The Finance Gem 2023💎 Week #14
Accounting vs. Finance, Financial Modeling and Cash Flow
Welcome to this week's edition of The Finance Gem 💎 where I bring you my unabbreviated Linkedin insights you loved - so you can save them, and those you missed - so you can enjoy them.
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The Cash Flow Masterclass
This week's strategic finance insights:
Without further ado, let's begin:
🎯 Cash flow ratios help you assess your company's financial health, operating efficiency, liquidity and performance.
🎯 Your 3 main cash flow drivers are Revenue, Operating Margin, and Operational Efficiency and each of these drivers should get captured into a ratio
🎯 Here are the top five cash flow ratios to know and track:
1️⃣ Free Cash Flow Margin
🎯 Measures your company's free cash flow generation capacity relative to its Revenue.
🎯 Calculate it dividing free cash flow by sales after discounts, allowances and returns
Free Cash Flow = Cash Flow from Operations - Capital Expenditures
Free Cash Flow Margin = (Free Cash Flow / Net Sales) x 100
2️⃣ Cash Flow Margin
🎯 This ratio indicates how efficiently your company generates cash from Revenue.
🎯 Similar to the Free Cash Flow Margin, but more relevant if your company doesn’t require substantial ongoing investment in its fixed asset base
🎯 Calculate it dividing cash flow from operations by sales after discounts, allowances and returns
Cash Flow Margin = (Cash Flow from Operations / Net Sales) x 100
3️⃣ Cash Flow Coverage Ratio
🎯 Measures your company's ability to meet debt obligations using cash from operations.
🎯 Calculate it dividing cash flow from operations by total principal and interest obligations.
Cash Flow Coverage Ratio = Cash Flow from Operations / (Principal + Interest)
4️⃣ Cash Conversion Efficiency Ratio (CCE)
🎯 Measures your company's effectiveness in managing its working capital and converting investments in inventory and accounts receivable into cash from Revenue.
🎯 Calculate it dividing Net Sales by the average working capital investment during the period
Cash Conversion Efficiency Ratio = Net Sales / (Beginning Working Capital + Ending Working Capital)/2
5️⃣ Operating Cash Flow Ratio
🎯 Measures your company's ability to meet short-term obligations using cash from operations
🎯 Calculate it dividing cash flow from operations by current liabilities.
Operating Cash Flow Ratio = Cash Flow from Operations / Current Liabilities
5 Cash Flow Ratios you need to know - Oana Labes, MBA, CPA
1// Gross Revenue and Gross Revenue Growth
🎯 The total amount of money you earn from sales before deducting discounts, returns and allowances for such.
2// Net Revenue and Net Revenue Margin
🎯 The total amount of money you earn from sales after deducting discounts, returns and allowances, expressed in absolute terms or as a percentage
3// Gross Profit and Gross Profit Margin
🎯 The residual gross revenue you earn after deductions, returns and allowances, and after paying for direct costs (Cost of Sales or Cost of Goods Sold) expressed in absolute terms or as a percentage
4// Operating Profit and Operating Profit Margin
🎯 The residual gross revenue you earn after deductions, returns and allowances, after paying for direct costs (Cost of Sales or Cost of Goods Sold) and also after paying for Operating Costs (Sales, General, Administrative, Research and Development)
5// Net Operating Profit after Tax and Net Operating Profit Margin after Tax
🎯 The residual gross revenue you earn after deductions, returns and allowances, after paying for direct costs (Cost of Sales or Cost of Goods Sold), after paying for Operating Costs (Sales, General, Administrative, Research and Development) and after paying for Taxes as well.
6// Monthly Recurring Revenue (MRR) and Annual Recurring Revenue (ARR)
🎯 The recurring portion of your subscription revenue on a monthly or annual basis.
7// Average Revenue per User (ARPU)
🎯 The average amount of money you earn from each user over a given time period.
8// Customer Lifetime Value (LTV)
🎯 The total amount of revenue you can expect to earn from a customer over their lifetime engagement with them.
9// Customer Acquisition Cost (CAC)
🎯 The total cost you incur to acquire a new customer.
