Gennaro Cuofano's Blog, page 247

The Innovative Business Models Using Blockchain Technologies

As more startup are springing up on Blockchain technologies, it is normal to see the proliferation of Blockchain protocols that promise to disrupt any industry. Just like when the web started to become mainstream, thanks to technologies like search engines.

We assisted to the birth of many search engines that made the search market fragmented; up to when Google became so dominant to tame most of the search market share.

Are we assisting also today to a similar phenomenon? We might be. In fact, when new technologies come about, competition initially is the norm.

Eventually, due also to the lack of regulation and the inability of bureaucrats to keep up with technological advancements, a few players dominate the market until they create real monopolies.

As of today, according to GS Statcounter, Google still dominates the market and there is no reason to believe it won’t:

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Unless of course, regulators won’t break those monopolies. This also happened at the beginning of the century, when people like Andrew Carnegie, J.D. Rockefeller, and Henry Ford were so wealthy that they would dwarf today’s billionaires.

Today we’re assisting to a similar phenomenon in the cryptocurrency and Blockchain space. Many players were birth in the last years. A countless number of ICO happened, and many other cryptocurrencies got created.

In the short term, all this noise is a normal process of evolutionary selection of what it will eventually survive. Given the Lindy Effect, the Bitcoin as the first cryptocurrency which laid out a Blockchain protocol should survive at least other nine years (as it began in 2009). Of course, this is a probabilistic rule it’s not a certainty.

Yet beside what it will survive and what not I think there’s a compelling reason why the Blockchain protocols will be so critical for the future of entrepreneurship.

The blockchain as a business model toolbox for innovation

When the web kept growing at an exponential pace, new companies and innovative business models sprouted up. On this blog, I have spoken at length about the innovation introduced by Google Business Model and why I believe this is what made it so successful.

The paradox though is that what seemed an innovative business model a few years back, it seems an ancient business model today. In fact, when you think about the hidden revenue generation model of Google and Facebook through advertising. This model today seems old for several reasons.

First, it is not aligned with the users’ interest. Right, users get free services but at what price? Second, as those models manage people’s data, they’re also responsible for that data.

With recent GDPR regulation, one might wonder whether that data which was an asset might instead turn as the most significant debt for both Google and Facebook.

The third, most critical point is connected to the previous two. As those companies have grown so large and powerful, many believe they will keep growing at that pace forever.

This belief in part is due to the high profitability of companies like Google and Facebook. Yet, although very profitable those companies are also very very fragile.

Tech giants that today dominate were allowed to do so also based on traditional economics beliefs (like economies of scales are good, large is more efficient and standardization wins). Now that new decentralized technologies, like the Blockchain have come about.

There is no more justification to believe that a large organization should be run by a few dictators taking most of the profits. In fact, the first element of a Blockchain is the ability to run a large organization in a decentralized manner.

One could start to wonder if we still need all those boards of directors, super paid executives, or people which only work is to manage other people.

The blockchain challenges all that. And in a way, it gives us the flexibility to experiment with new, innovative business models.

Let’s see some interesting ideas in the blockchain world. Remember, if you’re reading this article after a few years it might be that one, some or all of them turned out to be unsuccessful attempts.

Yet, I believe it will be undeniable that those unsuccessful attempts might have led to some great successes.

Bitpress for fact-checking

Bitpress is developing a framework that in a way should allow a better, bottom-up fact-checking mechanism. Will this succeed? Hard to say. There is one aspect though that I think is might be critical.

In their PageRank mechanism, they want to allow publishers to express an opinion on the resources they link to. In fact, those links can carry a vote which isn’t necessarily positive, but it can also have a negative connotation.

In other words, Google’s PageRank has also been built on the assumption that links are good votes that a site passes along another site.

Just like in academia, where referencing to another author means a favorable vote. So Google’s PageRank has used the same mechanism to rank web pages.

This has opened up manipulations and drawbacks. For instance, as of today nonetheless, the sophistication of Google’s new algorithms driven by AI, things like private blog network or PBN (a network of websites that exchange links from each other) are still a reality.

Those not only might be a mechanism that still works to rank web pages. But it also requires a lot of resources from Google to catch up with those networks. In fact, as of now, besides intelligent algorithms; Google might have a militia of engineers browsing the web to find those networks and blacklist them!

Would Bitpress mechanism prove successful?

What Is Bitpress? The Fact-Checking Blockchain Protocol for Digital Publishing

Steemit for getting paid as a publisher

I got passionate about the Steem Blockchain the day I’ve read their white paper and when I started to experiments with the many apps sprouted up on this blockchain.

The most exciting part of this blockchain is the way it allows its community to monetize while either curating or writing content.

In short, Steemit and other Steem Blockchain apps, pay their users to do what they already do on another social network, for free. This model has still proved to be sustainable in the long run and as I explain in this article there are still some challenges.

However, if this model proves effective, it might become the next big thing to take over purely centralized giants like Facebook, Reddit, and Quora.

What is Steemit? The Decentralized Social Network That Is Challenging Facebook Business Model

Dock.io for professional data management

A company which most crucial asset is made of the data of its users will make sure to preserve it. However, as short-term logic might prevail by time to time, those companies will also try to profit as much as possible from that data.

This places the company owning the data in the conflict of interests with its users. For how much that company is comprised of smart individuals. Conflict of interests and the way the system works might well make those companies mismanage the data.

Dock.io is envisioning a decentralized way to manage professional data, which gives ownership to the users and have them choose which third parties can reuse that data.

What is dock.io? The Decentralized Professional Network That Gives Data Back to Its Users

Key takeaway

What I find most striking of the new Blockchain protocols that are getting created is that those allow the experimentation of new business models that challenge the old ones.

The old business models that were designed with the rise of the web, the search industry, and the social media industry have led us to the creation of tech giants that have vast power and control over our data.

The Blockchain allows us to challenge that. Of course, those same tech giants might also take advantage of those protocols for their own sake. And we can even envision the rise of new tech giants that will be built on top of blockchain protocols.

However, what seems good to me is the intrinsic decentralized nature of those models.

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The post The Innovative Business Models Using Blockchain Technologies appeared first on Four-Week MBA.

A Quick Glance At Inditex, The Spanish Fast Fashion Empire

With over €25 billion in sales in 2017, the Spanish Fast Fashion Empire, Inditex, which comprises eight sister brands, has been able to grow over the years thanks to a strategy of expansion of its flagship stores in exclusive location around the globe. Its largest brand, Zara contributed to over 65% of the group revenue. The country that contributed the most to the fash fashion Empire sales was Spain, with over 16% of its revenues.

Inditex business model

Inditex is the holding that controls a set of brands, among them, Zara, one of the dominating brands in the fast fashion industry. In 2017, Inditex comprised eight brands:

Zara
Pull&Bear
Massimo Dutti
Bershka
Stradivarius
Oysho
Zara Home
Uterque

The holding, Inditex, continued to focus on commercial initiatives to grow the value of each brand, to expand its stores worldwide and to build up the e-commerce platforms. Let's have a quick overview of each brand part of the Inditex Holding.

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Zara

Zara is by far the largest brand of the group, which in 2017 made over €16.5 billion in sales and it represented over 65% of the net sales of the group. With its massive flagship stores around the world (Madrid, Venice, Mumbai and many others) Zara created a large recognized brand in the fast fashion industry. The company also extended its online presence in Southeast Asia and launched www.zara.com in Malaysia, Singapore, Thailand Vietnam, and in India. With

Pull&Bear

Pull&Bear with its over €1.7 billion in net sales represented almost 7% of the net sales of the group. The company has also opened up new flagship stores in exclusive locations around the world (like Rue de Rivoli in Paris, Ermou in Athens, and One World in Bangkok).

Massimo Dutti

Massimo Dutti made over €1.7 billion in net sales, which represented about 7% of the net sales of the group. The company expanded with its new stores in Valencia, Milan. Just like Zara flagship stores, Massimo Dutti position itself in exclusive locations, but with a minimalist interior design to convey a different style, compared to the sister brands.

Bershka

After Zara, Bershka is the largest of the sister brands in terms of sales, in 2017. Indeed, the company made over €2.2 billion, and it represented almost 9% of the total group sales. Just like its sister brands, Bershka also collaborates with influencers to enhance its brand awareness. Like the campaign with the Italian rapper, Fedez (Fedez for Bershka). The company also expanded its operations by opening up pop-up stores in New York and Rome.

Stradivarius

Stradivarius made almost €1.5 billion in 2017, which represented about 6% of the group total sales. Like its sister brands, the company has inaugurated a new flagship store in Barcelona.

