Understanding The Cash Conversion Cycle

by Jim Mueller (Contact Author | Biography)

The cash conversion cycle (CCC) is one of several measures of management effectiveness. It measures how fast a company can convert cash on hand into even more cash on hand. The CCC does this by following the cash as it is first converted into inventory and accounts payable (AP), through sales and accounts receivable (AR), and then back into cash. Generally, the lower this number is, the better for the company. Although it should be combined with other metrics (such as return on equity and return on assets) it can be especially useful for comparing close competitors because the company with the lowest CCC is often the one with better management. In this article, we'll explain how CCC works and show you how to use it to evaluate potential investments. 

What Is It?
The CCC is a combination of several activity ratios involving accounts receivable, accounts payable and inventory turnover. AR and inventory are short-term assets, while AP is aliability; all of these ratios are found on the balance sheet. In essence, the ratios indicate how efficiently management is using short-term assets and liabilities to generate cash. This allows an investor to gauge the overall health of the company. (For further reading, see Reading The Balance Sheet andIntroduction To Fundamental Analysis: The Balance Sheet.)

How do these ratios relate to business? If the company sells what people want to buy, cash cycles through the business quickly. If management cannot figure out what sells, the CCC slows down. For instance, if too muchinventory builds up, cash is tied up in goods that cannot be sold - this is not good news for the company. In order to move out this inventory quickly, management might have to slash prices, possibly selling its product at a loss. If AR is handled poorly, it means that the company is having difficulty collecting payment from customers. This is because AR is essentially a loan to the customer, so the company loses out whenever customers delay payment. The longer a company has to wait to be paid, the longer that money is unavailable for investment elsewhere. On the other hand, the company benefits by slowing down payment of AP to its suppliers, because that allows the company to make use of the money for longer. (To learn more, read Measuring Company Efficiency and Understanding The Time Value Of Money.) 




The Calculation
To calculate CCC, you need several items from the financial statements:

• Revenue and cost of goods sold (COGS) from the income statement
• Inventory at the beginning and end of the time period
• AR at the beginning and end of the time period
• AP at the beginning and end of the time period
• The number of days in the period (year = 365 days, quarter = 90)

Inventory, AR and AP are found on two different balance sheets. If the period is a quarter, then use the balance sheets for the quarter in question and the ones from the preceding period. For a period of a year, use the balance sheets for the quarter (or year end) in question and the one from the same quarter a year earlier.

This is because, while the income statement covers everything that happened over a certain period of time, balance sheets are only snapshots of what the company was like at a particular moment in time. For things like AP, you want an average over the period of time you are investigating, which means that AP from both the time period's end and beginning are needed for the calculation.

Now that you have some background on what goes into calculating CCC, let's take a look at the formula:

CCC = DIO + DSO - DPO

Let's look at each component and how it relates to the business activities discussed above.Days Inventory Outstanding (DIO): This addresses the question of how many days it takes to sell the entire inventory. The smaller this number is, the better.

DIO = Average inventory/COGS per day Average Inventory = (beginning inventory + ending inventory)/2

Days Sales Outstanding (DSO): This looks at the number of days needed to collect on sales and involves AR. While cash-only sales have a DSO of zero, people do use credit extended by the company, so this number is going to be positive. Again, smaller is better.

DSO = Average AR / Revenue per day Average AR= (beginning AR + ending AR)/2

Days Payable Outstanding (DPO): This involves the company's payment of its own bills or AP. If this can be maximized, the company holds onto cash longer, maximizing its investment potential; therefore, a longer DPO is better.

DPO = Average AP / COGS per day Average AP = (beginning AP + ending AP)/2

Notice that DIO, DSO and DPO are all paired with the appropriate term from the income statement, either revenue or COGS. Inventory and AP are paired with COGS, while AR is paired with revenue.Practical ApplicationLet's use some real numbers from a retailer as an example to work through. The data below is from Barnes & Noble's 10-K reports filed for the fiscal years ending January 28, 2006 (fiscal year 2005) and January 29, 2005 (fiscal year 2004). All numbers are in millions of dollars.

