S3 Learning Notes For Module 2

Wealthy Education
DISCLAIMER
LEGALLY REQUIRED DISCLAIMER – THIS COURSE CONTAINS THE PERSONAL IDEAS AND OPINIONS OF THE COURSE
PROVIDERS. THE INFORMATION CONTAINED IN THIS COURSE IS FOR EDUCATIONAL PURPOSES ONLY. THERE IS NO
RECOMMENDATION OR ADVICE ON MAKING ANY INVESTMENT DECISIONS, BUYING OR SELLING ANY TYPES OF STOCKS,
SECURITIES OR INVESTMENTS DISCUSSED IN THIS COURSE. THE COURSE PROVIDERS ARE NEITHER STOCK BROKERS NOR
REGISTERED INVESTMENT ADVISORS. WE DO NOT RECOMMEND MAKING ANY INVESTMENT DECISIONS PROPOSED IN
THIS COURSE. INDIVIDUALS SHOULD FIND REGISTERED INVESTMENT ADVISORS TO HELP THEM MAKE INVESTMENT
DECISIONS. ALTHOUGH THE COURSE PROVIDERS HAVE STRIVED FOR PROVIDING THE MOST ACCURATE INFORMATION,
THERE IS NO GUARANTEE OR WARRANTY CONCERNING THE RELIABILITY, ACCURACY AND COMPLETENESS OF THE
PROVIDED INFORMATION. INDIVIDUALS SHOULD BE CAUTIOUS ABOUT MAKING THEIR OWN INVESTMENT DECISIONS.
INDIVIDUALS ARE SOLELY RESPONSIBLE FOR THEIR INVESTMENT DECISIONS. THE COURSE PROVIDERS ARE NOT
RESPONSIBLE FOR ANY LIABILITIES AND LOSSES, WHICH MAY ARISE FROM THE USE AND APPLICATION OF THE
INFORMATION AND STRATEGIES PROPOSED IN THIS COURSE.
www.wealthyeducation.com
Wealthy Education
FINANCIAL STATEMENT ANALYSIS

THE ADVANCED FINANCIAL STATMEENT ANALYSIS
MODULE 2: OPERATING EFFICIENCY ASSESSMENT
LEARNING MATERIAL – TAKEAWAY NOTE
Wealthy Education
What is Operating Efficiency?

 Operating efficiency is how well a company’s management
makes use of its cash and other assets.
 The majority of the associated ratios address cash, from actual
cash on hand to cash inputs or outputs like AR and AP.
 Others measure management of inventory or use of fixed and
total assets.
Wealthy Education
Operating Efficiency Ratios

 We will use twelve ratios to measure operating efficiency:
 Cash Turnover  Accounts Payable Turnover
 Days Cash on Hand  Days Payables Outstanding
 Inventory Turnover  Working Capital Turnover
 Days Inventory Outstanding  Days Working Capital
 Accounts Receivable Turnover  Fixed Asset Turnover
 Days Sales Outstanding  Total Asset Turnover
Wealthy Education
Cash Turnover Ratio - In a Nutshell

 The cash turnover ratio is a measure of cash usage efficiency and
of the amount of cash needed for revenue generation.
 While it can be used by investors to analyze a company’s
performance, it is more commonly used by management to
assess cash requirements to increase sales.
Wealthy Education
Formula & Calculation
Annual Revenue
Cash Turnover Ratio =
Average Cash Balance
Wealthy Education
Real-world Examples
Apple, Inc. (AAPL) Microsoft (MSFT) Oracle Corp. (ORCL)
Revenue $215.64 billion $85.32 billion $37.05 billion
Avg. Cash Balance $20.80 billion $6.05 billion $20.93 billion
Cash Turnover
10.37 14.10 1.77
Ratio
Wealthy Education
Further Explanation
 It is very important to understand that the cash turnover ratio is
easily distorted.
 A company that pays out dividends will have less cash on hand
than a similar company that does not pay dividends, making the
ratio higher.
Wealthy Education
Further Explanation
 A company that sells extensively on credit will have a higher ratio
than a company that does not since it will have less cash relative
to revenue, with the balance sitting in accounts receivable.
 When analyzing a company as an investment prospect, you
would do better to look at how the company uses its cash, not
just this ratio.
Wealthy Education
Things to Take Away!

