WEBVTT 1 00:00:01.145 --> 00:00:03.175 Third mode of consolidation. 2 00:00:03.675 --> 00:00:06.935 We will now take complete control of the target 3 00:00:07.235 --> 00:00:11.455 by buying 100% of the shares the objectives. 4 00:00:11.455 --> 00:00:14.615 Therefore, now to integrate the target company 5 00:00:15.245 --> 00:00:16.295 into the strategy 6 00:00:16.675 --> 00:00:21.015 and operational decisions of the investor acquirer, 7 00:00:21.835 --> 00:00:25.015 we are going to widen the scope of consolidation 8 00:00:25.555 --> 00:00:29.935 and use a consolidation method called global integration. 9 00:00:31.095 --> 00:00:35.655 Concretely, we completely integrate the accounts at the same 10 00:00:35.765 --> 00:00:37.815 time as the activity. 11 00:00:39.035 --> 00:00:41.935 Of course, there is absolutely no change in the valuation 12 00:00:41.935 --> 00:00:42.975 of the target company. 13 00:00:43.715 --> 00:00:46.375 You remember that the equity assessment gives us a 14 00:00:46.375 --> 00:00:47.655 figure of 300. 15 00:00:48.155 --> 00:00:50.935 You add the net financial debt to get 320. 16 00:00:51.205 --> 00:00:52.695 This is the enterprise value, 17 00:00:53.395 --> 00:00:56.535 and you remember that the capital employed is 80, 18 00:00:56.715 --> 00:01:00.015 so the company is evaluated at four times 19 00:01:00.315 --> 00:01:01.335 its capital employed. 20 00:01:02.325 --> 00:01:05.615 It's a consequence obviously of a very profitable company, 21 00:01:06.115 --> 00:01:09.375 but now there will be plenty of accounting consequences 22 00:01:09.955 --> 00:01:12.655 of the gap between the value and the cost. 23 00:01:13.145 --> 00:01:16.015 There is a very significant change in the financial 24 00:01:16.035 --> 00:01:17.975 characteristics of the transaction. 25 00:01:18.795 --> 00:01:23.095 Now the investor is taking a 100% equity stake in the 26 00:01:23.095 --> 00:01:25.375 target, no more 40% 27 00:01:26.455 --> 00:01:28.315 as the cash available in the bank account 28 00:01:28.315 --> 00:01:32.115 of the investor is high enough, no need to make any capital 29 00:01:32.795 --> 00:01:33.955 increase for the investor, 30 00:01:34.735 --> 00:01:38.235 and now the shareholders are selling all their shares, 31 00:01:38.695 --> 00:01:41.075 so obviously it's not an equity issue, 32 00:01:41.505 --> 00:01:44.075 it's just simply selling their shares. 33 00:01:44.985 --> 00:01:47.515 Consequence for the investor, there's a cash out, 34 00:01:47.515 --> 00:01:49.595 which is no more, 40% of 300, 35 00:01:49.935 --> 00:01:54.275 but 100% of 300, which obviously is 300 36 00:01:55.275 --> 00:01:57.595 business As usual, we carry out the operation on the 37 00:01:57.595 --> 00:02:00.395 1st of January of year n plus one. 38 00:02:00.815 --> 00:02:03.875 No change as far as the process is concerned. 39 00:02:03.875 --> 00:02:06.195 We start building the balance sheet on the 1st of January 40 00:02:06.755 --> 00:02:10.235 n plus one just after the operation has been concluded. 41 00:02:11.015 --> 00:02:13.035 But first what we are going to do is 42 00:02:13.035 --> 00:02:15.075 to use the equity method. 43 00:02:15.335 --> 00:02:18.115 You remember the second consolidation method, 44 00:02:18.325 --> 00:02:21.595 which I described in order to consolidate the accounts 45 00:02:22.095 --> 00:02:23.195 and we'll see the impact 46 00:02:23.215 --> 00:02:26.675 of the equity participation on the investor's account, the p 47 00:02:26.675 --> 00:02:28.275 and l, the cash flow statement 48 00:02:28.575 --> 00:02:30.475 and the balance sheet at the end of the year. 49 00:02:31.375 --> 00:02:32.675 But you will see very quickly 50 00:02:32.745 --> 00:02:36.195 that it is absolutely not satisfactory in terms 51 00:02:36.215 --> 00:02:38.635 of information provided to the shareholders 52 00:02:39.015 --> 00:02:40.035 and to the stakeholders. 53 00:02:40.885 --> 00:02:42.635 Let's first start with the equity method. 54 00:02:43.005 --> 00:02:44.555 Let's observe what is missing 55 00:02:44.735 --> 00:02:47.035 and let's propose the full integration 56 00:02:47.335 --> 00:02:48.755 as an alternative method. 57 00:02:48.925 --> 00:02:50.835 Let's first have a look at the balance 58 00:02:50.835 --> 00:02:51.955 sheet on the 1st of January. 59 00:02:52.855 --> 00:02:54.595 On the asset side of the balance sheet, 60 00:02:55.015 --> 00:02:57.155 you show the financial fixed asset, 61 00:02:57.155 --> 00:02:58.795 which is the equity stake though 62 00:02:58.815 --> 00:03:01.325 100% and it's paid by cash, 63 00:03:01.625 --> 00:03:03.165 so there is a perfect trade off 64 00:03:03.165 --> 00:03:06.965 between financial fixed assets plus cash minus. 65 00:03:07.355 --> 00:03:10.565 This is why there is no change in equity and liabilities. 66 00:03:11.065 --> 00:03:13.085 You'll remember no equity issue, 67 00:03:13.425 --> 00:03:14.965 no change in the financial debt. 68 00:03:15.065 --> 00:03:17.165 Now on the asset side of the balance sheet, 69 00:03:17.745 --> 00:03:21.525 we have the same tangible fixed assets, intangible, nothing 70 00:03:22.235 --> 00:03:23.525 financial fixed asset. 71 00:03:23.705 --> 00:03:27.405 Now we have 100% of the shares. We paid 300. 