Discounted Cash Flow Analysis

Introduction

At times it may just be a little difficult for the business owners to know the exact worth of their business unless they conduct thorough stock analyses of what they already have within their premises. That is the same situation that faces Aunt Victoria at the moment. She has an idea of a new business that wishes to start within a short period from now. In order for her to be able to know how much the business will be worth and the expected cash flows, then she will have to use the discounted cash flow method. For a beginning she has an obligation of paying a down payment to the Roman herb company that manufactures herbal products in Romania. The company uses a concept of payment first then services later. It is therefore important for Aunt Victoria to know all the costs that will be involved in the process. For instance, she has to calculate the buying price of the products in terms of either Swiss franc currency or Romanian currency. Secondly, there will be the issue of transportation cost from Romania to Switzerland. That also has to be catered for as an expense since the Romanian company will not be shipping the products for free. The costs of developing the website where she will be selling her products also have to be taken into consideration. Moreover, there is an amount of CHF 7500 that she has already spent on her market study I order to know how much demand and supply there is in that specific market. The costs of the refrigerator and the rental expenses also have to be considered since they will also have an impact on the final value of the profits that will be obtained.

Aunt Victoria also seems to be set with her pricing strategy for the various quantities of jars that she will be selling to her customers. However, what is not known is the criteria that she has used in order to come up with such a pricing strategy. It can therefore be assumed that she took into consideration of both the short term and long term expenses that she will incur in the course of establishing her business. In addition, the pricing strategy that she has chosen might not necessarily bring her profits in the short run but it may benefit her to a great extent in the long run. For instance, the cost of developing her website and the costs of conducting a market survey are a one off payment that she will never incur again at any given point. Therefore, such expenses might affect her profitability in the short run but she may overcome that in the long run.
Using the method of discounted cash flow she may be able to know what her company will be worth in the future. The method may prove to be helpful since it helps in knowing the exact value of a company in the current period based on the projections made on the cash flows the company will be making in the future period. The worth of the company can be explained as the amount of money that the company will be ready and willing to give its investors if asked to do so. The process is known as a discounted method because the worth of cash in a future period is normally less as compared to what the same cash will be worth in the current period. For instance if we take an example of the current worth of  CHF 600 in the current period may not necessarily be the same in the future. What that amount can purchase in this year will be different from what it will be able to purchase two or three years from now. The same analogy will be used for the case of Aunty Victoria. Her current earnings will be invested in a business that will either give her profits or result into losses. The current earnings will be used to make projections of what the company will be worth in the next few years.

The discounted cash flow system will also be used in this case to help Aunt Victoria acquaint herself with the reality check of the fair value prices in the market. Moreover, it is through such an analysis that she will able to know the possible future growth of her sales. It is true that she has conducted a market survey related to the products that she wants to introduce to the market. The data that she has collected may be correct to some extent and faulty to some extent. However, through a discounted cash flow system she will able to know the exact rate of growth of her sales in the future. It is also that rate of growth that will enable her know the profit margins that she will e expecting to generate during that specific growth. Certain factors such as the risk-free interest rates will also have to be taken into consideration when determining the total expenses and the total profits for the company. The cost of capital for her company is another factor that she cannot afford to rule out. There is also the risk that her business will be facing in the market. For instance, it is not certain that she will have constant sales of her products in the market. There are certain periods when the sales will be very low and thereby the company will have to withstand the chances of making losses. Moreover, the company will be likely to face a lot of competition from other businesses in the industry that will most likely affect its profits. The analysis will also be important because it will enable Aunt Victoria to know whether her chosen pricing strategies are correct or wrong. There could be a possibility that the prices she has chosen for her products are so low as compared to the expenses that she will incur.

Apart from just starting the business casually, there will be a need for her to have the necessary skills that are required to run such a business venture. What most business personalities lack are the skills that are required to run their specific types of businesses that they run. Most of the business personalities normally get into business for all the wrong reasons. Most people get into business with the aim of generating profits without them having the necessary knowledge required to run the businesses. Moreover, she will have to possess a sound knowledge of finance management otherwise she might not be able to make calculations of what she will be using and earning in her business. Her finance management skills will also be coupled with the kind of vision that she will have for her business. The right visions for a business are one that can project a realistic growth over an achievable period. Otherwise if a business owner has no vision then such a venture might just be doomed to fail. A vision for a business goes hand in hand with a good purpose for one to get into business. For instance, one needs to get a business that will satisfy their needs at the end of the day. If one runs a business that will never satisfy their needs then they will never go far with their business.