Oysho

With a turnover of almost €570 million, Oysho represented over 2% of the net sales of the group. The Spanish clothing retailer of in women's homeware and undergarments expanded by bringing its store to Barcelona, Madrid, Milan, Doha, Moscow, Paris, Tunisia, Istanbul, Dubai, and Bali.

Zara Home

With €830 million in revenues, which represented over 3% of the group net sales, the company opened its first stores in Armenia, Belarus, Israel, the Czech Republic, and Tunisia.

Uterqüe

Uterqüe focused in manufacturing fashion accessories, and garments made €97 million in 2017, which represented less than 1% of the group total sales. The company launched its first collaboration with Pablo Thecuadro, and it opened its flagship stores in Barcelona and Madrid.

Inditex values, and key partners

Inditex group core values can be summarized in:

1. Strong customer focus

2. Modesty

3. Self-reliance

4. Non-conformism

5. Team work

6. Creativity

7. Diversity

8. Innovation

The principal partners of the group are:

Employees, considered as any person who works for Inditex Group stores, offices or logistics centers.
Customers, as anyone who purchases a product sold by Inditex Group’s eight sister brands.
Suppliers as companies that are part of Inditex supply chain
Community, as all people or entities that are part of the context of Inditex
Shareholders as any individual or entity that owns Inditex Group shares.
Environment, as part of Inditex attempt to build a sustainable business model.

Inditex integrated model 

Inditex follows an integrated model, where the customer journey is driven across several channels, but with a continuous dialogue, from store to online channels, Inditex creates multiple touchpoints with its brands.

Reference for the analysis: Inditex Annual Report 2017

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What Is a Financial Ratio? The Complete Beginner’s Guide to Financial Ratios

A financial ratio is a metric usually given by two values taken from a company’s financial statements that compared give five main types of insights for an organization. Things such as liquidity, profitability, solvency, efficiency, and valuation are assessed via financial ratios. Those are metrics that can help internal and external management to make informed decisions about the business. 

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The aim of the ratio analysis isn’t necessarily to give an answer by looking at a single metric. In many cases to have an overview of the business, it is critical to look at several metrics. Almost like in a decision tree that branches out. That is how we find answers!

Why Ratio Analysis?

Ratio Analysis allows us to answer questions such as: How profitable is the company? Will the organization be able to meet its obligations in the short and long-term? How effectively is the organization using its resources?

Of course, some of the ratios (such as the profitability ratios) if not assessed against other ratios do not mean anything. Also, if you want to know more about one company you have to analyze it in comparison with other companies which present the same characteristics, such as industry, geography, customers and so on.

For example, if you are performing an analysis on Apple Inc., you cannot compare its ratios with Coca-Cola. Instead, you should compare Apple Inc. with Samsung or Microsoft. 

Therefore, the ratio analysis is a tool that gives you the opportunity to interpret the information provided by the P&L and BS to understand how the business is operating in the marketplace.

Financial Ratio Analysis and interpretation

By looking at the primary financial statements (Balance Sheet and Income Statement), you won’t be able to find an answer unless you ask the right questions. 

Although the financial statements give you already a great deal of information about the business, there is still something missing. Financial ratios are a simple way to interpret those financial statements to extract critical insights to assess a company from the inside or the outside. 

In short, either you are a manager looking for ways to improve your business. Or you’re an analyst trying to figure out insights about an organization whose financial ratios will help you out. 

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Key financial ratios

There are several financial ratios to assess the health of a business.  Sone of the key ratios used by managers include the following:

Current Ratio
Quick Ratio
Operating profit margin
Net profit margin
Debt to equity ratio
Inventory Turnover
Return on equity
Earnings per Share
Return on assets

As we’ll see through this guide the choice of a financial ratio is also in accordance to the industry and business models we’re analyzing.

Types of financial ratios

Financial ratios are great “financial heuristics” to have a quick glance at a business performance. Those financial ratios, in particular, help us assess five things:

Liquidity
Profitability
Solvency
Efficiency
Valuation

Each of those aspects it’s essential for a business sustainable short and long-term growth.

What is liquidity?

Liquidity is the capacity of a business to find the resources needed to meet its obligations in the short-term. 

For such reason, the liquidity on the Balance Sheet is measured by the presence of Current Assets in excess of Current Liabilities or the relationship between current assets and current liabilities.

Why do we need to assess the liquidity of a business?

For several reasons; Imagine, you are establishing contact with a new supplier. There is no precedent history between you two. The supplier wants some sort of guarantee that you will be able to meet future obligations. 

Therefore, he asks for a credit report about your organization. This report shows whether an organization has enough liquidity to sustain its operations in the short-term. 

How? Based on the main liquidity ratios of your organization a rating will be assigned. The rating is a grade the organization gets if it meets specific criteria. 

Based on that rating the supplier will decide whether to entertain business with you or not. Of course, the Rating itself is more qualitative and quantitative. 

In other words, the numbers provided by the liquidity ratios will be intersected with other metrics (such as profitability ratios and leverage ratios). 

Another example, imagine you want to open an overdraft account with a local bank. The same scenario applies since the local bank will assess your credit score before approving the overdraft. Thereby, the bank will look at your BS and see how liquid the organization is.

What are the main liquidity ratios?
Current Ratio

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This ratio shows the relationship between the company’s current assets over its current liabilities. It measures the short-term capability of a business to repay for its obligations:

Current Assets /  Current Liabilities

Example: Imagine, your organization, in Year-Two has total current assets for $100K and total current liabilities for $75K. Therefore: 100/75= 1.33 times. Your Current ratio is 1.33.

Is it good or bad? Well, it depends.

You have to compare this data with the previous year ratio. Also, it depends on the kind of industry you are operating within. Of course, a clothing store or specialty food store will have a much higher current ratio. 

Thereby the current assets will be 4 or 5 times the current liabilities, mainly due to large inventories. Other companies, such as the ones operating in the retail industry can have current ratios lower than 1, due to favorable credit condition from their suppliers. 

This allows them to operate with a low level of inventories. For example, companies such as Burger King will have a ratio as high as 1.5, while companies such as Wal-Mart as low as 0.3.

Quick Ratio (Acid or Liquid Test)

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On the Balance Sheet (BS) the items are listed from the most liquid (cash) to the least liquid (inventories and prepaid expenses). The first section of the BS shows the current assets subsection (part of the Assets section). 

Current Assets are those converted in cash within one accounting cycle. Therefore, while the current ratio tells us if an organization has enough resources to pay for its obligations within one year or so, the Quick ratio or acid test is a more effective way to measure liquidity in the very short-term. Indeed, the quick ratio formula is:

Liquid Assets / Current Liabilities

How do we define liquid assets? Liquid assets are defined as Current Assets – (Inventory + Pre-paid expenses). Although inventory and pre-paid expenses are current assets, they are not always turned into cash as quickly as anyone would think.

Example: Imagine that of $100K of current assets. Of which $80K are liquid assets, the remaining portion is inventory. The liability stays at $75k. 

The quick ratio will be 1.06 times or $80K/$75K. Therefore, the liabilities can be met in the very short-term through the company’s liquid assets. To assess if there was an improvement on the creditworthiness of the business we have to compare this data with the previous year. 

Although, a quick ratio of over 1, can generally be accepted, while below one is usually seen as undesirable since you will not be able to pay very short-term obligations unless part of the inventories is sold and converted into cash.

Absolute Ratio

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This is the third current ratio, less commonly used compared to current and quick ratio. If the quick ratio is more stringent in comparison to the current ratio, the absolute ratio is the strictest of the three. This is given by:

Absolute Assets / Current Liabilities

Liquid assets – Accounts receivable = Absolute Assets. Generally, cash on hand and marketable securities are part of the absolute assets. The purpose of the absolute ratio is to determine the liquidity of the business in the very short-term (few days).

Using one current ratio or the other is really up to you, and it depends on the kind of analysis performed. Of course, if you want to know if an organization would be able to pay in the three-month time frame, then, the Quick Ratio may be a more appropriate measure of liquidity compared to the Current Ratio. 

In addition, I find much more reliable the Quick Ratio compared with the other two Liquidity Ratios. For two simple reasons, on the one hand, the Current Ratio is not stable enough to tell whether a company will be able to meet its obligations in the short-term since it comprises items such as Inventories and Prepaid Expenses which are hardly converted into cash. 

