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Illustration of a scientist pitching a new project to a finance-oriented executive

Well folks, we really saved the best for last here. In our final post on Finance for Scientists, we’ll be talking about one of the single most valuable tool I have learned in my adventures in finance: Net Present Value.

Why is NPV such a helpful concept for scientists? Because this tool is used by your business and finance counterparts to decide whether a particular project is worth pursuing. It is used to answer the question: relative to the low risk option of holding onto the cash needed to fund a given new project, how much money could this project generate over a particular time horizon? Understanding how NPV is calculated can not only help you make better sense of your company’s decisions, it can also help you structure projects in such a way as to make them more likely to be palatable to upper management (play around with these tools a bit and you will have a whole new appreciation for why timelines are so important.)

So what is NPV?

Net Present Value (NPV) is a way of measuring how much money an investment will generate in the future, compared to how much it costs today. NPV takes into account the time value of money, which means that a dollar today is worth more than a dollar tomorrow, because you can invest it and earn interest.

NPV is a powerful tool and the finance professional’s first choice for analyzing capital expenditures. There are three key reasons for this:

It takes into account the time value of money. Future cash flow is discounted to understand their value in today’s dollars.
It considers a business’s cost of capital or other hurdle rate. Cost of capital is the return expected by those who provide capital for the business. Hurdle rate is the minimum acceptable rate of return investors use to analyze profitability when evaluating a potential investment. In other words, NPV takes into account the specific situation of the business (which you will see shortly includes current interest rates).
It provides an answer in today’s dollars, allowing you to compare the initial cash outlay with the present value of the return.

So, to calculate NPV, you need to estimate the future cash flows (inflows and outflows) of the investment, and discount them by a certain rate that reflects the risk and opportunity cost of the investment. The discount rate is usually based on the cost of capital or the expected return of similar investments. The NPV is the sum of all the discounted cash flows.

The discounting equation looks like this:

PV = FV1/(1+i) + FV2/(1+i)2 + … + FVn/(1+i)n

PV = Present Value

FV = projected cash flow for each time period

i = discount or hurdle rate

N = number of time periods (typically years in biotech/diagnostics) you are looking at

NPV = PV – initial cash outlay

For example, suppose you want to invest in a new diagnostic device for a rare disease. You estimate that the device will cost $10 million to develop and launch, and will generate $2 million per year for 10 years. You also estimate that the discount rate for this project is 10%, which means that you expect to earn 10% per year on average from similar investments.

To calculate the NPV, you need to discount each cash flow by 10% per year.

So, for the first year, the discounted cash flow is:

$2 million / (1 + 0.1) ^ 1 = $1.82 million

For the second year, it is:

$2 million / (1 + 0.1) ^ 2 = $1.65 million

And so on, until the tenth year:

$2 million / (1 + 0.1) ^ 10 = $0.77 million

The NPV is the sum of all these discounted cash flows, minus the initial cost of $10 million:

NPV = ($1.82 million + $1.65 million + … + $0.77 million) – $10 million

NPV = $3.17 million

This means that investing in this device will generate a net profit of $3.17 million in today’s dollars, after accounting for the time value of money and the risk of the project.

However, this calculation assumes that the cash flows are certain and constant, which is rarely the case in reality. In practice, there are many uncertainties and risks involved in developing and launching a new diagnostic device, such as regulatory approval, market demand, competition, pricing, reimbursement, etc. These factors can affect both the amount and timing of the cash flows.

To account for these uncertainties and risks, some analysts use a modified version of NPV called risk-adjusted NPV (r-NPV). r-NPV adjusts each cash flow by multiplying it by a probability factor that reflects the likelihood of achieving that stage of development or commercialization. The probability factor is usually based on historical data or expert opinion.

Interest and Discount Rates vs. Your Research Project

Let’s talk briefly about interest rates and their impact on discount rates. Having never taken an economics class before, my mind was blown the first time someone walked me through this information, and it certainly has helped me better understand our current macroeconomic headwinds and Wall Street’s collective obsession with interest rates.

Higher interest rates mean a higher opportunity cost for funds. If your CFO uses a hurdle rate of 20%, it means she is pretty darn confident she can get almost that much return elsewhere for a similar level of risk. A high hurdle rate then sets a very high bar for new investments. When interest rates are high, there is always the low risk option of just sitting on your cash and still getting a pretty attractive return. So high interest rates increase the bar for investment. Similarly, if you need to raise capital to invest in this new opportunity, the cost of that capital will be higher due to the higher interest rates.

Conversely, if interest rates are very low, almost everything is better than sitting on your cash, so there is pressure for growth and investment. This situation was responsible for the halcyon days of 2019-2021. But as we are seeing now, because time scales are long in the biotech and life sciences sector, companies can get caught out by assuming that low interest rate/cost of capital days will last forever. And we are seeing this situation play out now as companies jettison development programs in order to preserve cash in the current economy (i.e., the discount rate has changed, so NPV calculations done in 2021 likely do not hold in 2024, and some opportunities are no longer worth pursuing— another reason why everyone likes shorter project timelines).

In summary, interest rates and NPV have the following relationship:

As the interest rate increases, NPV decreases, and the bar for what a good investment is increases
As the interest rate decreases, NPV increases, and the bar for what a good investment is decreases

One other important factor for scientists to consider in NPV calculations (which WILL be used to evaluate whether your pet project is worthwhile), is how the cost of the project is being estimated and how the projected cash flow is being estimated.

To do that, let’s go all the way back to the beginning of this series and think about the income statement. To refresh your memory, below is our favorite BioTechne example:

Many of the line items here will be used to estimate projected returns, so you need to know how your particular project is being ‘burdened,’ for example, with SG&A.

