WEBVTT 1 00:00:00.900 --> 00:00:03.700 We Stand now at the end of the third module 2 00:00:03.700 --> 00:00:07.000 out of 5 of this course accounting 3 00:00:06.300 --> 00:00:08.800 for business operations 4 00:00:10.100 --> 00:00:14.400 During two modules. We have simply sold products 5 00:00:13.400 --> 00:00:16.400 which we had purchased from 6 00:00:16.400 --> 00:00:17.200 A supplier. 7 00:00:18.100 --> 00:00:22.100 But in the third module, I have introduced a very significant 8 00:00:21.100 --> 00:00:25.400 degree of complexity by creating 9 00:00:24.400 --> 00:00:28.100 our own manufacturing footprint. 10 00:00:29.300 --> 00:00:32.300 The reason why I think now that it's 11 00:00:32.300 --> 00:00:35.800 very important to take a step back at the 12 00:00:35.800 --> 00:00:38.500 end of these first 10 months of business 13 00:00:38.500 --> 00:00:41.600 operations so that we can get back 14 00:00:41.600 --> 00:00:44.500 to the fundamental contributions of this 15 00:00:44.500 --> 00:00:44.800 course. 16 00:00:45.700 --> 00:00:49.000 I truly believe that there are four fundamental 17 00:00:48.700 --> 00:00:51.300 contributions. We have to Deep dive in 18 00:00:51.300 --> 00:00:54.700 the first one constant from module 1 19 00:00:54.700 --> 00:00:57.700 to module 3 change in cash is 20 00:00:57.700 --> 00:01:00.800 not profit. There is a significant difference 21 00:01:00.800 --> 00:01:03.400 and there are many reasons why which I 22 00:01:03.400 --> 00:01:05.200 am going to detail a little bit later on. 23 00:01:06.100 --> 00:01:09.300 The second contribution is we have accounted for 24 00:01:09.300 --> 00:01:12.600 business operations. And what is very important 25 00:01:12.600 --> 00:01:16.000 to understand is that it's a process which is very stable 26 00:01:15.300 --> 00:01:18.900 robust mechanism. It's 27 00:01:18.900 --> 00:01:21.200 always the same story and it 28 00:01:21.200 --> 00:01:23.500 works very well and it's reliable. 29 00:01:25.100 --> 00:01:26.100 third contribution 30 00:01:26.800 --> 00:01:29.800 accounting is about producing numbers 31 00:01:29.800 --> 00:01:32.200 but financial analysis is 32 00:01:32.200 --> 00:01:36.400 not about reading numbers and making simple calculations. It 33 00:01:35.400 --> 00:01:38.700 goes much Beyond this very 34 00:01:38.700 --> 00:01:41.500 simple activity. And again, I 35 00:01:41.500 --> 00:01:42.300 will detail that. 36 00:01:43.300 --> 00:01:46.600 Last but not least the force contribution is something I 37 00:01:46.600 --> 00:01:50.300 repeatedly said during the stream modules growth 38 00:01:49.300 --> 00:01:52.800 is a very ambiguous process. Is 39 00:01:52.800 --> 00:01:55.200 it economic performance? Of course, it's 40 00:01:55.200 --> 00:01:58.800 great because it's value creation for the customer. But what 41 00:01:58.800 --> 00:02:01.500 are the potential negative impacts of 42 00:02:01.500 --> 00:02:01.900 growth? 43 00:02:03.100 --> 00:02:06.800 The first contribution is that definitely profit does 44 00:02:06.800 --> 00:02:09.600 not match with cash. There are 45 00:02:09.600 --> 00:02:12.800 plenty of reasons, but I developed four key 46 00:02:12.800 --> 00:02:14.600 reasons why they don't match. 47 00:02:15.200 --> 00:02:18.700 The first one is a concept whose name is operating working capital 48 00:02:18.700 --> 00:02:21.000 requirement. Which comes from what? 49 00:02:21.700 --> 00:02:24.500 First there's a time lag between the 50 00:02:24.500 --> 00:02:27.400 moment you account for a revenue and the moment 51 00:02:27.400 --> 00:02:30.600 you cash from sales. There's a timelap 52 00:02:30.600 --> 00:02:33.700 between the moment you purchase you can't 53 00:02:33.700 --> 00:02:37.000 for expenses and you pay your suppliers. This 54 00:02:36.200 --> 00:02:39.400 is why because of this time lag 55 00:02:39.400 --> 00:02:42.900 you account for accounts receivable. You can't for accounts 56 00:02:42.900 --> 00:02:45.500 payable and the end of the day cash and 57 00:02:45.500 --> 00:02:48.700 profits are not the same. There's a third 58 00:02:48.700 --> 00:02:51.900 reason why which is about inventories and 59 00:02:51.900 --> 00:02:54.500 it is calculated in the operating working 60 00:02:54.500 --> 00:02:57.300 capital requirement. In fact, there is is 61 00:02:57.300 --> 00:03:01.300 Cash in a warehouse, but it's not profit you 62 00:03:00.300 --> 00:03:04.000 need inventories because there is uncertainty 63 00:03:03.200 --> 00:03:06.000 on the demand there is maybe 64 00:03:06.500 --> 00:03:09.500 a lack of flexibility in the manufacturing footprint, but that 65 00:03:09.500 --> 00:03:12.500 the end of the day it's cash. It's no profit 66 00:03:12.500 --> 00:03:13.900 not yet profit. 67 00:03:14.500 --> 00:03:17.700 Then operating working capital requirement, which is inventories 68 00:03:17.700 --> 00:03:20.700 plus receivables minus payables is definitely 69 00:03:20.700 --> 00:03:23.900 the reason why at first profits 70 00:03:23.900 --> 00:03:26.500 and cash do not match you remember 71 00:03:26.500 --> 00:03:29.500 funds from operations is a bit duck 72 00:03:29.500 --> 00:03:32.300 profit minus changing the 73 00:03:32.300 --> 00:03:36.000 operating working capital requirement and six difference 74 00:03:35.500 --> 00:03:38.600 between profit and cash is definitely 75 00:03:38.600 --> 00:03:41.800 first operating working capital requirement 76 00:03:41.800 --> 00:03:42.300 change. 