Page 24 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 2: Planning of Working Capital

The number-one retailer of automotive parts and accessories has seen net income increase Notes
from $245 million in 1999 to $642 million in 2008. Gross profit for fiscal 2008 was $3.268
billion, or 50.1% of net sales, compared with $3.064 billion, or 49.7% of net sales, for fiscal
2007. The increase in gross profit as a percent of net sales was due to the positive impact of
category management efforts, partially offset by increased distribution expense relating
to higher fuel costs. At the same time, earnings per share have risen from $1.63 to $6.40.
Common equity, on the other hand, has fallen from $1.3 billion to $171 million while the
debt to equity ratio has skyrocketed from around 40% to over 90%. There are two primary
reasons:
1. AZO has repurchased nearly half of its outstanding shares over the past five to ten
years, decimating common equity while providing a nice boost to EPS.

2. The management team has successfully migrated over 90% of vendors to a pay-on-
demand arrangement, increasing the accounts payable balance substantially while
reducing the investment in working capital.
Vendor funding is primarily recorded as a reduction to inventories and recognized as a
reduction to cost of sales as the inventories are sold; however, vendor funding for specific
selling activities is recorded as a reduction to operating, selling, general and administrative
expenses. AutoZone has since long convinced its vendors to put their products on its
shelves and retain ownership until the moment that a customer walks up to the front of
one of AutoZone’s stores and pays for the goods. At that precise second, the vendor sells
it to AutoZone which in turn sells it to the customer. This allows them to expand far more
rapidly and return more money to the owners of the business in the form of share
repurchases or cash dividends because they don’t have to tie up hundreds of millions of
dollars in inventory. In the meantime, the increased cash in the business as a result of
more favorable vendor terms and/or getting AutoZone’s customers to pay it sooner
allows the company to generate more income than its equity or debt alone would permit.

AutoZone classified the majority of its funding as a reduction to inventory; however,
during the current year it began to transition to more specific promotions and selling
activities as it increased its efforts with vendors to develop tactics to allow them to drive
sales and showcase their product, which affect selling, general and administrative expenses.
Questions

1. What is your main finding by the analysis of the case above?
2. What modifications did AutoZone made in its strategy for vendor financing and
how did it benefit the organization?

Source: www.wikinvest.com

Insurance Float

Insurance companies that collect money and can generate income by investing the funds before
paying it them out in the future in the form of policyholder payouts when a car is damaged, or
replacing a home when destroyed in a tornado, are in a very good place.
As Buffett describes it, float is money that a company holds but does not own. It has all of the
benefits of debt but none of the drawbacks; the most important consideration is the cost of
capital – that is, how much money it costs the owners of a business to generate float. In exceptional
cases, the cost can actually be negative; that is, you are paid to invest other people’s money plus
you get to keep the income from the investments. Other businesses can develop forms of float
but it can be very difficult.

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