Stock Turn or Inventory Turn

For example:

Annual turnover  $10 million
Annual cost of sales (60%)  $6 million
Stock value $1.5 million
Stock turn 4


This measures the number of times that total stock is used (turned over) in the course of a year.

The higher the stock turn the more efficiently the business is being run, though adequate safety margins must of course be maintained.

It is important that the terms are completely understood and that there are no abnormal factors.

Normally the definition of stock includes all finished goods, work in progress and raw materials.

The stock value will usually be taken from the closing Balance Sheet but you need to consider if it is a typical figure.

If the business is seasonal, such as a manufacturing of fireworks, it may not be.  

A better result may be obtained if the average of several stock figures throughout the year can be used.

LIFO and FIFO

Cooking the Books: Investors, be warned.

This discussion should make you better able to see the clues of fraud and remind you to be vigilant.

Managers most often cook the books for personal financial gain - to justify a bonus, to keep stock prices high and options valuable or to hide a business's poor performance.  Companies most likely to cook their books have weak internal controls and have a management of questionable character facing extreme pressure to perform.

All fast-growing companies must eventually slow down.  Managers may be tempted to use accounting gimmicks to give the appearances of continued growth.  Managers at weak companies may want to mask how bad things really are.  Managers may want that last bonus before bailing out.  Maybe there are unpleasant loan covenants that would be triggered but can be avoided by cooking the books.  A company can just be sloppy and have poor internal controls.

One key to watch for is management changing from a conservative accounting policy to a less-conservative one, for example, changing from LIFO to FIFO methods of inventory valuation or from expensing to capitalizing certain marketing expenses, easing of revenue recognition rules, lengthening amortization or depreciation periods.

Changes like these should be a red flag.  There may be valid reasons for these accounting policy changes, but not many.  Be warned.

Related:

• Cooking the Books: Why do managers cook the books?
• Cooking the Books: This is very different from "Creative Accounting"
• Cooking the Books: Puffing up the Income Statement
• Cooking the Books: Techniques to Puff Up the Income Statement
• Cooking the Books: Sweetening the Balance Sheet
• Cooking the Books: Techniques to Sweeten the Balance Sheet
• Cooking the Books: The Auditor's Job
• Cooking the Books: Investors, be warned.

How to Analyze Receivables & Inventory

How to Analyze Receivables & Inventory

Thu, Feb 11, 2010

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How to Perform Inventory and Receivables Anlaysis

I wanted to go through a quick exercise that I perform during a stock analysis.

A recent stock that has come up in the Graham stock screener and forum is CONN. Conn’s Inc is a specialty retailer of home appliances such as fridges, freezers, washers, dryers and consumer electronics such as TV’s, cameras, computers etc. Think Best Buy.

The company just released their results for their 2009 4th quarter results and the stock took a 17%hit. The actual financial statements hasn’t been released but I wanted to show how these things are foreseeable by analyzing the inventory and accounts receivables. This has also been discussed in the balance sheet analysis.

Sales, Inventory and Receivables Analysis

For any company that sells products, a careful look at the correlation between sales, accounts receivables and inventories is crucial. In the above example, I’ve only compared the 3rd quarter statements but you can see that CONN does not know how to manage their assets.

From what I see, the problem began to surface in 2006 where revenue only increased 0.23% while accounts receivables increased 31% and inventory went up 8%. Before 2006, the company was able to grow revenues at a faster rate than accounts receivables and inventory but from 2006 onwards, the correlation worsened until 2008 where you can immediately see that things were bound to fall apart.

In 2008, revenues declined 3% compared to the previous comparable period while accounts receivables increased by 116% and inventories up 9%.

The same thing happened in 2009 where accounts receivables increased another 102%! The only thing waiting for CONN is trouble, and it finally surfaced in their latest quarter. It goes to show that Wall Street does not perform the proper analysis required.

Here is a graphical view of the same thing.

Whenever you see either accounts receivables of inventory increase quicker than sales, watch out. But for inventory, you need to dig deeper.

When raw materials component of inventories is advancing much  more rapidly than the work-in-progress and finished goods components, this means that the company is receiving many new orders and an inventory buildup is necessary. So the company will simultaneously ship products from its finished goods inventory while ordering raw materials in larger amounts.

But in the case of CONN, the company only sells the items so 100% of inventory is finished goods so any excessive increase is a big red warning sign.

Dirt Cheap or Value Trap

All valuations point to a cheap company. Looks like the intrinsic value is roughly $15-$16.

If I had come across CONN when I first started investing, I’m pretty sure I would have bought it. At today’s price of $4.61 it is definitely cheap and tempting but until there are signs that management is able to get a handle on inventory and accounts receivables, it is best to leave it alone.

Sure the stock can go up, but it doesn’t hide the fact that the company is struggling. CONN has also increased their accounts payables and taken on huge amounts of long term debt.

If I was to buy the stock now, I would only be speculating and hoping that things improve.

http://www.oldschoolvalue.com/stock-analysis/inventory-receivables-analysis-conn/

Inventory Valuation: Tricks and Traps!

by Toby Tatum

Buying or selling a small business, if done in a way that minimizes the potential for purchase negotiations to fall apart or for post-transaction animosity—or possibly even litigation—between the buyer and the seller, can be a complicated process. As a business broker and as a former business owner who has bought and sold several restaurants, I have experienced first hand dozens of tricks, traps and unpleasant surprises that lie waiting to snare unsuspecting buyers and sellers. I addressed all of these things in my book, Anatomy of a Business Purchase Offer.

