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5:49 am
September 24, 2011
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somrh
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| Member | posts 336 |
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valueinvestortoday said:
Yes, but the only serious interest I have in regards to Inventory is to assess if an imbalance in relation to sales exists. I don't have much interest when in comes to turn-over. If a valuation comes down to the point that turn-over has a large affect on whether the business is worth, say, $10 per share or $20 per share – there isn't enough margin of safety and too much dependency on one item to capture my interest in investing my capital. Of course, I function in a different aspect of the investing world in that I don't often invest in Going Concern businesses (unless there's a huge margin of safety, i.e. 10 bagger) so it's possible my approach is much different than yours.
Fair enough.
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11:39 am
September 22, 2011
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valueinvestortoday
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| Member | posts 80 |
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Post edited 4:40 am – September 22, 2011 by valueinvestortoday
"So you don't find current/non-current distinctions to be useful at all?"
Not when it comes to affixing a value to them.
"Would you at least find it useful for assessing day-to-day financial condition in terms of meeting obligations, etc?"
Yes, but the only serious interest I have in regards to Inventory is to assess if an imbalance in relation to sales exists. I don't have much interest when in comes to turn-over. If a valuation comes down to the point that turn-over has a large affect on whether the business is worth, say, $10 per share or $20 per share – there isn't enough margin of safety and too much dependency on one item to capture my interest in investing my capital. Of course, I function in a different aspect of the investing world in that I don't often invest in Going Concern businesses (unless there's a huge margin of safety, i.e. 10 bagger) so it's possible my approach is much different than yours.
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11:29 am
September 22, 2011
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somrh
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| Member | posts 336 |
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valueinvestortoday said:
It matters not to me "how" the company categorizes any of their assets and/or liabilities. GAAP allows a company to get away with many things, all to the company's advantage in order to increase earnings per share (on paper). They can list a building as being current, non-current, or off-balance sheet and it doesn't make a difference to me because they can call it anything they want but the fact remains that a building exists and it has value. Therefore, my job as an analyst is to value it. Hope that helps.
So you don't find current/non-current distinctions to be useful at all? Would you at least find it useful for assessing day-to-day financial condition in terms of meeting obligations, etc?
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11:14 am
September 22, 2011
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valueinvestortoday
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| Member | posts 80 |
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My post was "general" and non-company specific.
"…my actual question which is more
on the issue of whether or not inventories should be considered current
or not? I'm curious both from an accounting as practiced standpoint but
also on a normative standpoint (should we at times consider inventory to
be noncurrent.)"
I value inventories, regardless of what they are, the same way I value anything. As an asset. In order to do so, I need to know a few things.
1. What they consist of
2. What kind of condition they're in
3. When they were purchased (correlates to #2)
4. Fair Market Value
5. Is there a market place for them/is there an inventory imbalance.
Much to the same way I'd value a piece of property – I would do the same with inventory. It matters not to me "how" the company categorizes any of their assets and/or liabilities. GAAP allows a company to get away with many things, all to the company's advantage in order to increase earnings per share (on paper). They can list a building as being current, non-current, or off-balance sheet and it doesn't make a difference to me because they can call it anything they want but the fact remains that a building exists and it has value. Therefore, my job as an analyst is to value it. Hope that helps.
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10:21 am
September 22, 2011
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somrh
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| Member | posts 336 |
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valueinvestortoday said:
If they haven't done so and have every intention of continuing as a going concern, it would make no sense to rely on a liquidation valuation because in many circumstances, a company who plans to continue operating and has a terrible track record of doing so will eventually erode the value you once expected.
That's actually the way I'm looking at it with TAIT but I don't think the track record is as bad as suggested. The last couple of years have, no doubt, had mixed results but positive cash flows were the norm prior to that. Much of that went towards paying down debt. Some of that went toward replacing inventory due to a European regulation that made some of the inventory obsolete (which they've already written off to my knowledge.)
The three main concerns I have are:
1) Whether management is successful in its commitment to reduce inventory levels.
2) Whether management keeps to its commitment to avoid further joint-ventures.
3) Whether the economy will pick up or will continue down the path of depression (why are we still calling this a recession?)
That last concern is my biggest.
But that all aside, it doesn't answer my actual question which is more on the issue of whether or not inventories should be considered current or not? I'm curious both from an accounting as practiced standpoint but also on a normative standpoint (should we at times consider inventory to be noncurrent.)
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10:18 am
September 22, 2011
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valueinvestortoday
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| Member | posts 80 |
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"..hmm, thats called a "value trap" ;-)"
Contrary, valuing a poor performing business based on its liquidation value when the company has no interest in liquidating itself and it later erodes its value, in which the metrics involved to determine liquidation value (current) is the first items generally eroded, is the definition of a "value trap".
