What is the Balance Sheet?
The balance sheet reflects the assets, liabilities, and owners equity at a point in time.
The balance sheet reflects three things:
- What the company owns
- What the company owes
- What the company is worth
Goodwill
As an asset, it is from acquisitions, the difference between assets of the acquired company and the actual purchase price. It reflects the intangible value of the acquired company, such as the brand name, acquired technology, and customer relationships.
For example, if a company’s net assets are valued at $1m and the acquirer pays $3m, then goodwill of $2m goes onto the acquirers balance sheet. That $2m reflects all the value not reflected in the acquirer’s tangible assets.
Return on Equity
Calc: Net Income / Total Shareholders equity
Current Ratio
Calc: Current Assets / Current liabilities
Debt to Equity Ratio
Calc: Total liabilities / Total shareholders equity
Days Sales Outstanding (DSO)
- a working capital management measurement
- Days sales outstanding, also called average collection period or days revenue outstanding, reflects the average time it takes to collect sales.
- Formula: Accounts receivable / Revenue per day
- Reducing DSO improves working capital and increases free cash flow.
Days in Inventory (DII)(Inventory Turnover)
- a working capital management measurement
Days in inventory is the number of days inventory is in the system.
Types of Inventory: Raw materials; work in process; finished goods
Formula: Average Inventory / COGS per day
(COGS Per day calc - Annual COGS / 360) then;
360 / DII = Inventory turnover
Reducing DII improves working capital and increases free cash flow
Days Payable Outstanding (DPO)
- a working capital management measurement
Days payable outstanding (DPO) reflects the average number of days it takes to pay outstanding invoices.
Formula: Accounts Payable / COGS per day
Increasing DPO improves working capital and increases free cash flow.
Why is cash referred to as King?
A business can have great profit and go under.
A business can have a lot of cash and be unprofitable.
A successful business must have both profit and cash.
In what way is Profit and Cash Different?
- Revenue is Booked at Sale
Revenue is generally booked when the service or product sells or when revenue is earned, not when the payment is received (unless the customer pays at the time of sale).
Revenue is the customer’s promise to pay; therefore, profit is based on promises.
- Expenses Matched
The cost of producing the service or product is booked in the same month the revenue is booked, i.e., when the service or product is sold or when revenue is earned:
Not the month the supplies and other items were purchased.
Not the month the supplies and other items were paid for.
- Current Expenses vs. Capital Expenditures
Cash purchases and payments are divided into two categories:
COGS and operating expenses, day-to-day operations.
Capital expenditures, longer-term investments.
COGS and operating expenses are subtracted from revenue in determining profit.
Capital expenditures are not subtracted from revenue to determine profit (except for the annual depreciation/ amortization charges).
What is equity?
Equity is the shareholders stake in the company as measures by accounting rules. It’s also called the company’s book value. In accounting terms, equity is always assets minus liabilities
Working Capital
Working capital is the money a company needs to finance its daily operations. Accountants usually measure it by adding up a company’s cash, inventory, and accounts receivable, and then subtracting short term debts
Accounts Receivable
A/R is the use of cash to finance customers purchases,
Cash Conversion cycle
is another way to understand working capital; its essentially a timeline relating the stages of production (the operating cycle) to the company’s investment in working capital
The cash conversion cycle gives you a way of calculating how much cash it takes to finance the business: you just take sales per day and multiply it by the number of days in the cash conversion cycle.
Calc: DSO + DII - DPO
