Alan Cring Productions in Association with Emergent Light Studio presents
the Illinois State Collegiate Compendium Academic Lectures in Business and Economics.
This is Business Finance, FIL 190 for spring semester 2024.
What are you going to do today?
Today, ratio analysis.
And just as a first pointer, I've uploaded some files for you.
And what I'm going to do today will be mostly Excel.
I'll try to go slowly. If I go too fast, you can shoot me with a tranquilizer dart or something like that.
But I will also upload the product of what I've done to Canvas for you, as well as another,
there's another document there for you to consider, a couple more for you to keep in mind.
But I'll probably spill, this lecture will spill a little bit into Monday, not a whole lot of it,
but some of it will. So I'll make sure that you have some extra time for the homework
that will be coming up due for this one.
But other than that, we are going to have a look, as we always do, at the numbers
before we dive into Excel and do a tedious lecture today on that.
But as you can see, the markets have, oh, we're still open, got a little less than an hour.
So we can go through this. And first things first.
Who haven't I bothered? Sir, is this a bull day or a bear day on the market?
Bull. It's a bull day. Not a big bull day, but it's a bull day.
I mean, we take our happiness where we can get it.
As you can see, the Dow is up about a half a percent, and the somewhat riskier S&P 500 is up more.
Normal pattern,.88 percent. And the riskiest of those that you see up there, the NASDAQ, is up 1.07 percent.
It's following a typical pattern of risk return for today, which it almost always does,
but sometimes it doesn't, and then we ask, well, what's going on that it's not doing what we usually see it do?
Which is good news. So investors were putting money into stocks.
They were pulling it off the sidelines, buying stocks, hence why the prices are going up.
But let's see what was going on with the bonds.
Ten-year bond. The yield is up, so the price would be down.
So as you can see, the yield was up about, what, 2.3 basis points, not much.
But that would mean the prices were down. So investors were drawing a little bit on net out of the bond market
and probably using those proceeds to buy into the stock market.
This is a good sign. Investor confidence, they're willing to take the higher risk of equities
because they see more potential gain and shed some of their more defensive position, which was in the bonds.
And so we have sort of a nice little, nothing spectacular, but it was nice good news today.
Looking at more physical things, crude oil is in that trading range.
I've mentioned it on a number of occasions, from about 72 to 79.
And it seems to like that range, and right now it's on the lower end of it, bouncing around.
And so that's giving us some indication that the traders are not concerned about supply disruptions of oil,
resulting from the conflicts around the Middle East and Southwest Asia.
So good news, gas prices, they're not going to go skyrocketing.
They may even shed a little bit of where they are, go down a little bit, but it won't be much.
Oil is just staying in a nice place. Now gold, pretty much flat.
There's no rush to buy gold because the world is coming to an end.
So we see some good numbers today. Equities are up, investor confidence is up, bonds are down,
so they're willing to take more risk, investors are, and no one is buying gold waiting for the apocalypse to happen.
All good news for the day. And of course, I can always change on a dime if something scary happens,
but it looks like there's generally positive sentiment in the markets.
Now over in Japan, the Nikkei 225 finished about flat. It was down all day, just a little grouchy.
But it was down 0.11%, which is pretty much not even anything to notice.
It's just a little grumpy Tokyo was, and they went finally closed, went to bed,
and then the sun rose over in Western Europe and in Great Britain.
And we see that that grumpiness had more steam in London. It went down, it slid downward, not hard, but it slid.
Then it stayed stable, and then there was another selling wave that brought it down even more.
It wasn't a horrible down day, but it was definitely a down day for the London Exchange and the FTSE,
which is the index of 100 big companies on it. But interestingly enough, that didn't come over here.
When the sun set over in London and rose over here, our investors were in a pretty good mood.
It was up through the day, had a good spike there, most of the markets did,
and then it just sort of drifted along waiting for some more good news.
But the optimism seemed to have let it lift up a little bit more towards the end of the day.
Looking at a couple here, just out of curiosity. Of course, my favorite whipping boy, Tesla, it had a good day, I think.
Yeah, it was up pretty nicely for the day.
Now, looking at a couple of other markets, what I want to look at here.
Oh, MRO, RMO, no, no, no, no, no, MRO, Marathon Oil.
Just look at the oil market, up a little bit, good day for oil.
And you say, well, doesn't the price of oil have to jump for those stocks? Not necessarily.
It has a lot to do with demand for what Marathon sells. It sells gasoline if demand is going up,
as we get into warmer weather in this part of the country,
and transportation is getting stabilized, delivery of goods and all that.
Yeah, it's going to show some signs. Looking at a couple more, Procter & Gamble.
Basics, look at that beta, Procter & Gamble, you probably know it, sells just basic consumer products, a lot of its businesses,
and they were up a little bit for the day, nothing big there.
Notice the beta, companies that sell basic products generally tend to be low-risk companies, and it's a profitable company as well.