Item	Fiscal Year 2005	Fiscal Year 2004
Revenue	5103.0	Not needed
COGS	3533.0	Not needed
Inventory	1314.0	1274.6
A/R	99.1	91.5
A/P	828.8	745.1
Average Inventory	( 1314.0 + 1274.6 ) / 2 = 1294.3
Average AR	( 99.1 + 91.5 ) / 2 = 95.3
Average AP	( 828.8 + 745.1 ) / 2 = 787.0

Now, using the above formulas, CCC is calculated:

DIO = $1294.3 / ($3533.0 / 365 days) = 133.7 days DSO = $95.3 / ($5103.0 / 365 days) = 6.8 days DPO = $787.0 / ($3533.0 / 365 days) = 81.3 days CCC = 133.7 + 6.8 - 81.3 = 59.2 days

What Now?
As a stand alone number, CCC doesn't mean very much. Instead, it should be used to track a company over time and to compare the company to its competitors.

When tracking over time, determine CCC over several years and look for an improvement or worsening of the value. For instance, for fiscal year 2004, Barnes & Noble's CCC was 68.9 days, so the company has shown an improvement between the ends of fiscal year 2004 and fiscal year 2005. Barnes & Noble achieved this improvement by decreasing DIO by 4.5 days, increasing DSO by 1.5 days and increasing DPO by 6.7 days. While between these two years the change is good, the slight increase in DSO might merit more investigation, such as looking further back in time. CCC changes should be examined over several years to get the best sense of how things are changing.

CCC should also be calculated for the same time periods for the company's competitors, such as Borders Group and Amazon.com. For fiscal year 2005, Borders' CCC was 101.2 days (168.4 + 12.0 - 79.2). Compared to Borders Group, Barnes & Noble is doing a better job at moving inventory (lower DIO), is quicker at collecting what it is owed (lower DSO) and keeps its own money a bit longer (higher DPO). Remember, however, that CCC should not be the only metric used to evaluate either the company or the management; return on equityand return on assets are also valuable tools for determining the effectiveness of management. (For more insight, check out Keep Your Eyes On The ROE, Understanding The Subtleties Of ROA Vs. ROE and ROA On The Way.) 

Interestingly, Amazon's CCC for the same period is negative,coming in at -31.2 days (29.6 + 10.2 - 71). This means that Amazon doesn't pay its suppliers for the books that it buys until after it receives payment for selling those books; therefore, Amazon doesn't have a need to hold very much inventory and still hold onto its money for a longer period of time. Although online retailers have this advantage, there are other issues that keep Borders and Barnes & Noble in the game. After all, you cannot curl up in those comfortable chairs with a fresh latte at Amazon - despite Amazon's success, there is still something to be said for the experience of going to a bookstore.




Wrapping It Up
The cash conversion cycle is one of several tools that can help you evaluate management, especially if it is calculated for several consecutive time periods and for several competitors. Decreasing or steady CCCs are good, while rising ones should motivate you to dig a bit deeper.

CCC is most effective with retail-type companies, which have inventories that are sold to customers. Consulting businesses, software companies and insurance companies are all examples of companies for whom this metric is meaningless. 

For additional reading, see Using The Cash Conversion Cycle and Cash 22: Is It Bad To Have Too Much Of A Good Thing? 

by Jim Mueller (Contact Author | Biography)
Jim Mueller started his career as a scientist, earning his advanced degree in biochemistry and molecular biology from Washington State University. He has since become a self-taught investor and financial writer. He is also a regular contributor to The Motley Fool.

http://www.investopedia.com/articles/06/cashconversioncycle.asp

Also read:
Cash Conversion Cycle
http://en.wikipedia.org/wiki/Cash_conversion_cycle

THERE are many different types of investors. Here are 10. Maybe you can spot yourself.

Many types make up the world of share trading
June 26, 2010

THERE are many different types of investors. Here are 10. Maybe you can spot yourself.

The Plodder This is your goody two-shoes investor. Holds a portfolio of long-term stocks. Out of 20 stocks bought for $50,000 each, all are worth $60,000 except for Telstra ($30,000) and the banks ($100,000 each). Carved out of the annals of financial theory. Focuses on franking. Quotes Warren Buffet.

Banks are 40 per cent of the portfolio because he got them in the float and never sold them. Never trades. Never sells. Is appropriately inattentive. Wishes he'd sold Telstra.

The fear of losing money to the Tax Office through capital gains has driven spectacular long-term annual compound returns and ensured an absolute belting in the global financial crisis.

But it doesn't matter because everything was bought for 10¢. Will leave millions to his undeserving children, who will cash it all in and live like kings.

