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Alan Cring Productions in association with the Emergent Light 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, ratio analysis. Now there will be a few resources that I will point you to that I've put in your Canvas files folder that will give you some help and I'll show you those after we look at the numbers for the day.

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And we should be getting pretty good at this. Sir, is this a bull or a bear day?

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A bull.

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It's not a massive bull, but it's a decent bull. As you can see, the Dow is up half a percent and then as usual, the S&P 500 higher risk portfolio is up more at about.84 percent and the most riskiest is the NASDAQ, which would be up.93 percent today.

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Now that is a very typical pattern. It just represents that risk return sort of relationship and we can sort of see that almost all the time. Once in a while it's not there and sometimes we can ask why it's not working the way it normally would.

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But going on from there, now keep in mind, this would mean that investors are pulling money off the sidelines and they are buying stocks or as we say in a fancy way, they're going long equities.

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You hear me use the word long? That means we're going long. That means we're buying as opposed to selling, which is going short, but that's a little bit trickier to use that term here.

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I'll explain that later in another class. But the investors are going long. They're pulling money off the sidelines and going long equities.

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And so if we run over here and see what's happening with the bonds, what we see is the bond is just bouncing around a little bit up on the yields, which would mean that the prices are down.

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So there's a little bit of selling off in the bond market. Nothing major right now, but the bond yields are up a little bit. Only two basis points. That's hardly anything at all.

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But anyway, going back over here, we'll get some stuff, physical stuff. Crude oil, as I have said before, it seems to like that 72 to 79 trading area and it's just sort of bounced around, went up a little bit,

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but it's still near the lower end of that trading range at 73, 79. And we hope it's over the next couple of weeks, they'll be reflected in a little bit lower gas prices, but that's kind of hard to say.

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I'll talk about that again later. Now you see that gold has done hardly anything at all. It's bounced around, but it's staying pretty much flat as a pancake.

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So investors are not putting any money into the metals at all, which generally tends to indicate that there's pretty good confidence.

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Most of what's happening is happening in the stock market, which when investors are putting money into stock, that means that they're bullish, not just on those stocks, but they're bullish overall on the economy.

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And then going over here, just have a quick look, the Nikkei hardly did anything. By the end of the day there yesterday, which was last night, our time, it was down a little bit.

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You can see there was a drop, the bears, but then the bulls came right back and put it near where it started.

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By the end of the day it was a little bit down, but nothing hardly at all that you could talk about.

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And then London had a day that just sort of trickled downward, just minor bad news through the day, and that just kept pushing the stocks down and down and down.

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If you look ahead, I think there are, no, they may still, they're still maybe trading, I don't know. But as you can see, that did not come over to our side of the world.

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We started out up and we had a little bit of a lull there, but in the last hour or so the bulls have picked up speed and they're pushing up again on equities.

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Well, decent day. Looking at a few just to see what's happening here and there in the world.

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My favorite whipping boy, Tesla, should be up a little bit today. Yeah, it's up actually pretty good today.

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And moving over to, what else would be worth looking at today? One of the technology stocks, AMD.

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Oh, it's up decent today too. Now, the one problem is getting involved in these stocks, you're buying, you're putting a pretty good chunk of change into buying even one share.

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That's the price of a share over $170. And so these are those kinds of stocks that are maybe not the ones that you want to put your money into.

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Although these days you can buy fractional shares of stocks if you want to. I think there's still a little bit of a fee for fractional shares.

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But you could do it, if you had $50 you could buy about a third of a share if you wanted to do that.

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But there are cheaper stocks that you can go into if you want to buy whole shares of stocks.

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There are a lot of stocks out there that are good price. For example, I could look at Verizon.

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Down a little bit today, but that's more in the price range that you might consider to be something you could afford.

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Marathon Oil, MRO, $22. So there's plenty out there. Now, how much? Oh, stop it.

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Now, it depends on, you're trying to make a nice round portfolio, a nice well-balanced portfolio.

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You buy in the single share of one stock, it's not a good idea.

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But if you're doing that so that you can accumulate different stocks over a period of time and you're doing it one stock at a time, well then, that's not so bad.

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Let's look over here. Today we are going to be talking about U.S. Steel.

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And I'm going to show you the links how you can get to the financial statements.

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And at the end of the day, I'm going to upload the U.S. Steel, what I've done, to your spreadsheets folder in Canvas, in File, in Canvas,

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so that you can bring that, download that one if you didn't keep up or check it against the one that you're doing.

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I strongly recommend that you do this with me as we go along and make, if you can, make some notes about why I'm doing things as I'm doing them,

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why I'm arranging my calculations in certain ways and all that.

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But look at U.S. Steel right off the bat. We can see that it's, as we said on, saw on Monday, it's a risky stock.

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Probably somewhat undervalued. It's profitable, pays a dividend.

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Okay, those are all good signs. It means that, well, the risk is a little bit scary there.

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But overall, it's not a bad place. Now let me show you something here.

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In Canvas, this is your view of Canvas when you go in.

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In Files, there are a couple of things I want to show you here.

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First things first, this, we're going to be doing financial ratios here and today, and I'll spill this a little on Monday too, I suppose.

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Well, where the heck is it? Oh, financial, huh, where are the financial analysis ratios? Is that it?

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I can't, oh, I see, it's not, is that it? No. Huh, it's not showing. Well, I didn't, oh, well, anyway, links.

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This one is the one that we want to start with anyway. I'll have to upload that and I'll send out an announcement that I've gotten it uploaded.

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This is that site that I showed you earlier, that the SEC, this is how you link right over to the Edgar Filings filings.

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And you might even want to put that as a bookmark because we'll be using that on a number of occasions through the rest of the semester.

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But you're right there where you can get to your financial statements.

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And again, I'm repeating what I did on Monday. You put in the ticker symbol of the company you want.

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You'll get a drop-down menu and you'll choose the one that's what you're looking for and it's usually the one right at the top, United States Steel Corp.

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Now from there, you've got these different forms the company files. You click on the plus sign by the 10K.

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And then from there, don't click on the text hyperlink, click on the little box that says filing for that 10K right there.

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Now you click on the filing and we're not going to go through all these paperwork.

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We're just going to go over on the landing page on the left, just a little above center, there's a big, there's a blue button that says interactive data.

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Click on that.

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And from there, mercifully, we will get to this hyperlink that says view Excel document.

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Now that's right on the left side, just a little above center, and it's above the bounded black box.

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It says view Excel document and that will download your Excel financial statements for U.S. Steel Corporation.

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And there they are. All there for you.

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And this is what I did on Monday. I'm just getting a running start here so that you see everything as it happens.

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Now a couple of things. The first thing you're going to do, you want to get the sheets that are what you need all together, one after the other.

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Now we've got the consolidated statement of operations. That's a fancy name for the income statement.

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So we'll leave that where it is. Now we're going to try to find the balance sheet. That's not it. There it is, consolidated balance sheet.

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Now you click and hold it and then you can bring it over so that it's sitting right next to your income statement.

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You'll see especially why this is important as I go on today.

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Now we're going to find the statement of cash flows. There it is.

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So now I'm going to click and hold that one and get that over there next to my balance sheet, just to the right of it.

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See that little arrow that tells you you're going to land it? And there they all are.

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Now I'm going to do something here. You don't need to know how to do this. But if I hold down the control key, I'll highlight the worksheets that I want.

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And I'm going to, if you highlight more than one sheet, whatever you do to any one of those sheets, you do it to all of them.

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So I'm just going to make them a little bigger so you can see them better.

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And then you click somewhere else on another worksheet and they'll unhighlight.

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And this is the part where this is essentially you're learning how to use a modern calculator, step by step.

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And again, as I said in the last lecture, you should be using your keyboard and not your mouse to execute, to do things.

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But because this is a teaching environment, you wouldn't be able to see me doing the keystrokes to do things. So that's why I use the mouse.

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And partly also because I can't remember all the keystrokes myself anymore.

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Okay, now one thing that you're probably going to want to do. Oops, I didn't mean to do that.

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Right here, usually I do it between the income statement and the balance sheet. Just a little bit to the right of where the income statement moves over to the balance sheet.

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I'm going to right click. I'm going to insert a worksheet.

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And I'm going to call that worksheet calculations.

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This is your scratch sheet. This is where you actually do the stuff that you have this Excel sheet loaded to do.

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As I said in finance, the financial statements themselves really aren't our final product.

