Introduction Optional Reading Workshop Content - Bivio

More documents

Recommendations

Info

RAW 2005 TurnoverA very useful variation of Receivables Turnover is to compare thepercentage change in receivables and the percentage change in sales. Ifthe percentage changes are the same then the Receivables turnover isremaining constant. This is just another way of saying that as acompany grows and increases its sales, then receivables will tend toincrease by the same percentage. However, if the percentage change inreceivables is significantly higher than the percentage change in salesthen there is a high probability that some of those increasedreceivables will never be collected. This can lead to an "unexpectednegative earnings surprise" when the allowance for doubtful accounts isincreased several quarters into the future. The following discussion ofthe Inventory Turnover Ratio covers this in more detail.MY OPINIONIt is advisable to track the Receivables Turnover Ratio of a company ona quarterly basis. A significant decrease in the value of this ratio(customers are taking longer to pay) is an early warning that problemsare developing. In practice I use the percentage change methoddescribed in the preceding paragraph. For me, this has proved to be oneof two very reliable early warning indicators. The second one is - lookdown about two inches.PEER REVIEWThe Market Guide Ratio Comparison report dated 01/16/98 shows thatPepsiCo has a Receivables Turnover Ratio of 14.32 and Coca-Cola has aReceivables Turnover Ratio of 10.74 compared to an industry average of11.62.____________________________________________________________________INVENTORY TURNOVER RATIOThe Inventory Turnover Ratio is defined as:Cost of Goods SoldInventory Turnover Ratio = ------------------InventoryCost of Goods Sold is the total cost of producing the inventory soldduring a year. The value listed for Inventory on the balance Sheetrepresents the cost to produce the inventory that is in stock. TheInventory Turnover Ratio is interpreted in the same manner as theReceivables Turnover Ratio.The preceding comments about tracking percentage changes in receivablesand sales also apply to inventory. A situation where inventory isincreasing much more rapidly than sales is often an early warningsignal. There may be problems on the production line. There may havebeen a decrease in demand for the product. In any case the value of theinventory may have to be written down leading to another "unexpectednegative earnings surprise".DOWNLOAD THE FOLLOWING CASE STUDYAn excellent article on the subject is "Regina - Cleaning Up, orGetting Cleaned Out?" by Phil Keating. A reprint is available on theNAIC web site at http://www.better-investing.org/bits/bits4.html. Anexcerpt from the article is shown below.START OF EXCERPTIgnore the Balance Sheet at Your Peril!Page 2
RAW 2005 TurnoverIt was not necessary to have an MBA or a CFA or even a college coursein financial ratio analysis to quickly determine that something wasvery wrong at Regina. You didn't need to calculate any "fancy" ratiossuch as average days receivables or inventory turnover. Simply look atthe box below, which is data entirely taken from the Value Line sheetin the "Current Position" section.Regina Co., Inc. 1987 1988 %Change(in millions)Sales $128.2 $181.1 41.3%Receivables 27.8 51.1 83.8%Inventories 19.6 39.1 99.5%Cash 0.5 0.9 80.0%Note the change in receivables and inventories from 1987 to 1988.Compare this with the change in sales from 1987 to 1988.You will quickly notice that although sales increased 41.3%,inventories and receivables increased over twice as much from year toyear. At the same time you will note that the absolute level of cash isless than $1 million dollars for a company doing $181 million in sales,ie. cash is equal to only two days worth of sales. Obviously Regina wasnot getting paid in cash for shipments that it was booking as sales,and inventory was piling up at an alarming rate! It turned out that K-mart, the largest customer with over 15% of sales, was returning asdefective over 30% of Regina's merchandise. Other merchants were doinglikewise. Even though a look at the cash position box on the Value Linesheet shows the current ratio is a "superb" 4.09 versus 2.61 the yearbefore, and working capital to sales has increased from 21% to 39%, andcash from 2% to 4% of current liabilities, this company is clearlyheading for bankruptcy? It is right there before your eyes in theburgeoning receivables and inventory figures.END OF EXCERPTSTB STOCK ANALYST PROVIDES PERCENTAGE CHANGESThe STB Stock Analyst (SA) program calculates and displays thepercentage changes similar to those shown in the preceding excerpt. Thepercentage changes in Receivables and Inventory are displayed in the"Balance Sheet" window. The percentage change in quarterly sales isdisplayed by selecting "Recent Q figures" while the "SSG Graph" windowis open. Note that SA calculates the percentage change of sales for themost recent quarter compared to the same quarter a year ago. The"Regina" article uses the most recent four quarters of sales comparedto the previous four quarters. (Note: for SA to perform thesecalculations you must enter the quarterly data or use the NAIC S&PDatafiles.)For those who do not care to purchase SA, it is not difficult to createa spreadsheet to perform the calculations for these and other ratios.TURNOVER RATIOS FROM MARKET GUIDE ARE DIFFERENTThis workshop has suggested that both Receivables Turnover andInventory Turnover should be tracked by comparing the most recentquarterly data with the data for the corresponding quarter a year ago.Market Guide does not use this approach. Check their glossary and youwill find that they use the average of five quarters to calculate bothreceivables and inventory. Just be aware that the values reported byMarket Guide have been "smoothed" by taking the average of fivequarters and will not be as useful for "early warning detection" asPage 3
Page 6 and 7: that is steady or slightly increasi
Page 8: PTP growth greater than Sales growt
Page 11: RAW 2005 TurnoverRatio Analysis I-C
Page 15 and 16: Evaluating Management Session 4Welc
Page 17: Reuters also provides a summary of
Page 20 and 21: RAW - LeverageRatio Analysis I-Club
Page 22 and 23: RAW - LeverageLong Term DebtLong Te
Page 24 and 25: RAW - Liquidity********************
Page 26 and 27: RAW - Liquiditybanks, Current matur
Page 28 and 29: Workbook.RAW - LiquidityThey discus
Page 30 and 31: RAW - LiquidityCash 100 100Accounts
Page 32 and 33: Welcome to Evaluating Management Se
Page 34 and 35: zero in the conversion of dollars t
Page 36: S t o c kS e l e c t i o nG u i d e

Introduction Optional Reading Workshop Content - Bivio

Create successful ePaper yourself

Delete template?

Save as template?