Whenever I look at the profitability of the company, I don't look at the P&L number but jump to the cash flow statement and look at Net Cash Flows from Operating Activities (the first of three). First, I look if this positive, and second, if it is growing over time.

Hope this helps

There is a reason we have GAAP, to keep crap like WeWork’s “Community Adjusted Ebitda” and Uber from saying that their financials really aren’t as bad as they look if you ignore a dozen expenses.

Let's say your income is 1100$ each year.

Your profit, according to accounting, would be 900$ for the first year, counting only $200 of the investment, then for the following years you'll see a profit of $700, $500, $300, and $100, as the investments accumulate. Oh no! A downward trend!

The cash flow, however, will simply show $100 profit each year.

Which one is more representative of the growing business with recurring investments?

By year five, you’re generating $1100 of income with $5000 of capital invested (that will require $1000 each year to keep up).

You’re _way_ better off in year one here, so it seems the GAAP approach is actually showing the decline accurately. This isn’t a growing startup, it’s a startup needing more equipment to make the same money each year.

(Imagining a bottom pricing scenario, while keeping a positive cashflow.)

Good point. At year 6 this logic breaks down. (Then again, no longer a 'startup' at that point.) Better hope the replacement equipment is double worth it's money. :)

Should make some spreadsheets with more scenarios.

External perception of business health (5x better service!) unintuitively is masking the the accounting reality here (worsening returns).

(Now look at all these cloud services giving better services and pricing every year, seemingly very healthy...) :)

Just as as microcosm, how many YC backed companies have reached profitability? Only two have gone public - DropBox and PagerDuty.

A commonly used valuation technique (discounted cash flow or DCF) relies on projected free cash flows and adjusting for expected CAPEX.

but does a company have to be "honest" about such depreciations? What if the asset isn't actually losing value at the stated depreciation rate? Then at the end of the depreciation period, the company may still extract the residual value by either selling or continue using the asset. Does that somehow then count as revenue? Or did they just magically managed to tax dodge using a fake depreciation schedule?

Theoretically, the only reason we have depreciation expenses at all instead of just expensing the entire cost at once (cash accounting) is that we decided that accrual accounting was more representative than cash based accounting.

I am not an accountant. I’m an MBA dropout after almost finishing.

We define Adjusted EBITDA as net income (loss), excluding (i) income (loss) from discontinued operations, net of income taxes, (ii) net income (loss) attributable to non-controlling interests, net of tax (iii) provision for (benefit from) income taxes, (iv) income (loss) from equity method investment, net of tax, (v) interest expense, (vi) other income (expense), net, (vii) depreciation and amortization, (viii) stock-based compensation expense, (ix) certain legal, tax, and regulatory reserve changes and settlements, (x) asset impairment/loss on sale of assets, (xi) acquisition and financing related expenses, (xii) restructuring charges and (xiii) other items not indicative of our ongoing operating performance.

I agree with depreciation and other non cash expenses obfuscating P&Ls, but can we agree that in an article focused on securing debt financing, which will incur real interest expense, the term “free cash flow profitability”, “loosely” meaning “profitability” is a little misleading?

Free cash flow and net profit should equal each other if summed up over the entire lifetime of a company.

The trickiness of course comes in the timing of when revenue and expenses are recognized. Whereas a large capital investment hits free cash flow the same year, it only impacts net profit over the course of its depreciation.

Free cash flow can be misleading for companies that require a disproportionately large capital investment upfront but negligible expenses thereafter. This can be illustrated by taking an edge case to the extreme: Let’s say a company required a $1,000,000 capital investment in Year 1, $0 in subsequent expenses, and brought in a piddling $1 in annual revenue until it shut down in Year 10. The company would have been free cash flow positive in Year 2 through Year 10, which would be misleading because in fact the company was never profitable and also had negative ($999,999) free cash flow in Year 1.

It depends on the industry. DO is in the capex heavy industry so depreciation is not a funky accounting cost, it is actually something that's applicable to the vast majority of their assets.

If they are consistently laying out capex, it actually could be very reasonable to just use CFS and not opex.

The same is true for other creative work/IP. The reasoning being, I believe, that it is hard to appreciate (as in: set a monetary value) for such work. If you buy, you’ve given the open market a chance to work its magic and the price is believed to be closer to something like truth.

Income statement, balance sheet and statement of cash flows together give you a pretty complete picture.

We could also agree that its a tech-blog article, which means 99% of the people reading it simply do not care about financials, other then "huge raise! wow, revenue! great profitability potential".

I understood the OP that mixing cash and profitability in one term is wrong. So yeah, I agree that the CEO told BS.

As just one example, if you pay for supplies in one accounting period, but only sell (and get paid) in the next, cash flow will fluctuate widely, even if your business is entirely stable.

Wow. What a sad indictment of modern accounting practices that its accepted practice to create 'noise' to prop up a P&L (or avoid paying tax).

I suppose you could do this with household expenses, but if you don't look at P&L in a household you would be ignoring things like credit card debt or car loans.

This kind of debt in either a household or a company represents risk and shouldn't be overlooked, IMHO.

Income statements include things like depreciation. That's real, in a sense. It's future CAPEX. But for the present health of a business, particularly a levered one, cash is king.

One way to think of it is in time frames. Cash flows are immediately relevant. If they're out of whack, it's an urgent problem. (They're also the most difficult to mess with.) Income statements are longer term. An unprofitable, cash-generating business may have structural issues with its PP&E, or it may be overleverd, or a bunch of options might have been issued or exercised. Balance sheets are the longest-term statement. (They're also the easiest to mess with.)

