The Finance Gem 💎 Week #64: Using EBITDA, Profitability KPI, ZBB and CFO Strategy

THIS WEEK’S ISSUE AT A GLANCE

• 4 Finance Gems 💎 remember to vote your favorite in the poll section

  • EBITDA is everywhere. Even where it doesn’t belong.

  • 12 Profitability KPIs You Should Measure, Monitor and Benchmark

  • The 10 Step Guide to Strategic Zero-Based Budgeting

• Cast Your vote: Cash Flow vs EBITDA

• Cast your vote: Where is your organization prioritizing capital allocation?

• The early enrollment deadline for the Wharton FP&A certificate program is coming up on April 15th. Don’t miss this opportunity to save up to $500 and build your FP&A career. Details below.

• I’d love to hear what you thought of this week’s issue. Share below!

• The Financial Analysis Masterclass pre-sale is now on. Save an additional 30% off the launch price. Details below.

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THIS WEEK’S FINANCE GEMS

1. EBITDA IS EVERYWHERE. EVEN WHERE IT DOESN’T BELONG.

Here are 10 typical scenarios where EBITDA is used and abused.

And what to used instead to replace it and improve each scenario.

Comparative Analysis

❌ EBITDA

✅ Free Cash Flow (FCF) provides a more accurate reflection of operating performance by considering capital expenditures and changes in working capital.

Valuation

❌ EBITDA

✅ Discounted Cash Flow (DCF) offers a comprehensive assessment by evaluating all future cash flows, accounting for growth and capital investment needs.

M&A Target Assessment

❌ EBITDA

✅ Discounted Cash Flow (DCF) ensures a thorough valuation that includes projected cash flows, risks, and future growth

Loan Covenants

❌ EBITDA

✅ Debt Service Coverage Ratio (DSCR) directly measures the ability to service debt, providing a better picture of financial health.

Performance Measurement

❌ EBITDA

✅ Return on Capital Employed (ROCE) evaluates profitability and efficiency in using capital, offering a complete performance picture.

Investor Communications

❌ EBITDA

✅ Net Income and Revenue Growth delivers a comprehensive overview of financial health, crucial for investor confidence and understanding.

Budgeting and Forecasting

❌ EBITDA

✅ Cash Flow Forecasting allows for precise financial planning by projecting all cash inflows and outflows, including capital and working capital adjustments.

Restructuring Decisions

❌ EBITDA

✅ A Segmented Income Statement provides profitability by business segment, guiding more focused restructuring efforts.

Sector-Specific Analysis

❌ EBITDA

✅ Operating Margin offers insights into operating profitability, accounting for costs of goods sold and operating expenses.

Incentive Compensation Planning

❌ EBITDA

✅ Economic Value Added (EVA) supports long-term value creation by aligning management efforts with the company’s broader financial objectives.

Download a copy of the carousel here.

2. 12 PROFITABILITY KPIS YOU SHOULD MEASURE, MONITOR AND BENCHMARK.

Here’s what they are and how to interpret them:

1. Gross Profit Margin Ratio: (Gross Profit / Sales) x 100

🎯 measures the percentage of sales that remain after deducting cost of goods sold.

2. Contribution Margin: (Sales - Variable Costs)/Sales x 100

🎯 measures the percentage of sales that remain after deducting all variable costs (direct materials, direct labor, variable overhead, variable sales and marketing)

3. Operating Profit Margin Ratio: (Operating Profit / Sales) x 100

🎯 measures the percentage of sales that remain after deducting cost of goods sold and also operating expenses.

4. Net Profit Margin Ratio: (Net Profit / Sales) x 100

🎯 measures the percentage of sales that remain after deducting cost of goods sold, operating expenses, interest and taxes.

5. Return on Assets (ROA) Ratio: (Net Profit / Total Assets) x 100

🎯 measures how effectively a company is using its assets to generate profits.

6. Return on Equity (ROE) Ratio: (Net Profit / Shareholders' Equity) x 100

🎯 measures how much profit a company generates for every dollar of shareholder equity.

7. Return on Investment (ROI) Ratio: (Net Investment Profit / Total Investment) x 100

🎯 measures the efficiency and profitability of a capital investment

8. Return on Capital Employed (ROCE) Ratio: EBIT/ (Long Term Debt + Equity) x 100

🎯 measures the return on your company's entire long term capital invested, taking into account both equity and debt financing sources

9. Earnings per Share (EPS) Ratio: (Net Profit - Preferred Dividends) / Average Shares Outstanding

🎯 measures the amount of profit attributable to each outstanding share of a company's stock

10. Price-to-Earnings (P/E) Ratio: Market Price per Share / Earnings per Share

🎯 measures the relationship between a company's stock price and its earnings per share to help assess the relative value of a company's stock.

11. Dividend Yield Ratio: Annual Dividend per Share / Market Price per Share

🎯 measures the amount of dividends paid out to shareholders relative to the company's stock price.

12. Dividend Payout Ratio: Annual Dividend per Share / Earnings per Share

🎯 measures the percentage of a company's earnings that are paid out as dividends to shareholders.

Download a copy of the carousel here.

3. THE 10 STEP GUIDE TO STRATEGIC ZERO-BASED BUDGETING

Making sense of different budget methods isn't easy.

▶ Top-Down Budgeting

▶ Bottom-Up Budgeting

▶ Zero-Based Budgeting

This guide will show you how to integrate ZBB and use it to maximize the effectiveness of traditional budgeting approaches.

🎯A Strategic ZBB framework will deliver:

- 𝗔𝗱𝗮𝗽𝘁𝗮𝗯𝗶𝗹𝗶𝘁𝘆 to changing business needs and priorities.

- 𝗔𝗹𝗶𝗴𝗻𝗺𝗲𝗻𝘁 with the organization’s high-level strategic goals.

- 𝗔𝗰𝗰𝗼𝘂𝗻𝘁𝗮𝗯𝗶𝗹𝗶𝘁𝘆 as departments contribute from the ground up.

🎯Here’s how to implement Strategic ZBB in 10 steps:

1. Step 1: Establish a Foundation of Understanding to Educate and Engage the Team

2. Step 2: Define Strategic Objectives to Align Resources with Goals

3. Step 3: Identify Cost Centers and Functions to Organize Spending Areas

4. Step 4: Analyze Activities and Cost Drivers to Detail Activities and Associated Costs

5. Step 5: Develop Budget Proposals from Zero to Justify Every Expense

6. Step 6: Review the Process to Challenge and Validate

7. Step 7: Integrate and Approve Budget incorporating ZBB and Top-Down Approach

8. Step 8: Implement and Monitor Budget to Execute and Track Performance

9. Step 9: Establish Feedback Loops to Learn and Adapt

10. Step 10: Continuously Improve: Iterate and Enhance to Achieve Strategic and Efficient operation

Download a copy of the carousel here.

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POLL TIME

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

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