Operating Working Capital Drills

Operating Working Capital Drills Operating Working Capital Drills 1. Use IBM s balance sheet below to calculate 2010 and 2011 working capital and operating working capital. Your VP has told you to consider short-term financing receivables as non-operational for purposes of the OWC calculation. 2010 2011 WC OWC Impact on cash 1

Operating Working Capital Drills 2. Use L Oreal s balance sheet below to analyze its operating working capital for 2009, 2010 and 2011. 2

Operating Working Capital Drills 2009 2010 2011 Net sales 17,472.6 19,495.8 20,343.1 Cost of sales 5,161.6 5,696.5 5,851.5 OWC Requires or provides funding? A/R days Inventory days A/P days Days funding 3

Operating Working Capital Drills 3. Use Hershey s balance sheet below to assess its working capital requirements. WC OWC Does the OWC require or provide funding for Hershey in each respective year? Impact on cash 2010 2011 4

Operating Working Capital Drills 4. Use McDonald s balance sheet and income statement to analyze its working capital. 5

Operating Working Capital Drills 2010 2011 Sales COGS OWC OWC as % of sales A/R days Inventory days A/P days Days funding (provided) / required 6

Operating Working Capital Drills 5. Use Singapore Airline s balance sheet to assess its working capital needs. Your VP has told you that derivative assets and liabilities relate to non-operating activities. 7

Operating Working Capital Drills 2011 2012 Sales 14,524.8 14,857.8 COGS 10,425.2 11,837.1 OWC OWC as % of sales A/R days Inventory days A/P days Days funding (provided) / required Does the OWC require or provide funding? How does this relate to what you know about this industry? 8

Operating Working Capital Solutions Operating Working Capital Solutions 1. 2010 2011 Total current assets 48,116 50,928 Total current liabilities 40,562 42,123 = Working capital 7,554 8,805 Notes and accounts receivable 10,834 11,179 + Other accounts receivable 1,134 1,481 + Inventories 2,450 2,595 + Deferred taxes 1,564 1,601 + Prepaid expenses and other current assets 4,226 5,249 Taxes 4,216 3,313 Accounts payable 7,804 8,517 Compensation and benefits 5,028 5,099 Deferred income 11,580 12,197 Other accrued expenses and liabilities 5,156 4,535 = OWC (13,576) (11,556) Impact on cash (2,020) Less free funding provided 9

Operating Working Capital Solutions 2. 2009 2010 2011 Inventories 1,476.7 1,810.1 2,052.1 + Trade accounts receivable + Other current assets 2,443.3 2,685.3 2,996.2 732.8 846.0 904.1 + Current tax assets 115.2 104.5 118.0 = Operating current assets Trade accounts payable + Provisions for liabilities and charges + Other current liabilities 4,768.0 5,445.9 6,070.4 2,603.1 3,153.5 3,247.7 510.0 536.9 500.7 1,750.5 1,958.1 2,066.7 + Income tax 133.2 166.6 224.0 = Operating current liabilities OWC (OCA OCL) Requires or provides funding? 4,996.8 5,815.1 6,039.1 (228.8) (369.2) 31.3 Provides Provides Requires A/R days 51.0 50.3 53.8 Inventory days 104.4 116.0 128.0 A/P days 184.1 202.1 202.6 Days funding (28.6) (35.8) (20.8) 10

Operating Working Capital Solutions 3. 2010 2011 Total current assets 2,005,217 2,046,558 Total current liabilities 1,298,845 1,173,775 = WC 706,372 872,783 Accounts receivable-trade 390,061 399,499 + Inventories 533,622 648,953 + Deferred income taxes 55,760 136,861 + Prepaid expenses and other 141,132 167,559 = OCA 1,120,575 1,352,872 Accounts payable 410,655 420,017 + Accrued liabilities 593,308 612,186 + Accrued income taxes 9,402 1,899 = OCL 1,013,365 1,034,102 OWC (OCA OCL) 107,210 318,770 Does the OWC require or provide funding for Hershey in each respective year? Require Require Impact on cash (211,560) Requires additional funding 11

