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Alan Kring Productions in association with the Emergent Lights Studio presents

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the Illinois State Collegiate Compendium, Academic Lectures in Business and Economics.

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This is Business Finance, FIL 240 for spring semester 2024.

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Today, accounting financial statements.

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I will go forward until 2.55 at which time you will begin your quiz that is scheduled for today.

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So without further ado, we first look at the numbers.

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Now the Federal Reserve met today to decide whether to increase, hold steady, or decrease the discount rate,

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a driver of all interest rates, and it chose to keep the interest rate where it is.

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There was an expectation that it would shave a quarter of a percent off the discount rate, but it didn't do that.

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The result was, notice how the expectation had to be changed with the new information.

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Well, let's do it this way. First of all, is this a bull or a bear day?

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Say it strong, you're right. Bear! You have to say bear day.

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Be confident about it. This is a bear day. Not a cave bear. It's just a down day.

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The markets were hurt, their feelings were hurt a little bit by the fact that they didn't get the discount rate cut that they were anticipating that they would get.

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And so you have the Dow down 0.2%. Now as usual, as the portfolio gets riskier, you will see the effect magnified.

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And in the S&P 500, a riskier portfolio than the Dow, it was down 0.94%. And the NASDAQ, which is a substantially riskier portfolio,

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the bear was magnified more, down a full percent, one and a half percent. So there you go.

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It was a down day. Just the markets were not happy with the outcome, but they've gotten over it.

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And you will notice that if you look closely at the spark chart, the information came in that the Fed was not going to lower the interest rate,

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so it just went down a little bit. And then it just kind of stayed right where it was from there, because there was no more information, good or bad.

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The markets just sort of stay where they are. The crude oil has eased up some, as I've said on several occasions here.

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Over the past couple of years, it has liked a trading band for the light sweet Brent of about $72 to $79 a barrel, and it's staying right in that pocket.

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It's not moving around. Well, it's down a little bit today, but it's staying in that trading band right there.

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This is despite some concerns, and you can tell that the world's financial markets aren't really worried.

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We are having something of an escalation in the tangle of conflicts in the Middle East right now.

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We are anticipating that the United States is going to take a rather dramatic retaliatory strike against the proxies of Iran, maybe even against Iran itself.

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And that will stir up the oil markets a little bit, but they're really, I mean, if they thought it was going to be bad, you'd see the price of oil already shooting up towards $90 a barrel.

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It's not, and these guys know what they are doing, these traders, they are, they have fingers on the pulse of every piece of information about world oil supplies and destruction potentials.

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So right now, not much worry on that end. Now, first of all, go over here to gold. It spiked, and then it tailed back off some.

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But over here, 10-year bonds, they dropped on the outset. This is yields, this is the prices.

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So the prices are doing the opposite of what you see here. In this market, you saw that the yields dropped, and then they just kind of stabilized.

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In other words, there was buying that drove the price up and the yield down, and then after that little fit, it stayed where it was.

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Notice something about this. This is kind of a special one. I had told you about flight to quality.

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The flight to quality is moving financial assets from riskier securities to safer securities, from stocks to bonds, from bonds to gold, from gold to bullets, that whole thing right there.

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And you see a one-day example of that right here. Investors were selling their stocks. That makes the price fall.

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As they sold their stocks, well, they moved those, that, the money that they got for the proceeds over here, and they bought bonds, which is why the price of bonds went up.

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There was a flight to quality. In fact, some of that money looks like it went over to gold even.

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So that was, this is stage one, money moves from stocks over to bonds. Stage two, money moves from bonds to gold.

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So you had both stages, stage one and stage two, flight to quality. Most likely it's temporary. It's just a hissy fit for the day.

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But at the same time, here's a classic example of that phenomenon we call flight to quality. Investors sold stocks that drove the price of stocks down.

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So they had the money that, from the proceeds from the sale of the stocks, they ran over here and they bought bonds, which drove the price of bonds up and the yields down.

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They also maybe threw a little bit of money at gold, and gold went up in price as a result of that increased demand. Classic flight to quality, but like I said, it's nothing to worry about too much right now.

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Now if you go over here, Tokyo started out, you know, on the bell it was down. This is last night this was happening.

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At the opening bell, it started out down and then it crawled slowly on little bits and pieces of good news through the day until it finished up.

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Not bad, I mean, it finished up about almost two thirds of a percent. So it kind of crawled out of its doldrums, its bearish sentiment through the day.

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Nothing dramatic at all. And then when the sun set in Tokyo, it was rising across Europe, got to England and London opened, opened down a little bit, crawled back up, and then something really spooked it there at the end.

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You see that drop off? There was a rather hellish selling frenzy there right before the closing bell. It just kind of dropped, so it ended the day down from where it began, almost a half a percent.

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But we had our own ways today. We were grouchy on the outset, and so that kind of translated into lower prices, but then it slowed, it quieted down.

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One thing that you do want to note though, and we usually use the S&P 500 sort of like a proxy for the market as a whole, if you look here at the volume, the volume is really weak.

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We're not quite close for the day, but it'll probably finish at about 2.1 billion shares.

