1 / 30

Balance Sheet Analysis

Balance Sheet Analysis. Alexander Motola, CFA. Quality of Earnings, Chapter 8 Two Key Ratios: Accounts Receivable and Inventories.

crwys
Download Presentation

Balance Sheet Analysis

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Balance Sheet Analysis Alexander Motola, CFA Alexander Motola, 2013

  2. Quality of Earnings, Chapter 8Two Key Ratios: Accounts Receivable and Inventories “…the best method I have ever discovered to predict future downwards earnings revisions by Wall Street security analysts – is a careful analysis of accounts receivable and inventories.” (QoE, pg. 107) • Was is predicting future downwards earnings revisions important? • Is A/R and inventory analysis difficult? Alexander Motola, 2013

  3. Quality of Earnings, Ch. 8 • All of the examples are 30 years old – are they still relevant today? • Those business are (largely) gone • Mgmt and investor psychology remain • Accounting standards have evolved, but not too much • 2000-2002 market “event” was a repeat of the 1984-1985 debaucle Alexander Motola, 2013

  4. Quality of Earnings, Ch. 8 • In most financial analysis, we are less concerned with the absolute (actual) numbers, and more concern with the change in the pattern • You need a lot of data • Many periods of numbers • Competitor/Industry data where applicable • You need to understand what the numbers mean, and how they might be derived Alexander Motola, 2013

  5. Accounts Receivable • Companies sell goods to customers– this is revenue • Customers either pay cash or use credit (usually 30 days) • If the customers don’t pay at the time of the transaction (revenue), then A/R is created • Credit is a normal part of business; it removes a transactional barrier • What can we learn from credit? Alexander Motola, 2013

  6. Accounts Receivable • Think about your job – what does your company do? How soon do customers pay? • There is normally an “appropriate” amount of credit, relative to sales, for most businesses • Calculations • EOP (easiest): AR/Rev*#days • AVE: [(Current period AR + Last Period AR)/2]/Rev*#ofdays (91.25) • 4Q Average: (5 AR [ave])/cumulative sales * #days Alexander Motola, 2013

  7. Accounts Receivable • What A/R is on the balance sheet? • What does “Net” mean? • What does “Gross” mean? • What is ADA? • Which # makes more sense, Net or Gross? • If Wall Street focuses on Net A/R, what does that mean? Alexander Motola, 2013

  8. Accounts Receivable • What is a “DSO”? • It is an average • It approximates the number of days – on average – that it takes a company to turn a sale (revenue) into cash • Lower is better, but it depends on the business cycle • The faster you grow, the more working capital you need… Alexander Motola, 2013

  9. Accounts Receivable • I like Gross • It *IS* the amount of money owed the company • The reserve does matter, it is estimated by the company based on their “experience” • If the reserve changes a lot, either the company is manipulating earnings, A/R, or their “experience” has changed – any one of these are important Alexander Motola, 2013

  10. Accounts Receivable • Allowance for Doubtful Accounts • Look at the trend • It’s not seasonal • It probably impacted A/R, DSO, and EPS Alexander Motola, 2013

  11. Accounts Receivable • Example of ADA T-Account • You can see the income statement impact Alexander Motola, 2013

  12. Accounts Receivable • DSO trend - ramps suddenly • Why are DSOs up? • Economy weakening • Regulatory changes • More credit extension – financing customers, channel stuffing, stealing from future revenues • Customers can’t/won’t pay Alexander Motola, 2013

  13. Accounts Receivable • Some companies will disclose their “Aging” in a footnote • Aging is more detail of the total A/R by different buckets based on how long “past due” or current they are • Sometimes just a few customers skew the DSO upwards because they can’t or won’t pay • Companies HAVE to disclose if they have 1 or more customers that make up 10%+ of sales or A/R in any reported period Alexander Motola, 2013

  14. Accounts Receivable • The dirty little secret – Factoring • Ramping DSO is seen as a collection issue, analysts understand earnings quality declines as DSO goes up • Companies can sell A/R to finance companies for X cents on the dollar • A/R down • Cash up • No tell tale on the SCF, either • It’s no economic for most companies, it’s purely cosmetic, and comes at a cost Alexander Motola, 2013