Quick example: let’s say you are developing a new product that runs on top of an existing platform. It will require some R&D investment, but because you are leveraging an existing platform, those costs are smaller than a new product that requires a totally new platform to be built. So your initial cash outlay will be smaller. Similarly, operating costs associated with running something on an existing platform will be relatively low (and scale with product volume). As a result, as you are calculating your projected cash flow, you would want to include some incremental operating costs in the first years after launch that then scale with sample volume. Conversely, if this new product requires building out a new sales and marketing team, those expenses can dramatically decrease the return expected in the early years after launch. However, if you are creating a new offering for an existing sales channel, then your returns will be higher. G&A can usually be approximated as a percentage of overall volume.

Finance for Scientists

All of these details will be important to understand as you are thinking about starting a new line of research, and then to consider more carefully (and this part is usually led by finance) when putting together the business case. Having your own understanding about these calculations can help you challenge assumptions that your finance team may be making that cause the business case to look significantly worse than it ought to. Similarly, as a savvy scientist, you can perhaps think about ways to decrease the upfront spend or brainstorm with your business development and marketing colleagues on alternative routes to revenue in the early days post product launch (can you reach some customer segments through existing channels? Are there channels that have lower regulatory or reimbursement requirements that can be accessed sooner? etc.). And by running a minimal NPV analysis for yourself in the initial concept phase of projects, you can get a feel for the likelihood of eventual success and prioritize your efforts accordingly.

I could probably write another 3 posts on NPV, if this topic is of sufficient interest to folks (reach out in the comments).

Otherwise, I will leave you with a few useful resources as I close out the final planned post of this series!

Thanks for following along! And a big thank you to Jeff Krimmel for inspiration and the authors of Financial Intelligence. A Manager’s Guide to Knowing What the Numbers Really Mean (Karen Berman and Joe Knight) for their easy-to-read book on finance!

Illustration of a scientist listening to an office speaker phone. The phone has various speech balloons with icons to cover topics typically covered in a company earnings call

Your Company’s Quarterly Earnings Call: How to Make Sense of It All

By Kristin Gleitsman

On December 6, 2023

In Finance for Scientists

An earnings call is a quarterly touch-base for publicly-owned companies to provide an inside look at their performance and expectations for the future.

Earning calls are not legally mandated, so a company doesn’t have to have one. However, almost all publicly traded companies host quarterly earnings calls, because they provide an opportunity for the company’s management team to explain and contextualize their most recent financial results, and to offer a small glimpse into the future. It also often provides the opportunity for investment analysts to engage directly with the company’s executives.

These quarterly calls align with a company’s fiscal year, which may be different from the calendar year. For instance, our favorite exemplar company, Bio-Techne, closed its third quarter in the spring, for instance.

You can either listen to these calls live via webcast. Or you can listen to the recording on the company’s website a short while after the call occurs. Or you can read the transcript of the call, which is what I most often do.

Let’s walk through Bio-Techne’s third quarter earnings call to better understand the structure and content of a typical earnings call. A transcript of this call can be found here: https://seekingalpha.com/article/4599539-bio-techne-corporation-tech-q3-2023-earnings-call-transcript

Safe harbor statement

A call usually begins with a safe harbor statement, which lets everyone know that financial results may include predictions about the future that may not necessarily come true. This disclaimer limits the company’s liability if the predictions about the future differ wildly from what the future actually brings.

In this part of the BioTechne earnings call, they also state, “During the call, non-GAAP financial measures may be used to provide information pertinent to ongoing business performance.” Recall from our early posts (Part 2), that GAAP stands for Generally Accepted Accounting Practices and are standardized accounting practices utilized in ensuring that financials are accurately recorded and managed. The justification for reporting non-GAAP earnings is that large one-off costs, such as asset write-downs or organizational restructuring, should not be considered normal operational costs because they distort the true financial performance of a company. In other words, context.

Presentation and discussion of the financial results

Once the Safe Harbor statement is out of the way, the CEO (in this case Chuck Kummeth) kicks off with some opening messages that essentially boil down to a sales pitch for the company. Typically the CEO will present a narrative designed to coach listeners about the company’s position in the market and how they should think about the subsequent information. As a result, this section gives listeners a deeper understanding of how the company is positioning themselves in the market, and how optimistic they are about competitors and external market forces.

In the case of the Bio-Techne call, Chuck opens with all the things investors should be happy about (milestones, strong growth, etc), and then talks about “continued challenges of COVID in China, lower biotech funding and OEM destocking from supply chain disruption concerns last year,” but ends with an optimistic statement about these headwinds decreasing in the coming year. He also welcomes a new senior leader to the company, and then dives into performance by geography and end market, essentially fleshing out the themes he opened the call with.

Following the pattern of a typical earnings call, they then move into the detailed financial section, where the CFO takes the baton and dive into numbers that will give investors a sense of the relative health of the business and how that compares to past periods. In the Bio-Techne earnings call, the CFO (Jim Hippel) starts with the EPS (earnings per share). We’ll cover EPS in the next post on the investor Big Five financial ratios, but here’s a sneak preview:

EPS measures the profitability of a company by dividing its net income by the number of outstanding shares. EPS reflects the earnings potential of a company and its ability to generate returns for shareholders. All other things being equal, a growing EPS portends an increase in stock price. In an economic slowdown, companies will work hard to keep EPS up by reducing costs (not always great for the humans working at these companies). Shareholders can accept revenue decline, but are unhappy to see a decrease in EPS.

Similar to the opening business statements, Jim starts with an overall perspective, and then goes through the financials from various geographies and business lines. At several points, he refers to ‘unfavorable foreign exchange’ as a headwind (to refresh your memory on how exchange rates can impact a life sciences company, see Part 12).

