Tag Archives | capital

ROCE (Return on Capital Employed)

See Also:
ROE (Return on Equity)
ROIC (Return on Invested Capital)

ROCE (Return on Capital Employed) Definition

ROCE stands for Return on Capital Employed; it is a financial ratio that determines a company’s profitability and the efficiency the capital is applied. A higher ROCE implies a more economical use of capital; the ROCE should be higher than the capital cost. If not, the company is less productive and inadequately building shareholder value.

ROCE Formula

Use the following formula to calculate ROCE:

ROCE =  EBIT/Capital Employed.

EBIT = Earnings Before Interest and Tax
Capital Employed = Total AssetsCurrent Liabilities.

Calculating Return on Capital Employed is a useful means of comparing profits across companies based on the amount of capital. It is insufficient to look at the EBIT alone to determine which company is a better investment. You also have to look at the capital and calculate the ROCE. Many consider ROCE a more reliable formula than ROE for calculating a company’s future earnings because current liabilities and expenses.


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ROCE Example

Look at the following table to see the importance ofReturn on Capital Employed (ROCE) in action.

Return on Capital Employed

Both Company A and Company B sell computers. Company A represents the Old Factory model; they are a distribution company that sells business to business. Company B is the New Factory; they are also a distribution company, but they sell on the Internet via credit card. Due to this modern convenience, Company B is able to receive payment within two days instead of the forty-five it takes Company A.

If you were to just consider EBIT, then Company A looks like the better investment at 7% return on sales compared to Company B’s 5%; however, with such a large DSO number, Company A is out $6,000,000 more than Company B at any given time. This means Company B needs less capital invested in the company which would result in a higher return on equity (ROE).

Thirty years ago, a similar scenario played out between IBM (Company A) and Dell (Company B). In his college dorm room, Michael Dell started taking credit card sales over the phone and was able to grow a billion dollar company with very little capital.

If you don’t leave any money on the table, then access our Top 10 Destroyers of Value to discover what areas of your business need to be attended to.
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Return on Capital Employed

(Originally published by  on June 9, 2016)

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5 Cs of Credit – How to Be More Credit Worthy

Are you credit worthy? Right now, is your credit good enough for a lender to give you a loan or line of credit today? If your answer is no or if your not sure of your answer, take a look at the 5 Cs of Credit. This 5-point checklist allows loan officers to easily determine if you are going to be good for their banking business. Although, banks don’t strictly rely on only the 5 Cs of Credit, it’s good to know where they start.

But first, what are the 5 Cs of Credit?

5 Cs of Credit

The 5 Cs of Credit include cash flow, collateral, capital, character, and conditions.

5 cs of creditCash Flow

The bank need to know that your company can generate (and has generated) enough cash flow to pay off the debt. To increase your chances of getting approved for a loan, display how you have paid off debt before, had consistent cash flow, and plan to pay off debt in the future. Remember, cash is king. Because of that, this is one of the most important Cs.

If you need to improve your cash flow, download our free 25 Ways to Improve Cash flow whitepaper. Get approved for that loan!

Collateral

Unfortunately, some companies fail. Regardless of whether the company fails or not, the bank wants to make sure that it can be paid. The bank looks for sufficient collateral to cover the amount of the loan as the secondary source of repayment. This C allows the bank to cover all their bases because at the end of the day, they just want to be paid.

The bank wants to make sure it is protected if you cannot repay the loan. As a result, the bank will look into your savings, investments, and/or property.

5 cs of credit

Capital

Capital is a huge sign of commitment. One of the reasons why the bank looks at capital to approve a loan is to confirm that the company can weather any storm and ensure that the owner will not just walk out any day. The bank needs to know that there is a significant commitment, that being an investment, from the owners of the company.

Character

One of the suggestions we give to clients when developing a banking relationship is to take their banker out to lunch. This provides an opportunity for the banker to assess your character. What are they looking for? Integrity, honesty, respect, and other virtues reflect a good business person who will stick with their commitments in the good times and the bad. Sound character is critical in business. The banks want to feel safe when doing business with you.