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But on the average day over the last year, it's been near 4 billion. So today, the market, a lot of market participants weren't even in there.

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That's the big dogs. They are sitting on the sidelines just waiting for the smoke to clear to see a better direction.

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So they just keep their money in their pockets, and that's why you see this really light volume on the S&P 500 for the day.

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And that's something that you should keep in mind. Well, the S&P was down a lot today, but that was on light volume.

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That's the amateurs in the small houses and the portfolio adjusters just jockeying around. The heavies weren't there, and they're the ones who you want to pay attention to.

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So what happens on a day like this, you have to kind of take, yeah, but this was the small players doing it today.

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As we do this over and over, and I'll do this every day, it begins to really sink in, and you begin to think in this much more professional, objective way about what goes on in the world.

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There's no apocalypse today, unfortunately, so we will make it to the point where you have to take the quiz later and all that kind of stuff.

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Now, I want to take you on a little bit of a journey here. I'm going to do something really quick here.

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I'm going to look at some more stocks, but first, this is a caution about looking at resources on the web and things that happen there.

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Where am I? I'm looking. No, I'm probably not going to see it. Let me do it this way.

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There are these supposedly reputable websites where good financial advice is given.

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One of those has the unfortunate name, The Motley Fool.

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This is the article, I think this is the one that was, well, no, I'm not going to find it here.

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There was an article earlier today where The Motley Fool was saying, well, you've got to get in on the AI wave.

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It's everything now. True enough, artificial intelligence is dominating the news and it's dominating technology and it's already beginning to shape the employment landscape.

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Now, unfortunately, though, if you are thinking that I should buy AI stocks, that's a bigger question.

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The Motley Fool said, okay, here's what we think you should buy.

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If you're going into AI, you should go with the leaders in AI.

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Unfortunately, that was the end of where they were talking without completely misleading investors.

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Their first recommendation was advanced micro devices.

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I think I've shown it to you before, AMD is a chip maker.

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Major competitor is Intel. And if we look at advanced micro devices and we say, is this a good stock for a small investor to buy?

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The first thing is that they are no longer even reporting a beta.

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The last beta they reported was above two.

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That's two is extraordinarily risky.

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That's an inappropriate investment for anyone except for high rolling speculative investors.

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So that right there. The other thing is I want you to look at the price earnings ratio, the P-E ratio.

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And if you look at that P-E ratio, can you tell me if that's a normal P-E ratio or if there's something really weird about that P-E ratio?

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It's pretty high. It's not pretty high. That's high AF.

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That is insane.

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Intrinsic value would be price that is near intrinsic value would have P-E ratio at about 30.

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If a price is much above its intrinsic, the P-E ratio will be well above 30.

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If a price of a stock is well below its intrinsic, you'll see a P-E ratio above below 30.

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Now you'll notice that that number right there, 1673, is a little above 30.

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This stock is insanely overvalued.

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First of all, you can't even look at the beta and assess the risk of the stock.

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Now the beta has disappeared.

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Second of all, the P-E ratio is telling us that this stock has an incredible potential for downside price movement.

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This is a terrible piece of advice.

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You're getting to the point just this early in the semester where you can make that assessment for yourself

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and see that these websites run by these gurus, they don't know what they're talking about.

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The truth of the matter is that artificial intelligence is red hot.

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The second thing though is that AMD is not into AI.

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It's just a computer chip maker.

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The heavies in AI right now are Google, obviously.

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AI is everything to Google now.

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The place where I get all of my certifications, IBM, places like OpenAI,

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and there are smaller companies that are in AI, but very few of them really are.

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Because in order to be a developer of AI, you need a lot of technological capital,

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computing space in the cloud, massive amounts of expertise in everything from

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fast machine learning to cyber security and all of that kind of stuff.

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It's not for small time players.

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There are a lot of companies saying, well, our software is AI powered.

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For them, it's just a marketing scam.

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It's something that they say.

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It's not real.

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So claiming that AMD, because it does computer chips, is a leader in AI is ridiculous.

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Let me show you the other stocks that they recommended.

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The other stocks that they recommended, what was the one?

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Oh, NVIDIA.

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NVIDIA.

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Now some of you who are into gaming or into computers,

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you would recognize NVIDIA as a maker of graphics cards.

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That's one of their big things that they do.

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So let's look at NVIDIA.

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Looking at the beta of NVIDIA, what could you tell me about this company?

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Sir?

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High.

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It is stupid high.

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When you see 1.25, that's risky territory.

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One is the fulcrum, remember.

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One means that it has the risk of the overall world portfolio.

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Above that, that risk is magnified.

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Below one, it's demagnified.

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So in this case, you have a magnification of 164% on the world portfolio's volatility.

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That's risky, very risky.

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At 1.25, I begin to get a little worried.

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At 1.5, my back leg begins to itch.

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And at 1.64, you're busy worrying about how you're going to eat tonight

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because any twitch in the market could be very bad for you.

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Now, if we're looking at the P-E ratio of it,

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is this stock undervalued, overvalued, or correctly valued?

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Ma'am?

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Look at the P-E ratio.

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Overvalued?

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Exactly, it's overvalued.