For the case of Victoria, her reasons might be because she wants to become independent after leaving her former job. Her business goals are not clearly stated, so it may be quite difficult to know what she aims to achieve with the business that she is starting. A goal is normally the driving force behind every successful business. Moreover, Victoria will have to consider all the advantages and disadvantages of starting such a business operation. If the advantages of starting the business outweigh the disadvantages then such a business will most likely succeed in its operations. On the other hand, if the disadvantages outweigh the advantages then the business operations is most likely to fail. She should therefore first try the get the details concerning her business so that she can know what outweighs the other. She should also exactly what her business will do in the market that the other business operations have not done. In short, Victoria will need to define her competitive advantage of her business. She should know what constitutes her strengths and what constitutes her weakness. For her to call herself a good business woman then she will need to make her own independent decisions and also work out the possible solutions to the most likely problems to occur.

It will also be important for her to know whether the business will make enough money for her or she will fail to achieve the financial independence that she is seeking at the moment. That should be in line with the consideration that she is no longer on payroll and that she may not be able to get enough money to back her up. For instance, if she does not plan her finances well in advance, she may end up running into financial losses. Once she gets to that point, she may not be in a position to get back on her feet because she currently does not have another source of income like she had before. That will require her to be realistic with her funding so that she does not run out of funds in the course of the business operations. She will need to be very conservative with her calculations so that she does overestimate neither does she underestimate what her business will most likely generate to her.

Some people get it wrong when starting their businesses because all that they do is to get a rough calculation of the amount that their business needs for a start. Once they get that then they doubl3 it up assuming that their businesses will generate cash immediately. One thing that she must realize is that businesses take time to mature and to get ready customers. It normally takes time for business to start generating income or profits because first the customers have to get convinced that the business offers what they need to get from the market. Such an assessment can at times take a long period of up to six months, depending on the nature of the business. She will therefore need to be on top of her cash flow management so that she keeps track of every coin that her business gets as well as the expenses that she incurs on her business.

Apart from that, she will need to conduct a market research on the capabilities and the weaknesses of her competitors. It is so unfortunate that some businessmen and women get into business without taking into considerations what their competitors. If the competitors offer better goods and services then chances are high that the one who offers inferior goods and services will be locked out of the competitive market. There will also be a need for Victoria to have a good business plan in place because her business will be an international business. In most cases, businesses start as small scale business and then they later grow within their countries before maybe finally expanding to become an international business. However, in Victoria’s case, she wants to begin straight as an international business operator.

She will therefore need to have a clear analysis of what she wants her business to achieve. That would require her to conduct an analysis on the opportunities that her business will be able to achieve within that timeframe as well as the threats that she will most likely face. That is the only way that she will be able to prove that her goals are objective and realistic as possible. Apart from her conducting her business online, she may also need to use the same platform to conduct a business marketing so that she can have a wide range of customers base. The advantage of an online marketing structure is that you not only have o rely on customers from your locality but you get customers from as far as neighbouring countries. Finally, she will need to come up with a realistic cash flow statement that shows the revenue generation for the business as well as the expenses that the business will expect to incur during its operations. It is also through the cash flow that she will be able to know how the business growth will be impacted.

Since the business will operate online, she may be required by law to register the business so that it gets recognition from the government as a legitimate business. It is also through the registration process that she will be ale to know all the red tapes that go hand in hand with such a business venture. She should also take into consideration the standards of living within that specific area for the purposes of setting her prices. For instance, if the area is occupied by well off families then she can decide to place a higher price than what she currently has. On the other hand, if the area of the business has a majority of middle class families, then she should consider setting an affordable price. The pricing strategy that she chooses to use will all depend on the nature of families or customers that she will be dealing with. Moreover, the market prices that have been set by her competitors will also influence the prices that she will implement. She will therefore have no chance of placing a high price when the other competitors are issuing the same products at a much lower price.

In terms of the cash flows, the expense and the revenue that will be generated may be categorized as follows:

The conversion rate that will be used is 1RON = 0.233CHF or alternatively 1CHF = 4.285RON

The herbs sell at 60Leu per jar but the company is willing to sell out the products to her at a discount of 40%. It therefore means that Victoria will be buying the herbs at a price of 36 leu per jar. Since the consignment will be shipped in cartons and each carton contains 40 jars, therefore the buying price of one carton will be 1440 New Leu. When that amount is converted into Swiss franc it will give an amount of 335.52CHF.

The transportation charges for the cargo are given at 150 RON per carton, equivalent to a total amount of 34.95CHF. The total amount of expenses and revenues generated will be calculated as follows:

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