On the other hand, the Absolute Ratio takes into account just those items, (Cash, cash equivalents and short-term investments) which are very volatile. Indeed, I would not be surprised if you saw the Absolute Ratio swinging from one excess to the other. 

In fact, companies usually invest their cash right away in other long-term assets that will produce future benefits for the organization. Therefore, unless you are Microsoft, which saves billions in cash reserves, I would not rely on the Absolute Ratio as well.

What is profitability?

Profitability is the ability of any business to produce “earnings.” The Financial Statement, which tells us whether a company is making profits or not is the Income Statement (or Profit and Loss Statement).

What are the main profitability ratios?

In order to understand if a business is making profits we have to look at its Net Profit Line also called “bottom line” since we always find it as the last item shown on this statement.

The main profitability ratios used in financial accounting are:

Gross profit margin
Operating profit margin
Return on capital employed (ROCE)
Return on equity (ROE)

Gross Profit Margin

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This is the relationship between Goss Profit and sales, and it is expressed in percentage:

(Gross Profit (Revenue – CoGS) / Sales) x 100%

Imagine, company XYZ had $100K in Gross profit and $250K in Sales, for Year-Two, therefore:

(100/250) * 100% = 40%

It means that 60% of your income is used to cover for the cost of goods sold.  This ratio is critical, since for many organizations, in particular, manufacturing, most of the costs are associated with CoGS (Cost of Goods Sold). 

For example, if you have to produce an Ice cream, you have to buy raw materials to make it. Also, someone has to “assemble” the Ice cream before it can be sold. 

Well, the raw materials and the work needed to produce the final product are considered CoGS. In other words, those are the costs required before the Ice cream can be sold.  

Therefore, this measure can be beneficial to assess the operational profitability of the business. In short, the Gross Profit Margin tells us whether we are properly managing our inventories as well.

Operating Profit Margin

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This is a relationship between Operating Profit and Sales, and it is expressed in percentage:

(Operating Profit (Revenue – CoGS – Op. Expense) / Sales) x 100%

Imagine, in Year-Two, the Operating profit was $25K and your revenue $250K. Therefore:

(25/250) * 100% = 10%

This measure compared to the Gross Profit Margin has a wider spectrum, and it assesses the profitability of the overall operations. Indeed, the operating profit is considered one of the most important metrics within the P&L. 

Indeed, the Operating Profit can be influenced by managers’ choices. Why? Managers cannot control Taxes and Interest payments (although they can reduce the leverage). 

Therefore, the Operating Profit is the measure that truly tells us how the management is administrating the business. For such reason, it is one of the most important metrics.

Return on capital employed

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This measure assesses whether the company is profitable enough, considering the capital invested in the business. 

Indeed, it tells for each dollar invested in the business, how much return is generated. Indeed, the ROCE is the relationship between Operating Profit, and Capital Employed, expressed in percentage terms. Let’s see below what is considered capital employed:

(Operating Profit / Capital Employed (Total Assets – Current Liabilities)) x 100%

Imagine, company XYZ operating profit for Year-Two is $100K, and the capital invested in the business (your total assets – current liabilities) is $500K. The ROCE will be 0.2 or 20% ((100/500) * 100%). 

Therefore, for every dollar invested in the business the company made 20 cents. The higher the ROCE, the better it is for its stakeholders. Consequently, an increasing ROCE overtime is a good sign.

Return on Equity

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This is the relationship between net income and shareholder equity or, the amount of revenue generated by the shareholder’s investment in the organization. This is one of the most used ratios in finance. The formula for the ROE is:

              (Net Income / Shareholders Equity) x 100%

Imagine the net income of Company XYZ in Year-Two was $20K and you invested $100K. Therefore the ROE is (20/100) x 100% = 20%.  Also, an increasing ROE is a good sign. 

It means that the shareholders are getting rewarded overtime for their risky investment. This leads to more future investments by other shareholders and the appreciation of the stock. 

The ROE itself is often used without caution. In fact, the problem of this ratio lies in its denominator. Indeed, the management can control Shareholders’ Equity. 

How? For instance, the Net Income is produced through assets that the company bought. Assets can be acquired either through Equity (Capital) or Debt (Liability). 

Consequently, when companies decide to finance their assets through Debt, usually revenue accelerate at a higher speed compared to interest expenses. This leads to a higher Net Income, although a lower Shareholders’ Equity. 

That, in turn, generates an artificially high Return on Equity.  For such reason, it is important to use this ratio cautiously and in conjunction with other leverage ratios as well (such as the Debt to Equity ratio).

What is Solvency?

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The solvency ratios also called leverage ratios to help to assess the short and long-term capability of an organization to meet its obligations. In fact, while the liquidity ratios help us to evaluate in the very short-term the health of a business, the solvency ratios have a broader spectrum.

Be reminded that the assets can be acquired either through debt or equity. The relationship between debt and equity tells us the capital structure of an organization. Until debt helps the organization to grow this leads to an optimal capital structure. 

When, instead, the debt grows (and interest expenses grow exponentially) too much this can be a real problem. Consequently, the Solvency Ratios help us to answer questions such as: Is the company using an optimal capital structure? If not, is debt or equity the problem?  

If the debt is the problem, will the company be able to repay for its contracted debt through its earnings?

What are the main solvency ratios?

The main solvency ratios are:

Debt to equity ratio
Interest Coverage Ratio
Debt to Assets

Debt to equity ratio

This ratio explains how much more significant is the debt in comparison to equity. This ratio can be expressed either as number or percentage. The formula to compute the debt to equity ratio is:

Total Liabilities / Shareholders’ Equity

The debt to equity ratio is also defined as the gearing ratio and measures the level of risk of an organization. Indeed, too much debt generates high-interest payments that slowly erode the earnings. 

When things go right, and the market is favorable companies can afford to have a higher level of leverage. However, when economic scenarios change such companies find them in financial distress. 

Indeed, as soon as the revenues slow down, they are not able to repay for their scheduled interest payments. Therefore, those companies will have to restructure their debt or face bankruptcy, as happened during the 2008 economic downturn to many businesses. 

Imagine that you own a Coffee Shop and in the second year of operations, (after many investments to buy new fancy machines) the balance sheet shows $200K in total liabilities and $50K in equity. 

This means that your debt to equity ratio is 4 or 200/50. Is it good or bad? Of course, a gearing ratio of 4 is very high. This means that if things go wrong for a few months, you will not be able to sustain the business operations. 

Not all contracted debt is negative. Indeed, debt that allows you to pay fixed interest helps companies to find their optimal capital structure. Instead, any increase in interest payments may result in burdening indebtedness and consequently to financial distress. 

A debt to equity ratio of 4 is extremely high although we want to compare it against previous year financials and the leverage of competitors as well. If we go back to the coffee shop example, a debt to equity ratio of 4 is ok if all the other coffee shops in the neighborhood operate with the same level of risk. 

It can be that operating margins for the coffee shop are so high that they can handle the debt burden. Imagine the opposite scenario, where all the coffee shops in the area operate with a leverage of 2. 

If the price of the raw materials skyrocket, you will have to raise the cost of the coffee cup. This, in turn, will slow down the revenues. While many coffee shops in the neighborhood will be able to handle the situations, your coffee shop with a gearing of 4 will go bankrupt after a while.

Interest Coverage Ratio

This ratio helps us to further investigate the debt burden a business carries. In the previous example, we saw how the leverage could lead to financial distress. 

The interest coverage tells us if the earnings generated are enough to cover for the interest expenses. Indeed the interest coverage formula is:

EBIT / Interest Expense

The EBIT (earnings before interest and taxes) has to be large enough to cover for the interest expense. A low ratio means that the company has too much debt and earnings are not enough to pay for its interest expense. 

A high ratio means instead the company is safe. Keep in mind that being too safe can be limiting as well. In fact, an organization that is not able to leverage on debt may miss many opportunities or become the target of larger corporations. 

Imagine that your coffee shop at the end of the year generated $10K in net income. The Interest expense is $120K and taxes $20K. How do we compute the interest coverage ratio?

1. Take the net income, $10K and add back the interest expense, $120K. This gives you the EBIAT or earnings before interest after tax. The EBIAT is 10 + 120 = 130.

2.  Take the EBIAT and add back the tax expense. Therefore you will get the EBIT. The EBIT is 130 + 20 = 150.

3. Take the EBIT and divide it by your interest expense. Therefore, 150: 120 = 1.25 times.

This implies that the EBIT is 1.25 times the interest expense. Therefore the company generates just enough operating earnings to cover for its interest. 

However, it is very close to the critical level of 1. Below one the company is risky. Indeed, it may be short of liquidity and close to bankruptcy anytime soon.