 Key points for this ratio:
 Measures cash usage efficiency and, for management, how
much cash is needed to generate a given amount of revenue
 “Cash and cash equivalents” used in the ratio normally
includes marketable securities as well since companies
usually avoid leaving cash sitting completely idle
Wealthy Education

 Both revenue and average cash on hand must be determined
for the period being examined (fiscal year, quarter, etc.)
 Formula inputs come from income statement and cash flow
statement
Wealthy Education

 The ratio is easily distorted by such factors as paying
dividends, buying back stock, or granting credit to customers
 The ratio is less useful than a careful examination of the cash
flow statement
Wealthy Education
Days Cash on Hand - In a Nutshell

 Days cash on hand is not a ratio, but rather a number indicating
exactly what the name says: how many days the company can pay
its current operating expenses before running out of money.
 This measurement is more commonly used by management,
especially for startup companies, but outside analysts do use it as
a rough indicator when evaluating a company’s financial health.
Wealthy Education
Cash and Cash Equivalents

Days Cash on Hand =
(Operating Expenses – Noncash Expenses) ÷ 365
Wealthy Education
Real-world Examples
Darden Restaurants, Brinker International, Hyatt Hotels Corp.
Inc. (DRI) Inc. (EAT) (H)
Cash/Cash Equiv. $275M $31M $482M
Operating Exp. $6.31B $2.94B $4.13B
Noncash Exp. $292M $156M $342M
DCOH 16.68 4.06 46.44
Wealthy Education
Further Explanation
 Also, even for companies that do have revenue challenges, DCOH
is not a perfect measure.
 When a company runs into cash flow problems, the first thing
management does is cut costs—sometimes drastically.
 It’s more informative for management to look at the actual cash
flow cycle rather than taking the DCOH number at face value.
Wealthy Education

 Provides a rough indicator of how long the company could
operate using its existing cash on hand
 Calculated using cash and cash equivalents and actual cash
expenses
Wealthy Education

 Not very useful for currently-operating companies because it
ignores cash inflows from revenue
 More useful to management, and even then only for startups
or companies with a seasonal or temporary revenue
disruption
Wealthy Education
Inventory Turnover Ratio - In a Nutshell

 The inventory turnover ratio is a calculation of how many times a
company sells and replaces its inventory in a given time period.
 The output of the formula can be used to calculate how many
days this process takes.
Wealthy Education
Total Cost of Goods Sold

Inventory Turnover Ratio =
Average Inventory
Wealthy Education
Real-world Examples
National Beverage Monster Beverage The Coca-Cola Co.
Corp. (FIZZ) Corp. (MNST) (KO)
Total COGS $463M $1.15B $16.46B
Inventory TY $29M $103M $844M
Inventory LY $25M $104M $1.03B
Avg. Inventory $27M $103.5M $938M
Inventory
17.15 11.11 17.55
Turnover Ratio
Wealthy Education
Further Explanation
 The Inventory Turnover Ratio number itself in isolation has only
limited usefulness. If inventory turns too fast, it means the
company may be unable to keep up with demand.
 Converting the ITR into days is helpful in this regard, but some
knowledge of the industry is needed, so what constitutes “too
fast” is very industry-specific.
Wealthy Education

 Calculated using Cost of Goods Sold and average inventory for
the period.
 Can be used to calculate how many days a company takes to
completely turn its inventory by dividing the number of days
in the period under consideration by the ITR.
Wealthy Education

 Inventory Turnover Ratio is most useful when analyzed as a
trend and/or in comparison to peers and industry average
 Should be calculated using sales instead of Cost of Goods Sold
only as a last resort, and then only for relative comparisons of
companies
Wealthy Education
Days Inventory Outstanding - In a Nutshell

 The days inventory outstanding measure, also referred to as days
sales of inventory or days in inventory, is an assessment of how
quickly a company can convert inventory to sales.
 It also shows quite literally how many days of sales can be
supported by the inventory the company has on hand.
 Its role is to assess how long cash is tied up as inventory.
Wealthy Education
Average Inventory
Days Inventory Outstanding = × 365
Cost of Goods Sold
Wealthy Education
Real-world Examples
General Mills, Inc.
Kellogg Co. (K) Hershey Co. (HSY)
(GIS)
Total COGS $10.71B $7.93B $4.28B
Inventory TY $1.41B $1.24B $746M
Inventory LY $1.54B $1.25B $751M
Avg. Inventory $1.475B $1.245B $748.5M
Days Inventory
50.27 57.30 63.80
Outstanding
Wealthy Education
Further Explanation
 Be careful about confusing the inventory turn ratio with Days
Inventory Outstanding.
 While a higher ITR is better, in general a lower Days Inventory
Outstanding is preferable.
 A high ITR and a low DIO both point to the same thing: the
company sells its inventory quickly.
Wealthy Education

