Calculating Leverage Ratios

October 5, 2017 Finance, Resources Comments (0) 155

Leverage Ratios indicate long-term solvency of a business and highlight the extent to which long-term debt is used to support the business.

These ratios include:

DEBT-TO-EQUITY RATIO

The Debt-to-Equity Ratio measures how much debt is used to run a business and further highlights how much debt the business has for every dollar of equity. The formula is as follows:

Debt-to-Equity Ratio = Total Liabilities/Shareholders Equity

In most cases, investors would want to this ratio to hover around 1.0 or slightly less.  Higher ratios suggest the company may be in financial distress, while lower number suggests the company is relying on equity financing which may be too costly and inefficient for the business.

 

DEBT-TO-ASSET RATIO

The Debt-to-Asset Ratio measures the percentage of a business’s assets that are financed by creditors. The formula is as follows:

Debt-to-Asset Ratio = Short-Term Debt + Long-Term Debt/Total Assets

Most investors and lenders see a lower ratio as a good indicator to repay debt and take on new debt for new opportunities; a higher ratio might suggest financial weakness.

While these formulas are straightforward, I have created a spreadsheet calculator for readers to use an explore. If you’re interested, you can download the Leverage Ratio Calculator using the button below. If you would like to learn more about Financial Ratios and how they may be used, read the post, Financial Ratio Analysis and the Entrepreneur.

 

 

 

A few notes on this calculator:

  • This calculator is an example and is for use as is. It is not supported in any way. It is not intended to be a tool to use without customization based on the specifics of an entrepreneurial venture and its unique financial statements.
  • This calculator is only an example to give the reader an idea of how such a tool can be developed. The numbers within are not based on a real business. I compiled this as an offshoot of work in a graduate class, but I have created developed similar models for entrepreneurial ventures. Each business venture is different, and so is...

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Financial Ratio Analysis and the Entrepreneur

October 5, 2017 ENT650 – Adv. Entrepreneurial Finance, M.E. Program Coursework Comments (4) 329

ENT650 - WEEK 6

Lenders, and often investors, will calculate one or more financial ratios when reviewing an entrepreneur’s financial statements to gain a quick understanding of the health of the business before determining whether to lend or invest. Within an industry, there will be “good” and “bad” benchmarks against which the venture will be measured (Rogers, 2014). Investors and lenders will consider the particulars of a business and likely weight the importance of the ratios differently when comparing to the industry benchmarks.

Many financial ratios could be applied, but the following appears to be most common types (BDC Staff, n.d.):

Leverage Ratios. Leverage Ratios provide an indication of the long-term solvency and highlight the extent long-term debt is used to support the venture.

Liquidity Ratios. Liquidity Ratios measure the businesses ability to cover its debt and provide a high-level overview of financial health.

Efficiency Ratios. Efficiency Ratios provide insights into operations and help to spot problem areas related to inventory management, cash flow, and collections.

Profitability Ratios. Profitability Ratios evaluate the financial viability of a venture and provide a measure of comparison and performance to the venture’s industry.

There are other ratios, of course, and as mentioned before investors particularly have ratios they rely on more based on their experience and industry knowledge. For example, a recent interview with an investor uncovered a preference for knowing the Customer Acquisition Costs. Customer Acquisition Costs are not often viewed as part of a Financial Ratio Analysis, but such factors are often important measures for both investors and entrepreneurs alike.

The entrepreneur, investor, and lender can gain useful information and financial trends on a business venture when using Financial Ratio Analysis. However, it is important to note that financial ratios have little meaning without comparison (Peavler, 2017). For example, a company can compare its ratios to those average ratios of their industries, but the best and most accurate comparisons come from using benchmark companies—high performing companies within their industry. Comparisons against these companies can create and encourage stretch goals for a business.

While Financial Ratio Analysis does provide numbers for performance...

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Startup Funding Option: Strategic Alliances

September 29, 2017 ENT650 – Adv. Entrepreneurial Finance, M.E. Program Coursework Comments (2) 280

ENT650 - WEEK 5

Entrepreneurs often look to friends, family, their bank account, and even credit cards when funding a startup, but many perhaps overlook this startup funding option: The strategic alliance.

