Where can I find the short videos explaining how to read the Profit & Loss, Balance Sheet, and how to make a Cash flow statement?
They are on YouTube here:
Where can I find the slide deck for the “How to read a Profit & Loss and a Balance Sheet ” to share with a friend?
The deck is available here:
How to read a Profit & Loss and a Balance Sheet
How to make a Cash Flow Statement
Option 1. Prioritizing customers
How do I quantify the P&L impact of something I recommend?
For any marketing activity you propose, always quantify its P&L impact.
The easiest way to solve Financial problems is to start by looking at the “what happens if I do nothing scenario”, quantifying the impact of what you are proposing to do, and then comparing the two alternatives.
Example number 1
Customers will get a 10% discount for Pre-ordering. Unless this will get you to sell more units, the cost is easy: you will lose 10%
Do nothing: 10 units at$1,000= $10,000
10% discount 10 units at $900=$9,000. You lost 10% or $1,000.
Example number 2. This is for the Accounts Receivables problem (option 3)
The Account Receivable for your company is 30 days. Because your company is a Fortune 500, you can assume that the cost of debt is 5%. If you get paid now, instead of in 30 days, you will reduce your borrowing cost by one month. You pay 5% to borrow money for a year, or 0.4% for a month. You would save 0.4%. Imagine you would give a 10% cash discount. This is how you could quantify it:
Do nothing and collect in 30 days: your borrowing cost is 0.4%. Your sales are $ 10 Billion, the cost is $40 million (0.4% of $10 Billion)
You offer a 10% cash discount: Your cost is 10% of sales or $10 Billion, or $1 Billion. You spend $1 Billion on the discount and save $40 million on borrowing cost. You are $960 million worse off compared to the do-nothing scenario. In general, cash discounts only pay off if it enables you to sell more units
Option 2. Inventory Management
For inventory management, the number that I can find on the balance sheet is the number for cost. I am confused about how to calculate our inventory units, could you please help to guide me on how should I do it? Moreover, for the strategy to deal with this inventory situation, is it how should I sell the inventory?
Let’s break the problem into pieces to make it easier to solve. First, let’s understand what we are looking at. On a Balance Sheet, you don’t see either a number of units or cost. What you are looking at is the number of all the units you have valued at cost.
Imagine you are Jenny, the businesswoman we use in class as an example. She is launching a new pair of shoes. How would you calculate how many pairs of shoes she will sell? Normally she sells 10 pairs of shoes. If she orders too many, she will be left with some in stock which she may never be able to sell. If she orders too few, she may lose the chance to sell some pairs. How would you help her? Once you have developed a process for Jenny, try to use a similar way of solving the problem for your company, Coca-Cola. For Coca-Cola is easier, because you can hold drinks in stock for a longer period of time, but if your launch is a complete failure, you will need to get rid of it.
For the inventory management, can we just use the “inventory turns” figures for the 4-5 years and explain that?
Yes, you can. I prefer inventory days because it’s easier for me to understand “42 days of inventory” than “inventory ratio of 8.75” See example here
Can we select any product and check for an upgrade of that product?
Yes, you can select any product that would make sense for Nike or McDonald’s to sell.
Can we use the NIKE 2019 report?
Yes, that is better because it has more data.
We use data about the past product and then forecast for demand for the upgrade?
Correct, for Nike it may be easier to find data than for students who chose McDonald’s. But you will still need to make an educated guess using the data you find in your research.
Option 3. Accounts receivables/ accounts payable
See Option 1 above an example on how to quantify the impact of what you will propose
Is it necessary to increase the payables and decrease the receivables? Can we go vice-versa or increase/ decrease both?
The objective is to increase cash. If we decrease Payables we would need more cash. If we increase receivables we are getting less cash, so it doesn’t help either. While you could do just one, it’s safer if we develop a strategy for both.
By the logic of increasing payables and decreasing receivables, is it because we want more ready cash and more immediate payments and we increase payables because we want a grace period for payments since we have less cash?
Yes, the objective is to increase cash. However, we need to measure the financial consequences of it. For example, if we get a 3% discount for paying cash instead of in 30 days, we are much better off paying cash. The annualized rate of interest is 43%, and our cost of borrowing is substantially lower than that. On the other hand, if suppliers don’t give us any incentive to pay on time or faster, we need to develop a strategy. When we think about receivables, we need to do the opposite. What incentives does a customer have to pay ontime? If when they pay late, nothing happens to them, while would they pay on time?
Immediate payments go to cash and do not go to accounts receivables, correct?
Yes, that is correct.
Nike doesn’t split its financial report into “unit sales by product” into the specific product i.e. the Air Force One (it just splits it into apparel, footwear, equipment, other). How would I go about calculating my accounts receivables/accounts payables for a product? ? I know Nike sells over 10 million Air Force Ones a year.
