Entrepreneurs Journal - PREMAT

Date Topic Category What I learned What I Don’t Understand/Have Yet to

Learn

May 25, 2009 Ultimate FIT

Note

Framework An attractive opportunity is the most important element of FIT How do you determine whether or not an

opportunity is attractive? The FIT framework note

lists a lot of questions - I would like to apply or see

these applied to a real scenario to understand how

the framework helps you make the distinction.

- I would also like to get to the point where this

framework is part of the way I think anyway.

May 25, 2009 The Accounting

Game

Lesson CASH is the most important thing to measure in a business.

More cash is better

Cash sooner is better

Less-risky cash is better

Never run out of cash

How do you "never run out of cash?" What

questions must you have answered adequately

right at the beginning to minimise the chances?

And what do I need to be monitoring closely?

May 25, 2009 The Accounting

Game

Lesson - Expenses are the cost of doing business regardless of the level of

production.

- Expenses reduce earnings

- An expense becomes An asset when we pay in advance and it has value

into future accounting periods. E.g. A prepaid insurance policy. The

prepaid portion of it is An asset. the current portion of it is An expense.May 25, 2009 The Accounting

Game

Lesson Gross Profit is Sales less COGS

Net Profit is Gross Profit less ExpensesMay 26, 2009 Acting on

Insight

Lesson Acting on insight is what distinguishes those who truly make a difference,

and those who simply dream.

I know this is one of my weak areas. I love insight

more than I love action. I need to develop the habit

of always translating insight into action, effectively.

I'm glad the LoM study groups are structured so

that we identify an insight and an action after each

lesson. This will be very helpful for me.

May 26, 2009 Managing

Oneself

Question What are my most valuable strengths?

What are my most dangerous weaknesses?May 27, 2009 Personal

Transformation

Lesson Questions are more important than answers What questions have I not yet asked myself that I

really need to over the next 12 months?May 27, 2009 LoM

Framework

Framework

Summary

"How Can I Find My Calling?"

- Preference and Potential / Self-knowledge (What do I want?)

- Possibility / How the World Works (What does it cost?)

- Priority / Trade offs (Is it worth it?)

May 30, 2009 Cash and

Valuation

(Sub)

Framework

A useful profitability diagnostic framework (from the Accounting Game)

Calculate Trends of COGS/Sales, Exp/Sales, NP/Sales

Ask: (1) Did we make a profit?

(2) How is the NP/Sales trending, up or down

(3) If NP/Sales is trending down, is the problem reflected in COGS/Sales or

Exp/Sales or both? (remember they all add up to 1)

(4) What has been happening in the business that is causing the problem?

(5) What do we need to do to resolve the problem?

May 30, 2009 Customers Lesson There are attractive customers and unattractive customers:

Attractive customers have intense needs, have few or no substitutes, are

easy to find and qualify, and easy to communicate the benefit to; They are

low risk to try, are likely to buy many times, and are hard to lure away

In what circumstances would you still go for

unattractive customers?

What questions do I need to ask potential

customers to determine if they are attractive or

not?

How can you work when it becomes worthwhile?

ENTREPRENEUR’S TOOLKIT

Pre-Mat Week # 1 (w/c 25 May 09)

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May 30, 2009 All courses Lesson Overarching questions:

LoM: How can I find my calling?

C&V: How can you make the firm and your equity worth as much as

possible?

O&C: How do you build a production or service delivery process that

delivers exactly the

right product or service, in the right quantities, at the right time, with the

lowest cost

per unit and the smallest upfront investment possible?

Cust:How do you identify, listen to and segment customers; price products

and services; and build a sales funnel to close the right customers, at the

right time, in sufficient quantities, at as low a cost per sale and with as

small an upfront investment as possible?

EJ: Should you invest you money and your life in this venture?

May 30, 2009 Operations and

Cost

Lesson Operations is not about what you want to produce.

It is about what the customer wants you to produce. Never lose sight of

thisMay 30, 2009 LoM Lesson Suggestions for making "Acting on Insight" a habit

1. Make it a reflex: Ask "how can I honour this insight?"

2. Start small

3. Make a provisional commitment

4. Be curious - discover what's working/ not and why

5. Discuss with people you trust

What insight from this week do I need to honour by

taking action?

Jun 2, 2009 O&C Lesson The Goal of any business is to make money: to make money by increasing

net profit while simultaneously increasing return on investment and

simultaneosuly increasing cashflow.

What about social enterprises? Can you run a

social enterprise on business principles? Is there a

conflict of goals?Jun 2, 2009 O&C Lesson The goal can be restated in different forms, but to say exactly the same

thing to a different audience.

The goal of a manufacturing outfit is to make money: to make money by

increasing throughput while simultaneously reducing inventory, and

simultaneosuly reducing operating expense.Jun 2, 2009 O&C Lesson Throughput = the rate at which the system generates money through sales

(MONEY COMING IN)

Jun 2, 2009 O&C Lesson Inventory = All the money that the system has invested in purchasing

things which it intends to sell

(MONEY INSIDE)Jun 2, 2009 O&C Lesson Operational Expense = All the money the system spends in order to turn

inventory into throughput (MONEY GOING OUT)Jun 3, 2009 C&V Lesson You must understand the incremental impact to profits and free cash flows

of every incremental sales, operational, or financial decision.Jun 3, 2009 C&V Lesson The essential skills needed to become a successful entrepreneur are

straightforward. You

need to: (1) understand the “basic mechanics” of business; (2) learn

how to read, motivate and lead people; and (3) understand your own

motivations, talents and blind spots.

How will I know when I have these 3 essential

skills?

Jun 3, 2009 C&V Lesson Mastering the basic mechanics of business requires: (1) keeping

track of profitability and cash flows on a unit-by-unit basis; (2)

valuing the resulting cash flows;

and (3) designing, building, and improving the processes that attract

and serve customers.

How will I know when I have mastered the basic

mechanics of business?

NOTES -

I would like to come up with a simple paper-based way of capturing my EJ lessons and notes. Preferably something I can carry with me and be able to jot the nites

down "in real time". Then when I type them up, it's an opportunity to review them.

