Marc’s Salesforce Lemonade Stand 2016

Standard

lemonadestand2016

On the back of the full year report, I also do an analysis of Salesforce’s cash flow. To make it easier to understand, I convert the Salesforce business into a lemonade stand.

What is Cash Flow?

The Cash Flow Statement is one of the three standard financial statements issued by companies to communicate their financial health. The three statements are:

  • Statement of Operations (Revenues and Costs)
  • Balance Sheet (Assets and Liabilities)
  • Cash Flow Statement (Incoming and Outgoing Cash)

In my quarterly analysis, my focus is on the statement of operations where we consistently see strong revenue growth and no profits. Here we look at the cash going in and out of the business to see how Salesforce survives. You can be very creative in your accounting in the statement of operations and the balance statement but the cash flow is very difficult to manipulate and is arguably the best way to see how a company is going.

Marc’s Lemonade Stand

To make the numbers a bit more intuitive, I convert the cash flow entries to their equivalents as if it was a lemonade stand.

Marc buys the ingredients from the local corner store (Subscription and Support Costs) and puts up posters in the surrounding streets to promote his stand (Marketing and Sales). His sister also helps out, making the lemonade and sitting on the stand (General and Administrative Costs). She is a strong believer in the future success of the stand and frequently buys shares in the business from Marc (Expenses Related to Stock-Based Awards).

I go through all the cash flow entries and come up with lemonade-related equivalents. Let us see how the numbers play out.

The Numbers

To scale from $6.6b company to a stand, I make the revenue $1 and scale everything else down accordingly. This means we get to see what cash entries significantly contribute to a $1 of lemonade revenue. Values above or below 10c are highlighted in green or red, respectively. In effect, the number of cents is a percentage of contribution.

 

2012

2013

2014

2015

2016

Sales of a Cup of Lemonade

$1.00

$1.00

$1.00

$1.00

$1.00

Cost of Ingredients From Corner Store

-$0.22

-$0.22

-$0.24

-$0.24

-$0.25

Taste Testing

-$0.13

-$0.14

-$0.15

-$0.15

-$0.14

Posters

-$0.52

-$0.53

-$0.53

-$0.51

-$0.49

Paying Sister to Make Lemonade and Sit on Stand

-$0.03

-$0.01

$0.00

$0.01

$0.02

Bank Account Interest (minus fees)

$0.00

$0.00

-$0.02

-$0.01

-$0.01

Overcharging/Undercharging

$0.00

$0.00

$0.00

-$0.01

$0.00

Uncle Sam Subsidizing/Taking a Free Lemonade

$0.01

-$0.05

$0.03

-$0.01

-$0.02

Net Income Before Depreciation/Amortisation

$0.12

$0.04

$0.09

$0.08

$0.11

Selling sister a share of the business

$0.15

$0.24

$0.19

$0.16

$0.16

Lending Dad Money for Lemonades

-$0.11

-$0.06

-$0.10

-$0.10

-$0.09

Profit Share Paid to Sister

-$0.07

-$0.08

-$0.07

-$0.06

-$0.06

Money Put in Bank

$0.00

$0.00

$0.03

$0.01

$0.01

Money Owed to Corner Store

$0.04

$0.06

-$0.01

$0.03

$0.04

Loyalty Program

$0.20

$0.16

$0.15

$0.15

$0.15

Net Cash From Operating Activities

$0.32

$0.36

$0.29

$0.27

$0.32

Buying Out and Taking Over Other Lemonade Stands

-$0.21

-$0.19

-$0.65

-$0.03

-$0.11

Fixing up the Lemonade Stand

-$0.09

-$0.07

-$0.08

-$0.03

-$0.04

Comic Purchases and Sales

$0.06

-$0.06

$0.13

-$0.08

-$0.09

Net Cash From Investing Activities

-$0.24

-$0.32

-$0.61

-$0.14

-$0.24

Borrowing Money From Mom

$0.00

$0.00

$0.33

-$0.10

-$0.04

Net Cash From Financing Activities

$0.00

$0.00

$0.33

-$0.10

-$0.04

Cash Profit

$0.08

$0.05

$0.01

$0.02

$0.04

Marc’s Sources of Cash

Marc’s main sources of cash are:

  • Lemonade Sales (Subscription and Support Revenue): $1.00
  • Selling Sister a Share of the Business (Expenses related to stock-based awards): 16c
  • Loyalty Program (Deferred Revenue): 15c

which are the same main sources as in 2015.

So every year, Marc sells more shares to his sister in the business and every year people continue to pre-purchase their lemonades. Neither of these can go on forever. There will be a point where the sister gets tired of buying into a business which is barely getting by, on the hopes of future riches.

In the case of the loyalty program, Marc still needs to deliver the lemonade so the costs associated with delivering on the loyalty program will eventually catch up with him.

We can see, certainly in the last four years, that these two supplemental sources of cash have reduced as a percentage of revenue. In my opinion, this is probably a healthy thing. Relying on unsustainable sources of cash income is not good for the long term so if they dry up and if costs can be reduced as well, the business will be in better shape.

Marc’s Main Costs

The main costs in the business are:

  • Costs of ingredients (Subscription and Support Costs): 25c
  • Taste Testing (Research and Development): 14c
  • Posters (Marketing and Sales): 49c
  • Buying Out Other Lemonade Stands (Business Combinations): 11c

This list is down from last year with Accounts Receivable reducing (Salesforce is getting tougher on credit terms) and we are not paying back as we did last year on borrowings.

The stand-out is, of course, Marketing and Sales. Literally half of the cash revenue Salesforce receives is absorbed in Marketing and Sales, which is massive compared to their industry peers. Marketing is defined as ‘demand generation’ so it is no surprise that Salesforce get the revenue growth they do when half of the money they receive from sales is ploughed back into the marketing and sales engine.

In terms of which direction the costs are trending, it is a mixed bag. Subscription and Support Costs are increasing, up 4c (4% of revenue) in five years. Marketing and Sales have largely offset this with a reduction of 3%.

Overall

In total, the cash profit is 4c. That is pretty tight but in the last three years has been improving. Unfortunately, as we can see above, without the two additional sources of cash income, the business would be in a lot of trouble. As I discussed last year, while sales growth remains, everything is fine. However, if sales flatten, the additional sources of cash income will disappear and costs will need to be reduced.

The most likely candidates for cost reduction are buyouts and marketing. Even if we completely stop buyouts, we will need to reduce our marketing and sales spend significantly. Again, this may not be such a bad thing and will bring Salesforce in line with its industry competitors, in terms of marketing and sales spend.

Conclusions

Salesforce finds itself in an interesting position. It can continue to feed the marketing and sales beast, subsidised by share sales and 12 month contracts, growing revenues but flirting with cash disaster or it can seek to slow things down, and make itself sustainable before the market forces their hand.

As a shareholder, this would be difficult to weigh up. Do I want my company to grow, make no money now but, presumably, in the future be very profitable (somehow), or do I want to see a sustainable business and a return on my investment now, at the expense of world domination.

Historically it seems the Salesforce shareholders have embraced growth at the expense of dividends and profit, very rare for shareholders. For me, I am waiting for revenue growth to flatten either at the hand of Salesforce or at the hand of the market. My hope is the resulting fall in share price will make Salesforce a bargain but, even then, it will only be worth buying if the business is stable and profitable.

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