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- The Finance Gem 💎 Week #72: Profit, Cash Flow and Key Finance Skills for Managers
The Finance Gem 💎 Week #72: Profit, Cash Flow and Key Finance Skills for Managers
WELCOME TO ISSUE NO #72
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THIS WEEK’S ISSUE AT A GLANCE
This issue’s finance Gems 💎 vote your favorite at the end of the newsletter.
10 Levels of Profitability
Cash Flow 101
7 Finance Skills all Managers Need
The Profitability Cheat Sheet
2. The Finance Gem has gone bi-weekly
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’ve listened and now The Finance Gem is published 2x per month or bi-weekly.
3. Check out the results of some of last week’s polls and share your votes and comments below:
Poll #1 - what’s your take?
Poll: What do you think is the most critical KPI for business profitability? |
Poll #2 - what’s your take?
What should be the CFO's top priority today? |
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THIS WEEK’S FINANCE GEMS
10 Levels of Profitability
10 Levels of Profitability
Each of them tells a story.
Each of them has a purpose.
Do you know what those are?
Gross Profit:
Story: Reflects a company's efficiency in producing the products or services it sold, before considering general operating costs.
Purpose: To assess the direct profitability of a company’s operations.
Operating Profit (EBIT = Earnings Before Interest and Taxes):
Story: Provides insight into how well a company manages its day-to-day operations, including production, staffing, and overhead.
Purpose: To gauge the company's operating efficiency before finance and tax expenses.
Net Profit (Net Income):
Story: The bottom-line indicator of a company's financial health, reflecting its ability to generate profit after all expenses, including taxes and interest.
Purpose: To provide a comprehensive view of the company's overall profitability.
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization):
Story: Shows operating profitability by excluding non-cash expenses like depreciation and amortization, which can vary greatly between companies.
Purpose: To compare profitability across companies with different capital structures or accounting practices.
Adjusted EBITDA:
Story: Refines the EBITDA calculation by adjusting for one-time, irregular, or non-recurring items, providing a clearer picture of sustainable operating performance.
Purpose: To assess the company's ongoing operational profitability.
Segment or Product Line Profitability:
Story: Reveals the performance of individual business units or product lines, showing which areas are contributing the most to overall profitability.
Purpose: To identify strengths and weaknesses within the company's portfolio, guiding strategic decisions on resource allocation and product development.
Return on Equity (ROE):
Story: Demonstrates how effectively a company is using shareholders' equity to generate profits, indicating management’s ability to deliver returns to investors.
Purpose: To measure the profitability relative to shareholders' equity, helping investors understand the efficiency of their investment.
Return on Assets (ROA):
Story: Highlights how efficiently a company is utilizing its assets to generate earnings, reflecting overall asset management effectiveness.
Purpose: To assess the company's ability to turn its investments in assets into profit, providing insight into operational efficiency.
Economic Profit (or Economic Value Added - EVA):
Story: Goes beyond traditional accounting measures to assess whether the company is truly creating value over and above its cost of capital.
Purpose: To determine if the company is effective at generating value for its shareholders.
Operating Cash Flow Profitability:
Story: Focuses on the actual cash generated from business operations, cutting through the noise of accounting conventions and non-cash items.
Purpose: To evaluate the company's ability to generate cash, which is essential for liquidity, growth funding, debt repayments, and shareholder distributions.
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Cash Flow 101
Here’s what you need to know.
1. Cash Flow is the net amount of cash and cash-equivalents being transferred into and out of a business.
That means cash coming in - cash going out.
Inflows - Outflows.
2. There are 3 types of business activities giving rise to specific cash flows
↳ Operating Activities
Main sources are sales and collections; main uses include payments for supplies, wages, and taxes.
↳ Investing Activities
Involves cash flows from purchasing or selling assets and investments.
↳ Financing Activities
Cash flows related to equity and debt transactions, including dividends.
3. Positive isn’t always good and Negative isn’t always bad.
But generally speaking:
↳ Positive Operating Cash Flow indicates robust day-to-day operations, enabling growth and stability.
↳ Negative Operating Cash Flow suggests potential issues, possibly impacting the ability to invest or repay debts.
4. Cash Flow requires Optimization not Maximization.
↳ Enhance operating cash flows by automating processes, improving inventory management, and speeding up receivables collection.
↳ Enhance investing cash flow by prioritizing investments in high-return projects and consider selling underperforming or non-essential assets
↳ Enhance financing cash flow by balancing debt and equity financing to reduce costs and improve cash availability for shareholders.
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The CRO Checklist
The COO Checklist
The Management Cheat Sheet
The Business Governance Checklist
The Performance & Returns KPIs
7 Finance Skills all Managers Need
7 Finance Skills All Managers Need
Understanding Financial Statements
Presentation & Communication
Budgeting and Forecasting
Investment Analysis
Financial Analysis
Risk Assessment
Cost Analysis
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Here are the 7 Finance Skills All Managers Need to Know.