  15. Accounts Receivable • Is there a way to discover if a company is factoring? • Not really • Most companies will tell you if you ask • You can delve into their banking relationships, but you aren’t likely to get very far • If you want to learn more, a good next step is to read either • What’s Behind the Numbers? Del Vecchio and Jacobs • Financial Shenanigans – Schilit Alexander Motola, 2013

  16. Inventory • This reflects the value add created by the company on the balance sheet at the product level • It is a direct input into COGS • Should a company have a lot of inventory? • What questions should we ask about a company’s inventory? Alexander Motola, 2013

  17. Inventory • Like A/R, we can look at the absolute level as well as the amount of inventory relative to sales • “Relative to sales” means DIO • Days of Inventory Outstanding • Is it really relative to Sales/Revenues? • Basic calculation is: Inv/COGS*#days • Why? • What does DIO tell us as analysts? Alexander Motola, 2013

  18. Inventory • Most companies report 3 “buckets” of inventory • Raw Materials • WIP (Work in Progress) • Finished Goods • It obviously depends on the business model Alexander Motola, 2013

  19. Inventory • Here’s an example of a footnote • All three categories are there • They also have the LIFO/FIFO adj Alexander Motola, 2013

  20. Inventory • What does a lot of Finished Goods tell us (as a mix of inventory)? • What does a lot of Raw Materials tell us? • These are both examples which would cause Inventory $ and DIOs to go up, but the conclusions are different… Alexander Motola, 2013

  21. Inventory • DIO example • ONNN has a long history of DIO around 80 days • But then there’s this move of +40 days • Big acquisition (SANYO) • Not really worrying if they can “work it down” Alexander Motola, 2013

  22. Inventory • DIO example • ONNN has a long history of DIO around 80 days • But then there’s this move of +40 days • Big acquisition (SANYO) • Not really worrying if they can “work it down” – which they were obviously able to do Alexander Motola, 2013

  23. Inventory • DIO example • ONNN has a long history of DIO around 80 days • But then there’s this move of +40 days • Big acquisition (AMI Semi) • Not really worrying if they can “work it down” – which they were obviously able to do Alexander Motola, 2013

  24. Inventory • Sometimes there is just a problem… • UTSI grew > 75% each of the first two quarters of 2003… • Having accelerated from the previous year (around the 30-40% range) • With the help of some acquisitions… • And the stock had been awesome as the revenue acceleration happened Alexander Motola, 2013

  25. Inventory Alexander Motola, 2013

  26. Inventory • Inventories go nuts, up to $1b in 2Q03, equating to 374 days • The inventories come down, but we later learn they’ve tried to move them “OBS” (the # in row 264). • UTSI – after clearing mgmt house – conducted a series of self investigations regarding their accounting and business practices, and much mischief was found Alexander Motola, 2013

  27. Inventory Alexander Motola, 2013

  28. Other “Cookie Jars” • “A disingenuous accounting practice in which periods of good financial results are used to create reserves that shore up profits in lean years. “Cookie jar accounting” is used by a company to smooth out volatility in its financial results, thus giving investors the misleading impression that it is consistently meeting earnings targets.” - Investopedia • You can analyze DDR, or days of deferred revenue, on a similar basis • Warranties are another place to store expenses Alexander Motola, 2013

  29. Other “Cookie Jars” “One of the best-known cases of cookie jar accounting in recent years was that of computer giant Dell, which in July 2010 agreed to pay a $100 million penalty to the Securities and Exchange Commission (SEC) to settle SEC allegations that it used cookie jar reserves. The SEC maintained that Dell would have missed analysts’ earnings estimates in every quarter between 2002 and 2006 had it not dipped into these reserves to cover shortfalls in its operating results. The cookie jar reserves were created through undisclosed payments that Dell received from chip giant Intel in return for agreeing to use Intel’s CPU chips exclusively in its computers. (Intel made these payments to Dell to lock out rival chipmaker Advanced Micro Devices from Dell computers.)” - Investopedia Alexander Motola, 2013

  30. Summary • Earnings (EPS) isn’t just a number – you need to evaluate what’s behind it • Most of the information necessary to determine Earnings Quality is available • The larger your sample (more periods), the more insightful you can be • Everything has context; the numbers are clues, but you still need to piece together what they are saying Alexander Motola, 2013

More Related