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9:52 am
September 22, 2011
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nell
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| Member | posts 101 |
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>>"If they haven't done so and have every intention of continuing as a going concern, it would make no sense to rely on a liquidation valuation >>because in many circumstances, a company who plans to continue operating and has a terrible track record of doing so will eventually erode the >>value you once expected."
..hmm, thats called a "value trap" ;-)
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9:34 am
September 22, 2011
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valueinvestortoday
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| Member | posts 80 |
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There are more valuation techniques than the two you've presented; arbitrage being one of them. However, the two you mentioned are the basis for nearly all others – and I think you probably meant that. However, the only time a liquidation valuation should be used is when the company has actually stated that they plan to liquidate. If they haven't done so and have every intention of continuing as a going concern, it would make no sense to rely on a liquidation valuation because in many circumstances, a company who plans to continue operating and has a terrible track record of doing so will eventually erode the value you once expected.
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8:23 am
September 22, 2011
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nell
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| Member | posts 101 |
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@somrh:
Lets change the perspective.. You are trying to value this company and you choose NCAV. Im not sure
if this is the correct valuation method here. There are two types of valuation methods.
1. Liquidation Value
2. Going-Concern Value
As this company isnt earning a satifactory return on equity for its shareholders, i would choose a
liquidation valuation method (like you). But in a liquidation inventory should be discounted. Inventory is
a cost as a Going-Concern and in liquidation im not sure if one would get alot value out of commodity
integrated circuits. So i would discount this inventory heavily.
So lets sum it up..
1. ROE < 10% -> We choose a liquidation valuation.
2. We are looking for Cash, Securities, Real estate etc. in a liquidation.
3. Special inventory (e.g. electronics, fashion etc.) should be heavily discounted.
Best wishes,
Nell
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8:06 am
September 22, 2011
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somrh
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| Member | posts 336 |
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Both your sources seem to be calculating operating cycle in the way I initially thought it should: DSI + DSO. In spite of that, it's still less than one year for Boeing (from 79 to 169 days).
To give this a little more substance here's an example of what I'm considering.
Taitron Components (TAIT)
Based upon TTM numbers, I get:
DSO: 50 days
DSI: 955 days
DPO: 70 days
Operating Cycle = DSO + DSI = 1005 days
Cash Conversion Cycle = DSO + DSI – DPO = 935 days
For the kind of business that TAIT does, they require large inventories on hand in order to meet customer demand for product that is not typically available by other suppliers. So one could argue that the high operating cycle is appropriate.
In spite of that, it's pretty clear that it is unlikely that TAIT will sell it's inventory within one year. The company's current DSI is relatively consistent with its historical DSI number so it seems to be pretty "normal". So should we count TAIT's inventory as current?
The big question we might ask is this. What is the "Net Current Asset Value" of TAIT? If we include their inventory, it's NCAV is $2.38/share. If, however, we adjust inventory for just that inventory that can be sold in a year we get a different number. We can estimate that $7.6m will not be sold and make an adjustment. This means that current assets goes from $16m to $8.4m. NCAV/share would then end up being $1.
So is it ever appropriate to make an adjustment to current assets such as inventory if those inventories are considerably high? TAIT might not be the best example in virtue of the fact that it seems to be a feature of their business model and we could argue that it's part of the normal operating cycle.
Disclosure: I am long TAIT.
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1:05 pm
September 21, 2011
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nell
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| Member | posts 101 |
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Interesting stuff.. I just looked up how Boeing accounts for this.. Inventory is booked under "current assets". Working capital
is defined as "current assets – current liabilities". So this makes sense.. They account for long-term contracts in progress and subtract
advances and progress billings when milestones are met.. Furthermore, you get a snapshot every year and i would average this measure.
Here are some nice resources:
- http://www.stock-analysis-on.n…..g-Activity
- http://dpapevents.com/may2010/…../Scott.pdf
Note 7 – Inventories
Inventories at December 31 consisted of the following:
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2010 |
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2009 |
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Long-term contracts in progress
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$ |
14,400 |
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$ |
14,673 |
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Commercial aircraft programs
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26,550 |
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18,568 |
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Commercial spare parts, used aircraft, general stock materials and other
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5,788 |
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5,004 |
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Inventory before advances and progress billings
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46,738 |
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38,245 |
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Less advances and progress billings
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(22,421 |
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(21,312 |
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Total
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$ |
24,317 |
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$ |
16,933 |
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Long-Term Contracts in Progress
Long-term contracts in progress included Delta launch program inventory that will be sold at cost to United Launch Alliance (ULA) under an inventory supply agreement that terminates on March 31, 2021. At December 31, 2010 and 2009, the inventory balance was $1,385 and $1,685. As of December 31, 2010, $1,070 of this inventory relates to yet unsold launches. ULA is continuing to assess the future of the Delta II program. In the event ULA is unable to sell additional Delta II inventory, our earnings could be reduced by up to $70. See Note 12.
