THIS WEEK’S ISSUE AT A GLANCE

This issue’s finance Gems 💎 vote your favorite in the poll section

• Accounting vs. Finance Careers

• The CEO’s Performance Checklist

• 20 Cash Flow Drivers to Know

• 7 Cost Drivers to Use

• BONUS Content: My custom cash flow measure

1. The Finance Gem has gone bi-weekly

Thanks to all that have taken the time to answer the poll below. For everyone else getting value from this newsletter, here’s your chance to contribute your thoughts!

Thousands of you reached out and answered polls over the past few months to suggest the length and frequency of the newsletter could be revised. I’m starting by reducing the frequency from 4x monthly to 2x monthly. Stay tuned for more updates.

As of this issue, you will find more custom content and practical examples included in every post to help you both understand and apply concepts better.

 Let me know if you’re loving these changes using the poll below!

2. Check out the results of some of this week’s polls and share your votes and comments below:

Poll #1 - what’s your take?

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Poll #3 - what’s your take?

3. My new course is now live: The Financial Analysis Masterclass sale is on. Save with the launch price for a limited time. Details below.

4. I’m speaking once again at the largest finance conference in the world! AFP2024 takes place in Nashville in October - reply to this email to let me know if you’re attending!

   

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THIS WEEK’S FINANCE GEMS

1. Accounting vs. Finance Careers

Accounting and Finance are not the same.

And neither are Accounting and Finance Careers

Accounting and Finance are distinct functions

And they each require a different focus and skills.

Accounting focuses on recording, reporting & compliance.

Finance focuses on forward looking business decision-making.

And together they complement each other to enable the financial goals of every organization.

Read more in this week's issue of The Finance Gem. Subscribe and get my bonus cheat sheets: https://bit.ly/3T3CtPm

➡ What are the main positions in each function?

⚫Accounting Roles include: Staff Accountant, Senior Accountant, Accounting Manager, Controller, Chief Financial Officer

⚫Finance Roles include: Financial Analyst, Senior Financial Analyst, Financial Manager, Chief Financial Officer, Investment Banker

➡ What are the typically required designations?

⚫Accounting designations include: CPA (Certified/Chartered Professional Accountant), CMA (Certified Management Accountant), CIA (Certified Internal Auditor), CGMA (Chartered Global Management Accountant)

⚫Finance designations include: CFA (Chartered Financial Analyst), FRM (Financial Risk Manager), CAIA (Chartered Alternative Investment Analyst), CPA (Certified/Chartered Professional Accountant)

➡ What are the soft skills needed for success in each position?

⚫ Key Soft skills in Accounting include: Detail oriented, Conservative thinking, Analytical and Organized, Process driven, Business acumen, Problem solving and Critical thinking

⚫ Key Soft skills in Finance include: Research Oriented, Analytical and Collaborative, Risk-taking, Innovative thinking, Results driven, Business acumen, Communication, Problem solving and Negotiation

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2. The CEO’s Performance Checklist

CEOs dream big.

But they also struggle big.

They struggle to make informed decisions

They struggle to align goals across their organizations.

They struggle to implement effective performance management

Here’s a 15 point checklist with 140+ check points to help CEOs achieve big dreams.

1. Align Organizational Goals:

↳ Define and communicate clear, strategic objectives company-wide.

↳ Ensure individual and team goals align with the overall business strategy.

2. Develop and Implement Effective Performance Management Systems:

↳ Establish continuous performance evaluation processes.

↳ Use a mix of qualitative and quantitative metrics for assessment.

3. Enhance Data-Driven Decision Making:

↳ Leverage analytics and business intelligence for informed decision-making.

↳ Encourage input from various departments for a well-rounded perspective.

4. Create Balanced Incentive Structures:

↳ Align incentives with both short-term achievements and long-term goals.

↳ Customize incentives to suit different team needs and motivations.

5. Foster a Culture of Continuous Improvement:

↳ Promote regular feedback and learning opportunities.

↳ Recognize and reward innovation and efficiency improvements.

6. Improve Risk Management Strategies:

↳ Develop a proactive approach to identifying and mitigating risks.

↳ Train teams to recognize and report potential risks promptly.

7. Enhance Leadership Communication Skills:

↳ Practice transparent and consistent communication.

↳ Use storytelling and empathy to connect with and inspire teams.

8. Build Resilience and Adaptability:

↳ Prepare for and effectively manage crises.

↳ Encourage flexibility and agility in strategies and operations.

9. Invest in Employee Development and Succession Planning:

↳ Offer training programs aligned with future organizational needs.

↳ Identify and nurture potential leaders within the organization.

10. Promote Ethical Leadership and Corporate Governance:

↳ Uphold integrity and ethical standards in all business practices.

11. Adopt a Global Perspective and Cultural Sensitivity:

↳ Understand and adapt to global market dynamics.

↳ Embrace cultural diversity in the workplace.

