The Finance Gem 💎 Week #77

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THIS WEEK’S ISSUE AT A GLANCE

1. This issue’s Finance Gems 💎 vote your favorite at the end of the newsletter.

• 20 Cash Flow Drivers to Know

• Budget vs. Forecast

• The Fed Rate cut and what it means for everyone

• Accounting vs. Finance: Controlling vs. FP&A

• The CFO role is all about Capital

2. If you’re attending AFP 2024 in Nashville this October, consider our session on Bridging Finance and Non-Finance. Take a free DISC assessment and share your profile below.

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3. If you haven’t had a chance to join me and Oracle Netsuite VP Ranga Bodla on September 3rd, you can still download our free business guide: CEO vs. CFO: how two critical roles shape strategy. I’d love your feedback, so please reply to this email and let me know what you thought of this session.

THIS WEEK’S FINANCE GEMS

1. 20 Cash Flow Drivers to Know 

Your Business grows with Revenue and ends with Cash Flow.

Cash flow performance metrics help you assess your company's financial health, operating efficiency, liquidity and performance. The 3 main cash flow drivers are Revenue, Operating Margin, and Operational Efficiency and each of these drivers should get closely monitored.

Sales Revenue Forecast:

🎯 The revenue you expect to generate y/y from normal business operations

Sales Revenue Budget to Actuals:

🎯 A comparison of the revenues you budgeted for the period against those you actually achieved

Sales Pipeline:

🎯 A visual representation and tracking of where potential customers are in the process of becoming actual customers, from initial contact to closing the sale.

Sales Backlog:

🎯 Represents confirmed sales orders that have not yet been fulfilled; an indicator of future revenue that is secured but not yet realized.

Gross Profit:

🎯 Total revenue minus the cost of goods sold (COGS); indicates how efficiently a company uses labor and supplies in the production process.

Gross Profit Margin:

🎯 Shows the percentage of revenue that exceeds the cost of goods sold; a key metric to assess pricing strategy and production efficiency.

Net Profit:

🎯 The actual profit after all expenses, including operating expenses, interest, and taxes, have been deducted from total revenue.

Net Profit Margin:

🎯 Indicates what percentage of revenue remains as profit after all expenses; a critical indicator of overall financial health and operational efficiency.

Operating Cash Flow (OCF):

🎯 Cash generated from regular operating activities, indicating the company's ability to generate sufficient positive cash flow to maintain and grow operations.

Financing Cash Flow:

🎯 Cash flows associated with funding the business which includes cash activities related to debt, equity, and dividends.

Investing Cash Flow:

🎯 Cash flow resulting from the purchase or sale of assets like equipment and investments, minus capital expenditures that are not expensed in the income statement.

Days Sales Outstanding (DSO):

🎯 The average number of days you take to collect on outstanding customer (AR) balances

AR/Revenue x 365

Days Inventory Outstanding (DIO):

🎯 Average number of days you take to sell your inventory

Inventory/COGS x 365

Days Payable Outstanding (DPO):

🎯 Average number of days you take to settle outstanding supplier (AP) invoices

AP/Purchases x 365

Cash Conversion Cycle (CCC):

🎯 The average number of days it takes you to convert your inventory investment into sales, your sales into receivables and your receivables into cash.

DIO + DSO - DPO

Free Cash Flow (FCF):

Cash Flow available after operating costs

🎯 Net Income + Interest + Taxes + Depreciation/Amortization +/- Non-Cash Items +/- Changes in Working Capital +/- Changes in Fixed Assets

Cash Burn Rate:

🎯 Showcases how long current cash reserves will last.

Cash on hand / Monthly cash outflow.

Cash Debt Service Coverage Ratio;

🎯 Measures ability to repay debts from operating cash flow.

Operating Cash Flow / Total Debt Service

Operating Cash Flow Margin:

🎯 Evaluates the efficiency of a company's operations by comparing operating cash flow to sales.

Operating Cash Flow Margin = (Operating Cash Flow / Sales) x 100

Free Cash Flow to Equity (FCFE):

🎯 Represents the cash flow available to equity shareholders

FCFE = Net Income + Depreciation/Amortization - Changes in Working Capital - Capital Expenditures + Net Borrowing

2. Budget vs. Forecast

Here’s your visual roadmap

And a simple 5 step plan to get there.

 1️⃣ Align Strategy and Finance:

- Ensure the 5-year financial plan integrates seamlessly with the business vision and strategic objectives.

- Bring together leaders from different departments to ensure financial plans support the overall business goals.

- Develop clear financial indicators that track the company’s progress towards its strategic goals, making sure everyone understands these metrics.

2️⃣ Detail Annual Budgets:

- Translate the long-term strategy into actionable annual budgets for the current operating cycle.

- Work closely with department heads to create budgets that meet both their operational needs and align with the company’s strategic objectives.

- Set up regular reviews to adjust scenario planners and forecasts based on new information or changes in the business environment

3️⃣ Create a Rolling Forecast:

- Continuously update the budget with actual results to adjust and improve future financial performance projections.

- Use the latest data to update financial forecasts at every month end close to ensure they remain accurate and relevant

- Plan routine check-ins throughout the year to reassess forecasts and make necessary adjustments based on performance.

