The Finance Gem 2023๐Ÿ’Ž Week #18

Strategic Finance Insights you Absolutely Need

Welcome to this week's edition of The Finance Gem ๐Ÿ’Ž 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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Before we get started with this week's newsletter I have some great news to share:

THE CASH FLOW MASTERCLASS - my on-demand video course  - is LIVE

Here's what comes with the Cash Flow Masterclass:

  • 28 lessons on cash flow intelligence

  • 190 downloadable course slides

  • 10 downloadable infographics

  • 10 downloadable practice Excel models

  • Purchased Power Parity Pricing

Here's what's included in the Curriculum:

  • Cash flow fundamentals

  • Techniques to read, analyze, and prepare a cash flow statement

  • The key cash flow management principles and cash flow drivers

  • The strategic approach to effectively improve cash flow

  • The main cash flow traps and how to avoid them

For more details, head over to oanalabes.com and scroll down for a free preview!

In case you missed it:

This week's strategic finance insights:

  • The Cash Flow Cheat Sheet

  • Is Free Cash Flow Free

  • 5 Incredibly useful Financial Modelling Excel Tips

  • Does Free Cash Flow care about working capital?

Let's dive into this week's finance gems:

The Cash Flow Cheat Sheet 

Because Cash is King.

Cash Flow intelligence is critical for business success.

โ™ฆ๏ธ It helps you identify potential cash shortfalls.

โ™ฆ๏ธ It helps you take proactive measures to address them.

โ™ฆ๏ธ It helps you strategically manage cash flow to support long-term goals.

โ™ฆ๏ธ It helps you avoid insolvency and financial distress.

๐Ÿ‘‰ ๐‡๐ž๐ซ๐ž ๐ข๐ฌ ๐ฐ๐ก๐š๐ญ ๐“๐ก๐ž ๐‚๐š๐ฌ๐ก ๐…๐ฅ๐จ๐ฐ ๐‚๐ก๐ž๐š๐ญ ๐’๐ก๐ž๐ž๐ญ ๐ข๐ง๐œ๐ฅ๐ฎ๐๐ž๐ฌ:

๐ŸŽฏ The 5 Types of Cash Flows compared, with their components

๐ŸŽฏ The Direct vs. Indirect Cash Flow comparison

๐ŸŽฏ 10 critical Cash Flow Ratios from which to choose your KPIs

๐ŸŽฏ The Cash Conversion Cycle Diagram + Formula

๐ŸŽฏ The 3 Main Cash Flow Drivers and 30 Subdrivers

๐ŸŽฏ The difference between EBITDA and (Operating) Cash Flow

๐ŸŽฏ The 5 Steps to Manage your Cash Flow

๐ŸŽฏ The Cash Inflows and Outflows

๐ŸŽฏ The relevant and incremental Cash Flows in Capital Budgeting

๐ŸŽฏ The 16 Cash Flow Mistakes to Avoid

๐ŸŽฏ The Cash Flow Story Waterfall

๐ŸŽฏ The 15 Benefits of Effective Cash Flow Management

Use this Cheat Sheet to improve your cash flow knowledge.

And help others to the same.

The Cash Flow Cheat Sheet - Oana Labes, MBA, CPA

Is Free Cash Flow Free?

Free for whom? Free to do what?

Turns out, despite its misleading name, Free Cash Flow isnโ€™t freely available to your company.

๐ŸŽฏ๐๐ฎ๐ญ ๐Ÿ๐ข๐ซ๐ฌ๐ญ, ๐ฐ๐ก๐š๐ญ ๐ข๐ฌ ๐…๐ซ๐ž๐ž ๐‚๐š๐ฌ๐ก ๐…๐ฅ๐จ๐ฐ?

Free Cash Flow is cash generated by your companyโ€™s core operations, after paying for working capital and capital expenditures.

๐ŸŽฏ๐–๐ก๐š๐ญ'๐ฌ ๐ญ๐ก๐ž ๐Ÿ๐จ๐ซ๐ฆ๐ฎ๐ฅ๐š ๐ญ๐จ ๐œ๐š๐ฅ๐œ๐ฎ๐ฅ๐š๐ญ๐ž ๐…๐‚๐…?

๐—™๐—ฟ๐—ฒ๐—ฒ ๐—–๐—ฎ๐˜€๐—ต ๐—™๐—น๐—ผ๐˜„ (๐—™๐—–๐—™) = Operating Cash Flow +/- Changes in Fixed Assets

๐ŸŽฏ๐–๐ก๐š๐ญ ๐๐จ๐ž๐ฌ ๐ญ๐ก๐ž ๐ง๐š๐ฆ๐ž ๐ฆ๐ž๐š๐ง?

The name โ€œFree Cash Flowโ€ comes from the fact that FCF is presumably free of obligations and available for:

>> discretionary spending or investing by management

>> distribution to shareholders

๐ŸŽฏ๐ˆ๐ฌ ๐ข๐ญ ๐ซ๐ž๐š๐ฅ๐ฅ๐ฒ ๐Ÿ๐ซ๐ž๐ž?

Nope.

Your Free Cash Flow only paid for Interest expense on debt, not Principal which means:

>> your company hasnโ€™t satisfied all its payment obligations to creditors

>> your Free Cash Flow is not freely available to until all creditor claims have been paid

๐ŸŽฏ๐“๐ก๐ž๐ง ๐ฐ๐ก๐ข๐œ๐ก ๐œ๐จ๐ฆ๐ฉ๐š๐ง๐ฒ ๐œ๐š๐ฌ๐ก ๐Ÿ๐ฅ๐จ๐ฐ ๐ข๐ฌ ๐Ÿ๐ซ๐ž๐ž?

