The Finance Gem 2023💎 Week #20 - Demystifying Finance

Demystifying Corporate Finance

Welcome to this week's edition of The Finance Gem 💎 where I bring you unabbreviated Linkedin insights you loved - so you can save them, and those you missed - so you can enjoy them.

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This week's strategic finance insights:

  • The Corporate Finance Cheat Sheet (back by popular demand)

  • The Place and Purpose of the CFO Office in a Company Org Chart

  • Learn Your Cash Flows

  • Accounting vs. Finance KPIs

Without further ado, let's dive in:

The Corporate Finance Cheat Sheet

Corporate Finance can be tough to understand.

But having the right perspective can change everything.

👉 𝐇𝐞𝐫𝐞 𝐢𝐬 𝐰𝐡𝐚𝐭 𝐓𝐡𝐞 𝐎𝐧𝐞-𝐏𝐚𝐠𝐞 𝐂𝐨𝐫𝐩𝐨𝐫𝐚𝐭𝐞 𝐅𝐢𝐧𝐚𝐧𝐜𝐞 𝐂𝐡𝐞𝐚𝐭 𝐒𝐡𝐞𝐞𝐭 𝐢𝐧𝐜𝐥𝐮𝐝𝐞𝐬:

🎯 Financial projections with assumptions for growth, cost breakdown, fixed assets and working capital investments
🎯 Working Capital Schedule with calculations for the Cash Conversion Cycle
🎯 Break-even Analysis: Contribution Margin & Break even Revenue
🎯 Capital Budgeting: NPV, IRR, Payback Period
🎯 Financial Analysis Ratios & Metrics
🎯 Vertical / Common Size Analysis
🎯 Horizontal / Trend Analysis
🎯 Free Cash Flows Calculations
🎯 Cash Flow Ratios
🎯 DCF Discounted Cash Flow Valuation with assumptions
🎯 Enterprise Value Sensitivity Table Analysis
🎯 Equity Value Sensitivity Table Analysis

The Place and Purpose of the CFO Office in a Company Org Chart

Do you know the place and purpose of the CFO Office in your company’s Org Chart?

Think about it like this: if your organization was a building, your org(anizational) chart would be its blueprint.

Here’s what your org chart does in simple terms:

🎯 it outlines the structure of your company

🎯 it shows your different departments and teams

🎯 it provides a plan for organizing your people and resources

🎯 it defines roles and inter-relations, the span of control, and the reporting hierarchies

🎯 it promotes communication and coordination to improve your organizational effectiveness and avoid inefficiencies

Because your organization is different than others, your org chart will also look differently.

And while the design of your org chart may differ from that of other companies, it will still need to perform all the relevant functions necessary to operate your business.

So what is the purpose of the CFO Office in a typical org chart?

In very simple terms, your company’s CFO takes care of your company's money and makes sure that they’re working to support your company’s goals.

The CFO office has 3 main functions reporting to it: controlling, treasury, and FP&A.

🎯 The Controlling function ensures financial reporting complies with internal policies and external regulations.

🎯 The Treasury function ensures that your company has enough funds to meet its financial obligations.

🎯 The FP&A function (financial planning and analysis) ensures that your CFO and senior management have the right support to make informed financial decisions

Let’s break down the structure and work for each of these:

1️⃣ The Controlling function is structured around 6 main sub-functions with different responsibilities

⚫ financial reporting involves the preparation of monthly, quarterly, and annual financial statements in accordance with generally accepted accounting principles (GAAP).

⚫ compliance involves ensuring that the company's financial operations are conducted in accordance with relevant laws, regulations, and internal policies

⚫ risk management involves identifying, assessing, and mitigating financial reporting risk

⚫ audit management involves coordinating and leading the annual audit process, liaising with external auditors, and assessing necessary changes.

⚫ budget oversight involves ensuring the accuracy, completeness, and consistency of the budget data, and its compliance with accounting principles and internal regulations.

⚫ tax management involves ensuring the compliance with regulatory reporting requirements and tax filings.

2️⃣ The Treasury function is structured around 6 main responsibilities

⚫ cash management involves forecasting daily cash requirements and managing short term liquidity

⚫ banking management includes ensuring the efficient operation of the company's banking and cash management systems.