The Gambler Thinks the sharemarket is everything the product marketers say it is and is quickly skinned alive in some derivative product he didn't understand.

The 10-Bet Investor Has 20 stocks bought for $50,000 each. Two stocks have gone to zero. Sixteen are worth between $45,000 and $55,000. One stock is worth $200,000. One stock is worth $2 million. Focus on resources exploration, biotechs and new issues. No banks. No big blue chips. No yield. This is organised gambling where the odds are narrowed by a lot of work, information and networking.

The "Blind and in Love" Investor Has $1 million and it is all in one stock. Next year it will be worth anything between zero and $10 million. This is the investor who knows absolutely everything about a stock of which you've never heard.

Is in the top 20 shareholders. The first holding cost less than a cent. Loses more than your mortgage on a 1¢ move and it moves 2¢ a day.

Doesn't sell on the spikes. Doesn't sell on the troughs. This is long-term, high-risk investment, but they know all the risks. Talks about the stock, and is very rich, or very poor. They ring you up when they're 60 either to (a) borrow money or (b) invite you to join them in the Bahamas.

The Day Trader If he has $1000 he has one stock worth $100,000, but he has to sell by the end of the day. Pays the average salary in dealing costs every year. High attrition rate. Only the devoted survive.

The Income Investor Through necessity or tradition is investing in equities for income. Made huge losses in the financial crisis having never sold "as long as they still pay the dividend". Has now learnt that $1 of income is exactly the same as $1 of capital, especially when it is a capital loss.

Hates the volatility. Wishes things would "just go back to the way they were". Is now thinking that 5 per cent in bonds isn't bad just so long as you can sleep at night.

The Value Investor Makes long-term declarations about stocks based on historic information and grand assumptions. Can explain everything but cannot trade and is useless at timing. Needs 50 years to prove he is right. Usually is.

The Lone Ranger An amateur trader who has given up his day job to trade the sharemarket. Will survive until he runs out of money or wakes up to the fact that trying to make $1000 a day out of necessity, even if successful, is a difficult, tough, demanding, soulless and ultimately boring existence.

The One-Stock Trader Has worked out that diversification is for people who don't know what they're doing and a lot more risky that trading one stock again and again and again. Does it quite well. Is vulnerable to once-in-a-lifetime events that seem to happen once a year.

The ETF Trader After many years trying to trade stocks has finally realised that his nirvana is trading the market through an index ETF. No need to read any research about stocks. No need to read 99 per cent of the business section.

All that matters is timing the market, which he does through vigilance and a combination of technical and fundamental "feel". He is relaxed. Has realistic expectations and trades just five times a year.

Who did I miss?

Marcus Padley is a stockbroker with Patersons Securities and the author of the daily stockmarket newsletter Marcus Today. For a free trial of the Marcus Today newsletter please go to marcustoday.com.au

Source: The Age

Hard choices as China's boom fades

Hard choices as China's boom fades
July 13, 2010

Australia's export prices remain about as good as they have been in a century, but the peak is now behind us. What we have seen in the past few years is as good as it will get.

Last week alone iron ore spot prices fell 9.4 per cent and Brazil-China freight prices fell 20 per cent. China's trade figures showed iron ore imports fell 14 per cent last month, measured year-on-year, after rising an average 8.4 per cent each month until May.

Given that China bought 70 per cent of the world's iron ore exports last year, and Australia's iron ore exports this year will be worth about $US50 billion, it is not hard to see that the huge Chinese tail wind for Australia's national income is no longer blowing like it was.

The underlying reason for Australia's once-in-a century resources boom was that China's heavy industry sector has been growing much faster than its overall economy. The boom was inflated by distortions in the economy linked to China's hybrid market-authoritarian form of government.

Now a series of command-economy edicts has flipped this pattern around. Steel production has been falling in absolute terms for two months and the rate of decline accelerated through June. That was despite a surge in exports as mills pocketed export rebates before they are scrapped today.

Over the coming decade the trend in Chinese resource consumption - and therefore Australian national income - will be determined partly by consumer and investor preferences. But the aggregate of those private choices will be trammelled by policy and political choices that the Chinese leadership will either face or evade.

Many of those challenges will be outlined tomorrow at the Australian National University's China Update conference. Zhongxiang Zhang will look at China's efforts to reduce fossil fuel consumption, and its equally serious challenges. Last year China installed more wind power turbines than any other nation. And yet, in the first quarter of this year, 60 per cent of wind power generation capacity was wasted because it was not hooked up to the grid.