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In fact, roughly, maybe the price has about – it might be –

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if 30 is our fulcrum, this thing is maybe two times its intrinsic value right now.

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This has a lot of downside potential.

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And that's magnified by that bad – that risky beta, that high beta.

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So this is, again, they're violating that rule I mentioned before,

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appropriateness of investment.

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They're giving advice to the average person who thinks he or she is smart

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by looking at the experts.

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And then they're giving this kind of advice.

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That's not good.

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It's like going to a doctor for advice on how to be a little bit more active,

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and he suggests that you try meth.

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It might work, yeah, but you're also going to find yourself wandering around on the

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highway saying, my apartment has Stately Bay windows and things like that.

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Okay, so just as a cautionary tale, just be careful when you're taking advice from

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experts.

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I'm going to do what I can to make you good enough to do your own advice in this

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and to be careful and measure the advice of these blogs and Internet resources.

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They are almost always going to be in one way or another in it for themselves to

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make ad revenue, to get subscribers, to make themselves look like they're giving

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you the real story.

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You can figure out the real story for yourselves.

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Anyway, enough of that for the day.

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Now, let me do one right here.

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This one I'm going to use, I'll probably do this part of the lecture, tie up the

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lecture on Monday, but just as a normal stock, let's look at United States Steel

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Corporation.

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Now, this one was down for the day and you notice that it is actually down, that

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beta is seriously high.

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Oddly though, can you see that this is also an undervalued stock?

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So, I mean, if you want to take risk, yeah, I'm a risk taker, I'm wild and crazy.

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I put extra chocolate in my chocolate milk.

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I mean, if you're going to do that, here's one that does have magnified risk, two

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times the volatility of the market portfolio, but it also has a third of the

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normal price earnings ratio.

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So, this has, it is definitely undervalued and so it has upside potential, but

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that upside potential is going to be, you're going to take that at a high risk on

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that.

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So, this is kind of one of those where, yeah, you want to take a hard bet, but

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you want to have the dice loaded in your favor.

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This would be something that might fit that bill.

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And also notice that it is profitable, pays a little dividend even, so I mean,

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it's one of those stocks that's just kind of a difficult one to decide on.

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The one thing you have to appreciate is that U.S. steel is in an industry that is

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pretty darn competitive.

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We are, I hate to use cliches, but this is a global economy and there are other

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companies, other nations, companies in other nations that make steel too.

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And some of them make steel by technologies that we still haven't completely

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embraced or fully put into the line for the production.

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So, like Japan, they make steel, they may use basic oxygen furnaces, which we have

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finally kind of embraced, but at the same time, they can make a lot of steel

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against us.

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So, it's in a competitive industry.

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And so, you keep those in mind.

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This is called fundamental analysis.

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Look at the numbers, but then think beyond the numbers.

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Ask yourself about competitiveness of the markets, the quality of the managerial

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team, and all of that goes into a decent analysis.

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You can do it.

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I'm going to show you how.

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Speaking of which, it is time now to go on to the painful part of today's lecture.

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This is accounting.

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Now, I am assuming that you've all had accounting 131.

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I come to this lecture, I know this is a lecture where I teach accounting.

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And so, as I walk down the hall, I, every time, I have to decide whether I'm going

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to go in here and teach about accounting or if I'm going to kill myself first.

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Unfortunately for you, again, I've decided I'm going to go through this.

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But understand something important is that finance, we don't do accounting.

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In fact, we have to fix accounting numbers so that they mean something to us.

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Accounting is a production.

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It produces a line of products, a product line.

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We call those financial statements.

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And those financial statements are produced for a variety of consumers,

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what we call constituencies.

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The information products are generated for a number of different groups.

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One group is the upper level management of the company.

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The accountants produce those financial statements for them.

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In fact, they produce a kind of specialized version of those financial statements

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for the management.

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And that's the subject of accounting 132, managerial accounting.

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However, they also produce them for, the accountants produce these financial

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statements for other consumer groups, other constituencies.

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One important group is the investors.

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But there are two types of investors.

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One are the existing investors.

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They already hold the stock.

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And then there's another type of investor, the potential investor,

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the ones who are considering buying the stock.

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So those information products are used by them as well.

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Another separate constituency is government agencies at the federal

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and state and even maybe the municipal level.

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They use those financial statements completely separate.

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And then there are other constituencies as well.

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Among them are outside stakeholder groups.

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For example, the unions will, and the employees,

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they will use those financial statements sometimes against the company.

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Look, you don't give us a raise, but look at this massive compensation package

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you just gave to your big dogs in the company.

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There's other groups.

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Special interest groups will use those information products as well.

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Environmental groups, ethics groups, all kinds of outside special interests

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will use them.

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The political side of government will use those too.

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Both the liberals and the conservatives will use those financial statements

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to support certain legislation or certain positions on the corporate world

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and what laws and regulations are needed or need to be removed.

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They're in looking at those financial statements too, for heaven's sakes.

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And other countries will look at the financial statements of other companies,

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I should say.

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Other companies will look at those financial statements as what we call comps, comparables.

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Well, how are they doing?

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Well, how are their costs doing?

