fcf conversion formula

MV (bond) / conversion ratio. Equity value. Total shares outstanding x stock price. Enterprise value - debt + cash. Enterprise value. FCF conversion is expressed as a percentage. If a company's free cash flow is equal to its adjusted net. Cash conversion rate > 100% in H1 2019 This ratio, also called cash conversion ratio (CCR), assesses the efficiency FREE CASH FLOW. fcf conversion formula

Cash conversion

A good company must make profits its income must be higher than its costs. However, profits can be manipulated with clever accounting and may not reflect the underlying reality. Savvy investors will look at a company's ability to generate hard cash, as this is what actually pays their dividends. Companies that aren't good at generating cash can be bad investments and can go bust.

So making profits is one thing but you southern heritage classic parade 2019 to know how well a company converts these profits into cash. You can do this by comparing the operating profit number from a company's income statement with the operating cash flow number from its cash flow statement.

So if a company has operating profits of £100m and operatingcash flow of £80m, it has a cash conversion ratio of 80%.You can also compare a company's net profit (the profit forshareholders) with its free cash flow (the amount of cash leftover after all costs have been paid and investments made).

There can be good reasons for cash flow falling short of profitsfor a short period of time, but big differences that happenfrequently may be a warning sign one that you shouldnot ignore.

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Источник: https://moneyweek.com/glossary/cash-conversion

How to Calculate Free Cash Flow

In investing, free cash flow represents the amount of money a company has left after all its bills are paid. Healthy free cash flow is key to keeping a company growing, expanding and thriving. Read on to learn how to calculate free cash flow.

To get started, you'll need a copy of the company's annual report--its Form 10-K. You can find it by doing a web search for the company's name and the phrase "Form 10-K," you can look at the Securities and Exchange Commission's EDGAR database, or you can go to the company's website and look for its adams bank and trust ogallala nebraska Relations" page. For this example, we'll use Microsoft's 2007 annual report.

In the 10-K, you'll want to search for the section labeled "Financial Statements," then find the cash flow statement. Here's where you'll find the numbers you need to calculate free cash flow. Those numbers are: cash flow from operations and capital expenditures (financing and investing).

Understand that the actual calculation is incredibly simple. Find the cash flow from operations. In the 2007 Microsoft report, it's $17,796 (Technically, that's in millions, but who's counting?). Subtract the capital expenditures from this number. For Microsoft, that's -$24,544 in financing and $6,089 in investing (again in millions). So the math looks like this:$17,796-$24,544+6,089---------------$659.So Microsoft had a negative cash flow of $659 (million) this quarter; it spent $659 million more than it brought in.

Know that negative cash flow isn't always bad. Sometimes a company needs to spend to expand its business, and in Microsoft's case, even though its cash flow was negative in 2007, it nonetheless finished out the year with plenty of money on hand. The cash flow statement also shows that it had $6,714 million in cash and cash equivalents in the bank at the beginning of the year, so even though it spent $659 million more than it made during the year, it still ended up with a healthy $6,055 million to its name. (On the cash flow statement, its cash and equivalents at the end of 2007 actually comes out to $6,111 million due to exchange-rate adjustments.)

Once you're armed with your free cash flow number, it's time to dig a bit deeper into the company to find out the reason behind it. Microsoft spent a lot of money in 2007, but Microsoft has a lot of money--it can spend without breaking the bank. A company that hoards all its money might actually be better served by reinvesting some of that money in the business (or paying a dividend), whereas a company that spends freely might be doing so for one-time reasons that will lead to more profit in the future. Do your homework.

Источник: https://bizfluent.com/how-2364074-calculate-free-cash-flow.html


In this Discounted Cash Flow chapter, we will cover four key topics:

  • Discounted Cash Flow (DCF) Overview
  • Free Cash Flow
  • Terminal Value
  • WACC (Weighted Average Cost of Capital)

Discounted Cash Flow (DCF) Overview


What is DCF?

DCF is a direct valuation technique that values a company by projecting its future cash flows and then using the Net Present Value (NPV) method to value those cash flows. In a DCF analysis, the cash flows are projected by using a series of assumptions about how the business will perform in the future, and then forecasting how this business performance translates into the cash flow generated by the business—the one thing investors care the most about.

NPV is simply a mathematical technique for translating each of these projected annual cash flow amounts into today-equivalent amounts so that each year’s projected cash flows can be summed up in comparable, current-dollar amounts.

Why use DCF?

DCF should be used in many cases because it attempts to measure the value created by a business directly and precisely. It is thus the most theoretically correct valuation method available: the value of a firm ultimately derives from the inherent value of its future cash flows to its stakeholders.

DCF is probably the most broadly used valuation technique, simply because of its theoretical underpinnings and its ability to be used in almost all scenarios. DCF is used by Investment Bankers, Internal Corporate Finance and Business Development professionals, and Academics.

However, DCF is fraught with potential perils. The valuation obtained is very sensitive to a large number of assumptions/forecasts, and can therefore vary over a wide range. If even one key assumption is off significantly, it can lead to a wildly different valuation. This is quite possible, given that DCF involves predicting future events (forecasting), and even the best forecasters will generally be off by some amount. This leads to the concept of Garbage in = Garbage Out—if wrong assumptions are made, the result will be wrong.

Additionally, DCF does not take into account any market-related valuation information, such as the valuations of comparable companies, as a “sanity check” on its valuation outputs. Therefore, DCF should generally only be done alongside other valuation techniques, lest a questionable assumption or two lead to a result that is substantially different from what market forces are indicating.

DCF Advantages and Disadvantages


PROs and CONs of Using DCF



  • Theoretically the most sound method if the analyst is confident in his assumptions
  • Not significantly influenced by temporary market conditions or non-economic factors
  • Especially useful when there is limited or no comparable information
  • Valuation obtained is very sensitive to a large number of assumptions/forecasts, and can thus vary over a wide range
  • Often very time-intensive relative to some other valuation techniques
  • Involves forecasting future performance, which is very difficult


Remember C.V.S.

When doing a DCF analysis, a useful checklist of things to do has a mnemonic that is easy to remember: “C.V.S.”

  • Confirm historical financials for accuracy.
  • Validate key assumptions for projections.
  • Sensitize variables driving projections to build a valuation range.

Note that the “C.V.S.” acronym for Comparable Companies Analysis, discussed in the previous chapter, is slightly different (in that acronym, “S” stands for “Select” rather than “Sensitize.”)

Key Assumptions & Projections:

When performing a DCF analysis, a series of assumptions and projections will need to be made. Ultimately, all of these inputs will boil down to three main components that drive the valuation result from a DCF analysis.

  • Free Cash Flow Projections: Projections of the amount ofCash produced by a company’s business operations after paying for operating expenses and capital expenditures.
  • Discount Rate: The cost of capital (Debt and Equity) for the business. This rate, which acts like an interest rate on future Cash inflows, is used to convert them into current dollar equivalents.
  • Terminal Value: The value of a business at the end of the projection period (typical for a DCF analysis is either a 5-year projection period or, occasionally, a 10-year projection period).

The DCF valuation of the business is simply equal to the sum of the discounted projected Free Cash Flow amounts, plus the discounted Terminal Value amount.

There is no exact answer for deriving Free Cash Flow projections. The key is to be diligent when making the assumptions needed to derive these projections, and where uncertain, use valuation technique guidelines to  guide your thinking (some examples of this are discussed later in the chapter). It is very easy to increase or decrease the valuation from a DCF substantially by changing the assumptions, which is why it is so important to be thoughtful when specifying the inputs.

The Discount Rate is usually determined as a function of prevailing market (or known) required rates of return for Debt and Equity, as well as the split between outstanding Debt and Equity in the company’s capital structure. These required rates of return (or discount rates or “costs of capital”) are generally then blended into a single discount rate for the Free Cash Flows of the company as a whole—this is known as the Weighted Average Cost of Capital (WACC). We will discuss WACC calculations in detail later in this chapter.

Terminal Value is the value of the business that derives from Cash flows generated after the year-by-year projection period. It is determined as a function of the Cash flows generated in the final projection period, plus an assumed permanent growth rate for those cash flows, plus an assumed discount rate (or exit multiple). More is discussed on calculating Terminal Value later in this chapter.

Two Different DCF Fcf conversion formula Levered vs. Unlevered Cash Flows

There are two ways of projecting a company’s Free Cash Flow (FCF): on an unlevered basis, or on a levered basis.