 Days Inventory Outstanding is the first of three measures that
calculate a company’s cash conversion cycle. It assesses how
long a company keeps cash tied up as inventory
 The DIO formula uses work in progress and raw materials as
well as finished goods when calculating inventory
Wealthy Education

 Days Inventory Outstanding should only be used within the
same industry segment since not all companies maintain a stock
of raw materials
 Generally speaking, a low Days Inventory Outstanding number is
better
Wealthy Education
Accounts Receivable Turnover Ratio - In a Nutshell

 The accounts receivable turnover ratio is a measure of how
quickly a company is able to collect receivables from customers.
 It compares the average accounts receivable balance to the total
net credit sales.
 It is a liquidity measure, since it indicates how quickly a company
converts receivables to cash.
Wealthy Education
Net Credit Sales

A/R Turnover Ratio =
Avg. Accounts Receivable Balance
Wealthy Education
Real-world Examples
General Electric Co. 3M Co. Siemens AG

(GE) (MMM) (SIEGY)
Net Credit Sales Unknown $28.501B Unknown
Avg. A/R Balance $25.549B $4.273B $14.095B
ARTR Unknown 6.67 Unknown
Wealthy Education

 Indicates how many times a company turns its average
Accounts Receivable balance within the period
 Can be used to calculate how many days the company takes
to collect its receivables
Wealthy Education

 Net credit sales can be very difficult to find for public
companies; you will normally have to review the management
discussion and analysis in the annual report
 In some cases, the annual report may specify the Accounts
Receivable Turnover Ratio itself
Wealthy Education
Days Sales Outstanding - In a Nutshell

 The days sales outstanding (DSO) indicates how many days a
company takes to receive cash after a sale is made.
 This ratio is the second of three components of the cash
conversion cycle.
Wealthy Education
Avg. A/𝑅
Days Sales Outstanding = × Days in Period
Net Credit Sales
Wealthy Education
Real-world Examples
3M Co. (MMM)
Net Credit Sales $28.501B
Avg. A/R Balance $4.273B
Days Sales Outstanding 54.72
Wealthy Education
Further Explanation
 A Days Sales Outstanding under 45 is viewed as quite good. A DSO
around 60 is fairly typical.
 If the DSO is reaching closer to 90, it is a sign of financial trouble.
 The trend over time is more important than any single snapshot in
time. An unusually low DSO (compared to industry peers) is normally
a negative.
Wealthy Education

 Calculates how many days on average a company takes to
collect its receivables
 Since it is the converse of the ARTR, a low number is better
and indicates that the company receives its money more
quickly
Wealthy Education

 As with ARTR, net credit sales can be very difficult to
determine from publicly-reported data
 While industries vary, a DSO of 45 is good and 60 is average
 An unusually low DSO is a negative indicator, as it means the
company’s credit policies are probably costing it sales
Wealthy Education
Accounts Payable Turnover Ratio - In a Nutshell

 The accounts payable turnover ratio (APTR) is an assessment of
liquidity, although instead of looking at long-term debt, it
measures how quickly a company pays its vendors.
 The ratio calculates the number of times the company pays off
its total average accounts payable balance during the course of
the period.
Wealthy Education
Total Purchases
A/P Turnover Ratio =
Avg. Accounts Payable Balance
Wealthy Education
Real-world Examples
International Paper Avery Dennison Corp. Sealed Air Corp.

Co. (IP) (AVY) (SEE)
Total Purchases $15.362B $4.427B $4.043B
Avg. A/P Balance $2.1935B $828.5M $607M
APTR 7.00 5.34 6.66
Wealthy Education

 Calculates how many times a company pays its average
Accounts Payable balance in a given period
 Total purchases will not appear in the financial statements
and so must be calculated
Wealthy Education

 Does not address all accounts payable, but only those
associated with COGS
 Can be used to calculate the length of the company’s average
payables cycle. Nonexistent for companies that do not
maintain an inventory of physical goods.
Wealthy Education
Days Payable Outstanding - In a Nutshell

 The Days Payable Outstanding calculation shows how many days
a company takes to pay its vendors.
 DPO is the third and final component of the cash conversion
cycle, which begins when a company purchases raw materials or
inventory and ends when it pays for those purchases using cash
collected from customers.
Wealthy Education
Avg. A/P balance

Days Payable Outstanding = ×Days in Period
Cost of Goods Sold
Wealthy Education
Real-world Examples
International Avery Dennison Corp. Sealed Air Corp.

