Views
Notes
Folders
Read
Financial Modeling 101: Part II - Balance Sheet, Working Capital and Cash Flow Items
Follow Video Tutorial Along With Note
Excel File Shown In Video Is Available In Part III
In Part I - Revenue and Income Statement Build-Up we discussed creating drivers for future revenue of NVIDIA and how to calculate operating and non-operating expenses as a function of revenue or driven by other factors.
Revenue and costs are recognized based on revenue recognition accounting rules. But often there is a timing mismatch between when items are revenue is recognized or costs expensed on the income statement and when cash goes in or out the door. Those differences are picked up in the balance sheet and cash flow statement as asset and liability line items and changes in those line items.
Balance Sheet, Working Capital and Cash Flow Items
Working capital is current assets less current liabilities. It is cash that is consumed or produced by the balance sheet rather than income statement. Cash flow before working capital (also known as Funds From Operations, or "FFO") tells you how much cash the business generated in any one period whereas cash from operations ("CFO") equals FFO plus or minus the change in working capital.
Using historical metrics as a guide post for reasonable future assumptions, we can use income statement and balance sheet line items to calculate three important working capital items for the balance sheet:
•
Accounts Receivable ("AR") Turnover = revenue divided by accounts receivable
•
AR Days = 365 / AR Turnover
•
AR = revenue recognized but unpaid
•
Higher AR is a USE OF CASH and lower AR produces cash
•
Accounts Payable ("AP") Turnover = cost of revenue divided by accounts payable
•
Days Payable = 365 / AR Turnover
•
AP = expensed but unpaid costs
•
Higher Payables PRODUCE cash while the opposite is true
•
Inventory Turnover = costs of revenue divided by inventory
•
Inventory days = 365 / Inventory Turnover
•
Inventory = goods and materials that will be converted into revenue
•
Like receivables, higher inventory uses cash - it is the case that higher current liabilities generate a working capital benefit, whereas higher current liabilities produce cash
•
Additional current asset or liability line items can be calculated as a percentage of revenue
•
Prepaid expenses and other current assets
•
Accrued and other current liabilities
•
Other current liabilities
•
Once calculations are done to produce all needed working capital line items on the balance sheet, the differences between the current and prior year can be calculated to show the cash flow statement impact of those changes
•
Using historical data and prior year net plant, property and equipment ("PP&E"), together with capital expenditures ("Capex") assumptions, and depreciation and amortization ("D&A") from the cash flow statement, future PP&E and D&A can be derived
•
Historical net PP&E divided historical D&A = average remaining life of PP&E
•
Capex is calculated as a % of revenue
•
D&A = beginning PP&E divided by average remaining life + a partial period of depreciation current year Capex
•
Beginning PP&E + Capex - D&A = Ending PP&A (tie to balance sheet)
•
Street estimates for Capex can be used as a reasonableness check
•
We can now start to build the cash flow statement
•
Net income (+)
•
D&A (+)
•
Stock compensation (+)
•
Deferred taxes (+/-)
•
Other non-cash charges(+/-)
•
Change in working capital (+/-)
•
= Cash from operations
•
Capex = investing cash flow
Margin expansion can be seen in scaling metrics (revenue growing faster than costs), but ultimately also shows up as cash flow margin (FFO) expansion. Think of FFO margin like this: for every $1 in revenue, how much cash does the business generate. The improving cash flow NViDIA has seen in recent years was foreseen in 2015.
Unidentified Participant So assuming that the revenue continues to grow at a healthy clip and the team continues to drive an OpEx growth that is lower than the revenue growth, obviously that still paints a picture of margin expansion. We have the team delivering low 20% operating margins this calendar year. Longer term where can the upper end of the operating margin spectrum be?
Reference Materials
•
•
•
•