The Finance Gem 💎 Week #59: EBT vs EBITDA vs Cash Flow vs. KPIs

BEFORE WE GET STARTED

• Last week I asked our community: “What skill do you think is most crucial for finance professionals to develop right now?” Here’s what the votes were:

• In case you missed it and want to improve your cash flow knowledge, we had over 1,000 people join us live for the Export Development Canada’ s Payment Terms Webinar . We discussed cash flow management strategies for growing internationally and the recording is available on EDC’s portal.

• I’d love to get your thoughts on this week’s polls. Scroll below to share what you think!

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1. EBT vs. EBIT vs. EBITDA

How are they different?

Let’s break down EBT vs EBIT vs EBITDA differences step by step.

1. Definitions:

↳ EBT: Profit excluding tax expenses.

↳ EBIT: Profit excluding interest and income tax expenses.

↳ EBITDA: Profit excluding interest, taxes, depreciation, and amortization expenses.

2. Formulas:

↳ EBT: Revenue - COGS - Operating Expenses - Other Expenses + Other Income

↳ EBIT: Revenue - COGS - Operating Expenses

↳ EBITDA: Revenue - COGS - Operating Expenses + Depreciation + Amortization

3. Operational Insight:

↳ EBT: Insight into profitability before tax.

↳ EBIT: View of operating profitability excluding financing costs.

↳ EBITDA: Rough measure of profitability by adding back Depreciation and Amortization to EBIT.

4. Degree of Separation from Net Income/Profit:

↳ EBT: Closer to net income, excluding only taxes.

↳ EBIT: Excludes effects of financing and taxes from operating profitability.

↳ EBITDA: Excludes effects of depreciation and amortization from EBIT

5. Uses and Applications:

↳ EBT: Analyzing profitability and tax strategy.

↳ EBIT: Operating analysis, valuation, and company comparison.

↳ EBITDA: Valuation, investor analysis, and company comparison

6. Impact of Taxation and Financing:

↳ EBT: Highlights impact of taxation, not financing on total earnings.

↳ EBIT: Ignores tax and financing impacts, focusing on operating earnings.

↳ EBITDA: Ignores impact of taxation, financing, depreciation, and amortization on operating earnings.

7. Key Formulas using these metrics:

🎯EBT:

↳ Net Income = EBT - Taxes

↳ Effective Tax Rate = (Taxes / EBT) * 100

🎯EBIT:

↳ Interest Coverage Ratio = EBIT / Interest Expense

↳ Return on Capital Employed = EBIT / (Total Assets - Current Liabilities)

🎯EBITDA:

↳ EBITDA Margin = (EBITDA / Revenue) * 100

↳ Enterprise Value to EBITDA = Enterprise Value / EBITDA

↳ Free Cash Flow = EBITDA - CAPEX - Change in Net Working Capital - Taxes

2. How Finance actually works

You might think you're in Sales, Marketing, Accounting, or Engineering...

But you're not. You're in Finance.

Here's why:

Every business decision you make somehow invests or returns a company's capital.

And that's what Finance is all about:

Capital Allocation For Shareholder Value Creation.

Did you authorize the purchase of new equipment? You invested capital.

Did you approve customer payment terms? You invested capital.

Did you negotiate terms with a supplier? You invested capital.

Did you transfer funds to repay a loan? You invested capital.

Did you just call your best customer? You invested capital.

Did you take your client to lunch? You invested capital.

Did you just make a new hire? You invested capital.

Did you buy back shares? You distributed capital.

Did you pay dividends? You distributed capital.

But how does investing or returning capital actually work in Finance?

Finance deals with allocating capital to create value for shareholders.

And it needs to make it worthwhile for them to keep capital invested.

That means it needs to:

🎯 realize sufficient returns on the invested capital

🎯 return the capital back to shareholders when it runs out of good investment opportunities

➡️ Here are the 5 main business purposes for which finance allocates capital:

1️⃣ Organic Growth

↳ Expands business operations (e.g., investing in R&D, sales/marketing teams)

↳ Increases operating cash flows for future distribution or reinvestment

2️⃣ Retire Debt

↳ Uses free cash flows to reduce debt obligations

↳ Reduces leverage, enhance the business risk profile and increase future borrowing capacity for growth

3️⃣ Inorganic Growth (Mergers and Acquisitions)

↳ Allocates capital to acquire other operations rather than expanding existing ones

↳ Utilizes company's expertise and resources to boost cash flows in acquired entities

4️⃣ Share Buy-Backs

↳ Reduce outstanding shares, improving financial ratios and share value

↳ Direct cash flows outside the business, potentially limiting future growth capital

5️⃣ Capital Distributions

↳ Distribute free cash flows to investors as dividends

↳ Provide a steady income stream to investors which may increase future appeal for your equity value

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3. 10 Strategic Cash Flow Mistakes and How to Fix Them

If you're making these, your organization and career might be at risk.