12. Focus on Personal CEO Development:

↳ Engage in continuous learning and self-improvement.

↳ Balance professional responsibilities with personal well-being.

13. Leverage Technology for Efficiency:

↳ Implement cutting-edge tools for better productivity.

14. Build Strong Stakeholder Relationships:

↳ Engage actively with customers, partners, and shareholders.

15. Ensure Sustainability and Social Responsibility:

↳ Integrate sustainable practices into business operations.

Download a complimentary image here or purchase the CEO’s checklist or the CEO’s Power Bundle in my online store.

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3. 7 Cost Drivers to Use

You can’t control your Profits…

If you can’t control your Costs.

There are 7 main Cost Drivers you should control to drive your profitability.

Some are within your control (internal) and others are outside your control (external).

🎯 Your internal cost drivers are within the control of your business, and you can influence them through your operations and management practices.

🎯 Prioritize these drivers to improve your cost structure and competitiveness

☑️ Internal cost drivers include: volume, efficiency, process improvements, and quality.

🎯 Your external cost drivers are outside the direct control of your business, and they are influenced by external market conditions, such as supply and demand, commodity prices, and regulatory requirements.

🎯 Monitor these drivers and adapt your strategy as necessary to respond to market conditions.

☑️ External cost drivers include: material costs, labor costs, and overhead costs.

Here’s how you can use each of these 7 drivers to positively impact your Costs:

1️⃣ Volume

🎯 Increase production volumes to take advantage of economies of scale

🎯 Implement a just-in-time (JIT) inventory system to reduce inventory costs

🎯 Consolidate your production facilities to reduce fixed costs

2️⃣ Efficiency

🎯 Reduce your cycle time by implementing lean manufacturing

🎯 Automate manual processes to increase productivity

🎯 Improve product design to reduce waste and scrap

3️⃣ Process improvements

🎯 Streamline workflows and eliminate non-value-added activities

🎯 Invest in technology to automate manual processes

🎯 Implement kaizen programs to drive process improvements

4️⃣ Quality

🎯 Implement quality control procedures to reduce your defects and scrap

🎯 Invest in employee training and development to improve your product quality and performance

5️⃣ Material costs

🎯 Optimize your material usage through better inventory management and production planning

🎯 Explore alternative materials or substitutes to reduce costs

6️⃣ Labor costs

🎯 Cross-train employees to improve flexibility and reduce overtime costs

🎯 Improve employee retention and engagement to reduce your turnover costs

🎯 Use temporary or contract labor to supplement permanent staff

7️⃣ Overhead costs

🎯 Outsource your non-core functions to reduce fixed overhead costs

🎯 Implement a telecommuting program to reduce your office space costs

4. 20 Cash Flow Drivers to Know

Because your Business grows with Revenue and ends with Cash Flow.

➡️ Cash flow performance metrics help you assess your company's financial health, operating efficiency, liquidity and performance.

➡️ The 3 main cash flow drivers are Revenue, Operating Margin, and Operational Efficiency and each of these drivers should get monitored

↳ ↳ ↳ Join my free Cash Flow Masterclass and learn essential skills to compound your impact and influence: https://bit.ly/49n7Lqh

1. Sales Revenue Forecast:

🎯 The revenue you expect to generate y/y from normal business operations

2. Sales Revenue Budget to Actuals:

🎯 A comparison of the revenues you budgeted for the period against those you actually achieved

3.Sales Pipeline:

🎯 A visual representation and tracking of where potential customers are in the process of becoming actual customers, from initial contact to closing the sale.

4.Sales Backlog:

🎯 Represents confirmed sales orders that have not yet been fulfilled; an indicator of future revenue that is secured but not yet realized.

5.Gross Profit:

🎯 Total revenue minus the cost of goods sold (COGS); indicates how efficiently a company uses labor and supplies in the production process.

6.Gross Profit Margin:

🎯 Shows the percentage of revenue that exceeds the cost of goods sold; a key metric to assess pricing strategy and production efficiency.

7.Net Profit:

🎯 The actual profit after all expenses, including operating expenses, interest, and taxes, have been deducted from total revenue.

8.Net Profit Margin:

🎯 Indicates what percentage of revenue remains as profit after all expenses; a critical indicator of overall financial health and operational efficiency.

9.Operating Cash Flow (OCF):

🎯 Cash generated from regular operating activities, indicating the company's ability to generate sufficient positive cash flow to maintain and grow operations.

10.Financing Cash Flow:

🎯 Cash flows associated with funding the business which includes cash activities related to debt, equity, and dividends.

11.Investing Cash Flow:

🎯 Cash flow resulting from the purchase or sale of assets like equipment and investments, minus capital expenditures that are not expensed in the income statement.

