Assess the Value of Formal Investment Appraisal Techniques - Essay Example

?Assess the value of formal investment appraisal techniques Introduction This essay looks at the overall topic of assessing the value of formal investment appraisal techniques. To do this effectively, three major articles have been selected by the writer. These articles or sources are going to be critiqued into detail to find out the views and conclusions of the writers on formal investment, formal investment appraisal techniques and the values of formal investment appraisal. This means that there are going to be three major themes that are going to be analyzed in the course of this essay. The question however remains whether the best business practices that need to be followed are being followed in the course of these formal investment ventures. The central themes of all three writers under review have therefore been to look into how best practices in formal investment start up have been adhered to; particularly with the cases of acquisition of venture capital. Below, there is a detailed discussion of the three themes of the essay as presented from the perspectives of the three writers. Formal Investment Appraisal as Part of a Businesss Plan (Ashmalla et al.) Ashamalla, Orife and Abel (2008) who pointed to venture capital as a formal investment type in today’s contemporary world, they point to the designing of business plans as the most viable formal investment appraisal to use to secure venture capital and also assess the progress of the ventures that come out of the venture capital investment. Ashamalla, Orife and Abel (2008 p. 385) take the meaning of formal investment from the perspective of venture capital. The writers therefore undertake exclusive research on how business owners perceive venture capital and how they go about the subject. The writers explain that venture capital is an aspect of formal investment whereby business owners and investors seek for source of funding to start up their businesses and ventures. This is has indeed been an ongoing phenomenon in contemporary business setting for a very long time. Primarily, investors and entrepreneurs seek for capital to start up their businesses because of the belief they have always had in their abilities to make revenues, amass profits and pay off the sources of their capital. Because the search for capital to start up any venture results in an eventual amassment of wealth, Ashamalla, Orife and Abel (2008, p. 386) regard the practice as an important investment pattern in contemporary business scenarios. Generally, investments are undertaken to make profits. To this extent, the writer agrees with Ashamalla, Orife and Abel (2008) on this point that venture capital is now regarded as an important source of formal investment for business owners and investors. The writer however criticizes the situation whereby investors have to look for other form of funds to pay off their debts. This is because it is not always certain that the ventures they start will be profitable. The writers therefore collected data on how different respondents who were all business oriented personnel viewed and envisioned the use of business plan as an appraisal technique. In the larger sense, there were several respondents who agreed to the importance of business plans in helping investors secure venture capital. The reason given by such respondents has to do with the fact that business plans helps the creditors in assessing the real strategies and visions of the capital seekers. In this way, the capital seekers are put in a better position to convince creditors that they have put enough plans in place to pay off the debts should it be granted. There were respondents who also held the view that business plans are only cosmetic and that they do not actually raise the chances of capital seekers of securing capital. From the estimation of the writer, an investor who has not started a venture yet could have nothing more tangible in proofing his lot than a business plan. Business plans are there very important appraisal techniques for securing venture capitals. Even after the security of the capitals, business plans helps in giving investors directions on what they have already stated about their businesses so that adherence to the plan would be rigorous. From the discussions, a lot of value or importance can be seen from the need to undertake formal investment appraisal as part of the business plan. In the first place, business plans have been identified as very useful tools for achieving both long term and short term goals for companies. This means that when formal investment appraisal is taken by the use of business plans, companies have the value of being guided in their long term and short focus towards the building of a well consolidated business. Already, it has been established that the presence of a business plan helps in raising the chances of a company in securing venture capital. By using the business plan to appraise the business, the possibility that business owners would be fast-tracked towards the recover of capitals they take from creditors will be faster Ashamalla, Orife and Abel (2008, p. 390) Formal Investment Appraisal as Part of a wider appraisal of an investment (Kut et al.) Investments can really go wrong for investors. To avoid some of these instances, Kut, Pramborg and Smolarski (2006) looked at the various appraisal techniques at the disposal of investors to use in monitoring their private equity fund. On the part of Kut, Pramborg and Smolarski (2006), they view private equity fund as a source of useful formal investment in contemporary business scenario. This is to say that in order to start up an investment, a business owner or an entrepreneur would consider private equity funding as a major source of investment. The writers explain private equity fund as a long term fixed savings term that is often spread over a period of ten years. The term is dubbed ‘private’ because it commonly involves private partners and entities who want to have a fixed funding over a long period of time. There are several scenarios by which private entrepreneurs and investors invest in private equity fund. Some of these are discussed by the authors as including the raising of funds from cash-oriented institutions including pension plans, health insurance companies and endowments. Indeed the writer agrees with Kut, Pramborg and Smolarski (2006) on the choice of private equity fund as a source of formal investment. This is because in the estimation of the writer, private equity fund is a useful means of raising capital to undertake major money making projects. A major advantage for investing in private equity fund is the