Earnings
125 Capital
6. 6
Business Capital
Balance sheet representation
Assets Liabilities
Non Current Assets
Less Depreciation
Non Current Loan Capital /
Owners’ Equity Capital x 100
= Gearing %
Current Assets -
Current Liabilities
= Working Capital
7. 7
Business Capital
Revaluation of Non-Current Assets to Net Realisable Value
Assets Liabilities
Non Current Assets $ 50 25 Non Current Loan Capital
Current Assets 50
(Current Liabilities) -25
75 Subscribed Equity Capital
Net Assets 75
(25) Retained Earnings
75 Capital
8. 8
Business Capital
Example
Assets Liabilities
Non Current Assets $100 25 Non Current Loan Capital
Cash [overdraft] (10)
Inventory 35
Receivables 25
(Current Liabilities) -25
75 Subscribed Equity Capital
Net Assets 125
25 Retained Earnings
125 Capital
9. 9
Business Capital
What is profit?
Revenue – Expenses
Depreciation
Valuation adjustments
Profits aren’t Cash
10. 10
Business Capital
Direct investment
Owner risk
Investment is non liquid
Shared responsibilities
Value in performance
Investment through stock market
Owner risk reduced
Investment is liquid
Reduced responsibilities
No choice of ownership
12. 12
What is Direct Investment?
Shares not listed on stock exchanges bought directly from
owners of company
Business Valuation for Direct Investment Decisions
13. 13
Direct investment means direct risks if the company is not
listed – i.e. It’s shares are not in a stock market
Therefore the shares are NOT liquid assets
As the investor will share directly the fortunes of the
investee, his interest is in performance and profitability
This changes the style of investment document for an IPO
prospectus.
Cash based performance measurement becomes important
Business Valuation for Direct Investment Decisions
14. 14
Values
Asset values
- break-up values ‘fire sales’
- goodwill of a going concern
- value to competitors
Business Valuation for Direct Investment Decisions
15. 15
Equity Capital
Ownership of business
Non – refundable
Preference shares may be convertible
Ordinary shares have voting rights
Non-interest bearing
Dividends paid after tax at discretion of managers
Transferable – subject to shareholders’ agreement
Ordinary shareholders last to be paid in event of
liquidation – so high risk – but limitable
Business Valuation for Direct Investment Decisions
16. 16
Bonds and Loans vs equity
No ownership of business
Repayable
May be convertible
No voting rights
Fixed or floating interest rate
Interest paid before tax (deductible) at fixed dates
Transferable
Repayable before equity in the event of liquidation
May be secured against assets to reduce lender risk
Business Valuation for Direct Investment Decisions
17. 17
Dividend values of ordinary shares
Dividends are a share of the after-tax profits of a company.
They are paid at the discretion of the directors
They cannot be paid if there are no profits
They are usually paid in cash
Business Valuation for Direct Investment Decisions
18. 18
Direct investors’ decision criteria
1 How much money am I likely to make and when?
2 How much money can I possibly lose?
3 What is the likelihood of loss?
5 What are the exit choices?
Business Valuation for Direct Investment Decisions
21. 21
Exit from investment
Investors can sell shares in a restricted market – not public
at a profit
at a loss
If the company is profitable or shows potential for growth an
equity investor may sell to another interested party
If an investor wants to guarantee a sale, he should write a
‘put’ option into the original shareholders’ agreement
Investors and management may opt for an IPO if the shares
and the business are suitable
Business Valuation for Direct Investment Decisions
22. 22
Valuing a direct investment
Accrual accounting methods
Business Valuation for Direct Investment Decisions
23. 23
Business Capital
Capital is finance used in acquiring assets employed in
the establishment and day to day running of a business
Working Capital is the value of assets bought and sold in
the course of trade.