77 00:03:43.100 --> 00:03:46.700 But there are some other reasons you remember in a 78 00:03:46.700 --> 00:03:49.500 module 3. We are in April and we buy a 79 00:03:49.500 --> 00:03:52.800 machine and we start depreciating. I told you that the 80 00:03:52.800 --> 00:03:55.900 investment itself is a cash flow, but the 81 00:03:55.900 --> 00:03:58.300 depreciation is not a cash flow. It is 82 00:03:58.300 --> 00:04:01.500 a cost. It is a conception. It is a usage of the machine the 83 00:04:01.500 --> 00:04:04.200 progressive usage of the machine. So it is a 84 00:04:04.200 --> 00:04:07.900 non-cash expense, which is absolutely fundamental to 85 00:04:07.900 --> 00:04:10.500 take into account in the calculation of the production 86 00:04:10.500 --> 00:04:10.900 cost. 87 00:04:11.700 --> 00:04:14.300 This is a non-cash expense. This is 88 00:04:14.300 --> 00:04:17.700 in the profit but it's not cash second difference. 89 00:04:17.700 --> 00:04:20.500 There are some other non-cash expense. For 90 00:04:20.500 --> 00:04:23.100 example, if you receive stock options, it's going to 91 00:04:23.100 --> 00:04:26.800 show in a p&l as labor related expenses, but 92 00:04:26.800 --> 00:04:30.000 it's no cash out for the company even when 93 00:04:29.400 --> 00:04:31.300 it is exercised. 94 00:04:32.900 --> 00:04:35.200 Third reason let's go back to 95 00:04:35.200 --> 00:04:39.100 the machine. It's an investment. It's a cash outflow, but 96 00:04:38.100 --> 00:04:41.300 it's a cash out flow, which is not an expense. 97 00:04:41.300 --> 00:04:44.800 It will generate revenues an income 98 00:04:44.800 --> 00:04:47.800 in the future because you are going to generate cost savings. 99 00:04:47.800 --> 00:04:51.000 It's going to show in a p&l but later but the 100 00:04:50.100 --> 00:04:53.200 moment you account for the investment. It has 101 00:04:53.200 --> 00:04:56.400 absolutely no impact in a p&l the moment 102 00:04:56.400 --> 00:04:59.500 you start depreciating the investment. It has 103 00:04:59.500 --> 00:05:03.100 an impact on the p&l but it's not the capital expenditures itself 104 00:05:02.100 --> 00:05:04.300 as a cash outlay. 105 00:05:05.500 --> 00:05:08.500 Same story for the financing financing is Cash in but 106 00:05:08.500 --> 00:05:11.500 it's not an income. It's not a revenue and it's 107 00:05:11.500 --> 00:05:12.200 not an expense. 108 00:05:12.900 --> 00:05:15.800 When you convince the banker to provide funds so 109 00:05:15.800 --> 00:05:18.200 that you can Finance at least part of the 110 00:05:18.200 --> 00:05:21.700 purchase price of the machine. This is an inflow, 111 00:05:21.700 --> 00:05:24.500 but it does nothing to do with selling goods and 112 00:05:24.500 --> 00:05:27.400 services. So it should not be in the p&l. It 113 00:05:27.400 --> 00:05:30.500 is in the balance sheet. It is in a cash flow statement. It's 114 00:05:30.500 --> 00:05:31.300 not a profit. 115 00:05:32.300 --> 00:05:35.400 It was the same story by the way in module 1 when we 116 00:05:35.400 --> 00:05:38.600 created the company, we provided the cash 117 00:05:38.600 --> 00:05:41.500 account of the company with capital. It was cash. 118 00:05:41.500 --> 00:05:44.600 It was capital and we had not yet 119 00:05:44.600 --> 00:05:47.500 started the business operations. We had not 120 00:05:47.500 --> 00:05:50.500 yet started selling anything, but it was cash 121 00:05:50.500 --> 00:05:51.800 and it was financing. 122 00:05:52.300 --> 00:05:56.400 You understand that there are many reasons including four 123 00:05:55.400 --> 00:05:58.400 key factors, why profit and 124 00:05:58.400 --> 00:06:01.000 cash they definitely don't match. 125 00:06:02.500 --> 00:06:03.500 so on point 126 00:06:04.200 --> 00:06:07.900 these three statements are perfectly integrated. 127 00:06:07.900 --> 00:06:11.000 You remember we first build the p&l 128 00:06:10.200 --> 00:06:13.600 the income statement revenues less 129 00:06:13.600 --> 00:06:16.500 cost in parallel. We have a second film 130 00:06:16.500 --> 00:06:19.900 which is accounting for cash inflows and 131 00:06:19.900 --> 00:06:20.400 outflows. 132 00:06:21.400 --> 00:06:24.700 Which is very interesting is that there is an interaction between period and 133 00:06:24.700 --> 00:06:27.100 cash for example accounts receivable. 134 00:06:27.700 --> 00:06:30.300 You have the accounts receivable at the beginning of the month. What 135 00:06:30.300 --> 00:06:33.200 is due from your customers? What do you 136 00:06:33.200 --> 00:06:36.800 add a p&l item revenues? What 137 00:06:36.800 --> 00:06:40.000 do you deduct the cash collection 138 00:06:39.300 --> 00:06:42.500 from sales? What do you get at the 139 00:06:42.500 --> 00:06:45.400 end the accounts receivable at the end of the month which is going 140 00:06:45.400 --> 00:06:46.700 to show in the balancing. 