TTMG 5103 Module Innovation Financial Management

Patrick O’Halloran

TIM Program, Carleton University

Agenda

Objective

Financial Planning & Management

Financial Terminology

Methods and Techniques

Conclusions

References

Objective(s)

Identify key financial terminology essential to understand the intricacies of the financial domain.

Identify Methods/Techniques to manage finance in association with innovation

Agenda

Objective

Financial Planning & Management

Financial Terminology

Methods and Techniques

Conclusions

References

Financial Management

Financial Management What does it involve? Planning

How much capital you will need and when? Funding

Where do we get the capital we initially need to operate efficiently and to exploit its opportunities?

Two Types of capital: Debt and Equity

Financial Management

Capital Investment What assets do you need to invest in and what

are the considerations involved in choosing them?

Financial Control How do you keep the accounts balanced and

track profit and losses? Financial Reporting

What happens at the end of the year? Owe vs. Own?

Moment of Truth

Discussion Examples

Euro Disney Youtube Chrysler and Daimler

Agenda

Objective

Financial Planning & Management

Financial Terminology

Methods and Techniques

Conclusions

References

Financial Terminology

Time Value of Money Question: If you are offered

Option A: $100,000 today Option B: $100,000 in three years

Which would you take? Why?

Net Present Value The present value of an investment's future

net cash flows minus the initial investment.

nrPVFV )1(

Financial Terminology

NPV – Example Condo in Nepean costs $180,000. Predicted that a

year from now it will cost $195,000. Buy the condo or bonds with 6% interest.

962,3

000,180183,962

183,96206.01

000,195

NPV

VP

%3.8000,180

000,180000,195

return of Rate InvestmentProfit

Financial Terminology

Fixed Costs: A fixed cost is one that does not vary with the

level of output Rent, Rates, Salaries, Accountancy etc.

Sunk Costs: A sunk cost is an investment that can not be

recovered if a project is shut down and equipment sold.

Brand name promotion, pre-ordered movie ticket etc.

Financial Terminology

Free Cash Flow - FCF Represents the cash that a company is

able to generate less the cost to maintain or expand its’ asset base

Weighted Average Cost of Capital – WACC The Weighted Average Cost of Capital is your

market based cost of debt and cost of equity weighted by the proportion of your debt to equity.

Financial Terminology

Discounted Cash Flow – DCF A Discounted Cash Flow analysis tells you how

much an investor would be willing to pay for the present value of a company’s future FCF

Real Options Real options are features of a project that

provide flexibility. Economic Value Added – EVA™

Method to link performance incentives more closely to increases in shareholder wealth

DCF vs. Real Options

Along with NPV, the DCF tool ignores flexibility of managers based with project criteria – scaling project based on needs/issues.

NPV and hence DCF methodologies have an aversion to risk, and incorporating it into the typical model can lead to negative NPV and hence break the NPV rule. Leads to incorrect assumptions.

Innovation Killers

Why do smart companies fail when it comes to innovation? Too much focus on most profitable customers Misuse of Financial Analysis tools

Underestimation of real returns and benefit of innovation investment

Myopic view on investments based on Earnings-per-share

Fixed and sunk costs - not accounting for obselescence

Innovation Killers

How does it manifest itself? Underestimation – do-nothing scenario as

baseline state

A

C

How cash flow typically looks When investing in an

innovation

More accurate baseline for such Innovation calculationsMore likely scenario when

Choosing do-nothing mode of operation

DCF and NPV calculations Based on incorrect baseline

B

Moment of Truth

Discussion Examples

Agenda

Objective

Financial Planning & Management

Financial Terminology

Methods and Techniques

Conclusions

References

Discovery Driven Planning

Planning for New Ventures vs. Conventional Unknown vs. Facts Need to envision what is unknown, uncertain and not

yet obvious to the competition. High ratio of assumptions to knowledge.

Discovery Driven Planning (McGrath & MacMillan, 1995) Little is known and much is assumed. Converts assumptions into knowledge as strategic

ventures unfold

Discovery Driven Planning

Steps Involved ‘Key Assumptions Checklist’ identifies the

business hurdles and assumptions for the initiative.

‘Reverse Income Statement’ models the business economics.

‘Pro-Forma Operations Specs’ defines operations needed to run the business.

‘Milestone Planning Chart’ specifies when the assumption needs to be tested.

Technique 11

Document Initial Assumptions Document verified knowledge and determine

unverified assumptions and unknowns Prepare Reverse Income Statement

Determine level of profit margin and amount of profit to make the project worth while, then determine revenue to meet this goal.

Estimate Operating Specifications What are the ongoing overhead costs (pro

forma operations specs.

Technique 11

Update Income Statement Now that we have the estimated costs update

the initial income statement. Are we still on track?

Identify Critical Assumptions Which of these if not controlled could seriously

effect your innovation financially. Link Assumptions to Milestones Test and Validate Assumptions

Financial Models

Equity Financing Venture Capitalist Angel Investors Public Stock Markets – IPO

Debt Financing Banks

Mindset Change New Light at the end of tunnel

Bootstrapping – bioscience model

Moment of Truth

Discussion Examples

Agenda

Objective

Financial Planning & Management

Financial Terminology

Methods and Techniques

Conclusions

References

Conclusions

Assumptions must be validated or prioritized for all innovation objectives.

Traditional techniques for investment decisions are not set in stone

Options for decisions points should be incorporated into your business/investment plans.

Traditional financing models are also being questioned.

Moment of Truth

Discussion Examples

References

Ridlehoover, J. (2004) Applying Monte Carlo Simulation and Risk

Analysis to the Facility Location Problem. The Engineering

Economist, Vol. 49, No. 3, pp. 237-252.

Davis, C. R. (2002) Calculated Risk: A Framework for Evaluating

Product Development. MIT Sloan Management Review. Vol. 43, No.

4, pp. 71-77.

Christensen, C, et al (2008), Innovation Killers–How Financial Tools

Destroy Your Capacity to Do New Things, Harvard Business Review,

January, pp. 98-105.

References

Willoughby, K (2008). How do entrepreneurial technology firms really get financed and what difference does it make? International Journal of Innovation and Technology Management Vol.5, No.1 pp. 1 – 28.