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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Before we get started with this week's newsletter I have some great news to share:

Here's what comes with the Cash Flow Masterclass:

Here's what's included in the Curriculum:

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

Because Cash is King.

Cash Flow intelligence is critical for business success.

♦️ It helps you identify potential cash shortfalls.

♦️ It helps you take proactive measures to address them.

♦️ It helps you strategically manage cash flow to support long-term goals.

♦️ It helps you avoid insolvency and financial distress.

👉 𝐇𝐞𝐫𝐞 𝐢𝐬 𝐰𝐡𝐚𝐭 𝐓𝐡𝐞 𝐂𝐚𝐬𝐡 𝐅𝐥𝐨𝐰 𝐂𝐡𝐞𝐚𝐭 𝐒𝐡𝐞𝐞𝐭 𝐢𝐧𝐜𝐥𝐮𝐝𝐞𝐬:

🎯 The 5 Types of Cash Flows compared, with their components

🎯 The Direct vs. Indirect Cash Flow comparison

🎯 10 critical Cash Flow Ratios from which to choose your KPIs

🎯 The Cash Conversion Cycle Diagram + Formula

🎯 The 3 Main Cash Flow Drivers and 30 Subdrivers

🎯 The difference between EBITDA and (Operating) Cash Flow

🎯 The 5 Steps to Manage your Cash Flow

🎯 The Cash Inflows and Outflows

🎯 The relevant and incremental Cash Flows in Capital Budgeting

🎯 The 16 Cash Flow Mistakes to Avoid

🎯 The Cash Flow Story Waterfall

🎯 The 15 Benefits of Effective Cash Flow Management

Use this Cheat Sheet to improve your cash flow knowledge.

And help others to the same.

Free for whom? Free to do what?

Turns out, despite its misleading name, Free Cash Flow isn’t freely available to your company.

🎯𝐁𝐮𝐭 𝐟𝐢𝐫𝐬𝐭, 𝐰𝐡𝐚𝐭 𝐢𝐬 𝐅𝐫𝐞𝐞 𝐂𝐚𝐬𝐡 𝐅𝐥𝐨𝐰?

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

🎯𝐖𝐡𝐚𝐭'𝐬 𝐭𝐡𝐞 𝐟𝐨𝐫𝐦𝐮𝐥𝐚 𝐭𝐨 𝐜𝐚𝐥𝐜𝐮𝐥𝐚𝐭𝐞 𝐅𝐂𝐅?

𝗙𝗿𝗲𝗲 𝗖𝗮𝘀𝗵 𝗙𝗹𝗼𝘄 (𝗙𝗖𝗙) = Operating Cash Flow +/- Changes in Fixed Assets

🎯𝐖𝐡𝐚𝐭 𝐝𝐨𝐞𝐬 𝐭𝐡𝐞 𝐧𝐚𝐦𝐞 𝐦𝐞𝐚𝐧?

The name “Free Cash Flow” comes from the fact that FCF is presumably free of obligations and available for:

>> discretionary spending or investing by management

>> distribution to shareholders

🎯𝐈𝐬 𝐢𝐭 𝐫𝐞𝐚𝐥𝐥𝐲 𝐟𝐫𝐞𝐞?

Nope.

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

>> your company hasn’t satisfied all its payment obligations to creditors

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

🎯𝐓𝐡𝐞𝐧 𝐰𝐡𝐢𝐜𝐡 𝐜𝐨𝐦𝐩𝐚𝐧𝐲 𝐜𝐚𝐬𝐡 𝐟𝐥𝐨𝐰 𝐢𝐬 𝐟𝐫𝐞𝐞?

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

🎯𝐖𝐡𝐚𝐭 𝐚𝐫𝐞 𝐭𝐡𝐞 𝐚𝐝𝐯𝐚𝐧𝐭𝐚𝐠𝐞𝐬 𝐭𝐨 𝐮𝐬𝐢𝐧𝐠 𝐅𝐫𝐞𝐞 𝐂𝐚𝐬𝐡 𝐅𝐥𝐨𝐰 (𝐅𝐂𝐅)?

✅ Easy to calculate

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

🎯What are the limitations of Free Cash Flow?

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

❌ Overstates CAPEX in the year of acquisition and understates it in subsequent years

❌ There is no standardized calculation of Free Cash Flow so it’s important to check with your bank or investor for their definitions

🎯Can Free Cash Flow be manipulated?

Absolutely.

💣 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.

💣 You’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.

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.

2. 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

3. 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

4. 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

5. 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

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

Absolutely. All cash flow measures do.

But why?

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

⚫And 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:

⚫Free Cash Flow FCF is:

= Net Income

+ Depreciation/Amortization

+/- Non-Cash Revenues and Expenses

+/- Changes in Working Capital

+/- Changes in Fixed Assets

⚫Because Net Working Capital is being adjusted from Net Income, it’s clear that Free Cash Flow cares deeply about Working Capital.

Here’s why it does, and why you should care too:

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

⚫️ 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.

⚫️ 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.

⚫️ It’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.

2️⃣ The cash invested into Working Capital Assets directly reduces your company’s net earning potential

⚫️ When your company’s ability to grow Revenues is dependent on it growing its Net Working Capital first, Free Cash Flow will reflect that.

⚫️ Your company’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.

⚫️ Your company’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.

Thanks so much for reading. See you next week.