72 00:03:28.185 --> 00:03:30.685 No change in current operating assets 73 00:03:31.345 --> 00:03:34.245 and cash is down by the amount of money we paid 74 00:03:34.245 --> 00:03:35.925 to the shareholders as a target. 75 00:03:36.905 --> 00:03:39.565 No change in the total asset for a very simple reason. 76 00:03:39.755 --> 00:03:42.085 There's a mathematical trade off 77 00:03:42.085 --> 00:03:45.005 between financial fixed asset plus 300 78 00:03:45.555 --> 00:03:47.125 cash minus 300. 79 00:03:47.495 --> 00:03:48.645 Still, you understand 80 00:03:48.645 --> 00:03:51.805 that it's not only a change in the financial characteristics 81 00:03:51.825 --> 00:03:55.605 of the operation, the economics have completely changed. 82 00:03:56.225 --> 00:03:59.405 Now it's no more a simple financial investment of 10%. 83 00:03:59.915 --> 00:04:02.925 It's no more a significant equity stake of 40%. 84 00:04:03.105 --> 00:04:05.445 Now it's a fully owned subsidiary. 85 00:04:05.905 --> 00:04:07.445 As a consequence, you are going 86 00:04:07.445 --> 00:04:10.725 to completely integrate the strategic decisions, 87 00:04:11.145 --> 00:04:12.445 the operational decisions. 88 00:04:13.025 --> 00:04:15.045 Of course, there is still a legal barrier 89 00:04:15.075 --> 00:04:18.365 because there are two legal entities which are different 90 00:04:18.365 --> 00:04:22.205 from each other, but there's absolutely no economic barrier. 91 00:04:22.735 --> 00:04:26.565 These companies, they behave like a one unique entity. 92 00:04:27.025 --> 00:04:29.165 If we now consider the accounting information, 93 00:04:29.165 --> 00:04:30.565 which is going to be provided, 94 00:04:31.145 --> 00:04:34.205 of course there is a significant amount invested. 95 00:04:34.575 --> 00:04:38.885 40%, it was 120, now 100% it's 300. 96 00:04:39.705 --> 00:04:42.845 We have to provide some information on the financial 97 00:04:43.565 --> 00:04:44.645 relevance of the investment. 98 00:04:45.145 --> 00:04:48.405 Is it good investment? Does it show any performance? 99 00:04:48.545 --> 00:04:51.645 You remember? That performance is what creates value. 100 00:04:51.915 --> 00:04:54.525 Then according to the equity method, we are going 101 00:04:54.525 --> 00:04:57.885 to show the share of the net income of the participation 102 00:04:57.985 --> 00:05:01.565 of this equity stake in the p and l of the acquirer. 103 00:05:01.715 --> 00:05:02.805 When we build the p 104 00:05:02.805 --> 00:05:05.485 and l of the investor, we show the sales, 105 00:05:05.825 --> 00:05:08.085 the EBITDA depreciation, ebit. 106 00:05:08.835 --> 00:05:11.735 We also show the earnings from affiliate companies. 107 00:05:11.995 --> 00:05:15.695 You remember that when the company was holding 40% 108 00:05:15.695 --> 00:05:18.655 of the shares, 40% of the earnings 109 00:05:18.655 --> 00:05:20.855 of the target were showing in the p 110 00:05:20.855 --> 00:05:23.255 and l as earnings from affiliate companies. 111 00:05:23.715 --> 00:05:28.455 It was 40% of 60. Now it's 100% of 60. 112 00:05:29.215 --> 00:05:31.295 Assuming that we keep the same equity method 113 00:05:31.355 --> 00:05:34.655 to consolidate the accounts, no change in interest expense. 114 00:05:34.995 --> 00:05:39.215 Now the earnings before tax are up to 156, 115 00:05:39.235 --> 00:05:42.695 but only 96 are taxable income 116 00:05:42.885 --> 00:05:45.135 because the 60 correspond 117 00:05:45.155 --> 00:05:47.735 to earnings which have already been taxed. 118 00:05:48.275 --> 00:05:52.815 So we pay 25% of 96, which is 24 as an income tax, 119 00:05:53.355 --> 00:05:54.695 and basically the earnings 120 00:05:54.695 --> 00:05:58.845 after tax is 156 minus 24, 121 00:05:58.845 --> 00:06:00.925 which is 132. 122 00:06:01.225 --> 00:06:04.845 Now we can build a cash flow statement year n plus one 123 00:06:04.845 --> 00:06:07.725 for the investor, which free cash flow has been generated 124 00:06:07.745 --> 00:06:12.085 by the investor EBITDA minus interest minus income tax 125 00:06:12.415 --> 00:06:16.285 minus changing working capital requirement minus CapEx 26, 126 00:06:16.385 --> 00:06:20.165 no change, but what changed is the amount 127 00:06:20.165 --> 00:06:22.165 of dividend the company's receiving from 128 00:06:22.165 --> 00:06:23.405 affiliate companies. 129 00:06:24.185 --> 00:06:28.605 You remember that it was 40% of 40, now it's 100% of 40. 130 00:06:29.145 --> 00:06:31.765 Now the change in cash position as 66, 131 00:06:31.975 --> 00:06:35.085 which is free cashflow generated by the investor 132 00:06:35.425 --> 00:06:39.445 by itself 26 plus the dividend which is received from the 133 00:06:39.445 --> 00:06:43.885 target, which is now fully owned, so it's no more 40% 134 00:06:44.305 --> 00:06:46.285 of 40, it's 100% of 40. 135 00:06:46.505 --> 00:06:49.245 26 plus 40 is 66. 136 00:06:49.985 --> 00:06:51.245 If we look at the equity 137 00:06:51.265 --> 00:06:53.845 and liability side of the balance sheet for the investor, 138 00:06:54.785 --> 00:06:56.085 no change in capital 139 00:06:56.225 --> 00:06:58.805 and additional paid in capital retain earnings are 140 00:06:58.805 --> 00:07:02.165 incremented by the earnings of the investor beginning 141 00:07:02.165 --> 00:07:05.565 of the year, 600 earnings of the year, 132, 142 00:07:05.665 --> 00:07:08.205 no dividend paid, retain earnings at the end of the year, 143 00:07:08.255 --> 00:07:11.685 732, no change in long-term 144 00:07:11.945 --> 00:07:16.125 and short-term financial debt respectively 400 and 200 145 00:07:16.745 --> 00:07:19.645 and you remember that the current operating liabilities, 146 00:07:19.685 --> 00:07:23.005 accounts payable and others are up by 10%, 147 00:07:23.585 --> 00:07:27.405 so 150 is transforming to 160 for both case. 148 00:07:28.105 --> 00:07:29.285 Now the total equity 149 00:07:29.445 --> 00:07:33.445 and liabilities is 1,962. 