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FINANCIAL PERSPECTIVE

FINANCE AND ENTREPRENEURS


Allocation of scarce resources within the firm
How decisions should be made? Finance is for general managers too!
Finance cannot stand alone to ignore human or production perspective
will be as fatal as ignoring financial perspective
Effects of decisions on shareholders and other constituencies
(management, labor, suppliers, customer, government, society)
Useful to general managers and critical to entrepreneurs
Cash
Risk
Value

CASH
Key goal is to keep playing the game!
Cash can be consumed, traded for other assets.
Accountants match revenues with expenses, distinguish between
expenditures and expenses Managers focus on cash inflow and cash
outflow

Performance Evaluation and Incentive Compensation


Firms objective : Maximize value depending upon cash and risk
Individuals act to maximize their own wealth
Hence companys incentive compensation policy is important

Taxes and Cash


4 kinds of decisions affect taxes: Legal, Investment, Financing, Accounting
Try to minimize the resources siphoned off to Govt. within the constraints of the law

Cash and Growth


Sales growth -> Growth in assets -> Increase of shareholders equity
Differentiation between real growth and inflation

Pattern recognition
Patterns affecting cash: cyclical, seasonal,
competitive, technological, regulatory and
tax
Identifying opportunities: Using past and
current data -> Predict future
Decision making: Offensive or defensive
move
Not possible every time therefore responses
may be delayed

Scenario Planning
It is not the same as worst or best case
scenario considerations
Nor it is linear extrapolation

SITTING ON A CASH PILE


TATA motors acquires JLR
cash pile of Rs. 6000 Cr and FY 07 generated free cash
of Rs. 1000 Cr
March 2008 $2.3 Billion deal finalized

Cash Rich top 3 companies


Apple - $137.1 billion
Microsoft - $68.3 billion
Google - $48.1 billion

DONT RUN OUT OF CASH!


Forecast and plan future cash flow patterns to avoid jeopardizing
the firms survival
Lack of cash: potential opportunities cant be seized
Competitive or offensive moves from business rivals

TYPES OF RISK
Systematic Risk:Risk inherent to the entire market or an
entire market segment. affects the overall market, not just a
particular stock or industry. This type of risk is both
unpredictable and impossible to completely avoid

Unsystematic risk: Sometimes referred to as "specific


risk". This kind of risk affects a very small number of assets.
An example is news that affects a specific stock such as a
sudden strike by employees. Diversificationis the only way
to protect yourself from unsystematic risk

TYPES OF SYSTEMATIC RISK


Interest rate risk: Arises due to variability in the interest
rates from time to time. It particularly affects debt securities
as they carry the fixed rate of interest
Market risk: Arises due to rise or fall in the trading price of
listed shares or securities in the stock market
Purchasing power risk: Also known as inflation risk. It
affects purchasing power adversely

TYPES OF UNSYSTEMATIC RISK


Business or liquidity risk: It originates from the sale and
purchase of securities affected by business cycles,
technological changes
Financial or credit risk: Financial risk is also known as
credit risk. It arises due to change in the capital structure of
the organization
Operational risk: Risks arising due to human errors. This
risk will change from industry to industry. It occurs due to
breakdowns in the internal procedures, people, policies and
systems

RISK & PERFORMANCE EVALUATION


How to evaluate and reward managers operating in
uncertain environment?

Measure
Performance in
relative sense
Assess Performance
on long term value
added

HOW THE RETURNS WILL BE


ACHIEVED
Ability to identify positive NPV decisions

Delivering the right value at


the right price
Managed two crucial product
inputs - labour cost
advantage and the
production flexibility by
leveraging China

SENSITIVITY ANALYSIS

VALUE CREATION POTENTIAL


FROM FINANCING DECISIONS

VALUE CREATION POTENTIAL


FROM FINANCING DECISIONS
Debt over equity
Value transfer among various owner
Its effect on incentive of various
players, especially management

CONCERNS OVER DEBT?


It increase the risk to shareholders but increases expected return also
US tax laws are biased towards Debt financing
Interest is a tax deductible expense
Increasing debt means financial difficulty
Introduction of debt in capital structure means cash flow increases for
owners

APPLES FIRST BOND 2013

Borrowed as part of a plan to return $1


to shareholders by the end of 2015

CONCERNS OVER DEBT?


FINANCIAL DISTRESS
Companies become vulnerable to competition

CHRYSLER IN 1980
Potential car buyers avoided Chrysler
acquainted with the fact about the large
debt pool.

CONCERNS OVER DEBT?


BANKRUPTCY

LEHMAN BROTHERS
2008
$619 BILLION IN DEBT
Market reluctance to buy
its bonds during 2008

VALUE TRANSFER
Size of Pie doesnt change, but size of slices
changes
Value transfer among various shareholder
may vary
Variation in company strategy also changes
the value transfer

EXAMPLE 1
SITUATION: Stock is overvalued
Issue of stock when stock is overvalued.
Results in a value transfer from new
shareholders to old shareholders and
management
They will benefit the extent of overvaluation

EXAMPLE 2
SITUATION: Management decision changes the
character of cash flow stream in a way
unanticipated by capital suppliers
Conservative to Risk company strategy
Supplier of debt will suffer a capital loss

The 2billion backlash: Zuckerberg sued


by Facebook shareholders for 'hiding
forecasts of future problems'

INCENTIVES
SITUATION 1: FIRM IS NEAR BANKRUPTCY
Incentive for management is to invest in Risky projects
Shareholders have a worthless claim unless the firm strikes it rich
SITUATION 2: DEBT-RIDDEN
Managers have strong incentive to perform well after leveraged buyouts
SITUATION 3: NATURE OF CONTRACT BETWEEN MANAGERS AND
SUPPLIERS
Entrepreneur expresses 51% ownership
Gives 100% equity to the capital supplier
Will keep the 51% on the basis of actual performance
Have strong faith in own abilities

SUMMARY
Finance is a way of thinking about cash, risk and value
It doesnt answer the questions, but identifies the right questions
Financial perspective tells whether a decision is feasible or not
Only recurrent danger is it can easily become the excuse for
inaction