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It's what we do with them and then what we interpret what we have done with them.

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That's what matters here. So I got to expand this sheet.

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Okay, so here we go. I'm just going to take you through the meat grinder with some of the things that we do.

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The first one that we're going to do is calculate. Now this is a dirty calculation.

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You can do it much more sophisticated with a lot more calculations.

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But the truth be told, I mean, I do it this way unless I really want something unusual.

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Here is how you calculate free cash flow. Free cash flow.

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Now the first thing you're going to do is you're going to take revenues minus costs.

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Now one thing you want to make sure is that those costs include depreciation.

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Like I said, some companies don't tell you whether it includes it or not, but we're hoping it will.

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Now on your financial statement itself, on the income statement, this should be called Earnings Before Interest in Taxes or Operating Income.

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So we don't actually have to do those numbers. We should be able to pull that mess right off the financial statement as one number, I hope, I think.

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Okay, so then we're going to take that times one minus the tax rate.

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A quick side note. This number right here.

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Over many, many decades, that top marginal tax bracket has changed. It started out as 90% over a century ago when taxes first started being collected.

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It went down in the, I think it was during the Kennedy administration in the early 60s, it went down to 70%.

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Then in the early 1980s, during the Reagan administration, it was brought all the way down to the top bracket being 39%.

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Republican administration cut taxes and all that.

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Interestingly enough though, just as a slight side warning, the actual tax rate by statute, by law or whatever, is for the largest companies possible,

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isn't 39%, wasn't 39%, it was a little lower, and I believe it was 35%. The 39%, oddly enough, applied to companies that weren't quite the biggest.

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That was just kind of an odd thing. There's all kinds of excuses you can find for why it was that way.

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But we traditionally, most of the time that I taught, you just use a.39 there, one minus.39.

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Then, however, in 2017, the top marginal tax bracket was dropped all the way down to 21%, almost cut in half the tax rate for corporations.

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Hence why we are running insane budget deficits and the national debt is accumulating now at a staggering rate.

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We essentially cut off one of the most important arteries for tax revenues into the federal government by half.

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And that will be your problem to figure out how to make that up in the decades to come.

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It will have to be made up, but that's your problem.

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I'll be in my grave and you won't know where it is, so you won't come there and piss on it.

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You've got all the problems we've left you.

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But anyway, what you use, unless you're told differently, that T would be a.21.

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Okay, now, we have something here.

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This revenue minus cost quantity times the quantity one minus T is called NOPAT.

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The Net Operating Profit After Taxes.

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NOPAT.

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Okay, so that is the first thing you do.

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Now, with Excel, this is a joke.

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And you'll see why I arrange the sheets the way I do, so that you can do these calculations just really rapidly.

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It's really not hard at all.

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You just have to know where to find each thing scrambling around a little bit.

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But you don't even have to type in any numbers.

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Pretty much, you don't have to type in any numbers.

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Okay, now, this animal right here.

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You'll notice on an income statement, you would have an intermediate line, the interest expense.

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And we don't use that in finance because what we care about is operating.

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Interest expense is not an operating expense.

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It's not something that makes the product happen.

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So interest expense is not something that we care about.

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That will be something that we consider once we've seen the free cash flow.

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We'll say, well, can they afford their interest payments and all that?

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Can they afford a dividend? Can they do this?

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It's not part of the operation, the blood that makes the company alive.

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So we don't put that in there.

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We jump right from operating income right down to taking out the taxes with that T there and getting what we want, which is called NOPAT.

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We're not finished, though.

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The next thing we'll have to do here is we're going to have to add back in the depreciation expense.

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It was taken out here, but we don't want to fix it there because it actually reduces how much we pay in taxes.

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It's called a tax shield.

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Okay, so but we have to add it back in because it really didn't happen.

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There wasn't any check written to depreciation expense.

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It's just that over here it protects us from a little, it protects our revenue from a little taxes.

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Okay, so now the next thing we're going to have to do, and then we're going to minus.

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Now make sure that you put this in parenthesis.

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There are two last pieces, and these two can be, one of them can be a whopper.

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The other one can be pretty noticeable.

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The first one is the capital expenditures of the company, the capital expenditures.

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Now I'm going to have to say something about this.

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There's something you have to remember and put this somewhere in Excel.

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You have to do something with the financial statements, a little thing.

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And then there's one more, plus the change in net operating working capital.

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This looks more complicated than it actually is.

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Excel makes this pretty straightforward.

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Let me explain net operating working capital.

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This is a change in net operating working capital.

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Now first of all, net operating working capital is your current operating assets

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minus your current operating liabilities.

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You're saying, well William, why didn't you put the O in those?

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It's because of this.

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Almost everything that will be in current assets, in current liabilities on that financial statement will be operating.

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If there's something that's not, it's going to be probably pretty trivial.

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So we just do current assets minus current liabilities.

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That's net operating working capital.

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You notice that if current liabilities are more than current assets, this will be negative.

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If current assets are bigger than current liabilities, it will be positive.

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So the change in net operating working capital is the current net operating working capital,

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Nowc sub-zero, minus the last periods, net operating working capital, Nowc sub-1.

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You'll see how to do this.

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I'm going to give you a moment to catch up.

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I can't emphasize this enough.

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This used to be kind of a pain in the butt, getting each of the numbers written down

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and then taking out the calculator and doing this, that, and the other thing.

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Now it's just knowing where to call the different numbers.

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And that's why I have this nice calculation sheet here.

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Now if I do go too fast, just shoot me with a tranquilizer dart and I'll slow down.

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I'm trying to give you enough time so that you can absorb this.

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But remember, we're still doing really lightweight Excel here.

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It might look a little sophisticated, but it's just basic Excel stuff.

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00:25:20,000 --> 00:25:23,000
Okay, so here we go.

189
00:25:23,000 --> 00:25:29,000
Now, I'm going to put a little title here at the top of this.

190
00:25:29,000 --> 00:25:33,000
Free cash flow.

191
00:25:33,000 --> 00:25:36,000
Okay, here we go.

192
00:25:36,000 --> 00:25:45,000
Now, I'm going to do a couple of years here.

193
00:25:45,000 --> 00:25:51,000
Let me check something here real quick.

194
00:25:51,000 --> 00:25:57,000
Okay, I'm going to do 2023.

195
00:25:57,000 --> 00:26:04,000
I'm going to put this on row three, starting in column B, 2023,

196
00:26:04,000 --> 00:26:17,000
and then in column C, 2022, and then in column D, 2021.

197
00:26:17,000 --> 00:26:25,000
Now, we're going to start doing some, we're going to build the model, as we say.

198
00:26:25,000 --> 00:26:35,000
So we're going to need a few things along the way here.

199
00:26:35,000 --> 00:26:43,000
Now, the first thing, if you look here, I need revenue minus costs.

200
00:26:43,000 --> 00:26:45,000
That's nothing but operating income.

201
00:26:45,000 --> 00:26:52,000
So operating income.

202
00:26:52,000 --> 00:26:55,000
I'm just going to go over here and grab it.

203
00:26:55,000 --> 00:26:59,000
I put operating income in cell A5.

204
00:26:59,000 --> 00:27:05,000
In cell B5, I'm going to do the core calculation, equals.

205
00:27:05,000 --> 00:27:07,000
And then I'm going to go here.

206
00:27:07,000 --> 00:27:10,000
This stuff is on the income statement.

207
00:27:10,000 --> 00:27:13,000
And I'm going to say, okay, where's operating income?

208
00:27:13,000 --> 00:27:14,000
It's EBIT.

209
00:27:14,000 --> 00:27:15,000
They call it EBIT.

210
00:27:15,000 --> 00:27:17,000
Right there it is, $7.99.

211
00:27:17,000 --> 00:27:21,000
I'm going to click on it.

212
00:27:21,000 --> 00:27:24,000
There you go.

213
00:27:24,000 --> 00:27:35,000
Now, the tax rate is 21%.

214
00:27:35,000 --> 00:27:40,000
You can either put.21 or 21%.

215
00:27:40,000 --> 00:27:47,000
I put the 21% because it's visually a little more elegant.

216
00:27:47,000 --> 00:27:52,000
Okay, so, NOPAT.

217
00:27:52,000 --> 00:28:02,000
Well, it says NOPAT is operating income equals operating income times,

218
00:28:02,000 --> 00:28:06,000
open parenthesis, 1 minus the tax rate.