150 00:07:33.785 --> 00:07:35.285 Now let's have a look at the asset 151 00:07:35.285 --> 00:07:36.485 side of the balance sheet. 152 00:07:37.065 --> 00:07:38.285 You remember that we have 153 00:07:38.285 --> 00:07:41.085 to reevaluate the equity stake according 154 00:07:41.105 --> 00:07:45.845 to the equity method and as a target retain earnings 155 00:07:45.985 --> 00:07:50.285 and equity have been up by 20, which is the difference 156 00:07:50.285 --> 00:07:53.005 between net earnings 60 and dividend 40. 157 00:07:53.745 --> 00:07:56.365 We account for 100% of the revaluation 158 00:07:56.365 --> 00:07:58.805 because we hold 100% of the shares. 159 00:07:59.955 --> 00:08:02.525 What about the tangible fixed asset up 160 00:08:02.705 --> 00:08:07.045 by investment minus depreciation, no change in intangibles, 161 00:08:07.515 --> 00:08:09.085 inventories, accounts receivable 162 00:08:09.085 --> 00:08:12.605 and other current operating assets are up by 10% 163 00:08:13.065 --> 00:08:15.085 and the cash situation, which was 500 164 00:08:15.145 --> 00:08:18.445 before the transaction is 200 after the transaction 165 00:08:18.465 --> 00:08:21.685 and now the cash is incremented by the amount 166 00:08:21.685 --> 00:08:24.805 of cash which is generated by the investor, which is 66. 167 00:08:25.425 --> 00:08:27.085 We make the sums of total assets 168 00:08:27.225 --> 00:08:31.725 and we get 1,962, which matches with equity on liabilities. 169 00:08:32.095 --> 00:08:34.285 Again, good news, of course, good news 170 00:08:34.285 --> 00:08:35.845 because the balance sheet is balancing 171 00:08:36.505 --> 00:08:39.605 but not that good news in terms of relevance 172 00:08:39.665 --> 00:08:41.845 and quality of the accounting information, 173 00:08:41.845 --> 00:08:44.525 which is at the end of the day quite limited. 174 00:08:45.025 --> 00:08:49.205 You understand that there is a fully owned subsidiary, 100%, 175 00:08:49.495 --> 00:08:52.365 which appears only in terms of its contribution 176 00:08:52.705 --> 00:08:54.485 to the group's net income, 177 00:08:55.265 --> 00:08:57.245 And that's purely financial vision. 178 00:08:57.665 --> 00:09:00.605 We don't know anything about this subsidiary except 179 00:09:00.635 --> 00:09:03.565 that it generates 60 and pay 40. 180 00:09:04.275 --> 00:09:08.205 It's purely and strictly uh, financial and accounting vision 181 00:09:08.265 --> 00:09:11.445 and says absolutely nothing about the economics. 182 00:09:11.625 --> 00:09:15.565 We have no information on the business on economic reality 183 00:09:15.625 --> 00:09:19.005 of the company, so it's purely legal accounting. 184 00:09:19.555 --> 00:09:22.845 It's a parent company plus a participation. 185 00:09:23.835 --> 00:09:26.365 It's what we name parent company account in the annual 186 00:09:26.465 --> 00:09:29.125 report, by the way, but now if we want 187 00:09:29.125 --> 00:09:32.765 to have a better picture about the company, we need 188 00:09:32.765 --> 00:09:35.685 to include a subsidiary in the consolidated accounts 189 00:09:35.825 --> 00:09:39.245 and not only as a financial fixed asset 190 00:09:39.505 --> 00:09:41.285 but as a business reality. 191 00:09:41.615 --> 00:09:43.285 Let's go back to the balance sheet. 192 00:09:43.945 --> 00:09:46.125 You remember that traditionally equity 193 00:09:46.145 --> 00:09:49.805 and liabilities are matching with assets, which means 194 00:09:49.805 --> 00:09:53.485 that equity is assets minus liabilities, 195 00:09:53.665 --> 00:09:56.845 not a very sophisticated mathematical transformation. 196 00:09:56.955 --> 00:09:59.565 Then you can also show equity as a difference 197 00:09:59.565 --> 00:10:02.005 between assets minus liabilities. 198 00:10:02.515 --> 00:10:04.525 It's not an extremely sophisticated 199 00:10:04.525 --> 00:10:06.045 mathematical transformation. 200 00:10:06.865 --> 00:10:11.125 Equity then is also named net assets, assets, 201 00:10:11.705 --> 00:10:12.885 net of liabilities. 202 00:10:13.755 --> 00:10:16.165 What do we show in the financial fixed assets 203 00:10:16.625 --> 00:10:17.925 of the investor? 204 00:10:18.425 --> 00:10:19.565 The equity of the target, 205 00:10:20.305 --> 00:10:23.445 but then you understand that we can replace the equity 206 00:10:23.505 --> 00:10:27.405 of the target by the assets of the target net 207 00:10:27.405 --> 00:10:29.205 of the liabilities of the target, 208 00:10:29.345 --> 00:10:31.725 so we replace financial fixed asset 209 00:10:32.545 --> 00:10:34.405 by net assets of the target. 210 00:10:35.385 --> 00:10:39.405 How do we allocate the net assets on a line by line basis? 211 00:10:40.065 --> 00:10:43.125 So we are going to add the operating assets long term, 212 00:10:43.495 --> 00:10:46.005 short term, the financial assets, cash. 213 00:10:46.305 --> 00:10:48.525 We are going to add the financial liabilities 214 00:10:48.665 --> 00:10:49.965 and operating liabilities. 