Now getting over here to our meat of the day, US Steel.
This is the one that we're going to break down with a hardcore financial analysis,
one of those tedious lectures where almost everything is done in Excel.
But before we get to that fun, we do see that, just as a reminder, it's a high-risk stock.
It seems to be undervalued though, and it is a profitable stock.
Now you keep that in mind, US Steel is a profitable company.
It has positive net earnings per share, which means it has positive net earnings, and it pays a nice little dividend.
Not a huge one, but it pays a nice dividend.
So we've got everything set up for us to be able to do our financial analysis.
Now let me take you over here for a little bit.
Now again, I will upload what I do here.
Try to keep up.
I'm going to stop a few times along the way to let you catch up if I start going too fast and all that kind of stuff.
But if you come over here, files.
First things first.
In your files, you will have financial analysis formulas.
These are the ratios for ratio analysis, all of them, that I would care about.
Now there are one or two in here that aren't in your book, and I may have missed one that the book brings up.
I don't think so.
But just to make it clear to you, you can have this sheet with you for quizzes and for exams.
Don't write anything else on it because you get a note card for exams.
But these ratios.
Now truthfully, I don't care if you memorize them or not.
You've got your sheet.
If you use them enough in my business, you remember them.
But I mean, even sometimes I'll go to one of these sheets like this to look.
And there are literally dozens and dozens of ratios.
And these are kind of like the top most important of them.
And we will do these in Excel.
The key here is that it is not your calculation.
If you can put it into Excel, you'll get the right number if you put it into Excel correctly.
The action for in finance is not on the what.
It's on the why.
Why did this ratio go up or go down?
Is this a good number or is this a bad number?
Now in that regard, there are a few ratios you don't want them to be less than a certain number or more than a certain number.
That's a very bad sign.
But inside of that, aside from that, these ratios, first of all you have to compare them to the industry.
Okay, this ratio is this.
Well, what's the industry average?
Is it above the average, below the average, or at about the average?
The second thing that you have to ask yourself is what are the changes that are happening in these ratios?
That's important.
That's where the key is.
To see, okay, this is a little bit worrisome, this ratio, but it has been trending in the right direction over the past couple of years.
Okay, so that means that the management knows there's an issue and you can see the issue being addressed.
Those kinds of things are kind of important.
You also want to ask yourself some deeper questions, which I would only touch on the surface, the deeper questions.
Let me give you an example.
See this inventory turnover ratio?
What it measures is how many times a year the company has wiped out all of its inventory and brought new inventory in to replace it.
Inventory turnover ratio, at least in a theoretical kind of way.
So the whole emphasis over the past 20 years or more is get that inventory turnover ratio higher and higher.
Get the inventory in, get it out.
Bring more in, get it out.
That means smaller warehouses and all that good stuff.
You don't have to hold as much inventory.
You sell it and you've got more in to sell the next day.
Getting it up there to 10 times a year, 20 times a year.
Hell, the limit is infinite inventory turnover ratio like the Japanese do with their just-in-time system.
No inventory, therefore the denominator is zero.
They bring in parts for a car as the car that they're building needs it.
They don't keep it inventory.
Therefore the bottom denominator is zero, so sales over zero is infinity.
That's the dream.
Get that inventory ratio up there as far as possible until the lockdown.
You're selling your inventory out, getting rid of it, and then you bring more in.
Well, what happens is the supply chain breaks.
You sold your inventory.
Oh, we don't have any more.
And then that was why we didn't have toilet paper on the shelves.
That's why we didn't have some other basic products on the shelves of stores.
It was because they were keeping so little in inventory, relying on getting more the next day,
that they stocked out and they couldn't get more, and so the shelves were empty.
That was what it was all about.
Never mind the talking, talking about these deep issues and complexities.
No, it was because there was this management fantasy,
this goal of getting inventory turnover as high as possible,
which meant that you kept very little in inventory.
Your inventory numbers were low, and that was the consequence of it.
And there are other ones, too, that the questions are not, well, what are they?
Is this good or bad?
But sometimes it's a question of, is it too good to be true?
And if it's bad, what are they doing to get this problem fixed?
So in a lot of ways, the ratio analysis would go well beyond a course at this level,
but you do have to appreciate that you look at these numbers,
look at the numerators and look at the denominators.
So I could say, okay, suppose, for example, that total assets of a company fell
and net income was rising.
Well, if you look over here at ROA, return on assets, you've got net income over total assets.
So if net income is going up, but you're driving the total assets down,
ROA goes up, yay, return on assets is getting bigger and bigger.
Isn't that wonderful?
Not always.
I'll give you an example of this one.
When I was in consulting, I got into, actually, personally, professionally,
into the oil and gas industry with a wildcat group out of Texas.
And we would just punch holes in the earth and see if we could find anything in there,
and then dust ourselves off and go to the next one.