10// Customer Churn
🎯 The number of customers which cancelled their subscription or which otherwise stopped doing business with your company, measured as a percentage of total customers at the beginning of the period.
11// Customer Retention
🎯 The number of customers which keep/renew their subscription or otherwise continue doing business with your company, measured as a percentage of total customers at the beginning of the period.
12// Revenue Conversion Rate
🎯 The percentage of your online platform/website/campaign visitors who make a purchase.
13// Revenue Concentration
🎯 The percentage of your revenue distribution across your largest customers.
14// Revenue to Operating Cash Flow
🎯 The proportion of sales revenues that your business converted to cash during the period.
15// Recurring Revenue Margin
🎯 The percentage of your revenue that comes from repeat customers
16// Revenue per Revenue Driver
🎯 The amount of revenue you earned per unit of each relevant driver (employees, square footage, market, etc)
17// Sales Volume Variance
🎯 The difference between your actual sales volume and your budgeted sales volume.
18// Sales Price Variance
🎯 The difference between your actual sales price and your budgeted sales price.
19// Sales Mix Variance
🎯 The proportion of different products or services you sell in the total makeup of your revenue during the period.
20// Pipeline Conversion Rate
🎯 The proportion of your sales funnel that converted to revenue during the period.
20 Revenue KPIs to Know - Oana Labes, MBA, CPA
Accounting and Finance and not the same.
They define value differently.
They have different objectives
They have different perspectives
They require different technical skills.
Knowing how they differ will help you appreciate how each of them ads value.
Knowing how they work together will help advance your career.
🎯 The Accounting approach is backward looking and concerned with compliance against accounting principles and reporting obligations.
🎯 It focuses on smoothing out the results of economic activity over time to match revenues and expenses.
🎯 It's also conservative in the recording and reporting of the results of economic activity.
🎯 The Finance approach is forward looking.
🎯 It has evolved in response to Accounting's accrual framework to uncover the true measure of profitability for a business.
🎯 It prioritizes cash and focuses on value creation through capital allocation.
Remember that despite their differences, Finance and Accounting are complementary, and you need both to drive profitability and growth in your business.
Excel has a number of functionalities which many of us are familiar with, but here are 5 of my favorites that not many people use.
🎯 Brings up the "Go To" dialog box, which allows you to quickly navigate to a specific cell, range, or defined name in your spreadsheet.
🎯 Used with Crtl + [ it helps you return to the cell you started from
🎯 Used with the Special + Constants + Numbers it can identify hard coded numbers in the worksheet, so you can color code them for easy identification later on.
2️⃣ Watch window (Formulas >> Formula Auditing)
🎯 Used to help monitor changes in cells you want to track
🎯 Especially useful when tracked cell information is in a different workbook
🎯 Can be toggled on an off, as well as dragged to the top or side of your screen and attached to your workbook
3️⃣ Named Ranges (Formulas >> Name Manager)
🎯 Used to make it easier to reference cells in your formulas and use descriptive names instead of cell references.
🎯 Used to improve your ability to read a formula so you know exactly what the formula is doing.
🎯 All named ranges can be pasted as a list so you can see an overview
4️⃣ Data Validation (Data >> Data Tools)
🎯 Used to control what data can be entered into a cell or range of cells and ensure that data entered is accurate and consistent.
🎯 Use the “List” option to create easy drop down menus where input values are either manually input or selected from the sheet
🎯 Use the "Error Alert" section to specify a custom error message that will pop up if an invalid value is entered
5️⃣ Print Headers (Select Header Rows >> Name Box >> name them “print_titles”)
🎯 Used to indicate which rows or columns will be repeated on every page when printing a worksheet.
🎯 Helpful for long vertical models where you want the headers to be printed on all pages
Accrual vs. cash basis accounting:
Accrual accounting records financial transactions when they are incurred, regardless of when the money is actually received or paid
Cash accounting records financial transactions only when the money is received or paid.
Depreciation vs. Amortization
Depreciation is a method of allocating the cost of a long-term physical asset over its useful life.
Amortization is the process of allocating the cost of an intangible asset over its useful life.
Gross profit vs. Net Profit
Gross profit is the difference between revenue and the direct costs of selling a product or service (cost of goods sold or cost of sales)
Net profit is gross profit minus operating expenses.