Debt to Assets Ratio

This ratio explains how much debt was used in acquiring the company’s assets and it is expressed either in number or percentage. The formula is:

Total liabilities / Total Assets

Imagine your coffee shop shows on the balance sheet $200K of total liabilities and $50K of equity. How do we compute the debt to asset ratio?

1. Compute the total assets: $200K of liabilities + $50K of equity = $250K.

2. Compute the debt to asset ratio: $200 of liabilities / $250 of total assets = 0.8.

This means that 80% of the company’s assets have been financed through debt. A ratio lower than 0.5 or 50% indicates a fair level of risk. A ratio higher than 0.5 or 50% can determine a higher risk of the business. Of course, this ratio needs to be assessed against the ratio from comparable companies. 

What is efficiency?

Efficiency is the ability of a business to quickly turn its current assets in cash that can help the business grow. In fact, the way you manage the inventories, accounts receivables and accounts payables that is critical to the short-term business operations.

What are the main efficiency ratios?

They assess if an organization is efficiently using its resources.  The primary efficiency ratios are:

Inventory Turnover
Accounts Receivable Turnover or collection period
Accounts Payable Turnover

These ratios are called turnover since they measure how fast current and non-current assets are turned over in cash.

Inventory Turnover

This ratio shows how the well the inventory level is managed and how many times inventory is sold during a period. The faster an organization can turn its inventory in sales, the more efficient and effective it is. This ratio is expressed in number. The formula is:

Cost of Goods Sold / Average Inventory Cost

Imagine that your coffee shop at the end Year Two sold $100K of coffee cups, with a $40K gross income. The inventory at the beginning of the year was $6K and at the end of the year was $8K. How do we compute our inventory turnover ratio?

1. Compute our CoGS. As you know we had $100K in sales and $40K in gross income. Therefore our CoGS will be 100 – 40 = $60K.

2. Compute our average inventory. The beginning and ending balances were respectively $10,000 and $12,000, therefore our average inventory will be: (10,000 + 12,000)/2 = $11,000.

3. Compute the inventory ratio given by COGS/Average inventory, therefore: 60,000/11,000 = 5.45 times.

This means that in one year time the inventory will be sold 5.45 times. How do we know how long it will take for the average inventory to be turned in sales?

Well, to compute the days it will take to turn the inventory in sales, compute the following formula:

                365 days/5.45 times = 67 days

Through this ratio, you know that every 67 days your inventory will be turned in sales. A high inventory ratio indicates a fast-moving inventory and a low one indicates a slow-moving inventory. 

Of course, a ratio of 5.45 is great since it means no capital is tied up to inventories and you are using the liquidity more efficiency to run the business. However, this ratio needs to be compared within the same industry.

Accounts Receivable Turnover or collection period

This ratio measures how many times the accounts receivable can be turned in cash within one year. Therefore, how many the company was able to collect the money owed by its customers.  It is expressed in number, and the formula is:

Sales or Net Credit Sales / Average Accounts Receivable

The net credit sales are those that generate receivable from customers. Indeed, each time a customer buys goods, if the payment gets postponed at a later date, this event generates receivable on the balance sheet. 

Therefore, the transaction will be recorded as revenue on the income statement and an account receivable on the balance sheet. Imagine the coffee shop you run sold $100K of coffee bags, of which $50K in gross credit sales. Of the $50K in gross credit sales, $10K of coffee bags was returned. 

The accounts receivable previous year balance was $12,000, while this year $10,000. How do we compute the accounts receivable turnover?

1. Compute our nominator, the net credit sales. This is given by the gross credit sales minus the returned product. Therefore: 50,000 – 10,000 = $40K of net credit sales.

2 Compute the average inventory that is given by the average between previous and current year, therefore: (12,000 + 10,000)/2 = $11,000 average receivable.

3. Compute the receivable turnover given by the net credit sales over the average inventory. Therefore: 40,000/11,000 = 3.64 times.

It means that the receivables were turned into cash 3.64 times in one year.

To know how many days it took to collect the money lumped in the receivable we will use the formula below:

365/3.64 = 100

The receivables were turned into cash in 100 days. This is a good receivables level it means that you can collect money from your customers on average every 100 days. 

When the receivable level is too low, usually companies turn their attention to the collection department and make sure they make the collection period as short as possible. Indeed, this will give additional liquidity to the business.

Accounts Payable Turnover Ratio

This ratio shows how many times the suppliers were paid off within one accounting cycle. This ratio is expressed in number, and the formula is:

Credit Purchases / Average Accounts Payable

The payable turnover ratio is the flip side of the receivable ratio. The credit purchases are those, which generate payable on the company’s balance sheet. 

Therefore, each time purchase on credit is made, this will show as CoGS on the income statement and an account payable on the balance sheet. Imagine that at the end of the year were purchased $25K of raw materials from suppliers, although, $5K was returned. 

The accounts payable was $5K on the previous year and $7K this year. How do we compute the accounts payable turnover?

1. Compute the net purchase amount given by the gross purchase amount minus the returned supplies, therefore: 25K – 5k = $20K of net purchases.

2. Compute the average payable. In year one the payable was $5K and $7K in year two. Therefore: (5K + 7K)/2 = $6K in accounts payable.

3. Compute the payable turnover given by the net purchases over the average accounts payable = 20K/6K = 3.3 Times.

The supplier during the current year was paid 3.3 times; it means that every 110 days (365/3.3) the debt with the suppliers has been paid off. Keeping a high payable turnover is crucial to conduct business. 

Indeed, suppliers will assess whether or not to entertain business with an organization based on its capability to quickly repay for its obligations.

What is valuation?

Valuation is a very tricky part of finance. Indeed, valuing a company means assessing how much that is worth. Valuing is so hard since the resources a company has been organized in a way for which it becomes challenging to determine the final value. 

In addition, we have the human capital aspect that is also very difficult to assess. For such reason, valuation can be considered more of an art than a science. We are going to list the main valuation ratios here. 

Indeed, it is essential as well to know what are the main valuation ratios also to understand whether a company is over or undervalued. In other words, valuation ratios assess the perception of the market of a certain company. 

This does not mean that “Mr. Market” is always right. Quite the opposite; for instance, if we find a company that is doing extremely well regarding profitability, liquidity, leverage, and efficiency but Mr. Market does not like it; it might be useful to understand why. 

If the reason stands behind things that Mr. Market knows and we don’t, I still would not buy it. On the other hand, if Mr. Market simply does not like that stock because it considers it “boring,” then I would give a thought about buying it.

What are the main valuation ratios?

The primary valuation ratios are:

Earnings per Share
Price/Earnings
Dividend Yield
Payout Ratio

Earnings Per Share

This ratio tells us what is the return for every single share. The formula is given by:

(Net Income – Preferred Dividends) / Weighted Average Number of Common Shares

When the ratio is increasing over time it means that the company may represent a good investment for its shareholders (although it must be weaved with other ratios before we can assess whether it is a good investment).

Price/Earnings Ratio

This ratio tells us how many times over its earnings the market is valuing the stock:

(Net Income – Preferred Dividends) / Weighted Average Number of Common Shares

A higher Price/Earnings ratio can be useful to a certain extent. For instance, technological companies tend to have a higher P/E ratio compared to others. Although, when the P/E is too high this may be due to speculations.

Dividend Yield

This ratio tells us how much of the stock value has been paid toward dividends. In other words, how much (in percentage) shareholders are getting back from their investment in stocks:

Dividends per Share (Dividends/Outstanding Shares) / Stock Price

Indeed a higher Dividend Yield is a good sign, and it means that the company is rewarding its shareholders. Also, stocks with historically high dividend yields have often been sought as good securities by stock market investors. But how do we assess whether the dividends yield is high enough?

Payout Ratio

This ratio tells us whether a company is paying enough dividends to its shareholders, and its formula is:

Dividends per Share / Earnings per Share

The payout ratio must be assessed case by case on the one hand. On the other side, a meager payout ratio is less attractive for investors, who are looking for higher returns.

How, why and when to use financial ratios 

Many “analysts” and “investors” are deceived by the use of the valuation ratios. Those ratios help us to have an understanding of how Mr. Market values a business. 

On the other hand, we want to use valuation ratios in conjunction with liquidity, profitability, efficiency, and leverage. In other words, decide before to start your analysis beforehand what will be the ratios that will guide you throughout your analysis. 

For instance, if you are going to analyze a technological business, you will use different parameters compared to a manufacturing one. 