Okay, that's an interesting business.
Down in that area, there was, everyone knew everything about oil.
And one thing that I was learning was that there were the refineries that had been built,
many of them in the 60s and 70s.
There were not a lot of new refineries being built after that period.
And the refineries that existed were depreciating, okay,
both in accounting and economically.
Well, what that would mean is that oil companies,
which were making bigger and bigger profits, net income was going up,
but the total assets were going down because there was all this depreciation on the old refineries,
but there were no new assets being added for depreciation to replace them.
You follow?
So total assets were falling against rising income, so ROA was going up.
Great thing.
Wow, these oil companies are awesome.
Well, there was a problem with that.
They weren't replacing refineries.
They weren't even upgrading and fixing the old refineries.
So by the time we get to around the beginning of the 21st century, boom,
oil refineries, these old ancient beasts, were exploding, killing workers,
poisoning the communities around the refineries where the workers' families lived.
It was a nightmare, all because they didn't replace refineries with new refineries,
replace old equipment with new equipment.
And so what you had were ROAs going through the roof,
and ultimately it was a catastrophe of human proportions and not just economic proportions.
So always be cautious when a good thing looks too good.
You start asking questions.
Why is this happening?
Now, again, this is beyond the wheelhouse in this course,
but those are the issues that you begin to think about.
And so when people throw numbers at you, don't be impressed until you know how those numbers came to be.
Good lesson for everyone.
Okay, now close that.
Now, the next thing I'm going to do, show you here, if you go under files,
I've put up a new folder in files called links,
and that will have links that I mentioned in class.
So remember when we went to the Edgar system to get the U.S. Steel?
Well, look, here it is.
Here's a link to that right here.
You get the link right here.
Just click on it, and there you are, right at it.
So it's there for you 24-7.
Instead of you having to remember what I did in book markets, you can just pull it up.
Okay, so there is the Edgar company filings.
And I'm going to go back through what I did on Monday,
and I try to do this as much as I can just to reinforce, repeat something, just to reinforce it for you,
especially if it's something important, and especially if it's something important beyond just this class.
And knowing where to go for these primary sources is big for the rest of your career here
at this great university.
Okay, so here we go.
Now remember, you're here at the Edgar company filings.
Click on the company and person lookup, and you type in the trade symbol.
I said you type in the trade symbol.
I hate, hate, hate the Internet here.
Seriously, let's refresh this page.
Try it again.
There we go.
You'll get a drop down.
And the first one is the one we want, United States Steel Corp.
And you'll be, the landing page will be the one on the right, it says Selected Filings.
Now I'm saying this as I'm going along so that it's in the podcast too,
so that if you don't get it here, you'll hear it in the podcast too.
But now we want 10Ks.
This is where your Qs and Ks are.
And we'll want the most recent 10K.
And as I said last time, don't click on the text hyperlink.
Click on the little box that says Filing.
Okay, the first thing you'll do is you'll go to a screen that mostly is dominated by those documents
and image files.
Ignore those.
Up here just above center on the left is a blue button that says Interactive Data.
You click on it.
Your landing page will have something special.
Up here just above the black bordered box, you'll see View Excel Document.
And this is the truth, no matter what the company is, they all are laid out exactly the same way,
the same steps, no matter which company you want to get to.
View Excel Document, just click, and it will download.
And there is the document right there.
Now again, this is a repeat of what I did on Monday.
I'm just getting a running start, create continuity for the lecture.
Okay, first things first.
We're going to scoot documents around to set up our workspace the way we can use it more efficiently.
We're going to need the income statement.
There it is, right there.
We're also going to need the balance sheet.
Well, that's not it.
The next one over is the balance sheet.
So I'm going to click and hold it and then draw it over so that it's just on the other side of the income statement.
So those two are together.
Now you'll see why this is important here in a minute.
Now the other one we'll need is the statement of cash flows.
There it is, right there.
Nope.
There it is.
So I'm going to click and hold it and I'm going to drag that one over so that it is just to the right of the balance sheet.
Now I've got my three primary documents, three primary worksheets together.
Now the last thing that I'll do is I'm going to put in, and I usually do this between the income statement and the balance sheet,
just a little to the right of where the income statement gives way to the balance sheet.
I'm going to right click and I'm going to say insert a worksheet.
And I will call that the calculations sheet.
That will be where I do my actual calculations, my back of the envelope, my scratch work.
That's where I'll do it.
Now I'm going to do something here that you don't need to worry about.
I'm going to make all of these bigger at once.
If you want to know what I'm doing, I'm holding down the control key and clicking on the sheets that I am interested in.
Those four, the income statements, the balance works of the calculations, the balance sheet, and the statement of cash flows.
And then if you highlight all of them together, what you do to one will happen to all of them that are highlighted.
That includes actually if you highlight all of them, what you type in one will happen in the same place in the other.