215 00:10:50.185 --> 00:10:53.805 We are going to increment the balance sheet of the investor 216 00:10:54.265 --> 00:10:56.245 by the net assets of the target. 217 00:10:56.595 --> 00:10:57.685 Then what we are going 218 00:10:57.685 --> 00:11:01.085 to observe is a full accounting integration 219 00:11:01.985 --> 00:11:04.485 and there are two complimentary perspectives, 220 00:11:05.305 --> 00:11:06.725 one feeding the other. 221 00:11:07.335 --> 00:11:09.285 First you allocate net assets. 222 00:11:09.715 --> 00:11:13.285 This is accounting, but also you provide some economic 223 00:11:13.625 --> 00:11:17.205 and business information on the firm which you purchased 224 00:11:17.985 --> 00:11:20.325 and then you integrated the accounts 225 00:11:20.385 --> 00:11:23.725 of the target into the parent company accounts, 226 00:11:23.975 --> 00:11:27.765 which at the end of the day is a very relevant information. 227 00:11:28.255 --> 00:11:29.845 Let's first have a look at the equity 228 00:11:29.905 --> 00:11:33.525 and liabilities of the parent company once the target has 229 00:11:33.525 --> 00:11:34.765 been fully integrated. 230 00:11:35.705 --> 00:11:37.765 Of course there is no change in equity. 231 00:11:38.105 --> 00:11:41.245 You don't integrate the equity of the target. 232 00:11:41.505 --> 00:11:45.005 You replace a financial asset by assets minus liabilities, 233 00:11:45.385 --> 00:11:47.525 no change in the equity of the parent company, 234 00:11:47.815 --> 00:11:50.685 which represents the amount of money which was invested 235 00:11:50.785 --> 00:11:53.645 by the owners of the investor. 236 00:11:53.825 --> 00:11:56.845 The long-term financial debt has been incremented 237 00:11:56.945 --> 00:11:59.405 by the financial debt of the target 40, 238 00:12:00.185 --> 00:12:01.885 so short-term financial debt. 239 00:12:02.105 --> 00:12:04.165 The accounts payable, the other current operating 240 00:12:04.405 --> 00:12:05.885 liabilities have been incremented 241 00:12:05.985 --> 00:12:09.285 by these respective items in their balance 242 00:12:09.285 --> 00:12:10.365 sheet of the target. 243 00:12:10.865 --> 00:12:12.645 Now we show total equity 244 00:12:12.665 --> 00:12:16.085 and levity, which is 1,910. 245 00:12:16.275 --> 00:12:17.565 It's about the same story 246 00:12:17.705 --> 00:12:19.565 for the asset side of the balance sheet. 247 00:12:20.025 --> 00:12:22.965 We have incremented the property, plant and equipment, gross 248 00:12:23.065 --> 00:12:25.445 and net value by what shows in the balance sheet 249 00:12:25.445 --> 00:12:29.005 of the target, no change in the intangible fixed assets 250 00:12:29.665 --> 00:12:32.325 so far and financial fixed asset. 251 00:12:32.345 --> 00:12:34.845 The figure of 300 has simply disappeared 252 00:12:34.845 --> 00:12:39.485 because it has been replaced by the net asset inventories, 253 00:12:39.845 --> 00:12:40.885 accounts receivable, 254 00:12:41.135 --> 00:12:44.005 other current operating assets have been incremented 255 00:12:44.065 --> 00:12:47.085 by the respective items in the targets balance sheet 256 00:12:47.425 --> 00:12:48.605 and what about cash? 257 00:12:49.195 --> 00:12:52.845 Cash was 500, but 500 minus 300 258 00:12:52.845 --> 00:12:56.605 because you cashed out for the acquisition and plus 60 259 00:12:56.605 --> 00:12:59.645 because there's an amount of 60 in a cash account 260 00:12:59.665 --> 00:13:01.925 of the target in its own balance sheet. 261 00:13:02.675 --> 00:13:04.245 Then you make the sum of all the assets 262 00:13:04.265 --> 00:13:07.485 and you get 1,670, 263 00:13:08.215 --> 00:13:10.925 which is quite far from the total equity 264 00:13:10.945 --> 00:13:15.765 and liabilities, which you remember was 1,910. 265 00:13:16.185 --> 00:13:18.525 Now we have first to calculate the variance 266 00:13:18.745 --> 00:13:21.325 and then to give an accounting interpretation. 267 00:13:21.905 --> 00:13:23.405 The calculation is straightforward. 268 00:13:23.985 --> 00:13:27.925 1,910 minus 1,670 269 00:13:28.545 --> 00:13:29.845 is 240, 270 00:13:30.025 --> 00:13:33.045 but you remember that the equity of the target was 60. 271 00:13:33.745 --> 00:13:36.685 Equity is assets minus liabilities, 272 00:13:37.705 --> 00:13:40.845 so basically we have acquired a company for 300, 273 00:13:41.375 --> 00:13:45.365 which was previously showed as a financial fixed asset, 274 00:13:45.705 --> 00:13:49.805 and we replace the 300, which is a cash outlet 275 00:13:50.345 --> 00:13:53.405 by the net assets which represent 60. 276 00:13:53.865 --> 00:13:57.125 We have replaced 300 by 60 277 00:13:57.425 --> 00:14:00.845 and then we have created a difference between these two, 278 00:14:00.845 --> 00:14:05.325 which is then the first consolidation gap 300 minus 60 279 00:14:05.705 --> 00:14:10.325 is 240, so this is a difference between a cash outlay 280 00:14:10.545 --> 00:14:14.325 and the integration of the book net assets of the target. 281 00:14:14.695 --> 00:14:17.725 Let's move now from accounting to economics and finance. 282 00:14:18.745 --> 00:14:21.405 You remember that the company which we purchase is 283 00:14:21.755 --> 00:14:23.085 very profitable. 