219
00:28:06,000 --> 00:28:09,000
Close the parenthesis.

220
00:28:09,000 --> 00:28:14,000
And there's your dinner, 631.21.

221
00:28:14,000 --> 00:28:21,000
Now, I'm going to take that and drag it over my ass.

222
00:28:21,000 --> 00:28:23,000
Oh, see what I did?

223
00:28:23,000 --> 00:28:27,000
I forgot to make the 21% an absolute reference.

224
00:28:27,000 --> 00:28:34,000
So I'll put it on the B6 and hit F4 and it's an absolute.

225
00:28:34,000 --> 00:28:35,000
Okay.

226
00:28:35,000 --> 00:28:37,000
Oh, I have to skid this one over too.

227
00:28:37,000 --> 00:28:39,000
Sorry about that.

228
00:28:39,000 --> 00:28:43,000
Not paying attention at all.

229
00:28:43,000 --> 00:28:44,000
Skid this one over.

230
00:28:44,000 --> 00:28:47,000
There you go.

231
00:28:47,000 --> 00:28:54,000
So we got NOPAT for the three years.

232
00:28:54,000 --> 00:29:03,000
Now, the next thing we're going to have to do is get the depreciation expense.

233
00:29:03,000 --> 00:29:09,000
Depreciation expense.

234
00:29:09,000 --> 00:29:12,000
And we'll go over equals.

235
00:29:12,000 --> 00:29:16,000
And that one, now if it's not on the income statement,

236
00:29:16,000 --> 00:29:22,000
the best place to get the depreciation expense is from the statement of cash flows.

237
00:29:22,000 --> 00:29:24,000
Because it's right there near the top.

238
00:29:24,000 --> 00:29:29,000
You see it?

239
00:29:29,000 --> 00:29:34,000
And then hit Enter, 916.

240
00:29:34,000 --> 00:29:42,000
Now, what I'm doing here is I am writing formulas that call references.

241
00:29:42,000 --> 00:29:45,000
That's why I put those sheets so close to each other.

242
00:29:45,000 --> 00:29:48,000
So I can jump between them and pull numbers from them

243
00:29:48,000 --> 00:29:52,000
without running around looking for where the heck it is.

244
00:29:52,000 --> 00:29:57,000
I could even drag that one over.

245
00:29:57,000 --> 00:29:58,000
Is that real?

246
00:29:58,000 --> 00:30:00,000
Is that right?

247
00:30:00,000 --> 00:30:04,000
Huh, it was the same for two years.

248
00:30:04,000 --> 00:30:06,000
Okay, so that's done.

249
00:30:06,000 --> 00:30:08,000
Now, what else do we need?

250
00:30:08,000 --> 00:30:14,000
Now, here's the one where you have to be careful.

251
00:30:14,000 --> 00:30:22,000
Capital expenditures.

252
00:30:22,000 --> 00:30:26,000
Now, the capital expenditures, now let me do something here.

253
00:30:26,000 --> 00:30:27,000
Hang on here.

254
00:30:27,000 --> 00:30:33,000
I want to go up here and do something real quick just for your benefit.

255
00:30:33,000 --> 00:30:48,000
I'm going to type here where I got these.

256
00:30:48,000 --> 00:31:11,000
Oh, there it is.

257
00:31:11,000 --> 00:31:21,000
Catch up with me.

258
00:31:21,000 --> 00:31:24,000
Capital expenditures.

259
00:31:24,000 --> 00:31:26,000
I want you to look here for a minute.

260
00:31:26,000 --> 00:31:35,000
You will find capital expenditures under investing activities right here.

261
00:31:35,000 --> 00:31:41,000
Now, you'll notice that there could be other numbers in here.

262
00:31:41,000 --> 00:31:48,000
And some would argue you use the net from investing activities.

263
00:31:48,000 --> 00:31:54,000
But that's not really a good idea because some of those are not operating.

264
00:31:54,000 --> 00:31:57,000
The capital expenditures is definitely operating.

265
00:31:57,000 --> 00:32:02,000
Whatever is under it is probably pretty small anyway.

266
00:32:02,000 --> 00:32:05,000
And it's probably not operating.

267
00:32:05,000 --> 00:32:11,000
It was some financial thing or some investment in another company or something like that.

268
00:32:11,000 --> 00:32:17,000
So now, however, you have to watch out for something here.

269
00:32:17,000 --> 00:32:23,000
This number is put in as a negative in the accounting.

270
00:32:23,000 --> 00:32:25,000
It always will be.

271
00:32:25,000 --> 00:32:30,000
But you don't want that because you're going to subtract it anyway.

272
00:32:30,000 --> 00:32:33,000
So that would mess up your calculation.

273
00:32:33,000 --> 00:32:39,000
So the way we deal with this is with now all these calculations.

274
00:32:39,000 --> 00:32:47,000
I'm going to key in equals and I'm going to type ABS open parenthesis.

275
00:32:47,000 --> 00:32:55,000
That means take the absolute value of what you have in the sheet.

276
00:32:55,000 --> 00:33:01,000
And then I'll go over here and I'll get that capital expenditure,

277
00:33:01,000 --> 00:33:05,000
which is right there, 2576, negative.

278
00:33:05,000 --> 00:33:09,000
Click on it, close the parenthesis and hit enter.

279
00:33:09,000 --> 00:33:17,000
See how it brings it up into the calculation sheet as a positive?

280
00:33:17,000 --> 00:33:22,000
That is the only place you have to remember to do that.

281
00:33:22,000 --> 00:33:28,000
If I'm thinking correctly, there is no other place where you'll run into that little issue.

282
00:33:28,000 --> 00:33:36,000
Now, scoot these over and you'll get all three years of them.

283
00:33:36,000 --> 00:33:47,000
And again, that came from the statement of cash flows.

284
00:33:47,000 --> 00:33:55,000
Now, we're going to have to do a side calculation here.

285
00:33:55,000 --> 00:34:08,000
We're going to get the current assets,

286
00:34:08,000 --> 00:34:22,000
the current liabilities.

287
00:34:22,000 --> 00:34:27,000
Let's try this again. There you go.

288
00:34:27,000 --> 00:34:55,000
And then we're going to get from that the net operating working capital.

289
00:34:55,000 --> 00:34:59,000
So I'm going to get the current assets.

290
00:34:59,000 --> 00:35:07,000
I'm going too fast. Get that in there.

291
00:35:07,000 --> 00:35:15,000
For almost all of you, this is going to just be routine stuff in your lives in business.

292
00:35:15,000 --> 00:35:24,000
Is creating these models, adding stuff to them, interpreting them, all that.

293
00:35:24,000 --> 00:35:27,000
This is just the normal stuff.

294
00:35:27,000 --> 00:35:34,000
And yes, I do recognize that for some of you, this is probably kind of boring,

295
00:35:34,000 --> 00:35:38,000
but it gets to be pretty quick once you're good at Excel.

296
00:35:38,000 --> 00:35:40,000
Okay, so the current assets equals.

297
00:35:40,000 --> 00:35:43,000
We always get those off the balance sheet.

298
00:35:43,000 --> 00:35:57,000
We get their current assets right here, and the current liabilities right here.

299
00:35:57,000 --> 00:35:59,000
Where the heck are the current liabilities?

300
00:35:59,000 --> 00:36:04,000
Oh, there they are.

301
00:36:04,000 --> 00:36:19,000
Okay, and then let me put over here that you get those from the balance sheet.

302
00:36:19,000 --> 00:36:30,000
Try that again.

303
00:36:30,000 --> 00:36:34,000
And if you don't know how I did that, put it on the one you want to copy,

304
00:36:34,000 --> 00:36:40,000
Control C, then put it where you want it to copy to, where you want to paste it,

305
00:36:40,000 --> 00:36:44,000
Control V.

306
00:36:44,000 --> 00:36:50,000
Okay, so the net operating working capital will equal the current assets

307
00:36:50,000 --> 00:37:07,000
minus the current liabilities.

308
00:37:07,000 --> 00:37:19,000
And then you want to take these three, and you're going to copy them over.

309
00:37:19,000 --> 00:37:24,000
You notice that I didn't copy them over to 2021?

310
00:37:24,000 --> 00:37:26,000
The reason is this.

311
00:37:26,000 --> 00:37:31,000
The balance sheet we're working with had only two years.