Huang Yiping will look at the price distortions that fed China's heavy industry boom, including cheap industrial land, cheap energy and cheap capital.

Huw McKay and Ligang Song will calculate how China's per capita steel consumption could peak earlier and at a higher rate than previously assumed - at double the present rate of consumption in little over a decade.

However, for my money these policy debates will be swamped in coming years by the core question of whether and how a one-party state can make itself accountable.

Over-construction will continue so long as officials receive great financial incentives and few political and legal disincentives against bribery and stealing land. State-dominated heavy industry will continue to over-produce so long as the services sector is stunted by politically powerful state monopolies.

That is why Yongsheng Zhang, at the State Council's Development Research Centre, will tomorrow tackle the question of whether local officials can ever be held accountable to their people when they are appointed from above.

And Yang Yao, the director of Peking University's China Centre for Economic Research, goes even more directly to the heart of things. He writes that the key to China's reform-era success is that the party did not allow policy to be hijacked by special interest groups at the expense of other sectors of the population. But that is now changing, as cadres meld seamlessly into the world of crony capitalism.

''While the private business community is realising the importance of cultivating the government for larger profits, it is the government itself, its cronies and government controlled [state owned enterprises] that are quickly forming strong and exclusive interest groups,'' he writes.

''All this suggests that some form of explicit political transition will be necessary to counterbalance the formation of strong and exclusive interest groups. The Chinese Communist Party must soon realise that there is no alternative to fuller democratisation if it wishes to maintain both high economic growth and enhance social stability.''

Time to be realistic about bank investments

Time to be realistic about bank investments
JOHN WASILIEV
July 13, 2010 - 1:12PM

Most long-term investors own shares in at least one, two or even more banks in their share portfolios. With solid dividends and the potential for capital gains if you buy when markets are going through a down period, banks are well worth taking an interest in.

While the outlook for them is considered to be positive and most financial commentators point to how well Australian banks have survived the global financial crisis, one investment expert cautions that investors should not get too carried with expectations for bank investments.

It’s still a tough market out there for banks, warns John Abernethy, chief investment officer with the Clime Investments StockVal share investing research service. Although they may appear to be quite complex, from a fundamental perspective banks are relatively simple businesses to understand. For such major multi-billion dollar enterprises, they have remarkably few moving parts.

A bank generates its income from three main sources.

1. There is the net interest rate difference between what it earns on loans and what it pays for deposits. 
2. There are the extra fees it charges for various services and 
3. there is the profit it earns from other activities like running a stockbroking division, a funds management business and offering services to customers like helping them with foreign exchange transactions. 

Banks can also be involved as active traders in financial markets.
As far as the income they earn is concerned, Mr Abernethy says this is generally about 3 per cent of the value of the multi billion dollars of assets for which they are responsible.

1. About 2.4 per cent of this 3 per cent comes from interest income and 
2. about 0.6 per cent from fees and other income.

From this it pays running expenses that reduce the income on total assets to about 2 per cent. The other major cost is allowing for bad debts, which can arise from people not being able to pay their interest as well as from losses on bank business enterprises.

These expenses can range widely from 0.2 per cent of assets when times are good to more than 1 per cent during bad times. Last but not least is tax which reduces any net income by 30 per cent.

From these basic observations, the major challenge banks currently face comes from bad debts.

An important issue for Australian banks, says Abernethy, is the growing level of Australian household debt. At present, Australian households owe $1.3 trillion, which is slightly more than the $1.2 trillion of total superannuation savings and equal to the annual value of all the goods and services Australia produces. A trillion dollars is $1000 billion.

Compared to the income households earn, the debt is 50 per cent more, or 150 per cent of income. As a percentage of income, Australia has one of the highest levels of debt in the world, says Abernethy.

From a bank perspective one major problem this creates is households not having the money to deposit with banks that banks can in turn lend to households and businesses wanting to borrow.

This is forcing Australian banks to seek money from offshore investors in places like Europe, America and Asia to keep the all important business of lending money for interest income going. There is a lot of demand at the present time for deposits, which is causing interest rates to increase. Abernethy believes the Reserve Bank of Australia doesn’t really need to keep increasing interest rates. It is already happening because banks have to pay higher interest to overseas lenders.

