The Daily Technical #28: What does free cash flow (FCF) represent?

Good morning. Welcome to the 28th edition of The Daily Technical. You’re here for one reason so let’s dive in.

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OVERVIEW OF YESTERDAY’S QUESTION
Would an acquirer prefer $100 in revenue synergies or $100 in cost synergies?

An acquirer would prefer $100 in cost synergies because all those cost savings (after accounting for tax) flow through to the bottom line, while revenue synergies have associated costs that reduce the bottom-line benefit.

For example, $100 in revenue synergies for a company with 40% pre-tax profit margins and a 25% tax rate would see $100 x 40% x (1 - 25%) = $30 flow to the bottom line, while the same company with $100 in cost synergies would see $100 x (1 - 25%) = $75 flow to the bottom line.

Common Mistakes

1. Ignoring the costs required to achieve revenue synergies. Remember to subtract these expenses from the potential revenues to find the true benefit.

2. Forgetting to adjust for taxes. Always account for the tax impact when calculating net benefits from synergies.

3. Treating both types of synergies as providing equal benefits. Understand that cost synergies usually translate more efficiently to the bottom line.

Key Takeaways / TLDR

• Cost synergies generally directly add more to net profit compared to revenue synergies.

• Always include related costs and tax effects in your calculations.

• Use clear examples to show the greater impact of cost synergies on the bottom line.

TODAY’S QUESTION
What does free cash flow (FCF) represent?

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See you tomorrow,

The HirePrep Team