No metric captures what I need to measure cashflow performance.
So I created my own.
It’s called Maintainable Free Cash Flow.
Here’s how it works:
So I created my own.
It’s called Maintainable Free Cash Flow.
Here’s how it works:
1/ Let’s start with why I love cashflow.
Cashflow doesn't lie like profit does.
Cashflow is that honest friend that tells you when you've got something in your teeth.
Cashflow is real.
Profit hides away in spreadsheets whispering secrets and telling stories.
Cashflow doesn't lie like profit does.
Cashflow is that honest friend that tells you when you've got something in your teeth.
Cashflow is real.
Profit hides away in spreadsheets whispering secrets and telling stories.
2/ Why Maintainable Free Cash Flow?
Maintainable Free Cash Flow or MFCF😍 for short, is a measure of the cashflow generated by the business, that can be used for things that make shareholders happy.
Sounds boring. But it isn't.
MFCF is f*cking awesome.
Maintainable Free Cash Flow or MFCF😍 for short, is a measure of the cashflow generated by the business, that can be used for things that make shareholders happy.
Sounds boring. But it isn't.
MFCF is f*cking awesome.
3/ Where did MFCF come from?
It's a measure I use internally which is developed as a hybrid of Free Cash Flow (FCF) and Buffet’s ‘Owner Earnings’
It's different to FCF in that it clearly separates cash generation activities, from capital allocation decisions.
It's a measure I use internally which is developed as a hybrid of Free Cash Flow (FCF) and Buffet’s ‘Owner Earnings’
It's different to FCF in that it clearly separates cash generation activities, from capital allocation decisions.
4/ Where did FCF come from?
FCF was created by Joel M Stern in 1972. Stern was a significant voice in finance theory. He also developed Economic Value Added.
He’s a big dog.
Stern said FCF was a purer measure of shareholder value creation than any profit measure.
FCF was created by Joel M Stern in 1972. Stern was a significant voice in finance theory. He also developed Economic Value Added.
He’s a big dog.
Stern said FCF was a purer measure of shareholder value creation than any profit measure.
5/ Why not FCF then?
FCF is a great measure for the right purpose.
As CFO though, it's about how do you drive the BEHAVIOUR needed from the business to create value.
So I designed a measure that does exactly that
*MFCF has entered the chat*
FCF is a great measure for the right purpose.
As CFO though, it's about how do you drive the BEHAVIOUR needed from the business to create value.
So I designed a measure that does exactly that
*MFCF has entered the chat*
6/ And what is that behavior?
At it's most fundamental level, 2 things;
a) To drive cashflow from core operations as hard as possible
b) To make correct capital allocation decisions with that cashflow
At it's most fundamental level, 2 things;
a) To drive cashflow from core operations as hard as possible
b) To make correct capital allocation decisions with that cashflow
7/ The problem is that the 2 things happen in completely different places in the business.
Cash generation happens on the ground in the business. It's decentralised. It's delivered in business operations not corporate HQ.
It's delivered by real people who make and sell stuff
Cash generation happens on the ground in the business. It's decentralised. It's delivered in business operations not corporate HQ.
It's delivered by real people who make and sell stuff
8/ It's delivered in factories, retail stores, oil rigs, bagel shops, car dealerships, design studios...etc etc
This is different to capital allocation decisions which should be taken in a very centralised way.
Karen on checkout 3 doesn't get to decide dividend policy.
This is different to capital allocation decisions which should be taken in a very centralised way.
Karen on checkout 3 doesn't get to decide dividend policy.
9/ So, you can use MFCF to ringfence the cashflow between cash generation and capital allocation.
If it's above the MFCF line, it's cash generation.
If it's below the MFCF line, it's capital allocation.
If it's above the MFCF line, it's cash generation.
If it's below the MFCF line, it's capital allocation.
10/ MFCF allows you to hold each part of the business to account to deliver their cashflow in their part of the operation.
What if they don't?
Well, everything goes to sh*t.
You don't have the cash we need to invest, repay debt or pay dividends.
No-one is happy.