Indeed, in the former case it might be more appropriate to use liquidity ratios when assessing the financial situation of a tech company rather than efficiency ratios (a tech firm hopefully does not carry inventories); in the latter case, instead, it might be more appropriate to use the efficiency ratios when it comes to manufacturing companies. 

In fact, on one hand, tech companies operate in a more competitive environment, where changes happen swiftly (and therefore revenues plunge quickly). In such scenario holding a safe (financial) cushion, it is more appropriate. 

For such reason, the Quick Ratio is going to tell us a lot about the business. On the other hand, when analyzing a manufacturing company, the efficiency ratios may tell us much more about the business. 

Indeed, in such scenario, the way inventories, receivable and payable are managed can be crucial to give enough oxygen to the business itself. 

Therefore, in conjunction with the quick ratio, the inventory turnover, accounts receivable and accounts payable turnover will give us a more precise account of the business. 

One last important point is that Ratios help us in the understanding of the past and the current situation. Although the past and the present are essential to interpret the future, they can be deceitful as well. Therefore, when analyzing any organization, it is essential to be guided by caution.  Having highlighted this point, let’s move on to dirt our hands now. 

The Three Most Important Financial Ratios for the Manager
13 Financial Ratios Formulas To Analyse Any Business

The post What Is a Financial Ratio? The Complete Beginner’s Guide to Financial Ratios appeared first on Four-Week MBA.

Coca-Cola Vs. Pepsi: Who Has The Best Business Model?

Both companies have massive scale. With Coca-Cola over $35 billion revenue, compared to PepsiCo over $63 billion. Where Coca-Cola has a large chunk of revenues in Europe, Middle East, and Africa. PepsiCo has its primary operations in the US. Coca-Cola is the largest beverage company in the world. PepsiCo got diversified between beverages and food, where food represented 53% of its revenues in 2017. Both companies have massive distribution strategies and nonetheless the size, they have a relatively quick decision-making process. That is critical as both companies top into consumer habits, therefore need to be fast in adapting to them. Both companies also spend massive resources on demand generation via marketing activities.

Why Coke and Pepsi have a different business model

At first sight, Coca-Cola and Pepsi might seem to have a business model which not only are similar but in a way compete with each other. While this is true, it is also true that those companies have two different business model and a portfolio of products that in many cases doesn't overall. Indeed, we'll see why, and in which respect Coca-Cola Company and PepsiCo business model are similar and where they differ.

Product: where Coca-Cola is about beverages, PepsiCo is quite diversified 

One aspect in which Coca-Cola and PepsiCo differ quite a lot is in their product offering. Where Coca-Cola is primarily about beverages, PepsiCo is about both food and drink.

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Coca-Cola Portfolio: from Coca-Cola Annual Report

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PepsiCo Portfolio: from PepsiCo Annual Report

Thus, while Coca-Cola is the largest beverage company in the world, PepsiCo has a vast array of products ranging from food and beverage.

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If you look at the mix of revenues of PepsiCo, food represented 53%, while beverage represented 47%.

Therefore, where in the minds of consumer Coke and Pepsi might be perceived as direct competitors, if we look at their business model those look entirely different regarding product offering and mix. Where Coca-Cola is a beverage company, PepsiCo draws its strength from offering snacks, complimentary to soft drinks. This in a way allows PepsiCo to compete to Coca-Cola at a better level. Imagine the scenario of a consumer buying a Coke and a packet of Lay's potatoes.

What Is a Business Model? 30 Successful Types of Business Models You Need to Know

Organizational structure: both are large yet efficient

When companies get too big, the risk is that they also get to slow in making a decision. However, for companies, like Coca-Cola and PepsiCo which focus on the consumer markets, it is critical to have a lean decision-making process, where layers of management need to be avoided.

Indeed, where the two companies too slow to adapt to consumer changing habits this would kill the business model in the long run. For instance, both Coca-Cola and PepsiCo, as more consumers perceive their products as unhealthy, they are focusing on diversifying their product portfolio to have more "healthy" choices.

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 PepsiCo change in portfolio composition 

Distribution strategy: both Coca-Cola and PepsiCo distribution systems are their key advantage

One of Coca-Cola key ingredient is its distribution system made of branded beverages available to consumers in more than 200 countries through a network of company-owned or controlled bottling and distribution operations, independent bottling partners, distributors, wholesalers, and retailers. Coca-Cola has the world's largest beverage distribution system. Also, PepsiCo has a massive distribution system based on both manufacturing and licensing agreements with several brands.

Both companies know how to tap into consumer habits 

Demand creation is a crucial ingredient for any company that wants to access consumer desires. However, that requires massive marketing resources and campaign to "enhance consumer awareness" which in simple words means generating demands for their product portfolio. Coca-Cola spent over six billion dollars in 2017 for promotional and marketing programs. PepsiCo marketing activities amounted to over four billion dollars. 

This process requires a rigorous brand positioning, developed around consumer insights.

Coca-Cola franchise leadership

Coca-Cola bottling partners is a crucial ingredient in its success. Coca-Cola also designs business models in specific markets to be able to have maximum penetration.

PepsiCo digital strategy

PepsiCo is putting a massive effort in digital strategy to grow their brands. Some of those initiatives include, as reported in PepsiCo financial statements:

Frito-Lay North America is using Big Data to help make sure consumers can help find their favorite snacks in local stores
In India, PepsiCo set up a Digital Command Center to analyze links between consumer behavior and business results
In China, we leveraged social media to launch the latest “Bring Happiness Home” Chinese New Year campaign, including a 20-minute video that generated more than 1 billion views

Those are some of the examples of how PepsiCo is doubling down on those initiatives.

Who has the best business model?

In my opinion, and that is an aspect I like the most about any business model, I like the fact that PepsiCo has a well-diversified portfolio between beverage and food. This allows the company to tap into larger consumer pieces of the market, while it also manages to compete with Coca-Cola at a larger scale. Where a consumer might prefer Coca-Cola beverages over PepsiCo, the company can still leverage on its large snack portfolio to tap into the same segments of the market. PepsiCo is swiftly moving toward "more healthy" choices and digitalization, by leveraging on organic business growth.

References for the article: Coca-Cola Annual Report 2017, PepsiCo Annual Report 2017.

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The post Coca-Cola Vs. Pepsi: Who Has The Best Business Model? appeared first on Four-Week MBA.

The Business Model Of The PepsiCo Food and Beverage Empire

With 53% of revenues coming from food, and the remaining 47% coming from the beverage. PepsiCo is a Food and Beverage Empire that in 2017 made over $63 billion in revenues. North America Beverage segment represented 33% of those revenues. 58% of its revenues were in the US. The company distributes its products via direct-store-delivery, customer warehouses, and other distribution networks.

PepsiCo key segments

With a multi-billion dollar empire, PepsiCo has refined its business model to make it as agile as possible. With reduced management layers and by leveraging on digitalization the food and beverage empire has managed its logic costs to capture as much growth from the world’s market. The company offers a vast range of products in food and beverage. In addition to that PepsiCo, through licensing agreements manufactures and distributes an even broader set of products by organizing joint ventures with other brands.

PepsiCo is organized in six main operating segments:

Frito-Lay North America (FLNA) (comprising branded food and snack businesses in the United States and Canada): this segment distributes and sells branded snack foods including Cheetos, Doritos, Fritos, Lay, Ruffles
Quaker Foods North America (QFNA), includes cereal, rice, pasta and other branded food in the United States and Canada. QFNA makes, markets, distributes and sells cereals, rice, pasta, and other branded products. This segment comprises Aunt Jemima, Cap’n Crunch, Life, Quaker Chewy, Quaker grits, Quaker oat squares, Quaker oatmeal, Quaker rice cakes, Quaker simply granola and Rice-A-Roni side dishes.
North America Beverages (NAB) comprises beverage businesses in the United States and Canada such as Aquafina, Diet Mountain Dew, Diet Pepsi, Gatorade, Mist Twst, Mountain Dew, Pepsi, Propel and Tropicana. Other products (such as Lipton from Unilever) are offered via joint ventures.
Latin America includes all of the beverage, food and snack businesses in Latin America. This comprises the manufacturing and distribution of Cheetos, Doritos, Emperador, Lay’s, Marias Gamesa, Rosquinhas Mabel, Ruffles, Sabritas, Saladitas and Tostitos, and many Quaker-branded bowls of cereal and snacks.
Europe Sub-Saharan Africa (ESSA), which includes all of beverage, food and snack businesses in Europe and Sub-Saharan Africa included in the other segments.
Asia, the Middle East and North Africa (AMENA), comprises includes beverages, food and snack businesses in Asia, the Middle East and North Africa.