Ultimate FIT - schedule in time to review again in a week's time

Pre-Mat Week # 2 (w/c 1 June 09)

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Jun 3, 2009 C&V Lesson Unit economics--a rough estimate of the sunk, fixed, and variable costs of

your business.

They yield the 4 numbers:

1) PSI

(2) break-even volume for fixed-period costs

(3) pre-tax payout, and

(4) the total pre-tax profit

These 4 numbers almost always give enough info to tell whether or not an

opportunity is attractive.Jun 3, 2009 C&V Lesson Fundamental entrepreneurs defer sunk investments and avoid fixed-period

commitments until their venture reaches cash-flow breakeven and payout

by selling a sufficient quantity of product, at a high enough price per unit.

They move forward only if their investment is likely to be returned and

potential losses are small and contained when compared to potential

profits. In addition, fundamental entrepreneurs prefer to own most of the

equity in their firms.Jun 3, 2009 C&V Lesson What you can (and can't accurately predict: in order of increasing difficulty

1) production line. e.g. effects of cost-cutting

2) sales expansion: even with loyal customer base difficult to predict

effects of sales expansion

3) new product: people's response to new product

4) market forces (interest rates, commodity prices and the general

economic environment)

Fundamental entrepreneurs seek investments whose value depends on

things they can predict, influence or control.

Fundamental entrepreneurs can take advantage of

speculative booms using four methods READ

LAST TWO PAGES AGAIN

I think I am fundamental rather than speculative by

nature

Jun 3, 2009 C&V Lesson 4 ways Fundamental Entrepreneurs can take advantage of speculative

booms:

1) Stay true to a bootstrap approach, even in heady times.

Even when others are “betting it all,” a fundamental entrepreneur can find

niches in which wise incremental investments lead to quick payouts,

staying clear of opportunities that require large sunk investments.

2) Finance investments with non-recourse debt.

“Non-recourse” means that a lender may only consider the assets of the

venture for repayment of its debts. Assets owned by the entrepreneur are

not at risk. Projects that begin in economic troughs and end before a boom

evaporates can be extremely profitable. If each project started during a

boom is financed separately—and with someone else’s money—an

entrepreneur can collect profits from the winning investments without

shouldering the costs of the losses.

3) Pursue a contrarian approach in cyclical industries.

Industries like mining, oil and gas, real estate, and venture capital are

cyclical. Factors such as the long lead time required to add capacity,

inelastic demand, high capital intensities, and high operating margins

make it certain that these industries will cycle between boom and bust.

Fundamental entrepreneurs can take advantage of this by investing in

these industries with non-recourse loans when prices approach variable

costs, and selling as soon as profit margins are high enough to attract new

entrants.

4) Collect “real options” while building a fundamental business that

may become valuable during a boom.

A fundamental entrepreneur can speculate by collecting, in the normal

course of business, assets that might rise in value during a boom. For

example, imagine that you ran an air-conditioning repair service in

downtown Houston during the 1960s and '70s. You add customers one by

one, being careful not to buy another truck until you need it. Over time, you

buy more and more parcels of land on which to park your growing fleet.

Before long you are making a decent living: $250,000 in salary and net

These are very sound principles that I do not

practice. How can I start testing them, and putting

them into practice?

How can I make them part of my thinking?

How do I ensure that any debts my business incurs

are non-recourse debts?

6/4/2009 C&V lesson "Do not let the complexity of your business get ahead of your number

sense" Learn the essential (keep your brain one step ahead of your

business)

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6/6/2009 Customers Lesson Selling to customers needs to be systematic - there needs to be a system

that qualifies customers and classifies them depending on their need and

preception of the benefits of the product

Although while playing ChaChing/Pro I felt like I

was making progress and getting better. I feel like I

am still a long way from where I want my

competence to be. How do I design the questions

for a product so that I can effectively qualify

prospects?

I also see with ChaChing that others are scoring

higher (being lower cost) - what are their

strategies?6/6/2009 EJ Lesson /Quote “Look around you. Take a fresh, hard, and uncompromising look at life as

you see it. Ask this question, ‘What needs to be done?’ When you have an

answer, and it may take some time to get it, then go and do what needs to

be done. Do it better than anyone else does it and the world will beat down

your door for your help. Then you will not need ‘a good job’; and you will

have more than a career. You will have a mission.”

R. Buckminster Fuller

What discipline can I master?

The clues offered in "S&S and the Heroes

Journey" are:

What gifts have I been given?

What brings me joy?

When have I experienced flow?

(check out authentichappiness.org for signature

strengths)

6/6/2009 EJ Lesson Stars and Steppingstones may draw you away from the comfort of the

crowd, bring you face-to-face with your fears and limitations, and incite you

to bet everything on the one dream that counts. It will also spare you the

ultimate horror of a meaningless life.

Jun 8, 2009 Customers Lesson The key lesson for me is the heirarchy of methods for "getting into a

customer's shoes" (increasing effectiveness)

1) Observe customer buying behaviour

2) Ask questions - well-crafted, deeply-probing ones

3) Conduct experiments

Another key lesson is recognising the limitations of the different methods:

Observing customer behaviour is still subject to the biases of the observer

Asking questions sometimes soes not yield the truth, and sometimes

customers change their minds

Experiments need to be very well-designed, testing one variable at a time.

The question I still have is: If conducting

experiments is the best way to gauge customer's

likely behaviour, does this not create a Catch 22

situation where you have to start the business to

be able to conduct realistic tests?

How can you create the conditions that will prevail

when your business is running without actually

running the business?

Jun 9, 2009 LoM Rule of thumb Net worth = (Age x realised pretax annual income from all sources except

inheritances / 10) less inherited wealth

Compare with: Current value of assets less liabilitiesJun 12, 2009 O&C Lesson Theory of Constraints (from The Goal)

Every system is limited from achieving its goal by a small number of

constraints - and there is usually one constraint.

1. IDENTIFY the constraint (the resource/policy that prevents the

organization from obtaining more of the goal)

2. Decide how to EXPLOIT the constraint (make sure the constraint's time

is not wasted doing things that it should not do)

3. SUBORDINATE all other processes to above decision (align the whole

system/organization to support the decision made above)

4. ELEVATE the constraint (if required/possible, permanently increase

capacity of the constraint; "buy more")

5. If, as a result of these steps, the constraint has moved, return to Step 1.

Don't let inertia become the constraint.