For investors in bank shares, the considerations include further rises in interest rates that could put pressure on already heavily indebted households and lead to higher bad debts. Any problems getting money from overseas will also affect banks because they won’t be able to lend money as freely and therefore earn interest profits. This suggests banks may not be as profitable as they were prior to the global economic problems for quite some time.

Understand Your Risk Capacity and Risk Tolerance

You must stay invested in the securities markets to earn market risk premiums

The securities markets pay risk premiums. You have to have your money invested and at risk to be paid a risk premium.

Attempting to avoid risk or losses by jumping in and out to "time the markets" does not work. Scientific finance studies demonstrate the both amateurs and professionals are lousy at market timing.

Historically, U.S. securities markets have paid substantial risk-adjusted returns or risk premiums to investors. While risk premiums have been substantial, they have occurred irregularly. There have been intervening periods of losses, some of which were substantial. (See: How stable have common stock equity risk premiums been over time?)

To earn market risk premiums, your assets must be invested and exposed to potential risk or loss. The more risk you can tolerate, then the higher your potential return and perhaps the rougher the investment road you may travel. Those who have better emotional tolerance for asset volatility can more easily weather market sell-offs.

Practical considerations will also affect your tolerance of investment risk.

In difficult times, whether you need to liquidate risky assets at depressed prices will depend on your expenses and on your other other holdings of less risky, salable assets. Paying necessary living expenses and taxes are good reasons to withdraw funds. Trying to time the markets for a better return is not a good reason.

If you do not need to take out money during a market retreat and recovery cycle, then risk tolerance is solely emotional. For a risk tolerant investor with stable earned income, the recent bubble crash was just a few years of unpleasantness, if he or she was fully diversified and, therefore, not heavily loaded with technology and communications equities. The same, however, could not be said for those who were poorly diversified and also found themselves to be highly risk averse, when risk actually happened. This is especially true, if job loss forced the liquidation of assets at depressed values.

To some degree, all sane individual investors are averse to risk, so risk tolerance is a relative rather than absolute issue.

Therefore, you need to judge your preference or tolerance for risk relative to other investors. While very few people like investment risk, those who can tolerate it better are those who will be less uncomfortable when risk happens from time to time and market values decline by a little or a lot. Tolerating the potential for loss is the cost that investors occasionally pay so that they are always at the table, when the markets deliver their positive rewards.

The vast bulk of individual investors’ publicly traded investment assets are held in the primary cash, fixed income, and equity financial asset classesin the form of individual securities or funds. Your relative investment risk tolerance should influence how your assets are allocated among these primary financial asset classes. If your actual asset allocation is more risky than your risk tolerance, you may not be able to handle the downturns. You might panic, when you should stand firm. If your asset allocation is less risky than your risk tolerance, then you are likely to need to spend less and save at a higher rate to reach your goals.

Nothing is certain about this process, and that is the nature of investment risk. However, the scientific investment literature is relatively clear on certain points. Amateur and professional investors are just not good at timing changes in the markets. Active strategies that attempt to time market turns have under-performed continuous investment strategies. Consistently and profitably calling serial market turns correctly has been a skill beyond mere mortals and certainly beyond the skill of even the most proud of professional and individual investors.


It is better to buy into the asset markets in proportion to your preferred asset allocation and risk tolerance and to stay in the securities markets through thick and thin.

Trying to sit on the sidelines and jump in when things seem safe simply does not work. When things seem safer, they also seem safer to others. In this situation, securities prices will have already reflected this confidence. Most of the "upside juice" or risk premium will already be reflected in current asset prices and only current securities holders will have been paid. (See: Introduction to investment valuation and securities risk)

The converse of trying to jump out to avoid the downturns also does not work. Real-time securities markets are auctions about the expected value of future securities returns. Particularly toward the downside, markets can react extremely rapidly. Getting out in time does not work, because it is usually too late when you realize you should have sold. Worse, however, you might jump out too early and be absent from the table when the market moves upward. Staying in the markets just tends to work better.

If you are more highly risk averse, it is more appropriate for you to select an asset allocation that reflects your relatively higher risk aversion.

You would hold a relatively small portion of your assets in the more risky equity asset class. Therefore, you might be more comfortable and more able and likely to keep your smaller equity allocation invested at all times. Having a smaller, but sustained exposure to equity assets tends to work much better for the more risk averse investor, compared to jumping in and out of the equity markets in larger proportions.