To calculate the level for one product, please use the overall numbers. I prefer the number of inventory days, but inventory turnover is also widely used. All the figures below are from Nike’s 2019 Annual report.
The number of inventory days is 94. Here is the “good enough formula”: ending inventory($5,622)/divided by cost of sales ($39,117 minus $17,474) times 365. That’s 94
The “correct formula” is
- Average inventory, (beginning inventory and ending inventory divided by two).
- Cost of goods sold,
- Divide cost of average inventory by cost of goods sold
Once we know that in general, we have 94 days of inventory, and we can add 10% more if you wish. Caution: what if it is a failure? What if there is greater demand?
If they sell 10 million units, 94 days of inventory would be 2.58 million. Once you add 10% more, that would be 2.8 million units.
How would I go about calculating my accounts receivables/accounts payables in this circumstance?
Treat the Accounts Payable and Accounts Receivable part of the exercise separately, it would be easier. Imagine that you have been asked to encourage the Finance team to save cash. You will use the launch of the new product as an excuse. What business incentives could you give?
First, how many days do we have? Receivables are $4,272/$39,117= 40 days
Payables are $2,612/$39,117= well above 24 days (It’s incorrect to divide by revenues as I am doing, we should have divided by cost, but we don’t know how much it is because payables may include expenses). Even if payables were twice as many days (48 instead of 24), it’s well below Receivables and inventory (94+40=134). What can we do to increase Payables and decrease Receivables?
I’m in the 3M team. By reading 3M Balance Sheet, I learned that 3M’s inventory control is very good, only 91 Million. This is due to excellent supply chain management and steady growth in market demand. In 2020, accounts receivable fell by nearly half compared with 2019. Accounts payable also doubled. Perhaps because of the pandemic, money is tight between companies and other enterprises. However, net income has increased a lot. 3M’s sales have been stable for the past three years but its debt has increased. This is an increase of nearly 34.2 percent compared to 2018.
The subject of my research is the Disney Corporation. By searching the internet for relevant information, I learned that Disney Corporation’s accounts receivables decreased by one percent in 2021 compared to 2020. This phenomenon indicates that the company’s cash flow in 2021 is still in good hands. Due to the pandemic in 2021, Disney’s main revenue comes from subscriptions. Let’s look at the situation of Disney’s accounts payable. The company’s accounts payable in 2021 increased by 29.2 percent compared to 2020, but I think the company still needs to increase its payable debt in the future because the company still needs a lot of cash flow.
Inventory Management: Apple introduces iPhone 14 and iPhone 14 Plus. A new, larger 6.7-inch size joins the popular 6.1-inch design, featuring a new dual-camera system, Crash Detection, a smartphone industry-first safety service with Emergency SOS via satellite, and the best battery life on iPhone. According to the Apple Balance Sheet 2021, Apple had Total asset of 351,002,000, Total Liabilities of 287,912,000, and Total Equity of 63,090,000. To calculate how many units to have on Inventory, first looking at Net sales for iPhone for 2021 was $ 191,973 million. As of 2021-09-25, Apple had Cost of Goods sold of $213 billion, Average inventory of $5.321 Billion; therefore the Inventory Turnover for fiscal year 2021 would be 40.0x. The Inventory Turnover ratio measures the number for times a company’s inventory is sold and replaced over a year. A low turnover ratio can serve as a leading indicator of poor sales (excess inventory) while a high ratio may imply strong sales. Therefore, Apple’s high ratio of Inventory Turnover indicates the strong sales for the new product. To deal with the strong sales for the new product, Apple allows customers to pre-order to receive new products on a first-come-first-serve basis. The pre-ordering through digital platforms can increase sales for new products and visualize the hype of demand for new products.
Apple inventory for the quarter ending June 30, 2022, was $5.433B, a 4.92% increase year-over-year. Apple’s average total inventories from the quarter that ended in Mar. 2022 to the quarter that ended in Jun. 2022 was $5,447 Mil. Even in an environment of demand uncertainty and disruptions caused by the COVID-19 crisis, Apple has managed its supply chain tightly.
Apple’s products have a life cycle of about twelve months, depreciating in value by 1-2% every week. With this in mind, Apple decided to treat inventory as if all of its products had an expiration date. The goal is to keep as little inventory as possible to ensure that they sold everything they produced
The annual report result that Apple has a high ratio of Inventory Turnover, which indicates Apple has strong sales for the new product. Apple launch a pre-order strategy for the customer to receive new products on a first-come-first-serve basis, this strategy through digital platforms will increase sales for new products, which also clearly noticed how much inventory Apple should prepare.
After reading the slides from Terrace Huang, I agree with how Apple deals with its inventory management. I believe it’s very efficient and cost-effective. However, my biggest concern is consumers would be willing to wait this long if the understocking persists, they might switch to other competitors with fewer wait times. And how would Apple address this problem?