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How are their ratios, their asset turnover ratio, all those kinds of things?

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They'll be looking at those too.

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So it's unbelievable all these information aggregators look at them.

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Like there's one I'll show you.

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It's supposed to have been emphasized in your Business 100 course,

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but I've found that it's not really emphasized enough.

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There's an information wellspring called Standard & Poor's Net Advantage.

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It collects all that financial accounting information,

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and it grinds it into all kinds of its own information products.

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And those are available to you as members of the ISU community.

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What would otherwise cost thousands of dollars for a subscription

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to Standard & Poor's Global Net Advantage, we get for free.

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And so I'm just emphasizing, these products that are made by these companies,

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public companies, are used by insanely large numbers of consumers of information

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in different categories of consumers.

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So there you are.

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Now, finance has kind of a special take.

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As I said, we need to take those numbers and oftentimes just twist them,

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add things in, take things out, and then put in other numbers that aren't there,

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aren't immediately obvious.

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We have to do a lot to them because the difference between accounting and finance

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is that the accounting numbers are historical.

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They are what has already happened.

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We in finance don't care about what has already happened.

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All we care about is what is going to happen next.

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We have to lean into the future.

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Now, the past can give us information, but it is like a dark crystal ball.

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It's not the best, and we have to think.

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And not only that, once we have ground through some numbers of our own,

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like financial ratios and that kind of stuff,

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we then have to take the next step and ask, what does this mean?

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And that is where fundamental analysis comes in.

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It's not enough for you to say, well, I got your numbers.

283
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In our business, we have to determine what actionable consequences those numbers have.

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What does that mean the stock price will be?

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What does that mean the prospects for the company's revenues will be?

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What does that mean about the company's cost structure

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and what it has to do to fix the problems in it?

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We have to look at the future.

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That's where you're going to be, too.

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The past means nothing.

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There are many companies that sat for years on their past,

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and the ultimate result of that was that they never saw that train coming at them called the future.

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Examples would be Sears, a great example.

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The Powerhouse, the first company that understood the concept of mass marketing

295
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was those Sears catalogs in the 19th century.

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My God, everyone got a catalog in the mail.

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That was ingenious, but this is the same Sears that didn't even set up an online e-commerce solution

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for consumers in the 21st century.

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That's the things that we have to watch out for.

300
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We have to say, where are they going, not where they come from.

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And that's where someone like you, sir, you might have been an arsonist, a murderer.

302
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I don't care. I want to know what you're going to be next.

303
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It's something bad. I don't know.

304
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But you see, I have to build, and that's one of the things about this college.

305
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The good teacher is going to say, it doesn't matter where you are,

306
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how do I find out where you're going to be and how can I help you get there?

307
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So that's what we do in finance.

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We have to look well past what the accountants do.

309
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And don't get me wrong, the accountants are awesome.

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The Lord knows I wasn't. I taught accounting and I gave up after a couple of semesters.

311
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But no, I've taught accounting as well. This is different.

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Now, let me emphasize a couple of things here.

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I'm going to give you real life examples of the processes that go on.

314
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But it boils down to just getting some things in your notes

315
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that will get you through a quiz or an exam.

316
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I'm not going to test you on, okay, well, do you know where the debits and credits go?

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That's not how it works for me.

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I'll mention them, but it's not the core concept.

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But in finance, we don't care about profit, earnings, net income.

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I'll wave them around and I'll say, well, let's look at their earnings per CR and all that.

321
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But the reality is that we've got to get way past that in what we're doing.

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And it's formulaic to a certain, to a large extent, it's just formulas.

323
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And you can write, and I'll show you how we write Excel routines.

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We'll start doing a lot of Excel starting next Monday.

325
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But you'll get the hang of it. It's just arithmetic for the most part.

326
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There's no calculus or anything.

327
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But net profit doesn't mean anything to us.

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I'll give you a good example. I've run several companies.

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I've owned several companies, my consulting company being one of them for a long time.

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And I had a profit. I had positive net income.

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No question about that. For several years I did.

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But there would be that dark night every two weeks on Thursday night when I had to cut payroll.

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And there were a number of times when I had to take money out of my own personal account

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and put it into the company account so that I could meet payroll.

335
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You understand? That's cash. That's real cash.

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What was happening on the income statement was just following rules.

337
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And that's the way it works all the time, is that what we care about is free cash flow.

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What really happens, the amount of cash that is being generated after all the bills,

339
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the revenues that come in and the bills have been paid.

340
00:32:15,000 --> 00:32:21,000
That is not net income. That's just how it worked in my company.

341
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Yeah, by the accounting rules I was doing great.

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But by what I had to cut for payroll, I was in trouble all the time.

343
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Catastrophe. I can give you all kinds of other examples.

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But let me get a little more specific with numbers on this.

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Now, as some of you know, I actually run a company.

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It's the longest standing company I've ever done.

347
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Founded in February 12th of 2012, the corporation was.

348
00:32:58,000 --> 00:33:02,000
Emergent Light Studio Incorporated.

349
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If you go to Amazon, you'll see I've got a storefront there.

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I've also got several other e-commerce platforms for solutions to selling, including PayPal.

