Module I· Cash Flow Statement ConstructionIntermediate
Question
What is FCF conversion, and what do you use it for?
Answer
Mechanics
FCF conversion measures how much of book profit actually converts into cash.
Formula
```
FCF conversion = FCF / EBITDA (or FCF / net income)
```
Rule-of-thumb benchmarks
| Sector | FCF conversion | Driver |
|---|---|---|
| Tech / asset-light (SAP, Microsoft) | 70–90% | low capex, fast cash conversion |
| Mid-cap industrials (middle-market) | 40–60% | moderate capex needs |
| Capital-intensive (steel, chemicals, telco) | 20–40% | high replacement capex eats cash |
| Real estate / REITs | 80–100% | FFO ≈ EBITDA, no capex drain |
Deep diveShow more details
Application in IB
- Valuation sanity check: a quick check — low FCF conversion should warrant a multiple discount.
- LBO screening: below 40%, carrying the debt load gets difficult.
- Quality of earnings: structurally declining conversion over several years is a red flag.
Pitch tip
'The target hits 65% FCF conversion, 500 bps above the sector median — justifying a 1.0x EBITDA premium to trading comps.'