I would like to understand more how TOC applies

to service organisations where it is more difficult to

characterise the processes. According to the book,

the challenge with service organisations is that the

processes are usually less well documented and

therefore, the first task is to document the

processes, which is usually a very big job. On the

other hand they have quite a few examples of

successful implementation of TOC in service

organisations.

NOTES

LoM, S&S "You must be willing to ask hard questions, listen quietly, and answer honestly... It will take great discipline to reserve time, to clear your mind and to

follow questions into uncomfortable places"

C&V - the C&V What are the Questions You Should Ask is heavy going. Need to read a few timesPre-Mat Week # 3 (w/c 8 June 09)

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Jun 12, 2009 C&V Lesson Always start with the customer need (do not use a cost-plus approach to

pricing.). Value is determined in the mind of the customer.

This is the essence of Unit Economics: determining where there are

enough customers who want a similar item, delivered in a similar way, who

are willing to pay enough per item, that we could build a production

process to profitably serve them. 12-Jun C&V Lesson According to Professor Amar Bhide in The Origin and Evolution of New

Business, the majority of highly successful entrepreneurial businesses in

the United States are not funded by venture capitalists. Most were started

with less than $10,000, usually by entrepreneurs who copied an idea,

made a few key sales to initial customers, and then discovered a way to

serve a certain set of customers more effectively and efficiently than

anyone else, in a manner that was difficult to copy.12-Jun C&V Lesson You can't hustle forever. To be successful I will need to choose which

customers I will NOT serve. Focussing on one specific type of customer

allows me to design a PROCESS for meeting their need that I can replicate

again and again - specializing in delivering a specific type of “unit” to my

chosen customers. I must do a few tasks well, must do these again and

again until I am efficient, and I must execute these tasks better than

anyone else12-Jun C&V Lesson How you have chosen your customer, your Primary Sunk Investment and

the “units” you produce and deliver will be the difference between success

and failure.

How to choose the best PSI, "units" for ensuring

success

12-Jun C&V Definitions Definitions of Unit Economics Terms

Unit of desire: The common need shared by a group of customers. In the

water pipeline example, this need is thirst, which is fulfilled by gallons of

water. Units of desire are measured and satisfied in the mind of each

individual customer.

Unit of production: What you make and deliver to satisfy a unit of desire.

It’s a physical entity.

Primary Sunk Investment (PSI): An investment in an asset or

standardized process that serves a group of customers with a similar need.

Price per unit of desire: The price you charge for each unit of desire – in

this case, water. This price can never exceed the subjective value placed

on the need in the mind of a customer. Often, this price is set by the price

of a close substitute.

Costs per unit of production: Includes two types of costs: (1) the variable

cost per unit; and (2) the fixed period costs.

Variable costs per unit: A cost that varies directly with the volume of

units. In the water pipeline example, this was $.01 per gallon.

Fixed costs per period (fixed period costs): A cost that, within certain

limits, does not vary with the volume of units produced. They are fixed for a

period of time. They are typically measured in dollars per unit of time.

Volume of “units per period”: The variable that links demand and

supply.

13-Jun C&V Question Why are utilities FPC's rather than VC's?

Because you'll have to pay for them even if you

make no product13-Jun C&V Lesson NPV at 15 years is roughly equal to 5 times the annual cashflow and can

be used as a proxy for a quick valuation?

Confirm if NPV,15 is roughly equivalent to 5 x

EBIDTA13-Jun Customers Question I've done the Customer Interview "Getting into your

customer's mind" and learnt a lot from doing the

interview. However, I still do not feel like I have a

good grasp of how I can actually get into the minds

of my POTENTIAL customers - especially if it's

product that does not exist yet.

I guess part of what this exercise does is expose

me of a way of talking to existing customers to

uncover why they buy, with a view to attracting

new customers and retaining existing ones

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Jun 15, 2009 C&V Lesson Both the unit economics and the monthly/annual performance are

important.C&V Lesson Being able to visualise the cashflow patterns for different business models

in competitive settings is an invaluable skill.

In order to develop the INTUITION of a master entrepreneur, I will need to

PRACTICE predicting pre-tax cashflows for different business models in

different competitive settings

I need to PRACTICE predicting pre-tax cashflows

for different business models in different

competitive settings - until it becomes second

nature

Jun 18, 2009 LoM Lesson From Success that Lasts article: "Research into success has shown that

one of the biggest causes of failure is an overreliance on one’s greatest

strengths. Are you favoring what you do best and neglecting your need for

fulfillment in all four categories?"

This is different from previous HBR article by Peter

Drucker "Managing Oneself" which said that the

best way to succeed is to focus on what we do

best, rather than on improving our weaker areas.

Jun 19, 2009 C&V Lesson Superior opportunities: Generate more revenue sooner - pick

opportunities with particularly attractive customers, or find an investor who

already has access to them. (The more basic the need (Maslow's heirarchy

- food, safety and shelter---->--->self actualisation) the more compelling it

is)

Jun 19, 2009 C&V Lesson Superior opportunities: require lower upfront investment and risk -

through innovative deals, and through borrowing (assets like excess

production capacity, brand, etc)

Staging investment: why do we want to make the

riskiest investments first, and not last?

Jun 19, 2009 C&V Lesson Superior opportunities: generate more cashflow longer (easily scalable,

and easily defendable from competition as evidenced by high barriers to

entry, a benign industry rival, and considerable power over customers)

Jun 19, 2009 C&V Lesson Best operating leverage strategy: Maintain low operating leverage (and

losses) until suffiecient demand is proven, and then invest to increase

capacity and improve operational efficiencies (bootstrapping)

I do not understand when it is best to apply

financial leverage (debt financing) to your

business. Is this an iteration of diiferent scenarios?

Jun 19, 2009 C&V Lesson Financial leverage (debt) allows you to control larger assets for lower

upfront equity investment. If you are right about your predictions of future

revenues and costs, the retun on your (smaller) equity will be magnified.