A levered DCF projects FCF after Interest Expense (Debt) and Interest Income (Cash) while an unlevered DCF projects FCF before the impact on Debt and Cash. A levered DCF therefore attempts to value the Equity portion of a company’s capital structure directly, while an unlevered DCF analysis attempts to value the company as a whole; at the end of the unlevered DCF analysis, Net Debt and other claims can be subtracted out to arrive at the residual (Equity) value of the business.

An Unlevered DCF involves the following steps:

  • Project FCF for each year, before the impact from Debt and Cash.
  • Discount FCF using the Weighted Average Cost of Capital (WACC), which is a blend of the required returns on the Debt and Equity components of the capital structure.
  • Value obtained is the Enterprise Value of the business.

By comparison, a Levered DCF involves the following steps:

  • Project FCF after Interest Expense (to Debt) and Interest Income (from Cash).
  • Discount FCF using the Cost of Equity (the required rate of return on Equity).
  • Value obtained is the Equity Value (aka Market Value) of the business.


Why use Unlevered Free Cash Flow (UFCF) vs. Levered Free Cash Flow (LFCF)?

UFCF is the industry norm, because it allows for an apples-to-apples comparison of the Cash flows produced by different companies. A UFCF analysis also affords the analyst the ability to test out different capital structures to determine how they impact a company’s value. By contrast, in an LFCF analysis, the capital structure is taken into account in the calculation of the company’s Cash flows. This means that the LFCF analysis will need to be re-run if a different capital structure is assumed.

In effect, UFCF allows the analyst to separate the Cash flows produced by the business from the structure of the ownership and liabilities of the business. In a UFCF the Cash flows of the business are projected irrespective of the capital structure chosen in a UFCF analysis; the exact capital structure is not taken into account until the Weighted Average Cost of Capital (WACC) is determined.

Which is more sensitive part of a DCF model: Free Cash Flows or Discount Rate?

FCF (and Terminal Value, which uses FCF as an input) are the more sensitive. Be careful, therefore, when making key Cash flow projection assumptions, because a small ‘tweak’ may result in a large valuation change. The analyst should test several reasonable assumption scenarios to derive a reasonable valuation range. Within FCF projections, the best items to test include Sales growth and assumed margins (Gross Margin, Operating/EBIT margin, EBITDA margin, and Net Income margin). Also, sensitivity analysis should be conducted on the Discount Rate (WACC) used.

DCF Pitfalls

Avoid these common pitfalls when building a DCF Model:

  • Making important assumptions based upon insufficient research.
  • Lack of footnotes and details documenting the thought process (and research process) behind the assumptions chosen.
  • Taking an improper approach to deriving the Costs of Capital for Debt and/or Equity (and/or WACC).


DCF Steps

  1. Project the company’s Free Cash Flows: Typically, a target’s FCF is projected out 5 to 10 years in the future. The further these numbers are projected out, the less visibility the forecaster will have (in other words, later projection periods will typically be subject to the most estimation error).
  2. Determine the company’s Terminal Value: Terminal Value is calculated using one of two methods: the Terminal Multiple Method or the Perpetuity Method. (Note that if the Perpetuity Method is used, the Discount Rate from the following step will be needed.)
  3. Determine the company’s Discount Rate: Calculate the company’s Weighted Average Cost of Capital (WACC) to determine all target locations near me Discount Rate for all future Cash flows.
  4. Use Net Present Value: Discount the projected FCF and Terminal Value back to Year o (i.e., back to today) and sum these figures to determine the Enterprise Value of the company.
  5. Make Adjustments: Ifusing an Unlevered Free Cash Flow (UFCF) approach, subtracting out net debt and other adjustments from Enterprise Value to derive the Market Value of the company.

Here is a graphical representation of these DCF Steps:

DCF steps graphic

Sources of DCF Information

In order to project a company’s future Cash flows reasonably well, the analyst will need to take into account as much known information about the company (and several market metrics) as possible. The following sources can help provide needed information to produce a high-quality DCF analysis:

    • Historical Financial Results:
      • The SEC (http://www.sec.gov/) has company Annual Reports (10-K), Quarterly Reports (10-Q), and Investment Prospectuses (where available).


    • Cost of Debt:
      • Use a weighted average of the Debt interest rates in a company’s capital structure to calculate the company’s pre-tax Cost of Debt.
      • This information is almost always available for each Debt instrument in a Company’s Annual Reports (10-K) and Quarterly Reports (10-Q).


    • Cost of Equity:
      • The Risk Free Rate:
        • The risk-free rate is needed in determining the Cost of Equity, and is estimated as a function of the current long-term Treasury Bond rate (assuming that the company’s cash flows are being projected in terms of US$). The benchmark rate used is generally that of the 10-year bond.
        • The Department of the Treasury (http://www.treasury.gov/) publishes U.S. treasury bond rates on a daily basis.
        • For European companies, use the relevant rate from Euro-denominated government bonds.
      • Beta :
        • Beta is a measure of the relationship between changes in the prices of a company’s securities and changes in the value of an overall market benchmark, such as the S&P 500 index.
        • Bloomberg, FactSet, Google Finance, and Capital IQ all publish historical and estimated Beta figures for individual stocks. If the Beta is not published, it can be estimated by means of a simple linear regression.
      • Market Risk:
        • The Market Risk Premium is a measure of the degree to which investors expect to be compensated for owning risky equity securities, rather than risk-free, fixed-rate investments (such as in government bonds). It is calculated using the Capital Asset Pricing Model, which assumes that the ONLY source of risk that demands compensation is overall market risk (as measured by Beta) rather than idiosyncratic (or stock-specific) risk. This model is generally pnc corporate credit card login to determine the Cost of Equity for a company.
        • Estimates of the Market Risk Premium are available from Morningstar, and can also be estimated using historical returns on government bond investments vs. overall equity market investments.


  • Financial Projections:
    • Management Estimates can be a useful starting point for determining a company’s expected performance and Cash flow projections. However, keep in mind that these projections are often on the optimistic side.
    • Sell-side Research Estimates also can provide useful insight into a company’s path of expected performance. Again, however, keep in mind that sell-side analysts often have an incentive to be optimistic in projecting a company’s expected performance.
    • Internal Estimates (from the investment bank you work for) can be the most useful source of information for projecting a company’s expected Cash flow—particularly if these estimates were not used as part of a sell-side advisory engagement (wherein the purpose of the analysis would be, at least in part, to advocate for a higher selling price for the client). If using internal estimates, be sure to note how they were generated and for what purpose.

Free Cash Flow (FCF)

In projecting Free Cash Flow for a business, remember “C.V.S.”, and that Garbage In = Garbage Out:

  • Confirm historical financials for accuracy.
  • Validate key assumptions for projections.
  • Sensitize variables driving projections to build a valuation range.

In order to calculate Free Cash Flow projections, you must first collect historical financial results.

Key Inputs to Free Cash Flow (FCF)

Free Cash Flow (FCF) is calculated by taking the Operating Income (EBIT) for a business, minus its Taxes, plus Depreciation & Amortization, minus the Change in Operating Working Capital, and minus the company’s Capital Expenditures for the year. This derives a much more accurate representation of the Cash that a company generates than does pure Net Income:

Free Cash Flow Calculation graphic

Projecting Free Cash Flow (FCF)


Key Assumptions in Projecting Business Performance

The projected FCF in the nearest-out years (Year 1, Year 2, etc.) will have the most impact on a company’s DCF valuation. The good news is that these Cash flow figures are the least difficult to project, because the closer we are to an event, the more visibility we have about that event. (The bad news, of course, is that any error in projecting these figures will have a large impact on the output of the analysis.)

FCF is derived by projecting the line items of the Income Statement (and often Balance Sheet) for a fcf conversion formula, line by line. As a result, the FCF results are sensitive to a variety of assumptions about the future operations of the company’s business, including the following:

  • Income Statement Items:
    • Revenue (Sales) Growth: Year-over-year growth projections are the most common mechanism, but the more granularity used, the better. For example, being able to project out unit growth and pricing per unit is better than a simple year-over-year growth projection for the Sales number as a whole.
    • Margins: Project Gross Margin and Operating (EBIT) Margin based on historical patterns. Consider inputs like commodity costs in Gross Margin and SG&A (Sales, General, and Administrative) expenses for Operating Margin.
  • Balance Sheet & Statement of Cash Flow Items:
    • Capital Expenditures (CapEx): Consider both Expansion CapEx and Maintenance CapEx. The difference delineates company costs associated with buying new fixed assets to facilitate growth in the business (Expansion CapEx) from company costs associated with adding to/maintaining the value of existing assets required to service existing business (Maintenance CapEx). Unfortunately, this breakdown is generally unavailable in a company’s financial reports.
    • Changes in Operating Working Capital (OWC): Operating Working Capital is equal to Current Assets minus Current Liabilities, excluding Cash, Cash-like items (such as Marketable Securities and Securities Available for Sale), and Debt. It can be found by incorporating the relevant line items from the Balance Sheet. Use historical patterns and common sense to evaluate this line item—most OWC items are driven by Sales of the company. Thus, growth in these items should at least to some extent be a function of Sales growth.