12. Days Sales Outstanding (DSO):

🎯 The average number of days you take to collect on outstanding customer (AR) balances

AR/Revenue x 365

13. Days Inventory Outstanding (DIO):

🎯 Average number of days you take to sell your inventory

Inventory/COGS x 365

14. Days Payable Outstanding (DPO):

🎯 Average number of days you take to settle outstanding supplier (AP) invoices

AP/Purchases x 365

15. Cash Conversion Cycle (CCC):

🎯 The average number of days it takes you to convert your inventory investment into sales, your sales into receivables and your receivables into cash.

DIO + DSO - DPO

16. Free Cash Flow (FCF):

Cash Flow available after operating costs

🎯 Net Income + Interest + Taxes + Depreciation/Amortization +/- Non-Cash Items +/- Changes in Working Capital +/- Changes in Fixed Assets

17. Cash Burn Rate:

🎯 Showcases how long current cash reserves will last.

Cash on hand / Monthly cash outflow.

18. Cash Debt Service Coverage Ratio;

🎯 Measures ability to repay debts from operating cash flow.

Operating Cash Flow / Total Debt Service

19. Operating Cash Flow Margin:

🎯 Evaluates the efficiency of a company's operations by comparing operating cash flow to sales.

Operating Cash Flow Margin = (Operating Cash Flow / Sales) x 100

20. Free Cash Flow to Equity (FCFE):

🎯 Represents the cash flow available to equity shareholders

FCFE = Net Income + Depreciation/Amortization - Changes in Working Capital - Capital Expenditures + Net Borrowing

BONUS Content: My Custom Cash Flow Metric

This week I asked my Linkedin community a strategic cash flow question:

What’s the best way to measure cash flow?

Bank Cash Balances

Operating Cash Flow

Operating Cash Flow Margin

Free Cash Flow

Overwhelmingly, people voted 57% in favor of Free Cash Flow which was exciting to see.

Here's my take: While each metric has its strengths, they also have limitations that can obscure a company's financial health if used in isolation:

Bank Cash Balances might seem a straightforward measure, but they can be misleading. They only reflect the cash available at a specific moment and don't account for upcoming liabilities or the timing of incoming cash flows. They also tell you nothing about the source of cash inflows or destination of cash outflows, or the health of the organization’s earnings to name a few shortfalls.

Operating Cash Flow is critical as it shows the cash generated from core business operations, indicating whether a business can sustain its operations independently of external financing. However, it fails to consider the cash used for capital investments or financing activities, which are crucial for growth and capital structure stability.

OCF = Net Income + Non-Cash Expenses + Changes in Working Capital

The Operating Cash Flow Margin is an excellent indicator of how efficiently a company converts sales into cash, reflecting operational efficiency. However, this metric alone isn't enough to judge the overall health of a business, as it doesn't consider how cash is being used to fund investments or service debt.

OCF Margin = (Operating Cash Flow / Total Revenue) x 100

Free Cash Flow provides a deeper insight by showing the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets. However, it still overlooks how cash is allocated to debt repayments, which can significantly affect a company’s financial flexibility.

FCF = Operating Cash Flow - Capital Expenditures

Given these nuances, my preference leans towards an adjusted Free Cash Flow to Equity (FCFE) measure.

Adjusted FCFE = Net Income + Depreciation/Amortization - Changes in Working Capital - Capital Expenditures - Debt Principal Payments

My adjusted FCFE specifically considers cash flows dedicated to debt outflows, offering a clearer picture of the cash available to shareholders or for reinvestments into the business after all obligations are met. This measure is more aligned with assessing the actual financial health of a company from an external financing party standpoint, as it focuses on what's truly available for allocation rather than just the operational efficiency or simple cash accumulation.

Here’s a quick example you can study to get a deeper understanding of these concepts.

Imagine you’re dealing with XYZ Co. and below is their cash flow overview:

• Operating Cash Flow (OCF): $30,000

  • Net Income + Non-Cash Expenses + Changes in Working Capital.

• Free Cash Flow (FCF): -$20,000

  • Operating Cash Flow minus $50,000 in capital expenditures, showing a deficit due to significant investment in assets.

• Adjusted Free Cash Flow to Equity (FCFE): -$70,000

  • Operating Cash Flow minus capital expenditures and minus $50,000 in debt principal payments, reflecting the real cash available to shareholders after fulfilling all operational and investing needs and financial commitments.

Do you see the problem?

• OCF indicates a positive cash flow from operations, suggesting effective operating management.

• FCF is negative, revealing that the company is spending more on maintaining and expanding its asset base than it's generating from operations.

• Adjusted FCFE is even more negative, emphasizing the additional financial strain from debt repayments, which is critical for understanding the cash truly available to equity holders.

So how much should this company distribute to shareholders or commit to investing in further debt repayments or growth investments?

$0.

This example highlights the limitations of OCF and FCF in revealing the full financial picture. OCF overlooks capital and financing needs, while FCF still doesn't account for cash used in debt repayments. In contrast, Adjusted FCFE provides a much more comprehensive view of the cash flow position by incorporating debt obligations, demonstrating its utility in assessing the true financial health of the business.

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