Quiz 2
How do we know whether an idea has the potential to become a viable business opportunity?
The answer is that we don't know with absolute certainty. While there is no infallible screening process, there are tools and techniques that can help examine similarities between a new idea and previously successful ventures.
What are the components of a sound business model?
The components of a sound business model are the abilities to generate revenues, create a profit, and produce free cash flow. These components must be achieved within a reasonable time frame as the venture progresses through the early stages of its life cycle.
Describe return on assets (ROA). What are the two major components of the ROA model?
The return on assets is a metric calculated by dividing the venture's net after-tax profit by its venture total assets and it represents a measure of the firm's performance relative to its invested assets. The return on assets measure can also be viewed in terms of the return on assets (ROA) model that expresses the return on assets as the product of the net profit margin and the assets turnover metrics or ratios. This relationship is depicted as follows: Return on Assets = Net Profit Margin x Assets Turnover This also can be represented as: Net Profit/Total Assets = Net Profit/Revenues x Revenues/Total Assets. Thus, the ROA of a venture is equal to its profit margin times its asset intensity.
Describe the meaning of venture opportunity screening.
Venture opportunity screening is the assessment of an idea's commercial potential to produce revenue growth, financial performance, and value.
Time to market is generally important, but being first to market does not necessarily ensure success. Explain.
"Time-to-market" is particularly critical when ideas involve information technology, as a few months might determine success or failure. EBay's rapid progression from concept to market dominance provides an example of the advantages of acting quickly in a technology market. "First to market," does not always result in success, as quite often companies entering the market later may achieve significant competitive advantages such as more efficient production, distribution, and service, superior product design, and a more sound financial position. The portable computer, first sold by Osborne, provides an example of a technology product that failed to achieve success by being "first to market."
Describe how a SWOT analysis can be used to conduct a first-pass assessment of whether an idea is likely to become a viable business opportunity.
A SWOT analysis is an examination of strengths, weaknesses, opportunities, and threats to determine the business opportunity viability of an idea. One typically "begins" by asking whether there is an unfilled customer need. Other considerations that could be potential strengths or weaknesses include: intellectual property rights, first mover, lower costs and/or higher quality, experience/expertise, and reputation value. Areas to consider as potential opportunities or threats include: existing competition, market size/market share potential, substitute products or services, possibility of new technologies, recent or potential regulatory changes, and international market possibilities.
What is a business plan? Why is it important to prepare a business plan
A business plan is a written document that describes the proposed venture in terms of the product or service opportunity, current resources, and financial projections. More formal business plan development is common in ventures moving from the development stage to the startup stage. The process of business planning is beneficial to the entrepreneur, who must be the first to believe the plan is reasonable. The entrepreneur must be convinced that starting this business is the right thing to do personally and professionally; the business plan reflects the excitement, opportunity, and reasonableness of the business idea to the members of the management team, potential investors, and other stakeholders.
What are the major elements of a typical business plan?
A typical business plan contains, in its Introduction, a cover page, confidentiality statement, table of contents, and executive summary. The Business Description section presents some of the considerations related to the venture opportunity-screening phase on industry/market factors. The Marketing Plan and Strategy section addresses the target market and customers, competition and market share, pricing strategy, and promotion and distribution. The Operations and Support section discusses how production methods or services will be delivered. The Management Team section presents the experience and expertise characteristics of the management team. In the Financial Plans and Projections, the business plan typically includes financial projections in the form of income statements, balance sheets, and statements of cash flows. These projections provide the basis for how the venture is expected to start up and operate over the next several years. The business plan should include a discussion of possible Problems or Risks. The Appendix should contain the detailed assumptions underlying the projected financial statements in the Financial Plans and Projections section.It should also include a timeline with milestones indicating the amount and size of expected financing needs.
What is meant by a viable venture opportunity?
A viable venture opportunity is one that creates or meets a customer need, provides an initial competitive advantage, is timely in terms of time-to-market, and offers the expectation of added value to investors.
Describe the characteristics of a viable venture opportunity. What is a VOS Indicator?
A viable venture opportunity will meet a customer need, have a competitive advantage, be able to be brought to market quickly, and offer attractive investment returns compared to the risk associated with it. A VOS Indicator is a guide to help investors and entrepreneurs screen business opportunities. It contains a checklist for indicating the potential attractiveness of a proposed venture.
