The Great Game of Investingand Risk Management

Mkt 443

Prof. Bill White

The Game of Money

Before 25 Warm-up

25 to 35 1st Quarter

35 to 45 2nd Quarter

Halftime

45 to 55 3rd Quarter

55 to 65 4th Quarter

65-plus Overtime

Out-of-Time/Game Over

Age Game 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

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 StrategyReal 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

ManagingCash FlowManagingCash Flow

Cash ManagementAll 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 BudgetA “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 LikelyPessimisticOptimistic

Forecast Sales

Sales Forecast for a Start-UpImport 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 CycleThe Cash Flow Cycle

OrderOrderGoodsGoods

Day 11

ReceiveReceiveGoodsGoods

1515

PayPayInvoiceInvoice

4040

1414 2525

218218

178178

SellSellGoods*Goods*

DeliverDeliverGoodsGoods

221221

33

CustomerCustomerPays**Pays**

SendSendInvoiceInvoice

230230

99

280280

5050

Cash Flow Cycle = 240 daysCash Flow Cycle = 240 days

* Based on Average Inventory Turnover:* Based on Average Inventory Turnover:

365 days 365 days = 178 days = 178 days 2.05 times/year2.05 times/year

** Based on Average Collection Period:** Based on Average Collection Period:

365 days 365 days = 50 days = 50 days 7.31 times/year7.31 times/year

Collecting Delinquent Accounts

13.60%

23.60%

42.80%

57.80%

73.60%

85.20%

93.80%

0.0% 20.0% 40.0% 60.0% 80.0% 100.0%

24

12

9

6

3

2

1

Probability of Collection

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 ReceivableAccounts ReceivableBeating 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 PayableAccounts PayableBeating 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.

InventoryInventoryBeating 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 buyAvoid nonessential cash outlaysNegotiate 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 currentInvest surplus cash

(continued)(continued)

Creating a Successful Financial

Plan

Creating a Successful Financial

Plan

Basic Financial Reports

Balance Sheet - Estimates the firm’s worth on a given date; built on the accounting equation:

Assets = Liabilities + Owner’s Equity 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 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 AnalysisThe 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 AnalysisDefinitions: 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

MarginB.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-upB.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.