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And I think I still have Square, I don't know.

352
00:33:18,000 --> 00:33:21,000
But here's the thing. Go to a show.

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Now, I sell online, but I also do the art shows and the exhibits.

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And I set up my display area with all the other gypsy tramps and thieves and their display areas around me.

355
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In mine, you'll have artwork on these wire frames, about 1200 pounds worth of it.

356
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And the frames and the art hanging there.

357
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You'll have a customer come in.

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You'll have a lot of people just come in, oh, this is pretty, and they'll walk back out.

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But sometimes you'll have someone come in and that person will just, somewhere along the line,

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he or she will stop and just start looking at something I've created.

361
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And of course, that's when I go into my act.

362
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The brooding, depressed artist who's on the verge of sadness.

363
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And I go up, you like this? Yeah, I do. Okay.

364
00:34:17,000 --> 00:34:21,000
Where would you put it? Do you have a place for it? Uh-huh.

365
00:34:21,000 --> 00:34:27,000
Well, would you like to buy it? I can't afford this. $1200. Oh, God.

366
00:34:27,000 --> 00:34:30,000
Yeah, it's way past that person's budget.

367
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Of course, they came here to that show to buy soy candles, for God's sake.

368
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And they just stumbled into my tent and saw something that catches.

369
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And that's the thing about art.

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Most people are going to say, oh, that's pretty or that sucks.

371
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But there's always that magic once or twice in a show.

372
00:34:47,000 --> 00:34:49,000
Okay, here's what I do.

373
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It's $1200. I have financing available.

374
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$400 now and then the rest six months from now.

375
00:35:02,000 --> 00:35:08,000
Get a sale. Once, well, not usually. Sometimes that's enough.

376
00:35:08,000 --> 00:35:14,000
Okay, so from that person's perspective, here she walks out with this ginormous,

377
00:35:14,000 --> 00:35:16,000
really gorgeous work of art.

378
00:35:16,000 --> 00:35:26,000
I, on my income statement in revenue, by law I have to put $1200 in revenue.

379
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But that is in fact a lie. That's not what happened in terms of reality.

380
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The reality is that I got $400.

381
00:35:36,000 --> 00:35:55,000
So what really happened here was that I got $400 in cash debit and I got $800 in accounts cash

382
00:35:55,000 --> 00:36:00,000
and in accounts receivable I got $800 on the debit side.

383
00:36:00,000 --> 00:36:03,000
I promise I wouldn't do this, so I'm doing it, aren't I?

384
00:36:03,000 --> 00:36:10,000
And then over here, but revenue, I've got the credit of $1200.

385
00:36:10,000 --> 00:36:15,000
So it all matches up and everyone sees $1200, well damn, you're good.

386
00:36:15,000 --> 00:36:23,000
No, I'm not nearly as good as it looks because I haven't got the $1200.

387
00:36:23,000 --> 00:36:33,000
So we in finance have to correct this mess, this wrongness from the financial statement called the income statement.

388
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We have to fix it. That's where changes in net operating work and capital come.

389
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And I'll get into that on Monday to some extent.

390
00:36:42,000 --> 00:36:47,000
But here's what's going to happen. $1200 is what I say happened.

391
00:36:47,000 --> 00:37:02,000
However, the reality is that this account right here, this current asset, went up by $800.

392
00:37:02,000 --> 00:37:15,000
So relative to the revenue that I am reporting, my free cash flow suffered $800, went down.

393
00:37:15,000 --> 00:37:28,000
So I have to subtract that change in current assets because that way I'm honestly reflecting what the true change in free cash flow was.

394
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Now, ultimately, what will happen is that I'll get the $800, so the credit will happen there.

395
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And those two will wash and I'll get that.

396
00:37:45,000 --> 00:37:53,000
So when the current asset drops by $800, my free cash flow rises.

397
00:37:53,000 --> 00:38:04,000
That's what we have to do, is make those corrections for what revenue is saying that free cash flow isn't doing.

398
00:38:04,000 --> 00:38:07,000
Now take the other side of this.

399
00:38:07,000 --> 00:38:16,000
Madam, I decided to hire you as my assistant at art shows.

400
00:38:16,000 --> 00:38:27,000
For the show, I shall pay you $300 for the show.

401
00:38:27,000 --> 00:38:35,000
So I will reflect on my income statement and expense wages of $300.

402
00:38:35,000 --> 00:38:40,000
But that's not what happened because I'm not going to pay you right away.

403
00:38:40,000 --> 00:38:46,000
You're faced with a show, you're exhausted, I made you carry the $1200 pound.

404
00:38:46,000 --> 00:38:49,000
Can I get paid now fat boy?

405
00:38:49,000 --> 00:38:53,000
And I say, well, I'll pay you at the beginning of next month.

406
00:38:53,000 --> 00:38:58,000
You say, now, wait a minute, you asshole.

407
00:38:58,000 --> 00:39:02,000
I said $300, but it didn't happen.

408
00:39:02,000 --> 00:39:12,000
So you see in that case, my wage expense looks like I spent $300.

409
00:39:12,000 --> 00:39:15,000
But, okay, here's $100.

