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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.