However if you overestimate revenue or underestimate costs even slightly,

and your whole investment could be wiped out, and you could lose control

of the co.Jun 19, 2009 C&V Lesson Combining operating and financial leverage is a dangerous game - it's

speculative, since the margin for error shrinks below what an entrepreneur

can hope to control.Jun 19, 2009 C&V Lesson You can increase operating levarage by investing in machinery to increase

efficiency, but also

- choosing higher paying customers preferentially

- increasing productivity of lower paid workers (by producing manuals)

- finding innovative ways to lower costs, increase capacity while

maintaining quality

- using negotiating leverage to demand price discounts from suppliers

THE KEY = Keeping costs stable as revenues rise

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20-Jun C&V Lesson Effects of competition:

1) lower price per unit from

- a more attractive substitute, or

- price war from competitor

(Vulnerable if: can easily be technologically leapfrogged, or if the relative

contribution to FPC's and profit is large, and therefore attractive to

competition, if customers matter more to you than you matter to them,

product is a large part of customers' cost structure, customers have an

attractive alternative)

2) Falling unit volumes, due to:

- you hold price per unit steady and customers defect

- you don't expand capacity fast enough and competitors serve customers

who would have been yours, and keep them

3) Increases in costs: due to:

- suppliers increase costs if a) their parts are critical to your success, (b)

there is more demand than supply, (c) you are relatively insignificant part

of their revenues.20-Jun C&V Lesson 6 major sources of barriers to entry

1) Economies of scale (declining costs per unit as volume increases)

2) Product differentiation - entrant has to spend to overcome existing

customer loyalty

3) Capital requirements

4) Access to distribution channels

5) Cost advantages indep of scale

- proprietary product technology

- favourable access to raw materials

- favourable locations

- government subsidies

- learning or experience curve (not to be confused with economies of

scale. This is dependant on cumulative volume, not volume per peiod)

6) Government policy

- licensing requirements

- product / waste spec laws

20-Jun C&V Lesson Retaliation is likely if:

- history of vigorous retaliation to entrants

- established firms have substantial resources to fight back (excess cash,

unused borrowing capacity, adequate excess production capacity,

leverage with dist channels or cust)

- slow industry growth (limited ability of industry to absorb new firm without

depressing sales of est. firms)The Entry Deterring Price = the prevailing price structure in the industry

adj for pdt qlty and service, which just balances the potential rewards from

entry (forecast by the potential entrant) with the expected costs of

overcoming entry barriers and risking retaliation. If current price is higher

than entry deterring price, entrants will forecast above average profits from

entry, and entry will occur.)

How to calculate the entry-deterring price

20-Jun C&V Lesson How Quickly Will My Margins Decline?

1) Business model: large margins + low investments = intense

competition

2) Power dynamics: The more power others have the more quickly your

margins will decline

3) Stability of pre-tax cashflows - see whether combination of operating

leverage and competitive forces suggests stable or erratic pre-tax

cashflows

21-Jun C&V Lesson Recipe for a price war: a # of equally sized competitors, with relatively

high fixed period costs and margins, selling similar products

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21-Jun C&V Lesson How to keep out competitors:

- Continue to innovate so that you always have sthg better, faster, or

cheaper than others

- offer customers sthg they can't get anywhere else

- create advantages that are difficult to copy like manf process, sales

funnel, or R&D team that take a long time and significant cost to duplicate

- continually reduce costs so that margins stay stable as prices drop.

- have fewer people who know how well you're doing

- suppliers and customers who need you more than you need them

- few attractive substitutes

Unless you continually improve faster than the competition, you can

expect pre-tax cashflows to reduce with time, esp as industry

approaches saturation and competitors are tempted to compete on

price

Jun 24, 2009 C&V Lesson Critical distinction: The Unit Economics summary collects all variable

(unit) costs, no matter where in the business (sales activities or

manufacturing activities) they are incurred, and separates them from the

fixed period costs (again, collected from all parts of the business) so that

the entrepreneur or manager can calculate breakevens and more

effectively measure the trade-offs between price, unit volume (sales), and

costs and calculate the value of new investments or other changes in the

business.

The Income Statement, on the other hand, organizes information by

activity – operations, sales, general administrative. The Income Statement

is a financial record that helps the owner track expenses by category,

recognize trends, and hold managers accountable for their respective

areas of responsibility.

In last week's study one of the things we learnt

was that you would ordinarily expect revenues to

decline with time, especially as the industry

matures (unless the company improves faster than

the competition). However all the projections we

have made this week based on historical records

assume that revenue growth will continue at a rate

similar to the past. Is this a simplification for

learning purposes, i.e. is this something I should

ocnsider in my projections? If so, how?

Jun 27, 2009 C&V Question What is my strategy for calculating projections of

future cashflows? Unit economics? Historical

income statements?Neither? Both?

What information will I need upfront in order to

complete the calculation? What protocol will I put

in place in order to get the information I need to

make decisions?Jun 27, 2009 C&V Lesson A manager must pay attention to how costs change when the business

increases its sales and output. One mustn’t naively assume that costs

increase steadily, proportionally with sales. A business may be able to

increase output over a wide range by adding only variable inputs.

Eventually, however, it will run into a capacity constraint. If it wants to grow

past the constraint, it must modify it manufacturing process (and/or its

sales process). Having relieved the bottleneck, the business has entered a

new range over which it can expand output by changing only its variable

costs. When it wants to grow beyond that range, it must incur the cost of

relieving another bottleneck. Because of these “discontinuities” – that is,

the discrete, step-up in costs required to get past a capacity constraint –

the ratio of COGS to Sales (or of SG&A to Sales) will vary as output (sales)

varies.Jun 27, 2009 C&V Lesson In general, as sales increase, some costs are variable – that is, they

increase proportionally with sales – some are fixed over the entire range of

sales considered, and some are what we might call “chunky costs.”

Chunky costs are fixed over a given range of sales volumes, but change

as sales crosses a boundary into another range.

They usually have the most variability in their ratio to sales. These are the

costs that are fixed over a certain range and then step-up when the

process is changed to relieve a bottleneck.

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Jun 27, 2009 C&V Lesson In making cashflow projections you need to understand how the sales

process works. (in addition to understanding the manufacturing process)

Do costs increase as revenue increases? If so how? Variable? Chunky?

