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The P&L and The Balance Sheet may think they're the popular kids.

But the real cool kid on the block is the Cash Flow Statement.

Because a company might have a profitable P&L,

And still face bankruptcy without enough cash:

To fund operating costs.

To invest in growth.

To service debt.

Here are 7 Essential Business Health Insights you can get from a company’s Cash Flow Statement:

1️⃣ Solvency:

- Whether the company generates sufficient operating cash flows to comfortably service debt obligations.

- Whether their use of operating cash flow for debt payments supports an acceptable risk profile.

2️⃣ Liquidity:

- Whether the company’s operating cash flow covers current liabilities.

- Whether the way the company manages its operating cash flow maintains financial stability and minimizes its liquidity risk.

3️⃣ Free Cash Flow:

- Whether the company's free cash flow has shown positive growth over time to support a robust and flexible business model.

- Whether the company consistently generates positive free cash flow, demonstrating its capacity to self-fund growth, pay down debt, and return money to shareholders.

4️⃣ Financing Activities:

- Whether the company has the flexibility to strategically shift its financing activities towards debt or equity as conditions require.

- Whether the company demonstrates strong performance and confidence in its future prospects by consistently returning capital to shareholders through dividends or share buybacks.

5️⃣ Investment Health:

- Whether the company is proactively investing in its future growth by increasing capital expenditure over time.

- Whether the company skillfully aligns its capital expenditure with operational cash flows.

6️⃣ Trends and Volatility:

- Whether the company's capital expenditure has been progressively increasing over the years to demonstrate a consistent investment in growth.

- Whether the pattern of the company's revenue and earnings is consistent and can reliably predict future performance.

7️⃣ Quality of Earnings:

- Whether the company primarily relies on genuine business activities to achieve its reported profits vs. relying on non-cash or non-recurring items

- Whether the company optimizes working capital accounts to maintain a stable cash flow from operations.

Controlling and FP&A are part of the finance and accounting function.

They are both essential to your organization’s financial health.

They both report to the CFO.

They are complementary.

They work differently.

They partner.

🎯 Controlling is responsible for the integrity and accuracy of your organization’s financial information.

➡️ It maintains the general ledger, oversees accounts payable and receivable, manages tax compliance, and prepares financial statements.

➡️ It also handles internal controls and risk management.

➡️ It interacts with external auditors and ensures compliance with relevant financial regulations and standards.

➡️ It provides the financial data needed for financial planning and analysis or FP&A

🎯 FP&A is primarily focused on the future financial health of your organization.

➡️ It involves budgeting, forecasting, strategic planning, and business case analysis.

➡️ It works closely with different business units, providing financial insights and advice to support decision-making.

➡️ It uses data analytics and financial modeling tools to provide an outlook of the organization's financial performance.

🎯 Both Controlling and FP&A report to the CFO with a goal to support executive decision-making.

➡️ Controlling ensures financial accuracy and compliance which forms the foundation for financial reports and statements.

➡️ FP&A provides forward-looking financial insights and strategic advice for business planning and decision-making at the executive level.

➡️ They partner to ensure consistency and accuracy in financial reporting and analysis, and to provide a cohesive financial view to the CFO and the wider organization.

Are you trying to evaluate a company’s financial performance?

Don’t use EBITDA.

Here’s why:

🎯 EBITDA is flawed and unfit for most of the roles it has today.

🎯 EBITDA frequently gets adjusted to suit users individual needs and help mitigate their risks.

