Welcome to our second Felix live in this series.

last week we covered the income statement and financial statement, uh, analysis.

apologies again at the end there. We got cut off by, technical difficulties. Hopefully, if, if you had a chance to go back and take a look at the materials, if you, a couple people emailed me with questions, that's great. Please continue to do that. And we also, as I mentioned, have videos available for, for you on Felix, which is one of the benefits of the Felix platform is this wealth of, of our teaching videos that are all there.

So what we're going to cover today in our second session is working capital, and it's either a very daunting subject which scares people away, or it's a very, misunderstood subject, which can, which can kind of scare people away as well.

I'll go into more of that momentarily, but first let me just remind everyone where we are. There is a, there is a link in the webinar chat for the materials that's on the Go FE training site.

What I'll do here is share my screen and go to the website itself for you to see where we are. October four, working capital.

And we're gonna primarily be working in this workout file here as well as, I'm gonna be on Felix itself doing some kind of, you know, impromptu stuff.

I've got a teaching assistant here this week as well, thankfully to help with the, uh, the numbers. We had a very, very large group last week. Typically once, once we get into the kind of north of 50, we'd like to have some help. So I've got Yolanda Wadowski here, here who, uh, she and I actually came from the same kind of origins, our origin story, so to speak. True, true. Startedat JP Morgan Yolanda was M&A, as I recall, and consumer.

One of the first associates I remember having a run upstairs to hand something to, and being very scared of as, as, as analysts tend to be. And again, we have this video playlist down here as well, if you wanna go back and recap everything. We know we've got about two hours, a little less than it's, it's a good chunk of time for this topic. You know, I can go longer and the reason why I say that is because, you know, I think, I think working capital is very much misunderstood in the sense that, either a lot of people don't understand what it is or they kind of, you know, poo poo it. Perhaps because I come from a leveraged finance background, you know, kind of a lending background particularly, you know, with generally speaking, either levered or smaller companies. It's a, very big deal. You know, it's a big deal for bigger companies too, but, but it can really knock smaller companies kind of out of the box.

So you know, we are going to talk about why that is, and hopefully that will, you know, that will turn some heads, in this direction. Now when we started last week, we covered, you know, that the income statement and you know I kind of just pulled this drawing in from the notes, which I was just trying to kind of draw some of the connections right off the bat between the income statement and the balance sheet. And we know, of course, that net income is, is linked to the equity section.

But we also, in learning about the income statement, we learned about some of these other kinds of accounts that can have an impact on our income statement because of accrual accounting.

And those were accounts like, you know, accounts receivable when, you know, when we make a sale and we sell on credit, we don't receive the cash right away, or if we purchase our inventory, you know, without using cash, with using our own credit with a supplier, how that impacts our cost of goods sold regardless of cash.

So we're going to take the next step, and we're gonna start learning about some of these accounts on the balance sheet themselves. We'll go back to the balance sheet and we'll, we'll deepen our knowledge of these connections between the two statements.

And we'll also kind of figure out again, you know what's going on here, what this is gonna bring us a little bit closer to that sheet on the right called the cashflow statement, which we have not yet touched, but is coming up next week.

So the first thing that I would like to do is I just want to, you know, start with a definition, a working definition, no pun intended, of working capital, because it's I think part of the misconception or misperception of of working capital is not necessarily knowing how to define it or what people mean when they're talking about it. And I recall meetings with senior bankers where they were talking about, you know, uh, what do they mean by working capital here? What's included? What's not included, right? So for anybody who's had any accounting, any intro to finance, I'm, I'm talking, you know, basic accounting, intro to finance, or perhaps even taken a, you know, a course maybe on campus or somewhere online, like, not unlike this one, you probably came across a textbook definition of working capital and a textbook definition of working capital is, and this is normally where I would ask the class for one, but we have kind of more of a lecture style here, so I'm going to be my own best student and do my, and do my answering. I certainly don't wanna put Yolanda on the spot for this.

So a working definition of working capital is current assets minus current liabilities, current assets minus current liabilities. So, you know, I mean, gosh, if you go to any balance sheet, you know, you, you, you look from top to bottom, or if you're under IFRS, you might look from bottom to top and you would see these classifications of current and non-current. So, you know, since we're talking about the balance sheet together, really for the first time, let's take a step back and define what we mean by current and or non-current.

So current in accounting terms means that we expect this particular account to convert to cash within one year.

That's the sort of technical definition, convert to cash within one year.

So if we think about what is, um, you know, what, what is in the current section, and let me just quickly go over to my, workout here, blow this up a tiny bit. We go into a, you know, an example of a, of a balance sheet, which we have here in the workout. You know, we can see that the, uh, this is a gap financial statement.

So we have the current assets and liabilities on top as we go to the bottom that they get longer in term. You know, what we see here is kind of a listing of these total current assets here. So that's our number, right? For working capital, total current assets. And what we see is technically speaking, a listing from most liquid, most convertible into cash into kind of the farthest or farthest away from being cash.

So cash obviously is, is liquid, so it's at the top, followed by, you know, some trade accounts trade, accounts receivable here. You might also see some marketable securities in here as well, kind of investments that are not quite cash, but readily available for sale.

And we'll talk about more of these accounts as we go through.

But immediately for this company, we get right into what they call the accounts receivable, what they expect to receive from their customers, then they move to inventories, which are the things that they expect to sell. So you know, again, the definition of an asset in general is anything that has future use. So when we think about, you know, our inventory, why does something go into inventory? Well, it goes into inventory because we expect to sell it, we expect it to have value for us, and the value that it would have for us is to be able to sell it and conver convert it into profit. So technically, or typically I should say, inventories are, you know, kind of right after accounts receivable.

Now, why are they, well, accounts receivable reflect sales that have already been made.

So accounts receivable are sales that have, that have already been made.

So make a little tally of these.

So if a sale's already been made, we don't even have to think about when we might collect, you know, or when we might, you know, realize that because it's done and we're just waiting for the, you know, for either the customer or the wholesale account that we have to, to kind of do their, you know, monthly payments or however these are done.

You know, for big companies usually it's typically about about monthly, sales that have been made waiting for cash, and then inventories why they come, come next.

And depending on the company, there may be different kinds of inventories, right? We might have things like raw materials.

If we are a manufacturer of inventory, things that we expect, to sell.

We go back to that list again. What else do we see? Well, we see some things, uh, in there that are here called deferred tax assets.

Won't get into many details about things like deferred taxes, in this course. But if they are being considered, uh, current that does in fact imply that we do intend to realize that, that particular account within the next year. And then lastly, we got some things here called prepaid expenses and other current assets.

And these would be things where we actually pay for the benefit in advance of using it. So if you think about, if you join a gym and you pay for a year upfront, you've, you've, you've basically created a prepaid asset for yourself, or if you prepay, a cloud subscription for three years because they gave you a better deal to do that a software subscription that would be a prepaid expense.

And companies certainly have them for lots of reasons like you know, for insurance as well as some of the things that I even just mentioned.

So all of those together create the current assets so they have future use.

And if we kind of go back to that definition of converting to cash within a year, we can also apply that to the liabilities as well. Sorry to interrupt. Chris, can you share that Screen? Oh, yeah. Sorry, I stopped. Yeah, that's okay. Stop sharing. Yeah, Yeah.

Okay.

Okay. So, just add prepaid here.

These would be things like subscriptions, insurance, et cetera.

Okay? Now, in terms of the liabilities, these would be things that we expect to actually pay off within a year.

So again, taking a quick look at this page, we, we scroll down to the liability section.

