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Type of Securities Investment Strategies Fundamental Analysis Technical Analysis
Understanding Financial Statements Income Statement Analysis Balance Sheet Analysis Cash Flow Analysis Shareholders' Equity Analysis Ratios and Definitions

Balance Sheet Analysis

 - Leverage and financial
   strength affect share value

 - Liquidity concerns can
   decimate a business

 - Cash is critical, to a point
    * Window Dressing
    * Cash Gap
    * Cash per Share
    * Burn Rate

 - Marketable Securities

 - Receivables are interwoven
    with cash flow
    * Past Dues and Write-offs
    * Receivables turnover ratios
    * Securitizations

 - Inventory - focus on the
   profit margins
    * Perpetual vs. Periodic
    * Inventory Accounting
    * Inventory Costing Methods
    * Lower of Cost of Market
    * Inventory Categories
    * Inventory Turnover Ratios

 - Fixed assets are necessary in
   order to be a world class

 - Liabilities with equity attributes
   are enriching

 - Emphasizing debt net of cash
   can be misleading

 - Book value is a tool to
   properly evaluate a stock

 - Off-balance sheet assets and
   liabilities are legal



Liabilities with equity attributes are enriching

I’m introducing a concept that I call “liabilities with equity attributes.” These are certain liabilities that have many of the characteristics of equity and that add value to investors without any of the associated cost. They include customer cash advances, accounts payable purchases, and deferred income taxes, and are usually reflected on the balance sheet as liabilities, or in deferred revenue accounts. Economically, if the company has unrestricted use of the cash, and the balances are steady from year-to-year, then they constitute a form of temporary equity.

These liabilities with equity attributes add to the profitability of a company, by reducing the amount of debt or equity financing a company needs, and improving its leverage and profitability ratios. This results in a positive impact on the stock price of the company, with increased EPS, as well as a higher P/E ratio.

Listed below are some examples:

Customer contributed equity – These are normally customer cash advances for future services (Unearned Revenue).

Moody’s Corporation is a good example of a company with customer contributed equity. As of December 31, 2006 their liabilities reflect $360 million of current deferred revenue advances, plus another $102 million of non-current deferred revenue advances. This represents money that was collected or accrued as a receivable, (and therefore could be borrowed against), for future rating agency fees and monitoring services. Moody’s creative billing feature acts as equity, and is one of the reasons a company with a relatively insignificant book value, of $167 million, commanded a market capitalization of approximately $18 billion in March, 2007.

Supplier contributed equity – These are supplier accounts payable. Many suppliers offer extended credit terms to their customers without any formal lending security agreements. This can enable the purchasing company to convert the merchandise into cash, which can be used in their operations until the credit terms become payable. In effect, these suppliers are providing free short-term financing. If one’s business is non-cyclical and consistent in nature, then this supplier financing essentially has many of the same characteristics as equity.  

Government contributed equity – The government offers various forms of temporary tax relief to companies, in order to stimulate the economy. The best known of these techniques is the use of accelerated tax depreciation. This and other tax incentives give companies larger tax deductions, or reduced taxable income, deferring their tax payments. These benefits are hopefully reinvested in additional capital purchases that will aid in growing the company. This generates jobs, more profits, and eventually more taxes for the government. These initial tax savings are reported on the balance sheet as deferred taxes. Individually, these tax benefits reverse as the transaction unfolds, but in a consistently growing business, the aggregate amount of the cash tax savings actually grows and is always outstanding.  This gives the organization a free source of capital that can be used to grow the business, similar to how equity dollars are invested.

Properly analyzing the book value section of the balance sheet can aid in making profitable investment decisions.

The unrestricted use of interest free funds can give a nice boost to a company’s stock price.




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