The purpose of establishing a company is generating profit, so one of the most concerning subjects whether we can draw the investors’ attention and acquire more capital to increase the market value. The investor needs to make the investment decision based on different criteria. One of them is financial report; the financial report is like a health report, helping investors to understand the running condition of the company. in the article, we will discuss the expenditure of cloud computing and the impact on various financial metrics.
The topic covered in this article:
- 5 financial performance measures to monitor
- The business model of cloud computing
- How cloud computing impact these financial metrics?
- The limits
5 financial performance measures to monitor
There are many financial metrics. Below are 5 metrics most commonly used by managers and stakeholders within an organization to consider. They are categorized into three different buckets: Growth, Profitability, and Financial Health.
For most investors, the critical element is whether the enterprise can keep growing as it implies the potential of cash flow generation. It is notable that high revenue growth doesn’t mean high-profit growth as many start-ups keep expanding the market through big investment, expecting a return in the future.
Revenue Growth Rate
Revenue growth rate refers to the percentage change of revenue within a specific time period, such as year-over-year, or quarter-over-quarter.
Profitability is a metric to evaluate whether the efficiency of a company. To be more precise, the return the company gains after investing a certain period of time and resources. The investor cares about the profitability of company A compares to company B and C providing similar services or in the same industry. If company A doesn’t necessarily gain more value, the investor would rather choose others. Moreover, company A may choose to develop other services.
Gross Profit Margin
（EBITDA，Earnings Before Interest, Taxes, Depreciation, and Amortization）
Both gross profit margin and EBITDA are the metrics to evaluate the profitability; the difference is gross profit margin counts the cost coming directly related to the production, whereas EBITDA is about the profitability of the entire company. The differences between both including ( but not limited to) depreciation, for instance, the factory and equipment in the petrochemical industry; non-direct expense, such as administrative expense.
Financial health refers to the company has sufficient cash, which can pay for the predictable and unpredictable expenditure in the short run. The expenditure ranging from HR expense, utility bill, equipment purchases, and merge & acquisition. Many technology companies — Alphabet Inc. (GOOGL)、Apple Inc. (AAPL), and Microsoft Corp. have billions of dollars in hand to respond to business needs.
Free Cash Flow
Capital expenditures are funds used to create value by acquiring and upgrading assets such as property, plants, buildings, or technology. There are instances where R&D can be considered CAPEX.
When buying the equipment, we need to pay the equipment upfront but it can be used for several years. We need to depreciate the asset for a period of time. For instance, you spent $10,000 buying a server and expect to use it for five years. The depreciation expense is $2,000 per year but $10,000 cash flow will be deducted at once. The business model of the cloud is different when there’s no depreciation expense. Instead, the operating expense will occur.
The business model of cloud computing
In the past, to fulfill IT’s requirement, the company will do everything themselves from scratch. For instance, purchasing the database to save the financial transaction, establishing their own servers, maintaining their own shopping platform, and even developing their own email server. The development effort is huge and also affects the time to market when the business is scaling along the way. In order to keep the company running, the company needs to spend that much resource and effort on the work that they are not familiar with, such as land acquiring, purchasing for building the data center, and hiring a bunch of IT professionals to maintain the system.
Thanks to the high-speed internet connection, the idea of cloud computing is gaining popularity among businesses. Cloud sells IT infrastructure, platforms, and applications as services through an on-demand, “pay as you go” model. The idea is actually established for a long period. Take French winery as an example, some winery will sign a contract with the landlord of the vineyard for a certain period of time in order to gather the grape. Instead of acquiring the land, having the rights for planting and harvesting grapes allows winemakers to have more business flexibility.
How cloud computing impact these financial metrics?
In general, IT expenditure belongs to capital expenditure, just as factory and equipment, it requires planning and purchasing in advance, then depreciate along with the time goes. In the business model of the cloud, companies have the right to use all kinds of IT resources that provides more flexibility and impact many financial metrics.