Operating Working Capital Solutions 4. 2010 2011 Sales 24,074.6 27,006.0 Food & paper 5,300.1 6,167.2 + Payroll & employee benefits 4,121.4 4,606.3 + Occupancy & other operating expenses 3,638.0 4,064.4 + Franchised restaurants-occupancy expenses 1,377.8 1,481.5 = COGS 14,437.3 16,319.4 Accounts and notes receivable 1,179.1 1,334.7 + Inventories 109.9 116.8 + Prepaid expenses and other current assets 692.5 615.8 = OCA 1,981.5 2,067.3 Accounts payable 943.9 961.3 + Income taxes 111.3 262.2 + Other taxes 275.6 338.1 + Accrued payroll and other liabilities 1,384.9 1,362.8 = OCL 2,715.7 2,924.4 OWC (OCA OCL) (734.2) (857.1) OWC as % of sales -3.0% -3.2% A/R days 17.9 18.0 Inventory days 2.8 2.6 A/P days 23.9 21.5 Days funding (provided) / required (3.2) (0.8) 12

Operating Working Capital Solutions 5. 2011 2012 Sales 14,524.8 14,857.8 COGS 10,425.2 11,837.1 Inventories 335.5 306.1 + Trade debtors (aka A/R) 1,381.8 1,354.8 + Deposits and other debtors 52.0 46.8 + Prepayments 103.6 98.5 = OCA 1,872.9 1,806.2 Sales in advance of carriage 1,459.8 1,456.8 + Deferred revenue 445.1 497.0 + Current tax payable 440.2 244.4 + Trade and other creditors 2,725.7 2,885.4 + Provisions 62.5 35.3 = OCL 5,133.3 5,118.9 OWC (OCA OCL) (3,260.4) (3,312.7) OWC as % of sales -22.4% -22.3% A/R days 34.7 33.3 Inventory days 11.7 9.4 A/P days 95.4 89.0 Days funding (provided) / required (49.0) (46.3) Does the OWC require or provide funding? How does this relate to what you know about this industry? Answer: The OWC provides funding and this makes sense given the operations of the airline industry. Customers purchase flights in advance and thus the airline receives cash in advance and provides the services at a later date. This is reflected in OWC via the Sales in advance of carriage and the Deferred revenue accounts. 13

Non-Current Asset Drills Non-Current Asset Drills 1. Please identify whether the following are tangible or intangible assets and whether they are depreciated or amortized: a) Equipment b) Patents c) Buildings d) Land e) Goodwill f) Copyrights 2. Identify the intangible assets below that cannot be amortized due to their indefinite useful life: a) Patents b) Copyrights c) Goodwill d) Intellectual property e) Business licenses f) Franchise rights g) Trademarks 3. What is the difference between amortization and depreciation? 4. Why is depreciation an add back in the cash flow statement? 5. True or False: a) Fixed assets are assets of a business intended for continuing use rather than shortterm in nature b) Fixed assets are assets that form part of the circulating capital of a business c) Fixed assets are replaced frequently or converted into cash during trade d) Fixed assets are categorized as either intangible or tangible assets on the balance sheet e) The benefits a company obtains from fixed assets extend over several years 6. What is the difference between the useful life and residual value of a fixed asset? 14

Non-Current Asset Drills 7. Tiffany & Co. property, plant & equipment as of the most recent year was as follows: Using Tiffany s historical PP&E and the assumptions shown below, your VP has asked you to project PP&E for the next two years. Forecast deprecation at 10.0% of the previous year s net PP&E balance Forecast capital expenditures at 5.0% of the respective year s sales Forecast Year 1 Forecast Year 2 Sales 3,085,290 3,642,937 Gross PP&E Accumulated depreciation and amortization Net PP&E Annual depreciation expense Beginning net PP&E + Capital expenditures Depreciation and amortization Ending net PP&E 15

