The Finance Gem 💎 Week #79

THIS WEEK’S UPDATES

1. This issue’s Finance Gems 💎 vote your favorite at the end of the newsletter and comment for a chance to have your thoughts posted publicly on Linkedin in one of my upcoming posts.

• How to make smart business investments

• EBITDA vs Cash KPIs

• If you bet on EBITDA, prepare to lose on Cash Flow

• BONUS Content: Bridging Finance and Non-Finance for enhanced performance

2. AFP 2024 was an incredible experience. Over 6,000 people gathered in Nashville to learn, get inspired and build the future of finance and treasury. How to Bridge Finance and Non-Finance was clearly in focus for the hundreds that joined our session and as loyal newsletter insiders you get a snippet of all that before anyone else (see below). Kudos to Bryan Lapidus who, alongside the AFP team, spearheaded the largest and best attended finance conference in the world. And big thanks to my co-presenter and friend Alina Traistaru for her passion and dedication to this project. Remember to take a free DISC assessment and share your profile below.

   
   

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1. How to make smart business investments

Don’t make another business investment until you read this.

Your investment opportunities are endless.

Your investment capital is limited, and

Your goal is to maximize $$$.

To choose the right investments.

Start with strategic alignment and solid data.

Because gut feeling can’t substitute for NPV and IRR.

🎯 Join my free cash flow webinar and start making better business investment decisions: https://bit.ly/49n7Lqh

Here’s my practical guide to get you there.

1️⃣ Strategic Analysis

- Alignment Check: Does the project align with organizational objectives, vision, mission, and key success factors (KSFs)?

2️⃣ Project CAPEX and Opportunity Costs

- CAPEX: Itemize and quantify the capital expenditures required for the project.

- Opportunity Costs: Include the forgone benefits of the next best investment.

3️⃣ Project Incremental Revenues, Costs, and Overall Tax Impact

- Incremental Revenues: Additional revenues generated from the project.

- Incremental Fixed Costs and Variable Costs: The added costs directly associated with the project.

4️⃣ Calculate After-Tax Operating Cash Flows

Calculate Incremental Revenues minus Incremental Fixed Costs and Variable Costs

5️⃣ Project Working Capital Changes

Calculate the spike in working capital needed during the project, and how much will be released at the end.

6️⃣ Project Salvage Values and Net Proceeds

Estimate residual values of assets at the end of the project.

Include revenue from the sale or disposal of assets.

7️⃣ Project Net Incremental Cash Flow

Calculate the cash flow for each period, considering all incremental revenues and costs.

8️⃣ Select Discount Factor

Hurdle Rate: This is the minimum rate of return expected from the project (use WACC adjusted for the specific risk profile of the project)

9️⃣ Calculate Present Value of Future Cash Flows

Discount the net incremental cash flows using the hurdle rate.

🔟 NPV, IRR, and Payback Period

NPV: The sum of all discounted cash flows

IRR: The discount rate that makes the NPV zero.

MIRR: The more accurate IRR alternative which assumes reinvestment at the project’s cost of capital rather than the IRR and always provides a unique solution

Payback Period: The time it takes for the initial investment to be recouped.

Remember to

>> compare your investment's financial metrics against other potential projects.

>> assess the actual performance against the projected KPIs and adjust as necessary.

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2. EBITDA vs Cash KPIs

EBITDA is not Cash.

So if you’re going to monitor and target EBITDA

Make sure you also track CASH KPIs for your liquidity sake.

Here are 5 EBITDA + 5 CASH KPIs and some useful insights to keep in mind.

1️⃣ Funded Debt to EBITDA Ratio: Measures the years needed to repay all financed debt if 100% of EBITDA went to principal payments.

- Highlights the company's leverage and its ability to manage long-term debt with its operating earnings, essential for assessing risk and financial stability.

2️⃣ EBITDA Margin: Shows the percentage of revenue that becomes EBITDA.

- This ratio is critical for understanding operating efficiency before financing and tax considerations affect earnings, reflecting the core profitability from regular operations.

3️⃣ Interest Coverage Ratio: Assesses how many times EBITDA can cover interest expenses on debt.

- A critical measure of a company's ability to meet its interest obligations, which can indicate financial health and creditworthiness.

4️⃣ Debt Service Coverage Ratio: Evaluates how many times EBITDA can cover total debt service costs.

- Essential for lenders and investors to assess the sufficiency of a company's EBITDA to cover its debt payments

5️⃣ Fixed Charge Coverage Ratio: Determines how many times net EBITDA can cover all fixed payment obligations (rent, debt, dividends).

- Provides insight into a company's ability to fulfill fixed charge obligations, which is essential for evaluating financial flexibility and operational risk.

6️⃣ Cash Flow Coverage Ratio: Indicates if operating cash flow can cover debt obligations.

- Shows the actual cash available to service debt, highlighting the difference between earnings and cash flows, which can be critical during financial planning.

7️⃣ Cash Conversion Ratio (Cash Flow Margin Ratio): Shows the efficiency in converting sales to cash.

- This ratio is key for assessing how quickly a company turns its sales into cash, impacting liquidity and operational effectiveness.

8️⃣ Operating Cash Flow Ratio: Measures whether operating cash flow can cover current obligations.

- Important for understanding the company's ability to generate enough cash from operations to meet its short-term liabilities

9️⃣ Working Capital Efficiency Ratio: Evaluates how efficiently working capital is used to generate sales.

