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UNDERSTANDING EBITDA & FREE CASH FLOW CORPORATE HUMAN RESOURCE March 2008 What is EBITDA? • EBITDA is an acronym that stands for E arnings B efore I nterest T ax D epreciation and A mortization • EBITDA is also known as operating cash flow Confidential 2 Why use EBITDA? EBITDA = REVENUE - OPERATING EXPENSES - = Revenue Revenue is the amount of money that is brought into a company by its business activities Revenue is calculated by multiplying the price at which goods or services are sold by the number of units or amount sold Cash operating expenses The essential things that a company must pay for in order to maintain business, e.g. payment of employees' wages and funds allocated toward R&D EBITDA EBITDA is a good metric to evaluate profitability, but not cash flow. EBITDA also leaves out the cash required to fund working capital and the replacement of old equipment, which can be significant. Confidential 3 Why use EBITDA? EBITDA = REVENUE - OPERATING EXPENSES - = Revenue Revenue Cash operating expenses Cash operating expenses EBITDA = Interest Expense Non Operating Income & Expenses Tax Provision Depreciation expense NET INCOME Confidential 4 Some shortcomings of EBITDA • Does not truly represent operating cash flow as it is based on accrual accounting. (Revenue and expense are recognised when they occur, not when cash is actually spent or received) • EBITDA does not take into account Capital costs, as depreciation is excluded. • Does not take into account cash for working capital • Does not take into account debt repayment and other fixed expenses Confidential 5 Free Cash Flow (FCF) Free Cash Flow is a measure of financial performance calculated as : FCF = Operating Cash Flow - Capital Expenditures. Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt. FCF is calculated as: Confidential 6 Free Cash Flow FCF = Operating Cash Flow - Capital Expenditures. EBITDA – – - Taxes Increase in Net working capital Capital Expenses Other Operating Investments = Free Cash Flow FCF represents the cash that we are able to generate after laying out the money required to maintain or expand its asset base. Confidential 7 Differences between EBITDA & FCF - EBITDA NET INCOME Revenue Revenue Cash operating expenses Revenue Cash operating expenses - Cash operating expenses - - Interest Expense - Capital Expenses - Depreciation expense - Increase in net Working capital - Other operating Investments = Free Cash Flow Tax Provision = EBITDA FREE CASH FLOW = Net Income Confidential 8 Taxes = EBITDA Drivers of EBITDA Price Revenue EBITDA - Volume Raw Materials Cost of Goods Sold Operating Expenses Labor Other Salaries of, non sales personnel SG&A Direct selling expenses Indirect Selling expenses Confidential 9 Drivers of Free Cash Flow Price Raw Materials Volume Labor Revenue EBITDA Free Cash Flow - Operating Expenses COGS SG&A Salaries Direct expenses Inventory Taxes Receivables Increase in net Working Capital Payables Plant & Equipment Capital Expenses Other operating Investment Other Property Good Will Intangibles Confidential 10 Indirect expenses How you can Increase EBITDA & Free Cash Flow Increase Revenue Increase EBITDA & FCF Reduce Costs Improve Capital Efficiency Confidential 11 How you can increase EBITDA & Free Cash Flow Improve Strategic Planning and Demand Management Improve Product Quality and Consistency Increase Volume Innovation & Faster Time-To-Market Increase Market Share Increase Revenue Increase EBITDA & FCF Improve Manufacturing Responsiveness Increase Average Sales Price Improve Customer Responsiveness Reduce Costs Increase Throughput and Reduce Downtime Improve Capital Efficiency Confidential 12 How to you can increase EBITDA & Free Cash Flow Reduce Raw Material Costs Increase EBITDA & FCF Increase Revenue Reduce Variable Cost Reduce Costs Reduce Fixed Cost Reduce Distribution Costs Reduce SG&A Costs Reduce Inventory Carrying Cost Improve Capital Efficiency Reduce Capital Cost Reduce Energy Cost Reduce Capital Cost Confidential 13 How you can increase EBITDA & Free Cash Flow Increase Revenue Increase EBITDA & FCF Reduce Costs Rationalize Manufacturing Optimize Fixed Asset Utilization Optimize Inventory Improve Capital Efficiency Reduce Capital Cost Reduce Cash Operating Cycle Reduce Cycle Time Confidential 14 How you can increase EBITDA & Free Cash Flow Improve Strategic Planning and Demand Management Increase Volume Improve Product Quality and Consistency Increase Revenue Innovation & Faster Time-To-Market Increase Market Share Improve Manufacturing Responsiveness Improve Customer Responsiveness Increase Average Sales Price Increase Throughput and Reduce Downtime Increase EBITDA & FCF Reduce Raw Material Costs Reduce Variable Cost Reduce Costs Reduce Distribution Costs Reduce SG&A Costs Reduce Fixed Cost Reduce Inventory Carrying Cost Reduce Capital Cost Reduce Energy Cost Reduce Capital Cost Improve Capital Efficiency Optimize Fixed Asset Utilization Rationalize Manufacturing Optimize Inventory Reduce Capital Cost Reduce Cash Operating Cycle Reduce Cycle Time Confidential 15