312
00:37:31,000 --> 00:37:36,000
I'd do it another year, and I'd have an error.

313
00:37:36,000 --> 00:37:45,000
Now, if I were doing this on my own, I'd go and grab that third year, that 2021,

314
00:37:45,000 --> 00:37:48,000
and fill that, the balance sheet in with that.

315
00:37:48,000 --> 00:37:55,000
But for us, I'm not worried about it.

316
00:37:55,000 --> 00:38:09,000
Now, I'll put here calculated.

317
00:38:09,000 --> 00:38:15,000
And what's the name?

318
00:38:15,000 --> 00:38:31,000
And so finally, we can put in the change in net operating working capital,

319
00:38:31,000 --> 00:38:38,000
which will be the net operating capital in the current year

320
00:38:38,000 --> 00:38:43,000
minus the net operating capital one year back.

321
00:38:43,000 --> 00:38:55,000
And you can see that the overall change was negative $912 million.

322
00:38:55,000 --> 00:39:00,000
It's negative, the change.

323
00:39:00,000 --> 00:39:06,000
So in terms of net operating working capital,

324
00:39:06,000 --> 00:39:09,000
did it change for the positive or for the negative?

325
00:39:09,000 --> 00:39:14,000
Did it change for the good of free cash flow or for the bad?

326
00:39:14,000 --> 00:39:15,000
Negative.

327
00:39:15,000 --> 00:39:16,000
You said negative.

328
00:39:16,000 --> 00:39:17,000
You're cheating.

329
00:39:17,000 --> 00:39:22,000
Did it change for the good or for the bad?

330
00:39:22,000 --> 00:39:24,000
For the bad.

331
00:39:24,000 --> 00:39:26,000
I knew you were going to say that.

332
00:39:26,000 --> 00:39:30,000
You were afraid to, but no, it was for the good.

333
00:39:30,000 --> 00:39:34,000
Because net operating working capital went down.

334
00:39:34,000 --> 00:39:39,000
So the net effect of current assets, accounts receivable,

335
00:39:39,000 --> 00:39:45,000
inventories against wages payable, accruals, things like that,

336
00:39:45,000 --> 00:39:49,000
was actually that net operating capital went down.

337
00:39:49,000 --> 00:39:51,000
That freed up.

338
00:39:51,000 --> 00:39:54,000
It's not tied into accounts receivable.

339
00:39:54,000 --> 00:39:57,000
It's not tied to accounts to inventories.

340
00:39:57,000 --> 00:40:04,000
It's actually going down, opens up cash.

341
00:40:04,000 --> 00:40:11,000
Last year, you owed at the end of the year $5,000.

342
00:40:11,000 --> 00:40:12,000
I know, right?

343
00:40:12,000 --> 00:40:18,000
But this year, you owed $8,000 at the end of this year.

344
00:40:18,000 --> 00:40:25,000
No better, because you didn't pay some of your bills, you scoundrel.

345
00:40:25,000 --> 00:40:28,000
You kept some of your money in your pocket.

346
00:40:28,000 --> 00:40:31,000
I did get $2 in the mail the other day.

347
00:40:31,000 --> 00:40:32,000
Wait, what?

348
00:40:32,000 --> 00:40:33,000
Where?

349
00:40:33,000 --> 00:40:34,000
What?

350
00:40:34,000 --> 00:40:35,000
I don't know why.

351
00:40:35,000 --> 00:40:38,000
I just got $2 in the mail.

352
00:40:38,000 --> 00:40:42,000
Dude, what exactly are you doing on this side hustle?

353
00:40:42,000 --> 00:40:50,000
Me, you know, I do mail escort, but that's just me.

354
00:40:50,000 --> 00:40:52,000
I don't make any money at it.

355
00:40:52,000 --> 00:40:53,000
God knows why.

356
00:40:53,000 --> 00:40:56,000
It will go to hell.

357
00:40:56,000 --> 00:41:02,000
But you understand that when your change is negative,

358
00:41:02,000 --> 00:41:15,000
that means that you didn't use some of your money that you had used the year before on net.

359
00:41:15,000 --> 00:41:17,000
So if I...

360
00:41:17,000 --> 00:41:19,000
Let me give you a good example.

361
00:41:19,000 --> 00:41:25,000
Last year, my inventory was about $12,000.

362
00:41:25,000 --> 00:41:30,000
But this year, it was only about $9,000.

363
00:41:30,000 --> 00:41:39,000
What that meant was that I made money off selling some of my stuff, but I didn't replace it.

364
00:41:39,000 --> 00:41:42,000
So I actually freed up money by doing that.

365
00:41:42,000 --> 00:41:45,000
It takes a while to get this in your mind.

366
00:41:45,000 --> 00:41:49,000
God knows I still get confused, but I'm going to copy this over one.

367
00:41:49,000 --> 00:41:53,000
No, I can't because it would have used that year, so I'm stuck here.

368
00:41:53,000 --> 00:41:59,000
Okay, now, end of the game.

369
00:41:59,000 --> 00:42:00,000
We got all the numbers.

370
00:42:00,000 --> 00:42:03,000
Now we can just use the formula.

371
00:42:03,000 --> 00:42:10,000
Oh, let me write this here.

372
00:42:10,000 --> 00:42:13,000
Free cash flow.

373
00:42:13,000 --> 00:42:18,000
This is our holy grail.

374
00:42:18,000 --> 00:42:24,000
This is what we consider not profit.

375
00:42:24,000 --> 00:42:28,000
This is the number that we are looking for.

376
00:42:28,000 --> 00:42:31,000
And it's...

377
00:42:31,000 --> 00:42:41,000
Before I even calculate it, I will tell you that this is actually a number that has to be there.

378
00:42:41,000 --> 00:42:50,000
If it's positive, that means actual cash was left over from all of our operations.

379
00:42:50,000 --> 00:42:58,000
If it's negative, that means that we had to find that cash somewhere to cover our operations.

380
00:42:58,000 --> 00:43:00,000
It had to happen.

381
00:43:00,000 --> 00:43:03,000
This is real money in this one.

382
00:43:03,000 --> 00:43:12,000
So we're going to say free cash flow on cell B14 equals following the formula, we need no pat.

383
00:43:12,000 --> 00:43:14,000
That's right there.

384
00:43:14,000 --> 00:43:20,000
And then we have to add back the depreciation expense right there.

385
00:43:20,000 --> 00:43:32,000
And then we have to subtract, open parenthesis, the capital expenditures plus the change in net operating working capital.

386
00:43:32,000 --> 00:43:36,000
And then we close the parenthesis.

387
00:43:36,000 --> 00:43:40,000
That is all there is.

388
00:43:40,000 --> 00:43:44,000
You see all that legwork I did up there, setting it all up?

389
00:43:44,000 --> 00:43:47,000
That is very common.

390
00:43:47,000 --> 00:43:59,000
You get everything into place, and then the end is just bringing together all the pieces of information that you brought in.

391
00:43:59,000 --> 00:44:02,000
Okay, so I'm going to hit this.

392
00:44:02,000 --> 00:44:05,000
Ouch.

393
00:44:05,000 --> 00:44:10,000
Real negative, if I did my calculations right.

394
00:44:10,000 --> 00:44:14,000
Negative 117 million.

395
00:44:14,000 --> 00:44:18,000
Now again, that's not an abstract number.

396
00:44:18,000 --> 00:44:23,000
The company had to get that.

397
00:44:23,000 --> 00:44:28,000
117 million dollars from somewhere.

398
00:44:28,000 --> 00:44:31,000
It had to.

399
00:44:31,000 --> 00:44:39,000
Because the rest of the accounting numbers said this was spent in real life.

400
00:44:39,000 --> 00:44:47,000
Once we fixed them up and took in things and put things out, the financial statements are saying this happened.

401
00:44:47,000 --> 00:44:49,000
So how did it happen?

402
00:44:49,000 --> 00:44:53,000
They're in the hole, 117 million dollars.

403
00:44:53,000 --> 00:44:58,000
Now let's try it this way.

404
00:44:58,000 --> 00:45:01,000
I'm trying to find someone.

405
00:45:01,000 --> 00:45:04,000
Okay, madam, you.

406
00:45:04,000 --> 00:45:09,000
You have to bring 117 million dollars together.

407
00:45:09,000 --> 00:45:13,000
How are you going to do that?

408
00:45:13,000 --> 00:45:15,000
You look in your pocket.

