New metrics to Define Financial Performance?
In the tumult surrounding the 3D maelstrom (Debt Ceiling, Downgrading and Deficit) of several weeks ago, you may have missed another chilling corporate finance update on the relentless pursuit of performance metrics that extol the sunshine while you’re in the heart of darkness. Yes, there may be some economic value for certain of these metrics, but they’re dangerous barometers of realizable value and highly misleading as to future achievements of tangible operating profits and free cash flow.
Most of us recall the “eyeball counting” that preceded the Dot-Com-Bomb and those certain “Signs of the Apocalypse”, as when your cab driver is telling you what stocks you should buy.
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“Financial Adrenaline” is a term we love around here because it reflects our commitment to help you turbocharge your business with practical tips and techniques to improve free cash flow, the lifeblood of business. As a further extension of our Financial Adrenaline program, we’re going to share a new Business Finance Tip every Wednesday specifically for those business executives who don’t have a finance background. Our current Big River series started with We’re Making Money. Why are we broke? … then No Cash? Can we borrow what we need?, What if our loan collateral doesn’t cut it? and the need for outside investors.
Last week, we began our conversation about business valuation. We continue that discussion today with a valuable chart that will help you understand some of the key valuation principles.
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“Can anybody remember when the times were not hard and money not scarce?”
~ Ralph Waldo Emerson
John Wilson, CEO of Ace Business Stuff, has been working diligently with his controller, Tom Sampson, to assess his financing needs. They may require an equity investor as he suspects that his controller’s right that bank financing may be insufficient.
“Hi Lary,” John said when he got Lary Blogger on the phone again.
“We’re almost finished with our forecast, but it still looks like we’ll need some equity. I’d like to explore what you said about strategic buyers and financial buyers and see the diagram you mentioned.”
“John, this diagram is only meant as a general overview of some key valuation concepts,” I said when I visited with John at his office a few days later. “It should help you better understand certain key concepts which underlie the valuation of an ownership interest in your company.
“At the top is the Strategic Buyer. In short, he’s looking for more than a simple financial return.
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“Financial Adrenaline” is a term we love around here because it reflects our commitment to help you turbocharge your business with practical tips and techniques to improve free cash flow, the lifeblood of business. As a further extension of our Financial Adrenaline program, we’re going to share a new Business Finance Tidbit every Wednesday specifically for those business executives who don’t have a finance background. Our current Big River series started with We’re Making Money. Why are we broke? … then No Cash? Can we borrow what we need? Last week, we faced What if our loan collateral doesn’t cut it?
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“The worst mistake is to have the best ladder and the wrong wall.”
~ Donald Rumsfeld
John Wilson, CEO of Ace Business Stuff, was thinking about several of the issues that he discussed earlier that day with his controller, Tom Sampson, and what Tom told him:
“Giving our customers an additional 30 days to pay, relaxing collections and neglecting the sale of inventory already on hand, isn’t a very sound strategy.”
Instinctively, he knew that Tom was right and that whatever bank loan they could obtain, it wouldn’t be enough.
Ted Deepockets, his long-time friend, had periodically needled John about the pros and cons of outside investors.
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“Financial Adrenaline” is a term we love around here because it reflects our commitment to help you turbocharge your business with practical tips and techniques to improve free cash flow, the lifeblood of business. As a further extension of our Financial Adrenaline program, we’re going to share a new Business Finance Tidbit every Wednesday specifically for those business executives who don’t have a finance background. Our current Big River series started with We’re Making Money. Why are we broke? … and continued last week with No Cash? Can we borrow what we need?
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“Anyone who lives within their means suffers from a lack of imagination.”
Oscar Wilde
Tom Sampson, the controller for Ace Business Stuff, was in his office considering how to explain to John Wilson, the Company’s CEO, the issues related to the Company’s borrowing capacity and the weaknesses in the Company’s Balance Sheet.
Tom pulled together several schedules for his meeting with his CEO that afternoon, but was still struggling with how to get across some of the subtleties that he knew John would want to understand. Tom knew that his CEO was absolutely committed to the Company’s success, yet became very frustrated when his convictions about future performance collided with the bank’s concerns about current performance.
Tom knew that the bank considered many factors when judging an asset-based loan. Having enough collateral to support the Company’s borrowing request was only part of it.
One key ingredient is the quality of the collateral.
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“Financial Adrenaline” is a term we love around here because it reflects our commitment to help you turbocharge your business with practical tips and techniques to improve free cash flow, the lifeblood of business. As a further extension of our Financial Adrenaline program, we’re going to share a new Business Finance Tidbit every Wednesday specifically for those business executives who don’t have a finance background. Last week we began our 12 part Big River series so you can pick up the story there.
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“Creditors have better memories than debtors.”
Benjamin Franklin
John, are you ready for our meeting? We said yesterday that we were going to meet to go over our financial projections and review a possible bank proposal.”
“I’ll be right there, Tom,” John Wilson, company CEO said to his controller. He reflected on their conversation last week about the Company’s expected negative cash flow and the need to borrow from their bank, most of which resulted from giving extended terms to their customers. John learned his lesson and wanted to avoid borrowing, but Tom had been pretty explicit about the need.
“John, I’ve gone over our short term cash needs again,” Tom said after they gathered in the conference room and were looking at some numbers on the overhead projector. “I’ve created a simple example on the screen with all the numbers shown in thousands.