And what we see here is well, you know, what are things, what are items that we can expect to, to repay within a year? Well, right off the bat is debt. And debt is typically, you know, again, the thing that would probably, you know, come due first, although that may depend I guess in terms of timing. You know, when that debt actually is due, this is debt that's going to be paid off within the year. So it's coming first.

It's kind of the most, you know, sort of payable, so to speak, in terms of the mos translatable into, into cash.

Because when you have a loan or you have a note payable or some kind of short-term debt, we know exactly what that amount is, and we know exactly when it's due.

So we see here is the short-term debt being first.

And then after that we've got some other things, accounts payable being of course, those bills we pay to our suppliers.

We've got employee compensation and benefits.

So occasionally you know, our books close on a certain date and we actually owe money to our employees.

Now, why would that be? Well, if you pay your employees every two weeks and the books close in the middle of that two week period from an accounting perspective, you would need to accrue, there's that dirty word again.

The amount that you owe them, even though you, you haven't actually issued those checks yet.

So that's certainly one thing that we would have to consider there.

In the world of finance, and this this point is particularly of I think importance to anyone in finance, is that when it comes time for incentive compensation, otherwise known as your bonus, those types of estimates are made throughout the year. Like, how much are we actually going to, you know, kind of pay are, are top performers.

And so we're often accruing those amounts during the year., If you're a bank or financial institution, and therefore, you know, you've got, you've gotta have that on the, on the balance sheet as well. So that could be in there. Taxes, same exact thing. You know, we, we, we accrue taxes throughout the year. We don't necessarily pay them once they're calculated, right? Even in, think about personal taxes, you know, the fiscal year end, December 31st, but the taxes are due April 15th or, or somewhere thereabouts.

So there's an, there's kind of an adjustment right there of accruing for the tax at the end of the year. Now, why are we accruing for it? Well, we're accruing for the tax because it matches the earnings from the last fiscal year or the last fiscal period. So again, we keep coming back to that concept of accruing and matching and everything here is kind of tying together for us and then in this case, we've also got something called other current liabilities.

We might similarly have something called other current assets.

Um, we'll probably see that in one of the examples coming up.

And your guess is as good as mine, what's in that account? we generally don't know sometimes under IFRS, the international financial standards of, of reporting standards IFRS is a little bit more detailed in some of the accounting notes that come with the financial statements. Then then gap, which is the US standard, right? So, going back to my notes here, accounts payable, talked about those, those are just mainly, what we owe to suppliers and, and other accruals can be really anything.

I'm just gonna kind of lump them all in there. So, because there can be many accrued expenses, accrued wages accrued, you know, accrued taxes those go in there as well, taxes, wages, et cetera. Okay? Now, again I started this by saying that this is sort of the textbook definition, current assets minus current liabilities. And so if we were, you know, to open up any financial statement and we were to go into the, that, that page of the balance sheet, we could do this calculation.

And I think, you know, probably just to kind of get, you know, a sense of it, you know, we can do that over here for our example is one as well.

If I come back to this company, and I forget which one this is now, um, we can simply take total current assets minus total current liabilities, always assets minus liabilities, by the way.

We never do it the other way around, uh, and figure out what our working capital account is working capital balances. So here we've got 8 41,818. And, I hate the fact that is a hard copy kind of situation where I can't link to it.

841,848 minus, and Yolanda, like a good associate to an analyst, if you could mind me of my mistakes of transposing numbers here, minus 5 61,172, and, you know, there you go. Working capital balance.

Now I could do that as well for, for year one but honestly it's not at this point in time, not, not really that important.

so I think, you know the reason why people get kind of turned off with working capital is that what this really tells me, this is a positive balance, right? It's a positive working capital balance.

And what this really tells me is that assets are better, are greater than liabilities and on the current side anyway, and that kind of from a maybe sort of a liquidity point of view, that this company is kind of in a better position maybe to pay its bills than another company that might have a negative working capital balances. So we, you know, we kind of, it leads us to a sort of shortcut logic, so to speak. And the reality is, is that, you know, while in fact that is, that is sort of what's, what's this is telling us, it's telling us in fact that they have more assets than liabilities, I suppose, if, uh, on the current side anyway. I suppose if we if we had to kind of liquidate on the spot from a current perspective, they would, they would be able to pay, you know, these bills pretty, uh, easily. Yolanda, did I see you raise a point? Yep.

Just One little typo. It's a minus 569,172 Okay, thank you. Yeah, Current liability, yeah.

So, um, you know, it is telling us that, but, um, but the reality is, is that that doesn't really tell us too much analytically about the company.

Um, and it doesn't even tell us that much about, about the actual, you know, kind of working capital itself. So, so, you know, what I wanna do is, I wanna take kind of a step beyond this, and I want to, I want to kind of narrow our focus of working capital into the sort of topic at hand, which is working capital as it becomes operating, working capital at working capital as it becomes operating, working capital.

So the more refined definition, therefore, of working capital.

And sometimes what's confusing is that we generally in the business still refer to it as working capital, even though we may probably most likely always be referring to operating working capital. Um, that's one of the things I think that can be a little bit tricky about it.

I know certainly when I'm teaching, I have to keep kind of reminding myself to, to, you know, specify exactly what I mean.

So by operating, working capital, basically what I'm saying is I wanna look at these accounts again, these kind of accounts that I just looked at, and I wanna be able to identify which accounts are linked to the operations of the business. Now, by operations of the business, I mean, which are linked to the actual day-to-day of the thing that that company does. So, you know, for Hershey, it's making chocolate, right? For you know for apple, you know, it's a little bit more complicated, right? Because they have hardware, they've got, you know, they've got music streaming, but, but we still kind of know in effect what Apple does, you know for it's you know, it's kind of day-to-day business.

And the difference here between working capital and operating working capital is that if we go back and look at that balance sheet, we go back up to the assets.

What we see here is that in this example, we start off with cash and cash equivalence.

Now cash and cash equivalence, which could include things like marketable securities and whatnot actually reflect kind of more more about the, the result of how Apple does its business, right? it's the cash it has on its balance sheet results from its operations or results from raising debt or equity Apple creating iPhones and laptops and iPads and, and selling them or selling streaming subscriptions for music or, or, or, or it's studio. It's TV content that's different, right? That's, that is the actual day-to-day business of what people at Apple do.

The cash and equivalence is more related to kind of the treasury of the company, right? And if we scroll down to the liabilities and, and equity section to the current liabilities, we can kind of say the same thing about the short-term debt.

What the short-term debt tells us is how much the treasurer of the company or the chief financial officer of the company felt that Apple needed to raise in the short term to fund its day-to-day operations.

So, I mean, just on that alone, think about it. I mean, if I were to go to the bank today and get a loan, I would immediately show that loan amount as debt and that loan amount as cash.

So those two accounts are impacting my working capital calculation. The one we just did, the textbook one, but they're not really telling me anything about those other accounts, accounts receivable, inventory, accounts payable.

So what operating working capital is going to do is focus on non-cash, non debt accounts.

And what that does is it basically allows us to understand what is Apple doing on a day-to-day basis, or what is Hershey doing on a day-to-day basis to actually run its business? How is it handling those transactions? How is it handling the decision to build inventory in advance of the iPhone release, right? So think about that for a moment, right? Think about why it's important.

And some of this has actually come up in the news as well. iPhone just released, apple just released a new iPhone, and that obviously requires them to have a lot of inventory on hand of that iPhone.

They have to have expectations of how that iPhone is going to sell.

If that iPhone hits and doesn't sell, what's going to happen to iPhones inventory? Well, the gonna pile up in all of the investment in that inventory is gonna just kind of sit there, right? And they're not gonna translate that into sales if the iPhone doesn't do well, it's just gonna sit there and hog the balance sheet space.