409
00:45:15,000 --> 00:45:18,000
It's not there.

410
00:45:18,000 --> 00:45:25,000
So what happens? What are you going to do?

411
00:45:25,000 --> 00:45:28,000
Well, yeah, I'll call the parents, you know.

412
00:45:28,000 --> 00:45:38,000
I got some friends up in Chicago who can lend you money, but their collection terms are rather aggressive.

413
00:45:38,000 --> 00:45:43,000
Okay, first place that the company would go is to its retained earnings.

414
00:45:43,000 --> 00:45:45,000
The real version.

415
00:45:45,000 --> 00:45:48,000
In other words, it would go to its long-term.

416
00:45:48,000 --> 00:45:51,000
What did it accumulate in bank accounts?

417
00:45:51,000 --> 00:45:55,000
In its money markets, in its long-term investments, whatever.

418
00:45:55,000 --> 00:45:57,000
It would dig there.

419
00:45:57,000 --> 00:46:02,000
In other words, it would pull what we call internally generated equity.

420
00:46:02,000 --> 00:46:07,000
It would pull out from where it had over many, many years.

421
00:46:07,000 --> 00:46:09,000
U.S. Steel is an ancient company.

422
00:46:09,000 --> 00:46:13,000
It's built up money in, well, capital.

423
00:46:13,000 --> 00:46:18,000
It's built up into investments and into bank accounts, checking accounts, whatever.

424
00:46:18,000 --> 00:46:24,000
That would be the first place it would go to see what to do.

425
00:46:24,000 --> 00:46:30,000
And then the next thing that it would do is it would go to the capital markets.

426
00:46:30,000 --> 00:46:34,000
It could issue bonds, borrow the money.

427
00:46:34,000 --> 00:46:38,000
It could issue stock and bring in new owners.

428
00:46:38,000 --> 00:46:41,000
Those are all places where it can bring in.

429
00:46:41,000 --> 00:46:44,000
It issues new debt.

430
00:46:44,000 --> 00:46:51,000
We will see that in the long-term liability section.

431
00:46:51,000 --> 00:46:59,000
Now, if it draws from its retained earnings, we call that internally generated equity.

432
00:46:59,000 --> 00:47:04,000
In other words, it was earned for the shareholders through its operations.

433
00:47:04,000 --> 00:47:10,000
If it goes and brings in new stockholders by selling them stock,

434
00:47:10,000 --> 00:47:13,000
that's called externally generated equity.

435
00:47:13,000 --> 00:47:19,000
So equity, it can draw from what it has already earned for the shareholders

436
00:47:19,000 --> 00:47:22,000
or it can bring in new shareholders.

437
00:47:22,000 --> 00:47:23,000
That's externally generated.

438
00:47:23,000 --> 00:47:26,000
I'll get into that a little later, but as I've told you before,

439
00:47:26,000 --> 00:47:32,000
I pass through things, try to bring them up informally before I do them formally.

440
00:47:32,000 --> 00:47:34,000
So don't sweat too much about that right now.

441
00:47:34,000 --> 00:47:42,000
But one way or the other, it had to get that $117 million from somewhere

442
00:47:42,000 --> 00:47:46,000
because otherwise it can't...

443
00:47:46,000 --> 00:47:50,000
Okay, look at this $117 million.

444
00:47:50,000 --> 00:47:56,000
There are a couple places where it can't just ignore that.

445
00:47:56,000 --> 00:48:02,000
One thing that's clear, it would have to pay its wages and salaries.

446
00:48:02,000 --> 00:48:05,000
Another thing is clear, it would have to pay its interest expense

447
00:48:05,000 --> 00:48:07,000
because if it doesn't pay its interest expense,

448
00:48:07,000 --> 00:48:13,000
then the debt holders simply liquidate the corporation.

449
00:48:13,000 --> 00:48:15,000
So it's got to get that money together.

450
00:48:15,000 --> 00:48:17,000
It's got to get it together.

451
00:48:17,000 --> 00:48:19,000
And I want you to notice something.

452
00:48:19,000 --> 00:48:30,000
I'm going to come back over here just for a second to Yahoo.

453
00:48:30,000 --> 00:48:32,000
Here's something interesting too.

454
00:48:32,000 --> 00:48:40,000
Let me go back to U.S. Steel here just for one quick little notice.

455
00:48:40,000 --> 00:48:48,000
Do you see that U.S. Steel paid a dividend to its shareholders?

456
00:48:48,000 --> 00:48:54,000
Well, that would have had to come from somewhere too.

457
00:48:54,000 --> 00:48:55,000
Now, why...

458
00:48:55,000 --> 00:48:59,000
Now, remember, if you don't pay your debt holders what you owe them,

459
00:48:59,000 --> 00:49:03,000
interest and principal and all that, they will knock you down.

460
00:49:03,000 --> 00:49:05,000
They'll just end your corporation.

461
00:49:05,000 --> 00:49:08,000
They'll end it right there unless you run to bankruptcy court

462
00:49:08,000 --> 00:49:13,000
and get protection under Chapter 11, which is what would probably happen.

463
00:49:13,000 --> 00:49:19,000
Why would U.S. Steel, it's already in trouble with free cash flow,

464
00:49:19,000 --> 00:49:23,000
it's negative, why would it pay a dividend...

465
00:49:23,000 --> 00:49:27,000
Shareholders, all they can do is cry if you don't give them their dividend.

466
00:49:27,000 --> 00:49:29,000
They can't do anything to you.

467
00:49:29,000 --> 00:49:33,000
It's a bitch at you at the annual shareholders meeting.

468
00:49:33,000 --> 00:49:40,000
Why would they put themselves even more in the hole by giving a dividend?

469
00:49:40,000 --> 00:49:42,000
To encourage more investors.

470
00:49:42,000 --> 00:49:44,000
Oh, very good.

471
00:49:44,000 --> 00:49:46,000
And also...

472
00:49:46,000 --> 00:49:47,000
Here's something.

473
00:49:47,000 --> 00:49:51,000
Okay, sir, turns out you're my son.

474
00:49:51,000 --> 00:49:52,000
Don't ask, okay?

475
00:49:52,000 --> 00:49:56,000
It was a long night and it was Decatur.

476
00:49:56,000 --> 00:49:57,000
Yeah, we'll do it.

477
00:49:57,000 --> 00:49:59,000
Yeah, Travel America truck stop.

478
00:49:59,000 --> 00:50:02,000
Okay.

479
00:50:02,000 --> 00:50:06,000
Every year I give you a Christmas, no, on your birthday,

480
00:50:06,000 --> 00:50:09,000
I give you a $10,000 check.

481
00:50:09,000 --> 00:50:11,000
You've been getting it every year, right?

482
00:50:11,000 --> 00:50:15,000
No, I'm down with you as dad.

483
00:50:15,000 --> 00:50:16,000
Hey, dad.

484
00:50:16,000 --> 00:50:18,000
No, I'm not giving you...

485
00:50:18,000 --> 00:50:21,000
Okay, here.

486
00:50:21,000 --> 00:50:26,000
The thing though is that this year I'm in trouble.

487
00:50:26,000 --> 00:50:34,000
My salary went down the toilet and all of that.

488
00:50:34,000 --> 00:50:38,000
But why would I still give you your $10,000 check?

489
00:50:38,000 --> 00:50:41,000
I'd go to my retirement account, my savings account,

490
00:50:41,000 --> 00:50:43,000
maybe borrow the money, do something,

491
00:50:43,000 --> 00:50:47,000
but I want to make sure you get your $10,000.

492
00:50:47,000 --> 00:50:50,000
Is it because I care about you?

493
00:50:50,000 --> 00:50:51,000
Look at me.

494
00:50:51,000 --> 00:50:52,000
Do I?

495
00:50:52,000 --> 00:50:54,000
No.

496
00:50:54,000 --> 00:51:01,000
But what I want to do is I want to keep your confidence.

497
00:51:01,000 --> 00:51:03,000
That's important.

498
00:51:03,000 --> 00:51:04,000
You're right.

499
00:51:04,000 --> 00:51:07,000
With new investors, I damn well better give them confidence

500
00:51:07,000 --> 00:51:10,000
that an investment in U.S. Steel is a good idea.

501
00:51:10,000 --> 00:51:15,000
But I also want to give my existing shareholders confidence

502
00:51:15,000 --> 00:51:21,000
in my ability to make their investment do well.