410
00:39:15,000 --> 00:39:18,000
Damn, now go away, I'll see you next month.

411
00:39:18,000 --> 00:39:43,000
So what happens is that my expense in operating expenses was wages payable, operating expenses, I say I spent $300 wages.

412
00:39:43,000 --> 00:39:47,000
However, that's not what really happened.

413
00:39:47,000 --> 00:39:56,000
Cash credited only $100.

414
00:39:56,000 --> 00:40:06,000
And wages payable credits the other $200, which matches the $300 here.

415
00:40:06,000 --> 00:40:09,000
In other words, I'm saying I spent more than I really did.

416
00:40:09,000 --> 00:40:18,000
So ultimately I'll pay you and it'll wash, but the reality is that when a current liability goes up,

417
00:40:18,000 --> 00:40:27,000
that is a freedom of that opens, lifts free cash flow relative to operating expenses.

418
00:40:27,000 --> 00:40:39,000
I said $300, but because wages payable went up by $200, I really saved $200.

419
00:40:39,000 --> 00:40:47,000
I lifted the free cash flow by the amount that I didn't pay.

420
00:40:47,000 --> 00:40:55,000
And then ultimately, so free cash flow goes up.

421
00:40:55,000 --> 00:41:04,000
Eventually I'll pay her, she comes in with a couple of very large people with ball bats, so I pay her free cash flow.

422
00:41:04,000 --> 00:41:09,000
I will pay her eventually, and then wages payable will go down.

423
00:41:09,000 --> 00:41:15,000
So when that current liability goes down, that hurts free cash flow.

424
00:41:15,000 --> 00:41:19,000
Now what do you have to remember from this?

425
00:41:19,000 --> 00:41:23,000
Put this on your notes.

426
00:41:23,000 --> 00:41:25,000
Get it on there.

427
00:41:25,000 --> 00:41:28,000
I mean, you could even get this as a tattoo.

428
00:41:28,000 --> 00:41:31,000
It really looks good, or not.

429
00:41:31,000 --> 00:41:33,000
Okay, maybe not.

430
00:41:33,000 --> 00:41:34,000
But you remember this.

431
00:41:34,000 --> 00:41:38,000
Just be able to identify, okay, what happened here?

432
00:41:38,000 --> 00:41:43,000
Well, a current asset went up, or a current liability.

433
00:41:43,000 --> 00:41:54,000
Okay, so now, the next one, depreciation expense.

434
00:41:54,000 --> 00:41:58,000
My favorite example is one of my own.

435
00:41:58,000 --> 00:42:06,000
These days I do landscape photography, and I do original artwork, which you can see on Amazon.

436
00:42:06,000 --> 00:42:11,000
You can find my account on Instagram if you're interested in seeing my artwork.

437
00:42:11,000 --> 00:42:17,000
But back in the day, and you'll still see me walking around with my camera equipment here,

438
00:42:17,000 --> 00:42:20,000
if I've got a gig on campus to do.

439
00:42:20,000 --> 00:42:26,000
But I got a portrait lens about five years ago.

440
00:42:26,000 --> 00:42:30,000
$4,500.

441
00:42:30,000 --> 00:42:32,000
For God's sake, that's expensive.

442
00:42:32,000 --> 00:42:36,000
And when you look at it, you'll say, oh, that's insane.

443
00:42:36,000 --> 00:42:37,000
It's huge.

444
00:42:37,000 --> 00:42:40,000
And it's for photography.

445
00:42:40,000 --> 00:42:45,000
I used to do a lot of product, model, portrait photography.

446
00:42:45,000 --> 00:42:48,000
Okay, so $4,500.

447
00:42:48,000 --> 00:42:50,000
Out of my pocket, it just disappeared.

448
00:42:50,000 --> 00:42:51,000
$4,500.

449
00:42:51,000 --> 00:42:54,000
It just went to be with Jesus.

450
00:42:54,000 --> 00:42:58,000
But I can't say $4,500 as an expense.

451
00:42:58,000 --> 00:43:00,000
I'm not allowed to.

452
00:43:00,000 --> 00:43:06,000
You see, I have to, by the rules, I have to what they call capitalize it.

453
00:43:06,000 --> 00:43:13,000
I put it onto my total assets, my assets, long-term assets, go up.

454
00:43:13,000 --> 00:43:21,000
And then every year, for five years, I get to expense, depreciate some of it.

455
00:43:21,000 --> 00:43:25,000
If I did straight line, that would mean $900 a year.

456
00:43:25,000 --> 00:43:30,000
Goes onto my financial statements, onto my income statement.

457
00:43:30,000 --> 00:43:32,000
That's not what happened.

458
00:43:32,000 --> 00:43:38,000
There's no $900 anywhere in what really happened.

459
00:43:38,000 --> 00:43:44,000
What really happened was I spent $4,500.

460
00:43:44,000 --> 00:43:48,000
And it is nowhere on that income statement.

461
00:43:48,000 --> 00:43:53,000
So what we have to do is we have to correct that.

462
00:43:53,000 --> 00:43:58,000
Every year that there's $900 subtracted, we have to add it back.