141 00:06:47.300 --> 00:06:50.300 Through your understand that we are running to films in 142 00:06:50.300 --> 00:06:53.700 parallel. One is a p&l how much profit 143 00:06:53.700 --> 00:06:56.400 or loss do we generate out of selling goods 144 00:06:56.400 --> 00:06:59.300 and services. The second film 145 00:06:59.300 --> 00:07:02.300 is Cash in cash out. What is 146 00:07:02.300 --> 00:07:06.000 absolutely fascinating and integrated is 147 00:07:05.400 --> 00:07:08.400 out of these two films we end on the 148 00:07:08.400 --> 00:07:11.100 common picture which is a talented at 149 00:07:11.100 --> 00:07:14.700 the end of the period so we have two films to 150 00:07:14.700 --> 00:07:17.100 build a picture. This is a very 151 00:07:17.100 --> 00:07:19.400 well-oiled machine. 152 00:07:20.400 --> 00:07:23.200 You understand that we always do the same 153 00:07:23.200 --> 00:07:27.000 from module 1 to module three, I progressively introduced 154 00:07:26.800 --> 00:07:29.400 complexity but that we account 155 00:07:29.400 --> 00:07:32.500 for inventories. It's always the same thing when we account for 156 00:07:32.500 --> 00:07:36.000 accounts receivable. It's always the same thing when we account for net 157 00:07:35.500 --> 00:07:38.900 earnings more or less distributed more 158 00:07:38.900 --> 00:07:41.600 or less reinvested in a retain earnings. It's always 159 00:07:41.600 --> 00:07:44.700 the same thing though this mechanics. This 160 00:07:44.700 --> 00:07:47.600 machine is extremely robust and 161 00:07:47.600 --> 00:07:48.000 stable. 162 00:07:49.200 --> 00:07:52.800 One of the interesting consequence of that is 163 00:07:52.800 --> 00:07:56.100 the balance it always balances, 164 00:07:55.100 --> 00:07:57.200 whatever you do. 165 00:07:58.600 --> 00:08:01.800 Let's take four examples two business modifications 166 00:08:01.800 --> 00:08:03.200 and two mistakes. 167 00:08:04.200 --> 00:08:07.700 First you remember that we have decided to reinvest when 168 00:08:07.700 --> 00:08:10.600 her percent of the bottom line into retained earnings. 169 00:08:11.400 --> 00:08:14.300 Let's imagine that we change the dividend policy and we decided to 170 00:08:14.300 --> 00:08:15.300 distribute 50% 171 00:08:16.400 --> 00:08:19.500 What happens to the balance sheet it's going to be modified, but it 172 00:08:19.500 --> 00:08:20.000 will balance. 173 00:08:20.900 --> 00:08:23.400 Second modification you remember 174 00:08:23.400 --> 00:08:26.400 that we pay 50% of the purchases immediately and 175 00:08:26.400 --> 00:08:29.500 50% with a one month delay imagine that we've 176 00:08:29.500 --> 00:08:32.800 been able to convince our suppliers to pay one hundred 177 00:08:32.800 --> 00:08:35.600 percent of the purchases in one month instead 178 00:08:35.600 --> 00:08:38.000 of 50% What's going to 179 00:08:38.200 --> 00:08:41.900 happen to the balancy, but more interestingly. Let's imagine 180 00:08:41.900 --> 00:08:44.400 that we make a mistake. Oh in June 181 00:08:44.400 --> 00:08:47.700 we forgot to account for income tax the balance 182 00:08:47.700 --> 00:08:50.300 it will be wrong, but it's going to balance. 183 00:08:51.200 --> 00:08:54.400 Much more complex, imagine that in 184 00:08:54.400 --> 00:08:57.200 the calculation of the production cost. We forgot to account for 185 00:08:57.200 --> 00:09:01.300 the depreciation of the machine in the production costs calculation. 186 00:09:00.300 --> 00:09:03.500 The balance sheet will be wrong. The 187 00:09:03.500 --> 00:09:06.400 p&l will be wrong. But the balance sheet 188 00:09:06.400 --> 00:09:09.800 will balance. Let's have a look at these four situations one after 189 00:09:09.800 --> 00:09:10.300 the other. 190 00:09:11.100 --> 00:09:11.700 first one 191 00:09:12.500 --> 00:09:15.400 imagine that we decide to distribute 15% of 192 00:09:15.400 --> 00:09:20.500 the profit the net earnings in June were 12,886 50% 193 00:09:20.500 --> 00:09:24.100 of that is 6,443. If 194 00:09:23.100 --> 00:09:26.500 we decide at the end of June to distribute 195 00:09:26.500 --> 00:09:29.300 it if you don't to the shareholders will have to show that 196 00:09:29.300 --> 00:09:32.900 in the balance sheet. It's going to be dividend payable. 197 00:09:33.500 --> 00:09:36.200 It's decided in June. It's going to be Pat in July, 198 00:09:36.200 --> 00:09:37.200 August or whatsoever. 199 00:09:37.900 --> 00:09:40.400 But if we decide to distribute it 200 00:09:40.400 --> 00:09:43.500 if it done we are going to reinvest Less in 201 00:09:43.500 --> 00:09:46.400 the retained earnings. You remember that retainer. This 202 00:09:46.400 --> 00:09:48.400 is earnings minus dividends. 203 00:09:49.200 --> 00:09:52.600 So they retainer Nicks are going to be reduced by the amount 204 00:09:52.600 --> 00:09:55.500 of dividend which is going to be paid 205 00:09:55.500 --> 00:09:58.100 to the shareholders. And if you don't 206 00:09:58.100 --> 00:10:01.500 which is not going to be reinvested in the shareholders equity. 207 00:10:02.200 --> 00:10:06.500 So retainer earnings are down by 6,443 and 208 00:10:05.500 --> 00:10:10.100 dividends payable is by 6,443. 209 00:10:08.100 --> 00:10:12.000 The total balance. 210 00:10:11.200 --> 00:10:14.800 It is the same. There's plus something 211 00:10:14.800 --> 00:10:18.000 here and minus something there the 212 00:10:17.500 --> 00:10:19.200 balance it is balancing. 