fact that in most case, the eventual capital that is raised becomes the overall capital of the investor such that the investor does not have to think of paying off the capital after a given time. The concern of the writer however has to do with the fact that for investors who want immediate capital, private equity fund may not be a viable alternative of a formal investment type. The authors thus conducted a research on risk management in private equity fund. Kut, Pramborg and Smolarski (2006) pointed to private equity fund as their preferred formal investment type. Indeed private equity fund is a very realiable source of investment for investors who have long term dreams of starting up businesses or expanding existing businesses. However, if the equity fund is not well monitored, chances are that the fund will not raise as much capital as it is expected. As a matter of fact, there have been investors who have entered into the wrong equity fund all together and thus recorded outright losses. In their research, they found that risk management is an important technique for appraising private equity funds. Indeed the writer appreciates the fact that risk management allows investors to appraise their private equity funds at both the pre-investment stage and the post-investment stage. Kut, Pramborg and Smolarski (2006, p.42) in their research found that the type of risk that should commonly be an indicator to investors opting for private equity fund should be the principal-agent relationship. These principal-agent relationships are third party agents who act on behalf of the investors. It is always important to be weary of these agents as a major risk management idealization because they are the ones who have the legal mandate to monitor the progress of the fund and report to the major investor. In cases where these agents have conflict of interest, chances are that the investors will not record the expected profits. As part of the wider appraisal of an investment, Kut, Pramborg and Smolarski (2006, p.46) view risk management as having a lot of value when used in the wider appraisal of an investment. Generally, an appraisal system that is done with risk management option opens the investor up to several risk factors that should serve as spotlights and red-flags to be avoided. Indeed a comprehensive risk management appraisal exposes the entrepreneur to all possible liabilities and assets that are accompanied with a given investment portfolio. This way, entrepreneurs will be working their ways towards attracting the assets in the investment portfolio and leaving out on the liabilities. Formal Investment Appraisal as Part of the formal appraisal techniques used by companies (Graham and Harvey) Formal appraisal technique is indeed an important part of formal investment appraisal. In their view, the best form of technique to use is firm risk. Earlier, they had pointed to capital asset planning as a formal investment appraisal policy for starters and existing entrepreneurs. In the opinion of the authors, entrepreneurs and investors who want to raise long term capital that is free from future paybacks can resort to capital asset pricing (p. 191). Under the use of capital asset pricing by investors and entrepreneurs, Graham and Harvey (1999) note that there are often existing well-diversified asset portfolios. A model known as capital asset pricing modeling is then used to identify the right and deserving rate of return that have been put on the diversified portfolio (p. 202). The authors warn however that to solidify the viability of the comeback price from the diversification, it is important that the asset becomes a non-diversifiable risk. The writer rightly agrees with the authors on the dependence on capital asset pricing as a formal investment opportunity. The concern however is that in the event that inflation rates constantly rises, investors who opt for this type of investment might have the actual returns devaluing. The writer therefore holds the opinion that this should not be encouraged in a porous inflation region. Graham and Harvey (2001) outline ways in which entrepreneurs can maximize profits on funds by way of appraising their capital asset planning. In the view of the writers, the best technique available for appraising the capital asset planning is the use of firm risk. This conclusion was drawn as a result of a research undertaken by the writers. Through their research, it was established that several companies and businesses use firm risk in appraising their private equity fund and this was done by ensuring financial flexibility and credit rating at the point of issuing debt and earnings. The simple implication to this method of appraisal is that entrepreneurs should be in a position to create value on their share of the equity by ensuring that the private equity fund they are investing in is one that allows for financial flexibility in such as a way that there could be diversionary investment portfolios in case they detect in the course of the equity funding that their investment would not be profitable. In the estimation of the writer, it should always be important that equity funds should experience progressive earnings and not debts. This means that as soon as the trend begins to retard, investors should be in a position to readjust their investment portfolios. Based on all their arguments, Graham and Harvey (2001) give out the importance of Formal Investment Appraisal as Part of the formal appraisal techniques. When entrepreneurs undertake comprehensive firm risk appraisal, they are opportune with the setting of the best prices for their private equity funds. Though they may not have the bargaining power to determining percentage range and profit margins the mere fact that the investors will be privileged to selecting flexible and prudent credit ratings mean that the chances of securing better turn ups is higher. To conclude, the writer would admonish the continuous appraisal of all forms of investments that are taken by investors. This is because that is the only way by which investors can monitor the progress of their investments and put the right measures in place to ensure that their investments are directed towards profit making. REFERENCE LIST Ashamalla M. H., Orife J. N. and Abel I. Business Plans: Are They Relevant to Venture Capitalists? Journal of Small Business and Entrepreneurship 21, no. 4 (2008): pp. 381–92 Graham J.R. and Harvey C.R. The theory and practice of corporate finance: evidence from the field. Journal of Financial Economics 60 (2001) 187}243 189 Kut C, Pramborg B. And Smolarski J. Risk Management in European Private Equity Funds: Survey Evidence. Journal of Private Equity. 2006 Read More