Hi, if I encounter the situation where I see EBITDA margin compression but an explosion in the FCF margin, does this indicate that the company could be capitalizing on a number something large? If so, I would be grateful if you can give examples of how this can occur. It would be helpful if you can explain this by breaking down the components of FCF and EBITDA which makes them different so that I can see where the discrepancy is causing the problem. Thanks.
Starting from EBITDA, FCF = EBITDA(1-t) + NCC(t) - Investments (in NWC and Fixed Assets)
So, the most likely culprit for EBIT to be decreasing (as a % of sales) is that the firm is cutting back on investment (or to be more precise, they’re not changing proportionally with sales). Not all that unusual for a mature firm or one with declining sales and few or no good investment opportunities.
Ok, are you saying EBITDA margin decreases because firm’s investment margin decreases but the investment margin decrease is sufficiently large enough to offset EBITDA decrease which results in higher FCF margin?