503
00:51:21,000 --> 00:51:24,000
That's what dividends, the main purpose of dividends...

504
00:51:24,000 --> 00:51:26,000
Dividends actually are kind of...

505
00:51:26,000 --> 00:51:30,000
And we'll talk about this in the last half of the course.

506
00:51:30,000 --> 00:51:33,000
They are actually kind of illogical.

507
00:51:33,000 --> 00:51:36,000
Why would you give dividends?

508
00:51:36,000 --> 00:51:41,000
We've come up in the last several decades

509
00:51:41,000 --> 00:51:44,000
with the understanding that it's part of signaling theory.

510
00:51:44,000 --> 00:51:49,000
It's a signal that we're in good shape.

511
00:51:49,000 --> 00:51:54,000
The dividend is actually just a confidence measure.

512
00:51:54,000 --> 00:51:57,000
I've seen this in corporate life in many ways

513
00:51:57,000 --> 00:52:00,000
where they don't want trouble.

514
00:52:00,000 --> 00:52:02,000
They don't want bad PR.

515
00:52:02,000 --> 00:52:07,000
It's not so much that it's going to hurt them if the PR comes out,

516
00:52:07,000 --> 00:52:10,000
as much as it is that they want to continue

517
00:52:10,000 --> 00:52:15,000
to give positive signals at all times.

518
00:52:15,000 --> 00:52:20,000
And dividends are a signal, especially to Wall Street.

519
00:52:20,000 --> 00:52:23,000
Well, those Wall Street boys, if you don't give a dividend,

520
00:52:23,000 --> 00:52:26,000
they're going to spank your buttocks.

521
00:52:26,000 --> 00:52:29,000
They are going to sell off their stock

522
00:52:29,000 --> 00:52:33,000
from their holdings in your company.

523
00:52:33,000 --> 00:52:36,000
They're going to squeeze your board of directors.

524
00:52:36,000 --> 00:52:39,000
So you want to make sure that they get their dividend.

525
00:52:39,000 --> 00:52:42,000
And this is what that dividend is about.

526
00:52:42,000 --> 00:52:44,000
That negative $117 million,

527
00:52:44,000 --> 00:52:48,000
that includes that dividend of 20 cents per share

528
00:52:48,000 --> 00:52:51,000
times the number of shares outstanding.

529
00:52:51,000 --> 00:52:54,000
That's part of the problem.

530
00:52:54,000 --> 00:52:59,000
But they are not going to solve that by cutting off the dividend.

531
00:52:59,000 --> 00:53:02,000
They most definitely would not do that.

532
00:53:02,000 --> 00:53:05,000
As a matter of fact, I would speculate

533
00:53:05,000 --> 00:53:07,000
that that 20 cent of share dividend

534
00:53:07,000 --> 00:53:12,000
times the number of shares US Steel has outstanding

535
00:53:12,000 --> 00:53:17,000
is a pretty decent part of that negative $117 million.

536
00:53:17,000 --> 00:53:20,000
But they're not going to cut the dividend.

537
00:53:20,000 --> 00:53:24,000
That's like me not sending you your check.

538
00:53:24,000 --> 00:53:27,000
If I do that, then you're going,

539
00:53:27,000 --> 00:53:30,000
you're not my real dad anymore.

540
00:53:30,000 --> 00:53:32,000
Okay? That's the point.

541
00:53:32,000 --> 00:53:35,000
So anyway, I wanted to put that in there.

542
00:53:35,000 --> 00:53:40,000
That what we're doing here is the real thing.

543
00:53:40,000 --> 00:53:43,000
The net profit, net income, earnings,

544
00:53:43,000 --> 00:53:47,000
whatever you want to call it, that's just a number on paper.

545
00:53:47,000 --> 00:53:49,000
I can show you a number of corporations

546
00:53:49,000 --> 00:53:52,000
have negative net earnings,

547
00:53:52,000 --> 00:53:55,000
but they have positive free cash flow.

548
00:53:55,000 --> 00:53:57,000
I can show you a number of companies.

549
00:53:57,000 --> 00:53:59,000
On paper, they look like they're not doing so well.

550
00:53:59,000 --> 00:54:02,000
Look at their free cash flow. It's doing fine.

551
00:54:02,000 --> 00:54:05,000
I can also show you a lot of companies

552
00:54:05,000 --> 00:54:09,000
that have positive profit, positive earnings,

553
00:54:09,000 --> 00:54:11,000
but they have negative free cash flow.

554
00:54:11,000 --> 00:54:14,000
As a matter of fact, I'll show you one right here.

555
00:54:14,000 --> 00:54:17,000
I've got it on the screen.

556
00:54:17,000 --> 00:54:19,000
Statement of operating income.

557
00:54:24,000 --> 00:54:28,000
Well, look at that. Net earnings.

558
00:54:28,000 --> 00:54:33,000
A positive $895 million.

559
00:54:33,000 --> 00:54:38,000
U.S. Steel on paper is a profitable company for last year.

560
00:54:38,000 --> 00:54:45,000
In real life, U.S. Steel...

561
00:54:45,000 --> 00:54:49,000
What is that calculation?

562
00:54:49,000 --> 00:54:53,000
Has a negative free cash flow.

563
00:54:53,000 --> 00:54:56,000
That's why we care about that number

564
00:54:56,000 --> 00:54:58,000
right there on your screen right now.

565
00:54:58,000 --> 00:55:05,000
Not the profit, the net earnings,

566
00:55:05,000 --> 00:55:09,000
because this one's the one that tells the real story of it.

567
00:55:09,000 --> 00:55:12,000
You'd be surprised at how many people are walking around out there.

568
00:55:12,000 --> 00:55:16,000
They look like they're multimillionaires, billionaires,

569
00:55:16,000 --> 00:55:18,000
but if you look at their free cash flow,

570
00:55:18,000 --> 00:55:24,000
they are in the hole insanely.

571
00:55:24,000 --> 00:55:27,000
They can be in the hole for years and years

572
00:55:27,000 --> 00:55:31,000
because their bankers will just keep propping them up,

573
00:55:31,000 --> 00:55:32,000
and if those bankers say no,

574
00:55:32,000 --> 00:55:36,000
they'll go to less reputable bankers who will say yes,

575
00:55:36,000 --> 00:55:38,000
and they will just keep on rolling,

576
00:55:38,000 --> 00:55:43,000
and everyone will think they're geniuses.

577
00:55:43,000 --> 00:55:47,000
Not that there's any political implications of that, mind you,

578
00:55:47,000 --> 00:55:48,000
but keep that in mind.

579
00:55:48,000 --> 00:55:51,000
You're seeing it right here in real life.

580
00:55:51,000 --> 00:55:55,000
Okay, well that was all kinds of fun.

581
00:55:55,000 --> 00:56:13,000
Now we can go and we can look at these financial ratios.

582
00:56:13,000 --> 00:56:22,000
These drill in on the different components of operations.

583
00:56:22,000 --> 00:56:27,000
Most of these are operating ratios, and for heaven sakes,

584
00:56:27,000 --> 00:56:30,000
the first thing is you've got a sheet.

585
00:56:30,000 --> 00:56:32,000
You can bring it to quizzes with you.

586
00:56:32,000 --> 00:56:36,000
You can bring it to the final, the midterm and the final with you,

587
00:56:36,000 --> 00:56:38,000
as long as you don't write anything else on it.

588
00:56:38,000 --> 00:56:40,000
You've got a note card for that.

589
00:56:40,000 --> 00:56:46,000
Well, of course, and I pulled that up.

590
00:56:46,000 --> 00:56:53,000
Access denied my ass.

591
00:56:53,000 --> 00:56:56,000
Oh, sorry about that.

592
00:56:56,000 --> 00:57:01,000
I get really hurt when I'm told I can't go someplace.

593
00:57:01,000 --> 00:57:04,000
Files.

594
00:57:04,000 --> 00:57:07,000
Let me see if I've got them here.

595
00:57:07,000 --> 00:57:10,000
I know I uploaded them to one class.

596
00:57:10,000 --> 00:57:16,000
Financial ratios.

597
00:57:16,000 --> 00:57:17,000
I'll bet I didn't.

598
00:57:17,000 --> 00:57:19,000
I'll have to go back out here.

599
00:57:19,000 --> 00:57:21,000
I put them in the 190 class.

