Archive for November, 2008

The book value is the gross investment (that is, the original or historical purchase price) minus the accumulated depreciation expense. Book value is also called net value, meaning ‘net of depreciation’. In Motorola’s case, the gross asset value is dropping (which indicates asset dispositions) and so is the book value. Motorola has disposed of assets without a commensurate investment in new assets. Put another way, Motorola’s asset base is aging. (more…)

Depreciation is tricky because it is the allocation of a prior capital expenditure to an annual expense. Reported profits are directly impacted by the depreciation method. And because depreciation is a non-cash expense charge, some analysts prefer cash flow measures or EBITDA, which is a measure of earnings before the subtraction of depreciation. However, depreciation typically cannot be ignored because it serves a valuable purpose: it sets aside an annual amount (a sinking fund, if you will) for the maintenance and replacement of fixed assets. (more…)

In the preceding section, we examined working capital, which refers to the current assets and liabilities of a company. In this section, we take a closer look at the long-lived assets (a.k.a. non-current assets) carried on the balance sheet. Long-lived assets are those that provide the company with a future economic benefit beyond the current year or operating period. It may be helpful to remember that most (but not all) long-lived assets start as some sort of purchase by the company. (more…)

We also highlighted Delta’s increase in “Prepaid expenses and other” because this innocent-looking account contains the fair value of Delta’s fuel hedge derivatives. Here’s what the footnote says:

Prepaid expenses and other current assets increased by 34%, or $120 million, primarily due to an increase in prepaid aircraft fuel as well as an increase in the fair value of our fuel hedge derivative contracts…. Approximately 65%, 56% and 58% of our aircraft fuel requirements were hedged during 2003, 2002 and 2001, respectively. In February 2004, we settled all of our fuel hedge contracts prior to their scheduled settlement dates… and none of our projected aircraft fuel requirements for 2005 or thereafter. (more…)

Most of the other working capital accounts are straightforward, especially the current liabilities side of the balance sheet. But you do want to be on the alert for the following:
• Off-balance sheet financing.
• Derivatives.

Notice that Delta’s receivables more than doubled from 2002 to 2003. Is this a dangerous sign of collections problems? Let’s take a look at the footnote: (more…)

The turnover ratios do not mean much in isolation; rather, they are used to compare one company to another. But if you divide the turnover ratios into 365 (for example, 365/receivables turnover), you get the “days outstanding” numbers. Below, for example, a receivable turnover of 9.6 becomes 38 days sales outstanding (DSO). This number has more meaning; it means that, on average, Kohl’s collects its receivables in 38 days. (more…)

The cash conversion cycle is a measure of working capital efficiency, often giving valuable clues about the underlying health of a business. The cycle measures the average number of days that working capital is invested in the operating cycle. It starts by adding days inventory outstanding (DIO) to days sales outstanding (DSO). This is because a company “invests” its cash to acquire/build inventory, but does not collect cash until the inventory is sold and the accounts receivable are finally collected. (more…)

Inventory balances are significant because inventory cost accounting impacts reported gross profit margins. For an explanation of how this happens, see “Inventory Valuation For Investors: FIFO and LIFO.” Investors tend to monitor gross profit margins, which are often considered a measure of the value provided to consumers and/or the company’s “pricing power” in the industry. However, we should be alert to how much gross profit margins depend on the inventory costing method. (more…)

A recurring theme in this series is the importance of investors shaping their analytical focus according to companies’ business models. Especially when time is limited, it’s smart to tailor your emphasis so it’s in line with the economic drivers that preoccupy the company’s industry. It’s tough to get ahead of the “investing pack” if you are reacting to generic financial results–such as earnings per share (EPS) or revenue growth–after they’ve already been reported. For any given business, there usually are some key economic drivers, or leading indicators,that capture and reflect operational performance and eventually translate into lagging indicators such as EPS. For certain businesses, trends in the working capital accounts can be among these key leading indicators of financial performance. (more…)

Here we see one of the benefits of a weaker U.S. dollar: it boosts the international sales numbers of U.S. companies! In Office Depot’s case, international sales were boosted by $253 million because the dollar weakened over the year. Why? A weaker dollar means more dollars are required to buy a foreign currency, but conversely, a foreign currency is translated into more dollars. So, even though a product may maintain its price in foreign currency terms, it will translate into a greater number of dollars as the dollar weakens. (more…)