Chapter 3
The harsh realities of funding and finance
Looking for a sensible way to invest
Let's look for a moment at the more regular world of business funding, to see how investment decisions are made when working in a fairly stable and predictable business environment. In this world, business is about rational decision making; doing the right things. The strategy is concerned mainly with reducing risk and eliminating uncertainty. Monitoring and control are the main methods for keeping a business on track to meet targets and reach designated goals.
In a reasonably predictable environment, it is possible to estimate roughly how long it will take to complete a project and how much it will cost. In this way a funding body can have an idea of how much they will have to invest and what gains are possible. By suitably discounting for time and risk they can make an investment decision to fund or not to fund.
This situation is illustrated in figure 3.4, where funding or investment decisions are founded upon facts and figures based upon previous experience and carefully researched projections. The ability to make reasonably accurate future predictions, means that the risk of failure does not have to be heavily discounted in estimating future profitability.
Figure 3.4
In a reasonably stable environment, the value of the anticipated future value will not have to be too heavily discounted. This lessens the pressure on a business to produce exceptional earnings
In a stable and predictable environment, where future projections can be made with some degree of accuracy, a company does not need to forecast exceptional profits to attract funding. All that matters is that there is enough future profit forecast to cover any possible downside risk. The more predictable the environment, the less are the risks and the less the anticipated future profits need to be to cover those risks.
However, in the volatile and unpredictable environment of e-business, the risks associated with reaching an intended goal are much greater. There are too many unknowns. This means that there has to be a far greater allowance made for the risks and in most cases the discount that have to be applied to estimates of future earnings reduce the estimated future value of a business so much that although on paper the investment would appear to be profitable, the realities of the investment decision process make it an unsound investment. This is illustrated in figure 3.5.
Figure 3.5
The added risks associated with an uncertain and volatile environment can reduce the value of a seemingly promising business venture to a point where it would be considered a loss making investment
Figure 3.5 shows graphically how a business that would appear to offer an investor a chance of a very handsome capital gain would actually be a poor investment choice – once the risks and time to realise the gain are taken into account.
The reason why it should be rated as a poor investment decision is not obvious. So, it's worth pausing a moment here to go though a few pragmatic, investment decision calculations.