Remember “C.V.S.” when projecting all of these items. The assumptions driving these projections are critical to the credibility of the output.

  • Confirm historical financials for accuracy.
  • Validate key assumptions for projections.
  • Sensitize variables driving projections to build a valuation range.


Projecting Business Performance

As mentioned, we first project the company’s Income Statement. Below, we will walk you through a simple example of how to do this.

  • Revenue: For simplicity, Revenue in our example is projected out at an annual growth rate of 10%, which is in-line with historical growth rates of the hypothetical company. In order to increase accuracy for this assumption, remember to study management projections, sell-side projections, and internal estimates. Also remember that more granularity, where possible, is better.
  • Cost of Goods Sold (COGS): As Revenue grows, we increased the gross profit margin by shrinking COGS as a percentage of Revenue because of the concept of economies of scale at the company (as the company grows it should experience at least some improved utilization of existing equipment and human resources, increased purchasing power, increased pricing power, etc.). Also note that for the purposes of this simple example, we are excluding Depreciation from COGS. In many cases, we would include it and back it out later.
  • Selling, General, & Administrative (SG&A): Kept constant as a percentage of Revenue (14.5%) in this example, as the company will need to increase advertising and overhead in order to drive Sales growth. In some cases, some portion of SG&A can be considered fixed (such as Corporate Headquarters costs), which may lead to diminishing SG&A expenses as a percentage of Sales as the company grows.
  • EBITDA: This is a direct output of our Revenue and cost assumptions. Had we incorporated Depreciation into expenses, we would need to add it back to Operating Income (EBIT) to arrive at EBITDA.

Simple Income Statement Example

Depreciation and Capital Expenditures

Depreciation is a non-Cash expense, meaning the company books Depreciation as an expense on the income statement for GAAP (Generally Accepted Accounting Principles) purposes but in reality, no Cash was actually spent. It is an expense of Capital Expenditures made in prior years. Therefore, in order to calculate true “Cash flow,” this must be added this back. Similarly, CapEx must be subtracted out, because it does not appear in the Income Statement, but it is an actual Cash expense.

It should be noted that Amortization acts in much the same way as Depreciation, but is used to expense non-Fixed Assets rather than Fixed Assets. An example of this would be Amortization on the value of a patent purchased when acquiring a company that owned it.

Building up to Unlevered Free Cash Flow

The next step is to take our business performance projections and calculate Unlevered FCF (UFCF) in each year:

  • Tax-adjusted EBIT: D&A needs to be taken out of EBITDA in order to calculate after-tax Operating Profit (aka EBIT). D&A is an expense for tax purposes. Thus, first we must subtract D&A in this model to calculate taxes, and then add it back after taxes. In this case, it is projected as 5.1% of Sales.
  • Tax Rate: Use last twelve months (LTM, also referred to as trailing twelve months, or TTM) tax rate in order to project find my iphone location tax rates. In this case, 35% is used.
  • Depreciation & Amortization (D&A): D&A was initially taken out to calculate taxes but then added back, because it is a non-cash expense. Capital Expenditures (CapEx): Subtracted out, as this represents Cash needed to fund new and existing assets. It is not expensed on the Income Statement, asthese purchased assets will be used to support operations in upcoming years for the business (and is thus gradually expensed, via Depreciation, in those years). Note that net of inflation, CapEx and Depreciation should converge over time, provided that the company is not growing rapidly.
  • Change in Operating Working Capital (OWC): This is subtracted out, as it represents investments in short-term net operating assets needed to fund Revenue growth. This figure represents the annual change in Current Assets minus Current Liabilities on the Balance Sheet, excluding Cash, Cash-like items, and Debt.

Now we can apply the formula:

UFCF = Tax-adjusted EBIT + D&A – CapEx – Change in OWC

Simple Unlevered Free Cash Flow Example

Discounting the UFCF Figures

We have now projected the expected Unlevered Free Cash Flows (UFCF) in each of the upcoming years. However, to value the company, we have to discount those cash flows into equivalent current (today’s) dollars. This is where Net Present Value (NPV) comes in.

The formula for calculating Present Value (PV) is as follows:

Present Value Formula graphic
In this formula, the PV is equal to the FCF in each year (Year 1, Year 2, Year 3, etc.), divided by a discount factor. In each case, the discount factor is 1 + the discount rate (r), taken to the nth power, where n is the number of years into the future that the Cash flow is occurring (similar to the compounding of an annual interest rate).

We will go into more detail on determining the discount rate, r, in the WACC section of this chapter.

The difference between Present Value and Net Present Value is simply to incorporate any cash outflows that might occur in the scenario. Since a DCF analysis involves only the cash inflows from a company’s operations, Present Play go online now and Net Present Value are equivalent.

Example calculation of Present Value from Cash Flows

Terminal Value

Terminal Value represents the value of the cash flows after the projection period. Projections only go out so far in the DCF (i.e. 5 or 10 years), so this is a mechanism for estimating the future value of the business’s cash flows after that projection period.

The Terminal Value is based on the cash flows of the business in a normalized environment. What this means is that the business should be assumed, after the projection period, to grow at a rate that is appropriate for a business of its type at the end of the projection period, and/or to be valued at multiples consistent with those of its peers (see the chapter on Comparable Companies Analysis earlier in this training course).

Calculating Terminal Value

There are two primary methods to compute a company’s terminal value:

  1. Terminal Multiple Method: Also referred to as the Exit Multiple Method, this technique uses a multiple of a financial metric (such as EBITDA) to drive a business’s valuation. These multiples can be derived using multiples prevalent among comparable companies.
  2. Perpetuity Method: Assumes that the Free Cash Flows of the business grow in perpetuity at a given rate. The Perpetuity Method uses the Gordon Formula: Terminal Value = FCFn × (1 + g) ÷ (rg), where r is the discount rate (discussed in the next section on WACC) and g is the assumed annual growth rate for the company’s FCF. This will be demonstrated with an example shortly.

As a sanity check, you can use the terminal method to back into an assumed growth rate for the business, which should be similar to the growth rate used in the perpetuity method. Examples of this calculation are discussed later in this section.

Using the Terminal Multiple Method

Continuing with our DCF example from earlier, we will demonstrate the two steps needed to apply the Terminal Multiple Method:

  1. Identify reasonable EBITDA multiple range. For this exercise, we are assuming a range of 6.0x-8.0x EV/EBITDA. We chose 6.0x to 8.0x based on historical trading ranges for the company along with comparable companies in the industry.
  2. Multiply the EV/EBITDA multiple range by the end of period EBITDA estimate. The result equals the Enterprise Value of the company as of the end of the projection period.

Year 6 EBITDA = $13,367
EV/EBITDA Multiple Range = 6.0x – 8.0x
Terminal Value = $13,367 × [6.0x – 8.0x] = $80,203 – $106,938

Terminal Multiple Method Calculation Example
Here are a couple of important considerations to make when using the Terminal Fcf conversion formula Method:

  • Make sure the terminal year is a “normalized” year. Exclude years that are influenced cyclical factors or economic factors.
  • The growth rate that the EBITDA multiple implies needs to be in-line with long-term assumptions.
  • Be sure to use a “normalized” tax rate in the terminal year. A tax chase bank careers colorado can be skewed by previous losses, one-time items, and a change in international mix.


Using the Perpetuity Method

The Perpetuity Method uses the assumption that the Free Cash Flows grow at a constant rate in perpetuity over the given time period. You should use a conservative approach when estimating growth rates in perpetuity. Analysts typically use long-term growth rates such as GDP growth (or perhaps something slightly higher), as companies typically can’t register double digit FCF growth rates forever.

Here are t mobile refill account two steps needed to apply the Perpetuity Method:

  1. Identify reasonable long-term FCF growth rates to use in perpetuity, such a GDP or something slightly higher, depending on industry and company dynamics.
  2. Calculate the Terminal Value by taking FCF from the last projection year times (1 + the perpetual growth rate). Divide this figure by the difference between the discount rate (r) and the assumed perpetual growth rate (g).