What if they don't?
Well, everything goes to sh*t.
You don't have the cash we need to invest, repay debt or pay dividends.
No-one is happy.
11/ One of the limitations of Free Cash Flow, is that it is calculated using only what is publicly available.
It's why investors like it, it's the best they've got.
But I'm going to share with you how I look at MFCF as CFO from inside a business.
It's why investors like it, it's the best they've got.
But I'm going to share with you how I look at MFCF as CFO from inside a business.
12/ So how exactly do you calculate MFCF
*EBITDA is before any restructuring costs, but after an allowance for stock based compensation expenses
*EBITDA is before any restructuring costs, but after an allowance for stock based compensation expenses
13/ Some of you will tell me, that this cuts across the school books a bit.
And that this calculation is a Frankenstein of FCFE
Maybe ...
But I don't care.
Why?
And that this calculation is a Frankenstein of FCFE
Maybe ...
But I don't care.
Why?
14/ Because ALL you should care about... is this:.
How do you present the cashflow to the business in a way that;
Cash performance is maximised (important for shareholders)
Capital allocation decisions are correct (important for shareholders)
More later on this
How do you present the cashflow to the business in a way that;
Cash performance is maximised (important for shareholders)
Capital allocation decisions are correct (important for shareholders)
More later on this
15/ A word on capex
Traditionally FCF is calculated after deducting all capex.
In MFCF deduct only MAINTENANCE capex.
And treat GROWTH capex below the line
Why?
Traditionally FCF is calculated after deducting all capex.
In MFCF deduct only MAINTENANCE capex.
And treat GROWTH capex below the line
Why?
16/ Because they are completely different financial decisions.
Maintenance capex is any capex required for the operation to continue at its current level of operating performance.
I.e. It's necessary to support continuing the current level of EBITDA generation.
Maintenance capex is any capex required for the operation to continue at its current level of operating performance.
I.e. It's necessary to support continuing the current level of EBITDA generation.
17/ Growth capex on the other hand is different.
This is capex with the objective of increasing future EBITDA for an investment today.
That is a capital allocation decision with different opportunity costs
You can also treat discretionary opex lines, e.g. R&D, in the same way.
This is capex with the objective of increasing future EBITDA for an investment today.
That is a capital allocation decision with different opportunity costs
You can also treat discretionary opex lines, e.g. R&D, in the same way.
18/ Growth capex should be evaluated against other capital allocation options (dividends, debt pay down, M&A, etc)
Stock Based Compensation; this is a cash expense in EBITDA. This can be offset with an 'SBC add back' but BELOW MFCF.
That sh*t is an expense. Fight me.
Stock Based Compensation; this is a cash expense in EBITDA. This can be offset with an 'SBC add back' but BELOW MFCF.
That sh*t is an expense. Fight me.
19/ Interest & Tax. They are a function of the cashflow you have generated from operations. They go in MFCF.
If evaluating M&A or a refi, look at MFCF before interest (& tax shield).
But we aren’t here. We’re running the business, & for now interest is a recurring expense.
If evaluating M&A or a refi, look at MFCF before interest (& tax shield).
But we aren’t here. We’re running the business, & for now interest is a recurring expense.
20/ Let's work an example year in a chain of 1,000 imaginary coffee houses.
- They generate $100k per store of EBITDA. That's $100m. Before restructuring but after SBC.
- You've improved payment terms with the coffee bean supplier, and it's worth a $5m inflow
- They generate $100k per store of EBITDA. That's $100m. Before restructuring but after SBC.
- You've improved payment terms with the coffee bean supplier, and it's worth a $5m inflow
21/
- You have to spend $15m replacing end of life coffee machines. That's maintenance capex. Your business can't operate without functioning coffee machines.
- You’ve also spent £10m on 'cash restructuring'. Severance pay after a change in management structure
- You have to spend $15m replacing end of life coffee machines. That's maintenance capex. Your business can't operate without functioning coffee machines.
- You’ve also spent £10m on 'cash restructuring'. Severance pay after a change in management structure
22/ Operating cashflow (OCF) = $80m (100 + 5 - 15 - 10).