- Crucial for assessing the effectiveness of current assets and liabilities management to maximize sales, indicating operational efficiency.

🔟 Free Cash Flow Margin: Expresses what percentage of sales is converted into free cash flow.

- Provides insights into how much cash a company retains from its sales after accounting for capital expenditures, essential for evaluating investment potential and dividend-paying capacity.

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3. If you bet on EBITDA, prepare to lose on Cash Flow

I see it all the time...

Companies boasting record-high EBITDA, but struggling to pay their bills.

Why?

They’re caught in the EBITDA illusion, believing that this single metric defines their financial health.

But here’s the harsh truth:

EBITDA doesn’t equate to cash. Focusing too much on it can lead to major cash flow problems. And, ultimately, business failure.

EBITDA is used to show “core profitability,” but it completely ignores the lifeblood of any business: Cash Flow.

↳ Depreciation & Amortization? EBITDA strips it out.

But what happens when your equipment is outdated, and you need to invest millions in new assets?

↳ Interest Payments? EBITDA leaves them out too.

But if you’re over-leveraged, the cash flow drain from servicing that debt can sink you quickly.

↳ Working Capital Changes? EBITDA is blind to inventory buildups or slow receivable collections.

But these are all early warning signs that your cash is about to run dry. So, if you’re betting on EBITDA alone, you’re flying blind.

How to do better? Focus on Cash Flow

↳ Track Operating Cash Flow (OCF). Do you know how much cash you're generating after paying for inventory, salaries, and other costs?

↳ Use Free Cash Flow (FCF). If your business can’t generate FCF, you can’t fund growth, pay debt obligations or pay dividends without taking on debt.

↳ Analyze Working Capital Movements. Are you sitting on excess inventory or facing longer payment terms?

If after all this you still think EBITDA’s great, consider this:

↳ EBITDA might impress shareholders, but it doesn’t keep the lights on.

↳ IEBITDA might look good in earnings reports, but it doesn’t pay salaries.

↳ EBITDA might boost valuations, but that gets old quickly when free cash flow shows up.

Here’s a quick exercise:

Analyze your own business and ask yourself:

1️⃣ Is my EBITDA growing while operating cash flow is shrinking?

2️⃣ Am I using EBITDA to justify risky debt or investments?

3️⃣ Is my EBITDA growth creating a false sense of security about my capacity to repay my debt?

If any of these are true, you’re not just sitting on a problem—you’re sitting on a time bomb. 💣

Focus on cash flow, build a resilient business, and don’t fall for the EBITDA trap.

I see it all the time...

Companies boasting record-high EBITDA, but struggling to pay their bills.

Why?

They’re caught in the EBITDA illusion, believing that this single metric defines their financial health.

But here’s the harsh truth:

EBITDA doesn’t equate to cash. Focusing too much on it can lead to major cash flow problems. And, ultimately, business failure.

EBITDA is used to show “core profitability,” but it completely ignores the lifeblood of any business: Cash Flow.

↳ Depreciation & Amortization? EBITDA strips it out.

But what happens when your equipment is outdated, and you need to invest millions in new assets?

↳ Interest Payments? EBITDA leaves them out too.

But if you’re over-leveraged, the cash flow drain from servicing that debt can sink you quickly.

↳ Working Capital Changes? EBITDA is blind to inventory buildups or slow receivable collections.

But these are all early warning signs that your cash is about to run dry. So, if you’re betting on EBITDA alone, you’re flying blind.

How to do better? Focus on Cash Flow

↳ Track Operating Cash Flow (OCF). Do you know how much cash you're generating after paying for inventory, salaries, and other costs?

↳ Use Free Cash Flow (FCF). If your business can’t generate FCF, you can’t fund growth, pay debt obligations or pay dividends without taking on debt.

↳ Analyze Working Capital Movements. Are you sitting on excess inventory or facing longer payment terms?

If after all this you still think EBITDA’s great, consider this:

↳ EBITDA might impress shareholders, but it doesn’t keep the lights on.

↳ IEBITDA might look good in earnings reports, but it doesn’t pay salaries.

↳ EBITDA might boost valuations, but that gets old quickly when free cash flow shows up.

Here’s a quick exercise:

Analyze your own business and ask yourself:

1️⃣ Is my EBITDA growing while operating cash flow is shrinking?

2️⃣ Am I using EBITDA to justify risky debt or investments?

3️⃣ Is my EBITDA growth creating a false sense of security about my capacity to repay my debt?

If any of these are true, you’re not just sitting on a problem—you’re sitting on a time bomb. 💣

Focus on cash flow, build a resilient business, and don’t fall for the EBITDA trap.

3. AFP 2024 Brief

Bridging Finance and Non-Finance for Enhanced Organizational Performance:

Misalignments in organizations often stem from differences in priorities, communication styles, and performance metrics between finance and non-finance teams.

Key issues include:

1. Finance focusing on fiscal responsibility while other departments prioritize growth and innovation.

2. Communication barriers caused by different departmental perspectives and varying personality traits.

3. Conflicts arising from misaligned KPIs and competing incentives across departments.

Solutions:

1. Establish shared objectives that align all teams with the organization’s overall strategic goals.

2. Integrate KPIs to support collaborative success across departments.

3. Customize communication strategies to fit the distinct needs and traits of various teams.

4. Employ collaboration tools to aid in data visualization and management, enhancing trust and cooperation.

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