A strategic alliance is a cooperative arrangement between two or more businesses for the mutual benefit all involved businesses. The idea is that each involved entrepreneur or business entity brings something to the alliance which enables a greater opportunity for near-term successes for all parties than the parties might achieve individually. While it is possible one company might invest in another to gain access to products and services more quickly that it might develop the same for itself, the more likely scenario is one in which two companies with complementary services align to improve long-term revenue generation opportunities.

For example, one entrepreneur with design experience might align with another entrepreneur with software coding experience to form a structured partnership to pitch new software projects to a prospective client or develop a software-as-a-service (SaaS) application to offer to a broader customer base.

Another example might be a larger company that needs support products or the services provided by a startup and agrees to partner to gain access to that startup’s offering. More specifically, a mapping software company may find it has difficulty selling its software for certain business applications. It could partner with a business consultant who understands how to apply business thinking to the software tools to help a prospective customer better understand the software’s value. When a sale occurs, the consultant helps implement the software and train the client.

There are challenges to strategic alliances, of course, particularly among startup ventures. The biggest obstacles appear to be a difficulty in finding suitable cooperating partners, an inability to assess the upside and downside of the alliance accurately, the challenge of properly structuring the arrangement, and the fear that cooperation might result in an expropriation of business (Hsu, 2007). Moreover, some alliances can pose a challenge to future investment funding if investors have a conflict with one or more of the alliance partners, or if cash flow rights to alliance partners dilute the opportunity for investors...

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Interview: Gregg Smith on Entrepreneurial Investment

September 25, 2017 ENT650 – Adv. Entrepreneurial Finance, Interviews, M.E. Program Coursework Comments (0) 421

The following is an interview with Gregg Smith, Founder, Evolution Corporate Advisors, for my Advanced Entrepreneurial Finance graduate course. Gregg and I have known each other since about 2010. We discuss entrepreneurial investment from an investor’s perspective

Q. Tell me little about yourself and Evolution Corporate Advisors as it may relate to or support the financing of entrepreneurial ventures and small businesses.

A. I spent ~20 years on Wall Street as an investment banker, with most of my career spent helping growth stage companies execute private placements. I have completed over 120 private placement transactions for clients in the healthcare, technology, consumer & retail, energy and other sectors. I have also (conservatively) reviewed more than 1,000 business plans and met with 100s of management teams and entrepreneurs. I have seen many success stories of small companies I financed that were sold for >$10 billion, and many I financed that failed.

Q. When considering an investment, which is more valuable to an investor, experience in an industry vs. experience as an entrepreneur? Why?

A. Many outsiders have come to existing, “old world” antiquated industries and completely disrupted the norm—all with no prior in-depth industry experience. I would rather back a highly successful entrepreneur who has succeed elsewhere in a new industry, than back an industry insider who does not have any meaningful record of success. Also, many outsiders have a fresh perspective on things that don’t live with every day and may innovate and/or solve a problem that is not obvious to the industry insider.

Q. In your experience, which is more important in early state financing, the fit with the entrepreneur, the apparent accuracy of the pro forma assumptions, or the expected potential of the business? Why?

A. In the more than 120 transactions I completed, I have only had one client meet their first quarter projections after closing a deal. Things are very difficult to predict, and everything in life ends up costing more and taking more time than one anticipates. The same holds true with even the most sophisticated management teams using their best judgment to project where their business will be in one-quarter...

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Investor Tip: Customer Acquisition Cost is Key

September 24, 2017 ENT650 – Adv. Entrepreneurial Finance, M.E. Program Coursework Comments (4) 294

ENT 650 - WEEK 4

A conversation with an investor this week brought out that Customer Acquisition Cost is a key to his investment decision-making process. It occurred to me that many new entrepreneurs may not consider how important such a metric is for their venture, whether or not they are seeking investment. Customer Acquisition Cost is not just a measure to determine the average cost to acquire a customer; it is also used to determine the overall health of the business, the marketing budget, and the effectiveness of marketing and sales programs. For an investor, it will demonstrate the short- and long-term viability of the venture.

Let’s examine Customer Acquisition Cost in a little more detail.

CUSTOMER ACQUISITION COST

Calculating the customer acquisition cost (CAC) is not difficult. Start by totaling all of the marketing and sales costs for a period, and then divide those costs by the number of new customers acquired for the same period. Easy enough, right? Except that many entrepreneur’s—myself included—may miss costs in the calculation and do not get an accurate number against which to measure the customer acquired.