Q&A

The final, and probably most interesting, section on an earnings call is the Q&A, and it is usually the longest part of the call. The host company can call upon analysts in their preferred order, prioritizing the most relevant individuals and deprioritizing the rest. Some investors will consider the tenor of how an earnings call unfolds, paying close attention to how leadership explains key pieces of information and how they navigate analyst questions at the backend of the call.

One interesting exchange in this section was from Dan Leonard from Credit Suisse who asked, “I want to make sure I understood your summary comments appropriately. Did you say that Bio-Techne would return to double-digit growth in fiscal 2024?”

For context, the summary comments from the CEO included: “Through it all, and as Q3 demonstrated, our growth platforms are still winning with double-digit growth. As we enter Q4, some of the headwinds should diminish, especially in China, but some are likely to remain, namely the OEM destocking and smaller biotech rationalize spending.

Looking further ahead into fiscal year 2024, these remaining headwinds should further diminish a double-digit revenue increases we see in our strategic growth platforms to once again be reflected in our headline numbers. In the meantime, we expect Q4 overall momentum to continue to improve from Q2 and Q3 with an overall growth rate likely similar to how we started the fiscal year in Q1.”

The issue around OEM destocking comes up several times in the Q&A and warrants some additional context. OEM will be a term for those more connected with the manufacturing world- it stands for original equipment manufacturer, or an organization that makes devices from component parts bought from other organizations. Destocking is just what it sounds like- to reduce the amount of stock/inventory held. So OEM destocking here means that BioTechne’s OEM customers are cutting back on the inventory they are buying, which is obviously not great for BioTechne.

Let’s dig a bit deeper into the macro environment underlying this destocking trend. Pre-pandemic many companies tilted towards ‘JIT’ (just in time) inventory management practices- there are many reasons this practice is attractive for a company’s financial position (in the extreme: imagine how your cash flow statement looks like if you can sell and receive payment on inventory before you have to pay the vendors from which you bought the parts, because you’ve negotiated amazing terms- Net 90, for instance). But there is no free lunch, and JIT comes with risks to a company’s resilience, and during the pandemic massive supply chain disruptions made that risk very apparent. The upshot is that many distributors moved away from JIT and stocked up on inventory. In addition, many businesses diversified, strengthening their supplier base and giving them increased optionality with qualified sources for materials. So now with the pandemic now officially over, distributors are feeling more confident in ‘destocking’ a bit, or drawing down on that inventory. But it’s not only that, there are market pressures driving this destocking behavior as well. As we all know from the last 14 parts of this series, destocking will lead to an increase in operating cash flow. With debt markets enduring higher interest rates for at least the foreseeable future, CFOs are turning to alternative sources of capital, i.e., no one wants to borrow money at high interest rates if they don’t have to, so turning existing stock into products without replenishing it as quickly provides a convenient route to generate cash. This strategy may be great for the companies doing the destocking, but it’s not so great for the company’s selling the inventory that is now being destocked. Thus the BioTechne situation.

Okay, so with that context, what was the BioTechne’s response?

First the CFO chimes in, “Well, we’re in the process of building our plan right now for next year, right? What I was trying to indicate in my closing remarks was that if you take out the very isolated events OEM destocking. China, as an example, the ExoTRU deal and the rest of our business collectively is at double digits already. And our key growth programs, which are going to carry us to $2 billion and beyond are also all growing well in the double digits. And so it suggests that we get past these headwinds in fiscal year 2023, during fiscal year 2024, this underlying double-digit growth was seen not only in our core but definitely in our growth programs, growth platforms we’ll start to once again resonate and you’ll see it in the overall company results. And that’s our goal.”

And then the CEO pipes up: “Let me put a little ribbon on that. So, I mentioned our run rate – we watch our run rate and how we’re doing digitally with our catalogs. We are funded first and foremost, the catalog business for life sciences across the board, biopharma down through academia. And that’s remaining in teens tells us that things are okay. Then you look for other holes and we bridge it for you. This OEM thing is going to come and go, you pull that back, we’re back to normality. And on top of that, you have these growth programs. Our three top growth areas all hedged spectacular quarters. Spatial had double-digit, 45% GMP protein, 20%-plus in cell and gene therapy overall and Exosome at 87%. They’re not material enough right now to carry the average. But by next year, there are going to be a lot more material and they’re going to carry the average. So all the stuff fundamental coming back on top of these growth programs, we don’t give guidance, but we won’t be very happy here if we’re not a double-digit growth and so.”

This exchange highlights some of the richness of an earnings call. First, on this question both the CEO and CFO jump in to answer, one of the few times this happens in the Q&A, which may tell us something about the importance of the topic. Second, you can see the ‘hedging’ in language like, ‘we don’t give guidance, but we won’t be very happy here if we’re not a double-digit growth.’ And finally, you can see the narrative that BioTechne is advancing very clearly in this exchange: we have very strong growth areas and are optimistic that the headwinds bringing us down now are temporary and likely to improve in future quarters. Basically, they are trying to reassure investors about some less than spectacular numbers.

Finance for Scientists

A few more notes on how to listen to an earnings call

If you are following a company for multiple quarters, you can gain insight from listening closely for what the company disclosed relative to what prior research or earnings calls suggested they would disclose. Which topics did they emphasize, and which did they de-emphasize?

You might hear the word “guidance” on an earnings call, which is a term used to describe how the company orients analysts and investors around their projected future performance. Guidances are often given in ranges and with the caveat that they are directional only, so take them with a grain of salt. In the case of BioTechne, the CEO explicitly states ‘we don’t give guidance, but…’ When guidance is given, it’s generally a good idea to give it a close listen because sometimes the changes made to the guidance do provide important insight into the company’s future.

As stated above, some investors pay close attention to the tone used when delivering information. Is the information being delivered with energy and optimism? Or do the presenters seem sheepish and concerned? Of course, these assessments are highly subjective and can lead to false signal (and are much harder to get at from reading a transcript), but some investors will factor them into their overall read of an earnings call.