4️⃣ Manage Variance:

- Conduct regular variance analysis to manage discrepancies and adjust strategies as needed.

- Regularly examine any discrepancies between expected and actual financial results to understand the reasons behind them.

- Use insights from the variance analysis to quickly adjust plans or strategies to stay on track.

5️⃣ Scenario Planning:

- Incorporate multiple scenario analyses to enhance flexibility and preparedness for different future states.

- Regularly test financial plans against different potential future scenarios to identify opportunities and vulnerabilities, and strengthen resilience.

- Develop and maintain ready-to-execute plans for various scenarios to manage risks effectively and capitalize on opportunities swiftly.

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3. The Fed Rate cut and what it means for everyone

This is Economics 101

Here’s what you need to know about The Fed’s interest rate cut from September 18, 2024:

Why the Fed Cut Interest Rates

The Federal Reserve cuts interest rates to stimulate the economy during times of slow growth. This encourages consumers and businesses to spend and invest, supporting economic activity.

Immediate Effect: Cheaper Borrowing Across the Economy

Lower rates reduce borrowing costs for consumers, businesses, and the government. This results in banks lowering their interest rates on loans, mortgages, and credit lines.

How Consumers Will Respond

Consumers are likely to borrow more for major purchases like homes and cars. At the same time, lower savings rates discourage saving, leading to increased spending.

How Businesses Will Respond

Businesses will find it easier to finance their expansion and daily operations. As borrowing costs decrease, they tend to invest more in growth and hire additional workers.

How Investors Will Respond

With lower bond yields, investors shift focus to stocks for higher returns. This increased demand causes stock prices to rise.

How Lenders and Banks Will Respond

Banks face narrower profit margins on loans as the difference between what they charge for loans and pay on deposits shrinks. However, they may see higher loan volumes, though this increases credit risk.

How the Government Will Respond

The government benefits from lower debt servicing costs, making it cheaper to manage national debt. This may enable more fiscal spending on economic stimulus and infrastructure projects.

Ripple Effects on the Economy

As borrowing costs drop, both consumer spending and business investments increase, boosting economic activity. A rising stock market further supports company valuations and investor confidence.

Potential Long-Term Consequences

In the long term, the risk of inflation rises as spending increases. Higher debt levels could make the economy more vulnerable if conditions deteriorate in the future.

4. Accounting vs. Finance: Controlling vs. FP&A

Do you know the Difference?

Controlling and FP&A are two critical components of the finance and accounting function.

Both are essential to your organization’s financial health.

Both report to the CFO.

Both are complementary.

But they work differently and serve distinct purposes.

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

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

• It also ensures strong internal controls and effective risk management.

• It collaborates with external auditors and guarantees compliance with relevant financial regulations and standards.

• Controlling provides the foundational financial data needed for planning and analysis activities performed by FP&A.

➡️ FP&A focuses on the future financial health of your organization.

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

• FP&A works closely with various business units to deliver financial insights that support strategic decision-making.

• It leverages data analytics and financial modeling tools to present an outlook of the organization's future financial performance.

➡️ While Controlling and FP&A both report to the CFO, they have distinct roles that ultimately converge to support executive decision-making:

• Controlling ensures financial accuracy and compliance, forming the backbone of reliable financial reporting.

• FP&A provides forward-looking financial insights and strategic guidance for business planning and future growth.

• They work in partnership to deliver a consistent and cohesive financial narrative that equips the CFO and the broader organization with the information needed to drive success.

Thank you to those who joined us for a discussion with Oana Labes, president of Financiario, on her learnings from successful partnerships between the CEO and CFO. What we covered:

• How the CEO/CFO partnership shapes strategy.

• Why KPI alignment is not enough to drive effective financial and business strategy.

• The need for a skill overlap to strategically align the two roles.

• Maximizing enterprise value through strategic financial planning.

Learn more by downloading our free business guide here.

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5. The CFO Role is all about Capital

The Chief Financial Officer role is all about Capital.

Capital Sourcing

Capital Allocation

Capital Reporting

Capital Management

Want to be a great CFO? Get these 4 critical areas right:

1. Capital Sourcing:

- Diversify sources: Mix equity, debt, and alternative instruments to enhance financial stability.

- Build investor relationships: Cultivate connections with a diverse investor base to secure flexible funding options.

- Stay flexible: Adapt financing strategies quickly in response to changing market conditions.

2. Capital Allocation:

- Focus on Returns: Prioritize investments that offer the best risk-adjusted returns.

- Balance needs: Align capital deployment with both short-term operational needs and long-term strategic goals.

- Evaluate performance: Regularly assess investment outcomes to ensure optimal resource utilization.

3. Capital Reporting:

- Ensure accuracy: Uphold strict compliance and accuracy in financial reporting.

- Utilize analytics: Apply advanced analytics for deeper financial insights and decision-making support.

- Communicate clearly: Keep stakeholders well-informed with transparent and insightful financial updates.

4. Capital Management:

- Manage liquidity: Maintain sufficient liquidity to meet operational demands and seize new opportunities.

- Mitigate risks: Use financial instruments to hedge against market risks effectively.

- Streamline operations: Continuously enhance treasury functions for efficiency and efficacy.

POLL TIME

As always, if you have specific suggestions or feedback, or topic suggestions, simply reply to this email.

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