Indicators of character include credit history and stability. The biggest question asked is, “will you be able to repay the debt?”

Conditions

With any business, there are external factors that could impact the company’s success. Therefore, the bank looks for conditions surrounding your business that may or may not pose a significant risk to your ability to succeed (and pay off your loan). If there is high risk, the banks will be more cautious when approaching you. But if the risks are small and do not impact any of the 5 Cs of Credit, then the bank is more willing to offer a loan.

Ask yourself: can you repay the debt?

Why do banks follow the 5 Cs of Credit?

In short, banks follow the 5 Cs of Credit to mitigate any risk related to loaning to a company. The risk a bank incurs from lending money to companies can be managed by assessing different areas of credit. Although not every bank uses this list, it’s safe to assume that when approaching a bank, you need to address each of these factors.

Relationships

Business deals with people; therefore, it is critical for the management (especially the owner/CEO/CFO) to have a good relationship with their banker. Imagine a random person coming into your office to ask for a $350,000 loan. Because you have no relationship with them, you don’t know how honest they are, if they have integrity, how willing they are to pay back the loan, how they do business, etc. Because there are a lot of unknowns, the risk increases dramatically.

Trust between a bank and a company is developed when you have proven that you are able to pay off your loans, have long-lasting relationships with customers, vendors, suppliers, etc., and alert the bank if your projections are a little off.

5 cs of creditWhat Lenders Look For

Lenders look to reduce their risk. They are willing to provide loans that may not have the highest return over risky loans with high returns. Areas of risk include the amount of credit used, the number of recent applications for loans, how much the company makes, and available collateral.

To start the process of applying for a loan, address areas that need to be fixed before the application, explain any red flags that your banker might raise, and prove you are credit worthy.

How to be More Credit Worthy

Creditworthiness is a valuation method banks use to measure their customers, your company. Although there may be slight differences between personal and business credit scores, it is a good start to improve your personal credit score. If you follow the same guidelines in your business, the company’s creditworthiness will increase.

Be more credit worthy by:

  • Paying bills on time
  • Pay more than just the minimum amount required
  • Manage credit card balances
  • Limit or manage the usage of debt

In addition to addressing the factors that directly impact your credit score, take a look at the 5 Cs of Credit. If you find yourself lacking in any one of those areas, make it a goal to increase your creditworthiness in that area over the next quarter. If you have decided to start tackling the first “C” – cash flow – download the free 25 Ways to Improve Cash Flow whitepaper. Make a big impact today with this checklist.

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Hiring an Investment Banker?

investment bankerSince the economic recession that started in 2007, many people have perceived investment bankers negatively. The recession was caused in great part by the careless and unwise actions of investment banks and their regulators. Despite the negative impression people have of investment bankers, they are extremely beneficial for the economy and for individuals and companies to be profitable.

Hiring an Investment Banker?

Many larger firms use an in-house team for handling the issuance and trading of securities. However, there may be a point in the growth stage of your business that you need the external financial services of an investment banker. While there is a cost to investment banking, there are proven benefits of having outside intelligence oversee your company’s finances and securities. Following are the areas where investment bankers can help you:

Access to Capital:

Investment bankers have extensive relationships with investors, who have readily-available capital to invest in your business. Access to the investment bankers’ network of investors is a significant advantage when raising capital to invest in new technology, make strategic purchases or expand business operations. In addition, investment banks provide you with the resources and expertise you need to structure and implement deals to raise capital at profitable price points.

Knowledge about Partnerships, Mergers and Acquisitions: 

Business intelligence is the key to strategic decision-making. Investment bankers usually have extensive industry knowledge that can help you discover new opportunities to expand your business. These strategic opportunities include partnerships, mergers, and acquisitions.

Consultative Services:

Investment bankers make transactions happen for you in the moment. They also use their industry expertise and experience to advise and prepare you to act when advantageous opportunities present themselves in the future.

