Do You Know Your FCFE from Your EBITDA?

After my first successful startup exit, one of the most renowned figures in my industry reached out to me with an intriguing offer. They wanted me to head up their new incubator space for onboarding new businesses into their billion-pound turnover corporation. We agreed to speak further and we left it at that.

A few days later, a member of his inner circle called me. Her probing questions were aggressive, which was normal for the industry at that time, and I enjoyed the challenge. However, the conversation shifted to personal details, including my EBITDA from the company I had just sold. It felt like an unexpected interview, and the original contact hadn't mentioned anything about this. Unwilling to share personal information with someone I hadn't met, I politely ended the call.

The one person who truly knew me was my fantastic Ugandan accountant. I discovered him three years earlier in a cellar at a high street accountancy firm, where he was doing basic bookkeeping. Despite being more qualified than their senior partner, he had been overlooked. I employed him, and he quickly became invaluable. He had 25 wives in Uganda, yet he sat beside me in my Luton office five days a week!

Our financial abilities were so in sync that we communicated almost telepathically. Every Friday, he would open TAS Books, work his magic, and either smile or frown as he walked over to the printer. As a founder who was deeply involved in the business alongside my 11 direct reports, I already knew what he knew before he even looked at me. He was aware that my EBITDA was the best in the industry, thanks to our IR35-exempt contractors at the time. Whether he smiled or frowned, I always smiled back because I knew the real challenge lay in timing customer payments.......I'm sure that hits home for you too?

Anyone that runs a business needs to know their EBITDA, but don't lose sleep over it. My personal advice is to keep your Free Cash Flow to Equity (FCFE) and EBITDA-to-Interest Coverage Ratio metrics up-to-date and understand them well. These metrics will keep a bootstrapped startup founder, like I was, standing tall.........In future years, knowing these metrics will enhance your credibility among your peers.

My next adventure promises to be exciting! I'm ready to run a giant like Boeing or 星巴克 etc., solve their problems and scale them even further...... With the absence of Gerry Roche on the scene, I'm afraid I'll have to wait for Spencer Stuart or Egon Zehnder to reach out!

Below, I've explained FCFE and EBITDA in more detail. If you have any questions, please don't hesitate to reach out.......I'm always happy to help.

The Essence of FCFE

Free Cash Flow to Equity (FCFE) represents the cash available to a company's equity shareholders after all expenses, reinvestments, and debt repayments. It's a measure of a company's ability to generate cash and return it to shareholders.

Calculation: FCFE is calculated by subtracting capital expenditures, net debt repayments, and changes in working capital from net income.

Importance: This metric is particularly useful for equity investors as it provides a clear picture of the cash that can be distributed as dividends or reinvested in the business.

Unpacking EBITDA

Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) is a measure of a company's operating performance. It strips out the effects of financing and accounting decisions, focusing solely on operational efficiency.

Calculation: EBITDA is derived from net income by adding back interest, taxes, depreciation, and amortization.

Significance: This metric is often used by investors and analysts to compare profitability between companies, as it eliminates the impact of capital structure and tax rates.

Key Differences

While both metrics provide valuable insights, they serve different purposes:

Focus: FCFE focuses on the cash flow available to equity shareholders, whereas EBITDA concentrates on operational performance.

Usage: Investors use FCFE to evaluate a company's ability to return cash to shareholders. On the other hand, EBITDA is commonly used to assess a company's core profitability and efficiency.

Practical Applications

Understanding these metrics can significantly enhance your financial analysis and investment decisions:

FCFE: Ideal for assessing dividend policies and buyback potential. It helps in understanding the sustainability of shareholder returns.

EBITDA: Useful for comparing operational performance across companies and industries. It aids in identifying efficient and profitable operations.

Conclusion

Mastering both FCFE and EBITDA is essential for a comprehensive financial analysis, but don't forget your Free Cash Flow to Equity and EBITDA-to-Interest Coverage Ratio. These metrics, when used together, provide a holistic view of a company's financial health and operational efficiency. By understanding the difference of each, you can make better informed investment and strategic decisions.