Lesson 11 – How to Build a Simple Financial Model for Valuation Purposes

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Most people try to sell their companies on hype and it doesn’t work. When you have a potential investor, or lender, who knows what they’re doing, you will not get them on hype. You’ll get them on fundamentals, and you’ll get them on numbers.

Understanding everything we’ve covered in the previous section will help you understand how to sell a company.

If you can demonstrate consistently favorable trends in the ratios we’ve gone over, then you can demonstrate a company that is financially healthy, and well managed. That’s what an investor or lender wants to see.

The next thing an investor or lender want, is to feel confident that they will get their money back. In the investor’s case, they recapture their investment, and then they start seeing an ROI (Return on Investment). It’s the same thing we looked at when we looked at ROE (Return on Equity) only in this case, we are looking at it from the perspective of an outside investor. We look at only their share of the net income, compared with their share of the equity – what they’ve invested in their business.

Investors want to know that their investment is performing well.

When you buy stocks, you want the stock price to go up. When you invest in a small business, the value of the equity section of the balance sheet is the stock price. That’s what needs to go up, to make the investor happy.

In this video I’ll show you how to prepare a simple financial model that demonstrates, how to arrive at the valuation of your company, based on projected numbers that are realistic, and based on an ROI for the investor that makes the deal attractive.

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Lesson 10 – How do they Calculate Valuation on Shark Tank?

Get the template here

A firm of the future is one who embraces the latest technology. One of the primary reasons for doing this, is that we no longer want to spend any time entering financial transactions. We want to analyze them. More specifically we want to analyze the output that we can get, after we compile the data.

In short we want to spend time looking at financial reports, and developing the analytical data. This is where we can add incredible value for our clients. We can help them decide what is working, and what isn’t. We can help our clients make important decisions about investing in resources (human or otherwise). We can develop data that indicates where the company is more or less efficient about it’s operations.

This is the kind of information our clients have desperately wanted from us. They don’t care that the bank account is reconciled every month. They want to know what you can tell them about the financial position of the company, now that the accounts are reconciled. Clients want to know that the information is accurate and reliable. That, among other things are what reconciliations help ensure.

Course 5 is going to take a deep dive into the analytics, and valuation of our clients’ businesses. I hope you’ll join me.

Lesson 9 – Simplifying Ratio Analysis with Finagraph

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We’ve seen a number of ratios, and discussed how to analyze them. We’ve discussed what they mean, and how they’re calculated. You should make sure that up to this point, you can run a set of financial statements, get them into Google Sheets, like I did, and then write the simple formulas to calculate the ratios. Doing this will enlarge upon your understanding of these ratios, even if you think you already know them.

Once you have these ratios down – how to calculate them, what they mean, and how to analyze and interpret them, you are ready to look at a solution that packages these ratios up in a way that makes them really easy to understand, not to mention pleasing to the eyes.

Finagraph is a tool that takes everything we’ve reviewed so far, and then a whole lot more, and packages it up into a visually appealing, easy to understand, dashboard.

Not only does finagraph make it nice to look at, but as you click on the various metrics you’ll get pop up windows with explanations about everything.

Finagraph is a visual learning tool, that makes it easy to calculate and package the analytics that you want to use to better serve your clients.

Oh and it’s free!

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Lesson 8 – Efficiency Ratios

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How efficiently is your company running?

Accounts Receivable Turnover

One thing that can kill an otherwise profitable company is poor cash flow, and all too often, that happens from slow receivables turnover. Conversely, as a strategic consultant, one of the first things, you can often do, to improve a company’s financial health, is work on strategies for improving collections.

Accounts Receivable turnover is calculated by taking net credit sales divided by average net receivable for the period.

Inventory Turnover

Remember that return on Assets ratio we looked at? On of those assets that is included in total assets, is inventory. If the company is locking up too much cash in inventory, then your ROA will be decreased, and you also run the risk of obsolescence. In other words, we want to be sure that we’re being as efficient as possible with our inventory.

Inventory turnover can be calculated a number of ways (google it). For this exercise we’ll take Cost of Goods Sold and divide it by average inventory for the period.

Asset Turnover

Asset turnover looks at the amount of sales generated for every dollar of assets. How efficiently are our assets generating sales for us?

Asset Turnover is calculated by dividing sales in dollars by assets in dollars.

It also indicates pricing strategy: companies with low profit margins tend to have high asset turnover, while those with high profit margins have low asset turnover. It’s important to understand that this is because companies with low profit margins, generate more sales. That’s the reason why you operate with a low profit margin – you’re expecting to generate your profits by keeping your fixed costs low, so that your increased volume translates to the bottom line.

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Lesson 7 – Profitability Ratios

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The first profitability ratio we’re going to look at, is the one you likely already know and love –

Gross Profit %

The question is, do you look at this regularly? I’m going to guess that most small business accounting professionals only look at this t yearend. In fact many CPA’s I’ve worked with, use this as a benchmark for comparing current year to prior year, just to look for anomalies. If they find them, then they dig in, and start asking questions.

Most do not even explain to the client, how they came to the conclusion that a deeper look was needed in these areas. Imagine how much value that would have, if you took the extra five minutes at yearend to explain to the client what you did, and why, and how it can help identify problems, so that you can implement the solutions. It could be a bookkeeping error, which I think is what the CPA’s and EA’s who do this are looking for. It could also indicate a problem, or if the ratio improved dramatically, it could mean management did something really well.

Your client would value you, ten times more (which means you could increase your rates by 2X and be worth 5 times your rate in the eyes of your clients. All you have to do is spend a little extra time explaining these important ratios to them.

Once a year is not enough. Work with your clients monthly or quarterly, and charge them for the “strategic consulting.” This is what clients want, but aren’t getting from their CPA’s and EA’s.

Don’t believe me?

Check this out –

What do you wish your accountant would do for you that they’re not doing now?

Next let’s look at some other important measures of profitability.

EBITDA % Margin

Investors often consider debt, and interest, as well as non-cash expenses such as depreciation and amortization to be an undue burden on a company. They want to see how profitable is the company without these things?

Operating Margin

Operating Margin is a measure of well a company has priced their products and services, as well as how efficiently the company has operated.

The calculation is simple –

Operating income / Net Sales

Operating margin measures what proportion of a company’s revenue is left over after paying for variable costs of production such as wages, raw materials, etc.

“Operating income” is the profit that a company retains after operating expenses (such as cost of goods sold and wages) and depreciation.

“Net sales” is sales minus returns and allowances.

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