600
00:57:21,000 --> 00:57:22,000
I'll get them from there.

601
00:57:22,000 --> 00:57:26,000
Files.

602
00:57:26,000 --> 00:57:28,000
Financial analysis.

603
00:57:28,000 --> 00:57:32,000
This will be in yours by this evening with apologies for that.

604
00:57:32,000 --> 00:57:37,000
Let me download that.

605
00:57:37,000 --> 00:57:42,000
There we go.

606
00:57:42,000 --> 00:57:46,000
Wait, what?

607
00:57:46,000 --> 00:57:49,000
Okay.

608
00:57:49,000 --> 00:57:54,000
These, now these are pretty much what the book gives you to.

609
00:57:54,000 --> 00:57:56,000
You've got a page in there.

610
00:57:56,000 --> 00:58:00,000
Now I have one or two in here that aren't in the book.

611
00:58:00,000 --> 00:58:09,000
They're old school, but in just the last couple of years they've become very big again,

612
00:58:09,000 --> 00:58:11,000
and the textbooks haven't caught up.

613
00:58:11,000 --> 00:58:17,000
The one most important I'll point out that is not in the book is called the burn ratio.

614
00:58:17,000 --> 00:58:20,000
You will also hear that called the cash ratio.

615
00:58:20,000 --> 00:58:23,000
It's not in textbooks currently.

616
00:58:23,000 --> 00:58:25,000
Back in the day it was really important,

617
00:58:25,000 --> 00:58:31,000
and like I said in the last few years it's suddenly really big again

618
00:58:31,000 --> 00:58:39,000
because cash management, short-term financial management has become so big these days.

619
00:58:39,000 --> 00:58:44,000
And if you're interested in what can be a rather tediously boring subject,

620
00:58:44,000 --> 00:58:49,000
I do teach an upper level course in cash management.

621
00:58:49,000 --> 00:58:54,000
Your teaching assistant survived that, and he's still sane I think.

622
00:58:54,000 --> 00:58:58,000
So it's, but it's huge.

623
00:58:58,000 --> 00:59:04,000
Cash is king is one of those go-to things in corporate now.

624
00:59:04,000 --> 00:59:11,000
But anyway, other than that, now when I go through these,

625
00:59:11,000 --> 00:59:14,000
you can have, I don't care if you memorize the formulas or not.

626
00:59:14,000 --> 00:59:16,000
That's not the thing.

627
00:59:16,000 --> 00:59:21,000
For us in finance it's saying why did this happen?

628
00:59:21,000 --> 00:59:25,000
Oh, here's a pretty number. Why?

629
00:59:25,000 --> 00:59:29,000
What is this number compared to that same number for another corporation

630
00:59:29,000 --> 00:59:32,000
or for the industry average?

631
00:59:32,000 --> 00:59:34,000
Those are important.

632
00:59:34,000 --> 00:59:40,000
And another thing is also most of these ratios,

633
00:59:40,000 --> 00:59:45,000
it's not a question of whether they're too big or too small.

634
00:59:45,000 --> 00:59:47,000
There are a few exceptions to that.

635
00:59:47,000 --> 00:59:52,000
Most of them are relative, and that's where judgment comes in.

636
00:59:52,000 --> 00:59:57,000
That's why a course like this, I don't probe your judgment too hard,

637
00:59:57,000 --> 01:00:01,000
but I do ask you for a few, think your way through it.

638
01:00:01,000 --> 01:00:10,000
So for example, if I see that a company's inventory turnover ratio has gone up,

639
01:00:10,000 --> 01:00:13,000
okay, why did that happen?

640
01:00:13,000 --> 01:00:19,000
Well, if inventory goes down,

641
01:00:19,000 --> 01:00:26,000
that would tend to make inventory turnover ratio increase.

642
01:00:26,000 --> 01:00:31,000
The denominator of inventory turnover is inventory.

643
01:00:31,000 --> 01:00:39,000
So if inventory goes down, that will increase the inventory turnover ratio.

644
01:00:39,000 --> 01:00:42,000
That's considered a good thing.

645
01:00:42,000 --> 01:00:47,000
If you're turning over all your inventory more times every year,

646
01:00:47,000 --> 01:00:51,000
well, that means that you're selling stuff faster,

647
01:00:51,000 --> 01:00:54,000
you're not keeping as much inventory space, which has costs.

648
01:00:54,000 --> 01:00:59,000
It's a wonderful thing, until it's not.

649
01:00:59,000 --> 01:01:05,000
Here was what went on with that, and this is part of our thinking in these.

650
01:01:05,000 --> 01:01:11,000
Over the past 20 years, getting that inventory ratio up,

651
01:01:11,000 --> 01:01:15,000
you're selling off all your inventory more times every year,

652
01:01:15,000 --> 01:01:18,000
that was considered an ideal thing to do.

653
01:01:18,000 --> 01:01:20,000
Turn it over faster.

654
01:01:20,000 --> 01:01:23,000
We need smaller warehouse space, all that, great stuff.

655
01:01:23,000 --> 01:01:32,000
Until we got to the COVID lockdown, where the supply chains froze up.

656
01:01:32,000 --> 01:01:38,000
With all these companies that were getting rid of inventory real fast,

657
01:01:38,000 --> 01:01:43,000
well, once the supply chains broke, they had no inventory in their warehouses

658
01:01:43,000 --> 01:01:45,000
to put on the shelves.

659
01:01:45,000 --> 01:01:51,000
And suddenly, you were without toilet paper on the shelves of Wal-Mart and Kroger.

660
01:01:51,000 --> 01:01:58,000
You were without other things that would have been there if they'd had larger inventories

661
01:01:58,000 --> 01:02:02,000
as buffers against supply chain disruptions.

662
01:02:02,000 --> 01:02:04,000
So that's the whole point.

663
01:02:04,000 --> 01:02:09,000
Yeah, sometimes a number is the big thing, is get that number to go this way or that way.

664
01:02:09,000 --> 01:02:12,000
Sometimes you can make it go too far.

665
01:02:12,000 --> 01:02:14,000
I'll show you another one here.

666
01:02:14,000 --> 01:02:20,000
This is one, there's a definite no-no number on this one, times interest earned.

667
01:02:20,000 --> 01:02:27,000
This is your earnings before interest and taxes, divided by your interest expense.

668
01:02:27,000 --> 01:02:36,000
So EBIT is how much money that you have first to pay your interest expense.

669
01:02:36,000 --> 01:02:43,000
Well, what would happen if EBIT was a smaller number than what you owed in interest?

670
01:02:43,000 --> 01:02:48,000
That would technically, times interest earned, would be below one.

671
01:02:48,000 --> 01:02:52,000
Practically speaking, you'd be out of business,

672
01:02:52,000 --> 01:02:56,000
because the debt holders would say you didn't pay an interest expense,

673
01:02:56,000 --> 01:02:58,000
and so we're turning you off right now.

674
01:02:58,000 --> 01:03:00,000
That's the end of you.

675
01:03:00,000 --> 01:03:03,000
Real world example of that.

676
01:03:03,000 --> 01:03:07,000
Have any of you ever eaten at a Steak and Shake?

677
01:03:07,000 --> 01:03:09,000
They're overpriced, but they're okay.

678
01:03:09,000 --> 01:03:11,000
They're decent burgers and all that.

679
01:03:11,000 --> 01:03:13,000
Well, it was a couple of years ago.

680
01:03:13,000 --> 01:03:18,000
We were watching that EBIT over interest expense, times interest earned,

681
01:03:18,000 --> 01:03:25,000
and they were coming up on an interest payment, and times interest earned was below one.

682
01:03:25,000 --> 01:03:29,000
Which means they couldn't pay it.

683
01:03:29,000 --> 01:03:31,000
I think it was an interest payment.

684
01:03:31,000 --> 01:03:35,000
They didn't have the money to pay it, according to the number.

685
01:03:35,000 --> 01:03:38,000
Well, that would have meant they were gone.

686
01:03:38,000 --> 01:03:46,000
And somehow they managed to find a way to get the money together to pay that expense,

687
01:03:46,000 --> 01:03:49,000
that interest expense, so they didn't go under.

688
01:03:49,000 --> 01:03:51,000
But that was a classic example.

689
01:03:51,000 --> 01:03:56,000
We saw a train wreck coming at them, and we were all kind of surprised

690
01:03:56,000 --> 01:03:59,000
that they were able to pull it out of the fire like they did.