284 00:14:23.865 --> 00:14:27.125 It shows a very nice performance on strong cash flows. 285 00:14:27.425 --> 00:14:29.325 Now let's have a look at its balance sheet. 286 00:14:29.785 --> 00:14:33.365 The balance sheet simply records acquired assets 287 00:14:34.075 --> 00:14:37.885 that appear in the balance sheet, adds a history call cost, 288 00:14:38.985 --> 00:14:42.645 but the talent of a corporation consists in turning these 289 00:14:42.695 --> 00:14:47.245 costs of the past, this investment into value. 290 00:14:48.065 --> 00:14:50.085 Now the value is 300, 291 00:14:50.705 --> 00:14:54.045 but the cost where net of liabilities 60, 292 00:14:54.425 --> 00:14:58.925 so there is a value creation which is 240. 293 00:14:59.865 --> 00:15:02.005 The value creation is quite significant 294 00:15:02.195 --> 00:15:03.925 because the performance is great 295 00:15:03.985 --> 00:15:06.645 and you remember there is a link between profitability 296 00:15:07.395 --> 00:15:09.365 performance on the one hand, 297 00:15:09.735 --> 00:15:11.805 value creation on the other hand, 298 00:15:12.225 --> 00:15:14.445 so this is a quite normal situation. 299 00:15:15.115 --> 00:15:16.205 Once we have observed 300 00:15:16.275 --> 00:15:20.085 that performance was transformed into value, we have to try 301 00:15:20.085 --> 00:15:23.165 to find where the value is created, what the elements 302 00:15:23.165 --> 00:15:24.645 of the value creation are. 303 00:15:25.905 --> 00:15:29.445 For some assets, there has been a value which has increased, 304 00:15:29.535 --> 00:15:33.365 maybe premises buildings you bought for 100, 305 00:15:33.945 --> 00:15:35.245 now it's 150. 306 00:15:35.865 --> 00:15:38.085 The figure we chose in the balance sheet is 100, 307 00:15:38.385 --> 00:15:39.765 the value is 150. 308 00:15:40.755 --> 00:15:42.805 This is for assets which exists, 309 00:15:43.185 --> 00:15:47.245 but some assets have been created, not purchased 310 00:15:47.305 --> 00:15:50.565 by the company and then they do not appear in the balance 311 00:15:50.615 --> 00:15:54.925 sheet of the target in the list of items which were created. 312 00:15:55.505 --> 00:15:59.605 You can show brands market share, goodwill. 313 00:16:00.395 --> 00:16:04.845 Some assets are not going to appear in the balance sheet. 314 00:16:05.305 --> 00:16:08.805 For example, human capital does not show in the balance 315 00:16:08.815 --> 00:16:11.565 sheet the quality of the organization. 316 00:16:11.985 --> 00:16:15.405 The quality of its decision processes does not show in the 317 00:16:15.405 --> 00:16:17.285 balance sheet and of course it contributes 318 00:16:17.425 --> 00:16:19.005 to value creation. 319 00:16:19.275 --> 00:16:22.485 Then in the accounting procedures, how are we going 320 00:16:22.485 --> 00:16:26.085 to account for this first consolidation gap? 321 00:16:26.425 --> 00:16:28.005 We have to allocate the figure 322 00:16:28.185 --> 00:16:31.245 to different items in the balance sheet of the investors 323 00:16:31.745 --> 00:16:33.925 to show some accurate information. 324 00:16:35.095 --> 00:16:38.725 Maybe we have to reevaluate some assets, the care, 325 00:16:38.725 --> 00:16:42.165 because sometimes there are tax impact on the story. 326 00:16:43.305 --> 00:16:46.565 Now, there are some assets which have to be identified 327 00:16:46.745 --> 00:16:50.045 as created and we have to evaluate them. 328 00:16:50.395 --> 00:16:54.445 Most of them are intangible assets such as brand 329 00:16:54.745 --> 00:16:58.765 and market share, but very often the price you paid when you 330 00:16:58.765 --> 00:17:01.525 bought a company is more than the sum 331 00:17:01.525 --> 00:17:05.045 of the book net assets plus the value 332 00:17:05.065 --> 00:17:08.885 of these assets which you identified as created such 333 00:17:08.885 --> 00:17:12.965 as brands plus anything else, and there is a residual value. 334 00:17:13.315 --> 00:17:14.805 It's named the goodwill. 335 00:17:14.805 --> 00:17:17.725 There's a very big difference between the goodwill 336 00:17:17.725 --> 00:17:20.605 and all other assets, which I mentioned. 337 00:17:21.105 --> 00:17:24.285 You can sell a premise, you can sell a patent, 338 00:17:25.185 --> 00:17:26.725 you can sell a brand. 339 00:17:26.985 --> 00:17:28.525 You cannot sell a goodwill. 340 00:17:28.555 --> 00:17:31.805 This is the only asset which can be identified 341 00:17:31.945 --> 00:17:33.725 as a consequence of value creation 342 00:17:33.865 --> 00:17:36.365 and which cannot be sold per se. 343 00:17:36.585 --> 00:17:40.485 You don't sell the quality of your decision making process. 344 00:17:41.105 --> 00:17:42.805 Now, let's go back to our example. 345 00:17:43.305 --> 00:17:45.645 We have identified brands. 346 00:17:46.505 --> 00:17:48.725 90, 90 explains 347 00:17:48.755 --> 00:17:52.765 Part of the first consolidation gap, which is 240. 348 00:17:53.705 --> 00:17:55.605 The net is 150. 349 00:17:56.105 --> 00:18:00.005 150 is again human capital, quality of the organization 350 00:18:00.185 --> 00:18:01.405 and so on and so forth, 351 00:18:01.865 --> 00:18:03.925 and that's going to be allocated as 352 00:18:04.445 --> 00:18:06.045 goodwill in the balance sheet. 