What is working Capital?

In a business it can be defined as its current assets less its current liabilities. Current assets comprise cash, stocks of raw materials, work in progress & finished goods, marketable securities such as Treasury bills & amounts receivable from from debtors. Current liabilities comprise creditors falling due within one year, & may include amounts owned to trade creditors, taxation payable, dividend payments due, short term loans, long term debts maturing within one year & so on.

Every business needs adequate liquid resources to maintain day to day cash flow. It needs enough to pay wages & salaries as they fall due & enough to pay creditors if it is to keep its workforce & ensure its supplies. Maintaining adequate working working capital is not just important in the short term. Sufficient liquidity must be maintained in order to ensure the survival of the business in the long term as well. Even a profitable company may fail if it does not have adequate cash flow to meet its liabilities as they fall due.

What is Working Capital Management?

Ensure that sufficient liquid resources are maintained is a matter of capital management. This involves achieving a balance between the requirement to minimize the risk of insolvency and the requirement to maximize the return on assets .An excessively conservative approach resulting in high levels of cash holding will harm profits because the opportunity to make a return on the assets tide up as cash will have been missed.

The volume of Current Assets Required.

The volume of current assets required will depend on the nature of the company business.

For example, a manufacturing company may require more stocks than company in a service industry. As the volume of output by a company increases, the volume of current assets required will also increase.

Even assuming efficient stock holdings, debt collection procedures & cash management, there is still a certain degree of choice in the total volume of current assets required to meet output requirement. Policies of low stock-holding levels, tight credit & minimum cash holding may be contrasted with policies of high stock (To allow for safety or buffer stocks) easier credit & sizable cash holding (For precautionary reasons).

Over-Capitalization

If there are excessive stocks debtors & cash & very few creditors there will an over investment by the company in current assets. It will be excessive & the company will be in this respect over-capitalized. The return on the investment will be lower than it should be, & long term funds will be unnecessarily tide up when they could be invested elsewhere to earn profits.

Over capitalization with respect to working capital should not exist if there is good management but the warning since excessive working capital is poor accounting ratios. The ratios which can assist in judging whether the investment in working capital is reasonable include the following.

• Sales /working capital. The volume of sales as a multiple of the working capital investment should indicate weather, in comparison with previous year or with similar companies, the total value of working capital is too high.

• Liquidity ratios. A current ratio in excess of 2:1 or a quick ratio in excess of 1:1 may indicate over-investment in working capital.

• Turnover periods. Excessive turnover periods for stocks & debtors, or a short period of credit taken from supplies, might indicate that the volume of stocks of debtors is unnecessarily high or the volume of creditors too low.

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However, before trying to access these financial statements, it is important to understand more specifics about Yum’s business model. According to Reuters, Yum “is a quick service restaurant (QSR) with over 34,000 units in more than 100 countries and territories.” These quick service restaurants include consumer favorites such as Taco Bell, Pizza Hut, Long John Silver’s, and KFC. Whether the operating segment sells pizza or chicken, “Yum develops, operates, franchises and licenses a worldwide system of restaurants, which prepare, package and sell a menu of food items.” As each of these fast-food places is obvious to most readers in America, it is also quite interesting that over 100 countries are familiar with these names as well. In fact, segments like KFC were actually introduced in many markets like China before more obvious competitors like McDonalds. Since fast food is generally considered an inelastic, or non-cyclical, good, even during times of economic uncertainty, Yum will prosper. While most of its food is relatively cheap compared to rivals such as Brinker and Darden, consumers will still flock to Yum restaurants in similar volume during any stage of the economic cycle. Therefore, revenue growth should continue to remain steady, but positive, year after year making Yum a great portfolio choice at any time.

To justify this claim, during the past twelve months, Yum received a revenue figure, according to Reuters, of $9.56 billion. This number was a 5.05% increase compared to the previous year number. While this increase in margin was a bit below the average year-to-year increase of 6.58%, the difference in growth decline was only a 23% difference. Other companies like Brinker saw a 43% deceleration during this same time period. In addition, while some investors may critique the industry 11.31% growth in sales during the past to Yum’s lower numbers, it is also important to realize that Yum supports the seconds highest sales figure in its industry, and appreciation of revenue growth will be much difficult than smaller-capitalization companies to come-by. This is in addition to the fact that many lower-revenue companies in this industry are actually seeing negative sales growth (not deceleration) during the same time frame as the aforementioned analysis. With these thoughts on sales at hand, these numbers can be used at the broadest of levels to illustrate that the steady increase and influx of money into Yum over its career has aided in the appreciation of its share price. Since 2003, not once has Yum seen a calendar year decrease in price. This comes with a 25% appreciation in 2006 and a 12% escalation so far in 2007—despite the recent economic turmoil. These sales and share price indications illustrate that Yum will fair very well during all types of economic activity.