Terminal Value = FCFn× (1 + g) ÷ (rg)

In this case:

  • FCFn = last projection period Free Cash Flow (Terminal Free Cash Flow)
  • g = the perpetual growth rate
  • r = the discount rate, a.k.a. the Weighted Average Cost of Capital (WACC, covered in the next section of this training course)

If we assume that WACC = 11% and that the appropriate long-term growth rate is 1%, we get:

Terminal Perpetuity Calculation Sample
This is a very conservative long-term growth rate, and of course higher assumed growth rates will lead how do i close my santander business account uk higher Terminal Value amounts.

Terminal Perpetuity Method Calculation Example

Reconciling the Two Methods

Note that there are formulas to determine the equivalent multiples and growth rates for the two given methods.

  • Using the Terminal Multiple Method to solve for the equivalent Perpetuity Method growth rate:

Perpetuity from Multiple formula

  • Using the Perpetuity Method to solve for the equivalent Terminal Multiple Method multiple:

Multiple from Perpetuity formula

Weighted Average Cost of Capital (WACC): Different ways to describe the same concept

WACC can be a confusing concept. The technical definition of WACC is the required rate of return for the entire business given the risks to investors of investing in the business. Meanwhile, the layperson’s (and probably analyst’s) definition of WACC is the rate used to discount projected Free Cash Flows (FCF) in a DCF model.

These definitions refer to two sides of the same coin. If an investor requires a specific return on his investment dollars today, then future cash flows from an investment he makes can be converted into today’s dollars using that required return to create a “today-equivalent” value for those future cash flows. (The WACC simply does this for all investors in a company, weighted by their relative size.) Since the future FCF represent all of the value of a company available to all investors (Debt and Equity) in the company, they can be discounted by WACC to determine their value in today’s dollars.

But how do we determine what that required return should be? Put simply, it is a function of the alternative investment opportunities available to all of the investors in the company, and the riskiness of making that investment in the company relative to those available alternative returns. If the risk-equivalent return in other opportunities is X% per year, then an investor should require X% from this investment as well. And in order to gauge the current value of the investment in today’s dollars, we need to discount all future benefits accruing to those investors (namely, future Cash flows) by X%.

Here is a summary of things to make sure you understand about the WACC:

  • When discounting back projected Free Cash Flows and the Terminal Value in the DCF model, the discount rate used for each Cash flow is WACC.
  • The capital structure mix of Debt (tax-affected) and Equity times the Cost of Debt and Cost of Equity equals the WACC. In effect, WACC is the after-tax weighted average of the Costs of Capital for Debt and Equity, where the weights correspond to the relative amount of each component that is outstanding.
  • WACC is a forward-looking rate of return and is directly related to the risk of the investment and the alternative investment opportunity set available to the company’s investors across the capital structure (i.e., for the business as a whole, not just for the shareholders).

Now that we have described WACC and what it represents fully, here is the mathematical definition of WACC:

Weighted Average Cost of Capital formula


  • KE = Cost of Equity. KE = Krf + b × RP, where Krf equals the Risk Free Rate, b equals the levered (Equity) Beta for the company, and RP equals the Equity Market Risk Premium. The Beta and Risk Premium are calculated using the Capital Asset Pricing Model (CAPM).
  • KD = Cost of Debt. This is the weighted average of interest rates paid on the company’s debt obligations. Notice that in WACC, Cost of Debt is taken after taxes—i.e., it is multiplied by (1 – T). This is to acknowledge the fact that Interest Expense on Debt is (generally) tax-deductible, thereby creating a tax shield which adds value to the company. This is represented in the DCF framework by reducing the Cost of Debt component of WACC, resulting in a lower discount rate for the company’s FCF, and therefore a higher valuation for the company.
  • E = Market Value of Equity, i.e., Market Capitalization.
  • D = Book Value of the company’s Debt.
  • T = Marginal Tax Rate for the company. This rate can be different from the Effective Tax Rate used to determine Tax Expense based on EBIT.


Calculating WACC: An Example

Here is an example that illustrates the calculation of WACC for our hypothetical company, using the average adjusted (levered) beta for a sample of hypothetical, comparable companies:

Example Unlevered/Levered Beta Calculation

Example WACC Calculation

WACC formula

Example WACC Formula

Other WACC Hints:

  • WACC takes into account a capital structure that is assumed not to change over time. If it does, and that change is known, the WACC associated with each future capital structure should be used instead. An example of this might be a company in a leveraged buyout (LBO) where the capital structure will be changing as the company reduces Debt.
  • When using a DCF analysis to value an M&A transaction, use the target company’s WACC rather than that of the acquiring company. This is because the WACC of the target company will more accurately reflect the relevant risks inherent in the business being acquired.
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Scaling to $100 Million

As growth investors at Bessemer, we hear the same benchmarking questions over and over from portfolio companies as they mature: What should my gross margin be? How much should I be spending on R&D as a percent of revenue? How does my growth rate compare to peers in the market?

When it comes to building and scaling a cloud business, founders, CEOs, CFOs, and board members alike want to know what “typical” and “best-in-class” look like. Leaders, like you, want to model their businesses around these fcf conversion formula to achieve their goals.

There is a problem, though. Private market financial benchmarks are some of the most elusive financial data points in the world. They are also some of the most helpful. If you’re a cloud startup seeking to emulate the success of companies like Shopify, Procore, and Twilio, understanding how your predecessors grew and achieved key milestones is a critical part of the equation. But not everyone has access to this type of information. Private companies lack reporting requirements that would make their benchmarks known, and backers of private companies hold their portfolio company information close to the chest. Considering these factors, only the highest-flying, venture-backed companies have the opportunity to learn from the stories of the past, leaving other startups at an inherent disadvantage—until now!

We’re releasing “Scaling to $100 Million” as the industry’s definitive benchmarking report for cloud companies looking to scale to new heights. For more than a decade, Bessemer has made over 200 cloud investments and has one of the largest cloud portfolios of any venture firm in the world.* As we share this information with leaders like you, we hope this body of analysis proves to be a valuable resource for what growing your cloud business looks like at every stage.

Download our benchmarking templates to show off your metrics and how your company is scaling to new heights.

Scaling to $100 Million from Bessemer Venture Partners

  • Lesson 1: ARR is the North Star. Growing ARR (or CARR) is every cloud company’s North Star metric. The average growth rate for companies between $1-10MM of ARR was nearly 200%, decreasing to 60% for companies over $100MM+. Growth endurance measures the rate at which cloud company growth is retained YoY, which tends to be a predictable 70% in the private cloud universe. Strong gross retention and arthur state bank hours retention, which average ~85%+ and ~120%+ across cloud company lifetimes, contribute to maintaining strong growth rates.
  • Lesson 2: Win by Wide Margins. Optimizing your costs and expenses is key to building a winning cloud company. In cloud, gross margins measure how effective companies are in delivering their software to customers, and they average amazon rewards chase credit card login across company lifetimes. While COGS are primarily variable costs, you should expect to get leverage from operating expenses: Research & Development (R&D), Sales & Marketing (S&M), and General & Administrative (G&A). By $100MM of ARR, these expenses average 35%, 50%, and 20% respectively of cloud company revenue. As spend decreases, cloud companies get closer and closer to free cash flow (FCF) positivity, reaching an average of -35% FCF margins by $100MM+.
  • Lesson 3: Know Your Worth. Over the past decade, cloud company funding rounds have priced at an average of ~30x ARR between $1-10MM of ARR, fcf conversion formula to ~15x ARR beyond $10MM+. Between 2020/2021, though, the average multiple has increased to 20x, and top private cloud companies (measured by the Cloud 100) are receiving an even higher 34x. As ARR scales, round sizes tend to increase while dilution decreases.
  • Lesson 4: The TL:DR - Plot Your Way to the Next Milestone. Use our benchmarks to plot your company’s progress, and download our templates to include in your next board or fundraising deck.
  • Bonus Lesson 5: Run the Public Playbook. Target $100MM+ of GAAP revenue and visibility to FCF breakeven within 1-2 years before eyeing the public markets.

Annual Recurring Revenue (ARR) is the annualized amount of recurring software revenue that a cloud company has at any point in time. It is the main metric used to determine private cloud company valuations.