I strongly urge you to dig through past transcripts to get a sense of how both management and investors are thinking about the performance of the business.

Just for fun, here’s an article on GenAI prompts for analyzing earnings calls: https://www.mlq.ai/prompts/earnings-calls/

Next time we’ll talk about the ‘Big Five’ numbers that investors care about, including revisiting EPS. In the meantime, you can join the mailing list to be notified of when that comes out!

Illustration of a scientist looking at three pipes with money pouring out of them at different rates, representing different aspects of a cash flow statement

The Anatomy of a Cash Flow Statement: Operating, Investing, and Financing

By Kristin Gleitsman

On October 19, 2023

In Finance for Scientists

Recall from last time the cash flow statement from BioTechne, and the three main sections.

The first part describes cash flow from operating activities.
The second part is cash flow from investing activities.
The third part is cash flow from financing activities.

Let’s take these sections one by one.

Operating Activities

As is typical, the first part of the BioTechne cash flow statement describes cash flow from operating activities.

This is the cash the business collected from customers, minus all the cash that was left as any part of the process of producing goods or delivering services for customers. Many consider this category to be the single most important number for understanding the health of the business, because it signals how well the company is doing at turning profits into cash.

In our current economy, many biotech companies are dreaming about having a healthy operating cash flow. This is because a healthy operating cash flow means that further company growth can be internally funded, instead of needing to borrow or sell stock. And when interest rates are high and stock prices are low, external funding options are not particularly attractive.

Investing Activities

The second part is cash flow from investing activities.

Here we find available-for-sale investments, additions to property and equipment, and acquisitions. This section tells us something about how much cash the company is spending on investing for the future. If this number is low relative to the size of the company, then management may be treating the company as a ‘cash cow’ or potentially positioning itself for an acquisition. If the number is high, the company likely has high hopes for the future.

Let’s briefly compare BioTechne to Beckton Dickenson and Illumina on this front by making up a ratio so we can normalize by company size: cash flow from investing (amount spent in investing, so this is actually a negative number)/net income. For BioTechne in 2023, this ratio is 260,893,000/ 835,382,000 = 0.31, this is considerably higher relative to the previous year: 78,281,000/817,371,000 = 0.096. For BD, we get 3,220,000,000/18,870,000,000 = 0.17. For Illumina, 591,000,000/4,584,000,000 = 0.12. In the case of BioTechne in 2023, we see a big investment in Wilson Wolf, a manufacturing firm that invents, designs, and manufactures innovative cell culture devices and associated ancillary products, which accounted for almost 90% of the total investments.

Finance for Scientists

Financing Activities

The third part is cash flow from financing activities.

This is where we find the cash transfers involving the owners or creditors of the business. We see debt repayment, new debt, share repurchases or issues, dividend payments, etc., all here. This category is where we can see the extent to which the company is dependent on outside financing. A positive number here indicates that cash has come into the company through financing activities. A negative figure here indicates when the company has paid out capital, such as retiring or paying off long-term debt or making a dividend payment to shareholders.

For BioTechne, comparing the last couple years is pretty interesting: in 2022 BioTechne used $177,125,000 in financing activities (repurchasing common stock and paying off long-term debt), whereas in 2023, 46,838,000 was provided by financing activities (cash coming into the business, primarily through a line of credit agreement worth 619,661,000, while also paying off long-term debt).

I was a little curious about this part, so I dug around in the footnotes and found this statement:

“In October 2018, the Company entered into forward starting swaps designated as cash flow hedges on outstanding debt. The forward starting swaps reduce the variability of cash flow payments for the Company by converting the variable interest rate on the Company’s long-term debt described in Note 6 to that of a fixed interest rate. … In May 2021, the Company entered into a new forward starting swap designated as a cash flow hedge on forecasted debt. The forward starting swap reduces the variability of cash flow payments for the Company by converting the variable interest rate on the Company’s forecasted variable interest long-term debt to that of a fixed interest rate.”

Aren’t footnotes fun? 😉

Summary Section

After the cash flow from financing activities, you can see a summary section:

One interesting thing to notice here is the first line, ‘Effect of exchange rate changes on cash and cash equivalents.’ If you recall from our very first substantive post on finding financial statements using EDGAR and its utility in learning a new-to-you business, BioTechne listed international exchange rates (the price of one currency expressed in terms of another currency) as one of their financial risks, as is fairly typical in the Life Sciences. Let’s dig into this topic a bit further here.

Whenever a company from one country does business in another, the financial health of its operations will be affected by changes in exchange rates. Let’s say you buy 96-well plates from China, at a price of $0.50 USD per plate, and you are buying ~200,000/month, for a total of $100K transacted per month. With an exchange rate of ~$1 USD for 7 Chinese Yuan, you are paying 700K Yuan for these plates, or 3.5 Yuan per plate. Now let’s imagine the exchange rate changes to $1 USD = 7.5 Chinese Yuan. Each plate still costs 3.5 Yuan, but you now need only $0.47 USD for each plate, meaning your monthly order just got cheaper by ~$7K USD. The opposite situation, where the Yuan becomes stronger against the dollar as it did in the beginning of 2022, will lead to your monthly order costs effectively going up. This example is pretty simplistic, but hopefully it provides a sense of why exchange rates are important for companies with global supply chains.

And that concludes our consideration of the cash flow statement, and wraps up our dive into the three main financial statements (income statement, balance sheet, and cash flow statement).

In the next post, we’ll move on to touch on key financial ratios and why they are important. It’s not too late to join the mailing list to receive an update when it’s published!

Navigating a company’s financial condition with the cash flow statement

By Kristin Gleitsman

On October 12, 2023

In Finance for Scientists

“Cash is king,” or so they say. Let’s see how this plays out in the Cash Flow Statement.

