We have a cash generative operating cycle 1 because we turn our inventory quickly, collecting payments from our customers before payments are due to suppliers. The customer experience to grow sales and by maintaining a lean cost structure. We work to increase operating profit by focusing on improving all aspects of Discerning investors dont stop withįocus is on long-term growth in free cash flow per share.Īs free cash flow is driven primarily by increasing operating profit dollars and efficiently managing both working capital and capital expenditures. Though its more subtle and complex in the real world, this issuethe duality between earnings and cash flowscomes up all the time.Ĭash flow statements often dont receive as much attention as they deserve. Investors would run a net present value analysis on the economics and quicklyĭetermine it doesnt pencil out. In fact, our example is so simple and clear as to be obvious. No growth rate at which it makes sense to invest initial or subsequent capital to operate the business. Unfortunately our transportation business is fundamentally flawed. With only one piece of machinery, the gross cumulative cash flow doesnt surpass the initial machine cost until Year 4 and the net present value of this stream of cash flows (using 12% cost of capital) is still negative. Once the initial capital outlay has been made for the first machine, the ideal growth trajectory is to scale to 100% of capacity quickly, then stop growing. Year 2, 3 and 4 Sales and Earnings Growth RateĬash flow perspective, the slower this business grows the better off it is. What if we modified the growth rates and, correspondingly, capitalĮxpenditures for machinerywould cash flows have deteriorated or improved? Without taking into account the $1.28 billion in capital expenditures necessary to generate this cash flow, were getting only part of the story≾BITDA isnt cash flow. Sequential annual EBITDA would have been $50, $100, $200 and $400 million≱00% growth for three straight years. Interest, Taxes, Depreciation and Amortizationwould lead to the same faulty conclusion about the health of the business. Notice, too, that a focus on EBITDA≾arnings Before But as our transportation example illustrates, one cannot assess the creation or destruction of shareholder value with certainty by looking at the income statement alone. Other business models where earnings more closely approximate cash flows. Over the same four years, the transportationīusiness generates cumulative negative free cash flow of $530 million. However, looking at cash flows tells a different story. Investors considering only the above income statement would be delighted. Here are the income statements for the first fourġ00% compound earnings growth and $150 million of cumulative earnings. The companys primary focus is on earnings so based on initial results the entrepreneur decides to invest more capital to fuel sales and earnings growth, adding additional machines in Years 2 This leads to earnings of $10 million after deducting operating expenses Each trip sells for $1,000Īnd requires $450 in cost of goods for energy and materials and $50 in labor and other costs.Ĭontinue to imagine that business is booming, with 100,000 trips in Year 1, completely and perfectly utilizing the capacity of one machine. The machine is expensive$160 million with an annual capacity of 100,000 passenger trips and a four year useful life. To illustrate with a hypothetical and very simplified example, imagine thatĪn entrepreneur invents a machine that can quickly transport people from one location to another. This happens when the capital investments required for growth exceed the present value of the cash flow derived from those investments. Though some may find it counterintuitive, a companyĬan actually impair shareholder value in certain circumstances by growing earnings. Working capital and capital expenditures are also important, as is future share Future earnings are a componentbut not the only important componentof future cash flow per share. Why not focus first and foremost, as many do, on earnings, earnings per share or earnings growth? The simple answer is that earnings dont directly translate into cash flows, and shares are worth only the present value of their futureĬash flows, not the present value of their future earnings. Most want to drive over the long-term, is free cash flow per share. Our ultimate financial measure, and the one we
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