Good pro forma projections make use of everything the manager knows

about the manufacturing and sales processes – including the succession

of bottlenecks the processes will encounter, the output levels at which the

respective constraints begin binding, and what it will cost to relieve the

bottleneck and further expand capacity in each case.Jun 27, 2009 C&V Lesson Pre-tax cashflow (unit econ) = EBITDA (income stmt) for simple

businesses.

For more complicated businesses with inventories, customer credit,

supplier credit, recurring investment in plant and equipment, need more

complicated tools to evaluate profitability e.g. Free cashflow to the firmJun 27, 2009 C&V Lesson In order to make good decisions, a CEO would ideally use both unit

economics an dincome statements, AND ask lots of questions.

He would deeplyunderstand the sales funnel and the manufacturing

process so that he can understand how prices, volumes, and costs are

relatedJun 27, 2009 LoM Lesson 5 Master Keys:

1) Instruction

2) Practice

3) Surrender

4) Intentionality

5) The EdgeJun 27, 2009 Cust Framework /

System

David Sandler system for selling:

Make a series of upfront contracts with the prospect.

1) PAIN - find prospect's pain

2) MONEY - raise it upfront

3) DECISION-MAKING - will they decide now?

4) FULFILLMENT (the product presentation/demo)

5) CLOSE

Would the money point be less relevant if it as low

value item being sold? It can alienate the prospect

if the money is not an issue for them, but you seem

to be placing undue emphasis on it.

Jul 1, 2009 C&V Lesson Present value = how much you can borrow now against a future cashflow

Jul 1, 2009 C&V Lesson The difference between the present value of the cash coming in and the

present value of the cash going out is the net present value (NPV) of the

business’s cash flow - measure of the value of the business todayJul 1, 2009 C&V Lesson Value = Cash + Risk + Time

Jul 2, 2009 C&V Lesson Discount rate is “the rate of return required by an investor to accept the

risks of a certain investment.”

OR a combination of a risk-free rate to compensate investors for the time

value of their money and a risk premium that investors will demand in

order to invest in a firm like yours (a firm with your customers, your

operating leverage and your competitors).Jul 2, 2009 C&V Lesson Rule of thumb Risk premiums

Large, stable company - 5%

Mid-sized company - 10%

Small start-up - 15%


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Jul 2, 2009 C&V Lesson Warning: unlevered FCFF discount rates, by definition are designed to

measure the risk of a firm with no debt. It is incorrect to apply a discount

rate designed to measure the risk of the cash flows of a firm to the riskier

stream of cash flows for the equity owners once preferential payments to

debt holders have been made.

Read more about this cincept in AFEE note "“What

is the Intrinsic Value of Your Equity”

Jul 3, 2009 C&V Lesson Because of the volatility of equity cash flows and the distorting effect of

extreme discount rates on later year cash flows, it is generally better to

estimate an intrinsic equity value by first discounting the unlevered Free

Cash Flows to the Firm, then adding back the tax shield savings as a

result of interest payments and subtracting the market value of the debt.

Read more about this cincept in AFEE note "“What

is the Intrinsic Value of Your Equity”

Jul 3, 2009 C&V Lesson Other discount rate approaches, like WACC and CAPM, are not intended

for estimating the future value of an entrepreneurial firm and should not be

used for this purpose.

WACC - why is it calculated the way it is? How

does it represent risk?

Jul 3, 2009 C&V Lesson Tax shield - The Internal Revenue Service treats interest expenses as a

tax deductible expense. This means that tax payments go down as interest

payments rise. The value created by these foregone tax payments is called

the “tax shield.”Jul 3, 2009 C&V Lesson 3 components of discount rate:

- the “real” rate of return—compensates investors for putting money to

work instead of spending it. Over the past three hundred years, the world

economy has grown at approximately 3% a year, generally varying

between 2.5% and 3.5%. In other words, this is the value we create as

human beings by being willing to defer gratification to invest in our future.

- an adjustment for the expected rate of inflation. Because governments

debase the value of their currencies each year—by printing banknotes

whose value exceed the amount collected in taxes—each unit of currency

is expected to be worth less in the future than it is today. Over the past

several hundred years, inflation has averaged approximately 3% a year

- the premium over nominal returns that an investor should expect to

receive for bearing the risk of an investment

What discount rates would you apply for a

business in Zambia - inflation is not stable, but

probably predictable in the high teens;

Government treasury bonds pay quite a high

interest rate; So I imagine the nominal rate (=real

rate + inflation) will have to be at least 30% - and

this is before I have adjusted for the specific risk of

the business

3-Jul C&V Lesson There is no substitute for understanding the fundamentals: why customers

buy, how products are made and delivered, and how competitors can be

kept at bay.

Warren Buffet uses 9% (3/3/3) because he avoids any business he

does not understand. He run multiple free cash flow projections, uses

convertible debt or other types of options to protect himself from downside

cases and invests only when the market is pessimistic about the future.

This means that In “good times,” when inflation is low and too much money

is chasing deals, Buffett’s discount rate will be too high, and he will be

unable to find any interesting investments because others will outbid him.

In times when inflation is high or money is hard to find, Buffett’s 9%

discount rate will lead him to be aggressive, and since there will be few

other bidders, he will have his pick of investments that give him the highest

net present value at a 9% discount rate

4-Jul Cust Lesson Some Tips on the Sales Process

1. It is generally much cheaper to sort and qualify customers who are

interested in buying than to try to interest and persuade customers

(changing minds is expensive).

2. Each additional step in a Sales Funnel adds an exponential amount of

complexity and costs. Communications and handoffs from one step in the

process to another are expensive and difficult to execute.

3. Targeted approaches tend to work better than broad approaches.

4. Convincing customers to come to you is usually far more effective than

having to go to them.

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Jul 8, 2009 C&V lesson Terminal value (2 ways to calculate)

1) Ebidta multiple (=f{interest rates, competion barriers})

2) perpetuity of growth method = annual fcff in year after terminal year,

divided by (after tax discount rate minus stabilised growth rate) -

calculating the perpetual value of a stream of after tax cash flows, rising at

a steady rate, relative to the after-tax cost of funds (the discount rate.)