25. 25
Business Capital
Balance sheet representation
Assets Liabilities
Non Current Assets Non Current Loan Capital
Current Assets
(Current Liabilities)
Owners’ Equity Capital
26. 26
Business Capital
Example
Assets Liabilities
Non Current Assets $100 25 Non Current Loan Capital
Current Assets 50
(Current Liabilities) -25
75 Subscribed Equity Capital
Net Assets 125
25 Retained Earnings
125 Capital
27. 27
Business Capital
Balance sheet representation
Assets Liabilities
Non Current Assets
Less Depreciation
Non Current Loan Capital /
Owners’ Equity Capital x 100
= Gearing %
Current Assets -
Current Liabilities
= Working Capital
28. 28
Business Capital
Revaluation of Non-Current Assets to Net Realisable Value
Assets Liabilities
Non Current Assets $ 50 25 Non Current Loan Capital
Current Assets 50
(Current Liabilities) -25
75 Subscribed Equity Capital
Net Assets 75
(25) Retained Earnings
75 Capital
29. 29
Business Capital
Example
Assets Liabilities
Non Current Assets $100 25 Non Current Loan Capital
Cash [overdraft] (10)
Inventory 35
Receivables 25
(Current Liabilities) -25
75 Subscribed Equity Capital
Net Assets 125
25 Retained Earnings
125 Capital
30. 30
Business Capital
What is profit?
Revenue – Expenses
Depreciation
Valuation adjustments
Profits aren’t Cash
31. 31
Business Capital
Direct investment
Owner risk
Investment is non liquid
Shared responsibilities
Value in performance
Investment through stock market
Owner risk reduced
Investment is liquid
Reduced responsibilities
No choice of ownership
33. 33
Return on Equity (ROI) criteria and factors
Business Valuation for Direct Investment Decisions
Forecast Balance Sheet 1-1-15
Fixed assets cost 10,000
Depreciation for year -2,000
8,000
Current assets
Cash 1,000
Debtors less creditors 1,000
Inventory 1,000
3,000
Net Assets 11,000
Long term loans 5,000
Equity 5,000
Retained earnings 1,000
11,000
34. 34
Return on Equity (ROI) criteria and factors
Business Valuation for Direct Investment Decisions
Forecast income statement 1-1-15
Sales 50,000
Cost of sales 20,000
Gross Profit 30,000
Operating expenses 24,000
Interest 1,000
Depreciation 2,000
Net Profit before tax 3,000
Taxation 1,000
Net profit after tax 2,000
Dividend 1,000
Retained earnings 1,000
35. 35
Return on Equity (ROI) criteria and factors
Business Valuation for Direct Investment Decisions
NOTE
On 1 Jan 2015 NRV of assets
is estimated to be £5,000 fixed
and £2,000 current
Return on investment of £10,000
NPAT 2,000/10,000 = 20%
ROI of book value assets
2,000/8,000 = 25%
EBIT/Net assets
= 4,000/11,000 = 36%
Cash surplus / Asset NRV
1,000/7,000 = 14%
36. 36
Business Valuation for Direct Investment Decisions
Cash based investment appraisal
Cash flows mirror bank statements
Ignore debtors and creditors
Include only:
Payments
Receipts
Show an available cash balance
37. 37
Cash based investment appraisal
Business Valuation for Direct Investment Decisions
Forecast cash flow 2015 -2015 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
£000's
Capital received 10
Sales receipts 1 2 3 4 5 5 5 5 5 5 5 5
TOTAL 11 2 3 4 5 5 5 5 5 5 5 5
Capital expenditure 10
Inventory 1 1 1 2 2 2 2 2 2 2 2 2
Operating expenses 2 3 3 3 3 2 2 2 2 2 2 2
TOTAL 13 4 4 5 5 4 4 4 4 4 4 4
MONTHLY BALANCES -2 -2 -1 -1 0 1 1 1 1 1 1 1
BALANCE B/FORWARD 0 -2 -4 -5 -6 -6 -5 -4 -3 -2 -1 0
BALANCE C/FORWARD -2 -4 -5 -6 -6 -5 -4 -3 -2 -1 0 1
NOTE
Negative balances funded
by overdraft, repayable
on demand
38. 38
Business Valuation for Direct Investment Decisions
Westgate ROCE method answers the questions
How much of my money is tied up in this investment?
What is the fire-sale value of the assets employed?
What is the annual free cash surplus available for
distribution?