So we want to not let that happen, but I am going to make these bigger so you can see it better.
Okay, so now then to get out of it, you click on a sheet that's not part of what you did.
Okay, there you go. See all of them are now bigger. You can see them all.
Okay, now down to the grinder. On Monday we did our recon, just looked at them. This time we're going to do calculations.
Now the first thing we're going to calculate is the Holy Grail, the free cash flow.
We've got a darker marker here, the free cash flow.
And believe me, the way we do it in Excel makes it a lot really straightforward.
You're going to just collect the pieces of information from the different sheets, you'll put them in the calculation sheet,
and then you'll just run the calculation. It starts with this. Revenue minus costs.
Now I'm assuming that the depreciation expense is there in the cost somewhere. It's in there.
If it's not, we don't worry too much about that.
And now we're going to take one minus the tax rate.
Now first of all, this right here should, if the financial statements are well prepared,
this is what we call EBIT or operating income. It could have either name.
So all we do is we just pick that off of the income statement and put it in our calculation sheet.
We don't have to do the revenue. No, it's all there in the operating income,
or as some companies call it, the EBIT, earnings before interest and taxes.
Now a little note about this. When income taxes were first initiated over a century ago,
and for a long time, the T, that would be the highest tax bracket that a company could have.
That T would have been 90% of their earnings.
Over the years, it fell to 70% during the Kennedy administration.
Now by today's standards, that would have been just unconscionable, the horror of all times.
But the reality is that our country was, the economy was growing robustly.
We came from basically just one of the nations of the earth to the dominant power of the earth
during that time when we had a tax rate 70%.
So don't ever let anyone tell you that this high taxes are what destroys an economy, bullshit.
We did pretty darn well under 70%. Then in the early 1980s,
the Reagan administration had got Congress to lower the top marginal tax bracket to 39%.
Okay, whatever. However, it was kind of odd about that tax rate.
39% was not what the very largest corporations paid. They paid 35%.
It was the large but somewhat smaller corporations that were hit with that 39%.
Okay, well then we got to 2017 and the Congress lowered the tax rate to a flat, not a tiered progressive,
just to a flat 21%. In other words, almost they cut the tax bracket, the top tax rate,
all tax rates down to half, almost half of what they had been from 1981 I think it was to 2016.
That 39% was gone and it's 21% now. And this is why we are running the most insane budget deficits in history.
And our national debt is accumulating at the fastest rate in history.
Fortunately, that's not my problem, it's your problem. You'll have to figure out how to pay that mess.
I'll be in my grave and you won't know where it is so you don't come there and piss on it or something,
but it's your problem, not mine. Just a little side note there.
But for our purposes, that T will be 21% for any kind of calculations.
Now one more thing, interestingly enough, here's where we begin our journey away from the accountants.
Now if you look here, we are, you get to EBIT, we don't, the accountants don't calculate tax there,
they subtract out interest expense. We don't. Why? Because we are in the business of operations.
What makes the company sell products and get revenues from them?
Interest expense and dividends and all those things, that's after we see if we've got enough money to do it.
In other words, we would worry about those after we see what operations have done for the company.
So that's the first thing is that we stop here and calculate our taxes and we jump over interest expense
because interest expense doesn't cause operations.
Do you have any bills to pay like credit cards, madam? No? Oh, fine.
Someday you will. I want to see you in debt up to your ears. This pisses me off.
No, I've never heard of debt. Good God. Okay.
Realistically though, a company, it's got to pay interest expense every time it's due or it's out of business.
So why are we ignoring it here? Well, think about it this way.
All right, guys, on the assembly line, we paid our interest expense. Everyone crank up now.
No, they don't. What the hell are you talking about?
It has nothing to do with the operating of the company, making the products, getting them on the shelves, selling the product.
It is a non-operating expense. So that is out of our wheelhouse until we get to the point where we know if we can afford to pay that or not.
So that's why we get there. Now, we have a name for this.
NoPACT. Net Operating Profit After Taxes. NoPACT.
Now, from here, we begin to do repairs. The first thing we're going to have to do is we're going to have to add back depreciation expense.
It is in here somewhere. If it's not, then you all have to subtract it out independently.
But usually companies put it in their overall costs, operating costs.
And the reason we leave it there is because it does create a tax shield.
See, I told you about the lens that I have $4,500 actually went out. But every year I subtract $900.
There was no $900 anywhere in my purchase or use of the equipment.
However, it does protect some of that revenue from getting taxed. It drops the net a little bit.
So that's why we have to leave it in there so that we can have it do its tax shield there.
But once that's happened, then we have to add it back in.
The whole thing, depreciation expense, we add it back because it wasn't a real cash flow.
And then we have to subtract a few things.
And minus, traditionally we put these two in parentheses together and add them.
The first one is capital expenditures, what you actually did spend.
Capital expenditures, what you actually spent.
And then this little bugger right here, the change in net operating working capital, Now.