For a more detailed analysis of CAC, I think about spend and acquisition by channel. For example, in the chart below, I list the number of channels and further categorize them in measurable and non-measurable buckets. Measurable channels are those from which a customer’s purchase is trackable to the marketing or sales campaign, either through a link, a promo code, a special call-in number, or a sales order tied directly to a salesperson.

 

Non-measurable channels are channels which do not provide for an easily trackable source for a specific sale but are likely to contribute in some way to sales in general and should be calculated as part of the overall CAC. Brand campaigns might fall into this category, as would most promotional activities such as an entrepreneur’s speaking engagements, and networking events, to name a few. By adding the costs together and then dividing by the number of customers acquired for the period we arrive at an Average Customer Acquisition Cost.

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Answering Big What-Ifs: The Interactive Pro Forma

September 11, 2017 ENT650 – Adv. Entrepreneurial Finance, Entrepreneurship, Finance Comments (14) 435

ENT 650 - Week 3

Startup entrepreneurs face a daunting challenge in forecasting cash flow, profitability, and return on investment. It can be so overwhelming that many just ignore the numbers and jump right into developing a product or service. Certainly, a refined product or service is a critical early step in launching the entrepreneurial venture; however, understanding the financial aspects of the business, including the inputs to the product or service development is paramount to forecasting cash flow and business profitability, is equally important.

In business, particularly in the start-up phase, “pro forma” financial statements provide a way for the entrepreneur and potential investors to see the financial forecast of a business given a set of assumptions. The pro forma financials will include a set of assumptions on which the numbers were based, a cash flow statement, an income statement, and a balance sheet statement. Together, these statements provide an approximation of business performance considering the assumptions. Most investors place little value on the numbers a start-up provides because the core assumptions may be inaccurate (Rogers, 2014).  And if the assumptions are inaccurate, the financial performance will change. One of the best ways to understand how assumptions change the financial performance of a business is to build an interactive pro forma.

The interactive pro forma will allow an entrepreneur to quickly change assumptions and easily see the possible financial impact on the business as those assumption flow through the other financial statements. Once set up, it allows an entrepreneur to play a “What-if” game with assumption inputs and watch how those changes affect the business performance. The interactive pro forma is also a great tool to use when seeking outside investment. If the assumptions are challenged by an investor, they can be modified in real-time, and those modifications flow out to the other statements. This provides an instant view of the new business financials once new assumptions are in place.

Spreadsheet tools make building an interactive pro forma easy, although it does take some knowledge of the tools and a few hours to set up the models. Most of the time spent should be given to considering the...

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Financial Risk and the Entrepreneur

September 10, 2017 ENT650 – Adv. Entrepreneurial Finance, Entrepreneurship, Finance Comments (16) 408

ENT650 - WEEK 2

For many of us, the word “entrepreneur” conjures a vision of an individual working tirelessly to grow an idea into a business. This is certainly one type of entrepreneur, but there are other types of entrepreneurs, too. There are those who serve an entrepreneurial function in corporations, those who chose to buy a franchise, those who acquire established businesses, and those we mentioned earlier who start a business from nothing (Rogers, 2014). Each of these individuals is an entrepreneur, albeit with different skill sets and arguably a different level of tolerance for the financial risk in entrepreneurship. Understanding basic financial principles and the role these principles play in entrepreneurial ventures might help entrepreneurs balance their risk-reward tolerance when considering new opportunities.

Financial management is a valuable discipline for entrepreneurship, regardless of the entrepreneurial type. It is the single most useful toolset for mitigating business risk. Unfortunately, many entrepreneurs cite financial management as their weakest skill (Rogers, 2014). Why? It may be that some entrepreneurs see their strength as creating their venture’s product or service. In these situations, they may abdicate the responsibility of the venture’s finances. It is likely that the type of entrepreneurial activity factors into the value an entrepreneur places on the need to understand the underlying financial aspects of the venture.