We’ve already covered two of the three foundational financial statements— the balance sheet and the income statement.

The balance sheet told us about what the business owns, and what it owes. We use that information to understand the potential to create value for customers.

The income statement told us about the profitability of the business, or how much it costs to generate each dollar of revenue.

Let’s now turn to the third and final foundational financial statement.

The Cash Flow Statement

The cash flow statement is a recording of all the cash that entered and left the business over a period of time. It’s also the financial statement least subject to biases that creep in due to assumptions and estimates. The famous investor Warren Buffet is known to put the greatest emphasis on the cash flow statement when he examines financial statements, paying particular attention to ‘owner earnings.’ The owner earnings (also known as “Free Cash Flow”) can be calculated directly from the cash flow statement by finding the difference between the operating activities and the capital expenditures (i.e., the cash flow from investing activities).

The cash flow statement can provide insight into the financial health and status of an organization.

Specifically, by looking at the cash flow statement, we can answer the following kinds of questions:

What is the liquidity situation of the company (i.e., what can be readily converted to cash)?
What are the company’s sources of cash?
Is there free cash flow being generated to further invest in assets or operations?
Is the overall cash increasing or decreasing? How stable is it across different time frames?

The cash flow statement has an important structure. Below is the cash flow statement for BioTechne:

You can see in this example that there are three sections.

The first part describes cash flow from operating activities— cash flow that’s generated once the company delivers its regular goods or services
The second part is cash flow from investing activities— cash flow from purchasing or selling assets (both physical and non-physical property) using cash, not debt (sometimes referred to as capital expenditures)
The third part is cash flow from financing activities— cash flow from both debt and equity financing

Finally, there is a summary section at the bottom that looks like this:

This section tells us whether BioTechne is cash flow positive or negative in the ‘Net change in cash and cash equivalents’ line. So in both 2022 and 2023, BioTechne was cash flow negative, meaning the cash outflow was higher than the cash inflow during that period.

Finance for Scientists

Cash flow vs. profit

Negative cash flow doesn’t necessarily mean profit is lost. Instead, negative cash flow may be caused by a company’s decision to expand the business and invest in future growth. It can also indicate an expenditure and income mismatch, which should be addressed as soon as possible. Similarly, positive cash flow, while ideal, does not necessarily translate to profit. A business can be profitable without being cash flow-positive, and can have positive cash flow without actually making a profit (often through borrowing money).

Here it’s important to remember that profit is typically defined as the balance that remains when all of a business’s operating expenses are subtracted from its revenues, it answers the question: how much money is left over from selling a product after all expenses from producing it have been paid? This is fundamentally a different question than what cash flow answers, which centers more around whether a company has enough liquidity or cash to pay its expenses.

In a nutshell, this is why it’s important to look at financial statements together.

We’ll dig in more to the three sections of the cash flow statement in our next post. Stay tuned with via the mailing list for updates!

Illusration of a scientist examining concepts from the liabilities and equity portions of a financial balance sheet

Decoding Financial Health with Liabilities & Equity from the Balance Sheet

By Kristin Gleitsman

On October 4, 2023

In Finance for Scientists

Back to the balance sheet, specifically liabilities and equity.

In the previous post, we mentioned the fundamental equation of accounting:

Assets – Liabilities = Equity

We also walked through an example of assets from the BioTechne balance sheet.

Looking at liabilities

Now, let’s look at Liabilities. Quite simply, liabilities are what a company owes.

Let’s take a look at BioTeche’s liabilities in their 2022 Balance Sheet.

Here we see (balance sheet language is in parentheses):

The payments owed to the company’s vendors, e.g. service companies, raw material providers, etc. (Trade accounts payable),
future payment of employee salaries, benefits, etc. (Salaries, wages, and related accruals),
catch-all bucket (Accrued expenses),
pre-paid goods and services owed to customers (Contract liabilities),
expected taxes owed in the next 12 months (Income taxes payable),
lease payments due over the next 12 months (Operating lease liabilities- current),
expected near-term conditional payments that were agreed upon during an acquisition (Contingent consideration payable),
the amount of loans that due this year (Current portion of long-term debt obligations),
…and so on…

Just like the asset section, you can see there are two chunks of numbers for liabilities.

Any liabilities that require us to part with cash in a year or less are “current liabilities”. If we expect our cash outlay to come over a year in the future, we are dealing with “noncurrent liabilities”.

Finance for Scientists

Equity in the equation

Now we get to equity.

Owners’ equity as what’s left over once you subtract liabilities from assets. It includes the capital provided by investors and the profits retained by the company over time. As you can see in the BioTechne balance sheet below, equity is referred to as ‘Shareholders’ equity,’ which is common, as is ‘Stockholders’ equity.’

Here’s what the equity portion of the BioTechne balance sheet looks like:

The big picture from the balance sheet

We’ll close our introductory balance sheet conversation with a quick zoom out on how to use the balance sheet to evaluate a company’s financial health.

Is the company solvent? Is equity a positive number?
- for BioTechne, the answer is yes
Can the company pay its bills? How do the current cash assets compare with liabilities?
- cash for BioTechne is at ~$127M and current total liabilities are at ~$141M, which looks bad at first glance, until you notice that there are $217M in accounts receivable, so BioTechne seems quite likely to be able to pay its bills
Is the financial health of the company moving in the right direction? Is the equity increasing over time?
- for BioTeche, this is a yes

You can quickly get answers to these very basic questions from the balance sheet. Investors and other interested parties can also dig deeper to get a more complete picture of a company’s financial health and prospects through the balance sheet, the ever-important footnotes, and careful comparisons to other financial statements.

A few deeper questions to consider: how important is ‘goodwill’ to the company’s total assets line? What assumptions have been used in depreciation and amortization? Is equity rising because the company is making money or because of an inflow of capital?