While GAAP (generally accepted accounting principles) revenue only accounts for the ratable amount of annual contract value that cloud companies earn in a given period (whether recurring or one-time revenue), ARR gives full credit for the annualized recurring contract and nets out non-recurring revenue. As a result, revenue generally lags ARR, but in the private cloud markets, most investors are comfortable giving companies forward credit because ARR will manifest in revenue eventually, assuming the high retention rates that are common in cloud. ARR gives cloud companies credit for their customer growth that GAAP revenue alone would not capture. CARR (Committed ARR) builds on the ARR concept by adding committed but not yet live contract values to total ARR and netting out forecasted churn or downsell. CARR can be an even better indicator of topline momentum than ARR for some cloud businesses, as it captures more customer information than does ARR, but CARR-to-ARR-lag for companies with long implementation timelines can be www turbotax com full site drawback.

Scale wins in cloud economics.

As you acquire more customers and generate more ARR or CARR, generally the valuations you receive will, in turn, increase. In the 10 Laws of Cloud, we explain how scale wins in cloud economics—the larger you are, and the more revenue you have, the more defensible your cloud business. Market leaders create a virtuous cycle with pricing power, talent, and product that reinforce their lead. Growing ARR should therefore be your company’s top priority. In this lesson, we explain the main ARR drivers that matter as your cloud company grows: ARR Growth, Growth Endurance, and Net and Gross Retention.

ARR Growth Rate

ARR growth rate is a key signal private investors use to determine whether a company has the product, sales efficiency, and market leadership to become a market leader. While metrics like CAC payback for sales efficiency or monthly active user (MAU) growth for product usage are more exacting measures, the growth rate is a good proxy for the overall performance of a cloud business—not just historically, but also in the future.

While it’s generally accepted that more ARR will result in a higher valuation, the less intuitive reality is that the growth rate of that ARR matters almost as much as the quantum of ARR itself. The higher your growth rate, the quicker your company will “grow into” its valuation; therefore, investors are willing to pay higher prices for a higher growth rate. Maintaining an average or best-in-class ARR growth rate is a key driver of success. So what does that look like over time?

Year over Year Growth Rate Trends Chart

Examining Bessemer’s cloud portfolio over the last decade, we find that the expected growth rate for companies decreases over time, as it is easier to grow at a higher rate on a smaller base of revenue and the marginal dollar is always harder to acquire. The average growth rate for companies between $1-10MM of ARR was nearly 200%, and this average decreases to 60% for companies over $50MM of ARR. We also find that the middle 50% of cloud companies have a tighter and tighter band of growth rates as ARR scale increases: the middle 50% of companies from $1-10MM of ARR are growing from 100-230% while the middle 50% of companies from $50MM+ of ARR are growing from 35-80%.

While there is some selection bias for companies that are at the higher ends of the ARR range (the companies that make it to that scale are the most successful ones), an important note is that average growth rates continue at high rates, even at scale. We find that this tends to happen because of two reasons.

First, by $50MM or $100MM of ARR, the Cloud Giants are crowned. Given the virtuous cycle of market leadership, the leaders that emerge are able to further consolidate their markets, accelerating growth. For example, when Bessemer first funded PagerDuty in its Series B in 2014, it was at $12MM of ARR and had material competition from VictorOps, OpsGenie, and xMatters. By the time PagerDuty crossed $100MM of ARR in 2018, all of these competitors had either been acquired or fell behind, leaving PagerDuty as the only true standalone company in the incidence response category and allowing it to capture more of the pie.

Second, market leaders tend to accelerate their growth and expand their total addressable markets (TAM) by adding “Second Act” products, so even if there is growth decay in the core product, there are constant second, third, and even fourth winds behind company growth as a homes for sale in colorado springs 80911. Cloud leaders tend to be multi-product companies. For example, our portfolio company Toast has successfully layered Payments and Capital onto its already-large point of sale (POS) business.

Examining our cloud company data, we also note that it is very rare to see a best-in-class growth rate company quickly devolve into a laggard. Similarly, it is very rare to see a mediocre grower evolve into a high-grower. Generally, companies’ modus operandi are set early, and reorientations of the magnitude needed to change growth trajectory are difficult. Taking the recent example of Toast, throughout its entire journey from $1-100MM+ of ARR, it stayed within the top quartile growth range (or very close to it). But, the jump is possible, and Procore provides a good example of a company with the product-market fit and go-to-market muscle that was required to make it. Procore went from being a bottom quartile grower between $1-10MM of ARR to a top quartile grower by $25-50MM of ARR, going public in May 2021 for over $10 billion.

Growth Endurance

While we know the average growth rate for a cloud company tends to decrease over time, as investors we are often tasked with modeling out the future growth of a company based on imperfect information. A helpful heuristic that we like to use is the idea contact chime representative Growth Endurance, which we explored in this year’s State of the Cloud 2021. Growth Endurance is the rate at which growth is retained from one year to the next, which tends to be very consistent in cloud companies. As the analysis below shows, when we plot the percentage of ARR Growth lost between each year, we find that it decays at a fairly predictable 30%. As a private cloud company, you should expect next year’s growth rate for your business to be ~70% of the current year.

Growth Endurance Chart

While Growth Endurance in the private cloud market is strong at ~70% YoY, within the public cloud landscape as measured by the BVP Nasdaq Emerging Cloud Index, it is even stronger. Among that group, Growth Endurance is ~80%. Below we show the impact of growth endurance on when a company should reach $100MM of ARR, assuming that it triples to $1MM of ARR in year 1 (a typical trajectory at that scale).

The Good, Better, and Best of Growth Endurance Chart

Gross and Net Retention

In the cloud business model, companies pay upfront customer acquisition costs, but are generally only able to monetize monthly thereafter, creating a negative cash flow dynamic. However, given the fantastic margin structures for cloud companies, these customers generally end up being incredibly profitable and generate large streams of high-margin recurring revenue in the long run—if, and only if, they can be retained.

Retention is one of the most important measures of your cloud business’ health, as it preserves the unit economics of historical customer acquisition. Furthermore, when you retain existing customers, you do not need to use valuable sales and marketing dollars to refill a leaky bucket but can use that capital to generate net new revenue (and therefore net growth). Every cloud company quickly learns that every percentage taken out of your retention is taken out of your growth rate.

Gross retention (dollar basis) tells you what percentage of revenue your cloud company has maintained over a given period. It nets out the revenue from customers who turned off or how to update phone number on paypal account your service, but does not account for any expansion. Looking at gross retention by ARR range, we find that it is relatively consistent at 85-90%. While it would be easy to conclude that gross retention is a negligible metric, it is actually quite the opposite: It is difficult to build a successful cloud business without having high gross revenue retention. That said, gross retention will vary based on customer segment, and we have seen successful cloud businesses that address SMB segments – such as HubSpot (in its 3 years pre-IPO) – with i know my chicken cibo matto gross retention. In cases like these, you should make sure to keep a close eye on CLTV / CAC to ensure that the unit economics of incremental customer acquisition remain healthy.

Net retention, meanwhile, differs from gross retention by accounting for the upsells and expansion revenue that your cloud company earns over a given period. Unlike gross retention, the data for net retention shows more variance over time, ranging from 105-145% between $1-10MM of ARR and decreasing slightly to a range of 105-125% by $100MM+ of ARR.

For net retention, it’s worth noting that the middle 50% range, regardless of ARR scale, still exceeds 100%. Only the bottom quartile of cloud companies have <100% net retention rates. That is, the middle 50% of cloud companies experience a dynamic in which their existing customers pay them more over time, not less, to the extent that upsell/expansion revenue is greater than any downsell/churn. The average net retention is 140% between $1-10MM of ARR, decreasing to 120% for $10-100MM+. Again, net retention often differs by segment, with SMB segments experiencing lower net retention rates than enterprise segments. For example, when Mindbody went public it had 109% net retention on ~$2K ACVs—compare that to Okta which had 123% net retention on $50K+ ACVs.

Retentions by ARR Scale Chart

Cutting the data by industry rather than ARR range, we find that gross retention largely hovers in a similar jose gregorio de la rivera espiritismo but net retention varies much more across industries. Developer tools have the greatest average and median net retention rates across our portfolio, in line with what we would expect from a bottoms-up sales strategy that expands seat count and usage as it permeates an org. Collaboration software shows a similar dynamic. Though there are exceptions, industries such as sales and marketing software, customer experience software, and finance / legal tech tend to have lower net retention, likely because land ACVs are higher and expansion over time is lower (often these tools sell a complete platform, rather than individual seats or usage tiers).

While ARR and growth rate are the North Stars when it comes to evaluating cloud businesses, these metrics are not enough to capture how well your company is performing. If we have two companies with the same growth rate and revenue, but one of them is spending $10MM on sales and marketing and the other is spending $50MM, it’s pretty obvious which has a more compelling product.