Gross Profit vs. Gross Profit Margin
Gross profit is the difference between revenue and the direct costs of selling a product or service (cost of goods sold or cost of sales).
Gross Profit Margin is the Gross Profit divided by Revenue.
GAAP vs IFRS
GAAP (Generally Accepted Accounting Principles) is a set of accounting standards. US GAAP is the GAAP used in the United States
IFRS (International Financial Reporting Standards) is a set of accounting standards used globally.
Fair value vs. historical cost
Fair value accounting is a method of accounting that values assets and liabilities at their current market value
Historical cost is an accounting principle that values assets and liabilities at their original cost.
Allowance for Doubtful Accounts vs Bad Debt Expense
The allowance for doubtful accounts (AFDA) is a contra-asset account used to record the estimated balance of uncollectible accounts receivable.
Bad debt expense is the actual amount of accounts receivable that the company has written off and expensed as uncollectible.
Goodwill vs Intangible Assets
Goodwill is an intangible asset recorded as part of a business acquisition and representing the value of a company beyond its tangible assets.
Intangible assets are non-physical assets such as patents, copyrights, trademarks, and brand value, recorded at cost only if they meet recognition criteria and amortized over their useful life.
Capital Expenditures vs Revenue Expenditures
Capital expenditures (or expenses on account of capital) are investments in long-term assets which will support the company to generate Revenue over several periods.
Revenue expenditures (or expenses on account of revenue) are expenses incurred in the normal course of business to support the company to earn revenue in a particular period
Fair value vs. carrying value:
Fair value is an estimate of the price that an asset could be sold for between a willing buyer and seller in an open market.
Carrying value is the value at which an asset is recorded on a company's balance sheet.
Fixed Assets vs Current Assets:
Fixed assets are long-term physical assets used by a company to earn Revenue over several periods.
Current assets are short-term assets that are expected to be converted into cash or otherwise used within one operating cycle, typically a year.
Accumulated Depreciation vs Depreciation Expense
Accumulated depreciation is the cumulative amount of depreciation expense recorded to date
Depreciation expense is the amount of depreciation recorded in a specific period of time.
Contingent Liabilities vs Contingent Assets
Contingent liabilities are potential obligations that may become actual obligations if certain events occur.
Contingent assets are potential assets that may become actual assets if certain events occur.
Deferred Revenue vs. Unbilled (Accrued) Revenue
Deferred revenue is Revenue that has been invoiced but not yet earned (liability)
Unbilled (Accrued) Revenue is Revenue that has been earned but not yet invoiced (asset)
Deferred Taxes vs Current Taxes:
Deferred taxes are estimated future tax obligations resulting from temporary differences between the cost basis of accounting and the tax basis of accounting for various assets and liabilities.
Current taxes are tax obligations that are due and payable in the current period.
Provision vs Reserve
A provision is an amount of money set aside to cover a potential future liability.
A reserve is an amount of money set aside to cover an expected future liability.
Capital Stock vs Retained Earnings
Capital stock is the total amount of money received by a company from the sale of its shares or stock.
Retained earnings represent the accumulated Net Income from prior periods that is has not been paid out as dividends and instead has been retained in the company.
Lease vs Loan
A lease is a financing agreement where a company buys the right to use an asset whose title may or may not transfer over to it at the end of the agreement.
A loan is a financing agreement where a company borrows money from another.
Useful life vs. Economic life
Useful life is the length of time an asset is expected to be used by a company for the purpose for which it was acquired, determined by management and used to calculate annual depreciation expense.
Economic life is the total length of time an asset is expected to provide economic benefits to a company, which can extend well past the point where it’s been fully depreciated.
Accounting Policy vs. Accounting Estimate
An accounting policy is a guideline established by company management and based on GAAP, which helps provide comparability and consistency in the reporting of transactions and events in the company’s financial statements.
An accounting estimate is a prediction made by management to help record transactions or events where the outcome is uncertain, such as the useful life of an asset or the collectability of accounts receivable.
20 Confusing Accounting Concepts - Oana Labes, MBA, CPA
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