Let’s quickly look at goodwill for our BioTechne example. In 2023, goodwill accounts for just over 30% of BioTechne’s total assets, which seems pretty hefty. But for our comparator, Becton Dickenson, goodwill is nearly half of its total assets in 2023. For Illumina in 2023, it was ~25%, down from 46% in the previous year (interesting to dig into why, but that will have to wait for another day).

I hope you see how much we can learn about a company just by studying its balance sheet. We get real insights into its viability, and the tools available for future growth.

In the next part, we’ll move into the wonderful world of cash flow. Sign up for the mailing list so to stay updated!

Illustration of various elements of a balance sheet, such as patents, cash and due invoices, sitting in balance on a seesaw

Using the Balance Sheet to Understand a Company’s Financial Health

By Kristin Gleitsman

On September 20, 2023

In Finance for Scientists

To review, the big three in terms of financial statements are:

the income statement,
the balance sheet, and
the cash flow statement.

In this post, we will talk about the importance of a balance sheet.

Remember that a balance sheet tells us what a company owns, i.e. its assets, versus what it owes, i.e. its liabilities.

Equity measures the extent to which assets exceed liabilities, and is what “belongs” to the owners of the company.

Assets and liabilities are connected with equity via the fundamental equation of accounting:

Assets – Liabilities = Equity

Finance for Scientists

Why do we care about balance sheets?

First, healthy companies have more assets than liabilities. And looking at how assets, liabilities, and equity have trended over time helps us understand whether a company is getting healthier or sicker.

Profitability (discussed in the income statement section) relates to equity, in the same way a grade in college relates to your overall GPA. You can think of profitability sort of like a single course grade, whereas equity is more like your grade point average. A single course grade will influence your GPA, but it doesn’t define it. Similarly, a strong quarter of profits will increase the equity in your balance sheet, and vice versa. Over time, the equity reflects the accumulation of profits and losses.

Second, balance sheets tell us about leverage (here’s a fun vocabulary lesson for you: a financial analyst’s word for debt is leverage). How much debt does the company rely on?

The higher the debt load, the higher the company’s debt service costs, which reduces its ability to invest or spend in other ways.

Balance sheet takeaways

These are the kinds of questions about a company’s financial health that you can answer with the balance sheet:

How much debt does the company have relative to equity?
How liquid is the business in the short term (less than one year)- can it pay its bills?
What percentage of assets are tangible and what percentage comes from financial transactions?
Is the financial health of the company moving in the right direction- is the equity increasing over time?

Short post for today, but next time we’ll dig into the first part of the balance sheet: Assets, including a particularly interesting asset category called ‘Goodwill.’

Stylized illustration of a scientist examining money, signifying profits, with a magnifying glass

Profitability: the proverbial and literal bottom line

By Kristin Gleitsman

On September 17, 2023

In Finance for Scientists

We’ll close out the income statement with a look at profitability.

Again, we’re still anchored on the income statement with this portion of our analysis.

In prior posts, we first looked at revenue, then operating costs.

If we isolate only operating revenues, then pull out operating costs, we’re left with operating income. Divide operating income by operating revenue and we get operating margin.

(We can use the words “income” and “profit” interchangeably.)

Examples from Income Statements

So let’s go back to our BioTechne Income Statement again:

In some cases, we’ll find gross profit, which lives above the operating profit line.

Gross profit is when we just subtract the direct costs of producing a good or providing a service. Recall from previous sections that gross profit can be greatly impacted by when a business chooses to recognize revenue and by decisions about what to include in Cost of Goods (CoGs).

We exclude operating costs like corporate overhead, e.g. selling, general and administrative expenses. We typically also exclude research and development expenses, since those are investments in future goods and services.

Note that for BioTechne the gross margin is almost 70%- pretty healthy. Just for fun, let’s compare the gross margin of our comparator, Beckton Dickenson.

Here’s their income statement. They don’t list out their gross margin for us, but we can calculate it by subtracting the second line from the first one: $8477, which gets us to a gross margin of ~45%.

If the gross margin is low, then management is very likely to hawkishly monitor the cost of sales. And if you are on the receiving side of that (either in R&D for future product improvements or in an operations function), then that’s a key piece of information you’d want to know to be effective.

Going back to the BioTechne Income Statement, next we see the operating expenses broken out by selling, general and administrative (sometimes called SG&A, and some companies break Selling and ‘G&A’ into separate lines) and R&D. This is then subtracted from the gross margin to give the operating income.

Finance for Scientists

Pulling more meaning from the bottom line

Operating income or profit is a key to financial health— it shows the profit made from running the business. You may have heard the term EBIT in an earnings call. This acronym stands for Earnings Before Interest and Taxes, and is synonymous with operating income. Remember how we talked about all the shenanigans that are possible with depreciation and amortization? Well, due to outright fraud (beyond poor judgment or bias) being committed by some companies with those figures, Wall Street now prefers EBITDA, where the DA tacks on Depreciation and Amortization, which removes depreciation and amortization from the operating income to hopefully provide a more clear-eyed view of operating cash flows.

One other interesting thing to pay attention to here as someone in a scientific function is the percentage of gross margin a company is spending on R&D. In the case of BioTechne, R&D is about 11% of their gross margin. For BD, it’s about 14%. For Illumina, it’s close to 44%. Different sectors in life sciences will have very different investments, so it’s not a bad idea to poke around at a few financial statements to get a sense of what is standard and how a prospective employer, for instance, compares. Investors will sometimes look at something called Return on Research Capital (RORC), which is basically comparing the previous year’s R&D expenditure to this year’s gross margin. This might be somewhat challenging and discouraging for scientists. When you work for BD, 14% is a lot bigger in real dollars than when you work for Bio Techne.