Inventory balances included $236 and $235 subject to claims or other uncertainties relating to the A-12 program as of December 31, 2010 and 2009. See Note 20.
Commercial Aircraft Programs
As of December 31, 2010 and 2009 commercial aircraft programs inventory included the following amounts related to the 787 program: $9,461 and $3,885 of work in process (including deferred production costs), $1,956 and $2,187 of supplier advances, and $1,447 and $1,231 of tooling and other non-recurring costs.
73
Commercial aircraft programs inventory included $319 and $510 of deferred production cost, and $170 and $211 of unamortized tooling for the 777 program, at December 31, 2010 and 2009.
Commercial aircraft program inventory included amounts credited in cash or other consideration (early issue sales consideration), to airline customers totaling $1,970 and $1,577 at December 31, 2010 and 2009.
As a normal course of our Commercial Airplanes segment production process, our inventory may include a small quantity of airplanes that are completed but unsold. As of December 31, 2010 and 2009, the value of completed but unsold aircraft in inventory was insignificant.
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10:53 am
September 21, 2011
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somrh
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| Member | posts 336 |
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But this is still assuming that current means less than one year but that's not always the case. See http://www.financial-accountin…..assets.php for example:
The normal operating cycle for most companies is less than one year, but
there are exceptions. For example, because of the length of time it
takes The Boeing Company to build aircraft, its normal operating cycle
exceeds one year. The inventory used in building the planes is
nonetheless considered a current asset because the planes will be sold within the normal operating cycle.
So if there is inventory that won't get sold in a year does that mean it is noncurrent or does that indicate that the normal operating cycle is longer than a year and therefore the "one year" standard for current assets doesn't apply?
In other words "current asset = less than one year" is a good rule of thumb for most companies but companies' normal operating cycle is less than one year. But if their normal operating cycle is greater than one year then "current asset = less than normal operating cycle".
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9:55 am
September 21, 2011
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nell
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| Member | posts 101 |
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reference: http://business-accounting-guides.com/balance-sheet-format/
Cash is the most liquid of assets, but also may include treasury bills, money market funds, short-term loans, and certificates of deposit (CD’s).
Accounts receivable are what customers owe the company for products or services delivered on credit. Accounts receivable are less liquid than cash, but are expected to be collected within 30 to 60 days per payment terms.
Inventory is product for sale and is the next liquid asset because it is expected to be sold and converted to cash within one year.
Finally, prepaid expenses are those expenses that are already paid for future services not yet received. Typical prepaid expenses are prepaid insurance and prepaid rent. Prepaid expenses are assets because they represent cash payments already made for services not yet received.
Following the current assets are the non-current assets.
Non-current assets are also listed in order of liquidity. For example, companies list investments that are intended to be held for longer than one year as a non-current asset in the balance sheet accounts. Long-term investments include stocks, bonds, mutual funds, and long-term notes receivable.
Following investments are fixed assets, also called property plant and equipment (PP&E).
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11:03 am
September 20, 2011
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somrh
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| Member | posts 336 |
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Current assets are typically defined to be assets which are reasonably believed to be converted into cash in less than either
1) One Year
or
2) Normal operating cycle
whichever happens to be greater.
The normal operating cycle is typically defined as the time it takes to buy relevent needed inventories, produce goods and services and turn the goods and services into cash.
So can there be such a thing as "noncurrent inventory" or is all inventory necessarily current? Is there precedent for noncurrent inventory and what sorts of scenarios does that look like?
And on a side note, would DSO + DSI be a good estimate for normal operating cycle? The following article actually makes the operating cycle equivlaent to the cash conversion cycle:
Operating Performance Ratios: Operating Cycle
Personally I'm not sure why one would subtract DPO to arrive at an estimate of the operating cycle though I haven't given it much thought. If we take that as given then, the following should hold.
If DPO > DSO and DSI > 365 then
DSO + DSI – DPO < DSI.
Therefore some inventory will not likely be converted to cash during the operating cycle and will not be converted into cash within a year. Therefore some inventory is noncurrent. (A similar argument can be made for receivables as well.)
There's potentially a practical point to all of this so it's not all just academic.
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