If you stay out of the markets due to such fears, then you are likely to need to save far more to reach your goals. Over-cautiousness is not a free ride. There is never a safe time to be in the markets, because investing is always inherently risky. There is never a safe time to be out of the markets, because you cannot earn investment risk premiums on the cash under your mattress. (See: VeriPlan helps your to compare investment risk-return tradeoffs)

Finally, you should periodically rebalance you assets back toward your planned asset allocation proportions.

To minimize the negative impacts of investment transactions costs and taxes, you should rebalance infrequently and in a planned manner that anticipates deposit and withdrawal transactions that you would need to do anyway for other reasons.

If you want to understand your personal asset allocation and risk-return tradeoffs over your lifetime, VeriPlan provides powerful, automated "what-if" planning facilities. You can rapidly develop and analyze a range of fully personalized scenarios to see whether your asset allocation strategy would achieve your objectives with a level of risk that is acceptable to you. VeriPlan provides five adjustable and fully automated mechanisms to determine your preferred lifecycle asset allocation. VeriPlan gives you full control over rates of asset returns and asset return variability, and it automatically rebalances your assets annually. It even projects the annual expense coverage by your safer cash and bond assets throughout your lifecycle.

___________________________________________________________________
http://www.theskilledinvestor.com/ss.item.174/you-must-stay-invested-in-the-securities-markets-to-earn-market-risk-premiums.html

A roof over our heads: Should we buy or rent?

By RAYMOND ROY TIRUCHELVAM | Jul 10, 2010

A roof over our heads: Should we buy or rent?

PERSONALLY speaking, I have been faced with this question – to buy or rent a house – many times in my life. While I haven’t quite found a clear answer to that, I have decided to go with both. I have bought a house (or rather acquired one through financing) but am renting it out while I live in a rented premise with my family.

It is a known fact (if not compounded by our parents, and uncles and aunties) that one should, if they can, own a house. Generally speaking, renting somehow has some negative connotations. Ideally, we should buy a property early in our lives to take advantage of the longer loan financing period and if we can, try to settle the financing early.

While there may be no straight forward answer here, there are several pertinent questions we need to ask ourselves. Where do we see ourselves, five, 10, or 30 years down the road?

First, let us exclude investors from our category as they would naturally fall under the ‘buy’ status, and let us delve into the lives of the average man-on-the-street manifested in these four individuals – Robroy, Rizal, Rowena and Rossindra, who face a similar dilemma.

Robroy is 35 years old, married with two children, and works as an senior accountant. He works for a multinational company and therefore is required to travel, and at times is posted overseas for a few years. He also has chalked up some credit card debts from all the travelling, and have been delinquent in payments during his absence in Malaysia. Most recently, he was posted to New Zealand and is now considering migration.

Rizal is 30 years old, married with two wives and six children and is a businessman who owns several restaurants. His income is good, but it fluctuates, and he currently has some savings which he plans to invest. His big family helps him runs the business.

Rowena, is a 28 year old care-free person, whom after graduation could not hold a steady job, but is very happy with part-time jobs that give her the freedom to travel as she loves travelling. She has a boyfriend and plans to get married in a year or two.

Rossindra is 25 years old; she is a social science university graduate who has decided to dedicate her life helping the needy and healing the world. She is currently working under one of the Unesco projects in Myanmar. She gets paid pretty well, and with food and lodging fully provided at her workplace in Myammar, she saves almost all her salary. She recently took over the rental tenancy of her parents who live in a rented house, and is considering alternative options.

Of these four individuals, who do you think should buy a house or rent? The following represents my take, which of course, is open for discussion.

Robroy should rent, mainly because of his work commitment. His work requires overseas posting, which includes his family, especially since he is considering migrating to New Zealand. Furthermore, he has been delinquent in his credit card payments, and this may not go well for his loan financing if he wants to buy.

Rizal should buy, mainly because the nature of his income is uncertain and he has amassed some savings, which should aid in his down payment for a house. He had originally wanted to buy a house in cash but given the size of his family, he decided to buy a bungalow for which he has settled 50% of the payment while the remainder is financed through a loan. As he rents his restaurant outlets and the returns from his business is used to settle the rent, he is confident that buying a house is a much better option for him.

