Invested Capital

Hi All,

I am just analysing my first company and calculating ROIC.
The company is a travel agency that has a substantial amount of client funds held has cash.

The client funds are an asset in Cash.
And a liability in Accounts Payable.

I am using the Finance Approach to calculate Invested capital and I would like to subtract cash.

Because the clients funds are not a part of any ST or LT funding source, the amount is not apart of invested capital. When I subtract the entire cash balance it reduces Invested Capital to almost zero.

1) What is the correct procedure for situations like this?
Do I simply subtract client funds from the cash balance and simply subtract the adjusted cash balance?

2) If analysing the entire market, is there a better way to adjust for these situations to get a ball park result? For example could Accounts payable be included invested capital?

Thanks in advance for suggestions.

 
I am using the Finance Approach to calculate Invested capital

This is your problem right here. Use the method laid out in the McKinsey valuation book. The finance method is a very inaccurate way to calculate invested capital.

The company is a travel agency that has a substantial amount of client funds held has cash.

The client funds are an asset in Cash. And a liability in Accounts Payable.

Assuming that 100% of client funds are held in cash and not used at all in the business, the net effect of this transaction on invested capital is zero. However, usually with these types of arrangements the business either gets to use the posted cash or at least captures the interest generated by it, either of which boosts ROIC.

 

Thanks for the reply.

For my understanding, are you able to provide a typical example of where the finance approach to invested capital falls short?

I do have the McKinsey Valuation book and tried that approach first.

The reason why I ended up using this method is because I just kept finding example after example of where data providers would miss-classify items. When calculating invested capital for 2000 companies, the finance approach seemed quite reliable in comparison.

When analysing a specific company I can go through the balance sheet myself - point taken there.

I would be interested to know what common scenerios make the finance approach unreliable if you have time to reply.

Thank you

 
Best Response
For my understanding, are you able to provide a typical example of where the finance approach to invested capital falls short?

You pretty much answered your own question with this:

The company is a travel agency that has a substantial amount of client funds held has cash.

The client funds are an asset in Cash. And a liability in Accounts Payable.

A lot of companies receive prepayment or collateral from customers and then invest this in marketable securities. For example, this is common with many stock exchanges. Using the finance method, you would be undercounting invested capital since you would be deducting marketable securities, but not accounting for the working capital liability.

Goodwill is also another common example. There is great debate about this, but IMO goodwill should not be included in invested capital.

The reason why I ended up using this method is because I just kept finding example after example of where data providers would miss-classify items. When calculating invested capital for 2000 companies, the finance approach seemed quite reliable in comparison.

The finance method might be better if you're running a large screen. However, I've still found that the operating approach tends to produce better results. If you're screening through thousands of companies you're going to end up with some screwy results either way. That's when your experience and judgment as an analyst comes into play.

 

Hi TwoSocksBobby, don't worry, the WSO Monkey Bot is here.... I'm hoping one of these links will help find your answer:

  • Goodwill Creation for Minority Investment Deal Shareholders' Equity in Balance Sheet. Then we have to do the balance sheet adjustment: allocate the purchase ... goodwill creation in a minority investment / Growth Capital model? My previous thought is that minority ... Uses table, Purchase Premium Allocation table and Balance Sheet Adjustment table? O
  • Calculation of Goodwill in Acquisition? their balance sheet was acquired for $140M. We wrote down all their assets to equal the $140M. ... Can someone verify for me how to calculate Goodwill in an LBO? I think it's: Equity Purchase ... a write up of intangible assets and PP&E along with goodwill usually account for the difference. ...
  • Goodwill on a balance sheet When you see goodwill on a balance sheet, how is it analyzed with regard to a company's ... understand if it's really a negative? And so on. Goodwill analysis ... financial strength? I guess when one sees impairments of goodwill it would generally indicate poor company ...
  • Check Projected Balance Sheet based on your experience, which item on the balance sheet is the most difficult to estimate? Many ... sheet. Knowing that Assets = Liabilities + Shareholder's Equity balancing the statement is a matter ... balance sheet should be driven by projections that are made on the income statement, statement of cash ...
  • For valuation gurus: ROIC and goodwill partially reflect the growth assets of the firm? Seems to me like goodwill is something that was paid for ... a company issuing equity and boosting its APIC. Does the "invested capital" in that case not also ... goodwill. I read through Greenblatt's guide that says no because goodwill does not need to be ...
  • M&A, Goodwill and the purchase acct. method Mcgee's fair value market cap, and the goodwill is placed on the asset side (balance sheet) of the new ... for on Anardarko's new balance sheet? If Anardarko payed a premium of $10 bn, over Kerr ... entity, how does the SE/Liabilities side on the balance sheet balance
  • Valuation Question- Have some trouble valuing a few BS items on this company Hey guys, I'm having some trouble valuing a few balance sheet items on this company. How do ... and non-consolidated subsidiaries? Also, how should I treat goodwill and other intangible assets on ... the balance sheet? I always assumed goodwill just to be a "plug" number and did not include ...
  • More suggestions...

No promises, but thought I'd mention a few relevant users that work in the industry: alpinespringwater Yayseeqay roshanmahtani

Hope that helps.

I'm an AI bot trained on the most helpful WSO content across 17+ years.
 

Autem ea aut suscipit architecto voluptates ullam. Placeat iste saepe voluptates consectetur et.

I'm an AI bot trained on the most helpful WSO content across 17+ years.

Career Advancement Opportunities

March 2024 Investment Banking

  • Jefferies & Company 02 99.4%
  • Goldman Sachs 19 98.8%
  • Harris Williams & Co. (++) 98.3%
  • Lazard Freres 02 97.7%
  • JPMorgan Chase 03 97.1%

Overall Employee Satisfaction

March 2024 Investment Banking

  • Harris Williams & Co. 18 99.4%
  • JPMorgan Chase 10 98.8%
  • Lazard Freres 05 98.3%
  • Morgan Stanley 07 97.7%
  • William Blair 03 97.1%

Professional Growth Opportunities

March 2024 Investment Banking

  • Lazard Freres 01 99.4%
  • Jefferies & Company 02 98.8%
  • Goldman Sachs 17 98.3%
  • Moelis & Company 07 97.7%
  • JPMorgan Chase 05 97.1%

Total Avg Compensation

March 2024 Investment Banking

  • Director/MD (5) $648
  • Vice President (19) $385
  • Associates (86) $261
  • 3rd+ Year Analyst (13) $181
  • Intern/Summer Associate (33) $170
  • 2nd Year Analyst (66) $168
  • 1st Year Analyst (199) $159
  • Intern/Summer Analyst (144) $101
notes
16 IB Interviews Notes

“... there’s no excuse to not take advantage of the resources out there available to you. Best value for your $ are the...”

Leaderboard

1
redever's picture
redever
99.2
2
BankonBanking's picture
BankonBanking
99.0
3
Betsy Massar's picture
Betsy Massar
99.0
4
DrApeman's picture
DrApeman
98.9
5
Secyh62's picture
Secyh62
98.9
6
dosk17's picture
dosk17
98.9
7
CompBanker's picture
CompBanker
98.9
8
GameTheory's picture
GameTheory
98.9
9
kanon's picture
kanon
98.9
10
bolo up's picture
bolo up
98.8
success
From 10 rejections to 1 dream investment banking internship

“... I believe it was the single biggest reason why I ended up with an offer...”