A new metric gauges the amount of free cash flow companies can generate as they grow.
David M. Katz, CFO.com | US
May 18, 2011
This ratio seems like a change in name only. Basic analysis methods generate the same number but also take into account level changes in the ROA. As production levels increase there are additional constraints on the system that require (sometimes) major changes in asset investment. How does this approach correct for that? Or, why is this better than more traditional analysis methods?
Posted by Wayne Silverman | May 23, 2011 09:29 am
Interesting. How does this work for a non profit. All the formula points work, but was any 501c3 companies included in the study?
Posted by Manch Kersee | May 21, 2011 11:45 am
There's no need to over-complicate this issue. As I first wrote 30 years ago in Management Accounting magazine... Assume a company has the market potential to grow its revenues by 10% per year. If revenues are to grow by 10%, assets must grow at about the same rate over time. And to keep the balance sheet in balance, debt plus equity also must grow at 10%. Debt typically can grow by 10% if equity also grows at that rate, thus maintaining a constant debt-equity ratio. Assuming equity grows only from retained earnings, a company's financial ability to grow is limited by its rate of increase in equity from earnings. That is, by its after-tax Return On Equity, adjusted for dividends. This rate also is known as the Sustainable Growth Rate (g*). A company can grow faster than g*, but only for a short time. The time is limited because higher growth rates change ratios that can't continue to change for very long. Ultimately, g* prevails. It's simple arithmetic. Here are two short articles that explore this idea more fully: http://exceluser.com/tools/how_fast.htm http://exceluser.com/tools/debt_load.htm Charley Kyd www.ExcelUser.com
Posted by Charley Kyd | May 19, 2011 07:56 pm
Speed of growth vs A/R, Inventory turns would have a significant impact.
Posted by William Germanetti | May 19, 2011 01:35 pm
Can we really treat Apple as a pure manufacturer versus a developer and marketer of products? With so much manufacturing outsourced for the products that are producing a large portion of the company's revenue growth I would think that they would generate a higher percentage of Free Cash Flow from growth than a company that does a larger portion of its manufacturing in house.
Posted by Bruce Smith | May 19, 2011 08:14 am© CFO Publishing Corporation 2009. All rights reserved.