463
00:43:58,000 --> 00:44:03,000
Because there was no, you don't write a check to depreciation expense.

464
00:44:03,000 --> 00:44:04,000
It just didn't exist.

465
00:44:04,000 --> 00:44:13,000
So every year that I subtract that $900 of depreciation, I have to add it back to the income statement.

466
00:44:13,000 --> 00:44:23,000
But in that first year, when I actually spent $4,500, I have to subtract that because that really was out of my pocket.

467
00:44:23,000 --> 00:44:28,000
And it hurt like hell.

468
00:44:28,000 --> 00:44:39,000
So you see, I'm motivating the idea that the income statement is not, the financial statements are not telling the story.

469
00:44:39,000 --> 00:44:47,000
They're telling a rule-based story that is absolutely valuable to the information constituencies.

470
00:44:47,000 --> 00:44:52,000
And most of them will just look at those financial statements and they'll take them at face value.

471
00:44:52,000 --> 00:44:55,000
We in finance have to do two things.

472
00:44:55,000 --> 00:44:57,000
One, we have to fix the numbers.

473
00:44:57,000 --> 00:45:01,000
And then we have to say why.

474
00:45:01,000 --> 00:45:03,000
What happened here?

475
00:45:03,000 --> 00:45:05,000
What does this mean for the future?

476
00:45:05,000 --> 00:45:13,000
Now, as far as financial statements go, I don't think they show this particularly to you in accounting classes.

477
00:45:13,000 --> 00:45:17,000
But some of it should ring a bell when I tell it to you this way.

478
00:45:17,000 --> 00:45:20,000
There are five financial statements.

479
00:45:20,000 --> 00:45:24,000
One of those is the core.

480
00:45:24,000 --> 00:45:28,000
It is the reservoir of information.

481
00:45:28,000 --> 00:45:34,000
The other ones are rivers that flow into that reservoir.

482
00:45:34,000 --> 00:45:45,000
The core statement is the balance sheet.

483
00:45:45,000 --> 00:45:50,000
But the income statement, let's start with that one.

484
00:45:50,000 --> 00:45:53,000
The income statement.

485
00:45:53,000 --> 00:45:57,000
That produces one line.

486
00:45:57,000 --> 00:46:02,000
It is a long calculation to produce one line.

487
00:46:02,000 --> 00:46:08,000
It produces the net income.

488
00:46:08,000 --> 00:46:19,000
And that flows to the statement of retained earnings.

489
00:46:19,000 --> 00:46:29,000
Then that flows to the stockholders' equity section of the balance sheet.

490
00:46:29,000 --> 00:46:34,000
Over here, the statement of cash flows.

491
00:46:34,000 --> 00:46:40,000
Now here's something.

492
00:46:40,000 --> 00:46:52,000
We had, a long time ago, back when I was young and still believed in the world and my immortality,

493
00:46:52,000 --> 00:46:54,000
we had another name for this.

494
00:46:54,000 --> 00:46:57,000
I don't know if they ever taught you this.

495
00:46:57,000 --> 00:47:01,000
We used to call it the sources and uses statement.

496
00:47:01,000 --> 00:47:08,000
Now that was very descriptive because what this one does is it helps us in finance.

497
00:47:08,000 --> 00:47:16,000
Because it tells us, okay, in operations, how much did accounts receivable go up or down?

498
00:47:16,000 --> 00:47:21,000
How much did current liabilities go up or down?

499
00:47:21,000 --> 00:47:25,000
It tells us what I was talking about there.

500
00:47:25,000 --> 00:47:28,000
It begins with cash at the beginning.

501
00:47:28,000 --> 00:47:33,000
How much cash was in the coffer at the beginning?

502
00:47:33,000 --> 00:47:43,000
And then in different categories, it says added to that or subtracted from that was this much actual cash.

503
00:47:43,000 --> 00:47:46,000
Okay, accounts receivable went up.

504
00:47:46,000 --> 00:47:48,000
That would be a subtraction.

505
00:47:48,000 --> 00:47:51,000
Wages payable went up.

506
00:47:51,000 --> 00:47:53,000
That would be an addition.

507
00:47:53,000 --> 00:47:59,000
So it's showing what the actual flows of cash were back and forth.

508
00:47:59,000 --> 00:48:08,000
And then it's got these sections like the cash generated by investments, cash generated or used by financing activities,

509
00:48:08,000 --> 00:48:16,000
cash generated or used by other categories.

510
00:48:16,000 --> 00:48:22,000
And it also adds back the depreciation, which they know really isn't an expense.

511
00:48:22,000 --> 00:48:25,000
So it's actually an addition to cash.

512
00:48:25,000 --> 00:48:27,000
So they have the cash at the beginning.

513
00:48:27,000 --> 00:48:33,000
Then they have, okay, net income for this year and then plus any accounts receivable that go down,

514
00:48:33,000 --> 00:48:38,000
minus if accounts receivable, it just plus you build a factory.

515
00:48:38,000 --> 00:48:41,000
That would be a big minus because you spent all that money.

516
00:48:41,000 --> 00:48:46,000
Plus, well, we got dividends from the stock investments the company made.