1️⃣ Mismatching Cash Flow Maturities

↳ Utilizing short-term financing for long-term assets will lead to liquidity challenges.

↳ Match up the cash flows on the assets being financed with cash flows on the debt

2️⃣ Ignoring Foreign Exchange Rate Volatility

↳ Trading in multiple foreign currencies can quickly erode profitability, liquidity, and leverage.

↳ Design an active FX management strategy (forwards, options, etc) to safeguard against the adverse effects of currency fluctuations.

3️⃣ Ignoring Interest Rate Volatility

↳ Ignoring interest rate volatility can impact financing costs and cash flow predictability

↳ Develop an appropriate financing strategy to manage exposures (swaps, options, etc) and protect cash flows.

4️⃣ Misinterpreting Negative Operating Cash Flows

↳ Negative operating cash flows aren't a negative sign unless they're due to underlying financial distress

↳ Secure suitable working capital financing and avoid overtrading

5️⃣ Relying on One-Time Positive Investing Cash Flows

↳ Selling non-redundant assets to fund ongoing operating deficits can hide structural challenges

↳ Resolve underlying profitability issues early and seek sustainable financing solutions

6️⃣ No Growth Working Capital

↳ Failing to adequately finance growth working capital can slow expansions and deplete cash reserves

↳ Negotiate suitable working capital financing to fund current asset growth

7️⃣ Mismanaging Payment Terms

↳ Misaligning terms between suppliers and customers can lead to cash flow shortfalls and liquidity issues

↳ Negotiate terms that complement your cash flow cycle and secure backup financing

8️⃣ Failing to Leverage Cash Management Tools

↳ Manual cash management exposes organizations to errors and suboptimal cash positions

↳ Integrate modern cash flow management tools including automated receivables and payables for improved cash flow visibility and control

9️⃣ Neglecting Cash Flow Forecasting

↳ Lack of comprehensive cash flow forecasting will prevent opportunities and introduce undue risk, threatening business viability

↳ Use both short term rolling & long term cash flow forecasts

🔟 Ignoring Long-Term Strategic Implications of Cash Flow Decisions

↳ Short-term cash management decisions significantly diminish growth

↳ Balance immediate liquidity with long-term vision to align day-to-day needs with long term goals

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4. 100 Business KPIs

Because what gets measured gets done.

Here are 25 x 4 to choose from, measure, and benchmark.

To help your organization achieve its most strategic objectives.

▷ There are many ways to segment business measures and turn them into KPIs.

▷ Here are 4 essential business dimensions to consider:

1. Finance KPIs

2. Accounting KPIs

3. Investing KPIs

4. Cash Flow KPIs

▷ Let’s break them down one by one:

1. Finance KPIs:

▶ measure the financial health and performance of the business.

▶ provide a snapshot of how well the company is utilizing resources to generate earnings and cash flow.

▶ help companies make informed decisions on investments, cost management, and strategic planning

2. Accounting KPIs (some overlap exists with Finance KPIs):

▶ measure the efficiency of the business operations, and the effectiveness of accounting processes, and internal controls.

▶ essential for operational planning, financial reporting, and ensuring the integrity of financial data.

▶ help improve short term cash management, financial reporting accuracy, and compliance

3. Investing KPIs

▶ measure the performance of investment activities, focusing on returns and strategy effectiveness

▶ critical to assess how well invested capital is contributing to growth and strategic objectives.

▶ help optimize investment portfolios, strategic asset allocations, and risk vs. return investment profiles

4. Cash Flow KPIs

▶ measure liquidity, cash management effectiveness and business risk

▶ critical to ensure the availability of sufficient cash to fund operations, invest in opportunities, and meet obligations.

▶ enable companies to better manage working capital, anticipate cash shortages, and plan for sustainable financial growth.

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