Here's the side calculation. Net operating working capital is your current operating assets
minus your current operating liabilities.
Now if you're paying attention, you're going to say, wait a minute, fat boy, why didn't you put the O in either of those?
It's this.
Most of your current assets are operating. Most of your current liabilities are operating.
It's just that we kind of, current assets, we just take current assets.
It's easier to do it, we're lazy. Current liabilities are the same way.
Technically I could take out the non-operating current assets and the non-operating current liabilities,
but life is short. We're not going to do that. Don't do it yourself.
That's why you'll hear me sometimes say, I'm doing a dirty free cash flow.
Because little minor things that I really should do, I don't.
But the numbers come out very close to what they would be if I got in every tiny little detail.
Okay, so in order to get net operating working capital for a year, I take the current assets of the year
minus the current liabilities.
Now the change would be delta, N-O-W-C, would be the net operating working capital for the current year, sub-zero,
minus the net operating working capital for the previous year, sub-negative one.
And that will tell me on net, has your net operating working capital gone up or gone down
from the previous year to the current year.
That would tell us how much cash has been freed up or depleted.
If delta, N-O-W-C goes up, free cash flow is hurt, goes down.
If net operating working capital goes down, then free cash flow is helped.
See, because my net operating working capital goes up, that tells me that cash has been absorbed into your current affairs.
If net operating working capital went down, that would mean that you have freed up some capital.
Like suppose my inventories go down.
Well, that means that I didn't spend as much money as I did last year, so that's more money in my pocket.
If on the other hand current liabilities, wages payable, goes up from last year to this year,
that would mean that I'm keeping some money in my pocket that I should have paid in wages.
So that's the logic of that.
Just put it as a sidebar calculation.
It's one of those, if you've got it somewhere where you can get to it in notes or on a note card,
it's an easy question that I almost always ask somewhere on a quiz or an exam.
Sometimes I do it more than once.
At first it seems counterintuitive, but the more you do it, the more it kind of makes sense.
But anyway, here it is, the free cash flow calculation in a nutshell.
So we'll do that first so that you can see how we use Excel.
Now, a couple of things, and I think I said this in the last class.
In your professional work, you should use the keyboard and not the mouse.
I do the mouse in this class because you wouldn't be able to see what I'm doing on the keyboard.
Anyway, I still use the mouse sometimes.
I can't remember every keyboard command to get something.
Now, the second thing is, this is what you would be expected to do, just what I'm going to do here.
This would be basic stuff that you would be expected to just do in a corporate job,
to work out models, to do some financial model.
So kind of follow along and keep yourself informed about, well, can I do this on my own?
Would I be able to do this?
If the answer is yes, you should be able to say, I know Excel.
Well, at least that gives you a little more justification.
If this is fogging you, then I'll work with you for the rest of the course, getting you up to speed,
and that's why I require the certifications.
This isn't just finance.
This is any kind of corporate job where you'll be expected to use Excel from time to time.
So here we go, calculations, the worksheet.
I clicked on it, and I'm going to type up here at the top, free cash flow.
Free cash flow.
I'm going to jump down a line here to start this.
Now, what are the pieces we're going to need?
Okay, I'm going to need operating income.
I can pick that up off the income statement.
I don't have to do revenue and costs.
It'll be there for me.
It has to be.
That's required.
Free operating income or EBIT.
Okay.
Now, the next thing I'm going to need is the tax rate.
And that is always going to be 21%.
Now, you can put.21 or you can type T, 21%.
I usually do it as a percent just because it's visually more elegant to show what we would say in language.
Well, the top tax rate is.21.
Now, the top tax rate is 21%.
That's why I do it in more common language there.
Okay, what else are we going to need?
Well, that means that with those two, I can get no pat.
Then the next thing is I'll need the depreciation expense.
Below that, I'll need the capital expenditures.
And then I'm going to have to do a little bit of quick side calculation.
First, I'll need the current assets.
Well, let's do it this way.
And I'll need the current liabilities.
And from those two, I can get the net operating working capital.
And I don't abbreviate too much in here because that just makes me go faster and leaves you further behind,
especially when you go back to look.
And then from those two, I can get the change in net operating working capital.
And those all will leave us with nothing but the calculation of free cash flow.
Now, up here, I'm going to on row two, the one that I jumped, I'll put 2023, 2022, and 2021 across from B to C to D.
And I'll let you catch up here for a minute.
Okay.
Lock and load.
Operating income.
If you don't know how to do this, watch.
I'm going to say equals.
Now, operating income is going to come on the income statement.
So I say equals, then I click on the worksheet called consolidated statement of operations.
And I prowl around here.
There it is.
EBIT, they call it.
And I click on that 799 at cell B17.
And I just hit enter. And there it is.
And then I can just grab that little, whoops, grab that little, what the heck?
Why is it doing that?
Why did I change that?