213 00:10:20.500 --> 00:10:23.000 Second situation in which the total balance it 214 00:10:23.200 --> 00:10:26.600 is modified, even though the balance of the balance sheet 215 00:10:26.600 --> 00:10:29.300 is preserved. You have negotiated with your 216 00:10:29.300 --> 00:10:32.400 suppliers to pay them 100% of the purchases in 217 00:10:32.400 --> 00:10:34.700 one month instead of 50% 218 00:10:35.600 --> 00:10:38.800 What is a consequence of the balance sheet the accounts 219 00:10:38.800 --> 00:10:41.900 payable figure is going to be very much incremented. It's 220 00:10:41.900 --> 00:10:44.300 no more 50% of the purchases. It's 221 00:10:44.300 --> 00:10:49.400 100% of the purchases now. It's 50,960 which 222 00:10:48.400 --> 00:10:51.400 is the entire purchases of the 223 00:10:51.400 --> 00:10:51.800 months. 224 00:10:52.700 --> 00:10:53.700 that the first point 225 00:10:54.600 --> 00:10:57.300 now what is a second impact on the balance sheet 226 00:10:57.300 --> 00:10:59.200 it will show on the asset side. 227 00:10:59.800 --> 00:11:02.800 Because if you have postponed the payment of the 228 00:11:02.800 --> 00:11:05.900 50% of the purchases, you used 229 00:11:05.900 --> 00:11:07.900 to pair to your suppliers before. 230 00:11:08.800 --> 00:11:11.200 Now this cash is in your pocket. 231 00:11:11.800 --> 00:11:14.400 So you have more cash in your bank account 232 00:11:14.400 --> 00:11:17.600 simply because you did not pay your suppliers 233 00:11:17.600 --> 00:11:20.100 by the amount of money which shows 234 00:11:20.100 --> 00:11:23.200 in your accounts payable at the end of the month. So you have 235 00:11:23.200 --> 00:11:26.700 more cash which exactly compensates more accounts 236 00:11:26.700 --> 00:11:27.300 payable. 237 00:11:28.400 --> 00:11:30.900 What is interesting in these two situations is? 238 00:11:31.700 --> 00:11:34.200 The first alternative is that the compensation is 239 00:11:34.200 --> 00:11:37.800 going to show in the same column either assets 240 00:11:37.800 --> 00:11:39.400 or equity and liabilities. 241 00:11:40.200 --> 00:11:43.800 You have more dividend payable and you have less retained 242 00:11:43.800 --> 00:11:46.700 earnings plus minus. The resulting 243 00:11:46.700 --> 00:11:49.200 impact is Neil and the total balance sheet 244 00:11:49.200 --> 00:11:52.800 Remains the Same Sergeant alternative the compensation in 245 00:11:52.800 --> 00:11:55.400 one column will show in the other column. 246 00:11:56.100 --> 00:11:59.600 Then you're going to compensate accounts payable and cash for 247 00:11:59.600 --> 00:12:02.200 example, but then the balance sheet is 248 00:12:02.200 --> 00:12:05.800 going to keep on balancing which is extremely predictable. 249 00:12:05.800 --> 00:12:08.200 But the total balance sheet 250 00:12:08.200 --> 00:12:11.500 is going to be affected by the change in 251 00:12:11.500 --> 00:12:13.500 the value of these items. 252 00:12:14.200 --> 00:12:17.300 Now the next two steps are quite interesting because we 253 00:12:17.300 --> 00:12:20.100 are going to make a mistake. The p&l is 254 00:12:20.100 --> 00:12:23.500 going to be wrong the balance it is going to be wrong. But the 255 00:12:23.500 --> 00:12:26.300 balance it will balance imagine for example 256 00:12:26.300 --> 00:12:29.400 that we made a mistake and we forgot to account for 257 00:12:29.400 --> 00:12:32.500 taxes in June. So there is 258 00:12:32.500 --> 00:12:35.400 no increment in income tax payable 259 00:12:35.400 --> 00:12:38.200 because what is missing is 20% of the earnings before 260 00:12:38.200 --> 00:12:41.400 tax generated by our activity in the month 261 00:12:41.400 --> 00:12:41.800 of June. 262 00:12:43.600 --> 00:12:46.400 If the income tax payable is down by the tax which 263 00:12:46.400 --> 00:12:49.800 disappeared you have generated more earnings after 264 00:12:49.800 --> 00:12:52.400 tax because earnings before tax 265 00:12:52.400 --> 00:12:55.300 and the earnings after tax now and it's wrong 266 00:12:55.300 --> 00:12:56.100 are the same. 267 00:12:56.900 --> 00:12:59.500 You have not reduced the retainer earnings 268 00:12:59.500 --> 00:13:02.600 by the amount of tax. You should have paid and this 269 00:13:02.600 --> 00:13:05.400 decrease in a tax payable show in your contacts 270 00:13:05.400 --> 00:13:08.900 payable. The compensation is more earnings after 271 00:13:08.900 --> 00:13:11.700 tax and more retained earnings. So 272 00:13:11.700 --> 00:13:14.400 here the mistake is the amount of income tax. 273 00:13:14.400 --> 00:13:17.500 You should have accounted as tax payable in June. 274 00:13:17.500 --> 00:13:21.100 It is reducing the income 275 00:13:20.100 --> 00:13:24.000 tax payable and increasing the return 276 00:13:23.400 --> 00:13:25.700 and it's by exactly is the same amount. 277 00:13:26.700 --> 00:13:29.400 So you made a mistake the p&l is 278 00:13:29.400 --> 00:13:32.400 wrong because the bottom line is wrong the balance it 279 00:13:32.400 --> 00:13:35.400 is wrong because there are two items in the balance sheet 280 00:13:35.400 --> 00:13:38.400 which are wrong. But at the end of the day, there's no 281 00:13:38.400 --> 00:13:41.400 change in the total balance sheet and the balance 282 00:13:41.400 --> 00:13:42.100 it is balancing. 