On the other hand, Rowena, quite clearly falls under the rent category. First, she does not have the financial ability and second, she has not quite decided what she wants to do in life. Furthermore, her part-time jobs may not provide her with a good credit standing with the banks. Her boyfriend whom she intends to marry happens to be rich.

So, naturally, if things go as planned, she may be able to solve, to some extent, her financial issues.

Rossindra, on the other hand is in a real predicament. While her position and work do not necessitate her to rent or buy a house, she is undertaking the obligation to pay rent for the house her parents stay in. She is considering the option of buying a small house and naturally, her parents are overjoyed to finally live in their own house.

Buying a house is usually, for many, a once-in-a-lifetime decision. So don’t rush into it. Take your time evaluating the possible scenarios and outcomes and of course, make sure you choose a suitable property. Whatever it is, you must try to avoid putting significant pressure on your financial status.

● The writer, a business planner with SABIC Group of Companies says: I would rather my parents choose my house than choose my wife.

http://www.starproperty.my/PropertyScene/TheStarOnlineHighlightBox/5773/0/0

Market psychology pays off

MARTIN ROTH

July 7, 2010

Nerves of steel...a contrarian iinvestor may sell up and buy again after the fall.

In the first in our series on investment strategies, Martin Roth looks at contrarian investing.

In early 2009, as stocks continued the precipitous decline that had begun in November 2008, investors needed considerable courage to ignore the trend and plunge back in to buy.

Yet March 2009 marked a dramatic turning point, with the benchmark S&P/ASX 200 index soaring more than 50 per cent in the ensuing seven months. In retrospect, it is clear that investors were being offered a spectacular short-term buying opportunity of the kind that does not appear often.

Contrarian investing - an investment that goes counter to market trends or to conventional wisdom - can bring rich rewards. But it also requires considerable experience of the market and strong nerves. It is certainly not for every investor.

In 2002, investors generally believed that the US-dollar price of gold would continue to meander in a narrow range, as it had been doing for several years. Contrarians (who thought otherwise) have seen their investment soar more than fourfold since that time.

In essence, contrarian investing involves buying a quality asset when it appears to be mispriced and too cheap and then waiting for its price to rise. It can also mean selling an asset when it seems overvalued.

For equity investors this might mean taking advantage of the fact that markets can be based on investor emotion and so can overreact - sometimes quite dramatically - on both the upside and the downside.

"It means picking up the unloved companies, the beaten-up companies, the special situation-type companies," says the senior portfolio manager for Three Pillars Portfolio Managers, Otto Rieth.

Yet some market experts say this is little more than a variation of value investing, which involves seeking out undervalued companies and then waiting for the share price to rise. Many famous investors, such as Warren Buffett, do this all the time.

In addition, it can take time for a contrarian investment to yield a profit. In the mid-to-late 1980s, as the Japanese sharemarket continued to race ahead, some financial experts began saying that the increase was unsustainable and that the Japanese market was developing the characteristics of a classic financial bubble.

But contrarian investors who bet against the Japanese market at that time were forced to watch as it leapt from one new peak to another. It was only at the beginning of 1990 that the bubble burst and Japanese stocks began their long decline, from which they have yet to recover.

A similar observation could be made about the sub-prime debacle in the US.

"A number of high-profile contrarians were quite down on the US for some time," Rieth notes.

"They were saying it was an accident waiting to happen. But they were saying this for close to a decade before the market crashed. Eventually they were right. But a broken watch is right twice a day."

The sharemarket maxim "the trend is your friend" carries a lot of truth. Markets can continue moving in one direction for lengthy periods, sometimes sustained by little more than investor enthusiasm and emotion.

According to Rieth, a contrarian investor can take a bottom-up approach - for example, examining individual stocks - or a top-down view, which could involve making a judgment on an entire market or asset class.

The portfolio manager for the Select Alternatives Portfolio at Select Asset Management, Robert Graham-Smith, describes his approach as "trying to put together a very diversified portfolio of investments that are not correlated to traditional markets and that in some cases zig when the market zags, so to speak." Though not strictly contrarian investing, this method is quite similar.

In some cases it involves the purchase of out-of-favour assets, although quite often in relatively esoteric products such as hedge funds, managed futures, private equity, commodities and precious metals.

"The attraction of some of these types of investments is that they can genuinely make money when equity markets, in particular, are range-bound or are very choppy, even [during] overextended periods," he says.

One of his investments, in the Black Swan Fund, which specialised in long-dated options, showed a return of nearly 240 per cent in 2008.