Below operating income or profit, you find a compendium of other line items that we will skip over here (you can see that these are generally smaller dollar values than what we’ve already covered), before finally arriving at Net Profit. Or, as it’s called on the BioTechne Income Statement, ‘Comprehensive Income Attributable to BioTechne.’ This line is the oft referred to ‘Bottom Line.’

To summarize: Revenue = Top Line, Profit = Bottom Line. To this day I have to pause to remind myself of the difference between Revenue and Profit, but there it is.

There is plenty more to the Income Statement that we aren’t covering here, but hopefully these posts have helped orient you to what’s included and how to parse it.

In the next post we will move on from the income statement and start to tackle the second financial statement in the trifecta: the Balance Sheet. Don’t forget to join the mailing list to be notified when it’s published!

Illustration of a scientist considering the effects of depreciation on the pipette she is considering buying

How expenses and depreciation can affect the profitability of your scientific work

By Kristin Gleitsman

On September 12, 2023

In Finance for Scientists

In this post, we’re continuing our foray into the Income Statement, focusing on expenses. Our dive into expenses will include Research and Development (R&D) expenses, near and dear to any scientist.

Let’s return once again to the now quite familiar BioTechne Income Statement:

The second block of items in the Income Statement enumerates Operating Expenses. These are broken down into ‘Sales, General, and Administrative’ (sometimes you see this referred to as SG&A or G&A) and ‘Research and Development.’ Note that the line items here can change depending on the type of business you are in. If sales is a large part of your business, you may choose to have Sales as its own line, and G&A kept separate. Some business sectors may not pull out R&D as a separate line item, but this would be highly unusual for Life Science businesses, as R&D is a crucial part of our business models.

An important aspect of G&A for R&D leaders to understand is depreciation and amortization. How these expenses are handled can GREATLY impact the profit seen in an income statement. And while we’ll talk more about profit in the next section, I do want to pause briefly on the depreciation and amortization handling here.

Finance for Scientists

Depreciation and amortization

First, some definitions. If you are like me, depreciation already feels like a somewhat familiar concept. Depreciation refers to both (1) the decrease in the value of assets over time and (2) the method used to reallocate, or “write down” the cost of a tangible asset (such as equipment) over its useful life span. In accounting, we are referring to the second of those definitions. Amortization is the same basic concept as depreciation, except it applies to intangible assets like patents, copyrights, and trade secrets.

To really understand depreciation and amortization, we need to resurrect ‘The Matching Principle’ referenced in the first post on the income statement. The matching principle seeks to match the cost with its associated revenue to determine profits in a given time period. For instance: you buy a fancy new Illumina Sequencer this year, but the expectation is that it will help to bring in revenue for the next 5+ years, so some percentage of that initial cost of the sequencer needs to be recorded in future income statements. But how long exactly will this sequencer be (1) functional and (2) part of your clinical workflow? What the accountants decide can have a huge impact on the profit in the income statement.

Here’s a worked example. Let’s say you bought a NovaSeqX recently that put you back a cool $1M. Now let’s consider three different ways of approaching depreciation and see how it impacts profit for an imaginary CRO business in which you generate $900K in revenue and incur $500K in direct costs (technician salaries, reagents, etc) and $300K in overhead (rent, marketing, etc) in a given quarter. Scenario 1: we assume the sequencer will last us 5 years, so we depreciate it by $50K per quarter (cost – salvage value) / useful life; for simplicity I am assuming a $0 salvage value). Scenario 2: we assume the sequencer will last us 2 years, which then gives us $125K per quarter depreciation. Scenario 3: we assume we’ll be using this sequencer for the next 10 years, which puts quarterly depreciation at $25K per quarter. In the table below, you can see that in scenario 2, this business is now operating in the red, whereas things look pretty rosy in scenario 3.

(in $1000)	Scenario 1	Scenario 2	Scenario 3
Revenue	900	900	900
Cost of goods sold	500	500	500
Gross Profit	400	400	400
Expenses	300	300	300
Depreciation	50	125	25
Net Profit	50	-25	75

There are two things to take away from this example: (1) profit can be significantly influenced by the assumptions you make in depreciation and amortization and (2) these assumptions should be part of considerations to make significant capital investments. So next time you argue for a capital investment, keep in mind how it will impact your company’s income statement, financial health, and, ultimately, also the stock price.

In the next part of this series, we’ll take a more complete look at a company’s profitability. In the meantime, you can sign up to the mailing list to be updated when the next installment is out.

Income Statement Fun: What is included in the Cost of Sales and why you should care

By Kristin Gleitsman

On September 7, 2023

In Finance for Scientists

In this post, we’ll continue our foray into the Income Statement and dig into costs and expenses, part 1: ‘Cost of Sales.’

Let’s go back to the BioTechne Income Statement from last time:

You have net sales (revenue) at the very top, followed by the cost of these sales. Recall that one of the first things we learned about BioTechne was that ‘Bio-Techne Corporation is a global life sciences company that provides products and services for research and clinical diagnostics. Because they provide both products AND services, the cost of sales here includes both the Cost of Goods, or CoGs, that many of us are familiar with (i.e., the raw materials used in manufacturing) and Cost of Services.

Just like with revenue, there is nuance to what is and is not included in ‘Cost of Sales.’ And these nuances are important for anyone leading a scientific (or even operations) function to understand because it can frame the performance of your department to corporate and play into how your department’s targets are set.