[Basic Financial Ratios] A venture recorded revenues of $1 million last year and net profit of $100,000. Total assets were $800,000 at the end of last year. A. Calculate the venture's net profit margin. B. Calculate the venture's asset turnover. C. Calculate the venture's return on total assets
A. Net Profit Margin: net profit/revenues = $100,000/$1,000,000 = 10.0% B. Asset Turnover: revenues/total assets = $1,000,000/$800,000 = 1.25 times C. Return on Total Assets: net profit/total assets = $100,000/$800,000 = 12.5%
[Revenues, Costs, and Profits] In early 2013, Jennifer (Jen) Liu and Larry Mestas founded Jen and Larry's Frozen Yogurt Company, which was based on the idea of applying the microbrew or microbatch strategy to the production and sale of frozen yogurt. They began producing small quantities of unique flavors and blends in limited editions. Revenues were $600,000 in 2019 and were estimated at $1.2 million in 2020. Because Jen and Larry were selling premium frozen yogurt containing premium ingredients, each small cup of yogurt sold for $3 and the cost of producing the frozen yogurt averaged $1.50 per cup. Other expenses plus taxes averaged an additional $1 per cup of frozen yogurt in 2019 and were estimated at $1.20 per cup in 2020. A. Determine the number of cups of frozen yogurt sold each year. B. Estimate the dollar amounts of gross profit and net profit for Jen and Larry's venture in 2019 and 2020. C. A. Calculate the gross profit margins and net profit margins in 2019 and 2020. D. Briefly describe what has occurred between the two years.
A. Revenue = Price per unit x units sold, and Revenue / Price per unit = units sold: Units Sold for 2019 = 600,000/3 = 200,000 units Units Sold for 2020 = 1,200,000/3 = 400,000 units B. 2019 2020 Revenue $600,000 $1,200,000 COGS(UnitsxCOGS per Unit) 300,000 600,000 Gross Profit 300,000 600,000 OE + Tax 200,000 480,000 Net Profit $100,000 $120,000 C.Gross Profit Margin = Gross Profit/Revenues Net Profit Margin = Net Profit/Revenues Gross Profit Margin in 2019 = Gross Profit/Sales = 300,000/600,000 = 50% Net Profit Margin in 2019 = Net Profit/Sales = 100,000/600,000 = 16.7% Gross Profit Margin in 2020 = Gross Profit/Sales = 600,000/1,200,000 = 50% Net Profit Margin in 2020 = Net Profit/Sales = 120,000/1,200,000 = 10% D. The gross profit margins are the same in the two years because the "cost of goods sold per unit" stays the same. However, 2020's net profit margin declines because of the increase in the other expenses category
[Returns on Assets] Jen and Larry's frozen yogurt venture described in Problem 3 required some investment in bricks and mortar. Initial specialty equipment and the renovation of an old warehouse building in Lower Downtown, referred to as LoDo, cost $450,000 at the beginning of 2019. At the same time, $50,000 was invested in inventories. In early 2020, an additional $100,000 was spent on equipment to support the increased frozen yogurt sales in 2020. Use information from Problem 3 and this problem to answer the following questions. A. Calculate the return on assets in both 2019 and 2020. B. Calculate the asset intensity or asset turnover ratios for 2019 and 2020. C. Apply the ROA Business Model to Jen and Larry's frozen yogurt venture. D. Briefly describe what has occurred between the two years. E. Show how you would position Jen and Larry's frozen yogurt venture in terms of the relationship between net profit margins and asset turnovers depicted in Figure 2.10.
A. Total Assets 2019 = Warehouse + Inventory = $450,000 + $50,000 = $500,000 Total Assets 2020 = Warehouse + Inventory + Additional Capital Expenditure = $450,000 + $50,000 + $100,000 = $600,000 Return on Assets (ROA) = Net Profit/Total Assets ROA for 2019 = 100,000/500,000 = 20% ROA for 2020 = 120,000/600,000 = 20% B. Asset Intensity = Total Assets/Revenues Asset Intensity Ratio for 2019 = 500,000/600,000 = .80 Asset Intensity Ratio for 2020 = 600,000/1,200,000 = .50 Assets Turnover = Revenues/Total Assets Asset Turnover Ratio for 2019 = 600,000/500,000 = 1.20 Asset Turnover Ratio for 2020 = 1,200,000/600,000 = 2.00 C. ROA Business Model = Net Profit Margin x Asset Turnover Ratio ROA for 2019 = 16.67% x 1.2 = 20% ROA for 2020 = 10% x 2.0 = 20% D. The Returns on Assets were the same in the two years because the company's Net Profit Margins went down due to the increased operation expenses while Asset Intensity went up due to additional capital expenditure on equipment. E. In relation to Figure 2.10, one should position Jen and Larry's frozen yogurt venture in Case 1 where the company has high profit margins and low assets turnovers. In Case 2, companies compete on price, have very low profit margins and high asset turnovers. If the company is incapable of becoming a market leader, it will be squeezed out as the industry grows.
