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TTMG 5103 Module Innovation Financial Management

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).

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TTMG 5103 Module Innovation Financial Management

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  1. TTMG 5103 Module Innovation Financial Management Patrick O’Halloran TIM Program, Carleton University

  2. Agenda • Objective • Financial Planning & Management • Financial Terminology • Methods and Techniques • Conclusions • References

  3. 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

  4. Agenda • Objective • Financial Planning & Management • Financial Terminology • Methods and Techniques • Conclusions • References

  5. 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

  6. 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?

  7. Moment of Truth • Discussion • Examples • Euro Disney • Youtube • Chrysler and Daimler

  8. Agenda • Objective • Financial Planning & Management • Financial Terminology • Methods and Techniques • Conclusions • References

  9. 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.

  10. 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.

  11. 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.

  12. 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.

  13. 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

  14. 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.

  15. 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

  16. Innovation Killers • How does it manifest itself? • Underestimation – do-nothing scenario as baseline state How cash flow typically looks When investing in an innovation A DCF and NPV calculations Based on incorrect baseline B C More accurate baseline for such Innovation calculations More likely scenario when Choosing do-nothing mode of operation

  17. Moment of Truth • Discussion • Examples

  18. Agenda • Objective • Financial Planning & Management • Financial Terminology • Methods and Techniques • Conclusions • References

  19. 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

  20. 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.

  21. 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.

  22. 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

  23. 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

  24. Moment of Truth • Discussion • Examples

  25. Agenda • Objective • Financial Planning & Management • Financial Terminology • Methods and Techniques • Conclusions • References

  26. 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.

  27. Moment of Truth • Discussion • Examples

  28. 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.

  29. 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.

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