FIN101 #15 THE CASH CONVERSION CYCLE
A powerful way to frame the financing consequences of working capital is to frame working capital temporally rather than monetarily. This framing is called the cash conversion cycle.
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FIN101 #14 WORKING CAPITAL
Working capital, the capital that companies use to fund their day-to-day operations, is critical to understanding operating cash-flows. While you might think of finance as associated only with debt and equity, finance is deeply embedded in the daily operations of a business.
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FIN101 #13 FROM EBITDA TO OPERATING CASH FLOWS
Given the obsession with cash, it’s not surprising that there is a separate financial statement dedicated to it: the statement of cash‑flows. Many finance professionals consider the statement of cash‑flows a company’s most important financial statement. Rather than focusing on the income statement, which has the problems of noncash expenses and managerial discretion, or a balance sheet, which has the problems of historical cost accounting and conservatism, many people in finance focus on the statement of cash‑flows because it looks purely at cash.
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FIN101 #12 WHAT WE TALK ABOUT WHEN WE TALK ABOUT CASH
In the previous, we used net profit to measure corporate performance. Although net profit has merits – it’s a powerful measure for thinking about how shareholders have been doing – it has problems.
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FIN101 #11: FINANCE VERSUS ACCOUNTING: CONSERVATISM AND ACCRUAL ACCOUNTING
Finance takes issue with two of the foundations of accounting: conservatism and accrual accounting.
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FIN101 #10 THE MOST IMPORTANT RATIO
Which of those many ratios is the most important for managers to focus on?
This question is controversial, but many financial analysts focus on return on equity (ROE), since that number measures the returns to owners, who are arguably the ultimate bosses within a company. Because ROE is a widely used measure, it’s important to understand the factors that contribute to an ROE. The DuPont framework, a method of analyzing a company’s financial health originated by the DuPont Corporation in the early part of the twentieth century, provides a useful way to understand the levers of ROE.
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FIN101 #09 LET THE GAMES BEGIN – THE STRAGGLERS
After the retailers and service companies, we’re left with a motley crew – Microsoft, Nordstrom, Duke Energy, Pfizer, and Dell.
Three of the companies, C, D, and F, have barely any PP&E, while the remaining two companies have very significant PP&E. One is likely Duke Energy, which has power plants, and the other is likely Nordstrom, a brick-and-mortar retailer. But which is which?
To double-check, look at the three remaining companies and gauge their property, plant, and equipment. Dell, Pfizer, and Microsoft don’t really do any heavy manufacturing so their low levels of PP&E make sense.
Which of the two companies with significant property, plant, and equipment is Duke Energy and which is Nordstrom? The key differentiating factor here is inventory.
Nordstrom would have a large amount of inventory, while Duke Energy has very little (electricity can’t be stored). So, company L turns out to be Duke Energy, and company J is retailer Nordstrom.
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FIN101 #08 LET THE GAMES BEGIN – RETAILERS
When reviewing the receivables collection period, we saw that the companies were divided between those that collect quickly and those that take considerably longer. What kinds of companies would collect from customers so quickly? Since retailers sell goods directly to consumers, their receivables. The collection period is going to be short because customers pay immediately via cash or credit. In contrast, businesses that do business with other businesses give credit for a minimum of thirty days.
So, the retailers are A, B, H, I, and K. Which companies on the list are retailers that sell directly to consumers? Amazon, Barnes & Noble, Kroger, Walgreens, and Yum! are all retailers.
We can exclude Nordstrom here because the chain has its own brand charge card, so its customers, unlike those of the other companies, can take a long time to pay for their purchases. Through its charge card, Nordstrom behaves more like a bank than a retailer.
These five companies differ dramatically in the way that they turn over their inventory. Some turn over inventory quickly (company H). Others take a long time (for example, company B).
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FIN101 #07 LET THE GAMES BEGIN – SERVICE COMPANIES
Looking at the ratios, service companies are relatively easy to spot. Since they provide services rather than tangible goods, they don’t hold inventories – which points to companies E, G, M, and N. So, which four companies can we match to E, G, M, and N? Two of the companies have “service” in their name: the parcel delivery service, which is UPS, and the social networking service, which is Facebook.
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FIN101 #06 UNDERSTANDTING RATIOS
Ratios are the language of business, and - finance people love to create them, talk about them, ‑ flip them upside down, break them apart, and so on. Ratios make numbers meaningful by providing comparability across companies and through time. For example, Coca-Cola’s net profit for 2016 was $7.3 billion. Is that a lot of money for the company? It’s hard to tell without context. Alternatively, knowing that Coca-Cola’s net profit was 16 percent of its revenue (net profit divided by revenue) is much more helpful.
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