What in the world is going wrong here?
Okay. Now, see that 799? I'm just going to put the cell I'm on and then just drag it over.
And it copies the previous years.
Now, NOPAT.
NOPAT will be equal to, whoa, let me do something here real quick.
In cell E, I'm going to, for you, I'm going to upload this later this evening.
In cell E3, I'm going to type where I got it.
Income statement.
And the tax rate in cell E4, given.
Okay, so now NOPAT.
NOPAT is nothing but equal to operating income times, open parenthesis,
one minus the tax rate at B4.
But I've got to be careful here.
I'm going to hit F4 right now to make that an absolute reference
so that when I drag it across, it leaves that 21% in place.
Close the parenthesis, there.
Why does it keep doing that?
Now I'm going to take this and drag it across from 2023 through 2021.
And over here in the E column, I'll write calculated.
If I try to not look at the keyboard and talk.
Okay, so there we go.
Let you catch up to me.
Now you're pretty proficient in Excel as far as getting things done,
but I do want to not run over you on this.
Now the depreciation expense, B6.
Now the best place to get this is off the statement of cash flows,
because I know it will be there.
It could be in the income statement too,
but I know it will be in the statement of cash flows.
So I'll say equals, and then I'm going to shuttle over here to the statement of cash flows.
And there it is in the statement of cash flows on cell B6, 916.
Now I'll scoot that one all the way over.
And then I'm going to type in the E column for that one, statement of cash flows.
This will help guide you back if you wonder where I got things.
Now the next one is a little bit of a, you're going to have to remember something.
The capital expenditures are going to be in the statement of cash flows.
However, they are reported there as a negative.
You don't want that because you're going to subtract them right there.
So here's how we do that.
In cell B7, capital expenditures, I'm going to say equals,
and before I run over there and grab that in the statement of cash flows,
I'm going to type ABS, open parenthesis.
In other words, take the absolute value of this.
And now I can go over to the statement of cash flows.
Now, down here, let's go to the statement of cash flows.
You go to investment, investing activities.
You see, it's a negative.
You don't want it to be a negative because you're going to subtract it.
You follow?
Now, you notice that there are other items below that.
You don't want those because those are probably non-operating expenditures.
You want that top one.
In this sheet, it would be B25.
Now, some people say, well, just take the net one at the bottom of the investing activities.
I say you probably don't want to do that.
Even if you did it, they're trivial.
They're usually, in this case, there's only one that has a positive entry.
But overall, these numbers after the big dog in B25, they're trivial.
They're not operating anyway.
So I'm just going to leave it, close my parenthesis, boom.
Now, I'm going to take that B7 and I'm going to drag it across.
I'm going to type that also.
If you're wondering how I did that, the cell you want to copy from, you just put it on that cell and hit control C.
And then you go to the cell where you want to paste it and hit control V if you want to do it fast.
Now, we've done that.
Now, current assets, well, those will be on the balance sheet.
Equals, where the hell are current assets?
Total current, come on, for heaven's sake, there they are.
6943, cell B7.
Okay, that one's done.
Current liabilities, just go over and find those.
Equals, go to the balance sheet, find your total current liabilities, which here are cell B22.
Met operating working capital is just equal to cell B8 minus cell B9.
Now, I can take those three cells, B8, B9, and B10, and I'm going to slide them over.
But I'm going to take only one over.
Why?
Here it is.
The balance sheet is only two years.
I've got only two years.
So if I slid it over another year, I'd get the error, pound symbol, and all that.
Okay, now if I wanted, I could find the December 2021 entries for the balance sheet and put those in there, but life is short.
So the change in net operating working capital for 2023, you just take cell B10 minus cell C10.
And there it is, negative 912.
So your change in net operating working capital was $912 million.
Look there.
In other words, they freed up almost a billion dollars in free cash flow.
They cut some things down that were current assets, increased some things that were current liabilities,
and the net effect was to free up cash flow for the current year, for the year just ended, I should say.
Okay, here's the holy grail, the free cash flow.
And I'll be able to do this for only one year because I have only one year of change in net operating working capital.
Equals, okay, go here, no pat.
Where the hell is, up here at cell B5.
Well, I've already done that, so plus depreciation expense, cell B6, minus open parenthesis, capital expenditures,
plus change in net operating working capital, close the parentheses.
And what will come out of there is what really happened, the real story.
And it is, survey says, negative $117 million.
In other words, they were in the hole in actual cash that they had to use to pay all of those other accounting entries.
They were in the hole $117 million.
That's not money, that's not just an abstraction.
They had to have that money.
In order to have paid those items that you saw in the rest of those financial statements, they had to have that money.
So how did that happen? Where did it come from?
Well, there are a couple of places.
The first thing is, they could dig into their retained earnings.
Now, retained earnings are one type of equity.
This is what the company has put into the bank, as it were, over the years previous.