To understand how your cloud company is operating under the hood, you need to roll up your sleeves and dive into costs and expenses. The most relevant numbers are gross margins and free cash flow margins, with operating expenses—including sales and marketing, research and development, and general and administrative costs—all contributing directly to profitability. In this next lesson, we delve into each of these costs and expenses to help you target the appropriate margin structures for your scale.

Gross Margin

The beauty of software is that there is practically $0 marginal cost to replicate and distribute it. Gross margin, a company’s revenue after the cost of goods sold (or gross profit) divided by revenue, is an incredibly important metric for cloud companies because it measures the effectiveness with which companies can deliver their software to their customers. The aim is to make it as high as possible, reflecting the lowest marginal cost. A high gross margin means that a cloud company can invest more into operating expenses rather than product delivery, leading to more selling, product iteration, and ultimately, growth. Typical expenses that you will find in COGS for cloud companies are hosting costs, software implementation costs, and services costs, including customer success—these are all variable costs.

Given that the marginal cost for delivering software should be very low, investors expect gross margins for cloud companies to stay within a fairly tight band. It is perhaps the only operating or cost metric that has very little wiggle room—the average gross margin for a cloud business regardless of maturity is 65-70%, and the distribution of the middle 50% stays within ~60-80%.

That said, some of the strongest cloud companies amazon solar wind chimes our portfolio have been ones with gross margins below that range. For example, throughout much of its life in the Bessemer portfolio since the seed round in 2009, Twilio’s gross margin was ~50%, which accounted for the fact that it had to pay telecom service providers in its COGS. Twilio continues to be one of the strongest BVP Nasdaq Emerging Cloud Index performers today with a market capitalization of over $60 billion.

Gross Margins by ARR Scale Chart

Operating Expenses

After you deliver your product and incur the cost of doing so, you can spend the remaining amount of money—your gross profit—on operating expenses and retain any residual as cash flow. These fall into three major buckets: research and development (R&D), general and administrative (G&A), and sales and marketing (S&M).

R&D expense is the income statement line item that captures product, including product management, product development, engineering, and design. It is the core of what your cloud company is, and in turn, core to what you will be able to sell. Given its importance to your business, the irony is that R&D tends not to be the major cost driver for most cloud companies, representing an average of 95% of revenue in the early years but decreasing to only 35% by $100MM+ of ARR. This is generally because an investment in the product—and product innovation—propels a company’s growth in the early years, but ongoing investment in R&D does not scale linearly with revenue growth over time. There will be product enhancements and “second act” products that require investment, but maintenance and improving the core never costs as much proportionally as creation. For example, when we invested in PagerDuty in 2014, R&D expense fcf conversion formula almost 60% of revenue; however, by the time it went public, it was only about 35%.

The general and administrative (G&A) expense line item on the income statement generally includes the functions that run the back office of your company, including executive leadership, finance, legal and compliance, HR, information technology, and other administrative functions. G&A also includes outside costs for things like legal, travel, and auditing. Early on, G&A tends to be high as a percentage of revenue, since you need to establish these functions and hire leaders such as a CFO or CHRO; however, G&A costs reduce dramatically over time as these functions generally reach a growth plateau. No matter the size of the company, it will only have one CFO! Average G&A expense goes from being 70% of revenue from $1-10MM of ARR to only 20% at $50MM+.

Lastly, we turn to sales and marketing expense (S&M), which is the most important operating expense for cloud investors and founders to pay attention to. Sales and marketing expense is the income statement line item that captures sales expenses, sales compensation, content and brand marketing, demand generation, and customer success expenses related to sales, among other costs. This represents the highest cost centers in cloud companies, representing over 50% of the total revenues brought in every year, even at maturity, as salespeople and marketing talent scale more linearly with revenue growth.

Average Margin Structure by ARR Bucket Chart

As an example, when we invested in Adaptive Insights in 2013, the company spent almost 90% of <$20MM revenue on S&M, which had only reduced to about 70% on $100MM+ of revenue when it sold to Workday in 2018. As a consequence, you need to ensure that as your sales and marketing organizations are being funded, the ARR that they are generating justifies the cost.

CAC Payback

Sales efficiency is capital efficiency.

Given the large share of revenue that sales and marketing expenses represent in cloud, sales efficiency is capital efficiency. It is impossible to have a rational amount of burn in a michael zetterer werder bremen company without sales and marketing efficiency. The primary metric that we like to use to evaluate S&M efficiency is Customer Acquisition Cost (CAC) Payback. CAC payback is the rate at which the costs spent to acquire a customer are repaid by that customer, and it usually includes sales, marketing, and customer success expenses (at least the portion that ties to renewal/upsell/cross-sell). That timeline matters because it is only after you repay CAC that you are generating profit on that customer. During the payback period you are simply recovering the money that you expended to acquire the customer. We also measure CAC payback against gross margin-adjusted ARR given that the variable costs associated with selling a cloud software product do not accrete to profit.

Average CAC Payback by ARR Scale Chart

What we find is that the average CAC payback in the $1-10MM ARR bucket is 15 months, and this slowly increases over time, generally because early adopters are cheapest to acquire, and typically as a company matures it starts needing to compete for business with additional spend. However, by the $100MM+ scale, cloud businesses have generally unlocked a go-to-market model that rationalizes its S&M expense with strong Customer Lifetime Values (CLTVs). CLTV is the gross margin-affected value of a customer to a business over the course of its relationship, and it matters because the longer the lifetime, and the higher the lifetime value, the more profitable a customer is. It provides a check my discover credit card balance for how high customer acquisition costs can be, as only after 1x CLTV / CAC are customers profitable to a business; if CAC exceeds CLTV, you should not acquire incremental customers. We recommend investing in customer acquisition when CLTV / CACs are 3x+, and if much under that, continuing to experiment until you have unlocked stronger unit economics.

While we present the averages across Bessemer’s cloud portfolio, CAC paybacks can range materially, generally due to customer segment. For cloud companies selling into SMB-focused accounts, you should target CAC payback <12 months; for mid-market-focused accounts, target CAC payback <18 months; and for enterprise-focused accounts, target <24 months. The three-segment buckets tend to have different annual contract values (SMB the smallest, enterprise the highest) and churn rates (enterprise the lowest, SMB the highest), allowing enterprise-focused companies to support longer payback periods than SMB-focused ones. Put another way, enterprise segments tend to have long lifetimes and therefore high CLTVs and SMB short lifetimes and therefore lower CLTVs, thereby supporting significantly different customer acquisition cost structures.

Irrespective of the customer segment though, shorter CAC payback periods are always better than longer ones, since it’s only after the CAC payback period expires that customers become profitable to your cloud business.

Free Cash Flow Margin

Free cash flow (FCF) represents the cash that your company generates, or loses, after netting out its COGS, operating, and capital expenses, and adding back non-cash expenses. The reason FCF is so important is that in cases in which businesses are consuming capital—they are burning cash—free cash flow limits the amount of runway that a company has without accessing the capital markets. For cases in which businesses are generating cash, free cash flow is capital that can be either reinvested in the business to catalyze additional growth or doled out to shareholders as returns. Free cash flow determines profitability. As such, FCF margin, which is the measure of cash flow divided by revenue, is a core cloud KPI. As investors, we want to ensure that as a business consumes money for product, go-to-market, and administrative needs, it is doing so prudently.

While it is favorable for businesses to generate cash, in the cloud economy, sometimes generating that cash sacrifices revenue growth that might otherwise be acquired with more aggressive spending. As investors, we compare a cloud business’ ARR growth to its burn in order to determine its capital efficiency, and sometimes we actually trade off profitability for growth.

For example, at IPO, the top quartile of BVP Nasdaq Emerging Cloud Index companies operated at cash flow breakeven. Snowflake, however, burned over $100MM but in the process grew revenue by almost $170MM and over 170% YoY, which is certainly also in the top quartile.

FCF Margin of Revenue by ARR Scale

Efficiency Score

When looking at burn for a cloud business, we want to consider it in the context of growth. Burning $100MM a year sounds high, but what if a company burned $100MM and added $1 billion of net new ARR? In that context, it doesn’t sound so bad. As this hypothetical suggests, investors look at the cash consumption of a business relative to the revenue that it generates, which is why the efficiency score becomes a helpful metric. Efficiency score equals FCF margin of ARR plus ARR year-over-year growth rate—as such it helps to show the tradeoffs between growth and profitability, but it is generally only applicable after achieving $25MM+ of ARR (before which revenue community savings bank edgewood are too small for it to be meaningful). We encourage Bessemer portfolio companies to target 70% efficiency scores between $25-50MM of ARR, and a slightly lower 50% at $100MM+ as YoY growth rate drops off dramatically and companies find the right balance of profitability against a “grow-at-all-costs” model.