Rapid growing company focuses on revenue growth
Rapid growing company focuses on how to acquire more customers. Many companies would gain more resources, including talent and capital, to achieve their goal through fundraising. For example, Shopify needs to expand its global footprints for acquiring more customers. Also, spending on R&D for new features to differentiate themselves among competitors. All these need resources. The investor would evaluate the company to decide how much they should invest. For the company at this stage, it is more important to focus on business development rather than worry about IT infrastructure planning in a global scale. Cloud service providers are good partners to team up with as they have data center coverage globally.
Mature company wants to keep margin
Mature company has a rather stable business model. The top of mind of the C suite would be maintaining the margin. Let’s take Foxconn as an example, when the sales of its electrical components have been stable, the next question would be: how to keep the cost low? One of the nature of cloud computing is flexible cost structure, which would help companies lower the cost while the sales decrease, so to keep the margin.
Conservative company optimizes free cash flow
Rick management would be crucial for conservative companies, especially during the special situation. The company prefers to have enough free cash flow for uncertainty so that it can keep operating in the market. For example, many companies are affected during the pandemic. They can’t keep business running due to the lockdown. If they don’t have enough cash to pay the bill, such as salaries or rent, it would be an alert. Cloud computing turns CAPEX into operating cost to avoid upfront cost and keep cash on hand.
Shopify’s annual sales revenue grows more than 80%
During the pandemic last year, Many companies have been transformed their transactions online and sell the products globally through the integration with logistics and third-party warehouse systems. Shopify provides a series of services to fulfill the demand. In Shopify’s 2020 Q3 Quarterly Earnings Call, the word “growth” was mentioned 39 times, and the word “fast” mentioned 16 times; the company grows fast not only in sales operation but also in new services development. CFO Amy Shapero mentioned:
We are very focused this year building — continuing to build the software and the infrastructure for the network, focusing on optimizing things like inventory and order management and the network optimization.
The cloud does not only allows the fast-growing company to deploy globally in a timely manner but also lowers the upfront investment, focusing on what matters the most.
Foxconn to improve gross margin to 7% in 2021
Foxconn reiterates the goal of transformation and profitability in its 2020 Q3 Quarterly Earnings Call. the target is to improve the current gross margin from 6% rise to 7% next year,
In the call, President Mr. Liu, Yong-Wei, mentions that the strategy is to do more high gross margin product, such as components. Besides, entering into the high gross margin industry through digital transformation is top of mind. Foxconn announced the launch of the MIH EV open platform. The related development, such as Advanced driver-assistance systems (ADAS), Software and Hardware development platform, and EV Kit are good scenarios to leverage the cloud. The cloud helps faster time to market through high-performance computing and provides more business flexibility.
TSRC revenue down 20% in fiscal Q3
Due to the COVID-19, The business of some of the TSRC’s end customers, such as the automotive and sports industry, is impacted. As a result, the sales revenue of 2020 Q3 decreased by 20% compared to the same period last year. The CEO, Mr. Tsai, Wei-Chang, responded in the Quarterly Earning Call that the company will reduce the capital expenditure to maintain the cash flow. If there is any new IT system needs to go live or renew, the cloud helps to reserve more free cash on hand as it uses a subscription business model.
it is notable that CAPEX doesn’t necessarily reduce when turning capital expenditure to the operational expense as there is no item to depreciate.
Many investors like to use CAPEX as a measurement of valuation, evaluating whether the company emphasizes expanding and long-term investment. However, it may also imply the company doesn’t hold a large free cash flow. Cloud allows the company to reprioritize non-essential CAPEX by transitioning to the OPEX model.
Each company keeps its eyes on the different metrics based on the industry and various stages. Cloud helps the capital to be used with more flexibility and in an agile manner. Companies may use such a business model to adjust their expenditure. The company can certainly move the data, applied software, and platform to the cloud and gain many benefits, including reducing capital expenditure and maintaining the cost. Nevertheless, the company needs to consider the impact of the financial report. To manage the new investment, consult your CPA firms to have a deeper conversation about your company’s challenges with recent accounting changes.