353 00:18:06.425 --> 00:18:10.245 Now, all the figures which are introduced are not decided 354 00:18:10.385 --> 00:18:12.565 by the company standing alone. 355 00:18:13.135 --> 00:18:16.925 There must be an agreement from the external auditors. 356 00:18:18.025 --> 00:18:20.405 You remember that in a general shareholder meeting, 357 00:18:20.625 --> 00:18:22.485 the auditors are in charge of recommending 358 00:18:22.625 --> 00:18:24.885 or not to approve the accounts. 359 00:18:25.075 --> 00:18:27.365 They have to agree on your accounts, you have 360 00:18:27.365 --> 00:18:29.525 to agree on the valuation of the brand, so 361 00:18:29.525 --> 00:18:31.445 to evaluate the brand, maybe you are going 362 00:18:31.445 --> 00:18:33.725 to use the service of a consulting firm, 363 00:18:33.725 --> 00:18:36.005 which is an expert in brand valuation, 364 00:18:36.185 --> 00:18:39.565 but there must be a formal approval from the auditors. 365 00:18:40.475 --> 00:18:42.205 Same story for the value of the company 366 00:18:42.345 --> 00:18:44.365 and a goodwill which is associated with that. 367 00:18:45.185 --> 00:18:48.965 Now, once we have allocated the first consolidation gap 368 00:18:49.745 --> 00:18:52.965 to intangible assets, brands 90, 369 00:18:53.485 --> 00:18:56.885 goodwill 150, you understand that 370 00:18:57.225 --> 00:19:00.565 for all the assets we have incremented line by line, 371 00:19:00.865 --> 00:19:04.285 the bounty of the investor by the of the target, 372 00:19:05.105 --> 00:19:07.565 the financial fixed assets went back to zero 373 00:19:07.565 --> 00:19:10.645 because you remember we replaced the financial fixed asset 374 00:19:10.745 --> 00:19:14.725 by the net assets plus goodwill and brand, 375 00:19:15.065 --> 00:19:18.685 and we have introduced two items in the same chapter, 376 00:19:18.685 --> 00:19:20.445 which is interchangeable fixed assets 377 00:19:20.445 --> 00:19:23.925 because they are both interchangeable brands for 90, 378 00:19:24.405 --> 00:19:25.965 goodwill for 150. 379 00:19:26.745 --> 00:19:29.885 In some annual reports, you are going to see goodwill 380 00:19:29.945 --> 00:19:31.445 as a separate line 381 00:19:31.515 --> 00:19:32.645 because the nature 382 00:19:32.825 --> 00:19:36.085 of this immaterial asset is quite different from 383 00:19:36.085 --> 00:19:37.205 the rest of the balance sheet. 384 00:19:37.495 --> 00:19:40.565 Again and again, you cannot sell it now, 385 00:19:40.625 --> 00:19:42.325 no change on the current assets. 386 00:19:42.625 --> 00:19:45.005 The only change is intangibles 387 00:19:45.265 --> 00:19:48.925 and then the total asset is 1,910 388 00:19:49.025 --> 00:19:51.645 and obviously it matches with equity and liabilities 389 00:19:52.155 --> 00:19:54.245 because the gap was 240 390 00:19:54.265 --> 00:19:57.965 and now the gap shows in the intangible fixed assets 391 00:19:58.655 --> 00:20:01.365 based on the same principle which consists in adding 392 00:20:01.795 --> 00:20:02.925 line by line. 393 00:20:03.705 --> 00:20:06.325 We can now build the income statement of the investor 394 00:20:06.385 --> 00:20:08.725 and a cashflow statement of the same investor. 395 00:20:09.345 --> 00:20:13.485 We add sales, cost of sales, ebitda, capital expenditures, 396 00:20:13.715 --> 00:20:16.605 working capital requirement variation, et cetera. 397 00:20:16.705 --> 00:20:18.325 We add line by line. 398 00:20:18.905 --> 00:20:21.525 Now, there is a very big exception to that rule. 399 00:20:22.195 --> 00:20:25.125 It's a case of intra group flows. 400 00:20:25.985 --> 00:20:28.645 For example, the target sells goods 401 00:20:28.745 --> 00:20:30.965 or services to the investor. 402 00:20:31.905 --> 00:20:34.485 Now you understand that what will be a revenue 403 00:20:34.785 --> 00:20:39.725 for one is a cost for the other second example, the payment 404 00:20:39.825 --> 00:20:42.525 of a dividend from the target to the investor. 405 00:20:43.345 --> 00:20:47.005 Now let's have a look at the implication of this principle 406 00:20:47.665 --> 00:20:50.085 And of this exception on the p and l 407 00:20:50.305 --> 00:20:51.765 and on the cashflow statement. 408 00:20:51.775 --> 00:20:53.205 Let's start with the income statement 409 00:20:53.205 --> 00:20:55.205 of the investor year and plus one. 410 00:20:55.785 --> 00:20:57.325 We simply add line by line, 411 00:20:57.625 --> 00:20:59.525 so in the sales figure we have the sales 412 00:20:59.585 --> 00:21:01.885 of the investor plus the sales of the target. 413 00:21:02.555 --> 00:21:05.845 Same story for the ebitda, same story for depreciation, 414 00:21:06.515 --> 00:21:08.405 same story for interest expense. 415 00:21:09.345 --> 00:21:12.085 Now the income tax rate is the same for these two companies, 416 00:21:12.105 --> 00:21:15.045 so there's no problem in terms of income tax. 417 00:21:15.875 --> 00:21:17.965 It's a simplification obviously. 418 00:21:18.315 --> 00:21:20.205 Then we can calculate the earnings 419 00:21:20.415 --> 00:21:22.645 after tax, the net earnings, the bottom line, 420 00:21:22.745 --> 00:21:24.685 and we get 132. 421 00:21:25.595 --> 00:21:27.765 It's exactly the same figure as a profit. 422 00:21:27.865 --> 00:21:30.205 We calculated using the equity method 423 00:21:30.585 --> 00:21:31.885 for a very simple reason. 