Keep in mind, too, that income statements for investors are different from those prepared for the IRS.

Depreciation is past capex, not future capex. You could argue that the two are equivalent, because the assets being depreciated will need replacement in the future. But:

1. The assets' useful life may be longer (or shorter) than the depreciation schedule.

2. The future replacements may cost less (or more) or just not be needed at all.

Technically (from an accounting perspective), yes. Practically (from a financial/economic perspective), not quite.

Past capex is a sunk cost. Investors care about future cash flows. If you strip out depreciation, you’ll be surprised by the bill when your machine breaks down. (You may still be surprised. Life is unpredictable and depreciation schedules are an estimate. But that’s one of the problems the concept tries to solve.)

https://www.quora.com/Does-DigitalOcean-have-its-own-datacen...

That's because Alex Wilhelm wrote it. He was previously the editor for Crunchbase (just joined in the last few months). I've known him for years, he does great reporting that makes me incredibly envious. TC is lucky to have gotten him, he deserves Financial Times-quality media exposure.

Why would it be inappropriate? It's common to describe both debt and equity rounds as a 'raise'.

My guess is you're operating under the assumption that debt is inferior to equity because you're forced to pay it back. But, in reality, when you raise an equity round, you also have to pay back the principal + "interest"-- it just delays the repayment date til your liquidation event.

>> This is a low cost of capital line of credit, is it not (due to their infrastructure and broad customer base)?

Based on the wording "secured $100 million in new debt from a group of investors", my guess is it's a term loan of sorts vs a LOC (since banks typically issue LOC's, and they're generally not referred to as investors).

I disagree, I always interpret "raise" as equity.

> My guess is you're operating under the assumption that debt is inferior to equity because you're forced to pay it back. But, in reality, when you raise an equity round, you also have to pay back the principal + "interest"-- it just delays the repayment date til your liquidation event.

Debt and equity are two very different structures. Mainly due to whose cash moves where, and when.

Debt gets repaid from actual company cash flow on a pre-agreed timetable and at a specific interest rate. If debt isn't repaid, creditors can try and recover their debt in bankruptcy proceedings (usually second in line after unpaid wages).

Equity doesn't get "repaid" in any sense (aside from liquidation or share buy-backs, which almost never occur pre-IPO). Once raised, that money is the company's, and the equity you get in can only be bought and sold.

Raising equity means diluting your ownership stake (so its worth proportionately less of the entire value of the company). Once raised, it doesn't force the movement of cash in any direction. If there's no liquidity event, then equity holders can't force the company to cough up that money.

Note "liquidity event" is distinct from "liquidation" - the former means an opportunity for equity holders to sell down their shares, the latter means the company is bankrupt and i being dissolved, with assets sold/distributed.

- Redemption rights & liquidation pref in preferred shares effectively turn it into a loan

- Convertible notes are debt instruments but most obviously should be described as "raising"

- Venture debt typically has upside in the form of share options in addition to the debt repayment mechanism

No one will read those words and think they are raising equity...

Edit: Also debt and equity are not always that straightforward, they are shades of grey. Convertible notes are debt that look like equity.

Right, but that just reinforces my point. Debt is different from equity, which is different from a note. Legally and commercially, outside investors (or acquirers) are going to treat them all differently. It's not as simple as "raising $X means you have to repay $X+Y, no matter whether its debt, equity or note".

Isn't that what the parenthetical is doing? Maybe subtly, but it seems pretty clear what the author is trying to convey.

I suppose I’m just triggered on what feels like years of news-pieces being marketing pieces for established companies.

I would think if the author is well versed in financial speak, they would challenge (or omit) the positive spin the CEO is trying to push here?

When the CEO said "profitability" to the reporter, he challenged it by putting as "loosely". The reporters is informing us, but also making it a point that the CEO alleges something that is not consensus can be considered profitability, he is impartial in displaying the information, but making it clear it's sketchy. It's great writing actually!

It's interesting that debt finance has increasingly become a way mid-sized startups are funding expansion.

Headspace raised $53M VC funding and $40M debt the other day too: https://techcrunch.com/2020/02/12/headspace-raises-53-millio...

Congrats to Dropbox for being denied credit worthy. There is a parallel world at the top where money is free for the credit worthy, they are one step closer.

You can be making money and paying it all to Uncle Sam and your bank loans. 100 million is gonna be a lot of interest payments.

Have you both typo'd 'EBITDA' the same way, or is `EBITDA - Depreciation` a measure used too? (I searched, couldn't find anything.)

> Adjusted EBITDA represents net income before (i) interest and investment income, net, interest expense, other income or loss, net, income tax expenses and share of results of equity investees, (ii) certain non-cash expenses, consisting of share-based compensation expense, amortization, depreciation, operating lease cost relating to land use rights and impairment of goodwill, which we do not believe are reflective of our core operating performance during the periods presented.

> Adjusted EBITA represents net income before (i) interest and investment income, net, interest expense, other income or loss, net, income tax expenses and share of results of equity investees, (ii) certain non-cash expenses, consisting of share-based compensation expense, amortization and impairment of goodwill, which we do not believe are reflective of our core operating performance during the periods presented.

So yes, EBITDA - D!

[1] https://www.alibabagroup.com/en/news/article?news=p200213

They've been around for 9 years, they're just a company now.

How low cost? What interest rate, what fees, etc.?