So we as analysts need to understand that, right? We need to understand that, that they've had a product released that didn't do well, right? By the same token, we might also wanna understand if they're not collecting on their accounts receivable quickly enough. So we'll, we'll, we'll talk about some of these more, you know, in more detail as we get into some of the metrics.

But by focusing on these operational items, it, it brings us back to the business. And as we go through these 10 sessions, we're gonna, we're going to see how this focus on the core business really comes into play. Now, apologies, you know, again, for last week but if we think about, for example, EBIT and EBITDA, why, why were we focused on EBIT and EBITDA? Well, we were focused on EBIT and EBITDA because they were reflected the performance of the core business. If we think about where they came on the income statement, it was before interest, income or expense, right? Well, again, same thing.

We want the earnings before all of the decisions that have been made about the financing come into play.

And so this working capital from an operational perspective takes us along that same path. It, it just separates out the financing decisions from the decisions of running the company. So it's just, say, put focus, on operational accounts and in general, those are gonna be the accounts receivable, the inventory, the accounts payable. I could put other, other current assets here that could be kind of a blanket thing, you know, and I'll put other current liabilities here as well.

So what I'd like to do now is take another look at the exercises and just kind of come back to seeing if we can refine our knowledge, our understanding of you know, of that definition and see if we can just pick out which accounts belong in this operational discussion and which accounts do not. And that, that's kind of the first sort of big step. I, Hi everyone. It looks like Chris is frozen again.

So just bear with us a couple of, we'll give it another minute, see if he can get back on Yolanda.

Yep.

I'm just going to restart and plug back into my router just to make sure that it, okay, that, so just gimme one second. Yep.

I, Hey, Yolanda? Yes.

Could you do me a favor and just would you, the next exercise while I just get this set back up again about whether the items are operating or non-operating in nature, would you be able to just lead them through that while I Okay. Yeah, sure. That'd Be great. Thank you. Okay. Okay guys, I'm gonna step in. We are gonna look at workout number two.

So if you can open that I can't really, I don't know if I can share my screen, but I can certainly follow along with you. So workout two says identify whether these items are operating or non-operating in nature.

then identify if they are current or non-current.

So I think that if they're not operating, then they're either financial accounts, or some oth or something else. But anyway, so we'll go through the list.

The first one is short-term debt. So obviously that is not an operating account, right? That is non-operating, or to be more direct that is part of debt. So that is a financial, um, that would be show up on your cashflow in the financial section.

So that is definitely finance and obviously it's short-term debt.

So as we learned previously, that is a current account as opposed to non-current or longer term accrued expense.

Give a, give a thought. I know I can't ask anyone, but accrued expense, Chris spent a little bit of time talking about that, but if you think about that, that is an operating, That is an operating account because essentially a company knows that it has to pay out expenses or it accrues taxes, for example and then they pay quarterly taxes, but the, you know, the amount accrues each month. So they know that that's part of doing business.

So whether it's taxes or just kind of, um, accrued liability, some other expense that they have to pay, that is a nature of their operation.

So that falls under operating, and again, that is current.

Those are typically one year or less. So that is the definition of current.

Then we have cash. So cash is kind of an interesting one. Obviously that's a current one. We all know that's very liquid, but is that an operating or non-operating in nature? And if you said operating, you would be wrong. That is considered a financial asset. So that is not, I know it's sometimes counterintuitive, but cash is not considered an operating asset that comes, that's part of the company's cash account.

So they use either debt or cash to pay their bills, to meet their cash flow needs, et cetera. So that would be a non-operating account, but current cash equivalent is the same thing.

I'm not sure why they listed it twice, but that's almost the same thing, accounts payable. So that's obviously I think people, I think, I think everyone would understand that that is an operating account, that is where a company filters through its payables, to all its vendors, et cetera. So that is definitely an operating account, and we know that that's a current account because that falls under current liabilities. Then we have long-term debt.

So obviously that is non-current just by nature of the definition.

So that is long-term, that is not current, non-current, but it is also not operating all of your debt pieces, whether it's, or long-term debt investment securities, revolving credit facilities, those are not considered operating accounts.

They are part of your financing. Are you back on, Yolanda? So we, we were, we got to 62, 63, 64, the long-term debt pieces, those are all essentially the same. Yeah.

So I dunno if you wanted to add anything about that, but yeah, Yeah, no, no, no. I mean, part of the, as we go through, you know, some more of these, kind of understanding what the terminology is for debt will help you kind of pick out from the you know, from the working capital perspective or operating working capital perspective.

What's debt versus what's operating? So revolving credit facility is typically on, is in the current, um, is in the current side, but it's typically non-operating, right? Because it's how we finance our short-term needs.

A revolving credit facility is like kind of a credit card, you know, for a business in that sense, right? Investment securities, again, we talked about that as well. This is, this is current as well. Could, could also be non-current.

actually you could have long-term, what we call held to maturity securities, in which case those would be non-current.

So those really could be either current or non-core, current, but critically speaking, those are non-operating.

So there was one question that just popped up.

I think it just came up, Yolanda. So I'll let you handle that in the, in the q and a. Long-term debt, of course would be non-current or long-term.

That would be that would be non-operating accounts payable would be current, and that would be operating, I'm just going quickly. So we have these here.

Cash of course is current cash equivalent current. Those are both non-operating.

Now some people will say, well, you know, again, I mean, how do you cash is like so critical to running a business. I mean, how do you, how do you really separate that out? And, you know, again, what we're trying to get at here, if we can just sort of, you know if we can just sort of think about, you know, what, what a business owner, you know, goes through on a day-to-day basis.

Their generally their biggest concern. Most bus, if you talk to any CFO or any treasurer of any company from Fortune 500 down to I always joke about my wife's bakery here. My wife's former bakery here in LA, she's resigned or retired or moved on, we should say.

The PE you know, the her partner who ran, ran that business, well my wife was the pastry chef.

Their number one concern is running outta cash, right? Running out of cash.

So again, the cash is sort of like, how do we make the operations work in a way so that we are generating cash or that so that we always have a place to go for cash, right? A lending source. So again, yes absolutely, you cannot really do much in this world without cash.

But in most circumstances, cash is not kind of the thing that we're focused on.

It's kind of where we end up with the analysis. It's where we end up, it's where we are trying to get to in the analysis.

So accrued expense be current and that would be operating.

And then, um, short-term debt would be current and that would be non-operating.

Just to rehash those inventory we talked about this, this is obviously current and it is most certainly an operating item. Deferred taxes, you know, now it's telling us here that it is current, so there's not much guesswork there. Why do we how do we consider taxes? Well, taxes is probably after cash.

If you will, probably the most, you know the one that's hardest to kind of get our head around because taxes as well are kind of a result of doing business, right? We do business and then we have to pay the piper. Well, the reality is that, the taxes that we pay in, in most cases are almost always generated by the operations themselves.

So if we think about, for example, if we think about a business, um, what they do throughout the year, selling of computers, Hershey bars, whatever, that's what's generating their tax bill.

So everything that's related to the taxes is probably going to be operational in nature, right? There are very few things that come up that are like tax driven that are not operational. So for that reason, whenever you see anything tax related in the current assets or liabilities, we want to include that in our working capital.

So I'm gonna put operating here for deferred taxes, prepaid assets, we talked about that as well.

That's gonna be operating accounts receivable.

We've talked about accounts receivable.

Those are current in operating now, work in progress.