Learn them with my on-demand Masterclass Bundle or reach out for custom team training:
1️⃣ Understanding Financial Statements
🎯Understanding the three major financial statements:
⬛ The income statement, the balance sheet, and the cash flow statement
🎯Horizontal (Trend) Analysis: comparing financial data over time.
⬛Formula: (Current Year / Base Year -1)* 100
🎯Vertical (Common Size) Analysis: express each line item in a financial statement as a percentage of a base figure
⬛ Typically revenue for the income statement and total assets for the balance sheet
2️⃣ Analyzing Ratios and Metrics
🎯Liquidity Ratios: Measure a company's ability to meet short-term liabilities.
⬛Current Ratio (Current Assets / Current Liabilities)
⬛Quick Ratio ([Cash + Marketable Securities + Receivables] / Current Liabilities)
🎯Profitability Ratios: Measure a company's ability to generate profits.
⬛Gross Margin (Gross Profit / Sales)
⬛Operating Margin (Operating Profit / Sales)
⬛Net Margin (Net Profit / Sales)
🎯Solvency Ratios: Measure a company's ability to meet long-term liabilities.
⬛Debt-to-Equity Ratio (Total Debt / Total Equity)
⬛Debt Coverage Ratio (EBIT / Total Debt)
🎯Efficiency Ratios: Measure how well a company utilizes its assets and liabilities
⬛Asset Turnover (Sales / Total Assets)
⬛Inventory Turnover (Cost of Goods Sold / Average Inventory)
3️⃣ Preparing/Reviewing Budgeting and Forecasting
🎯Incremental Budgeting:
⬛ historical cost method which ads a certain amount of capital to a previous period's budget to drive the next period's budget
🎯Activity-Based Budgeting:
⬛ activity based costing method of driving the budget by recording, analyzing and researching the activities which actually drive the organizational costs
🎯Zero-Based Budgeting:
⬛ aggressive and involved budgeting method which requires all costs to be justified from scratch by starting with a "zero base" for each one
4️⃣ Cost Analysis
🎯Cost-Volume-Profit Analysis:
⬛examines the relation between cost, production volume and profit
🎯Direct vs Indirect Costs:
⬛direct costs can be traced to cost objects like products, whereas indirect costs cannot be traced back directly
🎯Product vs Period Costs:
⬛product costs are tied to the production process, while period costs are not tied to the production process and are incurred over time, like rent or administrative expenses
5️⃣ Investment Analysis
🎯Net Present Value (NPV):
⬛difference between the present value of cash inflows and the present value of cash outflows
🎯Internal Rate of Return (IRR):
⬛discount rate that makes the NPV of all cash flows equal to zero
🎯Payback Period:
⬛time it takes for an investment to generate an amount equal to the original investment
6️⃣ Presentation and Communication
🎯Financial Storytelling:
⬛ability to narrate a sequence of financial events in a way that it engages the listener and delivers a clear message
🎯Effective Listening:
⬛active process of making a conscious effort to hear not only the words being spoken but, more importantly, understand the complete message being sent
🎯Adaptive Leadership:
⬛practice of mobilizing people to tackle tough challenges and thrive
7️⃣ Risk Assessment
🎯Market Risk:
⬛risk of investments declining in value because of economic developments or other events that affect the entire market
🎯Credit Risk:
⬛risk of loss arising from a borrower who does not make payments as promised
🎯Liquidity Risk:
⬛risk stemming from the lack of marketability of an investment that cannot be bought or sold quickly enough to prevent or minimize a loss
🎯Operational Risk:
⬛risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events
The Profitability Cheat Sheet
The Profitability Cheat Sheet.
Because Revenue needs to turn into Profits.
Profits need to turn into Cash Flow.
Cash Flow needs to fund growth.
🎯Here’s what the Profitability Cheat Sheet includes:
1. Performance KPIs like revenue growth rate or customer lifetime value give you a snapshot of how well your business is capturing market opportunities.
2. Profitability KPIs like gross margin and net profit margin take the revenue numbers from the performance KPIs and assess how much is actually trickling down as profit.
3. Financial Performance Ratios ensure you're not taking on too much risk to achieve those profits.
4. Cash Flow Ratios indicate whether your profits are indeed converting into cash.
5. DuPont Analysis breaks down ROE into its components so you get a clearer picture of how efficiently your company is utilizing its equity to generate profits.
6. EBITDA vs. EVA helps in understanding if you are creating or destroying shareholder value.
7. Project Profitability Metrics (NPV, IRR, etc.) guide future investment and growth strategies.
Download a full resolution image of the cheat sheet here or purchase full size print-ready PDF here.
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POLL TIME
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Thanks so much for reading.
Oana