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“Financial Adrenaline” is a term we love around here because it reflects our commitment to help you turbocharge your business with practical tips and techniques to improve free cash flow, the lifeblood of business. Every Wednesday, we’re sharing a new Business Finance Tidbit specifically for those business executives who don’t have a finance background. You’ll get a head start by reading Warren Buffett’s letter to shareholders this year, and his comments about depreciation.
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“The importance of knowing accounting can not be underestimated, it’s the language of business. If you don’t know it, it’s like being in a foreign country without knowing the language.”
Warren E. Buffett, CEO of Berkshire Hathaway, Inc.
“We’re broke,” Tom mumbled to himself. Tom Sampson is the controller of Ace Business Stuff and was reviewing his latest calculations about their cash flow.
“What do you mean, we’re broke?” Tom looked up sheepishly to see John Wilson standing in his doorway. He fingered his collar and turned to address the company’s CEO. “We can’t be broke because business has never been better,” John said.
Read the full post »
“Financial Adrenaline” is a term we love around here because it reflects our commitment to help you turbocharge your business with practical tips and techniques to improve free cash flow, the lifeblood of business. As a further extension of our Financial Adrenaline program, we’re going to share a new Business Finance Tidbit every Wednesday specifically for those business executives who don’t have a finance background.
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We’ve kinda been on a Warren Buffett tear lately, and last week I encouraged you to read his recent 2010 Annual Report to Berkshire Hathaway shareholders.
I want to plant another seed this week about an often misunderstood concept: DEPRECIATIONIn accounting, an expense recorded to allocate a tangible asset's cost over its useful life. Because depreciation is a non-cash expense, it increases free cash flow while decreasing reported earning. It is used in accounting to try to match the expense of an asset to the income that the asset helps the company earn. For example, if a company buys a piece of equipment for $1 million and expects it to have a useful life of 10 years, it will be depreciated over 10 years. Every accounting year, the company will expense $100,000 (assuming straight-line depreciation), which will be matched with the money that the equipment helps to make each year.. (You can see the definition by placing your cursor over the term.)
Today, let’s just think about it in terms of EBITDA. In Does EBITDA Bury Its Own Dead?, I wrote about the perils of treating EBITDA as a placeholder for cash flow, and Buffett couldn’t agree more.
In his Annual Letter to Shareholders, 2002, Buffet describes
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“Financial Adrenaline” is a term we love around here because it reflects our commitment to help you turbocharge your business with practical tips and techniques to improve free cash flow, the lifeblood of business. As a further extension of our Financial Adrenaline program, we’re going to share a new Business Finance Tip every Wednesday specifically for those business executives who don’t have a finance background.
Most non-finance executives have picked up a few tidbits … from a class, from a financial colleague or friend, a banker, an accountant … and have assimilated a variety of random fragments that are probably more like a messy collage than a well-drawn portrait. Is it enough to get by? Maybe … but if you’ll take ownership of your own financial education, we’ll help you. Dig in, challenge what you read, add your comments or questions and we’ll answer them right here … every time … and we’ll get this conversation started. Are you with me?
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If you’ve ever exercised by lifting weights, you know that the amount of the weight on the bar is only one variable that needs to be considered for a particular exercise. If you’re doing a bench press, you can add more weight because your chest and shoulder muscles help your arms to lift the weight. But if you put 50% of that total weight on each of two dumbbells, you can’t lift either one. You’ve probably also learned that you can’t use the same weight for curls as you do for bench presses.
Likewise, if you’re going to do only one repetition, you can handle more weight than if you’re going to lift it ten times. If you are lying flat,
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We knew that 2010 was a pretty “fowl” year didn’t we … but did you think that the price of a French hen would increase by 233%? Or that two turtle doves would now cost 78.6% more? That a lone partridge would go up 20%?
Not that there’s anything wrong with a basket of assorted swans, geese, French hens and turtle doves … I’d prefer a beef tenderloin myself … but who expected that in 2010, the ”Christmas Price Index”, which has closely tracked the Consumer Price Index (CPI) for most of its 27 years, would rise by 9.2%, the 2nd largest increase over that period (2nd only to a 16% jump in 2003), according to the NY Times report?
It’s PNC Wealth Management that has tracked the cost of the fanciful mix of gifts heralded in the classic carol “The 12 Days of Christmas” for more than a quarter century. This year, they’ve included a popup book on their web site about this index.
Of course, this basket of good is much narrower than the CPI, but there’s one other interesting “nugget” in here … namely that the price of “Five Golden Rings” is up 30% to $650 this year, although a lower increase than last year’s 43%. Should have bought a bunch of gold a few years ago, huh? (I’m such a great rear-view investor, it’s actually scary.)
BTW, if you want to give all of the gifts featured in the song … repeats included … it’s 364 gifts for a total of a mere $96,824, up 10.8% from last year. It only costs $23,439.28 for just the 1-12 gifts. Oh, that’s all? Feeling better already ….
At least there’s one piece of good news in here. If inflation rears it’s ugly head, we can put it on a plate and serve it for dinner!
Happy Holidays!
Welcome to Exkalibur. I’m Lary Kirchenbauer, President of Exkalibur Advisors, Inc. Please take advantage of our resources to help you build your business ... and let me know what more we can do to serve you.
Read my latest column from the NY Times affiliate, the North Bay Business Journal.
Lary has a remarkable ability to provide a clear and thoughtful analysis of the business drivers and potential outcomes facing private companies at each stage of development. His insight has provided a powerful framework for decision-making in many challenging situations.
Noah J. Rosenkrantz, CEO, GreenLine Systems
