Venture Evaluation & Contribution Analysis PDF

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BU121 Break-even Analysis ● What does it mean? ○ when revenue covers cost ■ REVENUE = TOTAL COST ● What are the Break Even Drivers ○ Variable Cost (VC) ○ Cash Fixed Cost (CFC or FC) ○ Variable Cost Revenue Ratio (VCRR) ■ VC/ Price ○ Contribution ■ P - VC ○ Contribution Margin ■ CM = 1 - (VC/Price) or 1 - VCRR ● Survival Revenue? ○ Breakeven in terms of revenue instead of volume ■ (revenue needed to break even) Steps to Calculating Breakeven 1. Identify the variables 2. Choose the applicable Breakeven equation 3. Solve 4. Consider any further qualitative implications Formula 1. (in terms of units) # of units needed to breakeven = FC/ (P - VC) Formula 2. (in terms of revenue) $ revenue needed to breakeven = FC/ (1 - VCRR) Formula 3. (in terms of profit) Profit = (Price - VC) * (# sold) - FC

Leverage Typically two options available: 1. No fixed cost w/ a higher VC 2. An investment into fixed cost but w/ a lower VC HAVE TO CRUNCH THE NUMBERS! *We have to find the decision point (or the indifference point, where if you sell this much, profit from option 1 = profit from option 2) Consider the Risk-Return Tradeoff

Venture Evaluation ● 3 Approaches

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Income Approach ■ How is value determined? ● Based on the assumption that the value of the business = sum of the present values of any expected future benefits ■ Negative aspect? ● Too many unknowns for you to accurately value the company Market Approach ■ How is value determined? ● Value is determined based on comparisons to similar companies for which values are known ■ Negative aspect? ● May not necessarily reflect how your company will do… just industry overall Cost Approach ■ How is value determined? ● Value determined as measure of net cost of assets, original amount invested or ‘cost-to-duplicate’ ■ Negative aspect? ● Neglects subjective values, states that your company has no additional value other than what you’ve put into it

Different Stages of the Venture Life Cycle ● Development ○ Business is a prototype ■ Taking an idea and turning it into a business ○ Strategy ■ Your own assets, family investments ● Start-up ○ Revenue generation begins (time zero) ○ Strategies ■ angel investors and your own assets ● Survival ○ Some expenses are covered but not all ○ Strategies ■ venture capitalists, revenue from customers ● Rapid Growth ○ Cash inflows exceed outflows (cash flow positive) ○ Strategies ■ business operations, investment bankers ● Early Maturity ○ Most value is reduced, growth slows ○ Strategies ■ go public (PO), consider exiting Venture Driven by 3Ms 1. Market

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a. What questions will investors ask about the conditions of the market before deciding to invest? Management a. What questions will investors ask in relation to how the company is managed and how they can contribute value to the company? Moat a. What questions will investors ask in regards to protection mechanisms which a company have once they enter an industry and the barriers to entry present?

Contribution Analysis Example 2 Decisions 1. How much do I need to sell to break even? a. Two Issues i. Can we sell enough to make money? 1. Tool a. Break-even volume ii. At what level of sales will we make more money? 1. Tool a. Decision Point 2. Will I make money? a. One Issue i. Will this change improve profitability? 1. Tool a. Impact on Profitability

Example Questions...