This really refers to inventory and I think they were trying to kind of not give away the farm there with that, with the label, so they left inventory out.

But a but work in progress inventory is, is obviously part of the inventory and therefore going to be part of the operations. And then, you know, last couple things we have here, overdraft. Again, this is another, you know, term that you might see that we have to, you know, kind of put our heads around. Well, overdraft, if you think about your checking account, what's overdraft, that's the bank kind of backstopping you in case you, you know, pay more out than you have in the account.

So that's really kind of a debt funding. It's short-term debt funding.

So that's gonna be current and it's gonna be operating.

Now. The next one is tax payable.

So again, I will, I will turn, to the audience and say, taxes, how do we handle that? Well, we just said rule of thumb, taxes are always gonna be operating.

And lastly, we've got, uh, notes payable, notes payable also a current type of liability and also going to be like all debt non-operating.

So that's a little exercise that I think just starts to open us up to some of the different terminology when you pull open financial statements or equity research reports or whatever it is that you look at, because the, the biggest hurdle right off the bat when you start doing this is that everybody calls these accounts different names.

And then if you happen to look at a non-US company, you might actually see them referring to inventory as stocks, right? So that's really confusing. You're like, wait a minute, what are stock, what is stock doing, you know, on the, in the current asset side of the balance sheet, is that not, you know, an equity thing? Well, you know, sure enough, that just happens to be what, what they call, you know inventory overseas, certainly in, in Eng England and the UK and whatnot. So, let me just go back over to my slides, see if there's anything there that I have to kind of catch us up on.

Focus on operational accounts, always excluding anything related to cash or debt.

Always including anything related to taxes, if current.

And the reason I say that is because there's a lot of tax stuff on the balance sheet that's actually non-current.

There are non-current deferred tax assets, non-current deferred tax liabilities.

And we have to remember that with working capital, they must be current.

Must be current.

So what I'd like to do now is we'll just do a quick kind of working capital calculation. So we'll come down here and we'll take a look at, you know, let's, let's do workout eight.

Workout eight says, identify the operating and financing. Current liabilities provisions are for warranties on goods sold. So, you know, immediately, once again, we have kind of a new account, one that we haven't talked about. So what is my, um, my, what would be my working liabilities here? Yolanda, did you, were you gonna say something? Nope. Okay.

I've seem to have lost my video feed somehow.

I don't know where it went, but I can see the q and a in the chat, so, and I can hear you. So just jump in if you, okay, so workout, it says operating the calculate the operating and financing. Currently. This, this problem here only really focuses on the liabilities, but that's okay because, you know, again, it's really just a matter of understanding this terminology first. So what do we have here? Well, we have bank overdrafts.

So bank overdraft, and we did cover overdrafts in that, in that one above.

So overdrafts, of course, we would consider to be debt related, so we would not include overdrafts. Now, here's another new one.

The current portion of long-term debt. Now, what is that, right? What is the current portion of long-term debt? Well, this, this is the accountants kind of getting a little bit too cute in my mind, but, but you know, this is also part of really staying consistent with their, their, you know, with their ideology.

So the ideology is that if it's payable within one year, then it has to be considered a current liability.

So what happens is, is if you were to issue a 10 year bond, let's say in, let's say in 2014, you issue a bond, that means it's 10 years. As, as I said, it's a 10 year bond.

So you raise capital in 2014, and that means that that bond is due in 2024.

So you have to repay it to the investors in 2024.

So payback.

So if we were to flip open the 2023 annual report for this company in 2023, which obviously comes in here, but I'm gonna draw it down here so I have more room.

What the accountants would acknowledge is that that bond issuance is due within one year, and because it's due within one year, they don't care that it was originally a 10 year bond.

They don't care. That's long-term. For nine years, this bond existed down here in the long-term debt section for nine years, and in year 10 it got a promotion, it got bumped up to the top, and now that bond is showing up here in the long-term debt.

So that explains kind of why that is. Now, at the end of the day, from a, if we're just doing the working capital, operating, working capital calc, the operating part of it excludes all debt.

So we're gonna cross that out as well.

we also have something here we have accounts payable, which we've seen before. We have income taxes payable, which we've seen before. Those are included.

So I'm gonna go ahead and include these change over to yellow. Those are good.

These are good short-term provisions for risks and other charges, short-term provisions for risks and other charges. Now, it says here that the provisions are for warranties on the cost of goods sold. Now, where would we find that information? Well, we probably would get a description of what these accounts are in the financials, and we'd, we'd have to maybe do a search for it.

you know, just do kind of what we call control effort, right? For that account to see if it, we can find somewhere in the notes to the financials where that account is and what it means.

And what it's telling us is that it's provisions on for warranties on cost of goods sold. Now, that to me sounds very, very much like operations, right? Cost of goods sold, uh, is obviously, you know, way up high on the income statement. It's in the operating expenses, it's in you know, it's, it's part of operating profit and ebit, so re related of course, to inventory sale, you know, so that's definitely tried and true operational.

So I'm gonna go ahead and include that. And honestly, I would not have known that, you know, me with, you know, at this point, a lot of experience. I would've needed to look that up to be honest with you.

And that's why we provided that note.

So that kind of gets us down.

Last thing here is other liabilities and the rule of thumb again, on anything that's kind of other liabilities or other assets, as long as they're current, we generally include them.

And I, you know, I can't actually give you a better, you know, a better answer than that, a better reason than that, we generally always include the current other assets and liabilities.

So I'll just make a note of that on my notes. Because I, um, you know, I will post these for us Even if we don't know exactly what's in there.

So that was the, uh, the liabilities question. Now I think further up, although they separated them for some reason was number three. Yeah, well, this is the asset part of the question, so I'm gonna skip back up to three and, and I'm gonna do this, uh, calculation here as well. So just to have a, have another look at some more accounts. So this is you know a non-US income statement.

This is a non-US non-gaap, right? Non whoop, non-gaap. And the, the reason why I know this is two reasons.

One is that the current assets are way down there, and two, it's a hallmark of the gap.

what's that? No, it's a hallmark of the, IFRS statements to include these references to the notes and the references to the notes. That's where we're gonna actually that's where we're gonna find the detail on these accounts. Now, does that mean that there's no detail in the gap US statements? No. There, there are. It, it's in there, I f for us are just really methodical about how they lay that, lay out these reports and that, that note section there means that if you were to come across an account that you didn't understand, there might be that column here to tell you, Hey, you know, go to note, you know, 18 to find out, you know, what's going on with inventories or something like that, right? So let's go down to this, uh, non-current section. We'll take a look here. We've got inventories, we've got, those are obviously going to be included in our OWC, our prepayments to suppliers. That would be, again, prepaid assets.

Those are gonna be included, our short term receivables. So this, if we weren't sure about these, we could go to note 19 and read about them. Now, we're not gonna do that here. I don't have a link.

I don't know what company this is, but I generally, you know, I generally include receivables. Unless, unless it's says specifically that it's a loan receivable or something that implies that we made a loan.

That's a more of a financial arrangement.

This is not a financial arrangement, okay? Now, you may think that lending to customers, it implies a financial arrangement.

It doesn't, we're not in business to make loans and collect interest. We're not, you know, JP Morgan or, or Bank of America, Wells Fargo. We're not these company, right? We're not. We're in business to do what we do, make Hershey bars, computers, et cetera.

The short term arrangements that we have to allow customers to not pay cash upfront.

This is called, you know, trade credit and there's generally no interest on it.

If it's paid, you know, within a certain amount of time, there may be penalties if you kind of go longer than that, but it's not a loan.

So we see receivables, we're generally gonna include them. Income taxes, right? Magic word taxes, let's include them.

