In perhaps one of the most rigorous academic research projects ever undertaken to test the validity and effectiveness of a wide universe of financial metrics, Carton and Hofer, 2006 make the following concluding remark, “Very few non-public companies monitor the change in their Altman’s Z-score. However, the findings of this research indicate that this is the single most powerful measure for monitoring shareholder returns for both annual and three year time frames. Since this is a survival measure that is also important to creditors, management should pay particular attention to this financial performance metric”. Indeed, it only makes sense that this important measure once again outperforms every metric that it is compared against for the Z-score touches nearly every critical dimension of financial performance. While leveraging the benefits of this important metric makes perfect sense, it is the notion of capturing its change that is most meaningful. This article examines the challenges associated with capturing change and puts forth one solution to help make the process of measuring change useful from a practical perspective.

This paper offers a fresh perspective from which to gauge the ongoing viability of a firm. While investors, lending institutions and trade creditors share common concern with respect to risk, they differ according to both the time horizon and their interest in the ongoing viability of the firm. Using a synthetic credit score and the time tested Altman’s Z-score, this paper presents both measures along a simple X, Y axis plot that aims to provide a perspective of risk that is both straightforward and intuitive.

Understanding the intrinsic relationship between operating cash-flow and net-income may provide important insight into the performance and economic well being of the firm. Expansion in working capital account balances that place downward pressure on operating cash flow will often precede increases in net income. In contrast, increases in operating cash flow will oftentimes provide a false sense of security to company managers that are flush with cash as net working capital requirements decline. Most financial managers keenly follow both measures separately. However, this paper will demonstrate that the relationship and timing between the two measures may provide the most meaningful insight of all.

Individual companies exhibit substantial differences with respect to operating cash to net income. Steady, but not overwhelming pressure on operational cash flow compared to net income normally indicates a healthy, growing company. To be sure, astute financial managers that understand the proper tension between operating cash flow and net income are better equipped to respond to signals that foretell the story that lie ahead.

A review of the academic paper titled, “Information Provided by Accrual and Cash-Flow Measures of Operating Activities” by Ingram and Lee, (1997) is used as the backdrop for this paper and provides substantial evidence and support for the use of operating cash-flow to net-income as a management tool. Accordingly, this paper will draw heavily from the article and will therefore acknowledge the author’s important contribution to this subject.

A significant amount of literature favors the notion that a real-options approach to capital budgeting is superior to the conventional discounted cash flow technique when uncertainty is present in the investment opportunity. Unlike traditional licensed-based software, SaaS inherently provides the buyer with the flexibility to change the course of the investment as uncertainty related to the product or service is resolved. In this respect, SaaS changes the game with regard to the economic benefits provided by the product or service. The SaaS model builds management flexibility into the investment decision and that same flexibility may be valuable when uncertainty is present. With that said, the question at hand is whether or not conventional valuation techniques such as DCF can be counted on to make accurate SaaS capital budgeting decisions. And if such methods cannot be counted on, do OPM techniques such as binomial lattices or modified Black Scholes models provide a more accurate picture of their value? The final and perhaps more important question seeks to understand which of the two methods is most likely to be used by finance professionals when making SaaS capital budgeting decisions. This paper will show that a considerable gap exists between those that intend to use conventional DCF models versus more sophisticated OPM techniques when making capital investment decisions that involve SaaS. This gap should be a concern for those that buy or sell products and services delivered via SaaS for the value of flexibility may go unrecognized.