A Primer on Financial Concepts

WasteExpo Together Online session “All in the Numbers: Applications of Financial Concepts” examined the trade-off between debt and equity, the cost of capital, how to evaluate the value of projects or investments, and more — all geared toward non-finance people.

The featured speaker was Allia Saydjari, director of strategy at Wheelabrator, in conversation with Laura Askin Grannis, professional development chair of the NWRA Women's Council.

Grannis proposed a theoretical situation: “Let’s say I’m working on a new product that I’ve built a business case for — one that would require a significant capital investment — and I’m ready to share that internally for approval. How would the finance folks analyze it to determine whether it should be pursued?” Saydjari noted that, “When we’re measuring a project it’s always going to be a trade-off between the upfront money we have to invest and the free cash flow (FCF) that project is going to generate for us; the money it will put in our pocket after covering all expenses.” She noted that there are many metrics that can be used to analyze a business proposition, but FCF is “the most important component for investors.”

Saydjari then dug into several ways that investment returns can be measured. She showed the equation used to calculate payback period — dividing the cost of the investment by the annual cash flow it created — and noted that this is a simple metric to determine the breakeven point of an investment. Saydjari reminded the audience that there are a lot of other factors to consider, as well as several cons to relying too heavily on this metric. For instance, “Money today is worth more than money tomorrow” (which is referred to as the “time value of money”), and payback period doesn’t take this into account.

She then looked at Return on Investment (ROI), which is “a rudimentary gauge of profitability and efficiency” and expressed as a percentage (the higher the better). But, like payback period, ROI doesn’t offer any insights on timing. Saydjari notes that, “A full-blown financial analysis should include the Internal Rate of Return (IRR) calculation.” IRR is a more thorough and precise metric that measures efficiency and takes time value of money into account.

Next, Saydjari looked at Net Present Value (NPV), which she described as “the bread and butter of financial analysis, when you’re doing capital budgeting.” It is “the difference between the present value of our cash inflows and the present value of our cash outflows.” One good thing about the formula is that it takes the time value of money into account. It translates all the cash flows from over the course of the project into the value they are worth today.

Saydjari then discussed the components of cost of capital—acquiring the money to use on a project—and how it drives the company’s required rate of return. She dug into the formula and its implications and reminded the audience that, “A return on investment must be greater than the cost of capital in order to generate value.”

The last metric Saydjari looked at was Earnings Before Interest, Taxes, Depreciation, and Amortization (EBIDTA), which “helps us understand the operational performance of the company.” Comparing EBITDA “allows us to compare operations of one company to another, on an apples-to-apples basis.”

To dig into these topics further, check out WasteExpo Together Online.