Kristin Gleitsman

Leadership in Biotech

Tag: revenue

An illustration of a scientist looking up at a sort of monument to the the Big Five financial indicators, each perched on top of an Greek ionic pillar

The “Big Five” Numbers — What Investors Care About and Why

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On February 13, 2024

In Finance for Scientists

In this post, we cover the ratios and other financial indicators Wall Street or other outside investors care about. These ratios can have a large impact on managerial decisions, because companies generally need to keep shareholders and investors happy and how well leadership does in this endeavor will impact stock price, which in turn influences the success of a company.

Here are the ‘Big Five’:

  1. Revenue Growth
  2. Earnings per Share (EPS)
  3. Earnings Before Interest, Taxes, Depreciation, and Amortization (EBIDTA)
  4. Free Cash Flow (FCF)
  5. Return on Total Capital (ROTC)

Let’s dive deeper.

Revenue Growth

This metric measures how fast the company is increasing its sales over a period of time. A high revenue growth rate indicates that the company has a strong demand for its products or services, and that it can scale up its operations. No investor is going to put money in a company where the value of their investment will stay flat or decrease over time (okay— well there are really sneaky things people do with the intention of decreasing their tax liability, but we’ll set that aside for now). If a company wants to be successful, they need to show the potential for growth.

Earnings per Share (EPS)

First up is EPS, which we encountered in the last post on Earnings Calls. This metric 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.

Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) margin

This metric measures how much of the revenue is left after deducting the operating expenses, excluding interest, taxes, depreciation and amortization. A high EBITDA margin indicates that the company has a high profitability and cash flow generation; it’s a good indicator of future operating cash flow. EBIDTA is also often used in valuing a business, as a company’s sale price is often negotiated as a multiple of EBIDTA.

Free Cash Flow (FCF)

This metric measures the amount of cash that a company generates from its operations after deducting capital expenditures. FCF indicates the financial flexibility of a company and its capacity to invest in growth opportunities, pay dividends, reduce debt, or repurchase shares. In this economic climate, it’s especially important, as a company with a healthy free cash flow can continue to fund its own growth even when investment dollars are hard to come by.

Note that EBIDTA and FCF can be used together to understand how well a company is doing at converting profit to cash, by taking the ratio of FCF divided by EBIDTA. When this ratio is low, it can mean that a company is trying to make EBIDTA look strong through gimmickry even while its cash flow is weak.

Return on Total Capital (ROTC)

This metric measures a company’s net income relative to the sum of its debt and equity value, or the efficiency with which invested funds are used in a business.  Essentially it helps investors understand whether a business is generating a return high enough to justify their investment.

Finance for Scientists

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More terms of interest

A few other metrics investors care about: Market Cap, Price-to-Earnings, and Shareholder Value

Market Cap

Market cap is simply the current stock price of a company multiplied by the number of shares outstanding, which appears on the balance sheet under Capital Stock. This metric shows a snapshot of what the company is worth to investors. Savvy investors like Warren Buffett will look at the ratio of the market cap to the ‘book value,’ or the value of the equity as shown on the balance sheet. It is said that Buffett tries to find and invest in companies that are trading at market cap close to or below their book value, as this situation may indicate that a company is undervalued (note: another thing that is said about Buffett is that he invests only in businesses he understands, so I would imagine there is an element of critical thinking in determining whether the business is actually undervalued… also note, this strategy is inherently banking on the market eventually recognizing the value of a company in the LONG TERM).

Price-to-Earnings

This metric is the current stock price divided by the prior year’s earning per share, and measures how much the market is willing to pay for each unit of earnings. Companies with higher ratios are considered to have high growth potential.

Shareholder Value

This term does not point to any single concrete metric— in fact, every ratio discussed could be said to indicate ‘shareholder value.’ But regardless of the specific definition, increasing shareholder value is important to everyone— not just shareholders. Lenders, investors, employees, customers all like to work with/invest in companies with high shareholder value, as these companies are better positioned to survive through hard times, keep employees employed, pay back their loans, and offer more pricing flexibility. Total shareholder return (TSR), the stock price appreciation plus reinvested dividends over a period, is one way of looking at shareholder value, and is sometimes considered the ultimate measure of a company’s achievement for shareholders over the long term. The formula for calculating TSR is { (current price – purchase price) + dividends } ÷ purchase price. Higher TSR results in greater capital gains for shareholders, stock price appreciation for employee-owners and potential for future success.

Long-term Investor Value Appropriation (LIVA)

A newer alternative metric is Long-term Investor Value Appropriation (LIVA). The idea behind LIVA is simple is to use historical data to estimate how much value a company either created or destroyed for its entire investor base. This measure is closely related to net present value (NPV), which estimates the value of a project based on expected future cash flow. NPV, which we will cover in the next post, is the gold standard for CFOs to decide which projects to invest in.

After the last several posts, hopefully you have a better understanding of how to understand financial ratios from management and investors perspectives (and how those perspectives come together in an earnings call).

In our next post we will talk about ways to understand ‘return on investment.’ In my mind, this is one of the most critical pieces of financial intelligence a scientific leader can acquire, as they will help you translate the value of the projects you want to advance into a framework your finance partners can more easily understand. So join the mailing list and stay tuned!

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

Profitability: the proverbial and literal bottom line

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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:

Screenshot of Bio-Techne Income Statement

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%.

Screenshot of Becton, Dickinson and Company Income Statement

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

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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!

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

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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:

Screenshot of Bio-Techne Income StatementYou 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.

Screenshot of Becton, Dickinson and Company Income Statement

Finance for Scientists

A dollar sign with a pipette

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!

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