517
00:48:46,000 --> 00:48:47,000
So that would be an addition.

518
00:48:47,000 --> 00:48:51,000
So it's added and subtracting actual cash.

519
00:48:51,000 --> 00:48:58,000
And then they take the cash at the beginning and add how much was net of all these activities,

520
00:48:58,000 --> 00:49:03,000
and you get the cash at the end.

521
00:49:03,000 --> 00:49:12,000
That flows over here to the very first line of the balance sheet, cash and marketable securities.

522
00:49:12,000 --> 00:49:14,000
That's where it comes from.

523
00:49:14,000 --> 00:49:18,000
So the balance sheet is simply all these flows.

524
00:49:18,000 --> 00:49:23,000
I've taught you that the income statement is a flow through a year,

525
00:49:23,000 --> 00:49:28,000
and the balance sheet is the stock at the end of the year, the stock of capital at the end of the year.

526
00:49:28,000 --> 00:49:29,000
Yeah, this is what it is.

527
00:49:29,000 --> 00:49:38,000
These rivers are flowing from all of these other financial statements, oh, God, into the balance sheet.

528
00:49:38,000 --> 00:49:42,000
So that gives you, but there's one more.

529
00:49:42,000 --> 00:49:50,000
This is one that is oftentimes ignored, the notes to the financial statements.

530
00:49:50,000 --> 00:49:55,000
They are a veritable candy store of information.

531
00:49:55,000 --> 00:50:04,000
They'll tell you about the details of executive compensation, the details of lease agreements, the details.

532
00:50:04,000 --> 00:50:12,000
Some of it is numbers that you wouldn't find anyplace else except in the notes to the financial statement.

533
00:50:12,000 --> 00:50:24,000
And it also has all kinds of other goodies as far as qualitative information that is useful to us in terms of warnings.

534
00:50:24,000 --> 00:50:31,000
As a matter of fact, I was taught long ago that you can use the notes of the financial statement to warn investors away from your company.

535
00:50:31,000 --> 00:50:35,000
And I was even given the boilerplate.

536
00:50:35,000 --> 00:50:38,000
The last note in the financial statements is this boilerplate.

537
00:50:38,000 --> 00:50:42,000
If it's really a risky small startup, put this in there.

538
00:50:42,000 --> 00:50:47,000
And then the shareholders can't find some shareholder derivative lawsuit to sue you.

539
00:50:47,000 --> 00:50:50,000
It's right there in the public statements.

540
00:50:50,000 --> 00:50:55,000
So these are all the different ways that you can use a note.

541
00:50:55,000 --> 00:50:57,000
So it's worth it for you to look through those.

542
00:50:57,000 --> 00:51:06,000
But remember that the Securities and Exchange Commission is the only primary source for the financial statements.

543
00:51:06,000 --> 00:51:11,000
And in those, I will show you where to look for a lot of useful stuff.

544
00:51:11,000 --> 00:51:19,000
Every company must provide all of its financial statements in an Excel spreadsheet.

545
00:51:19,000 --> 00:51:25,000
Now, that spreadsheet might have 50 tabs, but I'll show you where to go and how to get them together,

546
00:51:25,000 --> 00:51:30,000
the ones that are important, these big five or the big four.

547
00:51:30,000 --> 00:51:33,000
And once you've got those, you've got the Excel sheet.

548
00:51:33,000 --> 00:51:42,000
You can make up quick little pretty graphs, add a blank worksheet, do some calculations, financial analysis calculations.

549
00:51:42,000 --> 00:51:44,000
I'll show you how to do that.

550
00:51:44,000 --> 00:51:47,000
We'll be using Excel extensively in this class.

551
00:51:47,000 --> 00:51:54,000
It saves a lot of time working on paper using a handheld calculator.

552
00:51:54,000 --> 00:51:56,000
You can do it all in Excel.

553
00:51:56,000 --> 00:52:06,000
And thank you to the SEC because we've got the core, the giant data set all set up ready for us to use.

554
00:52:06,000 --> 00:52:16,000
As a matter of fact, in another class, I'm showing how to use a chat GPT to go and get the financial statements of a company,

555
00:52:16,000 --> 00:52:21,000
bring them down, and do what I want it to do in terms of financial analysis.

556
00:52:21,000 --> 00:52:23,000
It's gotten that cool.

557
00:52:23,000 --> 00:52:26,000
If you're interested, I'll even show you a little bit about that.

558
00:52:26,000 --> 00:52:31,000
But you're going to have term papers to write in other classes, projects.

559
00:52:31,000 --> 00:52:33,000
This is where it all begins.

560
00:52:33,000 --> 00:52:37,000
Just get those financial statements down, and you're in business.

561
00:52:37,000 --> 00:52:41,000
And speaking of you're in business, it's time for you to take a quiz.

562
00:52:41,000 --> 00:52:46,000
The quiz is in Canvas, and I'll write the password here on the board.

563
00:52:46,000 --> 00:52:49,000
It opens in about two minutes.

564
00:52:49,000 --> 00:52:53,000
But once you're finished with that, that's all I have for you today.

565
00:52:53,000 --> 00:53:20,000
I thank you.