Working with investment bankers can be the key to your success. The ability of investment bankers to raise capital not only drives your business forward, but also the economy forward. For small businesses without financial investment divisions, hiring an investment banker will allow you to better manage investment decisions. An investment bank can put you in the best position to take advantage of strategic investment opportunities.

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Determine which candidates are the right fit for your company using our 5 Guiding Principles For Recruiting a Star-Quality Team.

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What is Investment Banking?

See also:
What Your Banker Wants You To Know
Alternative Forms of Banking
Debt Compliance 101: Keep Your Banker Happy
Manage Your Banking Relationship

What is Investment Banking?

What is investment banking? Investment Banking is an elite financial service to advise companies, individuals, and governments on financial and investment decisions. They also help them raise equity and debt capital. Investment banks help companies develop their investment portfolios and expand access capital markets. Capital markets include the stock and bond markets. Investment bankers are known to be the well-trained and effective contributors in the financial market. Because large firms raise significant capital through selling securities, they usually use the services of an in-house security issuance division or an investment banking institution. These banks often offer cost savings compared to maintaining an in house security issuance division.


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Investment Bank Analysts

Investment banking analysts serve as consultants for companies during mergers, acquisitions, and reorganizations of companies. Consultative services within an investment bank provide guidance and advice about the issue and placement of securities as well as the management of public assets. Furthermore, these analysts evaluate financial markets to guide companies on when to make public offerings.

Investment Bankers as Executors

Investment bankers are able to execute purchases and transactions for their clients. They act as their clients’ agents when purchasing, selling, or trading securities. If a company is in need of buyers for their stocks or bonds, then an investment bank finds those buyers and handles the transaction with appropriate attorneys and accountants.

Raising Capital

Investment bankers raise debt and equity capital for their clients. Raising debt capital includes issuing bonds to generate funds. Raising equity capital includes launching a company’s initial public offering (IPO).

The Buy Side

Investment bankers working on the “buy side” usually handle buying investment services, including the following:

The Sell Side

Investment bankers working on the “sell side” usually handle the trading. In addition, they sell investment services, such as facilitating security transactions, engaging in market making, and selling IPOs.

Examples of Investment Banking Firms

Some examples of investment banking firms include the following:

  1. Goldman Sachs
  2. Morgan Stanley
  3. JP Morgan Chase

If you want more tips on how to improve cash flow, then click here to access our 25 Ways to Improve Cash Flow whitepaper.

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Return on Invested Capital (ROIC)

See Also:
Return on Equity Analysis
Required Rate of Return
Return on Asset Analysis
Financial Ratios
Weighted Average Cost of Capital (WACC)
Return on Capital Employed (ROCE)

Return on Invested Capital (ROIC) Definition

The return on invested capital is the percentage amount that a company is making for every percentage point over the [Cost of Capital|Weighted Average Cost of Capital (WACC). More specifically the return on investment capital is the percentage return that a company makes over its invested capital. However, the invested capital is measured by the monetary value needed, instead of the assets that were bought. Therefore invested capital is the amount of long-term debt plus the amount of common and preferred shares.

Return on Invested Capital (ROIC) Formula

Use the following formula to calculate the Return on invested capital:

Net Operating Profit After Tax (NOPAT)/Invested Capital = ROIC

NOPAT – This is the operating profit in the income statement minus taxes. It should be noted that the interest expense has not been taken out of this equation.

Invested Capital – This is the total amount of long term debt plus the total amount of equity, whether it is from common or preferred. The last part of invested capital is to subtract the amount of cash that the company has on hand.

Return on Invested Capital (ROIC) Example

Bob is in charge of Rolly Polly Inc., a company that specializes in heavy agricultural and construction equipment. Bob has been curious as to how his company has been performing as of late and decides to look at the company’s return on invested capital analysis. Surprisingly, the company does not keep track of the return on invested capital ratio. Bob decides that he will go ahead and run the ROIC analysis, and obtains the following information:

Long-term debt – $25 million
Shareholder’s Equity – $75 million
Operating Profit – $20 million
Tax Rate – 35%
WACC – 11%

Plugging these numbers into the formula Bob finds the following:

$20 million – (20 million * 35%) = $13 million

$13 million/($25 milion + $75 million) = .13 or 13% = ROIC

To see how well the company is actually generating a return, Bob then compares the 13% to the WACC which is 11%. Thus, Bob find that the company is generating 2% more in profits than it cost to keep operations going.

