<THE RULE MAKER PORTFOLIO>
Cisco's Current Liabilities
By Phil Weiss
TOWACO, NJ (March 31, 1999) -- Last night, I started talking about what can be found in the current liability section of a balance sheet. Tonight, I'll continue that discussion by going through the balance sheet in Cisco's (Nasdaq: CSCO) most recent annual report. Here's a link to the company's consolidated balance sheet.
In the current liabilities section of the balance sheet, we find four main line items: Accounts payable, Income taxes payable, Accrued payroll and related expenses, and Other accrued liabilities. But, if we go to Note 4 (found by scrolling down after going to this link), we find further detail for the two accrued liability lines. Altogether, here are the networking giant's current liabilities as of July 25, 1998 (in thousands):
Accounts payable........ $248,872
Income taxes payable..... 410,363
Accrued payroll
and related expenses:
Accrued wages,
paid time off,
and related expenses... 170,446
Accrued commissions..... 82,767
Accrued bonuses........ 137,329
Other accrued liabilities:
Deferred revenue..... 330,000
Accrued warranties.... 48,109
Other liabilities.... 339,094
Total Current
Liabilities............$1,766,980
I'm going to look at these by starting with what I think is most meaningful. First up is accounts payable, which represent monies that Cisco owes to its suppliers. If Cisco can slow down payment to its suppliers without a corresponding decrease in service provided by the supplier, then John Chambers and company are flexing their financial might. Another way of looking at this scenario is that Cisco's patronage is more important to the supplier than the supplier's product is to Cisco. Small suppliers are forced to agree to Cisco's terms, or else risk losing Cisco's business to a competitor.
My next favorite accounts are deferred revenues and accrued warranties. In the case of Cisco, these accounts represent monies paid in advance by customers for the future delivery of networking gear and service on that gear. Think about this for a moment. For Cisco, these two accounts add up to more than $378 million that the company has pocketed before having provided any corresponding product or service. That's great. That's a sign of a company's strength. I really like seeing that a company has the ability to force its customers to pay for something before it has actually provided the product or service.
Some people could argue that deferred revenues are merely a means that some companies use to smooth earnings. I understand that argument, but I don't agree with it at all. My view of what's happening here is that the company is selling warranties, support, or service related to its products. These add-ons are embedded into the product's selling price. The customer pays for all of it up front. The income isn't all recognized up front because there may be some costs incurred in providing the embedded service and the company is trying to match up revenues and expenses.
Next on my list are accrued commissions, which are most likely for Cisco's salespeople, who are probably paid monthly or quarterly (salespeople often receive a draw on an interim basis). The details of Cisco's commission payment process are a matter of company policy. If a Cisco salesperson is dissatisfied with the way in which (s)he is paid, then (s)he'll have to go work for someone else. As Cisco sells its routers and other networking gear each day, the company accrues the portion of commission expense associated with that revenue. But, the company doesn't actually have to pay out these commissions in the form of cash until the monthly or quarterly pay day rolls around. I'll give Cisco some credit for its financial strength because of its ability to delay these payments a bit.
Let's look at accrued bonuses next. I've never worked anywhere that bonuses weren't paid once a year. The company accrues some amount here during the course of the year to keep its income recognition relatively smooth. As a general rule, both accrued commissions and accrued bonuses are related to the performance of the company in that the more products it sells and income it earns, the bigger these accruals are. Does this show that a company is a Rule Maker or has a lot of financial strength? I don't think so. It just shows that it sells a lot of product and/or makes money. Accrued wages don't tell us all that much either.
The "other liabilities" relate things like provisions or reserves for expenses that occur during the year. No cash outlay yet, just the recording of a charge on the income statement and a corresponding creation of a liability for future payment of the expense on the balance sheet. (FYI: That's an example of why accounting can be referred to as a double entry system.) The liability account is subsequently reduced as cash is actually expended.
Does this tell us that a company is a Rule Maker? No. No way. Not at all. All that these liabilities are telling us is that Cisco has provided for some expenses before it has actually expended the cash. As a matter of fact, earlier this year both Oak and I wrote about managing earnings (Oak's report; my report). These "other liabilities" are where you can find some buried accounts. If earnings are really good, you can find some expenses buried here in the form of reserves. Then, if at a later time earnings fall a bit short of expectations, some of these reserves can be released back into income.
Worse yet, sometimes, the expense that you'll find here is reported as a type of non-recurring charge. The subsequent release back into income is shown as ordinary income. Although this is more common in the long-term liability section of the balance sheet, it can happen. This scenario certainly doesn't sound good to me, so I'm not especially overjoyed by "other liabilities."
Another thing you'll find in current liabilities (besides debt) is income tax payable. This payable arises when, say, we've purchased some property that we will depreciate (write-off) over its useful life in the future. Generally, we get a financial statement tax benefit for that future deduction. The income tax payable account is where that tax benefit shows up on the balance sheet. In my opinion, this scenario tells us nothing about whether a company is a Rule Maker.