Efficiency score = FCF margin of ARR + ARR YoY Growth Rate

Younger companies tend to have higher growth rates and higher burn rates, and companies at maturity have lower growth rates and lower burn (and sometimes cash flow positivity). The “Rule of 40” is often referenced—that companies should have efficiency scores of 40%+ – but the average BVP Nasdaq Emerging Cloud Index efficiency score is actually closer to 50%, anchored up by the likes of Zoom, Shopify, Datadog, Crowdstrike, and other high performers. For example, even at over $3.8 billion of LTM revenue, Shopify is still growing ~60% YoY with ~10% FCF margins for an efficiency score of carolina state of mind sun realty to 70%.

Cash Conversion Score

The Cash Conversion Score (CCS) is another metric that we often use to evaluate whether or not the capital that cloud companies raise and consume is generating a meaningful return. As the ratio of the ARR to total capital invested into a company minus cash, the Cash Conversion Score is effectively the return-on-investment of each dollar ever invested into a company. For both founders and investors, the Cash Conversion Score is, therefore, a powerful proxy for returns. If a company has a CCS of 1.0x, one dollar of investment into the business yields one dollar of topline recurring revenue. If we assume that the average cloud company gets a 10x revenue multiple (more in-line with historical norms vs. the 23x revenue multiple of ^EMCLOUD today), the one dollar of revenue multiplied by the 10x multiple equals $10 of enterprise value. Every dollar put into the company is getting a 10x return. Similarly, a company with a 0.1x CCS would only return the capital invested. ROI is not driven by Cash Conversion Score directly, but CCS indicates multi-year trends in a couple of incredibly important things, including product-market fit and a scalable sales and marketing organization. It is therefore a core KPI we track in evaluating cloud businesses.

The average Cash Conversion Score for cloud companies tends to increase as it matures, from an average of almost 0.5x from $1-10MM of ARR to almost 1x at $100MM+. For cloud companies, revenue generation tends to lag spending and only the strongest companies will scale to the $100MM+ mark where they are seeing the most leverage from their operating model.

One of the strongest companies on this metric—from the start—has been our portfolio company Zapier, which has raised only $1.3MM in its lifetime and announced in March 2021 that it exceeded $140MM of ARR. While we don’t hold every company to this CCS efficiency, we look for companies with best-in-class CCS of 1x+.

Cash Conversion Score by ARR Scale Chart

As investors and board members of emerging cloud companies, one of the most frequent questions founders ask us is, ”What are we worth?”

Knowing the worth of a company matters to different constituents for different reasons: For founders, a higher round valuation might mean less dilution and ability to raise more capital and fund a new product or geography; for prospective employees, a lower valuation might mean more opportunity for upside and runway for career growth; and for current employees, a higher valuation might mean more value to their stock options. But just as company metrics are obfuscated in the private markets, so too are private company valuations. In this lesson, we will dig into what private investors are willing to pay for cloud companies, looking at valuation multiples, round size, and dilution.

Valuation Multiples

For cloud founders and executives looking to fundraise from VCs, understanding what multiple they will get is one of the biggest unknowns. In cloud, it is almost always a function of one thing: growth. In the private markets, investors are generally willing to pay ahead of ARR acquisition, betting on the company’s ability to “grow into” its valuation—but the higher the growth, the faster it “grows into” that number. For example, If a company is growing at 300% YoY, a 40x valuation multiple will become a 10x valuation multiple in just one year. As a consequence, the general rule is that higher growth rates command higher multiples. As growth rates steadily go down across ARR buckets, we therefore generally see that later stage companies raise at lower valuation multiples—and when they are still able to grow 100% at scale, they command premium valuations.

Across the past decade, Bessemer portfolio cloud companies have been priced at an average of over 30x ARR between $1-10MM of ARR, reducing to about 15x ARR beyond $10MM+. You might note that the valuation environment of the past decade was more conservative than that of 2021, as we analyzed in the Cloud 100 2021 Benchmarks Report. The average Cloud 100 multiple in 2021 was 34x (up from 9x in 2016). Below, however, we take a decade-long view in which the middle 50% of cloud companies priced at ~10-20x ARR, and, unlike in the Cloud 100 list, this data set is not limited to the 100 best cloud companies in the world in any given year.

Cloud Valuation Multiples by ARR Scale Chart

The valuations that different industries command can vary widely as well, oftentimes due to the size of TAM itself, but also because the specifics of selling into those markets correlate with different underlying growth rates. The industry that has commanded the highest multiples in the Bessemer portfolio over the past decade is fintech, with a 33x average, followed by security at 29x and data infrastructure at 27x; however, we have seen multiples as high as 50x and 100x in all three of these categories.

Cloud Valuation Multiples by Industry Chart

Today, though, we see a step-function change in the valuation environment for cloud companies, which we largely attribute to an increased quantum of capital in cloud, strong investor demand, and ongoing tailwinds that are driving growth rates to new heights. Below, we look at only the Bessemer portfolio companies in cloud that transacted between 2020-2021 and plot their growth rate relative to ARR. Regressing the two, you find that multiple is ~20x growth rate.

2020-2021 Company Growth vs Valuation Chart

Round Size

Round size is the other major lever that cloud companies can toggle when structuring a fundraise. Knowing how much to raise at each stage of growth while balancing the tradeoff of dilution and runway is a tension that you will likely have to grapple with.

As companies prove their abilities to grow, raising money gets easier and easier.

For most companies, the ability to raise money is a key to success. Without financing, you could not hire the engineers, salespeople, and other talent you need to grow. Given the negative cash flow dynamic that we covered in Lesson 2, cloud companies are often reliant on the capital markets to maintain enough runway for operations. The irony, though, is that as companies prove their abilities to grow, raising money gets easier and easier. Access to capital is easiest for those that do not need it. Over the course of a company’s maturity, we therefore see round sizes increase. Investors are willing to give companies more money as their investments are de-risked, and companies are more willing to take it as it represents less dilution.

Looking at the data validates this trend: As companies generate more revenue, their round sizes go up. The average round size for a Bessemer cloud company from $0-10MM of ARR is $20MM, but by the time a company is $50-100MM of ARR, the average round size is north of $75MM. Interestingly, even though the ARR buckets go up non-linearly, the round sizes go up linearly. That means larger companies are not raising larger rounds proportional to the size of their ARR. While this data extends over the past decade of Bessemer’s cloud investments, many have noted the recent increase in round sizes in 2020 and 2021 that exceed even the averages below.

Average Round Size by ARR Bucket Chart

As companies mature and their valuations grow, they understandably have to sell less of their businesses for the same quantum of capital—price per share goes up. As a consequence, we see the dilution that founders take decreases with scale. From $1-10MM of ARR (which roughly translates to Series A or B), companies generally sold about 20% of their businesses, but by $100MM (roughly Series E or F), they sold only a bit more than 5%.

fcf conversion formula Percentage by ARR Scale">

Building a business is not for the faint of heart—the founder’s journey is fraught with both professional and emotional highs and lows, as we’ve seen firsthand from dozens of category-defining companies, such as Toast, Shopify, Twilio, Procore, and PagerDuty. We are open sourcing this proprietary data with the hopes that these benchmarks serve as a reference point for founders who are shaping their businesses and want to icici direct com login page what they should be driving towards.

In the following sections, we lay out the exact metrics founders, CEOs, CFOs, and board members should track, based on our research and experiences in the Bessemer portfolio over the past decade. While the work to achieve these milestones may still be ahead, we hope we’ve painted a picture of the goals cloud companies should strive for.

Average Benchmarks by ARR Scale

Average Benchmarks by ARR Scale Chart

Benchmarks for Companies with $1-10MM of ARR

Top-performing cloud companies with $1 to $10MM of ARR have ARR growth rates of 230%+, Net Retentions of 145%+, Gross Margins of 85%+, and FCF margins of -65%+.

Benchmarks for $1 to 10MM of ARR Chart

Benchmarks for Companies with $10-25MM of ARR

Top-performing cloud companies with $10MM to $25MM of ARR have ARR growth rates of 135%+, Net Retentions of 135%+, Gross Margins of 80%, and FCF margins of -35%+.