How about other receivables? Well, you know, I don't know what those are specifically. It's a very small amount. I, I don't have, excuse me, I don't have a note here that says what these are.

So I'm gonna assume that receivables are related to the business here, and I'm going to include them.

And next we come to this derivative financial instrument., Now at the top it tells us that the financial instruments are being used to hedge interest rates. So what do we think about that? Right now it's basically saying that we've got some debt, maybe it's fixed and we're hedging floating, or it's floating and we're hedging into fixed. Well, that's all part of the treasurer's office now, isn't it? That's all the CFO's deal. That's not the operations, not about candy bars, donuts, or computers.

So I'm going to exclude that from this calculation.

Exclude that. Prepaid expenses, we've covered those marketable securities and cash, we have covered those as well. So this is, um, you know, relatively straightforward, but certainly not without kind of, its, you know, it, it, its occasional question marks as well.

And it's okay to have questions on these. Look we field them all the time from students on the job, you know hey, I'm doing an OWC calc, would I include this? You know, we get that kind of question, you know, a lot and we're always, you know, very happy to, you know, to answer it. Obviously you know, and I, and I certainly we will express that to you as well, you know with our students, we're always, you know, always happy to kind of, you know, respond to these kinds of questions as, as they come up for you, you know, on, on the job. Always, always ask that you don't reveal anything that might be, confidential in nature and also depending on the time of year, you know toward the summer months, we get a little bit kind of backed up. We're in the classroom a lot and teaching a lot of the full-time hires that start between June and, and August. And, and our responses tend to be a little bit slower at that point.

But as long as I've been doing this for a long time, every instructor I know is always welcome. These kinds of questions.

okay, so what I'd like to do is workout number nine, I, I'm just going to take kind of a slight pause here, like a couple of minutes.

And I'd like to have you take a crack at this. And I, I chose this one out of the kindness of my heart because it actually has accounts I think we've seen before, and it also has links. You can actually build a formula here without having to type and get the numbers wrong.

So what I'd like you to do is calculate the working capital in Workout nine and only take a few minutes, and then just allows me to make this class somewhat interactive.

Calculate the working capital. I want that, you know, working assets minus, right? Operating, working assets minus operating, working liabilities.

And also you can take this, you know, kind of minute or two if you need it to kind of step out for a quick sec for something you, you know, you could. And then I'm not going anywhere.

I'll be right here. Just take a, a pause of speaking and we'll, we'll come back in in a couple minutes and I'll, and I'll go through it.

So we had a question come in on Goodwill, Yolanda, we will cover that in the section.

I think it's like the fifth or sixth which is about how to account for acquisitions and things of that nature.

In case you weren't aware of that, Yolanda, I think you might be. But that's, somewhere, let me just go over to my course here, Peter. That would be, um, probably full. We October eight, two weeks full consolidation in NCI. That's when we'll cover Goodwill.

So, um, if anyone got it that's great.

I don't know, um, probably won't I can't call on anyone, so I'm just gonna go ahead and do it here.

First thing I'm gonna do here is I'm gonna calculate my operating, working, assets. And, you know, I think to be cute, somebody at at Financial Edge who, who developed this problem snuck the inventory up here in between cash and cash equivalents. You know, the reality is, is that, that it just isn't displayed that way.

I think that was just trying to catch somebody maybe make sure that you're reading. The reality is, is that inventory, you know, almost always because of the rules that accountants have has to come after accounts receivable. So that was just there to kind of maybe catch you asleep at the switch, as they say. We won't include cash, we won't include cash equivalents.

We've got accounts receivable here and we're also gonna have prepaid expenses.

so that's gonna be the total of my operating working assets, so to speak. Operating working capital, having working assets and working liabilities. And now I'm gonna come down here and put in a similar type of calc for the working liabilities and accounts payable. We've talked about these.

I think we know what they are going to include those.

What about the deferred revenue? Well, we did talk about deferred revenue last week.

I don't know what the carryover is from one week to the next. Obviously you're not required to come to everyone as far as I know.

So what deferred revenue is, is if we go back to that, um, income statement discussion last week, we talked a a lot about, about the about the airline taking payment from customers before delivering or providing the service or goods. So that's a deferred revenue.

And it's a liability because we owe some customer somewhere an airline flight or they paid for something that was out of stock, right? Maybe you, you wanted a TV at Best Buy, it's outta stock, you paid for it. And they said we're gonna ship it as soon as it's ready.

So the, um, hang on a sec, because my colleagues at Financial Edge messed with my order here. I've got that calc wrong.

So that's why we are going to include the deferred revenue here.

It is related to the balance to the operations of the company. We, we did offer an operational service or good before we were able to provide it, and therefore we owed them an answer.

Now I know Yolanda, in addition to correcting my mistakes is on that question in the chat, but it's a good one. So I wanna address it.

So my friend here who's some of you know, some of our identities are anonymous just so that we, you know, it's just kind of a way we provide, you know, in some cases if they've asked for anonymity, you know, so their names don't show up. That's just kinda what, why that is that way.

It's a fantastic question because I was just harping on the fact that we, in my notes here, make sure I even wrote it correct in my notes.

We always include anything related to taxes if current.

I'm glad I remembered to write down if current there. That's the issue there.

The issue with this problem is that the deferred tax year of 55, which is showing up on both the liability and the asset side is, is non-current. And you can never, never, never, never, never have a non-current item in the operating working capital calculation. Just can't, just can't have it.

It's not, it's not theoretically correct. And I'm going to take one, one further step into the theory in a moment, but very quickly, I'm gonna go ahead and calculate my operating working liabilities.

And I think I got these right now.

343, 234, 676. It's a lot of prepaid assets by the way.

Not sure what business this is, but so my operating working capital calc is going to be the operating working asset minus the operating working liability. And that's going to give me 891.

Okay? So that means obviously if we've excluded anything, it was either cash or debt related. And that question about the, um, about the notes is along those lines, which is to say that notes payable is another term for a kind of short-term debt, a note payable and very similar to account payable.

But once you get a little bit more comfortable with this terminology, you're going to understand that account payable means trade credit, that, you know the butter and eggs truck gave, you know, the bakery credit to receive, you know, delivery after delivery of butter and eggs and only pay them once a month.

And that, that just makes more sense from a business perspective because even though, look, we all love to get cash, you know, right away, we all love to get cash right away. But, the problem is that, you know, most businesses need kind of things coming in on a, you know, daily, weekly, biweekly basis. So you just don't, you're not always writing checks to the delivery truck or, or whatnot. So we, we, we use this credit system trade credit as it's called.

Okay? So that's kind of a good, you know, run there at doing, you know, kind of some of the calculations.

Workout 10 is another kind of working capital calculation. I'm gonna, I'm going to, you know, hold off on doing that as well as 11, if I have time at the end, I'll come back, but there's a little bit more theory I want, I want to get into, I, and I wanna make sure we have time for that. We, you know, we have answers to all these, which I will post at the end for you to try your hand at them.

What I want to talk about here is again to explain and, and maybe a little bit more detail from a different angle, perhaps why working capital is so important.

And, you know, again I keep, you know, I go back to my background coming from banking, from actual lending where it was really important to understand that companies needs a lot of, you know, probably people on the equity side of the business might not understand it as well or may not kind of need to think of it, but the, but the truth is, is that it is very important really from an investing perspective as well.