I need to read the terminal value note again as the

concepts haven't sunk in yet - esp how to calc

terminal value by perpetuity of growth method

Jul 8, 2009 C&V lesson Terminal value for a business with rapid revenue growth, high operating

leverage or continued heavy working capital and fixed asset investments?

Quite simply, there is no accurate way to calculate a value under these

circumstances.

You must run the FCFF projections long enough to saturate your market

until the growth in free cash flows begins to approximate the growth of the

overall economy.Jul 8, 2009 C&V lesson Entrepreneurs tend to use the EBITDA multiple method with low multiples

when buying (because the terminal value will be conservative) and the

Perpetuity with Growth method with high growth rates and low discount

rates when selling (because the terminal value will be aggressive.)

Jul 8, 2009 C&V lesson Taxes: (re terminal value calc)

- PWG method - you are extrapolating the value of the after tax free cash

flows, so there is no need to deduct taxes as if the company was sold in

the final year.

- EBITDA method, where you are selling the company in the final year, any

taxes will be paid by individual shareholders and not the company, so

taxes do not need to be deducted from the company’s free cash flows to

the firm.

- The only time taxes need to be deducted from a Terminal Value is if it is

assumed that the firm’s assets will be liquidated and taxes are paid on any

gains.Jul 8, 2009 C&V lesson Use the EBITDA Multiple Method or the Perpetuity with Growth methods to

estimate a Terminal Value only if the free cash flow in the Terminal

Year has slowed to at or below the growth rate of the overall

economy. You cannot use the PWG or the EBITDA methods for a

business with rapid revenue growth, operating leverage or heavy working

capital and capital expenditure investments.Jul 8, 2009 C&V lesson ALWAYS check with 5 x pretax cashflow from Unit EconomicsJul 8, 2009 C&V lesson Why 5 times? If you pay five times pre-tax cash flows for a company that

continues to have the same revenues and operating margins in perpetuity,

you will make the equivalent of a 20% pre-tax rate of return on your

investment, which is equivalent to a 13% after-tax rate of return (@34%

tax). If you understand how to run a business and work hard every day to

serve customers, a 20% compounded pre-tax rate of return will make you

very rich over a ten-year period.

So, five times pre-tax cash flows turns out to be a reasonable, if perhaps

somewhat conservative, starting valuation proxy for entrepreneurs.

NOTES

Have a look at websites

http://www.studyfinance.com/lessons/timevalue/index.mv

http://www.frickcpa.com/tvom/TVOM_Quiz.asp

wps.pearsoned.co.uk/wps/media/objects/1669/1709736/0273685988_ch03.ppt

Pre-Mat Week # 7 (w/c 6 July 09)

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Jul 8, 2009 C&V lesson WARNING: Pre-tax cashflow multiple can give misleading results if:

1. A firm’s revenues are growing quickly and the business model of the

firm requires reinvesting operating cash flows in working capital or capital

expenditures to support continued revenue growth.

2. A firm has substantial fixed assets that are depreciating—in other words

wearing out as items are produced, or deteriorating with the passage of

time.

3. A firm has a legal form resulting in tax rates that differ from those of

alternative investments.

4. The goal is to value the equity (owner’s share) of a firm with debt rather

than the entire firm itself. (pre-tax cash flows from unit economics measure

the value of a firm—the value of all of the cash flows from an enterprise. A

valuation based on pre-tax cash flows says nothing about how this value

might be divided between creditors and equity owners if the firm has debt.)

What do you do then??

Jul 8, 2009 C&V lesson Risky cash: The best investors focus first on recouping their investment

and only then consider how much they might make in profits. Do not

become too focused on financial concepts like rate of return and net

present value. Focus instead on projects that pay out quickly and it will be

hard to go wrong.

Measuring risk requires answering three questions:

1. How predictable are the cash flows?

2. How sensitive are cash flows to changes in revenues and costs?

3. Who gets paid first?

Measuring risk requires a deep understanding of your company’s

customers, cost structure, competitive environment, and financial

obligations. Jul 8, 2009 C&V lesson Sahlman's 3 principles of valuation:

Principle One: Value = Cash + Risk + Time

Principle Two: Sahlman’s Four Rules of Cash

1.More cash is better than less cash.

2.Cash sooner is better than cash later.

3.Less-risky cash is better than more-risky cash.

4.NEVER run out of cash.

Principle Three: Your goal in a valuation is to “narrow the region of

darkness,” not calculate a precise value (which is impossible). Hard work

and attention to your customers will close any gap between what you

pay to acquire and develop an opportunity and what it’s worth when

you sell it.

9-Jul O&C Lesson A balanced process has all the workstations operating at closely matched

capacities, with minimum idle time, and minimum wait time for WIP

9-Jul O&C cycle time = 1/ capacity What's the significance of the cycle time?

9-Jul O&C lesson It generally makes sense to locate the bottleneck at the workstation that

would require the greatest capital expense to add a parallel resource (this

means that the most expensive resource is as fully utilised as possible and

has little idle time)9-Jul O&C lesson Variability in a process can lead to unexpected idle time, which leads to

less than expected performance.

If a process depends on a workstation operating at 100% of capacity, then

slightest hiccup will lead to underperformance. Solution? Avoi d running

processes at 100% capacity

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10-Jul O&C lesson Buffer invetories can be expensive. Liberal use of buffer inventories to

smooth out variability tends to have adverse effects:

- mask sloppy processes

- inventories grow

- quality degrades

- productivity declines

Most constructive management action is to minimise variability in all

processes

- products languish in WIP and may become obsolete

How do you minimise variability? 24 1.5

11-Jul C&V lesson Valuation (FCFF) risk premium and multiple.

very stable, large firms 5% risk, multiple 7-10

medium-sized firms 10% risk, multiple 4-6

smaller, newer firms 15% risk, multiple 2-3

higher risk ventures 20%+ risk, multiple 1

How does this multiple relate to calculating

terminal values? Would you use a similar multiple

for the ebitda method of calculating terminal value?

Jul 13, 2009 C&V Lesson There is a delicate balance in managing accounts receivable

- you do not want to tie up valuable cash by extending credit to customers

who don’t demand it; and you especially want to avoid extending credit to

deadbeat customers who later will refuse to pay.