Finance for Scientists

Here are three examples:

Let’s say you run a Biopharma-focused informatics team at a diagnostics company. A large part of what your team does is interface with your biopharma clients to understand their needs and return the right kind of analysis. But you also work on algorithms that are used in your company’s core bioinformatics pipeline. Finance could reasonably justify putting your team’s salaries as either part of the ‘cost of services’ or part of ‘R&D.’ This choice, however, will heavily influence how much scrutiny there is, as things ‘above the line’ (i.e., in the first block of items on the income statement) usually face far more scrutiny than those below the line, especially if your margins are low.
Let’s say you run a scientific operations team. You will probably have specific CoGs targets to hit each quarter that are a big part of how you and your team are evaluated. In reviewing the numbers, you realize that there is an item around ‘contract administration’ listed against your CoGs. Does it belong there? Can you reclass that as G&A (general and administration)? If you do, your numbers are going to suddenly look better, so in a bad quarter, you may be tempted to push for a reclass.
Imagine you are in charge of running a CLIA lab at a diagnostics company. Some part of the environmental controls (i.e., air conditioning and heating) control the temperature of the CLIA lab space, and some part is used for the office space. What portion is attributed to ‘Cost of Sales’ and what portion should go under G&A (general and administration)? Do you use square footage? Do you allocate the cost in the same way for IT expenses?

Just like with revenue recognition, there is a large amount of discretion allowed here, but it’s also easy to see how things can get wonky.

That’s the basics for costs. We’ll go through expenses in the next post. As always, you can join the mailing list so you don’t miss it!

A stylized illustration showing how earning revenue is discrete from creating, delivering or even selling products

What scientists need to understand about revenue and its recognition

By Kristin Gleitsman

On August 31, 2023

In Finance for Scientists

Today we will talk about revenue.

Revenue seems like a pretty obvious concept: the dollar value of the products and services a company provided to its customers during a given period of time (remember the ‘Matching Principle’ we talked about in the last post?).

There are some subtleties here, because in order to record something as revenue, it must have been ‘earned.’ If you are selling a reagent, then you must have shipped it to your customer. If you are performing a service, say running a diagnostic test, then you should have performed the work. Easy enough? Sure, but consider:

Say BioTechne allows a customer to order reagents ahead of when they will need them (for instance, maybe the customer is looking to control the number of lots they have), but because this is a particularly important, high volume account, BioTechne is willing to hold those particular lots of reagents until the customer needs them (i.e., you haven’t shipped them yet). When can they recognize that revenue?

Or let’s say the diagnostics side of the business, ExosomeDx, signs a multi-year pharma contract for processing and analysis of clinical samples. When do they get to recognize the revenue from that deal? When the samples are run? Or when the complete analysis is delivered to the client?

Let’s keep these points in mind as we look through the numbers.

Below is the screenshot of the income statement for BioTechne:

You have Net Sales, i.e., Revenue, listed at the very top. Yet another place where different terms are used for the same concept. If we look at the income statement of another company in the space, Beckton Dickenson, their top line is called out as Revenue.

Finance for Scientists

When revenue reporting isn’t black and white

As we saw in the examples at the top of this post, there can be a fair amount of nuance in when and how to recognize sales, and tremendous pressure to make this figure look strong. And because of this, the place where the most accounting shenanigans happen is in revenue recognition. In fact, most accounting fraud occurs in the top line, but even non-criminal bias can land a company in hot water.

A quick example of how (non-criminal) bias can creep in could be around service contracts when an instrument is sold. Let’s say customers purchase a 5-year service contract alongside an instrument. When do you recognize that income? The service at year 0 has not been rendered, so you can’t recognize all the revenue, but you can claim that most of the cost of that service contract has been in making the initial sale, so 75% of the revenue should be recognized up front. Equally legitimate would be to say that only a small percentage of the revenue should be recognized up front, because most of the cost is associated with servicing that machine down the line. It’s really a judgment call that depends on the particularities of the business.

What’s interesting is that you can even change your revenue recognition strategy, although generally it’s fairly suspicious to be doing this often (remember “consistently applied” from the last post?). If there is a change in revenue recognition strategy, it would be called out in the footnotes— another reason why it’s not a bad idea to look through them.

Another example of bias and uncertainty in revenue is the quality of the customer. Will the revenue shipped actually be paid for? Have you given special consideration to the customer (6 months to pay for example)? Have you made promises (warranty) that the product will perform down the road (a product warranty)? All of these factors can contribute to revenue uncertainty.

Depending on where in an organization you sit, scientific and technical decisions you make may impact revenue and its recognition. Are you developing a stand-alone product? Is it part of an ongoing delivery schedule? Are other services attached to it? These questions might color the response your work gets from other stakeholders in your company if they’re targeting a particular revenue goal.

Those are the highlights for revenue. In the next two posts, we’ll get into the murky realm of costs and expenses. Make sure you’re on the mailing list so you don’t miss it!

Leadership in Biotech

Tag: finance Page 1 of 2

Net Present Value: Making the Financial Case for Advancing Scientific Projects You Care About

So what is NPV?

Interest and Discount Rates vs. Your Research Project

Your Company’s Quarterly Earnings Call: How to Make Sense of It All

Safe harbor statement

Presentation and discussion of the financial results

Q&A

A few more notes on how to listen to an earnings call

The Anatomy of a Cash Flow Statement: Operating, Investing, and Financing

Operating Activities

Investing Activities

Financing Activities

Summary Section

Navigating a company’s financial condition with the cash flow statement

The Cash Flow Statement

Cash flow vs. profit

Decoding Financial Health with Liabilities & Equity from the Balance Sheet

Looking at liabilities

Equity in the equation

The big picture from the balance sheet

Using the Balance Sheet to Understand a Company’s Financial Health

Why do we care about balance sheets?

Balance sheet takeaways

Profitability: the proverbial and literal bottom line

Examples from Income Statements

Pulling more meaning from the bottom line

How expenses and depreciation can affect the profitability of your scientific work

Depreciation and amortization

Income Statement Fun: What is included in the Cost of Sales and why you should care

What scientists need to understand about revenue and its recognition

When revenue reporting isn’t black and white