interview MF - NI negative but not impacted in FCF
Hi Folks,
I'm preparing for an interview (with a MF) and I've been practicing my LBO. However, I've come across a model from the same MF. The problem is that the net income is negative for 3 out of 5 years, yet the FCF starts at EBITDA, which means the negative net income doesn't seem to affect the returns or the model overall. How to approach this ? Specifically, how can I justify this to the interviewers?
Thanks for the help
Hey there,
This is a great question and it's fantastic that you're digging deep into your LBO model. It's not uncommon to see negative net income in an LBO model, especially in the early years. This can be due to a variety of factors such as high interest expenses, depreciation, or other non-cash charges that can push net income into the negative.
However, Free Cash Flow (FCF) starts at EBITDA, which is a measure of a company's operating performance before the impact of capital structure (interest expenses from debt) and non-cash charges (like depreciation). This is why FCF can be positive even when net income is negative.
In terms of justifying this to your interviewers, you could explain that the company is generating positive operating cash flows (as evidenced by the positive EBITDA), but the net income is negative due to the reasons I mentioned earlier. The key here is to show that you understand the difference between these two measures and why a company can have positive FCF but negative net income.
Remember, the goal of an LBO model is to assess whether the cash flows of the business can support the repayment of the acquisition debt and provide a return to the equity investors. So, even if net income is negative, as long as the business is generating sufficient cash flows to service its debt and provide a return to equity holders, the LBO could still be a viable investment.
Keep up the good work and good luck with your interview!
Sources: Why YOU Aren't Converting Your Interview - DCF Example (No Math), Top 5 Basic Technical Questions That Will Show You the Door, Beyond the guide: a list of real interview technical questions
Shouldn't matter - you can start a cash flow statement with either Net Income or EBITDA and should still reach the same operating cash flow (post taxes & interest).
If your Net Income is negative because of high depreciation, for instances, both approaches will eliminate the impact since D&A is non-cash.
Compare a cash flow statement for a publicly listed US company to a UK one.
Thanks for your reply Patrick, it's very useful! The negative net income comes from high interest charges (mainly cash, a bit of PIK)
How do I justify this in an interview? Is this something to worry about? (Negative net income for years 1 (-4%), 2 (-1%) then 4 due to dividend recap)
As long as you can pay the interest you're chilling. Net Income is fake and only matters for reporting / taxation purposes. In fact, one of the benefits of using lots of leverage in an LBO is that interest payments are tax-deductible (they reduce your pre-tax income).
I see thanks a lot for your help !
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