What Is a Business Model? 30 Successful Types of Business Models You Need to Know

Distribution strategy of PepsiCo

The company distributes its products via three primary channels:

direct-store-delivery
customer warehouse
distributor networks

The distribution strategy varies to cover several customer needs, segments, and local business practices.

Direct-Store-Delivery

It comprises independent bottlers and distributors operating direct-store-delivery systems for beverages, foods, and snacks to retail stores. This distribution strategy works well with products where in-store promotion and merchandising affect their commercial success.

Customer Warehouse

Other products are delivered to customer warehouses. This system works with products that are less fragile and have a longer life, compared to perishable items.

Distributor Networks

Through third-party distributors, a wide range of products can have a broader reach on the delivery vehicles. Those distribution networks are particularly effective as they serve restaurants, schools, stadiums and all the places where consumers hang out. Part of this distribution also goes through e-commerce websites.

PepsiCo key customers

PepsiCo key customers include:

wholesale and other distributors
foodservice customers
grocery stores
drugstores
convenience stores
discount/dollar stores
mass merchandisers
membership stores
hard discounters
e-commerce retailers
and authorized independent bottlers


Who Owns Coca-Cola? Coca-Cola Business Strategy In A Nutshell

Marketing campaigns 

Incentives and discounts through various programs to customers and consumers which comprise sales incentives, rebates, advertising, and other marketing activities played a key role. Advertising and other marketing activities amounted to $4.1 billion.

PepsiCo key financial metrics

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Source: PepsiCo Annual Report 2017

With 53% of revenues coming from food, and the remaining 47% coming from the beverage, PepsiCo is an empire that in 2017 made over $63 billion in revenues. North America Beverage segment represented 33% of those revenues. While 58% of its revenues were in the US.

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Source: PepsiCo Annual Report 2017

The company also generated over $10.5 billion in 2017, which represented a 16.5% operating margin.

Reference for data: PepsiCo Annual Report 2017

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The post The Business Model Of The PepsiCo Food and Beverage Empire appeared first on Four-Week MBA.

How To Read A Balance Sheet For Complete Beginners

The purpose of the balance sheet is to report the way the resources to run the operations of the business were acquired. The Balance Sheet helps us to assess the risk of the business. By looking at it, you will be able to answer questions, such as: What is the leverage? Is the company liquid enough? Remember, leverage is the proportion between equity and debt, while liquidity is the capacity of the business to repay for its short-term obligations, to run the operations.

Why the balance sheet is important

It has been my experience that competency in mathematics, both in numerical manipulations and in understanding its conceptual foundations (accounting), enhances a person’s ability to handle the more ambiguous and qualitative relationships that dominate our day-to-day financial decision- making by Alan Greenspan former FED Governor 

Understanding the balance sheet is critical to be able to dissect any business. We’ll start from the ten commandments of the GAAP accounting system.

A quick introduction to the main GAAP principles

Although the fundamental accounting system hasn’t changed, the principle and rules applying today have been updated in the last century.

The generally accepted accounting principles are standards and procedures used by organizations to submit their financial statements. Today we have two main accepted frameworks, globally: GAAP and IFRS. Indeed, after the 1929 market crash, the American government felt the necessity to create a set of rules to discipline and to harmonize the accounting system, and avoid what had happened. In the decade after the 1929 market crash institutions such as the Securities and Exchange Commission were created.

In 1934, the SEC, assisted by the American Institute of Accountants (AIA), started to work on the GAAP. The AIA subsequently instituted an organism to specifically create these principles, The Committee on Accounting Procedure (CAP).

Finally, the first set of GAAP was created, and in 1973 and the CAP board was substituted by the Financial Accounting Standards Board (FASB). From this work came out ten basic principles, that are the foundation of the modern accounting system in the US:

Economic entity assumption: If you have a business, even if you are a sole proprietor, the accountant will consider yourself separately from your business.
Monetary Unit Assumption: The Business activity you undertake is considered in US Dollars.
Time Period Assumption: a Business activity you undertake can be reported in separated time intervals, such as weeks, months, quarters or fiscal years.
Cost Principle: If you buy an item in 1980 at $100, it will be reported on your balance sheet as worth $100 today, independently on inflation or appreciation of the asset.
Full Disclosure Principle: You have to report all the relevant information of the business in the financial statements or the footnotes.
Going Concern: The accountant assumes that your business will continue its operations in the foreseeable future.
Matching Principle: If you incur an expense, it should be matched with the revenues, according to the accrual principle. If you decide to pay your employees a bonus related to 2015 but you pay it in 2016, you still will report it as 2015. You will report the expense when it was recognized and not when actual cash disbursed (accrual principle).
Revenue Recognition Principle: if you sold a product in January 2015, but you will receive the money from the customer in April 2015, you will report the sale in January, since it was the period when the actual sale was realizable.
Materiality Principle: when you report the financials, it will be allowed to round them, since if an amount is insignificant can be neglected by your accountant.
Conservatism Principle: When in doubt between $80 or $100 loss, your accountant has to choose the most conservative alternative, report $100.

These principles are the “ten commandments” of the accountant. Keep them in mind. They will guide you throughout the book. Also, the accrual principle in practical terms states: “Revenues and expenses are recognized when occurred, independently from cash disbursement.”

This principle is crucial to building our primary financial statements, in particular, the Income Statement and Balance Sheet.

A quick glance at the main accounts of a financial statement

An account is an item on the financial statements that has certain characteristics. Usually, accountant group them in five main types. Each of those types has subtypes. For now, it is critical to understand each main type to have a better understanding of how financial statements work. The main accounts are:

Assets: Resources owned by an organization. They will produce future benefits for the company. For example, you own a bakery that has to produce biscuits. For you to produce them, you have to buy a machine. The machine will be an asset to your organization.
Liabilities: Obligations (Debt) contracted by an organization. Your bakery bought $100 of raw material from the supplier, and you will pay in 60 days. Until the payment will be made the $100 will show as a liability (future debt) on your balance sheet.
Owner’s Equity: Amount of money or resources you endowed to your organization. The accounting definition is Owner’s Equity = Assets – Liabilities.
Revenue or Income: The $ amount of sales occurred in a certain period. According to the accrual principle, income is recognized independently from cash receipt.
Expenses: The $ amount of costs occurred in a certain period. According to the accrual principle, expenses are recognized independently from cash disbursement. 

While assets, liabilities and equity will be shown on the balance sheet. Revenue and expenses will be shown on the income statement.

A snapshot of the primary financial statements

“Unless you are willing to put in the effort to learn accounting – how to read and interpret financial statements – you really shouldn’t select stocks yourself” Warren Buffet

The primary financial statements are Balance Sheet, Income Statement and Cash Flow Statement. Each of these statements has a different purpose, and together they give us specific information in regard to: “Return, Risk and Cash.”

First, if you look at the income statement, there is no way you would make any assessment about the risk of the organization in that particular point in time or the cash produced in a certain period. Instead, the Income Statement (or Profit & Loss) will show you the return generated by the business.

Second, if you want to understand how an organization acquired the resources to operate the business, you have to look at the Balance Sheet. How does the balance sheet assess the risk of an organization? Simple: there are two ways a company can acquire resources, either through Equity or Debt.

As you can imagine, too much debt can be dangerous. What would occur if you run a business, and suddenly your creditors ask for the money you owe them? You would go bankrupt. Instead, when debt in proportion to the equity is dismal, this makes your organization creditworthy and safer.

Third, it is highly probable seeing an organization which makes profits but out of cash. The cash flow statement helps you to answer questions such as: How much cash did we make? Where this cash came from? An organization can find cash through three main activities: Operating, Investing and Financing.

What is the income statement?

The primary purpose of the income statement is to show the return of the business in a certain period: Quarterly, Biannually or Yearly. The income statement is built around the bottom line, the “net profit.” Do not be surprised to notice your eyes unexplainably falling on the net income. Accountants make it as visible as a fluorescent fish ready to mate. This distracts you by other metrics on the Income Statement that are as important as the Net Income.

What is the balance sheet?

The primary purpose of the Balance Sheet is to show the risk of the business in the particular moment you are looking at it. If you look the balance sheet on January 1st, it won’t be the same on January 2nd. Of course, this is true for the P&L and CFS (Cash Flow Statement) as well, but the balance sheet

is an instant snapshot of the business more than a collage of pictures taken in different moments, like the Income Statement.