Let’s look at each entrepreneurial type in a little more detail from the lowest to the highest financial risk related to entrepreneurial activity:

Corporate Entrepreneur

Corporate entrepreneurs, or intrapreneurs, are those who perform entrepreneurial functions within an organization. The work these individuals do can range from creating new lines of business and developing new opportunities from within an organization (as I did for the Boy Scouts of America’s National retail operations) to starting a separate venture with funding and direction from an organization. In both cases, the greatest challenge for the entrepreneur is walking the line between organizational culture and the entrepreneurial mindset needed to grow and develop the new venture (Gavin & Levesque, 2006). The business culture often does not allow for the level of out-of-the-box thinking necessary to get the...

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On public speaking

August 5, 2017 ENT645 - Entrepreneurial Marketing, M.E. Program Coursework, Marketing, Speaking Comments (5) 640

ENT645 - WEEK 7

I was first asked to speak publicly sometime in the early 90’s for a broadcasting trade association meeting. I had a small media-buying business, and my model was a little different than the local agencies. The association believed my thoughts on media buying would be useful to those who were trying to sell media. I was part of a panel, but I cannot recall what I talked about or how useful my comments might have been to those in attendance. I do remember I was quite anxious about participation but managed to get through it because I understand how important public speaking opportunities were to help build credibility for my business and my entrepreneurial endeavors.

Public speaking does not come naturally to me.

It makes me uncomfortable in all sorts of ways, none the least of which is feeling unprepared regardless of how much preparation time I put into the talk. There are other challenges, too. I want to everyone to find something of value in my talk, I want to be entertaining as well as informative so those listening don’t get bored. I want those in the audience to have at least one “ah-ha” moment or walk away with one piece of information that is useful. And I really don’t want to hang around afterward to talk to people—the introvert in me needs to recharge—but I do. Public speaking, even for the most experienced, can be exhausting.

I am certain I fail at more than one of things I noted above every time I speak publicly. That doesn’t stop me from continuing to do so. Practice breeds improvement, not perfection. Improvement should be the goal.

Six things I have learned that make me a better speaker.

Perhaps these learnings from my experiences speaking might be helpful to you:

You will not be perfect. You shouldn’t strive for that in your talk. You will forget key points you wanted to make, and you may lose a thought or two. Usually, no one will know unless you tell them. Everyone listening expects you to be human, so imperfection is expected and allowed.

Know your...

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Can long copy still make the cash register ring?

August 3, 2017 ENT645 - Entrepreneurial Marketing, M.E. Program Coursework, Marketing Comments (0) 427

ENT645 - WEEK 6

Long copy ruled direct response marketing, once. Marketers could create a brilliant story-driven copy to draw a reader in and then close the sale with a strong call to action.  David Ogilvy (in the photo above) and his team at Ogilvy and Mather were the masters. But that was more than thirty years ago.

Twenty years ago, I had a great deal of success with long copy in printed direct mail. Just simple letters to the target market that would bring them along in a story and then get them to take action. I am not sure that’s possible any longer. I believe the proliferation of email spam and the dawn of mobile phones have decreased the effectiveness of long-form direct response appeals.

A recent grad school assignment asked for the creation of a two-step direct response campaign. In such a campaign, the first step generates the lead and the second step closes the sale. In the direct mail days, a long letter—often several pages—was more effective as that first step—it told the story and offered the benefits to the prospect. The close came with a phone call or a response card. It was highly effective, and of the campaigns, I was involved in we often pulled a 5-6% response with a 50% conversion to a sale.

The assignment further asked for the creation of a “squeeze page.” A squeeze page is a page on that “squeeze that last bit of info out of you” so that you might get what you’re looking for from the site.  Typically, it is your name and an email address.

In the early days of the Internet, that long-form direct mail piece was often used in a two-step process. You may remember that time. The pages were often a single page with a lot of copy, a few photos, some bulleted text, and multiple opportunities to buy or subscribe as you read down the page. If you took action, you would go to another page—the “squeeze page”—to provide your name and email address for more information or so the sale...

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Interview: Rachael Harper on Entrepreneurship

July 23, 2017 ENT645 - Entrepreneurial Marketing, Interviews, M.E. Program Coursework Comments (0) 449

Rachael Harper, owner of Vida Calma Wellness and former owner of On Track Yoga shares her thoughts on entrepreneurship for my Entrepreneurial Marketing graduate course. Rachael and I discuss what it’s like to start a business, grassroots marketing, the importance of creating a business built for community and social good, and many other things. 

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