[Financial Ratios and Performance] Following is financial information for three ventures: Venture XX Venture YY Venture ZZ After-tax Profit Margins 5% 15% 25% Asset Turnover 2.0 times 1.0 times 3.0 times A. Calculate the return on assets (ROA) for each firm B. Which venture is indicative of a strong entrepreneurial venture opportunity? C. A. Which venture seems to be more of a commodity type business?
A. Venture XX: 5% x 2.0 = 10% Venture YY: 15% x 1.0 = 15% Venture ZZ: 25% x 3.0 = 75% B. Venture ZZ seems to represent a strong entrepreneurial venture opportunity based on a very high return on assets financial measure. C. Venture XX seems to be more of a commodity type of business as indicated by a relatively low return on assets.
How do asset intensity and asset turnover differ? What is implied by a high asset intensity?
Asset intensity is calculated as total assets divided by total revenues. Asset turnover is calculated as revenues divided by total assets. Asset intensity is the reciprocal of asset turnover and asset turnover is the reciprocal of asset intensity. A high asset intensity implies a large investment in fixed assets and/or net working capital is needed to support revenue growth.A high asset intensity also usually requires large amounts of external financial capital in order to support revenue growth.
Describe and discuss some of the best financial practices of high growth, high performance firms. Why is it also important to consider production or operations practices?
High-growth, high-performance firms consider their financial practices as important as their marketing and operating functions. To this end, they plan for future growth and unexpected contingencies that may develop as the firm operates. They prepare realistic monthly financial plans for at least the coming year, and also may prepare annual financial plans for the next three to five years. As rapid growth typically requires multiple rounds of financing, successful ventures anticipate financing needs in advance and seek to obtain financing commitments before the funds are actually needed. Financing sources that allow, whenever possible, the entrepreneur to maintain control over the firm, are highly desirable. Successful high growth firms devote the necessary resources and effort to manage the firm's assets, financial resources, and operating performance efficiently and effectively. They also develop preliminary harvest or exit strategies and may indicate potential liquidity events in their business plans. It is the production or operations area that carries the responsibility of delivering high-quality products or services on time. Customers want their products or services delivered when they are promised. Thus, the production or operations area is equally important to successful high-growth, high-performance firms.
How do the concepts of operating cash flow and free cash flow to equity differ?
Operating cash flow is a measure of the cash generated by the daily operations of selling the company's product or service; it represents the figure that remains after the cost of goods sold and other business expenses (primarily general and administrative expenses along with marketing expenses or "SG&A") are subtracted from revenues. It approximates the operating cash flows over a specified time period, such as a year. Free cash flow to equity is the cash available to the entrepreneur and venture investors after operating cash outflows, financing and tax cash flows, required investment in assets needed to sustain the venture's growth, and net increases in debt capital. Free cash flow to equity is calculated as the venture's revenues minus operating expenses, minus financing costs and tax payments, after adjustment for changes in net working capital (NWC), physical capital expenditures (CAPEX) needed to sustain and grow the venture, and net additional debt issues to support the venture's growth. In short: Free cash flow to equity = net profit + depreciation charges - DNWC - CAPEX + net new debt.
Briefly describe the process involved in moving from an idea to a business model/plan.
Refer to Figure 2.1 "From Entrepreneurial Opportunities to New Businesses, Products, or Services." Start with "ideas," then assess the "feasibility" (finding an unfilled need), and then develop a "business model/plan."
Identify three types of startup firms.
Salary-replacement firms are firms that provide their owners with income levels comparable to what they could have earned working for much larger firms. Lifestyle firms are firms that allow owners to pursue specific lifestyles while being paid for doing what they like to do. Entrepreneurial ventures are entrepreneurial firms that are flows and performance oriented as reflected in rapid value creation over time.
Identify some of the best marketing and management practices of high growth, high performance firms.
Successful high-growth, high-performance firms typically sell high quality products or provide high quality services. Such firms also generally develop and introduce new products or services considered the top or best in their industries; they are product and service innovation leaders. Their products typically command higher prices and profit margins. In summary, these firms' "marketing profiles" are characterized by high quality, innovative leadership, and pricing power. Best management practices include: (1) assemble a management team that is balanced in both functional area coverage and industry/market knowledge, (2) employ a decision-making style that is viewed as being collaborative, (3) identify and develop functional area managers that support entrepreneurial endeavors, and (4) assemble a board of directors that is balanced in terms of internal and external members.