So if you are in the private equity world, you will often be finding yourself again, private equity is the section of the business that in that, that makes investments in companies, buys out ownership of companies, invests new capital, and then attempts to run the company differently and sell it, right? So private equity really needs to understand working capital as well, and we'll often look for businesses to invest in that have a certain kind of working capital situation. Now why is that? Well, if we go back to our basic understanding of a balance sheet, our basic understanding of a balance sheet is that the assets equal the liabilities and the equity, right? That's day one, kind of accounting, the assets equal liabilities of the, in the equity. And furthermore, if we think about that kind of in maybe less accounting terms, more analytical terms, what that means is that I raise capital And I go out and I buy assets a, to run the business.

So these are in effect my resources that I use to generate profits, cash flows, et cetera.

And they're paid for obviously by the right hand side of the balance sheet, which is the capital. So that's kind of, let's think about that for a moment. Now, let's think about, you know, maybe a more realistic balance sheet, A more realistic balance sheet would have if I were to kind of draw this out.

Couple of nice even boxes here.

let's just say you've got some cash.

Let's say you've got some operating working assets.

That would be the accounts receivable, the inventory, the prepaid assets.

And then you've got some long-term assets.

And we haven't talked a lot about them. We did a little bit last week with depreciation and whatnot.

The long-term assets would be things like your property, plant and equipment, right? So long-term in nature, right? The buildings that you own, that you make the goods in, or run the business out of your trucks or your distribution warehouses, et cetera. The computer systems that you use, there could also possibly even be some intangible assets in there as well.

Copyrights, patents, trade trademarks, software, right? That's all in there too.

So pp and e et cetera is in the long term side.

And then let's say over on the right hand side, you know, maybe you've got, you know, some short-term debt as well. We'll put that up here, ST. Debt.

And then maybe you've got some operating, working, um, liabilities. And then you've got some debt, and then you've got some equity. So if we were to, you know, right off the bat in this particular example, do a, an operating working asset minus operating working liability calculation, otherwise known as an OWC calc, we can kind of rearrange the balance sheet in a way to help us understand a little bit more about that kind of funding versus resources question. Okay? So if I were to just kind of net this out, rearrange it, so to speak, the first thing that I, that I would do is, you know, I can immediately kind of assume that my short-term debt and my cash kind of net out. Now, this is just one example, right? So I'm doing this to simplify things.

My short-term debt and my cash are roughly the same size here, little bit of each, right? Netting them out.

So now what I'm going to do is I'm going to net my operating working assets and my operating working liabilities.

So to do that, I'm gonna take the operating working liabilities, and I'm going to kind of eliminate them and I'm going to net them off of my OWA box.

So what that'll do is it'll, it'll basically kind of bring down my operating working assets into an operating working capital calculation, right? So I've kind of just netted those off. So let me kind of redraw this. This is kind of where, you know, where I'm sort of going with it. Let me just sort of redraw this in a different setting.

So now, if I think about a company that has here, we had, similar to that kind of last problem that we just did.

We have a company that had operating working assets that were greater than the operating working liability. So OWC was positive.

So what that means is that if we were to just kind of rearrange the balance sheet, they would have a operating working capital box that's positive, has an asset balance that's on the left hand side.

They still have the same amount of, um, operating, uh, I'm sorry, of a non, of, of non-current assets, which is the PP&E, right? Et cetera.

And now they've got the same kind of deal with the debt and the equity, right? So, once again, right? I just, I just redrew this to kind of make it a little bit neater. Once again, we're looking at this company, we're looking at this company, and what we're seeing is that in order to fund this company, in order for this company to have enough capital on the right hand side to pay for the resources on the left hand side, we need to be very

very clear that part of the resources in this particular example are these operating working capital accounts that form an asset balance.

So if I look at my accounts receivable plus my inventory plus my prepaids, right on the one hand, and then I subtract from that, my account's payable, my other accruals, et cetera, right? That brings me an asset balance. Now, who knows why? Maybe they, maybe this is a company that has to keep a large amount of inventory on hand. Think about a retailer, right? Think about Home Depot, which I'm hopefully get to an example of by the end, right? Companies that have to have big balances on hand, they have large amounts of operating, working capital asset balances as a result.

Now it's possible that they have those accounts because of other reasons. Maybe it's because of the accounts receivable.

Now, what would be the issue with accounts receivable? Well, they might not get paid as quickly as they like.

Now that's not something that's nice to think about, but it happens all the time, particularly with small businesses doing business with big business.

You know, you're a small little, you know shop that provides product through Amazon or through Target or Walmart.

It's very difficult for those businesses to meet the expectations of giant retailers like that because you're just providing, maybe it's a toy or electronic device or who knows what it is. And you got, you have to always have inventory on hand for Amazon or for Target or Walmart, which costs money, right? You keep, things just don't appear at inventory, right? You've gotta pay for all that stuff and then you've gotta sell it through them and wait for them to pay you.

You gotta wait for Amazon and Target and Walmart. Now, the good thing about doing business with those companies is that they will pay you, right? But, but it may take longer.

So that could lead to big accounts receivable balances, okay? And that means from a balance sheet perspective, if that chunk of accounts has a balance that puts it on the left hand side, which it does here, a positive working capital balance, that that's gotta get funded somehow. It's gotta get funded.

So, we'll, we'll continue to look at examples of this in a moment. Now, let's go back and think about, you know, maybe another type of company that, that has, you know, maybe a lot of, a lot of working liabilities, a lot of accounts payable or a lot of deferred revenue perhaps.

The airline company. Now, I think we actually had the airline company in here.

And I'm just curious if we if we do the OWC calculation for the airline, if it were to come out negative, I would certainly look good if it did. But let's, let's go ahead and do it.

So now I'm gonna have to, of course do this transposing business, but you, but you can do it with me because it's, it's always good just to keep practicing these, okay? So once again, we don't want cash. Is there a question there? No, we don't want cash, we don't want short-term investments.

We don't want cash and equivalence. So Yolanda, I guess this is where the cash and cash and equivalence example comes from cash equivalence example comes from, they've got this particular airline's got got lots of variety of, of cash here, okay? Now therefore we will be doing 1,425 plus 863 plus 748. That would've been funny if it was 747. Because that's an airliner, but it's not. So there's my OWA, now let's come down here and do the OWL and that we we're gonna eliminate that current portion of long-term debt.

We've already kind of talked about that and everything else in here looks pretty good.

I don't see anything there that I would consider to be debt related.

If anybody has any questions about these accounts, that I'm seeing, feel free to pop them into the chat.

But they're all related to this airline running its business, alright? That's gonna be equal 1,563 plus 1,205 plus. Hey, there's a 3,747 plus I got, I need a plus here though, plus 3,747 plus 2,525 plus 2,334.

All right? And lo and behold, I have a massive liability balance here. So what's my working capital? Well, my working capital here is actually gonna be negative.

So right off the bat, I'm thinking, okay, you know, again, going back to that original kind of you know as I said, introductory, maybe intro to finance, intro to accounting, sort of view of working capital.

You might be like, Ooh, no liquidity, or how are they gonna pay their bills? Right? Well, you know, that definitely is kind of the you know, the immediate perception of this, that they're much more heavily to the liability side, the owing side than they are to the cash side.

And if they had to pay their bills today, you know, we're going to bankruptcy or whatever. There, there's, there's an, there is an issue here, right? Seemingly, but what I want to do now is kind of put this back into my, my boxes terminology to see what's actually happening here.

So here I've got a situation where

my operating working assets are less than my operating working liabilities, and that leads to negative OWC or OWC in parentheses, right? Which is what we have here, 83, 38.

So that is a different kind of set of boxes now.

So now what this implies here is that that ow C box is on the liabilities and equity side, right? And I've got debt and I've got equity.

