Musings on project management: Cash on the barrel-head

Saturday, June 11, 2016

Cash on the barrel-head

Has everyone got a handle on EBITDA?

NO?

In a few words, EBITDA is a measure of cash earnings from the real business, the day to day stuff that creates value for customers, users, and stakeholders: cash, as Earnings, Before any Interest payments, Taxes, or Deductions for non-cash items like depreciation of tangible assets and Amortization of intangibles.

Profit is an opinion; cash is a fact

Tom Pike

Fair enough. But since this a project management blog, why should we care?

Well, for one we PMs are in the value business; mostly we're in the earned value business. When the project is successful and earns its value, then it's ready for the business. The deliverables can go on to deliver on EBITDA.

What about NPV and EVA you ask?

Haven't we PMs been told by CFOs that the way the business goes about measuring financial success in the business domain is with measures of discounted cash flow (DCF), like NPV (net present value) and EVA (economic value add)?

And, haven't we all seen the IRR (internal rate of return) calculations that demonstrate that this project can't miss (at least in terms of discount)?

I took up this very thing with a CFO in the private equity business with whom I've done business for many years, Steve McBrayer. He writes:

[Private equity] is ..." much more cash flow oriented than [publically traded businesses]. I think it is the nature of the private equity industry in general – Capitalism at its finest in my opinion – very investor focused.

Our primary measure is EBITDA (basically a proxy for cash flow). Our focus is converting EBITDA into operating cash flow as efficiently as possible, while balancing the business needs (investments) against these demands.

I like to see the business unit bonus program limited to about 5% of EBITDA (I don’t always get there, but that is a reference point)

I use 10 % of EBITDA as my reference point for Cap-Ex (some business units get more if they have high growth potential and are more “value added” and some get less (for example a pure distribution business with little value add and lower growth prospects)

At the end of the day, the primary responsibility of the CFO is to prioritize the various projects competing for the limited capital budget. The valuation tools [EVA and NPV] ... are useful, but not the primary tool that I use...[which] is business judgment: does it make sense; who is responsible for the project; do I have confidence in them; is it critcal?