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What Lenders Look At?

See Also:
Relationship With Your Lender
What Does a Lender Want to Know
Don’t Tell Your Lender Everything
Due Diligence on Lenders
Finding the Right Lender

What Lenders Look At?

I recently spoke to students at the University of Houston in the Wolff Center for Entrepreneurship on the topic of Dealing with Lenders. During the question and answer portion of the program, I was asked by a student, what lenders look at when they are deciding whether or not to approve a loan.

I answered the question by saying all lenders start with looking at the C’s of credit. There are normally five Cs of credit which I will define in a minute. But, the really important issue in getting your transaction approved rests upon your ability to present your case in satisfying each of the C’s.


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5 Cs of Credit

Depending upon your lender, the weight assigned to each “C” may vary, so you must understand the order of importance to the specific lender you are dealing with.

Character

The first C is Character. Normally borrowers don’t consider this but, lenders do. Lenders look at such things as your willingness to pay obligations, morality, and integrity. Lenders determine the borrower’s business character based on the historical information. To form an opinion on character, lenders will review the borrowers past success, payment history, and intangibles such as personal credit, family background and employment records.

Capacity

Another C is the borrower’s Capacity to pay. The lender normally looks to the business and determines if the business has a history of successful operations. The lender will determine if the business has paid their debts when they were due and shown a proven ability to generate cash flow. If you are trying to fund a start up, you must show prior business experience relating to the operation of the business you are trying to start. You must provide evidence of the capability of operating successfully and paying your bills.

Capital

Next, lenders look at another C Capital. Capital is the equity or net worth of a company. Capital signifies the company’s financial strength as a credit risk. The more capital a company has, the smaller the credit risk. Your company needs a history showing increasing sales, profits and net worth. Additionally, your company needs favorable trends in your operations, such as, constant or increasing gross profit margins.

Conditions

Another of the C’s is Conditions. Lenders will analyze how current and expected economic situations may affect your business. Such items might include past and current political history, and business cycles for you and who you sell to. Normally, the lenders like industries that are in periods of dynamic growth.

Collateral

The final C is Collateral. Lenders will determine the company’s ability to access and provide additional resources such as, equity or other assets, to use for repayment if the company’s capacity or character fails.

By addressing these C’s in your business plan and on your loan application you make the lender’s job faster and easier. Therefore, understanding and selling your C’s will improve your chances of getting the lender to approve your request.

For more tips on how to improve cash flow, click here to access our 25 Ways to Improve Cash Flow whitepaper.

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Why Venture Capital?

See Also:
The Dilemma of Financing a Start-up Company
Angel Investor
Mezzanine Debt Financing
What is a Term Sheet
Working Capital

Why Venture Capital?

Why venture capital versus other forms of equity? For one, VC partners tend to be experienced entrepreneurs themselves who have taken a startup from inception to an exit through an IPO or private sale once or more. They can help an entrepreneur avoid common mistakes and also help position the company as it nears an exit opportunity.

They also tend to have a large number of industry contacts, which can make it easier to strike deals with suppliers and customers, as well as weather the ups and downs within a given market.

It should be noted that most VC backed startups fail, but the ones that do succeed can do so spectacularly, as a host of VC backed firms, especially in tech, have done so since 1995, such as eBay, Yahoo!, and Google.

But one must know why they believe they need to bring in a VC investor. It can be costly and business history is replete with examples of entrepreneurs who took their startup from an idea on the back of an envelope into some of the largest firms in the world without any outside equity partners.

What is Venture Capital?

Venture capital is an expensive form of financing for an entrepreneur. With most VC funds expecting compounded annual returns in excess of 25% from their investments, an entrepreneur can find themselves giving up a substantial part of their equity in the company, not to mention the loss of control and a new demanding partner to contend with. So why do it?

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