The Great Game of Investing and Risk Management Mkt 443 Prof. Bill White

The Game of Money Before 25Warm-up 25 to 351 st Quarter 35 to 452 nd Quarter Halftime 45 to 553 rd Quarter 55 to 654 th Quarter 65-plus Overtime Out-of-Time/Game Over AgeGame Period Modified from: Rich Dad’s “Who Took My Money.”

Playing the Money Game: Rich Dad’s Strategy Invest money in assets that give cashflow. The cattle rancher versus the dairy farmer. Get your original investment money back ASAP. Keep control/ownership of the original asset. Move the money into a new cash-flowing asset. Get your money back ASAP. Repeat the process. Asset

Some Basic Rules of the Game The first rule is to know that it’s all a game. You are playing an active part/role in the game. There are winners and losers whose fates are constantly shifting. Never invest more than you can afford to lose without saying OOUCH! Don’t invest in anything you don’t understand.

Some Basic Rules of the Game Invest with a plan. 1. Have evidence that the odds are stacked in your favor. An “Edge.” 2. Decide in advance how much you will make or lose. Have an “Exit Strategy”. Stop loss. Profit-taking. 3. Know that you can trust yourself execute your plan precisely and without hesitation.

Sample Investment Strategy Real Estate: Buy and Hold using money you can afford to lose. Properties in areas where demand for housing exceeds the supply. Lower-middle price range. Refinance regularly to pull out cash to reinvest and/or to live on. Retirement Accounts: Earn and purchase additional years of service in order to increase retirement salary. Business Ventures: Asymmetrical Bets using money you can absolutely afford to lose. Low-to-medium probability bets with high expected values. I’m involved in the businesses and therefore influence the outcomes. Financial Paper: Not sure, but am leaning toward: Reverse mortgage on my home. Tax-free government bonds Variable life insurance

Managing Cash Flow

Cash Management All businesses, but especially young, growing businesses are “cash sponges.” Can a business be profitable and broke at the same time? Cash management – forecasting, collecting, disbursing, investing, and planning for the cash a company needs to operate smoothly. Taxes are your biggest expense.

Cash Faucet Slide

Cash Flow Faucet

Five Cash Management Roles of an Entrepreneur Cash Finder Cash Planner Cash Distributor Cash Collector Cash Conserver

The Cash Budget A “cash map,” showing the amount and the timing of a firm’s cash receipts and cash disbursements over time. Predicts the amount of cash a company will need to operate smoothly. A helpful tool for visualizing the firm’s cash receipts and cash disbursements and the resulting cash balance.

Preparing a Cash Budget Determine a Minimum Cash Balance Forecast Sales Forecast Cash Receipts Forecast Cash Disbursements Estimate End-of-Month Cash Balance

Remember Goldilocks, the Three Bears, and the porridge: Not too much... Not too little... but a cash balance that’s just right... for you! Determine a Minimum Cash Balance

The heart of the cash budget Sales are ultimately transformed into cash receipts and cash disbursements. Prepare three sales forecasts: Most Likely Pessimistic Optimistic Forecast Sales

Sales Forecast for a Start-Up Import Car Repair Service Example: Number of cars in trading zone 84,000 x Percent of imports x 24% = Number of imported cars in trading zone 20,160 x Average expenditure on repairs x $485 = Total import repair sales potential$9,777,600 x Estimated market share x 9.9% = Sales estimate $967,982

Record all cash receipts when actually received (i.e., the cash method of accounting). Determine the collection pattern for credit sales; then add cash sales. Forecast Cash Receipts

The Cash Flow Cycle OrderGoods Day1 ReceiveGoods 15 PayInvoice SellGoods* DeliverGoods CustomerPays** SendInvoice Cash Flow Cycle = 240 days * Based on Average Inventory Turnover: 365 days = 178 days 365 days = 178 days 2.05 times/year 2.05 times/year ** Based on Average Collection Period: 365 days = 50 days 365 days = 50 days 7.31 times/year 7.31 times/year

Start with those disbursements that are fixed amounts due on certain dates. Review the business checkbook to ensure accurate estimates. Add a cushion to the estimate to account for “Murphy's Law.” Don’t know where to begin? Try making a daily list of the items that generate cash and those that consume it. Forecast Cash Disbursements

Take Beginning Cash Balance... Add Cash Receipts... Subtract Cash Disbursements Result is Cash Surplus or Cash Shortage (Repay or Borrow?) Estimate End-of- Month Balance

The “Big Three” of Cash Management Accounts Receivable Accounts Payable Inventory