424 00:21:32.595 --> 00:21:34.765 When you add line by line all the p 425 00:21:34.765 --> 00:21:37.845 and l items, what happens, you have the profit 426 00:21:37.905 --> 00:21:40.165 of the investor plus the profit of the target, 427 00:21:40.985 --> 00:21:43.605 so it shows integrated line by line 428 00:21:43.745 --> 00:21:45.845 or it shows on a separate line 429 00:21:46.645 --> 00:21:47.925 earnings from affiliate companies, 430 00:21:47.925 --> 00:21:50.765 but at the end of the day, the bottom line is exactly the 431 00:21:50.765 --> 00:21:53.165 same, but now there is a very big difference, 432 00:21:53.165 --> 00:21:55.525 which is the dividend paid by the target 433 00:21:55.665 --> 00:21:57.445 to the investors, to the parent company. 434 00:21:58.465 --> 00:21:59.845 We show nothing. Why? 435 00:21:59.845 --> 00:22:03.605 Because it is an intra group cash flow. 436 00:22:04.205 --> 00:22:05.765 I will give you the interpretation 437 00:22:05.865 --> 00:22:07.805 of this change in the next slide, 438 00:22:08.665 --> 00:22:11.165 but if we look at the free cash flow generated 439 00:22:11.265 --> 00:22:12.405 by the investor 440 00:22:12.625 --> 00:22:14.765 and the free cash flow generated by the target 441 00:22:14.865 --> 00:22:17.645 and we add them all, it's a change in the cash 442 00:22:18.085 --> 00:22:19.285 position of the group. 443 00:22:20.325 --> 00:22:24.405 Consolidated, integrated. Now we have 79. 444 00:22:25.185 --> 00:22:28.885 You remember that the same figure was 66 when we were 445 00:22:29.365 --> 00:22:31.685 consolidating with the equity method. 446 00:22:32.125 --> 00:22:35.725 A few words about the reason why the dividend from T two 447 00:22:35.845 --> 00:22:36.965 I disappeared. 448 00:22:36.985 --> 00:22:40.045 In the process, the target pays 449 00:22:40.335 --> 00:22:42.005 40 to the investor. 450 00:22:43.065 --> 00:22:47.645 For the investor cash is up by 40 for the target, 451 00:22:48.075 --> 00:22:51.005 cash is down by 40, so today you want 452 00:22:51.005 --> 00:22:52.725 to build a cashflow statement. 453 00:22:52.785 --> 00:22:55.645 The integrated cashflow statement, you understand that 454 00:22:56.185 --> 00:23:00.685 the plus 40 is compensated by the minus 40. 455 00:23:01.185 --> 00:23:04.045 The resulting figure is Neil. 456 00:23:04.915 --> 00:23:09.525 There's a kind of compensation between cash in and cash out, 457 00:23:09.665 --> 00:23:12.885 and this is a consequence of a group perspective. 458 00:23:13.905 --> 00:23:16.805 Now it's no more the investor which has an 459 00:23:16.805 --> 00:23:17.965 equity stake in the target. 460 00:23:18.675 --> 00:23:19.725 It's the investor 461 00:23:20.385 --> 00:23:23.885 and the target as a one unique entity, 462 00:23:24.345 --> 00:23:27.125 and of course there is an impact in a change in the 463 00:23:27.125 --> 00:23:28.365 cash position of the company. 464 00:23:29.345 --> 00:23:31.605 Now it is 79. Why? 465 00:23:31.675 --> 00:23:34.685 Because it's I plus T. 466 00:23:35.035 --> 00:23:36.085 It's a free cash flow 467 00:23:36.145 --> 00:23:39.245 of the investor plus a free cash flow of the target. 468 00:23:39.985 --> 00:23:42.565 It was 66 according to the equity method, 469 00:23:42.565 --> 00:23:44.685 which was a free cash flow of the investor 470 00:23:45.275 --> 00:23:50.125 Plus only the dividend paid by the target to the investor, 471 00:23:50.625 --> 00:23:53.045 but you understand that it shows only 40. 472 00:23:53.145 --> 00:23:56.325 It does not show a free cash flow generated by the target. 473 00:23:56.745 --> 00:24:00.605 It is simply a cash transfer. It's not a cash generation. 474 00:24:01.265 --> 00:24:03.445 Now, if we show a 79 as 475 00:24:04.165 --> 00:24:07.365 consolidated integrated free cash flow, it's 476 00:24:07.365 --> 00:24:10.565 because we want to add in a group perspective the investor 477 00:24:10.865 --> 00:24:14.005 and the target, the parent company and the subsidiary. 478 00:24:14.465 --> 00:24:17.765 Now let's build a balance sheet of the investor at the end 479 00:24:17.765 --> 00:24:19.205 of year end plus one. 480 00:24:20.105 --> 00:24:23.365 No change in capital and in additional pending capital 481 00:24:24.065 --> 00:24:27.165 and retain earnings have been incremented by the group. 482 00:24:27.265 --> 00:24:30.965 Net earnings. You remember it was 132 equity method 483 00:24:31.305 --> 00:24:34.925 or full integration, no change in long-term 484 00:24:34.925 --> 00:24:36.365 and short-term financial debt. 485 00:24:36.925 --> 00:24:39.725 Accounts payable and other current operating liabilities 486 00:24:39.795 --> 00:24:42.845 have been incremented by the respective evolution 487 00:24:42.845 --> 00:24:44.365 of the investor and the target. 488 00:24:45.095 --> 00:24:48.925 Total equity and liabilities 2078. 489 00:24:49.585 --> 00:24:51.885 Now let's move to the asset side of the balance sheet. 490 00:24:52.305 --> 00:24:56.205 Net tangible fixed assets have been incremented by CapEx 491 00:24:56.825 --> 00:24:59.405 and dec incremented by depreciation of the year, 492 00:25:00.055 --> 00:25:04.205 intangible fixed assets So far, we're going to consider 493 00:25:04.235 --> 00:25:05.365 that there is no change 494 00:25:05.595 --> 00:25:08.285 because the auditors agree on the fact 495 00:25:08.285 --> 00:25:10.005 that it's still the same value, 496 00:25:10.505 --> 00:25:13.365 at least financial fixed asset zero, 497 00:25:13.675 --> 00:25:15.405 because there is no acquisition 498 00:25:15.425 --> 00:25:19.325 or any financial investment of any kind, inventories, 499 00:25:19.325 --> 00:25:22.565 accounts receivable and other current operating assets is 500 00:25:22.565 --> 00:25:26.085 simply the dynamics of the investor plus the target. 