🎯 EBITDA needs replacing with a better profitability/cash flow measure that includes

☑️ working capital investment

☑️ long term capital investment

☑️ debt payment obligations

☑️ tax payment obligations

Here are 5 alternatives to EBITDA you can consider, depending on your business objectives:

1️⃣ Adjusted EBITDA

= Net Income + Interest + Taxes + Depreciation + Amortization + Adjustments

⚫Possible Adjustments:

>> non-recurring expenses (management/M&A)

>> normalized depreciation/amortization (management/ M&A)

>> working capital changes

>> (unfunded) CAPEX

>> cash taxes

>> shareholder distributions (banks)

✅Pros: easily calculated

❌Cons: most adjusted EBITDA formulas will still be far remote from any measure of free cash flow

2️⃣ 𝗢𝗽𝗲𝗿𝗮𝘁𝗶𝗻𝗴 𝗖𝗮𝘀𝗵 𝗙𝗹𝗼𝘄(𝗢𝗖𝗙)

= Net Income + Depreciation/Amortization + Other Non Cash Items +/ Changes in Working Capital

✅Pros: includes tax payment obligations and working capital investment

❌Cons: doesn’t include long term capital investment or payments on debt obligations

3️⃣ 𝗙𝗿𝗲𝗲 𝗖𝗮𝘀𝗵 𝗙𝗹𝗼𝘄 𝘁𝗼 𝘁𝗵𝗲 𝗙𝗶𝗿𝗺 (𝗙𝗖𝗙𝗙 𝗼𝗿 𝗨𝗻𝗹𝗲𝘃𝗲𝗿𝗲𝗱 𝗖𝗮𝘀𝗵 𝗙𝗹𝗼𝘄)

= Operating Cash Flow + Interest x (1- Tax Rate) +/- Changes in Fixed Assets

✅Pros: includes tax payment obligations, working capital & long term capital investment

❌Cons: doesn’t include debt payment obligations

4️⃣ 𝗙𝗿𝗲𝗲 𝗖𝗮𝘀𝗵 𝗙𝗹𝗼𝘄 𝘁𝗼 𝗘𝗾𝘂𝗶𝘁𝘆 𝗛𝗼𝗹𝗱𝗲𝗿𝘀 (𝗙𝗖𝗙𝗘 𝗼𝗿 𝗟𝗲𝘃𝗲𝗿𝗲𝗱 𝗖𝗮𝘀𝗵 𝗙𝗹𝗼𝘄)

= Operating Cash Flow +/- Changes in Fixed Assets +/- Changes in Net Debt

✅Pros: includes working capital & long term capital investment, tax payment obligations, and payment of debt obligations

❌Cons: could be complex to calculate

5️⃣ Economic Value Added (EVA)

= EBIT - Taxes - WACC x (Fixed Assets + Net Working Capital)

✅Pros: includes tax payment obligations, cost of capital charge for working capital & long term capital investment, and outstanding debt.

❌Cons: could be complex to calculate and information may not be readily available.

Are your accounting profits sufficient to cover:

🎯 the opportunity cost of equity

🎯 the opportunity cost of debt

🎯 or both?

Here's what you should understand:

❌EBITDA pays no rent.

✅ EVA pays rent to shareholders and debt holders.

The “rent” is the opportunity cost of debt and equity capital required to get from Accounting Profit to Economic Profit.

➡️ If economic profit is positive, it means the company is generating returns above the opportunity cost of all resources used, not just the costs recorded on the books

However,

➡️ EBITDA doesn’t account for any opportunity costs.

➡️ Only EVA accounts for the opportunity cost of both debt and equity capital.

Here’s what you should know about EBITDA vs EVA:

1️⃣ Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)

- Formula: EBITDA = EBIT + Depreciation + Amortization

- Caveat: EBITDA does not consider the cost of capital (debt or equity) and might also provide a distorted picture of financial health, especially for companies with high levels of debt or substantial capital investment needs

2️⃣ Economic Value Added (EVA)

- Formula: EVA = EBIT x (1-Tax Rate) - (Total Invested Capital * Cost of Capital)

- Caveat: EVA might be less relevant for companies whose value primarily comes from internally generated intangible assets (like intellectual property or brand recognition), as these are not traditionally recognized on the balance sheet or factored into the cost of capital

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Oana