283 00:13:43.800 --> 00:13:46.500 Sagon mistake, which is a much more complex and 284 00:13:46.500 --> 00:13:49.400 sophisticated imagine that in June you 285 00:13:49.400 --> 00:13:52.500 forget to account for the depreciation of the machine in 286 00:13:52.500 --> 00:13:54.000 a calculation of the production cost. 287 00:13:55.300 --> 00:13:58.500 What's going to happen for impacts in the balance 288 00:13:58.500 --> 00:14:01.500 it the first one is obvious property plants and 289 00:14:01.500 --> 00:14:04.800 Equipment grows value no change 60,000 which 290 00:14:04.800 --> 00:14:07.800 is a purchase price of the machine but accumulator 291 00:14:07.800 --> 00:14:10.500 depreciation if you forget to depreciate in June, 292 00:14:10.500 --> 00:14:13.400 you have two months of depreciation instead of three. This 293 00:14:13.400 --> 00:14:16.800 is why your property plant and Equipment your tangible fixed 294 00:14:16.800 --> 00:14:20.100 assets net of accumulated depreciation is 295 00:14:19.100 --> 00:14:23.200 overevaluated and it's 58,000 296 00:14:22.200 --> 00:14:26.200 when it should be 57,000. So 297 00:14:25.200 --> 00:14:29.100 you increase your total assets by 1,000. 298 00:14:29.900 --> 00:14:32.900 The second impact is on the inventories. 299 00:14:33.400 --> 00:14:37.000 Because if you forget to account for depreciation you reduce 300 00:14:36.300 --> 00:14:39.800 by the same amount the production cost and 301 00:14:39.800 --> 00:14:41.900 the production cost per unit. 302 00:14:42.600 --> 00:14:45.300 This is why there will be an earned or 303 00:14:45.300 --> 00:14:48.300 evaluation of the inventories of finished goods at the end of the month. 304 00:14:49.200 --> 00:14:53.300 Here what You observe is 21,200 instead 305 00:14:52.300 --> 00:14:56.700 of 21,000,562. 306 00:14:57.300 --> 00:15:01.100 There is a difference of 362. 307 00:15:02.500 --> 00:15:04.400 Let's make a simple calculation. 308 00:15:05.100 --> 00:15:08.400 Depreciation figure which is missing is 1000. 309 00:15:09.400 --> 00:15:09.800 second 310 00:15:10.700 --> 00:15:15.500 the inventory level is under evaluated by 362. 311 00:15:16.200 --> 00:15:19.300 Out of 1000 you can deduct from 312 00:15:19.300 --> 00:15:23.400 that that 36.2% of 313 00:15:22.400 --> 00:15:26.100 the number of units produced in 314 00:15:25.100 --> 00:15:26.700 June. 315 00:15:27.300 --> 00:15:30.900 Have not been sold and show in the invatore 316 00:15:30.900 --> 00:15:32.000 is of finished goods. 317 00:15:32.700 --> 00:15:36.200 But if 362 of 318 00:15:35.200 --> 00:15:38.900 depreciation are wrongly under 319 00:15:38.900 --> 00:15:41.600 evaluating the inventory, what does 320 00:15:41.600 --> 00:15:44.900 it mean the net between this figure and 1000 is 321 00:15:44.900 --> 00:15:46.200 missing in the cost of sales? 322 00:15:47.200 --> 00:15:51.200 1000 minus 362 is 323 00:15:50.200 --> 00:15:53.400 exactly 600 and 324 00:15:53.400 --> 00:15:54.500 38. 325 00:15:55.300 --> 00:15:58.900 So the cost of sales have been wrongly decremented 326 00:15:58.900 --> 00:16:01.600 by 638. 327 00:16:02.700 --> 00:16:05.400 And this is definitely an over evaluation of 328 00:16:05.400 --> 00:16:07.200 the profit before tax. 329 00:16:07.800 --> 00:16:10.400 Now look at the consequence on the asset side 330 00:16:10.400 --> 00:16:14.100 of the balance sheet. We are and Julie increasing 331 00:16:13.100 --> 00:16:16.300 the property plant and Equipment net by 332 00:16:16.300 --> 00:16:17.200 1,000. 333 00:16:17.900 --> 00:16:20.400 And reducing the invitory by 334 00:16:20.400 --> 00:16:23.200 SRI Harrow 62 the difference between these two 335 00:16:23.200 --> 00:16:26.300 figures is 638 which 336 00:16:26.300 --> 00:16:29.200 is increase in a total asset, which is wrong. 337 00:16:29.900 --> 00:16:32.600 But the 600 and 38 is 338 00:16:32.600 --> 00:16:35.400 the increase in earnings before tax. 339 00:16:35.400 --> 00:16:38.400 What is the impact on the equity and liability side 340 00:16:38.400 --> 00:16:39.300 of the balance sheet? 341 00:16:39.900 --> 00:16:42.800 But if you're over evaluate your 342 00:16:42.800 --> 00:16:46.500 earnings before tax by 638, you 343 00:16:46.500 --> 00:16:49.300 are going to overevaluate your income tax 344 00:16:49.300 --> 00:16:53.400 payable by 20% of 638, which 345 00:16:53.400 --> 00:16:56.600 is 128. This is 346 00:16:56.600 --> 00:17:00.100 why your income tax payable is now 7,000 which 347 00:17:00.100 --> 00:17:04.300 is exactly 6,872 plus 348 00:17:03.300 --> 00:17:06.600 100 and 28. 349 00:17:07.500 --> 00:17:10.600 And you're over evaluate all so your 350 00:17:10.600 --> 00:17:13.300 bottom line your net earnings your earnings after 351 00:17:13.300 --> 00:17:17.000 tax by 80% of 600 and 352 00:17:16.800 --> 00:17:19.400 38, which is the earnings before 353 00:17:19.400 --> 00:17:21.700 tax minus income tax payable. 354 00:17:22.500 --> 00:17:25.400 And the difference is 638 minus 355 00:17:25.400 --> 00:17:29.400 128 which is 510. This 356 00:17:28.400 --> 00:17:31.500 is why your retain earnings are 357 00:17:31.500 --> 00:17:34.700 36,720, which 358 00:17:34.700 --> 00:17:39.600 is exactly the sum of 36,210 plus 359 00:17:39.600 --> 00:17:42.000 510. 