The only truly free cash flow in your company is called Free Cash Flow to Equity (FCFE), and it accounts for everything Free Cash Flow does + net debt

๐ŸŽฏ๐–๐ก๐š๐ญ ๐š๐ซ๐ž ๐ญ๐ก๐ž ๐š๐๐ฏ๐š๐ง๐ญ๐š๐ ๐ž๐ฌ ๐ญ๐จ ๐ฎ๐ฌ๐ข๐ง๐  ๐…๐ซ๐ž๐ž ๐‚๐š๐ฌ๐ก ๐…๐ฅ๐จ๐ฐ (๐…๐‚๐…)?

โœ… Easy to calculate

โœ… Accounts for both cash consumed by CAPEX and cash consumed by sales growth or working capital efficiency losses

๐ŸŽฏWhat are the limitations of Free Cash Flow?

โŒ Assumes all CAPEX is a required investment, despite the fact most companies have a mix of replacement and growth CAPEX

โŒ Overstates CAPEX in the year of acquisition and understates it in subsequent years

โŒ There is no standardized calculation of Free Cash Flow so itโ€™s important to check with your bank or investor for their definitions

๐ŸŽฏCan Free Cash Flow be manipulated?

Absolutely.

๐Ÿ’ฃ If your company wants to increase Free Cash Flow, it can simply under-invest in fixed assets and distribute those resources out to shareholders instead.

๐Ÿ’ฃ Youโ€™ll have the shareholders celebrating in the short term while putting your company in double jeopardy over the long term - both from reduced cash balances and from an underproductive asset base.

5 Incredible useful Financial Modelling Excel Tips

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.

  1. F5

๐ŸŽฏ Brings up the "Go To" dialog box, which allows you to quickly navigate to a specific cell, range, or defined name in your spreadsheet.

๐ŸŽฏ Used with Crtl + [ it helps you return to the cell you started from

๐ŸŽฏ 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.

2. Watch window (Formulas >> Formula Auditing)

๐ŸŽฏ Used to help monitor changes in cells you want to track

๐ŸŽฏ Especially useful when tracked cell information is in a different workbook

๐ŸŽฏ Can be toggled on an off, as well as dragged to the top or side of your screen and attached to your workbook

3. Named Ranges (Formulas >> Name Manager)

๐ŸŽฏ Used to make it easier to reference cells in your formulas and use descriptive names instead of cell references.

๐ŸŽฏ Used to improve your ability to read a formula so you know exactly what the formula is doing.

๐ŸŽฏ All named ranges can be pasted as a list so you can see an overview

4. Data Validation (Data >> Data Tools)

๐ŸŽฏ Used to control what data can be entered into a cell or range of cells and ensure that data entered is accurate and consistent.

๐ŸŽฏ Use the โ€œListโ€ option to create easy drop down menus where input values are either manually input or selected from the sheet

๐ŸŽฏ Use the "Error Alert" section to specify a custom error message that will pop up if an invalid value is entered

5. Print Headers (Select Header Rows >> Name Box >> name them โ€œprint_titlesโ€)

๐ŸŽฏ Used to indicate which rows or columns will be repeated on every page when printing a worksheet.

๐ŸŽฏ Helpful for long vertical models where you want the headers to be printed on all pages

Here are 10 Excel Functions you should know compliments of the Financial Modelling World Cup

Does Free Cash Flow care about Working Capital?

Absolutely. All cash flow measures do.

But why?

โšซFree Cash Flow FCF is Operating Cash Flow OCF adjusted for the Net Changes in Fixed Assets.

โšซAnd Operating Cash Flow OCF is Net Income adjusted for Non-Cash items, Depreciation and Amortization, and Net Changes in Working Capital.

So putting these together:

โšซFree Cash Flow FCF is:

= Net Income

+ Depreciation/Amortization

+/- Non-Cash Revenues and Expenses

+/- Changes in Working Capital

+/- Changes in Fixed Assets

โšซBecause Net Working Capital is being adjusted from Net Income, itโ€™s clear that Free Cash Flow cares deeply about Working Capital.

Hereโ€™s why it does, and why you should care too:

1๏ธโƒฃ The cash invested into Inventory and Accounts Receivable is not available for your company to put to other uses.

โšซ๏ธ Cash spent on unsold inventory, or cash not collected from credit sales is not available to pay suppliers, pay taxes, or grow the business, invest in net new assets, or repay debt obligations.

โšซ๏ธ As Inventory is sold and turned into Receivables, and Receivables are sold and turned to Cash, the amount of cash invested in working capital assets (or Net Working Capital) during the year will change.

โšซ๏ธ Itโ€™s important to remember that the timing of the Net Working Capital measurement can have a magnifying or minimizing effect on Free Cash Flow, so time your reporting wisely.

2๏ธโƒฃ The cash invested into Working Capital Assets directly reduces your companyโ€™s net earning potential

โšซ๏ธ When your companyโ€™s ability to grow Revenues is dependent on it growing its Net Working Capital first, Free Cash Flow will reflect that.

โšซ๏ธ Your companyโ€™s capacity to scale earnings and service debt will not grow in line with topline Revenue, because part of the newly generated cash will stay invested in the current assets that power those revenues.

โšซ๏ธ Your companyโ€™s DCF valuation, calculated by further adjusting FCF to arrive at FCFE and then discounting those cash flows, will also reflect the true cash flow generation power of the business.

Profit is Not Cash Flow - Oana Labes, MBA, CPA

Whenever you're ready here are more ways in which I can help you:

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Thanks so much for reading. See you next week. 

The mother of Cash and EBITDA - compliments of Nicolas Boucher