About 90% of industrial and wholesale sales are on credit, and 40% of retail sales are on account. Recent survey of small companies across a variety of industries found that 77% extend credit to their customers. Remember: “A sale is not a sale until you collect the money.” The goal with accounts receivable is to collect your company’s cash as fast as you can. Accounts Receivable

Establish a firm credit-granting policy. Screen credit customers carefully. When an account becomes overdue, take action immediately. Add finance charges to overdue accounts (check the law first!). Develop a system of collecting accounts. Send invoices promptly. Accounts Receivable Beating the Cash Crisis

Stretch out payment times as long as possible without damaging your credit rating. Verify all invoices before paying them. Take advantage of cash discounts. Negotiate the best possible terms with your suppliers. Be honest with creditors; avoid “the check is in the mail” syndrome. Schedule controllable cash disbursements to come due at different times. Use credit cards wisely. Accounts Payable Beating the Cash Crisis

Monitor it closely; it can drain a company's cash. Avoid inventory “overbuying.” It ties up valuable cash at a zero rate of return. Arrange for inventory deliveries at the latest possible date. Negotiate quantity discounts with suppliers when possible. Inventory Beating the Cash Crisis

Avoiding the Cash Crunch Consider bartering. That means exchanging goods and services for other goods and services, to conserve cash. Trim overhead costs. For example: Lease rather than buy Avoid nonessential cash outlays Negotiate fixed loan payments to coincide with your company’s cash flow

Avoiding the Cash Crunch Trim overhead costs. For example: Buy used equipment Hire part-time employees and freelancers Develop an internal security system Devise a method for fighting check fraud Change shipping terms Switch to zero-based budgeting Keep your business plan current Invest surplus cash (continued)

Creating a Successful Financial Plan

Basic Financial Reports n Balance Sheet - Estimates the firm’s worth on a given date; built on the accounting equation: Assets = Liabilities + Owner’s Equity n Income Statement - Compares the firm’s expenses against its revenue over a period of time to show its net profit (or loss): Net Profit = Sales Revenue - Expenses n Statement of Cash Flows - Shows the change in the firm’s working capital over a period of time by listing the sources of funds and the uses of these funds.

Breakeven Analysis The breakeven point is the level of operation at which a business neither earns a profit nor incurs a loss. It is a useful planning tool because it shows entrepreneurs the minimum level of activity required to stay in business. The breakeven point may be calculated in dollars and in units. Adding desired profit, markdowns, and theft when computing the breakeven point provides a more significant insight into the financial analysis.

Break-Even Analysis Definitions: Margin = Unit contribution to fixed costs/overhead = Selling price minus Variable cost. Variable costs vary with the level of production. Fixed costs/overhead remain constant regardless of the level of production. Breakeven Formulas: B.E. in Units Sales = Total fixed costs/overhead Selling price - Variable cost B.E. in $ Sales =B.E. in units x Selling price

Assume a store sells bubble gum machines for $100 that cost $75 to make. Monthly overhead is $10,000. Breakeven Analysis Margin B.E. in Units = Fixed/Overhead Costs B.E. in $ =B.E. in Units x Selling Price Fixed/Overhead Costs = Price - Variable Cost B.E. in Units = $10,000 $100 - $75 = $10,000 $25 = 400 units B.E. in $ =40 units x $100 = $40,000

Profit Analysis Mark-up B.E. in Units = Fixed/Overhead Costs + Profit + Markdowns/Theft B.E. in $ =B.E. in Units x Selling Price B.E. in Units = $10,000 + $5,000 + $2,500$17,500 $25 = 700 units B.E. in $ =700 units x $100 = $70,000 For each month, assume the owner needs to breakeven, make $5,000 profit to live on, and cover expected markdowns/theft of $2,500. = $25 Desired

Profit Is More About Margin Than Volume Mark-up B.E. in Units = Fixed/Overhead Costs + Profit + Markdowns/Theft B.E. in Units = $10,000 + $5,000 + $2,500$17,500 $25 = 700 units What would a 20% increase or decrease in margin look like? = $25 Desired B.E. in Units = $17,500 = 583 units $30 B.E. in Units = $17,500 = 875 units $20

Weighted Average Product A (70% of orders) Price:$50 Cost:$20 Margin$30 Product B (30% of orders) Price: $100 Cost:$40 Margin$60 Average (100% of orders) Price: $65 Cost:$26 Margin$39 x 70% = $35 x 70% = $14 x 70% = $21 x 30% = $30 x 30% = $12 x 30% = $18 $65 $26 $39 How to determine an “average” price, cost, and margin if you’re selling a variety of products at different prices and costs.