This is the most complex line to manage, You have to deliver $80m of operating cashflow through a network of 1,000 coffee houses.
Each with it's own local challenges and some with good management and some with bad.
This is the most complex line to manage, You have to deliver $80m of operating cashflow through a network of 1,000 coffee houses.
Each with it's own local challenges and some with good management and some with bad.
23/ The most important job as CFO is building a reporting and performance management cycle that makes it simple for the 000s of staff to deliver that $80m.
$80m delivered. One coffee cup at a time.
Another thread coming on how to do that.
But for now ....
$80m delivered. One coffee cup at a time.
Another thread coming on how to do that.
But for now ....
24/ What goes on in the cashflow below OCF to get down to MFCF?
Starting with $80m of OCF
- Annual interest bill to pay of $30m. This is the cost of the established cap structure funding the business. It's MFCF.
- Taxes of $10m. Death & taxes and all that.
Starting with $80m of OCF
- Annual interest bill to pay of $30m. This is the cost of the established cap structure funding the business. It's MFCF.
- Taxes of $10m. Death & taxes and all that.
25/ MFCF is $40m; $80m of OCF - $30m - $10m.
That is the cash generated from the core business of operating 1,000 coffee shops.
You must measure the delivery of that $40m relentlessly.
Cash is like water, it will leak into gaps and cracks you don't even know are there
That is the cash generated from the core business of operating 1,000 coffee shops.
You must measure the delivery of that $40m relentlessly.
Cash is like water, it will leak into gaps and cracks you don't even know are there
26/ A buyer will give it away in payment terms to hit a rebate target.
An administrator will set the inventory MOQs at a level that makes their job easier and leaks cash to inventory.
An operator will waste capex for minimal payback in search of a narrower target.
An administrator will set the inventory MOQs at a level that makes their job easier and leaks cash to inventory.
An operator will waste capex for minimal payback in search of a narrower target.
27/ A CFO must design the performance control system to root this waste out.
It will be different in every business, but converting business performance into MFCF is one of the fundamental duties of CFO.
Remember who you work for.
Don't let your shareholders down
It will be different in every business, but converting business performance into MFCF is one of the fundamental duties of CFO.
Remember who you work for.
Don't let your shareholders down
28/ So, you’ve generated $40m of MFCF in the coffee shops.
It is new capital generated by the business, and everyone will want a piece.
Your next duty as CFO is to make sure that $40m MFCF is allocated in a way that is best for shareholders
But that's for next time ...
It is new capital generated by the business, and everyone will want a piece.
Your next duty as CFO is to make sure that $40m MFCF is allocated in a way that is best for shareholders
But that's for next time ...
29/ MFCF is the truest measure of business performance..
Shareholder value is simply the present value of future MFCF.
The business (including the CEO) will get distracted by vanity metrics. The job as CFO is to anchor them back to MFCF.
Every. F-ing. Day.
Shareholder value is simply the present value of future MFCF.
The business (including the CEO) will get distracted by vanity metrics. The job as CFO is to anchor them back to MFCF.
Every. F-ing. Day.
TLDR - Free Cash Flow
1. MFCF is a CFO's best friend
2. Purest measure of business performance
3. Separate cash generation, from capital allocation
4. MFCF doesn't manage itself. It needs hand to hand combat.
5. Driving MFCF = Driving shareholder value
1. MFCF is a CFO's best friend
2. Purest measure of business performance
3. Separate cash generation, from capital allocation
4. MFCF doesn't manage itself. It needs hand to hand combat.
5. Driving MFCF = Driving shareholder value
That's Maintainable Free Cash Flow...
Please RT the original post below and follow @SecretCFO for more content simplifying business finance.
Please RT the original post below and follow @SecretCFO for more content simplifying business finance.
https://twitter.com/1419038550931263491/status/1638549764005326848
I need a much better name than MFCF.
Anyone got any ideas?
Anyone got any ideas?
Some good ideas. Distributable, Recurring & Sustainable all work I think …
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