360 00:17:42.600 --> 00:17:45.700 So you understand that both side of the balance sheet 361 00:17:45.700 --> 00:17:48.800 are going to be incremented by the 362 00:17:48.800 --> 00:17:51.700 increase in yearnings before 363 00:17:51.700 --> 00:17:54.400 tax, which is a consequence of making a 364 00:17:54.400 --> 00:17:58.000 mistake in a calculation of the production cost. I strongly 365 00:17:57.400 --> 00:18:00.500 suggest you go back to this calculation 366 00:18:00.500 --> 00:18:03.700 a little bit later quietly. But if 367 00:18:03.700 --> 00:18:06.800 you really understand the mechanics of 368 00:18:06.800 --> 00:18:09.200 this calculation, you are 369 00:18:09.200 --> 00:18:12.700 extremely comfortable with a mechanics of building 370 00:18:12.700 --> 00:18:16.100 the balance sheet as an integrated document 371 00:18:15.100 --> 00:18:18.800 with p&l and cash flow statement. Now, 372 00:18:18.800 --> 00:18:22.300 let's move to the third contribution financial 373 00:18:21.300 --> 00:18:25.100 analysis Financial Accounting. Why 374 00:18:24.100 --> 00:18:27.900 do we produce accounting statements simply 375 00:18:27.900 --> 00:18:30.500 to record what is happening in 376 00:18:30.500 --> 00:18:34.000 business operations so that we can understand what 377 00:18:33.300 --> 00:18:36.600 is really happening and we can take good 378 00:18:36.600 --> 00:18:40.300 decisions. You remember quite early 379 00:18:39.300 --> 00:18:42.400 in the process. I introduce. 380 00:18:42.700 --> 00:18:45.400 Financial analysis at the end of each 381 00:18:45.400 --> 00:18:46.200 and every month. 382 00:18:47.100 --> 00:18:51.100 Financial analysis is very useful process, but 383 00:18:50.100 --> 00:18:53.400 it is not simply reading the 384 00:18:53.400 --> 00:18:55.800 accounts and making simple calculations. 385 00:18:57.300 --> 00:19:00.800 It's not just about adding and subtracting figures. It 386 00:19:00.800 --> 00:19:03.500 is understanding the link between the figures and 387 00:19:03.500 --> 00:19:06.400 the reality of business operations. Let's 388 00:19:06.400 --> 00:19:08.300 take a very simple example. 389 00:19:09.500 --> 00:19:12.300 You remember that in May the gross margin is down. 390 00:19:13.300 --> 00:19:16.300 If you just observe that the gross margin is down. You're going 391 00:19:16.300 --> 00:19:19.200 to say something terrible, which is happening in a company, 392 00:19:19.200 --> 00:19:20.300 which is absolutely wrong. 393 00:19:21.100 --> 00:19:24.800 The reason why the growth margin is down in May 394 00:19:24.800 --> 00:19:27.300 is that in the cost of sales now, we 395 00:19:27.300 --> 00:19:30.500 show the production cost of these products which 396 00:19:30.500 --> 00:19:33.700 we manufactured in April and whose cost 397 00:19:33.700 --> 00:19:37.200 per unit is 26 dollars as opposed to 20 or 398 00:19:36.200 --> 00:19:39.700 19. Why because volume was 399 00:19:39.700 --> 00:19:43.100 low. So the explanation is volume. It's 400 00:19:42.100 --> 00:19:46.300 a business explanation to an 401 00:19:45.300 --> 00:19:47.600 accounting reality. 402 00:19:48.300 --> 00:19:52.200 Then you understand that mastering technical skills 403 00:19:51.200 --> 00:19:54.300 in accounting is not just 404 00:19:54.300 --> 00:19:57.600 about observing the past. It is also being 405 00:19:57.600 --> 00:20:00.800 good at taking decisions whose impact 406 00:20:00.800 --> 00:20:02.600 is going to show in a future. 407 00:20:03.700 --> 00:20:07.000 And that's why accounting is absolutely of 408 00:20:06.500 --> 00:20:09.400 strategic importance. It's of strategic 409 00:20:09.400 --> 00:20:12.600 importance for the company, but it's of strategic importance 410 00:20:12.600 --> 00:20:16.000 all so for you managers in business operations. 411 00:20:17.300 --> 00:20:20.800 If you just observe the figures and you don't understand the 412 00:20:20.800 --> 00:20:24.400 mechanics, you don't understand the rationality behind 413 00:20:23.400 --> 00:20:27.000 the financial documents. You're 414 00:20:26.200 --> 00:20:29.900 not going to be able to understand really 415 00:20:29.900 --> 00:20:32.100 what happens and you're not going 416 00:20:32.100 --> 00:20:35.600 to be able to take the best decisions for your business 417 00:20:35.600 --> 00:20:36.400 operations. 418 00:20:37.300 --> 00:20:40.700 So you understand that there are very big difference between two 419 00:20:40.700 --> 00:20:44.300 managers two operating managers one who 420 00:20:43.300 --> 00:20:46.600 understands accounting the other 421 00:20:46.600 --> 00:20:47.600 one who does not. 422 00:20:48.400 --> 00:20:51.500 Really understanding what's behind the figures 423 00:20:51.500 --> 00:20:55.000 is a competitive Advantage for you managers 424 00:20:54.100 --> 00:20:56.800 when you run your business operations. 425 00:20:58.400 --> 00:21:01.600 But then you understand that the information which is 426 00:21:01.600 --> 00:21:04.800 in your hands should be as accurate as 427 00:21:04.800 --> 00:21:04.900 possible. 428 00:21:05.900 --> 00:21:08.600 If you use wrong figures in 429 00:21:08.600 --> 00:21:11.800 your understanding of reality and in 430 00:21:11.800 --> 00:21:14.800 your financial analysis, you're going to make wrong 431 00:21:14.800 --> 00:21:15.200 decisions. 432 00:21:16.200 --> 00:21:20.000 This is why accurate information is absolutely fundamental 433 00:21:19.600 --> 00:21:22.500 together with a relevant information. 434 00:21:23.400 --> 00:21:27.000 You managers in business operations, you 435 00:21:26.200 --> 00:21:30.100 need to be provided with information, which 436 00:21:29.100 --> 00:21:32.700 you need in order to take your decision. 