What is the cash flow statement?

The primary purpose of the CFS is to show the cash generated by an organization in a certain period: Quarterly, Biannually or Yearly. It doesn’t matter how much profits a business is making, one way to know whether the business will survive in the next future is to look at the cash. Generating cash is not an easy task, and the organizations who can keep their profits stable and make enough cash to sustain their operations and invest for future growth are the ones who thrive.

All you need to know about the Balance Sheet

The purpose of the balance sheet is to report the way the resources to run the operations of the business were acquired. The Balance Sheet helps us to assess the risk of the business. By looking at it, you will be able to answer questions, such as: What is the leverage? Is the company liquid enough? Remember, leverage means the proportion between equity and debt, while liquidity is the capacity of the business to repay for its short-term obligations, to run the operations.

Imagine you have to open a restaurant. The overhead costs, plus the costs of running the business are $200,000. There are two ways for you to find the money needed to open the business, assuming you don’t have the resources to do it your own. Either you find a partner that would put personal money, or you ask for a loan. Therefore, Equity and Debt are the two ways to finance your business. This is how a typical balance sheet looks like:

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To have a deep understanding of the balance sheet look this video, we put together for you:

Other resources for your business:

What Is a Business Model? 30 Successful Types of Business Models You Need to Know
What Is a Business Model Canvas? Business Model Canvas Explained

The post How To Read A Balance Sheet For Complete Beginners appeared first on Four-Week MBA.

ARPU: This Is How Much You’re Worth To Facebook

ARPU or average revenue per user is a critical measure to assess Facebook ability to monetize its users. ARPU is given by total revenue in a given geography during a given quarter, divided by the average of the number of monthly active users in the geography at the beginning and end of the quarter.

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As specified on Facebook financials “this is calculated by computing revenue by user geography based on our estimate of the geography in which ad impressions are delivered.”

Important Note: It is important to notice that as reported on Facebook financials “ARPU includes all sources of revenue, the number of MAUs used in this calculation only includes users of Facebook and Messenger as described in the definition of MAU above.” That means the metric might be biased in favor of Facebook, as it comprises all the sources of revenues (comprising Instagram and WhatsApp). This implies that in part the monetization ability of Facebook might also be due to the increase in revenues from other platforms such as WhatsApp and Instagram. We can’t know for sure as this is not broken down in Facebook financials. 

What Is a Business Model? 30 Successful Types of Business Models You Need to Know

Why ARPU is a critical metric for Facebook financial success

The critical business metrics Facebook tracks comprise:

daily active users (DAUs): daily active users are defined by Facebook “as a registered Facebook user who logged in and visited Facebook through the website or a mobile device, or used the Messenger application (and is also a registered Facebook user), on a given day.“
monthly active users (MAUs): monthly active users are defined by Facebook “as a registered Facebook user who logged in and visited Facebook through the website or a mobile device, or used the Messenger application (and is also a registered Facebook user), in the last 30 days as of the date of measurement.“
and average revenue per user (ARPU)

As an attention merchant, Facebook has to make sure to have its users to go back to the platform. Indeed, attention harvesting and the ability to sell it back advertisers and marketers is the Facebook primary business model. That is also why is critical to monitor the ARPU to understand how its business model is evolving.

In the third quarter of 2018, the ARPU worldwide was $6.09, while in the US and Canada it was $27.61 and in Europe, it was $8.82.

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This means that Facebook can monetize its users at a growing rate. Which might be due to several reasons: for instance, an increase in ad spending, a larger marketers base, and better engagement rates of users all affect the ARPU. At the same time, the fact that Facebook might be monetizing other platforms such as Instagram and WhatsApp might also affect that.

Warning: ARPU is not how much your data is worth

It is critical to remark that what Facebook can make of users in terms of monetization doesn’t represent the real value. In other words, the value of users’ data might be way higher than what Facebook can generate via advertising. Therefore, it is important not to confuse average revenue per user with the real value of the data behind users, which is another story!

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Snapshot Of The New York Times Business Model

The New York Times made over $1.6 billion in revenues in 2017. Its monetization strategies based on both subscription (both print and digital) and advertising (both print and digital). NY Times has successfully managed to shift its business model over subscription over the years. As of 2017, subscriptions contribute more than advertising to its revenue generation. The subscription revenues primarily based on print have also been slowing down, while digital subscriptions have increased substantially. The NY Times is shifting toward a digital subscription business model.

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How does The New York Times make money?

As a global media organization that “focuses on creating, collecting and distributing high-quality news and information” the company’s principal business consists of distributing content across its digital, print platforms and in small part to third-party platforms. The New York Times monetizes its content in two simples ways:

subscriptions: both printed and digital
advertising: display, classified and others

Let’s give a quick look at The New York Times business model.

Subscription-based strategy driven by a freemium model

The New York Times offers users free access to a set number of articles per month until it shows a paywall requesting users to join the platform for a basic subscription fee, that can initially be as low as $1 per week:

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The content gets distributed across print and digital. In 2017 NYTimes had about 3.6 paid subscribers to print and digital. Digital-only subscribers were over 2.6 million.

At the same time in 2017, NYTimes had an average print circulation of about 540,000 for weekday (Monday to Friday) and 1,066,000 for Sunday.

How The NYTimes subscription-based business model is evolving

Over the years NYTimes has shifted its business model toward a subscription. Indeed, the revenues coming from subscriptions surpassed those coming from advertising. This is a massive and vital change, as publishers have for over a century lived off advertising revenues.

It is important to notice that the most significant portion of subscription revenue is still based on the print newspaper. However, as the competition with digital formats has increased, NYTimes is also emphasizing on its digital-only subscription.

NYTimes advertising revenue model 

With a comprehensive portfolio of advertising products and services provided across print, web and mobile platforms the advertising revenues comprises three main sources:

Display Advertising

The New York Times had the largest market share in 2017 in print advertising revenue among national newspapers (compared to USA Today, The Wall Street Journal and The Times, as reported by MediaRadar). an independent agency that measures advertising sales volume and estimates advertising revenue.

Display advertising comprises
banners
video
rich media
other interactive ads
branded content

Classified and Other Advertising

Classified advertising includes line ads sold in the major categories of real estate, help wanted, automotive and other. In print,

Classified advertising comprises three major types: real estate, help wanted, and automotive. Those pay on a per-line basis. While on the web or mobile platforms the pay is on per listing base, which can be mixed as an add-on to the print ad.

In 2017, digital and print classified and other advertising represented approximately 13% of NYTimes advertising revenues.

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Other businesses part of the NYTimes galaxy

As reported on NYTimes financial statements:

Other revenues primarily consist of revenues from news services/syndication, digital archive licensing, building rental income, affiliate referrals, NYT Live (our live events business) and retail commerce. Digital other revenues consists primarily of digital archive licensing revenue and affiliate referral revenue. Building rental income consists of revenue from the lease of floors in our New York headquarters building, which totaled $16.7 million, $17.1 million and $16.9 million in 2017, 2016 and 2015, respectively

NY Times distribution strategy

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It is interesting to notice the massive reach NYTimes has been able to build over the web. In short, it is the case in which a player from the printed mastered the digital world as well. With a site, that according to Similar Web estimates has more than three hundred million visits per month

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The marketing mix shows directly as the primary source. This implies a strong brand recognision. The company advertising expense to promote the brand, subscription products, and marketing services were $118.6 million in 2017, compared to $89.8 million in 2016.

Reference data: NYTimes Annual Report 2017

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How Mobile Advertising Is Driving Facebook Growth

In the first nine months of 2018, mobile advertising was estimated at 92% of the total advertising on Facebook products. Active monthly users decreased from 376 million to 375 million in Europe. In the US and Canada, users increased from 241 million to 242 million. At the same time, average revenue per user grew worldwide. Besides all the buzz of 2018, the Facebook business model seems (for now) unshakable.

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The buzz about Facebook death

In early 2018, Mark Zuckerberg announced a change in the Facebook algorithm, which in Mark Zuckergerg words meant "One of our big focus areas for 2018 is making sure the time we all spend on Facebook is time well spent." He continued "recently we've gotten feedback from our community that public content -- posts from businesses, brands, and media -- is crowding out the personal moments that lead us to connect more with each other."

This shift meant a rehaul and change of how the newsfeed - the most important asset Facebook has - where the product team has been focusing on how to show you more things from friends and family rather than businesses you might be following.