501 00:25:26.465 --> 00:25:29.405 Now, the free cash flow of the group is fully showing 502 00:25:29.905 --> 00:25:32.125 as an incremental cash situation. 503 00:25:32.865 --> 00:25:36.845 Why? Because the free cash flow has not been consumed 504 00:25:37.465 --> 00:25:40.885 by paying any dividend, which is leaving the group, 505 00:25:41.055 --> 00:25:42.645 which is cashed out. 506 00:25:42.995 --> 00:25:44.045 With the group perspective, 507 00:25:44.705 --> 00:25:46.485 it would have been the dividend paid 508 00:25:46.505 --> 00:25:48.445 to the parent company shareholders. 509 00:25:48.865 --> 00:25:50.765 No dividend is paid, no cash out, 510 00:25:51.065 --> 00:25:53.205 no dividend shows in a cashflow statement. 511 00:25:53.425 --> 00:25:55.205 No cash is leaving the group. 512 00:25:55.395 --> 00:25:59.165 Current operating assets plus cash are 937. 513 00:25:59.545 --> 00:26:03.885 The sum of the balance sheet, total assets 2078, 514 00:26:04.295 --> 00:26:06.885 which matches with equity and liabilities. 515 00:26:07.405 --> 00:26:11.005 A few comments to conclude this module, which is devoted 516 00:26:11.005 --> 00:26:14.365 to full integration of the accounts of a subsidiary. 517 00:26:15.545 --> 00:26:17.565 The first thing we had to do is 518 00:26:18.365 --> 00:26:20.125 recognize the value creation. 519 00:26:20.545 --> 00:26:22.965 The value creation has been observed 520 00:26:23.145 --> 00:26:25.085 as a first consolidation gap 521 00:26:25.425 --> 00:26:28.285 and then we have to allocate this value creation. 522 00:26:29.315 --> 00:26:31.565 Very often it's about intangible assets, 523 00:26:31.705 --> 00:26:33.445 but it might be tangible assets. 524 00:26:34.105 --> 00:26:35.645 In our case, we decided that 525 00:26:35.645 --> 00:26:39.485 to 240 were about brands and goodwill. 526 00:26:39.535 --> 00:26:42.605 These are intangibles. Now, we had 527 00:26:42.795 --> 00:26:45.925 Also in order to build the consolidated accounts 528 00:26:46.265 --> 00:26:48.245 to adopt a group perspective. 529 00:26:49.145 --> 00:26:51.965 The group perspective means that we are adding line 530 00:26:52.065 --> 00:26:55.285 by line the accounts as a subsidiary in the accounts 531 00:26:55.285 --> 00:26:57.165 as a parent company, but we have 532 00:26:57.165 --> 00:27:00.405 to exclude everything which is in track group. 533 00:27:00.755 --> 00:27:02.845 What is really critical is 534 00:27:02.845 --> 00:27:04.805 to take into account everything which 535 00:27:05.365 --> 00:27:07.565 impacted the relationship between the group 536 00:27:08.025 --> 00:27:11.765 and its environment, what got in, what got out, 537 00:27:12.355 --> 00:27:13.485 something which happens 538 00:27:13.865 --> 00:27:17.125 inside the group has no impact on the group as a whole. 539 00:27:18.505 --> 00:27:21.045 Now, what is very interesting in this kind 540 00:27:21.045 --> 00:27:22.125 of consolidation is 541 00:27:22.125 --> 00:27:26.645 that it provides information on all the business operations 542 00:27:26.705 --> 00:27:29.605 of the group, not just a parent company 543 00:27:30.395 --> 00:27:32.645 plus the bottom line, which is incremented 544 00:27:32.705 --> 00:27:35.565 by the earnings generated by affiliate companies. 545 00:27:35.945 --> 00:27:39.565 No, we have information about the business operations, 546 00:27:39.565 --> 00:27:43.365 about the industry, about the economics of the company, 547 00:27:43.655 --> 00:27:45.085 which is quite important, 548 00:27:45.545 --> 00:27:47.805 but again, adopting a group perspective 549 00:27:48.775 --> 00:27:53.685 eliminates all the flows which are intra-Group flows Y 550 00:27:53.915 --> 00:27:55.725 because A plus x, 551 00:27:55.775 --> 00:27:59.045 which you show somewhere is a minus x, 552 00:27:59.045 --> 00:28:01.285 which you show somewhere else inside the group. 553 00:28:01.655 --> 00:28:04.685 These are intragroup flows which have 554 00:28:04.685 --> 00:28:08.125 to be eliminated the day you adopt a group perspective. 555 00:28:08.275 --> 00:28:10.765 What we observed in this module is a situation 556 00:28:10.765 --> 00:28:14.765 of a parent company which acquires 100% 557 00:28:14.945 --> 00:28:17.085 of the shares of a subsidiary. 558 00:28:17.915 --> 00:28:20.285 Then we were fully integrating the accounts 559 00:28:20.285 --> 00:28:22.805 for a very simple reason we control, 560 00:28:23.345 --> 00:28:25.645 but there are other situations in which you 561 00:28:25.675 --> 00:28:26.925 control a subsidiary. 562 00:28:27.105 --> 00:28:30.165 For example, if you hold 70% of the shares, 563 00:28:30.825 --> 00:28:34.125 but then it's a different situation because you control 564 00:28:34.665 --> 00:28:37.325 and you don't hold 100% of the shares. 565 00:28:37.355 --> 00:28:40.325 This is a specific situation which is going to be 566 00:28:40.925 --> 00:28:41.845 analyzed in the next module.