437 00:21:33.400 --> 00:21:36.600 This is why you need to have relevant and 438 00:21:36.600 --> 00:21:39.400 accurate information to assess a situation 439 00:21:39.400 --> 00:21:43.000 understand judge evaluate 440 00:21:42.400 --> 00:21:44.000 and decide. 441 00:21:45.300 --> 00:21:48.800 Last but not least a contribution on which I insisted 442 00:21:48.800 --> 00:21:51.700 throughout the three modules growth. 443 00:21:52.200 --> 00:21:55.300 Of course if revenues are growing you're quite 444 00:21:55.300 --> 00:21:58.400 happy because it means that your business model 445 00:21:58.400 --> 00:22:01.400 is right you create value for your customers. 446 00:22:01.400 --> 00:22:04.600 You have the right product. The price is 447 00:22:04.600 --> 00:22:07.900 probably quite okay, at least for your customers and 448 00:22:07.900 --> 00:22:11.700 you are validating the commercial marketing policy 449 00:22:11.700 --> 00:22:14.600 of the firm. This is great because this 450 00:22:14.600 --> 00:22:17.600 is a purpose of the company to serve its customers. 451 00:22:19.300 --> 00:22:22.200 And a performance point of view growth in 452 00:22:22.200 --> 00:22:25.300 revenues is also quite valid and 453 00:22:25.300 --> 00:22:26.300 good for the company. 454 00:22:27.100 --> 00:22:30.500 When you consider fixed costs, which 455 00:22:30.500 --> 00:22:33.400 are not affected by revenues, if you grow 456 00:22:33.400 --> 00:22:36.900 the volume you reduce a fixed cost per unit 457 00:22:36.900 --> 00:22:39.600 and then you improve the economic performance of 458 00:22:39.600 --> 00:22:42.100 the company, which is named economy is a 459 00:22:42.100 --> 00:22:42.200 scale. 460 00:22:43.300 --> 00:22:46.600 Take care because the fixed cost should be really fixed. 461 00:22:46.600 --> 00:22:50.200 And sometimes there are thresholds in 462 00:22:49.200 --> 00:22:51.000 the fixed cost. 463 00:22:51.700 --> 00:22:54.900 You remember the capacity of the machine is 5000 464 00:22:54.900 --> 00:22:57.700 units, but you need three operators from 465 00:22:57.700 --> 00:22:59.700 0 to 2500. 466 00:23:00.400 --> 00:23:03.400 If it goes beyond 2500 you need 467 00:23:03.400 --> 00:23:05.100 three additional operators. 468 00:23:05.800 --> 00:23:08.300 Then you understand that fixed costs are fixed 469 00:23:08.300 --> 00:23:10.600 within a range of figures. 470 00:23:11.200 --> 00:23:14.400 But if you cross the border, then the fixed costs 471 00:23:14.400 --> 00:23:17.600 are incremented by a lumpsum amount 472 00:23:17.600 --> 00:23:20.100 from three to six workers. 473 00:23:21.100 --> 00:23:24.200 I also mentioned depreciation as a fixed cost which is 474 00:23:24.200 --> 00:23:25.700 not entirely true. 475 00:23:26.500 --> 00:23:29.400 Depreciation is a consequence of buying a 476 00:23:29.400 --> 00:23:32.400 machine whose capacity is 5,000 units, 477 00:23:32.400 --> 00:23:35.000 but imagine that in a month, you have to 478 00:23:35.500 --> 00:23:38.200 produce more than 5,000 units. Then you need 479 00:23:38.200 --> 00:23:41.100 to increase the capacity of the machine all you need to buy a second 480 00:23:41.100 --> 00:23:45.000 machine in both case you are going to increase the depreciation. So 481 00:23:44.800 --> 00:23:47.400 depreciation is also a fixed cost 482 00:23:47.400 --> 00:23:51.000 which is fixed within a range beyond 483 00:23:50.300 --> 00:23:53.300 the range depreciation is no more 484 00:23:53.300 --> 00:23:56.000 fixed. It's incremented by the new capacity. 485 00:23:57.300 --> 00:24:00.600 So take care about fixed cost because fixed costs 486 00:24:00.600 --> 00:24:03.400 are fixed within a range and take care about what 487 00:24:03.400 --> 00:24:06.300 happened when you cross the border and you go beyond 488 00:24:06.300 --> 00:24:07.000 the threshold. 489 00:24:08.100 --> 00:24:11.800 We have so far observes a two positive impacts 490 00:24:11.800 --> 00:24:15.000 of growth even though there were some constraints 491 00:24:14.600 --> 00:24:16.600 unlimitation in seron one. 492 00:24:17.200 --> 00:24:19.900 The third one is definitely not positive. 493 00:24:20.700 --> 00:24:24.100 If you want to sell and produce more, what 494 00:24:23.100 --> 00:24:27.300 do you need to do increase your production capacity? 495 00:24:26.300 --> 00:24:30.100 You need to buy a machine. It's 496 00:24:29.100 --> 00:24:32.200 a cash conception you cash out the 497 00:24:32.200 --> 00:24:35.100 purchase price as a machine and what about the 498 00:24:35.100 --> 00:24:38.300 operating working capital requirements going to increase? 499 00:24:39.100 --> 00:24:42.700 You produce more you have more inventories. You 500 00:24:42.700 --> 00:24:45.200 sell more you have more cancerous of all 501 00:24:45.200 --> 00:24:48.200 you produce more you purchase more you have 502 00:24:48.200 --> 00:24:51.700 more accounts payable though. The operating working capital 503 00:24:51.700 --> 00:24:54.300 requirement is mechanically linked with 504 00:24:54.300 --> 00:24:57.600 volume of activity of the company and more 505 00:24:57.600 --> 00:25:00.500 operating working capital requirement is 506 00:25:00.500 --> 00:25:03.600 less cash you remember again, 507 00:25:03.600 --> 00:25:07.200 and again that funds from operations are ebida 508 00:25:06.200 --> 00:25:09.500 minus change in 509 00:25:09.500 --> 00:25:13.100 the operating working capital requirement more operating 510 00:25:12.100 --> 00:25:15.700 working capital requirement less funds 511 00:25:15.700 --> 00:25:16.400 from operations. 