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Publishers that had invested time and resources in building up their organic reach (content not sponsored or paid to Facebook to show it in the newsfeed) over Facebook, saw a significant drop in referral traffic from the platform. In short, now Facebook algorithm emphasized organic content from family and friends, rather than those businesses that had built part of their reach on social media, which saw a quick drop.

Also, as the Cambridge Analytica scandal revealed the harvesting of personal data from millions of Facebook users, movements such as "Delete Facebook" have taken over: 

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Is all this buzz having an irreversible effect on the Facebook business model?

Is Facebook losing users?

My argument is that - in many cases - when a company has figured a solid business model, this will help them go through the hardest times. That holds true for Facebook as well. With a business model, which is even more profitable than Google, Facebook seems to be still solid:

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Source: Facebook 10Q 

Facebook saw a slight growth in monthly active users in the US and Canada in the quarter between the beginning of July and end of September, while there was a decline in Europe. Facebook users in the US and Canada went from 241 million to 242 million. In Europe instead, users decreased from 376 million to 375 million.

However, if we look at global scale Facebook still experienced an increase in users:

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At a global level, Facebook went from 2.23 billion users to 2.27 billion in the third quarter of 2018.

What about monetization? At the end of it, Facebook is a business, which main aim is to create substantial financial growth. Therefore, fewer users, but with a higher monetization might be better for the Facebook business model.

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Is Facebook losing money on its users?

One of the critical metric Facebook uses to assess its ability to monetize users (keep in mind that Facebook is a digital advertising machine that sells users' attention to businesses) is the ARPU (or average revenue per user).

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The global Facebook ARPU went from $5.97 in the second quarter of 2018 to $6.09 in the third quarter.

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Similar growth can be seen in the ARPU for the US and Canada (from $25.91 to $27.61) and Europe (from $8.76 to $8.82).

In short, it doesn't seem that Facebook is slowing down its monetization machine.

Important Note: It is important to notice that as reported on Facebook financials "ARPU includes all sources of revenue, the number of MAUs used in this calculation only includes users of Facebook and Messenger as described in the definition of MAU above." That means the metric might be biased in favor of Facebook, as it comprises all the sources of revenues (comprising Instagram and WhatsApp). This implies that in part the monetization ability of Facebook might be also due to the increase in revenues from other platforms such as WhatsApp and Instagram. We can't know for sure as this is not broken down in Facebook financials. 

Facebook mobile advertising machine

One interesting aspect of the Facebook business model is its distribution, merely based on the strength of its brand. Where a change in consumer habits in consuming content is a threat for Google, Facebook dominates it. Where Google has to pay Safari billions of dollars to be featured as the primary search engine on mobile devices, by making its traffic acquisition costs higher, Facebook main driver of growth is represented by an increase in ads from mobile devices.

As reported on Facebook financial statements for the third quarter of 2018:

Revenue in the third quarter and the first nine months of 2018 increased $3.40 billion , or 33% , and $11.24 billion , or 41% , respectively, compared to the same periods in 2017 . The increases were mostly due to an increase in advertising revenue.

Where mobile advertising revenues represented 88% and 87%, in the third quarter and first nine months of 2017. In 2018 those numbers jumped to an estimated 92% in 2018.

The jump seems to be driven by both an increase of cost in mobile advertising (the average price increased by 19% in the first nine months of 2018) and the number of ads served (an 18% increase in the first nine months of 2018).

Factors that affected these increases are:

increase in demand for ad inventory
increase in spending from existing marketers
increase in the number of marketers actively advertising on Facebook and related products
quality, relevance, and performance of those ads
increase in users and their engagement
increase in the number and frequency of ads displayed across Facebook products

Those factors combined represent an important driver for growth for Facebook.

Facebook (for now) unshakable business model

Facebook has been able to build over the years a solid business model. Highly profitable, with a strongly recognized brand, it has been able to grow its revenues and profitability even in a challenging year like 2018. Of course, the strength of the brand and the ability of Facebook to keep users going back is critical for its long-term success. At the same time as Facebook has proven to be the strongest attention merchant on earth, it will need to be able to keep that attention at the highest level to keep its monetization strategy to grow.

While the company is monetizing on its mobile ads, it has also tweaked the algorithm so that people can experience more "meaningful social interactions" with family and friends. What it means though in big bucks is that Facebook has killed the organic reach of many businesses that had built it over the years, and made its ads more expensive while expanding its advertisers base.

This is in part the game of the attention merchants. The organic reach isn't something to take for granted. When the attention merchant decides the time is right, he might take away the organic reach from you and ask you money to reach the audience that once was yours!

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The post How Mobile Advertising Is Driving Facebook Growth appeared first on Four-Week MBA.

A Snapshot Of Booking Business Model

Booking Holdings is the company the controls six main brands that comprise Booking.com, priceline.com, KAYAK, agoda.com, Rentalcars.com, and OpenTable. Over 76% of the company revenues in 2017 came primarily via travel reservations commisions and travel insurance fees. Almost 17% came from merchant fees, and the remaining revenues came from advertising earned via KAYAK. As a distribution strategy, the company spent over $4.5 billion in performance-based and brand advertising. 

Booking Holding mission via six brands

Booking mission is "to help people experience the world."

The six brands comprise:

Booking.com: booking online accommodation reservations platform
priceline.com: a hotel, rental car, airline ticket and vacation package reservation service in the US
KAYAK: a meta-search service to search and compare travel itineraries and prices
agoda.com: an accommodation reservation service primarily focused on the Asia-Pacific region
Rentalcars.com: a worldwide rental car reservation service
OpenTable: a provider of restaurant reservation and information services to consumers

How does Booking make money?

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The three primary sources of income are broken down in three main segments:

agency
merchant
Advertising and other revenues

Agency revenues

Those comprise revenues derived from travel-related transactions where Booking doesn't facilitate payments for the travel services provided. It can be broken down in:

travel reservation commissions;
certain GDS reservation booking fees
certain travel insurance fees

Merchant revenues

Those are revenues derived from services where Booking does facilitate payments for the travel services provided.

Advertising and other revenues

Those comprise revenues from:

KAYAK for sending referrals to travel service providers and advertising placements
OpenTable for reservation fees, and subscription fees
priceline.com for advertising on its websites
Booking.com's BookingSuite branded accommodation marketing and business analytics services

The Booking business strategy

Booking focuses on a few key strategies to accomplish its mission:

leverage on a large inventory of options and low prices
creating a frictionless user experience to book travel destinations
enable business partners to track their success via insight tools and platforms
keep investing in enhancing the consumer experience
partner up with travel service providers and restaurants
maintain multiple brands
investing a sustainable growth.

How does Booking acquire traffic to be monetized? The key is performance-based and brand advertising 

Traffic acquisition is the key ingredient for any digital business. Also, tech giants like Google and Facebook need to focus their efforts in keeping the traffic acquisition cost stable over time to be able to monetize their pages and sites at a margin which is high enough to generate a sustainable business model.

Booking Holding has managed so far to do that via two main channels:

performance advertising
brand advertising

Performance advertising has proved a sustainable way to acquire traffic and not that far from the traffic acquisition cost rate other companies like Google have to sustain:

[image error]TAC stands for traffic acquisition cost, and that is the rate to which Google has to spend resources on the percentage of its revenues to acquire traffic. Indeed, the TAC Rate shows Google percentage of revenues spent toward acquiring traffic toward its pages, and it points out the traffic Google acquires from its network members. In 2017 Google recorded a TAC rate on Network Members of 71.9% while the Google Properties TAX Rate was 11.6%.

If we look at Booking Holding numbers, you can notice how the company spent in 2017 33.3% of its gross profit in performance advertising:

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In 2017 Booking spent $4.1 billion in performance advertising channels generate a significant amount of traffic to Booking Holding websites. Those expenses primarily comprise

search engine keyword purchases (mostly Google)
referrals from meta-search and travel research websites
affiliate programs
other performance-based advertisements

Brand advertising spending was $392 million in 2017. Those expenses primarily consist of television advertising, online video advertising, and online display advertising.

Google is coming: Will Google threaten Booking business model?

Over the years Booking has been able to keep growing thanks to its expansion, acquisition of other brands and its ability to create a sticky platform for its users. At the same time, most of the traffic that goes toward its sites come from performance-based advertising and a good chunk of it is paid traffic via Google.

As Google enters more and more into travel related services (see Google Flights), it becomes harder for Booking to keep a competitive business model able to continue gaining traction. Therefore, Google does represent a threat for Booking sustaiability in its business model.

Reference for the data: Booking Holding Annual Report 2017

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The post A Snapshot Of Booking Business Model appeared first on Four-Week MBA.