Paper Co. (IP) (AVY) (SEE)
Total COGS $15.152B $4.387B $4.247B
Avg. A/P Balance $2.1935B $828.5M $607M
Days Payable
52.84 68.93 52.17
Outstanding
Wealthy Education
Further Explanation
 APTR cannot be calculated for companies that do not hold
physical inventories, so for the most part the same will hold true
with DPO.
 It is possible to determine DPO even when APTR cannot be
directly ascertained.
Wealthy Education

 Indicates how many days on average a company takes to pay
its vendors
 Is the third and final component of the cash conversion cycle
 APTR can be used to calculate DPO, and conversely DPO can
be used to “back into” APTR
Wealthy Education

 Can be calculated for more companies than Accounts Payable
Turnover Ratio because even those that produce intangible
goods often show a cost of sales or cost of revenue line item,
which can substitute for COGS
Wealthy Education
Working Capital Turnover Ratio - In a Nutshell

 The working capital turnover ratio (WCTR) is a measure of
management effectiveness.
 It assesses how much revenue is generated by each dollar of
working capital.
 Excessive accounts receivable and/or excessive inventory have a
negative impact on WCTR.
Wealthy Education
Sales
Working Capital Turnover Ratio =
Average Working Capital
Wealthy Education
Real-world Examples
Winnebago Ind., Sturm Ruger & Co.

Mattel, Inc. (MAT)
Inc. (WGO) (RGR)
Avg. Working Capital $1.3945 billion $186 million $120.5 million
Sales $5.457 billion $975 million $664 million
WCTR 3.91 5.24 5.51
Wealthy Education
Real-world Examples
Spiral Toys, Inc. (STOY)
Avg. Working Capital $70,000
Sales $5.96 million
WCTR 85.14
Wealthy Education
Real-world Examples
Amazon (AMZN)
Avg. Working Capital $136 billion
Sales $1.8915 million
WCTR 71.89
Wealthy Education

 Measures how efficiently a company uses its working capital
to generate sales
 Higher is better, but an extremely high ratio (above 20) is a
red flag
Wealthy Education

 It is important to compare Working Capital Turnover Ratio
only among industry peers
 Look closely at the underlying numbers to see exactly why a
company has a high Working Capital Turnover Ratio
Wealthy Education
Days Working Capital - In a Nutshell

 Days working capital measures how much money a company has
to fund its operations, measured in days.
 It is a measure of efficiency and of liquidity as well.
 This is the companion measurement to the working capital
turnover ratio.
Wealthy Education
(Avg. WC × Days in Period)

Days Working Capital =
Period Sales
Wealthy Education
Real-world Examples
Winnebago Ind., Inc. Sturm Ruger & Co.

Mattel, Inc. (MAT)
(WGO) (RGR)
Avg. Working Capital $1.3945 billion $186 million $120.5 million

Sales $5.457 billion $975 million $664 million
Days Working Capital 93.27 69.63 66.24
Wealthy Education
Further Explanation
 Numbers at either extreme - too high or too low - tend to be
negative.
 DWC can also be negatively impacted by underleveraging.
 If a company takes on long-term debt, the current assets
increase, but the current liabilities do not. This will cause DWC to
increase.
Wealthy Education
Fixed Asset Turnover Ratio - In a Nutshell

 The fixed asset turnover ratio is an efficiency measure that looks
at how much revenue a company produces with its fixed assets.
 It is also a critical measure because it shows how easily a
company can pay for expensive fixed asset investments.
Wealthy Education
Net Sales
Fixed Asset Turnover Ratio =
Avg. NBV of Fixed Assets
Wealthy Education
Real-world Examples
Caterpillar, Inc. Navistar Int. Corp.

Deere & Co. (DE)
(CAT) (NAV)
Fixed Assets-NBV (Avg.) $10.612 billion $15.706 billion $1.293 billion
Net Sales $26.644 billion $38.537 billion $8.111 billion
Fixed Asset Turnover

2.51 2.45 6.27
Ratio
Wealthy Education
Further Explanation
 It is important to examine the underlying data to detect factors
that can distort FATR.
 Look carefully to determine what method of depreciation the
company is using, as accelerated depreciation will cause NBV to
decline more rapidly and artificially improve FATR.
Wealthy Education

 Measures how efficiently a company generates revenue with
its fixed assets
 Based on depreciated (net book) value of the assets, and best
calculated using average NBV for the period
Wealthy Education