512 00:25:17.700 --> 00:25:20.300 Growth consumes cash. It's 513 00:25:20.300 --> 00:25:23.600 a fundamental statement for large companies and it 514 00:25:23.600 --> 00:25:27.000 is even more fundamental for startups. You 515 00:25:26.400 --> 00:25:29.700 are started you build a business model. You 516 00:25:29.700 --> 00:25:32.300 start selling your products and You observe 517 00:25:32.300 --> 00:25:33.400 a commercial success. 518 00:25:34.100 --> 00:25:37.300 So you are quite happy because it means that there's a product 519 00:25:37.300 --> 00:25:40.400 Market fit and it works. Absolutely great. 520 00:25:41.200 --> 00:25:44.800 But when you start selling your goods and services, maybe you 521 00:25:44.800 --> 00:25:47.300 have not yet Rich Break Even. You're a 522 00:25:47.300 --> 00:25:50.700 bit dies negative or you're a bit dies hardly positive. 523 00:25:51.500 --> 00:25:54.200 But if revenues are up you need 524 00:25:54.200 --> 00:25:57.800 to invest in capital expenditures cash out you are 525 00:25:57.800 --> 00:26:00.600 going to observe your operating working capital requirement, which 526 00:26:00.600 --> 00:26:02.000 is up cash out. 527 00:26:02.600 --> 00:26:06.100 And then negligible a bit minus capex 528 00:26:05.100 --> 00:26:08.600 minus increasing working capital requirement 529 00:26:08.600 --> 00:26:11.400 is going to give you a strongly negative free cash 530 00:26:11.400 --> 00:26:11.600 flow. 531 00:26:12.200 --> 00:26:15.100 Then you visit your bankers and your Bankers say I don't want to 532 00:26:15.100 --> 00:26:18.400 provide any debt because you're a bit is not large enough 533 00:26:18.400 --> 00:26:19.800 to pay the interest expense. 534 00:26:20.500 --> 00:26:23.300 So if Bankers are out of the picture, you have to visit the 535 00:26:23.300 --> 00:26:27.100 shareholders and what is very interesting is the 536 00:26:26.100 --> 00:26:29.300 more you grow the more you 537 00:26:29.300 --> 00:26:32.800 consume cash the quicker you have to visit your shareholders 538 00:26:32.800 --> 00:26:35.500 and the quicker as an entrepreneur you are 539 00:26:35.500 --> 00:26:36.800 going to be diluted. 540 00:26:37.700 --> 00:26:41.700 This is definitely one of the key issues startups 541 00:26:40.700 --> 00:26:43.600 and entrepreneurs are facing 542 00:26:43.600 --> 00:26:44.900 about growth. 543 00:26:45.900 --> 00:26:48.500 Now, let's go back to you as managers and 544 00:26:48.500 --> 00:26:51.400 business operations. Of course, you have to increase 545 00:26:51.400 --> 00:26:54.200 a bit down. Take care. They are a little 546 00:26:54.200 --> 00:26:58.000 bit of biases with indicator. But if you increase a 547 00:26:57.200 --> 00:27:00.400 bit, it's not enough. You also 548 00:27:00.400 --> 00:27:03.600 have to manage a cash conversion cycle the operating 549 00:27:03.600 --> 00:27:06.700 working capital requirements so that you can transform the Bida 550 00:27:06.700 --> 00:27:09.500 into funds from operations. And you also 551 00:27:09.500 --> 00:27:13.100 have to carefully select your investment projects. You 552 00:27:12.100 --> 00:27:15.500 can invest in capital expenditures today 553 00:27:15.500 --> 00:27:19.000 because you selected great investment projects 554 00:27:18.400 --> 00:27:21.600 yesterday, we charge generating a bit 555 00:27:21.600 --> 00:27:24.900 today, which you can transform into funds from operations and 556 00:27:24.900 --> 00:27:27.300 those great projects which you decide to 557 00:27:27.300 --> 00:27:30.500 invest in today are going to generate even more funds from 558 00:27:30.500 --> 00:27:33.500 operations in the future. That is the essence 559 00:27:33.500 --> 00:27:36.500 of your job. You operating managers as 560 00:27:36.500 --> 00:27:39.800 Fast Finance and Accounting are concerned. 561 00:27:40.800 --> 00:27:43.500 Now the progress report on the first three 562 00:27:43.500 --> 00:27:46.300 modules is over we can start 563 00:27:46.300 --> 00:27:49.600 with module 4 now you remember in module 3 564 00:27:49.600 --> 00:27:52.400 we invested in material in 565 00:27:52.400 --> 00:27:56.100 tangible investment. We bought a machine property 566 00:27:55.100 --> 00:27:58.400 plant and Equipment a real asset but 567 00:27:58.400 --> 00:28:01.900 as you know companies invest intangible fixed 568 00:28:01.900 --> 00:28:04.500 assets increasing capacity in a manufacturing 569 00:28:04.500 --> 00:28:08.200 footprint, but they also invest in intensible assets. 570 00:28:07.200 --> 00:28:10.500 It's going to be the issue of 571 00:28:10.500 --> 00:28:11.300 module 4 572 00:28:12.200 --> 00:28:15.600 That will be two imagerial investment one is 573 00:28:15.600 --> 00:28:19.200 going to be purchasing intellectual property a 574 00:28:18.200 --> 00:28:21.200 software. I will give you the description of 575 00:28:21.200 --> 00:28:24.900 that and invest in research and development so 576 00:28:24.900 --> 00:28:27.700 that we can design different new 577 00:28:27.700 --> 00:28:30.700 Innovative products to serve our customers. 578 00:28:31.700 --> 00:28:34.700 This will be the focus of module 4.