Financing the Business Strategy and Financial Controls

Transcription

1 Financing the Business Strategy and Financial Controls Joe Denig NC State University Wood Products Extension Raleigh, NC Tel:

2 North Carolina State University Wood Products Extension Since 1950 has supported the wood products industry in North Carolina in the areas of wood education, training, troubleshooting problems, research and overall assistance in making a large variety of wood products. It is the policy of the State of North Carolina to provide equality of opportunity in education and employment for all students and employees. Educational and employment decisions should be based on factors that are germane to academic abilities or job performance. Accordingly, the North Carolina State University ( NC State ) does not practice or condone unlawful discrimination in any form, as defined by this policy.

3 Wood Education and Resource Center Is the center of the US Forest Service effort of support of the hardwood forest industry in the states east of the Great Plains Located in Princeton, West Virginia, WERC project s websites = and The work upon which this webcast is based was funded in whole or in part through a grant awarded by the Wood Education and Resource Center, Northeastern Area State and Private Forestry, U.S. Forest Service. In accordance with Federal law and U.S. Department of Agriculture policy, this institution is prohibited from discriminating on the basis of race, color, national origin, sex, age, or disability. To file a complaint of discrimination, write USDA Director, Office of Civil Rights, Room 326-W, Whitten Building, 1400 Independence Avenue, SW, Washington, DC or call (202) (voice and TDD). USDA is an equal opportunity provider and employer.

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5 Avoid Blindly Copying Your Neighbor Their financial numbers do not necessarily represent yours Production levels Depreciation Market development Their situation may be different Using waste raw material versus purchasing You have to work your own numbers Life example

6 Why is cash flow so important? You run out of cash You can t pay your bills You creditors call your loans

7 In Evaluating Your Investment You Should Look At Financial analysis Ability to pay back your loan Short term cash flow analysis Your future production cost versus industry low cost producers

8 Some reasons for failure The business plan was over optimistic on the market and too much capital was spent Too slow of a start up on the project... unanticipated delays Did not adequately consider build up of required inventory

9 Some reasons for failure Poor accounting, disbelieve of accounting numbers or no accounting system Disparity between cash outflows and cash inflows (customers not paying on time)

10 The business plan was over optimistic on the market and too much capital was spent The demand for the product is not as high as expected Sunk too much money, fancy offices, overhead, paying yourself too much Start with a way you can bring the product to market with a minimum of financial commitment to see if the idea will fly

11 Too slow of a start up on the project... unanticipated delays Technical problems... CNC lathe Time value of money... When does a dollar received have the most effect Your future success

12 Did not adequately consider build up of required inventory Forest products industry is inventory intensive Operating credit line size, need enough cash to build up inventory, process the material, sell it, and get paid (reduce your accounts receivable)

13 Cash demand for red oak drying operation 120,000 Bf kiln capacity 3 month air drying inventory Assumes all that can be produced is sold How soon will your customers pay (aging accounts receivable)

14 CASH REQUIREMENTS Cash ($) 900, , , , , , , , ,000 0 START UP CASH DEMAND ,000 Bf kiln capacity 3 month air drying inventory assumes all that can be produced is sold Weeks

15 START UP CASH DEMAND Two 60 MBF Kilns - Oak Drying Operation Weekly Accumulated Accumulated Lumber Capital Energy Payment Cash Cash Cash Demand Week Purchases Expeditures Leasing Payroll Cost For Kiln Revenue Demand Demand Interest After Interest 1-45, ,000-67, ,127 67, , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,540

16 Red Oak Dry Kiln May be a very sound investment but need to be able to have a strong operating line. What can you do to help mitigate the above?

17 Ability To Pay Back Your Loan (Coverage Ratios) The greater and more stable the expected future cash flows of the firm are, the greater the debt capacity of the firm. With coverage ratios we are analyzing the ability of a firm to pay back loans. Often we use EBIT or earnings before interest and taxes in comparison to the interest on the debt or the full debt burden.

18 Coverage Ratios The greater and more stable the expected future cash flows, the greater the debt capacity of the firm. Coverage ratios analyze the ability of a firm to payback its debt. EBIT or earnings before interest and taxes is often used

19 Times Interest Earned Times Interest Earned = EBIT Interest on Debt EBIT is used as a rough measure of available cash flow Concern is raised when it is below 3:1 Tells us nothing about paying back the principal

20 Debt-Service Coverage EBIT Debt-Service = Coverage Interest + Principal Payments (1- Tax Rate) This can be extended to included leases Ratio depends on stability of EBIT May want to use a projected EBIT in the worst of times

21 Cash Flow Versus Total Debt William H. Beaver conducted a study that correlated the rate of business failures versus ratio of cash flow versus total debt. Seventy nine larger firms For failing firms cash flow declined in relation to total debt

22 Cash Flow Versus Total Debt Cash Flow Versus Total Debt 0.5 Cash Flow/Total Debt Failed firms Non-failed firms -0.3 Years Before Failure

23 Poor accounting, disbelieve of accounting numbers or no accounting system Simple facts, accounting lets you see what is occurring Human nature is if things are going well ignore the signs This leads to certain failure

24 Disparity between cash outflows and cash inflows (customers not paying on time) Nothing is real until the check is in the bank You need to plan how you are going to get paid and how you follow up if you don t

25 Production Cost Analysis Are you in a commodity market or a niche market? If you are in a commodity market compare your cost of production to the low cost producers in the industry. Your new investment should be heading you in the direction of the low cost producers! The cost comparison figures are available from some associations, or hire an independent consultant to conduct a survey of the upper quartile producers.