Nevertheless, revenue cannot be the only financial analysis required to find superior companies. It is vital to understand how efficient a company is in reducing costs and using capital and labor to actually produce the final good. These intangible-sounding comparisons can actually become tangible given the use of margins. Starting from gross margins, investors should be happy to find out that over the past twelve months, growth at 25.69% has been higher than the pervious five year average of 24.82%. While the former is a bit below the industry’s average of 29.04%, it is important to stress that Yum’s revenue is the second highest in a fairly large industry, making outstanding margins difficult to come by. Nevertheless, compared to close revenue competitors, Yum’s gross margins are better than Starbucks’s (23.62%), Darden’s (23.50%), and Brinker’s (16.42%). In addition, Yum’s operating margins of 13.14% are not only higher than its five year average of 12.84%, but is doing better than the industry’s twelve month margin of only 11.76%. Moreover, these operating figures for Yum are also better than the same-time period numbers of Starbucks (11.18%), Darden (9.53%), and Brinker (7.87%). While these numbers all indicate growth for Yum, the biggest instrument (that will be justified later with valuation tactics) is earnings differences. Fortunately for Yum, a 16.27% increase in earnings per share over the past year is 29.74% higher that the company’s five year average increase. Compared to competitors, all three of Brinker, Darden, and Starbucks saw a deceleration of earnings growth last year, and none of these yearly increases matched the top-revenue producer, Yum.

While there is clear evidence that Yum is great growth story, some investors may wonder whether Yum is overvalued given its success. Fortunately for these investors, this is not the case. In fact, some potential shareholders may make the claim that Yum is undervalued. Currently the industry has a P/E multiple of 31.88 and a price to sales ratio of 2.10. However, if analyst expectations are correct or and underestimate actual results (5/5 and 4/5 correct or below last five quarters for EPS and sales respectively), Yum sees a forward price to sales ratio 1.79 and price to earnings ratio of 20.18. Now while these numbers are not extraordinarily undervalued, as companies like Darden have slightly lower figures, compared to the industry as a whole and competitors like Starbucks (2.25 price to sales and 31.48 price to earnings), Yum’s valuation is far from being labeled as a negative characteristic. Therefore, given good growth reports and not too much speculation relative to share price, there is strong news from both further financial achievement and valuation.

However, before reaching a final conclusion, there are some other indicators to look at. One of these criteria is management efficiency. According to Reuters, Yum had seen a 60.80% ROE figure for the past twelve months. While a bit smaller than the five year average, the number easily obliterates the industrial average and all three aforementioned market-cap competitors. This figure illustrates that Yum is not only increasing its net profit year after year, but helping investors by purchasing back some of its stock. Although capital spending is a bit below industrial averages at -0.70% over the past five years for Yum, the company still has a healthy balance sheet of cash, especially compared to its price (undervalued). In addition, efficiency also comes from the company’s turnover ratios. Receivable turnover at 41.62%, inventory turnover at 80.93%, and asset turnover at 1.61% are all quite above the industrial averages and many competitor averages as well. Solvency with a current ratio of 0.59 is quite low, but inline relative to the rest of the industry, but fast food restaurants need not to worry too much about liquidating assets. In addition, 83.13% of equity for Yum is owned by institutional investors. This number is above the industrial figure at 74.07% and also above Darden’s and Starbuck’s respective numbers. While there are many intelligent retail investors, having the real experts in institutional investors carry the bulk of the company shows optimism for future performance. And in additional to this control, another enticement in a 1.81% dividend yield should also help investors relay this company into more hands at a higher share price.

Looking at the business model and fundamental features, there is strong evidence to support that investing in this company will yield strong returns. Technically speaking, the share price of Yum just recently crossed both the 50 day SMA and EMA—a bullish signal, and while there is encouragement to invest any time to profit from this company, now would be an almost ideal situation. Therefore, with the above information provided to benefit long term investors, it is closely assured that investing in YUM! Brands will produce genteel capital gains for shareholders.

Dennis Biray presents advice on all kinds of topics ranging from finance and investing to fitness to sports. For more information email him at dbiray@gmail.com, or to view other articles written by him visit http://www.biraynetworks.co.nr