In conclusion, when it comes to analyzing the current liabilities section of the balance sheet, I like accounts payable, deferred revenues, and accrued warranties the best. To me, they're the most meaningful in terms of evaluating a company's ability to get free financing in the form of non-interest bearing liabilities. The other current liabilities just aren't as significant in gauging the strength of a Rule Maker.
Having said that, what can I do about it? Nothing at all. I'm still stuck with the fact that the Pure Flow Ratio numbers seem too random. Plus, companies like Cisco report the detail related to accrued liabilities that I just discussed only once a year. (I've asked Cisco about this and I'm expecting an answer soon.)
This is why the Rule Maker managers believe the new Flowie (that we began discussing last Friday) is our best option for a simple and effective way to analyze a company's working capital efficiency. If you'd like to see how our Rule Makers and a handful of other companies stack up with the old Flowie vs. the new one, check out this link. We think you'll see the new Flowie's superiority in closing the loophole for short-term debt.
If you have questions or concerns regarding the new Flowie, join the discussion on the Strategy board. And, if you're a new Fool, and are confused by the Flow Ratio, feel free to ask a question on the Rule Maker Beginners board.
Enjoy your evening,
-Phil
- Rule Maker Strategy Board
- Rule Maker Companies Board
- Rule Maker Beginners Board
- Rule Maker Spreadsheet (Excel 97, 68k)
- Rule Maker Spreadsheet (Excel 95, 41k)
03/31/99
Close
Stock Change Bid AXP -3 3/4 117.75 CHV - 1/4 88.75 CSCO - 3/8 109.56 KO -1 7/8 61.38 GPS -1 11/16 67.31 EK -1 63.88 XON - 3/4 70.56 GM - 3/8 87.00 INTC -2 7/16 119.13 MSFT -3 3/8 89.63 PFE -3 9/16 138.63 SGP -1 1/16 55.25 TROW + 7/16 34.38 YHOO -3 15/16 168.38 |
Day Month Year History
R-MAKER -1.88% 6.85% 11.39% 40.94%
S&P: -1.11% 3.88% 4.97% 29.89%
NASDAQ: -0.75% 7.59% 12.27% 48.94%
Rule Maker Stocks
Rec'd # Security In At Now Change
2/3/98 48 Microsoft 39.13 89.63 129.02%
5/1/98 55 Gap Inc. 34.37 67.31 95.85%
6/23/98 34 Cisco Syst 58.41 109.56 87.57%
2/3/98 22 Pfizer 82.30 138.63 68.44%
2/13/98 22 Intel 84.67 119.13 40.69%
2/17/99 16 Yahoo Inc. 126.31 168.38 33.30%
8/21/98 44 Schering-P 47.99 55.25 15.12%
5/26/98 18 AmExpress 104.07 117.75 13.15%
2/6/98 56 T. Rowe Pr 33.67 34.38 2.08%
2/27/98 27 Coca-Cola 69.11 61.38 -11.19%
Foolish Four Stocks
Rec'd # Security In At Value Change
3/12/98 17 General Mo 72.41 87.00 20.16%
3/12/98 20 Exxon 64.34 70.56 9.68%
3/12/98 15 Chevron 83.34 88.75 6.49%
3/12/98 20 Eastman Ko 63.15 63.88 1.15%
Rule Maker Stocks
Rec'd # Security In At Value Change
2/3/98 48 Microsoft 1878.45 4302.00 $2423.55
5/1/98 55 Gap Inc. 1890.33 3702.19 $1811.86
6/23/98 34 Cisco Syst 1985.95 3725.13 $1739.18
2/3/98 22 Pfizer 1810.58 3049.75 $1239.17
2/13/98 22 Intel 1862.83 2620.75 $757.92
2/17/99 16 Yahoo Inc. 2020.95 2694.00 $673.05
8/21/98 44 Schering-P 2111.7 2431.00 $319.30
5/26/98 18 AmExpress 1873.20 2119.50 $246.30
2/6/98 56 T. Rowe Pr 1885.70 1925.00 $39.30
2/27/98 27 Coca-Cola 1865.89 1657.13 -$208.77
Foolish Four Stocks
Rec'd # Security In At Value Change
3/12/98 17 General Mo 1230.89 1479.00 $248.11
3/12/98 20 Exxon 1286.70 1411.25 $124.55
3/12/98 15 Chevron 1250.14 1331.25 $81.11
3/12/98 20 Eastman Ko 1262.95 1277.50 $14.55
CASH $185.03
TOTAL $33910.47
Note: The Rule Maker Portfolio began with $20,000 on February 2, 1998, and
it adds $2,000 in cash (which is soon invested in stocks) every six months.
