Last week I reviewed the Salesforce yearly results and, as usual, railed against their ‘growth at the expense of sustainability’ strategy.
This week I look at Salesforce from a slightly different perspective: where does the money go? To do this I am going to take the Salesforce yearly financials and represent them as a lemonade stand business. The idea being we can see exactly what Salesforce is spending their money on to deliver their excellent lemonade (or Kool Aid, you decide).
You Can Fake a Lot of Things But Not Cash Flow
If you open any annual report from a public company, you will see three financial reports:
- Statement of Operations (talks at Revenues, Costs and Profits)
- Balance Sheet (talks at the assets and liabilities of an organisation e.g. money in the bank and outstanding loans)
- Cash Flow Statement (shows where the money has moved over the year)
Revenues can be defined in creative ways, as can costs. Assets can be overvalued and loans can be set up in interesting and special ways. Therefore, the first two financial reports, at least in the short term, can be massaged to be more favourable than they possibly should be. However, it is much harder to fake cash flow.
Marc’s Lemonade Stand
Here is the scenario: Marc is running a very popular lemonade stand held outside of his home in Hawaii. He buys the ingredients from the local corner store and gets his sister to make up the drink. She also sits with him on the lemonade stand, helping with sales.
Marc and his sister spend a lot of time taste testing to make sure they are providing a quality product and, to drive business to their stand, put posters up in the local area advertising their drink.
In terms of the money made from the stand, some goes into the bank to earn interest and Marc also buys old comics, as an investment, which he sells to make a profit.
His sister gets paid for helping out with the stand and, keen for a bigger slice of the action, is also constantly buying shares of the business and taking a profit share/commission on sales.
Most days, his dad will buy a lemonade when he comes home from work, but does not always have change on his and so he owes the stand a few bucks. Similarly, Marc does not always have quite the amount of money for his ingredients but the kind owner of the corner store lets him take the goods on credit.
His mom helps him with the finances and lends Marc money when times are tough.
Being an enterprising lad, Marc also offers a loyalty scheme where, if a customer pays for twelve lemonades up front, they get a discounted rate. This means Marc is often holding money for lemonades he has not made yet. He also has bought out other lemonade stands in the area, taking their equipment and ingredients, and gets the former owners to redirect clients to his lemonade stand.
Finally, around Christmas, his uncle Sam comes to visit. Sometimes uncle Sam takes a lemonade, sometimes he pays a little back but he always seems to take more than he gives and there are no clear rules about when uncle Sam will take money or give it. Marc’s mom and dad simply tell Marc it is impolite to question uncle Sam and to let him do what he wants; it is only once a year, after all.
The Lemonade Stand Finances
All finances are relative to the sales of one cup of lemonade ($1) (equivalent to the total annual revenue of Salesforce). In other words, a 2013 cup of lemonade is equivalent to $3b in Salesforce revenue while a 2014 cup is equivalent to $4b in Salesforce revenue.
Like a normal cashflow statement, a positive number is cash flowing into the business and a negative is money flowing out of the business.
|Sale of a Cup of Lemonade||$1.00||$1.00|
|Cost of Ingredients From the Corner Store||-$0.09||-$0.09|
|Taste Testing Costs||-$0.14||-$0.15|
|Paying Sister to Make Lemonade and Sit on the Stand||-$0.14||-$0.15|
|Uncle Sam Subsidising/Taking a Lemonade For Free||-$0.05||$0.03|
|Selling Sister a Share of the Business||$0.24||$0.19|
|Lending Dad Money for Lemonades||-$0.06||-$0.10|
|Change in Profit Share Not Yet Paid to Sister||-$0.08||-$0.07|
|Money Put in the Bank||$0.00||$0.03|
|Bank Account Interest||$0.01||$0.00|
|Bank Account Fees||-$0.01||-$0.02|
|Change in Money Owed to Corner Store||$0.06||-$0.01|
|Buying Out and Taking Over Other Lemonade Stands||-$0.19||-$0.65|
|Fixing up the Lemonade Stand||-$0.07||-$0.08|
|Borrowing Money From Mom||$0.00||$0.33|
|Net Change in Cash (+/- 1c for rounding)||$0.05||$0.01|
The headings above are approximate as I have combined some line items in the Salesforce financials.
The Big Ticket Items
So, for every cup of lemonade sold for $1, in 2014, the business gained 1c. In the previous year, it was 5c. This does not strike me as a lot of cash. The big transactions in each area are:
- Sale of a Cup of Lemonade ($1) (Revenue)
- Taste Testing Costs (-15c) (Research and Development)
- Posters (-53c) (Marketing and Sales)
- Paying Sister to Make Lemonade and Sit on the Stand (-15c) (Administrative)
For revenue/costs, obviously the big cost here are the posters. Marc is spending a lot of money getting the word out there to drive the business. Also, there is not a lot left over when costs are accounted for. In fact Marc only has 9c left.
- Selling Sister a Share of the Business (19c) (Proceeds and Expenses Related to Employee Stock Plans)
- Lending Dad Money for Lemonade (-10c) (Accounts Receivable)
- Loyalty Program (15c) (Deferred Revenue)
The largest operating activity is getting money into the business by selling shares to his sister. To do this, Marc takes his sister’s money then prints a certificate on the family computer saying she owns another share of the business. Of course, all Marc has to do is print off another share for himself and his sister’s total ownership of the business remains the same. His sister still has not caught onto this.
