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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)
Page 1 of 18
Date Topic Category What I learned What I Don’t Understand/Have Yet to
Learn
ENTREPRENEUR’S TOOLKIT
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)
Page 2 of 18
Date Topic Category What I learned What I Don’t Understand/Have Yet to
Learn
ENTREPRENEUR’S TOOLKIT
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)
Page 3 of 18
Date Topic Category What I learned What I Don’t Understand/Have Yet to
Learn
ENTREPRENEUR’S TOOLKIT
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)
Page 4 of 18
Date Topic Category What I learned What I Don’t Understand/Have Yet to
Learn
ENTREPRENEUR’S TOOLKIT
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
Page 5 of 18
Date Topic Category What I learned What I Don’t Understand/Have Yet to
Learn
ENTREPRENEUR’S TOOLKIT
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
NOTES
Pre-Mat Week # 4 (w/c 15 June 09)
Page 6 of 18
Date Topic Category What I learned What I Don’t Understand/Have Yet to
Learn
ENTREPRENEUR’S TOOLKIT
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
Page 7 of 18
Date Topic Category What I learned What I Don’t Understand/Have Yet to
Learn
ENTREPRENEUR’S TOOLKIT
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.
NOTES
Pre-Mat Week # 5 (w/c 22 June 09)
Page 8 of 18
Date Topic Category What I learned What I Don’t Understand/Have Yet to
Learn
ENTREPRENEUR’S TOOLKIT
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%
Pre-Mat Week # 6 (w/c 29 June 09)
NOTES
Page 9 of 18
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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.
Page 10 of 18
Date Topic Category What I learned What I Don’t Understand/Have Yet to
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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
Page 12 of 18
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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.
Pre-Mat Week # 8 (w/c 13 July 09)
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
Page 13 of 18
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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
Page 14 of 18
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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
Pre-Mat Week # 10 (w/c 27 July 09)
Pre-Mat Week # 9 (w/c 20 July 09)
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?
Page 15 of 18
Date Topic Category What I learned What I Don’t Understand/Have Yet to
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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)
Page 17 of 18
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