We avoid GAAP earnings in our valuations because accrual accounting allows an entitiy to record revenues before cash is collected and record expenses that do not involve payments of cash. Accrual income almost never matches the actual cash generated from operations. As investors we're primarily interested in the actual cash that a company generates from operations free of any form of manipulation.

To get there we estimate free cash flows to firm first by making two major adjustments to earnings;
1. We capitalize research and development, accrual accounting requires that R&D be expensed as it occurs, but we recognize and appreciate that results from R&D creates growth. We treat it the same as all other investments by capitalizing it.
   values in Millions

   R&D asset lifetime5 years

   R&D expense$6,153

   R&D amortized$3,524

   R&D asset value$16,813
   The R&D asset value is used to adjust the book value of equity, this in turn is used in the return on equity calculations.
2. The other major adjustment to earnings that is made is by putting a major off-blance sheet item such as operating leases back on the balance sheet. Operating leases are treated as Operating expenses where they should be treated as financial expenses that have the same obligations as debt. Our second major adjustment therefore is in converting operating leases to their debt equivalent.
   Operating lease expenses and debt adjustment in (Millions)

   Current year$342

   Year one$421

   Year two$148

   Year three$123

   Year four$117

   Post year four$33

   Total$1,184

   Debt value$720

   Depreciation$180

   Debt Adjustment

   + Debt$23,039

   + Value of operating lease debt$720

   = Debt (Adjusted)$23,759

Revenue/Earnings data

Revenue (Million $)

Earnings in (Millions)	2007	2006	2005
Revenue	$98,786	$91,424	$91,134
Expenses	$89,952	$83,674	$86,210
Net income	$10,418	$9,416	$7,994
Earnings before interest and taxes (EBIT)	$15,100	$13,595	$12,446
Adjusted EBIT	$17,891	$17,511	$17,652
Free cash flow to firm	$6,466	$4,752	$7,090
Free cash flow to equity	$7,704	$6,444	$7,980
Adjusted debt	$23,759	$14,365	$16,775
Adjusted equity	$42,654	$38,886	$38,771
Adjusted depreciation	$8,905	$7,432	$6,660
Total reinvestment	$5,163	$6,630	$4,384
Adjusted EBIT	$17,891	$17,511	$17,652
Adjusted EBIT(1 - t)	$11,629	$11,382	$11,474
FCFF	$6,466	$4,752	$7,090
FCFE	$7,704	$6,444	$7,980
Cash conversion cycle	72	72	68
Days inventory outstanding	17	19	19
Days payable outstanding	52	55	49
Days sales outstanding	106	107	98
Acid test	0.36	0.27	0.39
liberal acid test	1.14	1.04	1.22
Current ratio	1.20	1.11	1.30
Fixed charges coverage ratio	15.84	25.36	11.79
Interest coverage ratio	24.71	48.90	56.57
Current Assets
Cash and equivalent	$14,991	$8,022	$12,568
Short term investments	$1,155	$2,634	$1,118
Accounts receivable	$28,789	$26,848	$24,428
Inventory	$2,664	$2,810	$2,841
Deferred taxes	$1,687	$1,806	$1,765
Prepaid expenses	$3,891	$2,539	$2,941
Other assets
Total assets	$53,177	$44,659	$45,661
Current Liabilities
Accounts payable	$8,054	$7,964	$7,349
Debt payments	$12,235	$8,902	$7,216
Accrued Expenses	$10,546	$9,967	$8,558
Tax payable	$3,673	$4,670	$4,710
Other liabilities	$9,802	$8,587	$7,319
Total liabilities	$44,310	$40,090	$35,152
Working capital	$8,867	$4,569	$10,509
Non cash working capital	$4,956	$2,815	$4,039
Investment in working capital	$2,141	($1,224)	($662)

IBM’s Business Model

 

The company’s business model is built to support two principal goals: helping clients succeed in delivering business value by becoming more innovative, efficient and competitive through the use of business insight and information technology (IT) solutions; and, providing long-term value to shareholders. The business model has been developed over time through strategic investments in capabilities and technologies that have the best long-term growth and profitability prospects based on the value they deliver to clients. The company’s strategy is to focus on the high-growth, high-value segments of the IT industry.

 

The company’s global capabilities include services, software, hardware, fundamental research and financing. The broad mix of businesses and capabilities are combined to provide business insight and solutions for the company’s clients.

 

The business model is flexible, and allows for periodic change and rebalancing. The company has exited commoditizing businesses like personal computers and hard disk drives, and strengthened its position through strategic investments and acquisitions in emerging higher value segments like service oriented architecture (SOA) and Information on Demand. In addition, the company has transformed itself into a globally integrated enterprise which has improved overall productivity and is driving investment and participation in the world’s fastest growing markets. As a result, the company is a higher-performing enterprise today than it was several years ago.

 

The business model, supported by the company’s long-term financial model, enables the company to deliver consistently strong earnings, cash flows and returns on invested capital in changing economic environments.

 

1 NEW ORCHARD ROAD
ARMONK, NY 10504
Phone: (914) 499-1900