30/11/10

By David Bloom, co-founder and CEO, fd unlimited

Management Teams running dynamic SMEs (Small and Medium Enterprises) are constantly presented with new opportunities either home grown or external. Do we buy or build? Do we acquire? Shall we start that new complimentary division or continue to invest in our core offer? Resources to deliver those opportunities - time, money, and people - are always limited so the challenge is to determine their best allocation.

Whilst sometimes there are strategic reasons for a project you know you will lose money on or breakeven at best, success will be judged by how much value is created for Shareholders. Given this, a financial assessment should be undertaken for any project that is expected to utilise valuable company resource.

There are some fancy techniques for investment appraisal engaging terms such Net Present Value, Discounted Cashflows, WACC, Cost of Capital and IRR. If you have someone employed who knows them, reading this article will be a waste of your time. If you don’t, here are my tips for producing a simple investment appraisal which will give you the answer you need:

• Set up a template with time periods along the top, usually in quarters going out for say 3 to 5 years years. The first column should be time 0 i.e. when the project starts

• Starting with revenue, determine the size of the opportunity and what you believe you can generate over the next 3 to 5 years if resource was not an issue. Plug these into the template

• Next match the direct costs required to hit these targets. These could be product, headcount, and other variable costs. If you can link the revenue and direct costs so if one changes, the other adjusts

• Next add in any indirect costs — i.e. any costs that are not directly linked to revenue but are needed regardless. These could be marketing, premises, professional services etc

• Next add in any Capital Expenditure (CAPEX) required to deliver the revenue. You might need to spend on manufacturing equipment to create product or fit out a restaurant in order to start trading

• Make sure the table sums up all the columns and you add a row below the total that builds up a cumulative position by adding each year’s net cash generation.

Typically the first year or two will show a loss and the latter year’s significant cash generation — hopefully!

• Be realistic: when you have all the constituent parts, play around with the numbers until it ‘feels’ sensible in terms of time, money, headcount and returns.

If the funding requirement is £3m and you only have £1m available, you’ll need to raise money which could delay matters by 6 months and result in an opportunity lost.

By building up the costs and expected revenues over time you will have a framework for determining the value generated by a project. You can then use this same framework for comparing all projects and put the results side by side to see which of them you wish to proceed with. Some will cost more than others but deliver greater returns over time; some will cost less and deliver smaller amounts quicker.

It’s a good idea to set a benchmark or hurdle return that all projects must achieve before they are considered. For example, ‘all revenue opportunities should deliver at least a 30% return on investment over 3 years to be considered’;

All non revenue opportunities should deliver a 25% cost saving within 12 months. Your Finance Director should work with members of the leadership team to weed out any opportunities that aren’t going to make the grade. When management know what is acceptable, it gets them focused on the right things and avoids disappointment and time wasted on proposals with ‘no legs’.

If you would like an Investment Appraisal template that captures the key elements above please email us at support@financegofer.com.


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