 Differences even among companies in the same industry can
skew the FATR
 Look at the FATR trend over time and see whether changes in
business model or lack of investment in new assets is causing
the ratio to improve
Wealthy Education

 Calculates how many days of operations the company can
fund with its working capital
 Either extreme—high or low—of DWC is a red flag
 Make peer-to-peer comparisons and consider trends and
underlying data; don’t simply take the number at face value
Wealthy Education
Total Asset Turnover Ratio - In a Nutshell

 The total asset turnover ratio (TATR) is similar to the fixed asset
turnover ratio (FATR), but it is broader in scope as it considers all
assets.
 The TATR is applicable to far more companies since it includes
intangible assets such as intellectual property, which are far more
important in some industries than fixed assets.
Wealthy Education
Net Sales
Total Asset Turnover Ratio =
Average Total Assets
Wealthy Education
Real-world Examples
Caterpillar, Inc. Navistar Int. Corp.
Deere & Co. (DE)
(CAT) (NAV)
Total Assets (Avg.) $57.9645 billion $76.523 billion $6.151 billion
Net Sales $26.644 billion $38.537 billion $8.111 billion
TATR 0.46 0.50 1.32
FATR (for reference) 2.51 2.45 6.27
Wealthy Education

 Uses the same rationale as Fixed Asset Turnover Ratio but is
based on the total value of all of a company’s assets
 Not limited to physical asset-intensive industries as Fixed
Asset Turnover Ratio is
Wealthy Education

 Because it is broader, is also more subject to distortion by
balance sheet items not common to all companies being
compared
 Still valid only for comparisons of companies with similar
business models
WHAT YOU WILL LEARN?
• Fully Develop a Successful Entrepreneurial Mindset (Most Important)
• What does really mean ‘doing business’?
THANK YOU FOR READING!
• Create Multiple Streams of Income
• How to Start a Business Effectively
• Master in Using the Power of Leverage
• How to Build a Successful Business Plan

S3 Learning Notes For Module 2

Uploaded by

Copyright:

Available Formats

S3 Learning Notes For Module 2

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

S3 Learning Notes For Module 2

Uploaded by

Copyright:

Available Formats

Wealthy Education

FINANCIAL STATEMENT ANALYSIS

What is Operating Efficiency?

Operating Efficiency Ratios

Cash Turnover Ratio - In a Nutshell

Formula & Calculation

Apple, Inc. (AAPL) Microsoft (MSFT) Oracle Corp. (ORCL)

Revenue $215.64 billion $85.32 billion $37.05 billion

Avg. Cash Balance $20.80 billion $6.05 billion $20.93 billion

Things to Take Away!

Things to Take Away!

Things to Take Away!

Days Cash on Hand - In a Nutshell

Formula & Calculation

Cash and Cash Equivalents

Cash/Cash Equiv. $275M $31M $482M

Operating Exp. $6.31B $2.94B $4.13B

Noncash Exp. $292M $156M $342M

DCOH 16.68 4.06 46.44

Things to Take Away!

Things to Take Away!

Inventory Turnover Ratio - In a Nutshell

Formula & Calculation

Total Cost of Goods Sold

Total COGS $463M $1.15B $16.46B

Inventory TY $29M $103M $844M

Inventory LY $25M $104M $1.03B

Avg. Inventory $27M $103.5M $938M

Things to Take Away!

Things to Take Away!

Days Inventory Outstanding - In a Nutshell

Formula & Calculation

Total COGS $10.71B $7.93B $4.28B

Inventory TY $1.41B $1.24B $746M

Inventory LY $1.54B $1.25B $751M

Avg. Inventory $1.475B $1.245B $748.5M

Things to Take Away!

Things to Take Away!

Accounts Receivable Turnover Ratio - In a Nutshell

Formula & Calculation

Net Credit Sales

General Electric Co. 3M Co. Siemens AG

Net Credit Sales Unknown $28.501B Unknown

Avg. A/R Balance $25.549B $4.273B $14.095B

ARTR Unknown 6.67 Unknown

Things to Take Away!

Things to Take Away!

Days Sales Outstanding - In a Nutshell

Formula & Calculation

Net Credit Sales $28.501B

Avg. A/R Balance $4.273B

Days Sales Outstanding 54.72

Things to Take Away!

Things to Take Away!

Accounts Payable Turnover Ratio - In a Nutshell

Formula & Calculation

International Paper Avery Dennison Corp. Sealed Air Corp.

Total Purchases $15.362B $4.427B $4.043B

Avg. A/P Balance $2.1935B $828.5M $607M