- BUT there may be some customers who will pay a far higher price per

unit, and buy in large volumes, if only you will extend credit for a short

period of time.

- therefore, you cannot afford to look at accounts receivable simple as a

line item on a balance sheet. Rather, it should be viewed as a customer-

by-customer investment that must be weighed individually, based on the

long-term value of a particular customer relationshipJul 16, 2009 C&V Lesson Accounts Receivable = (Total Revenue / Days in Period) * Days

Receivable

Inventory = (Inventory Days x COGS)/365

Accounts Payable = (Total Cost of Goods Sold/Days in Period) * Payable

DaysJul 16, 2009 C&V Lesson Managing inventory: delicate balance.

- Inventory ties up valuable cash.

- It can also spoil, go obsolete or become lost, damaged or stolen while

waiting to be purchased

- BUT If you scrimp too much on inventory, shortages may occur at

different places in your assembly line, leading to a less efficient use of

manufactur-ing assets.

- a lack of finished goods inventory may lead to stockouts of popular items

and cause impatient customers to go elsewhere.Jul 16, 2009 C&V Lesson Accounts payable is the portion of your inventory that suppliers are willing

to finance, in return for you agreeing to be their customer. Use it to offset

investment in iventoryJul 16, 2009 C&V Lesson accounts payable should not be considered simply another line on the

balance sheet, but rather a series of supplier-by-supplier negotiations,

where the amount of credit demanded depends on the service required

and amount of leverage you have with the individual supplier.


I need to read the terminal value note again as the concepts haven't sunk in yet

Read "“Steppingstone Jobs” as a Scavenger Hunt" again. Excellent tips - need to work with this

DEVELOP A SCAVENGER HUNT LIST

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Jul 16, 2009 Cust Lesson Dealing with failure: "If you want big successes, you have to take big

risks. The key to dealing with those risks is to envision what failure might

look like. You have to take your time and fully imagine what the real

consequences will be to you personally. How much money could you lose?

Will your reputation be hurt? Is there legal liability in any way? Will you lose

any relationships? These types of questions force you to come face to face

with the possibility of failure. Once you have done that there is only one

question left: Can you live with that? If you imagine the worst and decide

that you are willing to accept that outcome as a possibility, you can stop

worrying about it and move forward, fully focused on a successful

outcome. If, instead, you choose not to deal with the possibilities of failure,

you run the risk of a constant and building anxiety nagging at your

subconscious. This can destroy your focus, leading to a higher probability

of failure." Randy Allen (Ben Allen's dad)Jul 16, 2009 Cust Lesson Ben Allen's 4 rules of failure:

1) There is no success without risk.

2) Managing risk involves accepting the possibility of failure and its

consequences.

3) When it comes to failure, quick and small is preferable to large and/or

slow.

4) My self-identity is not determined by my performance.Jul 20, 2009 O&C Lesson Process Definitions:

Capacity (aka Throughput): How many units (on average) can a given

workstation transform per unit of time?

Process Time: How long does it take to transform inputs into a unit of

output at a given workstation?

Cycle Time: How frequently are items completed at a particular process

stage? For a workstation with two workers performing tasks in parallel, the

cycle time will be 50% of what it would be if there was only one worker

performing the task. In general, the equation for calculating cycle time for a

workstation is:

(Task process time per unit) / (# of Tasks in Parallel at workstation)

Lead Time: How long does it take for a unit to flow from raw materials to

finished goods inventory? You can answer that question by adding up all of

the cycle times for all of the tasks required to transform the unit. This

calculation assumes that the unit will flow through the process without any

wait time between workstations.

Capacity and Cycle Time : An Inverse Relationship

If the cycle time for a task is 15 minutes, then the capacity for that task

is: 1 / (0.25 hours/unit) = 4 units/hour

Idle Time If a workstation does not have any product available to be

transformed, then it is experiencing idle time.

Wait Time The amount of time that the product being transformed has to

wait in queue prior to entering the next workstation is referred to as wait

time.Distinction between lead time and cycle time:

Cycle Time = The average time between completed units "coming out the

end of the pipe"

Example: the cycle time of motors assembled at the rate of 120 per hour

would be 30 seconds per unit

For Standard Work Analysis with more than one Operator: Cycle Time =

the operator with the longest Processing Time

Lead Time = the average time it takes for one unit of the thing to go

through the entire process - from start to finish - including time waiting

between sub-processes. (Also known as "Throughput Time" or

"Turnaround Time).

Lead Time = Sum of all Process Lead Times + Sum of all Queue Times

between processes

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Jul 26, 2009 O&C Question Galactic Zappers - follow the GOAL heirarchy for maximising profits

IDENTIFY, EXPLOIT, SUBORDINATE, ELEVATE, Repeat

I got a profit of $9526 but I see some people were

getting more than $12k - what did they do

different?Jul 26, 2009 Cust Lesson Pricing policy must flow from the overall marketing strategy and not be

independent from it, or, worse still, send conflicting messagesJul 26, 2009 Cust Lesson Often thinking about pricing is underresourced and left to the marketing

function. Must have a mechanism in place for ensuring that pricing benefits

from the input of different cross-functional people.Jul 26, 2009 Cust Lesson Pricing policy is NOT cost plus, it must start with value as perceived by the

customerJul 26, 2009 C&V Lesson Valuing raw materials - cost

Valuing WIP - It is reasonable to assume that the cost of each unit in WIP

includes full raw material cost + half of the labour direct charge (the

assumption is that the average unit is 50% complete)

Valuing FGI - selling price

Why do we need 2x as many units in FGI than we

can deliver in order to ensure that we have enough

quantities of all different types of products on

hand?

