C1 FC 2nd half

C1: Why is a year's EBITDA misleading (his example)?

It is skewed from the large non-cash impairment expense. It does not include the total contribution of the acquisition, given the M&A accounting.

C1: Adjusted EBITDA

EBITDA plus any non-cash or non-recurring expenses, minus any non-cash or non-recurring income.

C1: Why adjusted EBITDA matters

It is the market standard way to analyze a Company's profitability. It is used in every equity research report, buy side analysis, and bank on the planet.

C1: Where to find non-cash charges

In the cash flow statement. They will be added back to net income to bridge to cash from operations.

C1: Non-cash expenses

Expenses which reduce the Company's net profit (and thus bottom-up EBITDA), but do not result in a cash outflow from the Company.

C1: Asset impairment (example of a non-cash expense)

The Company needs to reduce the value of an asset on its balance sheet. In order for the balance sheet to balance they need to reduce retained earnings. The way they do that is running this through the P&L.

C1: Stock Based Compensation

The Company gives its executives stock as part of their comp. This is an expense that the Company is incurring, but it does not impact their cash flow.

C1: Why add back non-cash expenses?

These expenses are necessary to comply with GAAP, but they do not reflect the actual cash generated by the business.

C1: One-time expenses (examples)

Large lawsuit settlements; merger expenses (lawyers, bankers etc); restructuring expenses. The best way to identify one-time expenses is by discussing with management.

C1: Four key drivers of EBITDA

Revenue Growth, Gross Margins, Operating Expenses (SG&A), EBITDA Adjustments.

C1: Balance Sheet (modeling check)

Provides a snapshot of all assets and liabilities at a point in time. Assets = liabilities plus equity. Always check to ensure that the model is balancing.

C1: Cash (what matters)

Total liquidity. Cash + undrawn revolver balances.

C1: Accounts Receivable

When a company records a sale, they will typically give their customer a certain amount of time to pay them. These invoices due from customers are AR.

C1: Typical AR payment terms

Anywhere from 45 days to 180 days.

C1: AR Days

How many days worth of accounts receivable does the company have on hand? Calculation: AR balance/(annual revenue/365).

C1: AR days flat or declined vs increased

If flat or declined, no follow up needed. If it increases, we need to find out why. Is the Company having difficulty collecting AR? Are their customers unable to pay?

C1: Inventory

The goods that the company sells. Can be a combination of raw materials & finished goods.

C1: Inventory Days

How many days worth of inventory does the Company have on hand? Calculation: Total inventory / (cost of goods sold/365). If it increases: does the Company have stale inventory it is unable to sell?

C1: Prepaid expenses

Items that the Company has already paid in advance, and has yet to utilize the service.

C1: PP&E

Heavy machinery used in a facility.

C1: What a PP&E decline can mean when profitability is declining

The Company may be spending less maintaining its equipment in order to manage liquidity.

C1: Goodwill

When a company acquires another company (the "target"), then it will record goodwill if the purchase price is more than the book (accounting) value of the target's equity.

C1: Intangible assets

If the Company has acquired patents or other assets which lack physical substance.

C1: Accounts Payable

When a Company purchases inventory on credit, they record an accounts payable until the Company pays their vendor.

C1: AP Days

How many days worth of average annual purchases does the Company have on hand? Calculation: Total AP / (cost of goods sold/365). If it increases: is the Company paying its vendors on time? If not, that's a problem.

C1: Accrued Expenses

Exact opposite of prepaid expenses. The Company has received the service from their vendor; the Company has not paid said vendor.

C1: Total debt

Aggregate borrowings, comprised of: long term debt; current portion of long term debt (CPLTD); revolver / line of credit; operating leases; capital leases; notes payable.

C1: Leverage

Debt/Adjusted EBITDA.

C1: Net leverage

Net Debt/EBITDA: (Debt - cash)/Adjusted EBITDA.

C1: Why leverage matters

These are the most commonly used and the two most important metrics in credit. Many times changes in leverage is what drives rating actions, which in turn drives bond premiums - and thus bond prices.

C1: Leverage rule of thumb

Below 2x: very conservative. Between 2.5x and 3.5x: acceptable as long as business is doing well. 3.5x-4x: pretty aggressive. 4x-5x: may be difficult to secure bank financing, may need to pay higher borrowing costs at a hedge fund or non-bank lender. Above 5x: very difficult to secure financing, except for heavily collateralized transactions or Companies with incredibly strong competitive moats.

C1: Cash from Operations

Net Income + non-cash expenses - non-cash income - changes in working capital. (His slide mislabels the result as cash from financing.)

C1: Where to find non-cash expenses to add back

The cash from operations section of the cash flow statement. Everything else in CFO can be seen in the income statement and balance sheet.

C1: Capital Expenditures (capex)

What amount of cash does the Company spend per annum on its fixed assets?

C1: Maintenance capex

In a downside scenario, what is the minimum amount of capex the Company would need to incur in order to maintain its fixed assets.

C1: Cash from Financing (what matters)

If the Company records a large inflow from proceeds of debt, we need to understand what they are using the proceeds for. If debt did not increase, then CFF is not very important.

C1: How the three financial statements flow together

Cash from Operations = net income + non cash expenses - non cash income - change in net working capital. Ending retained earnings = beginning balance + net income - dividends. Ending cash = Beginning cash + cash from financing + cash from investing + cash from operations.