But does the relatively unsophisticated home investor have any hope of replicating such success?

"I do not want to give the impression that what we are delivering in packaged format is an overly complicated thing," he says.

"But understanding some of the underlying investments does require specialist skill and not all the investments are easily accessible.

"Although, that said, there are some areas of what we do that are available to the general public, such as listed infrastructure, some hedge fund strategies or gold."

Where might the contrarian investor be looking today for ideas?

Rieth suggests the example of China. "The bulk of the street seems to think China is going to continue doing quite well," he says. "A contrarian would say China is in a crazy credit bubble. We will find out who is right in the next six to 12 months or so."

Finally, consider the Australian housing market. Prices have continued to rise and rise for many years, despite the global financial crisis and tumbling equity markets. Low interest rates and a growing population - particularly from immigration - are generally cited as among the reasons. Today, a house in one of our major cities is more expensive - as a multiple of average incomes - than in most other big cities around the world.

Yet recently some contrarian voices have been heard. In June, the renowned US fund manager Jeremy Grantham was quoted as warning that the Australian and British housing markets were the last two bubbles remaining from the global financial crisis and he predicted it was only a matter of time before they crashed.

He said Australian house prices needed to fall 42 per cent to return to the long-term trend and predicted that "sooner or later, the [interest] rates will go up and the game is over".

A decline of that magnitude would have a profoundly negative impact on many areas of the Australian economy. It would also present opportunities. You could even sell your own home in the hope of buying another dwelling later at a significantly cheaper price.

But that is one contrarian manoeuvre that would require the strongest of nerves.

http://www.brisbanetimes.com.au/small-business/managing/breaking-down-your--business-plan-20100712-1071x.html

Breaking down your business plan

MAX NEWNHAM

July 12, 2010 - 12:49PM

Last week I answered a question from a reader who had set up an online business and wanted help in preparing a business plan.

In my opinion there are two types of business plans for small businesses. 

• The first can cost a lot of money and in the end produces very little in the way of results. 
• The second is a lot simpler and is based around the cash flow of the business.

The first step in this planning process is to reduce the business to its smallest component parts. That does not mean taking last year’s results and increasing all of the income and expenses by a fixed percentage to reflect the effect of inflation. It does mean breaking down revenue into the different major income sources then breaking these down further to each product or service.

For example it does not make sense for a service station owner to increase his or her annual sales by 3 per cent a year. It makes a lot more sense to break the sales down into fuel, groceries, snacks and take away. Then break each of those lines down into each major product such as unleaded, premium and diesel.

The same goes for expenses. The first step in this process is to identify costs that have a direct relationship with income. These include costs of goods sold in retail or hours worked by a trade or service provider. Each of these expenses needs to be analysed to work out how much these costs increase if income increases.

Next, identify those costs that a business pays no matter how much income is earned. These are the overheads of the business and include rent, loan repayments, insurance and administration costs such as bookkeeping and accounting fees.

Each overhead expense needs to be broken down as much is practically possible. At the end of this process the business owner should have a statement that details all of the historical income and expenses and which components of the business are the most profitable. One of the most important results of this process will be the amount of income that must be produced for the business to break even.

Items of expenditure that have blown out or are not strictly necessary, such as a luxury car lease or excessive entertaining, and business lines that are not covering costs will become apparent. It is from this point that the business planning process can start.

At the heart of every good business plan is an analytical process where the business is assessed and ways found of improving it. A tried and tested way of analysing a business is to prepare a SWOT analysis of the business. This involves looking at what the Strengths and Weaknesses of the business are, the Opportunities it has to grow and what Threats it faces.

Business planning action are formulated to maximise the strengths of the business and ways found to reduce the cost and business impact of weaknesses. This could mean increasing the price of a good or service that is not profitable or dropping it altogether. It could also mean a loss leader of the business is identified that results in more profitable items being sold.

The big advantage of using the cash flow budget as the centre piece for this planning process is that the financial impact of each planning action can be modelled. This means the business owner can establish which planning options have the greatest impact and have a basis for benchmarking whether the actions taken are working. 
   Questions on small business issues can be emailed to max@taxbiz.com.au 
Tax for small business, a survival guide, by Max Newnham is available in bookstores.     

http://www.brisbanetimes.com.au/small-business/managing/breaking-down-your--business-plan-20100712-1071x.html