How is the 2x derived? (see wk 9 note

Forecasting...)Jul 26, 2009 C&V Lesson Depreciation is NOT a reduction in the value of an asset. It is a

DISTRIBUTION of its cost / value over its useful life. Note 3 types of

depreciation (1) GAAP (2) Tax (3) EconomicJul 26, 2009 C&V Lesson Note difference:

Depreciation - assets to operation

Depletion - natural resources

Amortisation - intangible assetsJul 26, 2009 C&V Lesson When calculating FCFF depreciation is taken out in order to calculate tax

and hence NOPAT. Since it is a non-cash expense, it must be added back

in in order to calculate cashflows and hence intrinsic firm value (IFV)

Jul 26, 2009 C&V Lesson Depreciation analysis red flags:

- switching from acc to st line method may denote trouble maintaining

earnings high enough to support the former conservative approach to

depreciation policy

- unrealistically long dep lives

- declining dep : sales ratio. May denote mgmt is milking co and not

reinvetsting in assets - aka "riding down"

Aug 2, 2009 c&v lesson Debt: treat as any other asset. Do projections of free cashflows suggest

that the profits from additional growth and lowering the costs of financing

(incl benefit of tax-deductible interest) exceed cost and risks from higher

fixed-period costs and a loss of operating control and flexibility?

Don't understand the sustainable growth rate

formula. Need to read note again and understand it

from first pples

Aug 2, 2009 c&v notation Dr. Depreciation expense

Cr. Accumulated Depreciation



As I read all these notes I need to keep uppermost the question: How does the information in this note relate to more VALUE for the business?

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Aug 2, 2009 c&v lesson Cashflow modelling becomes more important when you have

- high revenue growth

- long supply chain and / or manufacturing process

- large and/or frequent investment in fixed assets

- low marginsAug 2, 2009 c&v lesson Net profits do not all go to the bank, they are split up between:

- purchasing inventory

- extending customer credit

- purchasing fixed assets, and

- cashAug 2, 2009 EJ lesson Porter's 5 competitive forces:

-

Aug 2, 2009 LoM ethical frameworks:

- utilitarianism - greatest good

- rights-based

- virtue-based - goodness for own sake

- justice and fairness

- religious

(- relativism - anything /nothing goes)

(- pragmatism - every situation is unique)Preference - what order are stakeholders paid in during normal running?

Priority: what order are stakeholders paid in in the event of a bankruptcy

- revolving debt

- term debt

- high yield debt

- equity owners

Aug 9, 2009 EJ lesson Management is an art - it involves seducing, screening, hiring, coaching,

and occasionally firing employeesAug 9, 2009 EJ Framework Levers of Control: My job as an entrepreneur is to find a compelling need

that begs to be satisfied, assemble people with the gifts to fulfill that need

and organise them to do so, arouse a passion for excellence and create a

sense of predictability and purpose out of the chaos that is the real world -

in a systematic way.

1) Belief Systems - deeply held values of the "tribe" (we believe

statements); Articultation of the mission - inspirational, compelling, "it

should inspire people to charge a hill", and be a clear message about

which hill must be charged, the type of people to take the hill and why it

matters.

2) Boundary Systems - "thou shalt not's" for the company; minimum stds

for ethical conduct. There are no exceptions for violating a boundary rule

3) Diagnistic systems - measuring the results that matter (there are

generally only a handful of numbers that matter - customer satisfaction,

market share (gaining or losing); tracking margins over time; capacity

utilisation (or turnover) of most important asset

4) Interactive systems - intentional ways of acknowledgeing, coaching

and developing individuals

Aug 9, 2009 EJ Lesson Learning to say NO can be the best growth strategy there is. Focus not on

"happy customers" but the right customers (clearly defined).

Started my scavenger hunt toolkit this week. This note to remind myself to follow up next week

- need to write a summary of the cashdays analysis note from 2 weeks ago.

Pre-Mat Week # 11 (w/c 3 Aug 09)

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Aug 9, 2009 C&V Lesson Valuation using a multiple (based on a comparable firm) should be close to

valuation done by DCF. Reasons for variance could be:

- comparable firms not chosen well (e.g. different growth prospects,

riskiness of cashflows)

- cashflows of firm (or of firm chosen as comparable) are not expected to

grow in stable manner (e.g large CAPEX investment expected

- market valuation on which multiple is based is wrongAug 9, 2009 O&C Lesson To maximise profitability of a company, think as if the company is selling its

most scarce resource, the minutes of the constraint. The products that

better pay for the minutes they use are the ones that most contribute to the

company's botom line.

Aug 15, 2009 E&J Formula Comparables:

1) Market value = # of shares outstanding * price per share + market value

of debt

2) Market price / EBITDA = EBITDA multiple

Why are we ADDING the market value of the debt

and not subtracting it?

Because FIRM = EQUITY + DEBTlesson Using price/earnings ratios as a yardstick for comparing firms (for market

price valuation purposes) can be useful. However watch out that the

financial levarage of the firms is not very different as P/E ratios do not take

this into accountlesson If someone offers to buy your firm

1) refuse to listen to price until you have calcuated IFV

2) compare their offer price with market price as determined by

comparables

3) Confirm whether they are offering you money for the firm, or for your

equity in the firm - big difference!Aug 16, 2009 LoM lesson Do not discard. All the aspects that make up YOU are important for your

hero's journey. I need to make sure I do not discard some things like

guitar, songwriting, theatre as I do business. I need to creatively determine

how all of them can work together to make my hero's journey truly

remarkable.

CRITICAL QUESTION - How can I combine my

love for leading worship, acting, and songwriting

with my passion for business and for helping the

under-appreciated?

Aug 15, 2009 LoM Overarching

question

How can I find a calling - good work that combines my passions and

my strengths and makes a difference in the world?Aug 16, 2009 C&V Overarching

question

How can I make my firm and equity worth as much as possible? i.e.

How do I make the right investment, operational, and financial

decisions to

maximize the value of my firm and my equity in it?Aug 16, 2009 Cust Overarching

question

How do I indentify, listen to and segment customers; price products

and services;

and build a sales funnel to close the right customers, at the right

time, in sufficient

quantities, at as low a cost per sale and with as small an upfront

investment as

possible?Aug 16, 2009 EJ Overarching

question

Should I invest my money and my life in this venture?

2-Sep LoM Lesson Think more consciously about "what commitment am I making to this job?"

esp for stepping stone jobs

The Art of Listening: I think the best place for me to learn to listen is when interacting with my daughter!!!

Pre-Mat Week # 12 (w/c 10 Aug 09)

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Entrepreneurs Journal - PREMAT

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