The buildup of profits of the company are there.
That would be the first place they would reach.
That retained earnings belongs to the shareholders.
We, in fact, have a name for it.
The first place, well, they would dig retained earnings.
We call that internally generated equity.
This is the shareholders' money that was generated by its operations in the past.
So that would be the first place you would go to get the money.
Another kind of equity would be new stock.
They could sell new stock.
That would be called externally generated equity.
New owners.
Sell some stock and get the money to pay off, pay your bills.
Or they could use debt, borrow.
They could borrow to do it.
Now, a couple of interesting things.
Right away, they're in the hole $117 million.
They have got to get that because that's how they're going to pay their bills that they weren't able to pay through their operations.
That would be how they would pay other things.
Let's look over here real quick.
Let me pull up US Steel again.
They paid a dividend.
They gave their shareholders money.
In other words, that's $117 million if you look back through where the numbers came from.
Some of that is what they paid their shareholders in dividends.
Now, understand this.
If you don't pay your debt holders, they'll turn you off.
They'll take you right into bankruptcy and you have to run to a bankruptcy court to protect you from them liquidating your company.
But what can the shareholders do if you don't pay them a dividend?
All they can do is cry.
So why in the heck is US Steel paying its shareholders a dividend?
Yeah?
No, that wouldn't be it.
Let's take you.
Turns out you're my son.
I know, easy.
We're just doing a story here.
Now, every year on your birthday, I give you $10,000.
That's why you like me.
Now, this last year, I've been having problems, lost my job, and I'm getting back on my feet.
But I'm still going to give you that $10,000.
Why?
Any idea?
So you'll still like me.
Dividends are given to shareholders as a signal.
They signal we're doing okay.
Everything is fine with our company.
In fact, the Wall Street boys, if I don't pay a dividend, those Wall Street firms that have massive amounts of my stock in their portfolios, they're going to kick my ass.
They're going to sell my stock.
They're going to have a conference call with us and put the squeeze to our board of directors to get rid of upper management and to get rid of the board itself.
Yeah, I'm going to give that dividend just to keep them from getting upset.
It's part we didn't understand it for a long, long time why companies would give dividends even if they were in great trouble.
And then came along 20 years ago signaling theory, which had been around forever, and it answers the question.
It's a signal.
We're doing okay.
Don't worry.
Everything is okay.
And that's what's going on here.
US Steel is going to keep paying its dividend saying everything's good.
We're fine.
Just to keep that from happening.
Now, something much more important, let me take you back to the spreadsheet and let's have a quick look here.
Free cash flow is negative $117 million.
Now, it doesn't take a rocket scientist to figure that that's a bad thing.
Oh, but wait a minute.
Let's look at what the accountants say and what all the talking heads say.
Oh, US Steel, well, look at this.
Their net earnings are positive $895 million.
Great company.
By God, slap them on the ass.
They're doing good.
We know they're not.
That's the whole problem with accounting.
It isn't showing what really happened.
You, madam, are my daughter.
You come in wearing a nice suit, looking great, hair really good.
You put some heavy makeup over the tattoo you got because you were dating a biker named Nick.
So you had Nick on.
Okay.
But if I were to do a CT scan of you, eww.
You, I told you, you know, my doctor said if the body is a temple, you, Professor Crane, are a Baptist revival tent.
Yeah.
Inside, we know you're not doing okay.
That's what's going on here is the accounting financial statements are telling a surface story.
And we have to dig in because we are responsible for advising on investments, for preparing a company to fix the problems instead of pretending they aren't there.
That's what we do.
And that's why you'll see this company is profitable, nearly a billion dollars profit, by golly.
And we're looking at it.
No, it's not.
It's bleeding.
Bleeding $117 million in real free cash flow.
That's the whole thing.
There are many, many companies and billionaires and millionaires.
On paper, they're fantastic.
But in reality, they are a disaster.
And oftentimes, they and all of the media and all of their acolytes just keep telling them damn good.
You're great.
You're awesome.
And no one has the guts to say you are a mess.
And that's what we have to do.
That's why we are different in our world.
We have to tell the truth, not just to the investors, but to the company.
We have to speak the truth to the power.
And that's what's going on here with U.S. Steel.
So now digging in, and I'm not going to do a lot of this today.
I'll save it for Monday.
The ratio analysis.
And if you look back, did I delete that Dagon sheet?
Well, let me pull it back up.
It should be in downloads.
Yeah.
Financial analysis sheet.
Now, these ratio...
Oh, shut up.
Quit it.
Leave me alone.
Get off of me.
Okay.
Now, this sheet, these are the ones...
Almost all of these are in your textbook, too.
But here's a sheet with just these on it.
You might want to even get this made into a poster and put it up in your living room.
It's just...
Okay, maybe not.
But there are a few in here, I can think of one, that isn't in your book.
It was around for decades, but then somewhere along the way, it just fell out of favor.
