Where is JJSF getting the money to pay off its short term debt? Annual free cash flow has been lower than current liabilities for the past three years (operating cash flow ratio < 1), but they're not using their cash reserves to pay down debt because cash has actually been increasing. Where's the money coming from?
Maybe you shouldn't try to make it quite so complicated and just look at it from a bottom line perspective. If they're making all their payments to vendors in a timely fashion (which apparently they are or we'd hear about the vendors screaming and yelling for their money) *and* show and ton of cash with a tiny amount of debt on the balance sheet *and* the cash keeps increasing every year then you really can't ask for more than that.
That clears things up a lot. Thank you for your patience in explaining this stuff - I learned a lot and I will definitely take your advice in seeking out more information about basic accounting. Cheers! :)
This ratio does still give you a feel for liquidity of a company but you can't really over stress it. It is simply an easy way of looking at liquidity similar to the current ratio or the quick ratio. I looked at this ratio for the last five years for JJSF and it has hovered in each year near 1. By using this ratio what you are looking at is if theoretically we were to freeze the company in place and do no more business could it pay all of its current bills from the cash flow it has generated. Since it can it wouldn't have to start using current cash or going into debt. However this doesn't change the fact that in any year you look at the company it will still have accounts payable and other current liabilities since it is an ongoing business.
If we were to compare it to your household you have bills (accounts payable) which if we did a balance sheet for you in any one month you would have outstanding then you would pay these bills out of your paycheck (cash flow) but next month we would probably see a similar amount of bills since you are continuing to buy things and then again your paycheck comes and you pay off the old bills just to have them replaced with new ones.
I hope that helps explain it better. Analyzing balance sheets, cash flow statements, and income statements is not an easy thing to grasp. What might help you is to sometime read up on basic accounting and how ledgers work.
Ah hah, I think I get it now! I suspected as much before, but then I got confused because I read about how you're supposed to look for an operating cash flow ratio ( operating cash flow / current liabilities ) greater than 1, otherwise the company may have trouble paying its bills. According to the way cash flow is calculated, the operating cash flow ratio shouldn't matter because you've already taken into account the cost of paying your accounts payable (through net income) before coming up with a cash flow figure, right?
You are correct a balance sheet is a point in time snapshot and yes you would have paid the liability usually multiple times each year between balance sheets.
Here is the problem that you are having though is in confusing the cash flow statement as showing where every dime has been used during that period. The cash flow statement shows CHANGES in accounts because this is what matters. The $1 million would be in the Cost of Goods Sold (COGS) figure and not reported in cash flow since cash flow already starts with Net Income. So if you look at the most recent cash flow statement for the December quarter you will see that the company generated $15 million in operating cash flow, then they invested 400K (net) in the business, used 600K (net) in financing, and they added $14 million to cash. The cash figure then matches the cash that is shown on the balance sheet. Effectively the bridges the income statement and the balance sheet. It also shows that they used $12 million to pay down accounts payable in the most recent quarter, so effectively they were lowering the time that a supplier would wait for payment.
So no your operating cash does not have to equal $1 million since it is considered in COGS which is reflected in net income which is where operating cash flow is derived from. What you want to watch for is how many days payable they are maintaining and whether or not this is starting to be out of bounds for the industry.
Thanks for the explanation! I'm still not sure I get it, though I definitely understand accounts payable better. Let me see if I can explain the point I'm stuck on...so, a balance sheet is essentially a snapshot of a company's financial condition at a single point in time, right? If you have $1 million in current liabilities on your balance sheet, then generally speaking, by the same time next year, you would've had to pay at least $1 million to your creditors. Your balance sheet next year would still list a similar amount of current liabilities, since you would've taken on more payables during that time to replace the ones you've paid off, but that doesn't change the fact that at least $1 million would've had to come out of your pocket from today to one year later.
In order to fund that $1 million, logically, your operating cash flow for the year has to equal or exceed $1 million, doesn't it?
Let me see if I can help you out some. You have to pay off one current liability but new current liabilities will always replace ones that are being paid off as long as the business is still in operation. Every-time JJSF buys new inventory this would create a payable to some company, so they pay on one that has been around for lets say 90 days and it is replaced by another payable. This is the same reason that you would never see inventory, receivables, or any of these other similar accounts with a zero balance.
What someone who analyzes balance sheets will look at is are payables growing more quickly than cost of goods sold (COGS). They would do this with the payable turnover ratio which is COGS/accounts payable 468/70 (really should be average accounts payable but I'm tired). Then someone could take 365/payables turnover 365/6.68=54.64 days. You would then compare this 55 day number to others in the industry and also past numbers from this company to see if it is out of whack. Usually longer is better since companies usually don't get large discounts for paying bills early and they give up interest that could be earned on the cash, or other uses of the funds.
Does that help or are you still stuck?
Sorry, I'm still extremely new to this investing thing (mostly self educated at this point), and came upon something I don't understand. I thought I was just missing something glaringly obvious, but I didn't realize it was so complicated that someone more knowledgeable wouldn't be able to explain it. Thank you for trying to help regardless.
In all due respect I would suggest taking an accounting course offered in a continuing education format. I would also recommend you buy mutual funds that have highly skilled people to evaluate the merits of investing in individual cos. I would not suggest buying individual stocks until you have some handle on interpreting a balance sheet. Best regards.
Hmm, I'm afraid I still don't understand how JJSF is paying down its current liabilities. Even if you don't have to pay them off in full at the end of each year, you'll still have to pay them eventually, yeah? And when your business creates new current liabilities, you'll have to pay that down too. Just from a mathematical standpoint, I don't see how that's possible when the amount of cash flowing into the company every year is less than the money the company owes each year for three consecutive years.
Maybe there's something really obvious I'm missing? The only thing I can think of is that current liabilities is already factored into operating expenses, so the cost of paying them is already incorporated into the income statement. Hence net operating cash flow is already discounted the amount of the period's current liabilities. Could this be the case?