⚫ currency risk management involves managing the company's foreign currency exposure and devising strategies to minimize risk.

⚫ risk management involves the assessment, management, and mitigation of key threats to the corporation's treasury operations (liquidity, credit, interest rate).

⚫ financing involves the coordination of long-term and short-term funding needs and strategies.

⚫ investment management involves identifying the most suitable investment opportunities for the company's excess cash, in line with its financial strategy and risk appetite.

3️⃣ The FP&A function is structured around 6 main responsibilities

⚫ budget management involves leading the process of creating the budget, including working with various departments to develop their individual budgets, analyzing those budgets for alignment with company strategic goals, and making adjustments as necessary

⚫ financial analysis involves interpreting the company financial information and providing updates and information as needed to the CEO, the executive team, and the board of directors.

⚫ forecasting involves providing accurate and timely financial and operational trend analysis including forecast vs. budget.

⚫ scenario analysis involves creating and using financial models to analyze aggregate sets of assumptions and their potential impact on the company's financial health and future performance.

⚫ strategic planning involves providing assistance for decision-making such as tracking performance by product, customer or region, evaluating major capital expenditure plans, and negotiating contracts.

⚫ performance management involves establishing and monitoring performance indicators, highlighting trends and analyzing variances.

Learn your Cash Flows, Master your Future

Regardless whether you’re a professional, an executive or a business owner, cash flow mastery will transform your future.

There are 3 types of business activities and each of them can absorb or release cash into a business.

1️⃣ Operating Activities

🎯 the primary sources and uses of cash in a company's day-to-day business operations

🎯 include cash generated from sales, cash paid for purchases and cash paid for operating expenses

Key sources of cash in this section include:

♦️ Cash received from new sales in the period

♦️ Cash collected from accounts receivable (sales in prior periods)

♦️ Cash received as interest and dividends

Key uses of cash in this section include:

♦️ Cash payments to suppliers and employees (includes cash paid for current COGS and OPEX as well as those owing from a prior period, extracted from changes in Inventory and AP balances)

♦️ Cash interest payments made on debt

♦️ Cash payments made for income taxes

***Depending on the accounting framework followed, dividends and interest paid/received may be classified into financing cash flows

How to Master your Operating Cash Flow:

☑️ Monitor and analyze your cash conversion cycles to identify inefficiencies in receivables, payables, and inventory management.

☑️ Perform sensitivity analyses to evaluate the impact of changes in key variables, such as sales, costs, and credit terms, on Operating Cash Flow

2️⃣ Investing Activities

🎯 involve the acquisition and disposal of long-lived assets, such as property, plant, equipment, and investments.

🎯 represent your investment in the future growth of your business

Key sources of cash in this section include:

♦️ Cash received from the sale of property, plant, and equipment

♦️ Cash received from the sale of investments (stocks, bonds, etc.)

♦️ Cash received from repayments of loans made to others

Key uses of cash in this section include:

♦️ Cash paid for the purchase of property, plant, and equipment

♦️ Cash paid for the purchase of investments (stocks, bonds, etc.)

♦️ Cash paid out to others as loans

How to Master your Investing Cash Flow:

☑️ Use capital budgeting techniques, such as net present value (NPV) and internal rate of return (IRR), to evaluate, rank and prioritize investment decisions.

☑️ Analyze the correlation between Investing Cash Flows and Operating Cash Flows to determine the effectiveness of your investment strategies in ultimately driving your cash flow growth.

3️⃣ Financing Activities

🎯 include transactions with the company's owners and creditors

Key sources of cash in this section include:

♦️ Cash received from the issuance of common stock or preferred stock

♦️ Cash received from the issuance of debt (bonds, loans, etc.)

Key uses of cash in this section include:

♦️ Cash paid to repurchase common stock or preferred stock

♦️ Cash paid for the repayment of debt (bonds, loans, etc.)

♦️ Cash paid out to shareholders as dividends

How to Master your Financing Cash Flow:

☑️ Determine your optimal capital structure by analyzing the trade-off between debt and equity financing in terms of cost, risk, and cash flow implications.