Well, in the past couple of years, this ratio has begun to be really, really important.
And companies are beginning to pay attention to it.
Investment analysts are beginning to pay attention to it.
In fact, here at Illinois State, a course that went away years ago was brought back.
And they looked around and they saw me and they said, okay, you can teach us.
Well, yeah, I can.
It is about the most boring course you could ever want.
It sucks the life out of you.
It just turns you into beef jer...
No, anyway, but it's so important.
It's the cash management course.
And I've got a ratio we used to use, but we haven't used.
It's in the liquidity ratios, this burn ratio.
It's also sometimes called the cash ratio.
Matter of fact, quick ratio, you'll oftentimes hear that called the acid test.
But these two, and especially this cash ratio, suddenly, well, gee, cash is king.
If you can't survive in the short run, there ain't no long run.
So that one's in there that you won't see in the book.
And the rest of these, again, if you use them enough, you'll memorize them, as I have.
Matter of fact, sometimes you'll even see me go back to this sheet.
It's more important that you know what they're telling us, what they're saying,
what the whispers are behind those raw numbers that you see on financial statements.
So the liquidity ratios, they simply say how many times over can you pay your current assets
with your current liabilities?
So in other words, if I've got a liquidity ratio of 1.0,
I've got just enough current assets to pay my current liabilities.
If it's much above 1, well, that's one thing.
If it's much below 1, that's another thing.
Things like the asset activity ratios.
There's that inventory turnover ratio I was telling you about.
This tells you how hard your assets are working for you.
The profitability ratio is similar.
It's actually measuring in percentage what your profit margins are.
Your gross margin, your operating margin, your net margin.
Now that's important because when you're comparing two companies,
their raw numbers could be vastly different, millions versus billions.
But if we turn them into percentages, then we're comparing apples to apples.
And then we can compare a billion-dollar company with a $10 million company.
And that's the way it is with a lot of these.
I'll just go through a couple of quick ones with you to finish the day.
Okay, ratios.
Come down here.
First one, we'll do liquidity, and that's the only ones I'll do today.
A couple of those.
Now the current ratio.
The quick ratio, which is sometimes called the acid test.
And then the burn ratio, sometimes called the cash ratio.
And these are just like I did before.
All you do is go to the different sheets.
The liquidity ratio, the current ratio.
That's current assets over current liabilities.
Equals, go over here to the balance sheet.
Okay, where's current assets?
Total current assets divided by total current liabilities.
And that's about 1.76.
That means that they can overall, if they liquidated all of their current assets today,
they could pay all of their current liabilities 1.76 times over.
Now the units on these are, for these ratios, are time symbols.
Now the quick ratio is similar, but it says, yeah, but, I mean, really, you take your current assets.
Fine.
Total current assets.
But inventory, you can't liquidate that at what the accountants say.
If you had to get rid of your inventory today to generate cash, you might get 10 cents on the dollar.
So the quick ratio subtracts out the inventory.
And then takes the result and divides it by current liabilities.
Well, they can still cover 1.2122 times over their current liabilities
with their current assets that actually can be liquidated pretty quickly.
The burn ratio simply says this.
The reality is that if you had to pay all of your current liabilities today,
the only thing that you could really draw would be your cash.
So the burn ratio, the cash ratio just says, just take your darn cash and divide it by your current liabilities.
And that one is pretty low.
It's not terrible.
Now, liquidity ratios, if they are too low, the company doesn't have enough liquidity.
However, if they're too high, that would tell me that they are not using their liquid investments
to turn those into long-term higher yield investments.
If I've got money in my pocket, $1,000, well, I'm highly liquid.
But at least some of that money I could put into stocks or bonds or something like that and get a much higher return.
So those liquidity ratios, you don't want them to be through the roof because that's saying you're wasting money.
An example of this very quickly, Netflix.
Three or four years ago, they borrowed over a billion dollars and they borrowed it at a stupidly high interest rate.
Everyone would say, okay, boy, I wonder what they're going to put that into.
Well, they're at sat in their current assets as cash.
And everyone would say, what the hell?
You're paying a high interest rate on this money, on this capital, and you're putting it into your money market accounts where you earn barely anything.
It was just absolutely ridiculous from our perspective.
As it turned out, they were explaining it like this.
Look, we have to have highly liquid resources.
So if we see a new TV show that we can get into production out of the script and into the can, we need to be able to do that within a few months.
If we see the prospect of being able to take over another studio like Paramount or whatever, we need the money to be able to strike right away on that.
So that was why they were explaining that transactions motive.
They wanted all that still liquid so that they could use it quickly.
We still thought, oh, God, this is ridiculous.
Over the last few years, they've been peeling it down to more sane levels, but still.
So in other words, you're seeing how these ratios, you have to think about them both ways, too high, too low.
We'll pick it back up on Monday.
But for today, that's all I have for you.
I thank you.