Benchmarks for $10 to 25MM of ARR Chart

Benchmarks for Companies with $25-50MM of ARR

Top-performing cloud companies with $25MM to $50MM of ARR have ARR growth rates of 110%+, Net Retentions of 130%+, Gross Margins of 75%+, and FCF margins of -35%+.

Benchmarks for $25 to 50MM of ARR Chart

Benchmarks for Companies with $50-100MM of ARR

Top-performing cloud companies with $50MM to $100MM of ARR have ARR growth rates of 80%+, Net Retentions of 135%+, Gross Margins of 80%+, and FCF margins of -25%+.

Benchmarks for $50 to 100MM of ARR Chart

Benchmarks for Companies Growing Beyond $100MM of ARR

Top-performing cloud companies growing beyond $100MM of ARR have ARR growth rates of 80%+, Net Retentions of 125%+, Gross Margins of 80%+, and FCF margins of -20%+.

Benchmarks for $100MM+ of ARR Chart

So what happens after $100MM? Just as we offered the Public Playbook as a Bonus lesson in our 10 Laws of Cloud, we offer it again here.

As you build a cloud company, we bet that you hope that it will go public one day. As investors at Bessemer, whether we are making an early-stage Series A bet or a late-stage Series D investment, we partner with founders who have long-term visions, and to go the distance generally requires becoming a publicly traded company. M&A outcomes will happen along the way as companies develop strategic positions in the market and build features that could add to acquirers’ product portfolios, but we invest in companies believing that they can and will turn into the platforms that can be standalone public companies. You probably are building your company to change the world and dream of ringing the NYSE or Nasdaq bell.

So how do you get there? What is beyond $100MM of ARR? We put together the same benchmarks that we tracked above for the past decade of Bessemer’s private cloud software companies for Bessemer’s public cloud index companies, tracked by the BVP Nasdaq Emerging Cloud Index.** These are the metrics that Toast, Amplitude, and Freshworks have already worked to as they prepare for their upcoming IPOs.

Very consistent with what we noted in the $100MM+ ARR buckets in the sections above, we find that at IPO, the average LTM revenue growth rate is 65%, net retention is 120%, gross margin is 70%, R&D % of revenue is 30%, S&M % of revenue is 55%, G&A % of revenue is 20%, and FCF margin is -20%.

What is new, however, is that to run the public playbook, you need enough GAAP LTM revenue. The average LTM GAAP revenue that cloud companies had in their last fiscal year before going public was $170MM. This number has ranged widely, from Ellie Mae with <$50MM of revenue when it went public in 2011 to Square with over $850MM in its last fiscal year before becoming a public company, but the 2020/2021 cohort average is even higher at $220MM. While there is no “magic number,” we recommend targeting $100MM+, which signals to public market investors a company maturity that will allow it to stand the test of time and a high enough market cap to warrant investor interest and fcf conversion formula. Note that per their preliminary IPO prospectuses, Freshworks has generated $308MM of LTM revenue, Toast $1.1 billion, and Amplitude $129MM.

To run the public playbook, you also have to understand that while the private markets generally expect a lot of up front investment and growth, the public markets tend to expect enough maturity that companies have visibility into operating leverage and profitability. We recommend that cloud companies only target going public when they have visibility into being free cash flow positive within about 1-2 years. The top quartile of cloud companies were actually already at FCF breakeven or positivity at IPO, and these companies include the likes of Atlassian, JFrog, and Zoom.

Running the public playbook and targeting these metrics will take you beyond $100MM ARR and to life as a public company!

The Public Playbook Chart

Are you about to raise your next round of financing as a venture-backed cloud startup? Download our templates so you can show us where your company lands as you scale your cloud business to $100 million in ARR and beyond, or use them in your boardroom as you track your business’ growth.

Download Benchmarking Templates

If you have any questions, would like to dive deeper into the metrics, or have a company that has best-in-class metrics, we would love to hear from you! Email Mary D’Onofrio at [email protected]

*The data you see in the report is based on financial information from Bessemer’s cloud portfolio from 2010-1H21; it is not a random sample of the entire private market.

**Any company that is currently or has ever been on the index.

Источник: https://www.bvp.com/atlas/scaling-to-100-million

Calculating Free Cash Flow to Firm: Method 3: EBIT

In the previous articles, we learned about how to calculate the cash flow from operations if the cash flow statement or the income statement were given in the question paper. In many cases, these financial statements may not be given in full in the question paper.

Instead, some excerpts from these statements may be provided in the question paper. One such example is when Earnings before Interest and Taxes (EBIT) is provided. Hence, we have to begin our calculation with EBIT and derive the free cash flow to the firm based on the supplementary information. This article will describe this process in detail.

It is important to understand the logic behind the formulas. Mindless rote learning of the formula may cause the students to forget the formulas or get confused. If the concepts are clear, students can derive the formulas themselves as and when required.

Here is a step by step procedure to calculate the free cash flow to the firm from EBIT.

Step 1: Add Back Depreciation:

Depreciation is a non cash expense. It has been reduced from the revenues to arrive at EBIT. Hence, to derive what the true cash flow of the firm is, we need to add back the depreciation amount. This is the standard procedure we use while preparing any cash flow statement.

Step 2: Adjust EBIT for taxes

Step 2 is where things get slightly complicated. Now, notice the fact that we are working with EBIT which is earnings before interest and taxes. This means that we haven’t accounted for interest as well as taxes and their effects on the cash flow.

Interest does not have any effect on the cash flow. We haven’t subtracted it from EBIT and hence there is no need to add it back.

Taxes on the other hand are a different matter. They are a cash outflow which occurs at a later stage in the income statement. Hence, while deriving free cash flows to the firm we must adjust the EBIT for taxes. This is done by subtracting the tax amount from EBIT.

For example, the EBIT was $1000 and there was a 40% tax rate. At a later stage on the income statement, the company will pay 40% of this $1000 as cash flow. Hence, its EBIT will be reduced to $600. We therefore need to adjust the EBIT for taxes and make it a post tax EBIT number.

Step 3: Subtract Fixed Capital and Working Capital Investment

Step 3 is the standard procedure we use to calculate free cash flow to the firm. Here, we will subtract our working capital and fixed capital investments from the amount derived by performing step 1 and step 2. The complications that may arise while doing so have been discussed in earlier articles.

These three steps can be summarized in the following formula:

FCFF = (EBIT *(1-tax rate)) + Depreciation – FC Investment – WC investment

Calculating Free Cash Flow to Firm: Method 4: EBIDTA

The fourth method of calculating free cash flows is closely related to the third method. Here too we are being provided with excerpts from the income statement. Instead of being provided with the EBIT number, we are provided with the EBIDTA number.

EBITDA stands for Earnings before interest, tax, depreciation and amortization. As we can see this appears even further up on the income statement as compared to the EBIT number.

Here even the depreciation has not been subtracted. Hence there is a slight change in the step 1 that we followed above.

Change in Step 1: Add Back Depreciation Tax Shield

Since the depreciation amount has not been deducted, there is no need to add it back. However, the depreciation amount does reduce the tax bill of the company. Hence, we need to add back the depreciation tax shield to find out the true free cash flow that will accrue to the firm.

Notice the difference. When we were given EBIT, we added back the entire depreciation amount. In this case we will only add back the tax shield provided by the depreciation.

For example, if the depreciation amount was $200 and the prevailing tax rate is 40%, we will add back only $80 i.e. ($200*0.4) and not the entire $200 as we did in the earlier case.

Apart from this, steps 2 and 3 need to be repeated exactly as they were in the above case.

This method can be summarized in the following formula:

FCFF = (EBITDA*tax rate) + (Depreciation*tax rate) – FC Inv - WC Inv

Thumb Rule:

The thumb rule in these cases is to adjust for any non cash changes above the income statement metric that you have been provided. All non cash changed below the metric must be ignored or only adjusted for taxation.

It is for this reason that we added back the entire depreciation amount in case of EBIT. (Depreciation appears above EBIT on the income statement) whereas we add only the depreciation tax shield in the case of EBIDTA (Depreciation appears after EBIDTA on the income statement)

Thus, we can derive free cash flow to the firm from a wide variety of metrics. We could use the cash flow statement, the income statement or even some selected information from the income statement.

Authorship/Referencing - About the Author(s)

The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.

Источник: https://www.managementstudyguide.com/earnings-before-interest-and-taxes.htm

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Источник: https://mimitoumorokoshi.blogspot.com/2021/08/free-cash-flow-conversion-formula.html

4 Replies to “Fcf conversion formula”

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