☑️ Evaluate the impact of your dividend payment policy on cash flow, leverage, debt coverage and shareholder value creation.

Accounting vs. Finance KPIs

🎯 Finance KPIs focus on the financial performance of a company and help assess value creation by measuring financial health, ability to generate profits and ability to manage capital appropriately.

⚫Key Finance KPIs include:

Profitability KPIs provide insights into a company's ability to generate profits and create value for shareholders.

➡️ Economic Value Added (EVA) = NOPAT - (Invested Capital x WACC)

➡️ Earnings Per Share (EPS) = (Net Income - Preferred Dividends) / Weighted Average Shares Outstanding

➡️ Price to Earnings Ratio (P/E Ratio) = Market Price per Share / Earnings per Share (EPS)

Cash Flow Management KPIs help assess a company's ability to generate cash from operations, which is critical for growth, reinvestment, and debt repayment.

➡️ Free Cash Flow (FCF) = Operating Cash Flow - Capital Expenditures

Capital Structure KPIs evaluate a company's capital structure, financing costs, and financial risk, informing decisions on debt and equity financing.

➡️ Weighted Average Cost of Capital (WACC) = (E/V x Re) + ((D/V x Rd) x (1 - Tax Rate))

➡️ Debt to Equity Ratio = Total Debt / Total Equity

Liquidity Management KPIs measure a company's ability to meet its short-term financial obligations, providing insights into its liquidity position and financial stability.

➡️ Current Ratio = Current Assets / Current Liabilities

➡️ Quick Ratio (Acid-Test Ratio) = (Current Assets - Inventory) / Current Liabilities

Shareholder Value Creation KPIs evaluate the company's ability to generate returns for shareholders and distribute profits through dividends.

ROE = Net Income / Average Shareholder’s Equity

Dividend Payout Ratio = Dividends / Net Income

Asset Management KPIs measure a company's efficiency in generating returns on its assets and invested capital, providing insights into asset utilization and capital allocation.

➡️ ROA = Net Income / Average Total Assets

➡️ ROIC = EBIT (1-tax) / (Long Term Debt + Equity - Cash)

🎯 Accounting KPIs focus on the day-to-day operations of a company to help measure and monitor financial operation efficiency, and the effectiveness of assets, liabilities, and cash flow management.

🟢Key Accounting KPIs include:

Accounts Receivable Management KPIs help assess the effectiveness of a company's credit and collection policies, as well as the efficiency of managing customer payments.

➡️ Accounts Receivable Turnover = Net Credit Sales / Average Accounts Receivable

➡️ Days Sales Outstanding (DSO) = Average Accounts Receivable / Net Credit Sales x 365

Accounts Payable Management KPIs evaluate how efficiently a company manages its payments to suppliers and other creditors.

➡️ Accounts Payable Turnover = Purchases / Average Accounts Payable

➡️ Days Payable Outstanding (DPO) = Average Accounts Payable / Purchases x 365

Inventory Management KPIs measure the effectiveness of inventory management, determining how quickly a company sells and replenishes its stock.

➡️ Inventory Turnover = Cost of Goods Sold / Average Inventory

➡️ Days Inventory Outstanding (DIO)= Average Inventory / Cost of Goods Sold x 365

Asset Utilization KPIs evaluate how effectively a company uses its assets to generate sales, helping identify areas for improvement and better resource allocation.

➡️ Total Asset Turnover = Net Sales / Average Total Assets

Cash Flow Management KPIs assess the efficiency of a company's cash flow management, providing insights into working capital requirements and cash flow optimization strategies.

➡️ Operating Cash Flow Ratio = Operating Cash Flow / Current Liabilities

Profitability and Margins KPIs help determine the effectiveness of a company's pricing strategies, cost control, and inventory management in generating profits.

➡️ Gross Profit Margin = (Net Sales - Cost of Goods Sold) / Net Sales

➡️ Net Profit Margin = Net Income / Net Sales

Accounting vs. Finance KPIs - Oana Labes, MBA, CPA

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Thanks so much for reading. See you next week.


The mother of Cash and EBITDA - compliments of Nicolas Boucher