The loyalty program is interesting in that people are paying for lemonades today which they will receive tomorrow. This is helping put money in Marc’s pocket but he will need to hand over lemonades without payment later on.
After his sister and the loyalty program have propped up the business through operating activities, Marc has 29c in his pocket.
- Buying Out and Taking Over Other Lemonade Stands (-65c) (Business Combinations + Strategic Investments)
- Comic Purchases (-14c) (Purchase of Marketable Securities)
- Comic Sales (26c) (Sales and Maturities of Marketable Securities)
Marc was aggressive in buying other stands this year which cost the business dearly. To partly cover this, Marc sold off some of his comics.
After his investing activities, Marc is left short 32c.
- Borrowing Money From Mom (33c) (Proceeds from Borrowing on Convertible Senior Notes + Insurance of Warrants + Purchase of Convertible Note Hedge + Payments on Convertible Senior Notes + Proceeds From Term Loan + Principal Payments on Term Loan)
Fortunately, Mom is there to bail him out and offers to lend him 33c to cover the shortfall, leaving 1c in his pocket.
Big Changes Since the Year Before
Compared to the previous year, the items which have changed the most are:
- Selling Sister a Share of the Business: Down by 19%
- Lending Dad Money for Lemonade: Increased 74%
- Buying Out and Taking Over Other Lemonade Stands: Increased 237%
- Comic Purchases: Decreased 59%
- Borrowing Money From Mom: Not Done in the Previous Year
Relative to the size of the business, his sister is not buying shares as much as the previous year. Could she onto Marc’s scheme? Is this an on-going trend with her purchases contributing less and less to the relative bucket?
Lending Dad money to buy lemonades has increased significantly since the previous year. It is easy to get people to buy lemonade when they do not have to hand over the money but collecting money from dad down the track may be tricky.
Buying other lemonade stands has increased massively relative to the previous year but, opportunities do not regularly present themselves, so this may be opportunistic. Similarly, the comic/mom funding may also be a once-off to cover the mergers and acquisitions.
Could Marc Run the Lemonade Stand Without Sister Buying Shares and the Loyalty Program?
We know that after costs are accounted for, the $1 from the cup of lemonade is reduced to 9c. Marc could stop most of the other Operating Activities without it adversely affecting the business. Dad may not be able to purchase lemonade each night but it is hard to recoup that money anyway so this may be ok.
Similarly, the loyalty program is good for getting cash through the door but it is robbing the future to improve present cash flow and it can be eliminated.
Marc can stop acquiring other lemonade stands but will always need to fix up his lemonade stand. Therefore, the 8c cost of maintaining the stand remains with all other Investing and Financing Activities going, leaving him 1c.
So, while it would be tight, Marc could sell lemonade but he would only make a margin of 1% on the sales.
In the previous year, Marc only had 4c after costs and after the costs of maintaining the lemonade stand are considered, we lose 3c on each $1 cup of lemonade.
Financial Calculations Used
For both of you interested, here is the conversion I used. Everyone else can skip to the conclusion.
- Cup of Lemonade (Subscriptions + Professional Services)
- Cost of Ingredients From Corner Store (Subscription costs + Professional Services costs + All Depreciation/Amortization)
- Taste Testing (Research and Development)
- Posters (Marketing and Sales)
- Paying Sister to Make Lemonade and Sit on Stand (Administrative)
- Bank Account Interest (Investment income)
- Bank Account Fees (Interest expense)
- Overcharging/Undercharging (Other+Effect of Exchange Rate Changes)
- Uncle Sam Subsidising/Taking a Lemonade For Free (Tax benefit + Excess tax benefits from employee stock plans + Excess Tax Benefits from Employee Stock Plan)
- Selling Sister a Share of the Business (Proceeds and Expenses related to employee stock plans)
- Lending Dad Money for Lemonades (Accounts Receivable)
- Change in Profit Share Not Yet Paid to Sister (Deferred commissions)
- Money Put in the Bank (Prepaid expenses, current assets)
- Change in Money Owed to Corner Store (Accounts Payable)
- Loyalty Program (Deferred Revenue)
- Buying Out and Taking Over Other Lemonade Stands (Business Combinations + Strategic Investments)
- Fixing up the Lemonade Stand (Land activity and building improvements + Capital Expenditures + Principal Payments on Capital Lease Obligations)
- Comic Purchases (Purchase of marketable securities)
- Comic Sales (Sales and Maturities of marketable securities)
- Borrowing Money From Mom (Proceeds from Borrowing on Convertible Senior Notes + Insurance of Warrants+Purchase of Convertible Note Hedge + Payments on Convertible Senior Notes + Proceeds From Term Loan + Principal Payments on Term Loan)
Marc is running lean. For every dollar of lemonade he sells, he only ends up with a few pennies in his pocket and this does not account for a purchase of a new lemonade stand sometime in the future when the current one wears out (depreciation/amortisation). Also, with his sister buying shares and the loyalty program, this is bringing money into the business but is not sustainable in the long term.
I maintain my concerns for Salesforce but the good news is it reversible if things like the loyalty program and ‘sister share purchases’ are wound down. As usual I wish Marc all the best with his stand and hope it with us for many years to come.