And if I were just to kind of bring over the same amount of property, plant and equipment as I had kind of in my previous example, I'm basically just kind of flipping, you know, flipping sort of the boxes around.

I'm stacking this OWC box over on the right now, right? I'm kind of stacking it over on the right. Well, what that means is I've now kind of got a situation where, because my working capital has a liability balance, it means in effect, in effect that I've been able to kind of take loans, trade loans, industry loans, right? Not bank loans, but other kinds of loans from people I do business with on a daily basis. Not banks, but business on a daily basis.

I've taken loans from them. And, and that means that I've effectively kind of held on to funding. I've created a funding source.

On the other example, what I described here was a company that had a funding kind of requirement. Who's gonna pay for this inventory? How do I pay for this inventory? How do I pay for the loans, trade loans that I extended to my customers? Some somebody has that money, somebody has that cash, right? This is the opposite.

So what we see here is the funding side, getting a boost from the working capital, from the negative working capital.

And you might say, well, this doesn't really work.

Then from an accounting perspective, if I take that box from the previous, example that would be this one.

If I take that box from the previous example and just kind of stack it over on the right, it does, it doesn't work as a, you know, as a, an accounting, uh, equation any longer.

And what that would imply is that perhaps, I need less debt, right? I could squeeze out some of this debt.

Now why? Because I don't need the funding. Debt is simply more funding, right? If I'm getting funding from my working capital, maybe I don't need that debt funding. That's one thing it could imply, or it could also imply that I've just got a lot of extra cash hanging around. It could imply that.

And interestingly, if I go over to the balance sheet that we just discussed what did they have? They had a ton of cash sitting around, didn't they? And why does an airline have a ton of cash sitting around? Well, just think about, you know, just think about all the cash they take in every day for flights that are 3, 6, 9 months down the road, right? I mean, people are booking, obviously, you know, stuff for the end of year for holidays. People are booking their ski trips, people are booking perhaps their summer trips now that, that's just cash sitting on the books for these airlines, right? And, and prices are high right now too, needless to say. So, that, you know, that that is kind of a, you know, essentially what we're, we're getting at here with working capital.

Can I understand a little bit more about how a company is funded or how much potential cash may be hidden in these accounts. And you know, again, it really, it it'll, it comes back to you know, to that need to strip out cash and debt from the equation in order to do it.

Because if we include the cash in the debt in this equation, we're chasing our tail because we you know we haven't isolated the accounts that are, that are really driving the business, okay? So what I'd like to do now is, um, you know, maybe do a couple further problems here and and see if we can get at this sort of you know, understanding of uh, o of the working capital. So let me just see if we've got one here.

Let's look at I wish there were another one that I don't have to type four, but that's just kind of the way that it is, isn't it? You know, what I'd like to do, since we don't have a ton of time left, I'm gonna go ahead and I'm gonna go over to Felix, our dear friend here.

And I'm gonna pull the, uh, balance sheets of a couple of different companies.

I will give you the answers to all these so that you have them. And I'm happy to clarify, as I did for a few students during the week, if you are working on them on your own and can't, you know, can't figure one out, um, I wanna go in and I'm gonna get a a balance sheet for the Home Depot.

And what I'm gonna do to kind of make this, you know, easy is I'm going to I'm just gonna go back to kind of the, the last 10 K, which is the last annual statement. And normally, you know, we're looking at balance sheet information. We want the most recent, so the most recent would be their last, um, quarter one, which is from, from July 30th.

Actually, let me just see if I can use that. No because it doesn't give me, I want year over year. Yeah. So I'm just gonna go back to the to the actual 10K, which is the annual document, right? And I'm gonna go in here and I'm gonna from here, now what I see is that I've got balance sheet as of January 20th, January 29th 2023 versus January 30th 2022.

So slightly dated information, but that's okay because we're just, I mean, we just looked at a bunch of financials in the worksheet that were not current either. This is about concept, right? And then what I can do in Felix, which is lovely, is I can hit copy and then if I come back over here to my Excel, I can paste this in and I don't wanna do that. Hang on, let me just get rid of the stuff that I, I don't really need, I only care here about the current stuff.

So I'm just gonna go in here and get rid of anything that's, anything that's non-current.

And that would be everything down here.

Don't care about the equity either.

And let me blow this up wee bit so we can see it a little bit.

And now again, back to that you know, back to that exercise of stripping out anything that's cash stripping or anything that's debt, I'm gonna go ahead and I'm gonna delete my cash and equivalences.

And now my total line is gonna be my total OWA receivables, inventories and other current assets. Copy that over alt HPP. And this is 2023. This is 2022. Ignore that formatting for a second.

I don't want to be overly overly cute with my formats. Just wanna kind of get this done.

Come down here to the current liabilities. I wanna get rid of the debt.

I want to get rid of what say you current installments of long-term debt. Absolutely right? We're gonna get rid of that Current operating lease liabilities, we haven't talked about that. I don't know if we will in our 10 10 sessions. Bit of an advanced concept, but that's really also, um, something that's trying very hard to be debt like debt equivalent, like.

So I'm gonna get rid of that as well.

And that's gonna leave me with a whole mess of liabilities.

And that's going to total the 2934 liabilities.

So if I come over here and do my o operating working capital calculation, that's going to be operating working assets minus the operating working liabilities.

Do that for each year. And we can see actually quite a big jump, so to speak, quite a big jump for, Home Depot from last year to this year in that asset balance, right? Working capital here has an asset balance.

I'll put my formula out here to the, to the right so you can see it.

I just took the assets and minus the liabilities. Okay? So let's just take a look at Home Depot for a moment and let's see if we can just put our analytical, you know, hats on so to speak and see if we can understand what's from an operational perspective is going on here. Well, the the first thing is that you know, if I were, you know, an analyst thinking about Home Depot's business, um, what Home Depot's business really involves for the most part is creating a warehouse that's full of everything for that an that any construction professional needs. Yes, I can go in there on a Wednesday afternoon and buy a garden hose.

I can go in there perhaps and buy a, you know, an appliance or something, or maybe some nuts and bolts for a home project.

But that's not what they're really out to do. I mean, they, they, they, they love the DIYers. It's called the DIY store. Do it yourself.

But what they really need to do is they need to be there for the big bills.

The big bills come from the contractors that go in there and they need to kind of clear out the place Lumber, PVC and conduit and all that stuff, right? So they're, the, the business here that they have is really designed around that.

And they have to do that. They have to have a full house. If they don't, then that contractor's gonna go to either a local lumber yard or a Lowe's or a Ferguson's Plumbing Supply or something like that, right? So the inventory of this store has to be massively kind of overbuilt in a sense. And we see that it's by far the, you know, kind of the biggest thing they have by far. Now, in terms of receivables, for the most part, they're, they're a cash business.

Um, even contractors come in there and at, at most we'll use a credit card.

And a credit card is technically, we consider it cash because they get settled immediately.

So on any given day, because remember the balance sheet is a moment in time, right? It's a point in time on any given day,

the number of accounts receivable will be very high.

Because Home Depot has a million stores and they're running credit cards constantly. So even in the two to three days, it takes Amex, visa, MasterCard to pay Home Depot to transfer the cash over.

You could still be looking at, at any one moment, a large quote unquote account receivable. But the reality is, is that Home Depot does not really sell on account.

They sell for cash slash credit card. Okay? So that's kind of how Home Depot, you know, drive is driving.

Its its asset side. Now, the other stuff, the other current assets, I mean, it's just a mere pits, right? The 1.5 billion, I mean, that's nothing. I mean, I have that in my checking account, right? That's nothing. But really relatively speaking, it is very small.

