We’ve all heard of the philosophy of thinking win-win when dealing with others in business and personal aspects of our lives. It calls for a frame of mind or heart that constantly seeks mutual benefit and sees life as a cooperative, not a competitive environment. It is based on an abundance mentality, the paradigm that there is plenty there for everyone.
An extension of that philosophy that is very useful in business negotiations is what Stephen Covey refers to as Win-Win... or No Deal. This negotiating philosophy sets the stage at the onset of negotiations that ending the process with no deal is OK, a viable option. It does not represent failure on the parts of the parties involved.
We usually enter business negotiations with reasonably high expectations of what the outcome might be. As discussions proceed and we come face to face with the reality of the issues and potential obstacles that must be addressed it is easy to allow frustration and disappointment to set in. This can result in a feeling that the other parties were not fair to the process in some way. One or both parties can leave the negotiations with a feeling of failure that the dreamed result did not materialize because of the other parties’ attitudes or positions.
When No Deal is an option we can feel liberated from the need to push our agenda and manipulate people. We can focus on facts more than feelings. It helps parties to think freely about various options that are mutually beneficial. We simply agree at the start that if we can’t find a solution that will benefit both we agree to disagree agreeably. No expectations have been created, no performance contracts established. We can think objectively about whether our values or goals are aligned as they should be for this deal to proceed. It can help preserve relationships after the negotiating process has ended if no deal is where the process ends. This result often increases the chances of a renewed and successful negotiation process later when the environment for the deal may have improved.
We all want favorable (win-win) results when we invest time and financial resources in a negotiation process. All parties should strive for that. But when both parties acknowledge that No Deal is a viable option at the start the resulting emotional freedom can actually improve the chances of the desired Win-Win solution.
Friday, October 30, 2009
Thursday, October 29, 2009
Business Value, It's All About Future Return and Risk!
Value is the expression of the worth of something. It can be measured in different ways. Some things may have sentimental value but little financial value. Many businesses have sentimental value, but when business value is discussed it should be focused on financial value.
Business value is future oriented.
Last year’s earnings of the business are valuable to a prospective buyer only to the extent they give some indication of future earnings. This is often the case but should not be assumed too readily. Businesses are always changing. Customers and employees come and go. Contracts expire and may not be renewed. Technology is changing most industries.
The future business earnings and cash flow potential from a group of assets is what a prospective business buyer is purchasing. That is the only financial benefit they will get.
Business value is about getting a return on an investment.
Return is the anticipated future cash flow from an investment to an investor. It is the cash flow that will be available to them to be considered a return on their investment and not consumed by the business for capital expenditures or working capital. Quantifying what is often referred to as future net free cash flow to invested capital and discounting it back to present day value is critical to arriving at an accurate business valuation.
One of the first due diligence procedures a sophisticated business buyer will perform is to ask management for their projections of the next few years’ business operations in the form of financial projections. This is the first step in quantifying future expected cash flows. If they are not available prospective buyers may work with management to create them based on the best available information and assumptions.
From the sellers prospective it is best to have these available before engaging in discussions with potential buyers.
Business Value is a Function of Risk
Risk is the essential variable used to quantify the fair market value (present value) of future cash flows to an investor. Risk measures the uncertainty that the future net cash flows will be received. Without consideration for risk every dollar of future return, no matter how speculative, would be equally attractive. Increased uncertainty in future cash flows will increase risk and reduce business value. Reducing future uncertainty will increase business value.
Quantified risk in the form of a desired rate of return can range from the return on a 10 year U.S. treasury security, normally considered the risk free rate of return, to high rates of return with numerous risk premiums required on highly speculative investments. Quantifying the risk of future cash flows from a business in the form of a required rate of return requires substantial insight, business knowledge and judgment.
So, business valuation is really very simple. Just measure the future cash flows and convert them to present value using a discount rate (expected rate of return) that fairly measures the risk involved.
Business value is future oriented.
Last year’s earnings of the business are valuable to a prospective buyer only to the extent they give some indication of future earnings. This is often the case but should not be assumed too readily. Businesses are always changing. Customers and employees come and go. Contracts expire and may not be renewed. Technology is changing most industries.
The future business earnings and cash flow potential from a group of assets is what a prospective business buyer is purchasing. That is the only financial benefit they will get.