There is one incident that I'll tell you about here that I encountered as a business broker assisting a client with selling his discount liquor/convenience store. It had to do with the amount the buyer would pay for the seller’s inventory.

In this case, which is typical, the purchase offer indicated the amount the buyer would pay for the inventory on hand at close of escrow. The offer stated that the buyer would purchase the inventory at the seller’s cost and included the caveat that the price stated in the purchase offer was only an estimate; that the exact value of the inventory would be determined via a physical count to be taken immediately preceding close of escrow.

As agreed between the parties, in the early morning hours on the day escrow was to close, the seller had an inventory counting service come into his store, count every product on the shelves and note the retail price of each item. The seller therewith came to the closing meeting with an exact representation of the value of his inventory at retail. And here is where the transaction process fell apart.

During the course of purchase negotiations, the seller told the buyer that, on average, his merchandise’s retail price was 30% above his wholesale cost. So, with a letter from the inventory counting service stating that the value of the seller’s inventory at retail prices was determined to be $130,000, the buyer agreed to pay 70% of that amount, or $91,000. The seller said that was not enough, an argument ensued and the buyer, together with the business broker assisting him, walked out of the meeting. The deal had fallen apart at the very last stage in the process.

Fortunately for me at least, since I wasn’t going to get paid unless the deal closed, the buyer and seller got back together later that day and consummated the transaction. The buyer agreed to pay the seller $100,000 for his inventory instead of the $91,000 he previously insisted was the correct amount.

So, whose calculation of the seller’s cost for the inventory was right, the buyer’s or the seller’s? I’ll give you a hint: I was representing the seller. Since the seller’s merchandise was marked up 30% (on average) above its wholesale cost, then the cost of goods sold reflected on his Profit & Loss statement was 76.9%. For example, if an item cost $1.00 and is sold for $1.30, the cost of goods sold expressed as a percent of the selling price is $1.00 divided by $1.30 which equals 76.9%. Therefore, once the retail value of the inventory was determined to be $130,000, the correct way to calculate its wholesale cost was to multiply that amount by the seller’s cost of goods sold of .769 as reflected on his P&L. $130,000 times .76923 = $100,000.

In the example I just cited, determining the wholesale cost of a business owner’s inventory given its retail price is simple. However, not all value determinations are this simple. In some cases it may be best to separate merchandise by the categories appearing on the profit and loss statement and calculate the wholesale cost of each category using the method described above. In other cases, the best way is to match each item of inventory with the vendor’s invoice—it all depends on the unique circumstances of a particular business, what’s reasonable and practical and what the buyer and seller can agree upon. I recommend that the buyer state the valuation methodology for the inventory in the offer itself. Doing so should avoid the kind of unfortunate incident I have related here.

A few days later the buyer asked me to meet him at the store he had just purchased. He said he wanted to show me something. When I met him at his new business he showed me several items on the shelves. Although he had no proof, he said it appeared that the seller had gone through his entire stock of merchandise the night before the escrow closing day and placed new retail price stickers on everything—at higher prices than his standard 30% mark-up!

Be careful, it’s a jungle out there!


http://www.businessbookpress.com/articles/article103.htm

Inventory Management

Managing inventory is a juggling act. Excessive stocks can place a heavy burden on the cash resources of a business. Insufficient stocks can result in lost sales, delays for customers etc.

The key is to know how quickly your overall stock is moving or, put another way, how long each item of stock sit on shelves before being sold. Obviously, average stock-holding periods will be influenced by the nature of the business. For example, a fresh vegetable shop might turn over its entire stock every few days while a motor factory would be much slower as it may carry a wide range of rarely-used spare parts in case somebody needs them.

Nowadays, many large manufacturers operate on a just-in-time (JIT) basis whereby all the components to be assembled on a particular today, arrive at the factory early that morning, no earlier - no later. This helps to minimize manufacturing costs as JIT stocks:

• take up little space,
• minimize stock-holding and
• virtually eliminate the risks of obsolete or damaged stock.

Because JIT manufacturers hold stock for a very short time, they are able to conserve substantial cash. JIT is a good model to strive for as it embraces all the principles of prudent stock management.

The key issue for a business is to identify the fast and slow stock movers with the objectives of :

• establishing optimum stock levels for each category and, thereby,
• minimize the cash tied up in stocks.

Factors to be considered when determining optimum stock levels include:

• What are the projected sales of each product?
• How widely available are raw materials, components etc.?
• How long does it take for delivery by suppliers?
• Can you remove slow movers from your product range without compromising best sellers?

Remember that stock sitting on shelves for long periods of time ties up money which is not working for you.

For better stock control, try the following:

• Review the effectiveness of existing purchasing and inventory systems.
• Know the stock turn for all major items of inventory.
• Apply tight controls to the significant few items and simplify controls for the trivial many.
• Sell off outdated or slow moving merchandise - it gets more difficult to sell the longer you keep it.
• Consider having part of your product outsourced to another manufacturer rather than make it yourself.
• Review your security procedures to ensure that no stock "is going out the back door !"

Higher than necessary stock levels tie up cash and cost more in insurance, accommodation costs and interest charges.

Our range of financial planners, Exl-Plan and Cashflow Plan, contain extensive facilities for exploring alternative stock-holding strategies. See also the white paper on Making Cashflow Forecasts and Checklist for Improving Cashflow.

http://www.planware.org/workingcapital.htm