So now if we go over to the liability side, you know, what do we see? I'm just gonna insert a row in here and put in Home Depot.

So we don't lose sight of this Home Depo, home Depot, liability side. What we see is that they have a massive accounts payable.

Well, that kind of makes sense, doesn't it? It makes sense because if they've got massive inventories, that means they've got massive supplier bills, massive bills to all of the various companies that fill up their stock, their stock room, you know, Milwaukee Tools, DeWalt you know, Samsung you know, whoever makes all those nuts and bolts and screws and whatnot, right? Stanley Hardware, I mean, just whoever they are, they, that's who Home Depot is money to. And that's a lot accrued salary. That's, you know, they owe they owe some money at any given moment to people that work there.

Not a big deal. Now, deferred revenue is interesting 'cause this never used to be a big part of Home Depots business.

If we were to go back to 2017, 2018, 2019, you would not see a massive amount of deferred revenue here for Home Depot.

But all of a sudden, 2020 comes along, the world goes nuts and supply chains are disrupted, and, and chips can't be found. And, you know, people can't staff their businesses. And all of a sudden now you cannot get parts, you can't get washers and dryers, you can't get refrigerators.

And so Home Depot is taking a lot of orders from customers and taking the cash and then saying, Hey, as soon as that refrigerator comes in, we'll send a truck right over to your house and doing it as well, you know, for apartment buildings where, where they have big accounts and whatnot.

So that's a huge kind of thing that they've got going on there.

So for, um, home Depot that's a good thing, right? Anytime you can take a take in cash and hold onto it, do whatever you want with it until, of course, you have to actually then provide the good or service or this case product, right? Appliance.

So regardless, Home Depot is sitting on a big asset balance, and that asset balance went way up from one year to the next.

So if we think about that from that balance sheet perspective, the asset balance, which is the resource balance, right? Increased. Well, what happens when you wanna increase your resources? What happens when you wanna all of a sudden have more stuff on hand, right? What happens? Well, in order to have more assets, you need to have more funding, asset funding, right? So when we see a company's assets going up, even if we're just focusing on that one chunk of working capital, we're we're learning that their funding needs to go up to, okay, now we've got 10 minutes.

So let me quickly go ahead and switch gears and let me show you Amazon.

So I'm gonna go back to good old Felix.

If there's anybody got any questions on that, please pop 'em in the, the old, uh, chat or q and a, I'm gonna go back to Felix.

Go over from click on Amazon.

Now Amazon's a little bit more complicated of a business than Home Depot. Now why is that? Well, we know Amazon mostly, no, Amazon for in my house, the daily truck that arrives with the stuff that we bought, it's like, oh, I can set my watch by this. Somebody bought something we know them as a massive retailer, right? But they really are a little bit more complicated than that. They've got their best business. Anybody knows their best business, their best business actually is the web services, right? Web services, really the business that separates them.

They've also got a studio, which I think probably, loses money like more than you could possibly imagine. But, and, and they're, they're gonna start charging extra for that too. If you might might've heard that the Amazon Prime business, prime Studio business is kind of, I don't know why they do it, but they do it.

And since the Bloom is a bit off the roads of the streaming business, Amazon's saying, okay, look, we gotta, if we're gonna be in this we've got to we've gotta actually get a little bit more money for it.

So they will start charging people to have Prime Studio, right? But regardless, we're gonna look at their, their company, pretend that they're just primarily a retailer, okay? We're gonna pretend.

So again, we've got 2022 and 2021.

Now are these different years than we're looking at above? Not really, because Home Depot, they call this 2023 because their books close in January.

Very common for retailers, by the way, even though the bulk of the year happened in 2022. Here, Amazon closes their books December 31st. I don't know why they do, it's kind of unusual, but they do. And I gotta quickly go through here and you know, and knock out this OWC calc. I'm gonna, first thing I'm gonna do is I'm gonna get rid of my not my non-current assets and liabilities and get rid of the equity as well.

Wiping out lots of value here. This is total OWL, this is total OWL, and now let's kind of see what's going on. So the first thing I'm gonna do is I gotta get rid of cash and equivalents done. And now I've got my total operating working assets.

And now if I go down to the liability section, they don't even have any short-term financing.

I'm just making sure I didn't delete it accidentally before explaining. They don't even have any short-term financing. They just have working liability accounts operating accounts, payable expenses, and then unearned revenue.

And immediately that should say something to us, right? That should say something to us about this company.

So what's their operating working capital balance? Wow.

Massively negative. Massively negative. And, you know, let's can think about why that is. They have a big inventory, but they're also very smart about their inventory.

Because nobody ever walks into an Amazon warehouse and demands anything right away. They just, you just need it in two days, right? So they have these relationships with distribution centers or, or distributors or I mean, or wholesalers where they can get the stuff quickly into their chain.

And they also probably take their time paying people, which is why this account's payable is so massively high.

and again, similar to Home Depot accounts receivable, well, they're mostly credit cards right on the spot. So at any moment, yes, they might be owed a chunk from credit card company, but they're not really waiting a long time to get paid.

So this account's pretty low. Account's receivable is pretty low.

So if I were to kind of draw this company out, what, what does it look like? Well the funding side of the balance sheet here has kind of stayed, you know, the same from one year to the next. Didn't, it didn't really grow a lot, right? The operating working liability account didn't really grow a ton. So they've kept it pretty consistent from year to year.

But just think about what kind of balance sheet Amazon has.

They have a balance sheet where this OWL account sits on the funding side.

So they've got the operating working capital, they've got their long-term debt and they've got their equity as well. And then they've got their operating assets, right? Their pp e slash operating assets.

And that means that Amazon, by and large is a cash making machine.

And we can kind of see that even just by going up and looking at their cash balance, right? Close to, you know, $70 billion, a little bit over $70 billion in cash, right? Because of the nature of their business, because of the way that they're able to do business, the leverage that they have. And, and really just again, how they've set themselves up.

So Amazon makes enough cash in the holiday season because of this arrangement, because of these accounts, right? To get them through July. That that's a fact.

They make enough cash just from that holiday season, you know, call it November, December, throw October in if you want to get them through the next six months of the year. And then guess what happens in July Prime day? And they create for themselves another mini kind of holiday season over those two days.

Just kind of drives home these accounts even more.

And there you go. There's another couple of months of cash gets them to October.

So coming up on the end of our, you know, of our two hours here, um, that's, you know, my take on working capital.

Uh, I always sort of joke with my colleagues they always say, oh, I could spend all day talking about EBITDA. I don't wanna talk about working.

I could probably spend all day talking about working capital. There's some stuff that we havet even covered in this about the cash cycle and whatnot. And I would encourage you to to take a listen, if we go, you go over to the Felix playlist, there are some topics here that we didn't cover FIFO and LIFO I don't honestly spend a ton of time on because we, I analytically speaking, uh, I don't really, don't really do a lot with it.

It's a good thing to know about, but I can't say in, in my life. I've done a ton with that. It's just a good thing to understand.

Go a little bit further down.

And there's some information here about working capital's, ratios that you could, can calculate. And I think those would be kind of a, you know, a good use of time. If you've got some, some spare time and this is a topic that you know, that comes up in your work, take a look at those. And by all means, you know, feel free to message me as well.

And thank you all very much for your time and I look forward to seeing you next week. We do cash flows, we're gonna pick right up on this next week.

So even if you're a little bit like, I maybe got it, there'll be some review of this next week, believe it or not built into the cashflow study. So I look forward to to seeing hopefully, or knowing you're there, I should say.

I look forward to knowing you're there next week.