Business value is about getting a return on an investment.
Return is the anticipated future cash flow from an investment to an investor. It is the cash flow that will be available to them to be considered a return on their investment and not consumed by the business for capital expenditures or working capital. Quantifying what is often referred to as future net free cash flow to invested capital and discounting it back to present day value is critical to arriving at an accurate business valuation.
One of the first due diligence procedures a sophisticated business buyer will perform is to ask management for their projections of the next few years’ business operations in the form of financial projections. This is the first step in quantifying future expected cash flows. If they are not available prospective buyers may work with management to create them based on the best available information and assumptions.
From the sellers prospective it is best to have these available before engaging in discussions with potential buyers.
Business Value is a Function of Risk
Risk is the essential variable used to quantify the fair market value (present value) of future cash flows to an investor. Risk measures the uncertainty that the future net cash flows will be received. Without consideration for risk every dollar of future return, no matter how speculative, would be equally attractive. Increased uncertainty in future cash flows will increase risk and reduce business value. Reducing future uncertainty will increase business value.
Quantified risk in the form of a desired rate of return can range from the return on a 10 year U.S. treasury security, normally considered the risk free rate of return, to high rates of return with numerous risk premiums required on highly speculative investments. Quantifying the risk of future cash flows from a business in the form of a required rate of return requires substantial insight, business knowledge and judgment.
So, business valuation is really very simple. Just measure the future cash flows and convert them to present value using a discount rate (expected rate of return) that fairly measures the risk involved.
Wednesday, October 28, 2009
Cash Is an Asset: Everything Else A Liability
When I was a young CPA one of my senior partner mentors used to have a favorite saying when talking about analyzing financial statements. It was “Cash Is an Asset: Everything Else Is a Liability”. He obviously new the difference from an accounting perspective. His intent was to emphasize that business value creation is all about maximizing cash flow. Things that get in the way of that (consume cash) can detract from value creation.
You cannot make debt service payments or buy equipment with accounts receivable, inventories or prepaid expenses. These assets consume cash and capital (which always has a cost) and have risks associated with them that cash does not. When a good financial analyst reviews financial statements of a business they immediately go from the Income Statement to the Statement of Cash Flows. That statement has the following three main sections:
Cash Flow from Operating Activities:
This section shows how much of the income reflected on the income statement was really in the form of cash inflow, sometimes referred to as free cash flow. A business that shows profits that are continually being consumed by growth in working capital items other than cash detracts from business value and indicates issues in the cash conversion cycle that need to be addressed.
Cash Flow from Investing Activities:
This section shows the investments in capital assets the business has made. The cash for these investments has to come from cash flow from operations, financing sources or the liquidation of other assets for cash.
Cash Flow from Financing Activities;
This section shows the change in how the business is financed, both debt and equity financing.
The Statement of Cash Flows starts with net income and then reconciles it to changes in the balance sheet and ultimately changes in cash. It addresses the question of where the profits from the business ended up and whether they were put to productive uses or not.
If you find yourself asking the question “If I made so much money last year why do I feel so poor?” a proper cash flow analysis will answer that question.
You cannot make debt service payments or buy equipment with accounts receivable, inventories or prepaid expenses. These assets consume cash and capital (which always has a cost) and have risks associated with them that cash does not. When a good financial analyst reviews financial statements of a business they immediately go from the Income Statement to the Statement of Cash Flows. That statement has the following three main sections:
Cash Flow from Operating Activities:
This section shows how much of the income reflected on the income statement was really in the form of cash inflow, sometimes referred to as free cash flow. A business that shows profits that are continually being consumed by growth in working capital items other than cash detracts from business value and indicates issues in the cash conversion cycle that need to be addressed.
Cash Flow from Investing Activities:
This section shows the investments in capital assets the business has made. The cash for these investments has to come from cash flow from operations, financing sources or the liquidation of other assets for cash.
Cash Flow from Financing Activities;
This section shows the change in how the business is financed, both debt and equity financing.
The Statement of Cash Flows starts with net income and then reconciles it to changes in the balance sheet and ultimately changes in cash. It addresses the question of where the profits from the business ended up and whether they were put to productive uses or not.
If you find yourself asking the question “If I made so much money last year why do I feel so poor?” a proper cash flow analysis will answer that question.
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