Financial Intelligence

The Harvard Business Press has recently issued a four-book, financial-intelligence pack, and one volume, Financial Intelligence for Entrepreneurs, provides clear explanations and methods for small-business entrepreneurs. In non-financial language, it defines terms, outlines methods and, better, tells you what’s important.
Chapter six appraises return on investment (ROI) and offers three methods to help you determine if an investment is somewhat sound. I say “somewhat” because the authors, Karen Berman and Joe Knight, emphasize that all investments entail a degree of risk.
They wrote, “Even if it does work as planned, you can’t know exactly how much cash the investment will help generate.” They describe how calculating an investment’s future value becomes financial artistry because it requires forward-thinking assumptions on the investment term.
The past year certainly demonstrates business-forecasting risks. Nevertheless, a business shouldn’t wither too long.
Berman and Knight said to consider three facets prior to investing:
Future value, the value the given amount of cash would be worth at a set, future time, if it was either loaned out or invested. To learn this, determine the investment’s full cost and then project its overall earnings over the set (contract or depreciation) time.
Present value, the reverse of future value, which you determine by estimating the investment’s future value and reversing this value to the present day, in cash. For example, today’s $100,000 may be worth $94,000 in three years, for various reasons.
Because future dollars may be worth less, you compare the future earnings with today’s actual cash outlay, to see if you’ll make money on the investment. The method is to reverse the investment’s estimated, future dollar value by employing an annual, loss percentage.
Required rate of return. How much money do you need to make on the investment, at a future point, to make it worthwhile? As with present value, you work backwards to compare future earnings against today’s investment. This figure helps you determine how much interest – monetary gain – you’ll need before you decide to invest.

Hurdle rate
Some financial pros refer to your required, return rate as the “hurdle rate,” meaning, the amount the investment must surpass before you spend.
The Harvard authors said your investment’s hurdle rate requires some judgment; don’t choose it arbitrarily. For example, they suggest you contrast your outlay risk to other investments, such as purchasing Treasury bonds.
All investments entail some degree of risk, but risk is the nature of business.
You can quickly calculate a red – or green — light figure by dividing the investment amount by the annual, projected payback. For example, a $30,000 digital-print machine purchase that returned $13,000 per year would pay for itself in 2.3 years. Because you know the printer will last more than three years, you can expect extra earnings.
Another method is to calculate the net present value.
Any investment-forecasting system’s danger lies in the original cost projections and the cash-return forecast’s accuracy.
To order the books, visit www.harvardbusiness.org, and search for “financial intelligence.”