Non-Current Asset Drills 8. SABMiller purchased machinery valued at 1,400 during the year that had an estimated useful life of 10 years and a salvage or residual value of 200. Calculate the following: Depreciable value at acquisition Annual depreciation Net book value year 5 Net book value year 7 Accumulated depreciation year 9 Net book value year 10 9. You are working one-on-one with the analyst of your client, TSK Chemicals, helping to prepare their forecast model. She has sent you two depreciation schedules related to next year s capital expenditures, one using the straight line method and the other using an accelerated method. Please answer the following questions: Straight line Accelerated Projected Year 1 depreciation 100,000 200,000 Projected Year 2 depreciation 100,000 150,000 Projected Year 3 depreciation 100,000 75,000 Projected Year 4 depreciation 100,000 50,000 Projected Year 5 depreciation 100,000 25,000 Total 500,000 500,000 Given the information you received from TSK, what is the cost of next year s capital expenditures? What is the cash out flow in year 3? Which method produces the highest net income in year 2? Which method produces the highest net income in year 5? Which method results in the highest net book value at the end of year 4? 16

Non-Current Asset Solutions Non-Current Asset Solutions 1. a) Equipment tangible and depreciated b) Patents intangible and amortized c) Buildings tangible and depreciated d) Land tangible and not depreciated e) Goodwill intangible and tested for impairment annually f) Copyrights intangible and amortized 2. C. Under U.S. GAAP and IFRS, goodwill is not amortized for book purposes. The other intangible assets listed are amortized over their useful lives 3. Amortization refers to spreading the cost of an intangible asset over its useful life where as depreciation refers to spreading the cost of a physical asset over its useful life 4. Depreciation is a non-cash expense in the income statement and thus an add back in the cash flow statement. The actual cash out flow or capital expenditure is reflected in the cash flow statement in the period it is incurred 5. a) True. b) False. This statement describes current assets, specifically operating working capital accounts c) False. This statement describes current assets, specifically operating working capital accounts. d) True. e) True. 6. The useful life on an asset is the length of time that a depreciable asset is expected to be useable. Residual (or salvage) value is the how much a fixed asset is worth at the end of its useful life. The cost of a fixed asset less its estimated residual value represents the total amount to be depreciated over its estimated useful life 17

Non-Current Asset Solutions 7. Forecast Year 1 Forecast Year 2 Sales 3,085,290 3,642,937 Gross PP&E (Previous year s gross PP&E + current year s capital expenditures) Accumulated depreciation and amortization (Previous year s accumulated depreciation + current year s depreciation) 1,912,576 2,094,722 1,067,854 1,152,327 = Net PP&E 844,721 942,396 Annual depreciation expense 76,717 84,472 Beginning net PP&E 767,174 844,721 + Capital expenditures (5.0% * current year sales) Depreciation and amortization (10.0% * beginning net PP&E) 154,265 182,147 76,717 84,472 = Ending net PP&E 844,721 942,396 8. Depreciable value at acquisition (1,400 200) Annual depreciation (1,200 / 10) Net book value year 5 (1,400 (120 * 5)) Net book value year 7 (1,400 (120 * 7)) Accumulated depreciation year 9 (120 * 9) Net book value year 10 (at end of year 10, net book value equals salvage or residual value) 1,200 120 800 560 1,080 200 18

Non-Current Asset Solutions 9. Given the information you received from TSK, what is the cost of next year s capital expenditures? 500,000 What is the cash out flow in year 3? The cash out flow in year 3 is 0. The actual cash outflow of 500,000 occurs at the time of acquisition Which method produces the highest net income in year 2? Straight line Which method produces the highest net income in year 5? Accelerated Which method results in the highest net book value at the end of year 4? Straight line will result in a higher net book value at the end of year 4. (100,000 net book value under straight line vs. 25,000 net book value under accelerated) 19