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.
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.
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
You pretty much answered your own question with this:
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 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.
Thanks for taking the time to reply, I really appreciate your insight.
Thanks again
Adjusting Goodwill on Balance Sheet for Invested Capital calculation (Originally Posted: 02/23/2018)
When calculating Invested Capital in a firm with goodwill and intangibles the McKinsey Valuation book says to adjust it by adding back any impairments. Their rational is "unlike other fixed assets goodwill and acquired intangibles don't wear out". Is this just the author saying that because you can't write up the value of goodwill (under GAAP, I think IFRS has a "recoverable amount" that you can write up impairment IIRC) you might as well use the historical cost? Or is there another reason to add back impairment to goodwill in order to generate invested capital?
Follow up question; Since impairment is typically a temporary income statement account does that mean I have to go back through all the 10-Ks and get accumulated impairments, or are those usually in the notes?
Hi TwoSocksBobby, don't worry, the WSO Monkey Bot is here.... I'm hoping one of these links will help find your answer:
No promises, but thought I'd mention a few relevant users that work in the industry: alpinespringwater Yayseeqay roshanmahtani
Hope that helps.
mutual fund switch and invested capital (Originally Posted: 11/06/2017)
Hey,
How can we identify a switch transaction in a wealth management platform?
A switch transaction is a sell/buy transaction we receive from the back office and we have no means to match those transactions to consider them as a switch.
Do you guys have an idea or a logic to manage fund switches effectively?
What conditions should be concidered to identify switches?
thnx
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