691
01:03:59,000 --> 01:04:01,000
But those are the kinds of things that we do.

692
01:04:01,000 --> 01:04:03,000
That's a definite no-no.

693
01:04:03,000 --> 01:04:08,000
You don't want times interest earned ever to be less than one.

694
01:04:08,000 --> 01:04:13,000
And I will ask that on a quiz and or an exam.

695
01:04:13,000 --> 01:04:16,000
That's one of those no-nos.

696
01:04:16,000 --> 01:04:19,000
Some of the others, you know, they're here and there.

697
01:04:19,000 --> 01:04:23,000
You have to kind of make your, take your positions on some of them.

698
01:04:23,000 --> 01:04:26,000
But I'll bring up other ones as time goes along.

699
01:04:26,000 --> 01:04:29,000
But let's just do a couple of calculations here.

700
01:04:29,000 --> 01:04:33,000
We notice on this sheet, we break them down into categories.

701
01:04:33,000 --> 01:04:37,000
Profitability ratios, just what they tell us.

702
01:04:37,000 --> 01:04:43,000
Profit, they're related to the profitability, the profit of the earnings of the company.

703
01:04:43,000 --> 01:04:45,000
And then the liquidity.

704
01:04:45,000 --> 01:04:47,000
Remember liquidity?

705
01:04:47,000 --> 01:04:49,000
We want liquidity.

706
01:04:49,000 --> 01:04:55,000
A company needs cash on, needs quick ways to get money together.

707
01:04:55,000 --> 01:05:00,000
But we don't want it to have so much, if you have liquidity too high,

708
01:05:00,000 --> 01:05:04,000
that means you're not putting money into long-term investments

709
01:05:04,000 --> 01:05:06,000
where you could make some extra money.

710
01:05:06,000 --> 01:05:12,000
Money I have in my pocket, if I have a lot of money in my pocket, I'm highly liquid.

711
01:05:12,000 --> 01:05:18,000
But that's also money that's not earning me anything like it would if I put it into stocks and bonds.

712
01:05:18,000 --> 01:05:25,000
So liquidity can be too low, meaning you don't have enough money maybe to pay your bills.

713
01:05:25,000 --> 01:05:28,000
But it can also be too high if you're keeping too much money

714
01:05:28,000 --> 01:05:34,000
that you should be able to, that you should be investing in long-term high-yield assets.

715
01:05:34,000 --> 01:05:40,000
Okay, and then we also have our debt ratios, debt to total assets.

716
01:05:40,000 --> 01:05:44,000
That's called capital structure, but don't worry about that right now.

717
01:05:44,000 --> 01:05:46,000
Asset activity.

718
01:05:46,000 --> 01:05:51,000
How hard are the company's assets working?

719
01:05:51,000 --> 01:05:56,000
Now there are, and so we want to keep an eye on those, obviously.

720
01:05:56,000 --> 01:05:59,000
And then some market value ratios.

721
01:05:59,000 --> 01:06:05,000
Now I won't get through all of these today, but I'll just sort of begin it here.

722
01:06:05,000 --> 01:06:08,000
We can break these down.

723
01:06:08,000 --> 01:06:13,000
The liquidity ratios.

724
01:06:13,000 --> 01:06:22,000
The first one would be your current ratio.

725
01:06:22,000 --> 01:06:29,000
The next one would be your quick ratio.

726
01:06:29,000 --> 01:06:36,000
You'll hear me call this one its old name, the acid test.

727
01:06:36,000 --> 01:06:56,000
And that last one, the burn ratio, otherwise called the cash ratio.

728
01:06:56,000 --> 01:07:01,000
And I won't go too far, but I do want you to see it's just like I did above.

729
01:07:01,000 --> 01:07:04,000
You just go and grab the numbers.

730
01:07:04,000 --> 01:07:10,000
So with the liquidity ratios, current ratio is your current assets over your current liabilities.

731
01:07:10,000 --> 01:07:23,000
Equals, and go over here to your balance sheet, your current assets divided by your current liabilities.

732
01:07:23,000 --> 01:07:27,000
Total current liabilities.

733
01:07:27,000 --> 01:07:30,000
There it is.

734
01:07:30,000 --> 01:07:32,000
The quick ratio.

735
01:07:32,000 --> 01:07:40,000
Now that takes all of your current assets.

736
01:07:40,000 --> 01:07:42,000
Total current assets.

737
01:07:42,000 --> 01:07:45,000
But it subtracts out the inventories.

738
01:07:45,000 --> 01:07:48,000
Because inventories really aren't that liquid.

739
01:07:48,000 --> 01:07:54,000
You might get 10 cents on the dollar with a factoring company for your inventories.

740
01:07:54,000 --> 01:07:58,000
So we take it out.

741
01:07:58,000 --> 01:08:00,000
Inventories.

742
01:08:00,000 --> 01:08:09,000
And then divide the result by the current liabilities.

743
01:08:09,000 --> 01:08:20,000
And then the burn ratio is nothing but your cash divided by your...

744
01:08:20,000 --> 01:08:28,000
Because basically at the end of the day, if you really needed to cover all of your current liabilities immediately,

745
01:08:28,000 --> 01:08:33,000
realistically all that would matter is your cash.

746
01:08:33,000 --> 01:08:36,000
A little side note here.

747
01:08:36,000 --> 01:08:39,000
These are multiples, multipliers.

748
01:08:39,000 --> 01:08:46,000
So in other words, this is saying that their current liabilities, current assets,

749
01:08:46,000 --> 01:08:55,000
can cover all of their current liabilities 1.76 times over.

750
01:08:55,000 --> 01:09:03,000
The quick ratio is saying that excluding inventory, which really isn't that liquid,

751
01:09:03,000 --> 01:09:13,000
they could cover their liabilities with their current assets 1.22 times over.

752
01:09:13,000 --> 01:09:19,000
But if all they had was their cash and they had to pay all of their current liabilities,

753
01:09:19,000 --> 01:09:28,000
they could do only about 0.32 of their current liabilities.

754
01:09:28,000 --> 01:09:34,000
Now, are these good or bad?

755
01:09:34,000 --> 01:09:37,000
This is where judgment comes in and I would certainly not ask you.

756
01:09:37,000 --> 01:09:42,000
First thing I would do is I'd say, well, what's their industry average for these?

757
01:09:42,000 --> 01:09:47,000
But aside from that, that's a surprisingly high liquidity.

758
01:09:47,000 --> 01:09:49,000
That's a little bothersome.

759
01:09:49,000 --> 01:09:55,000
And even if you don't count their inventory, they've got an awful lot of liquid assets.

760
01:09:55,000 --> 01:10:01,000
Maybe they could be using some of that to put into long-term investments.

761
01:10:01,000 --> 01:10:06,000
But what the heck is going on here?

762
01:10:06,000 --> 01:10:13,000
As far as just pure cash is concerned, they're actually fairly illiquid.

763
01:10:13,000 --> 01:10:17,000
So that's a little bit of a conundrum.

764
01:10:17,000 --> 01:10:27,000
Now, the next thing that I probably would want to do, did I get all those current assets in there?

765
01:10:27,000 --> 01:10:30,000
Where the heck?

766
01:10:30,000 --> 01:10:33,000
Yeah, I guess, well, that's liquidity.

767
01:10:33,000 --> 01:10:35,000
We usually do those first.

768
01:10:35,000 --> 01:10:40,000
Now, profitability, I'll just do a couple of those real quick here for you.

769
01:10:40,000 --> 01:10:53,000
Profitability, and I'll finish the rest next week.

770
01:10:53,000 --> 01:10:59,000
Gross margin.

771
01:10:59,000 --> 01:11:05,000
Operating margin.

772
01:11:05,000 --> 01:11:09,000
And net margin, I'll just do those.

773
01:11:09,000 --> 01:11:12,000
This is pretty simple to interpret.

774
01:11:12,000 --> 01:11:17,000
You take your gross margin.

775
01:11:17,000 --> 01:11:20,000
Whoops, I forgot.

776
01:11:20,000 --> 01:11:22,000
Tell you what, this is going to take too long.

777
01:11:22,000 --> 01:11:24,000
It's almost the end of the class.

778
01:11:24,000 --> 01:11:25,000
I'll pick it back up on Monday.

779
01:11:25,000 --> 01:11:26,000
That's all I have for you today.

780
01:11:26,000 --> 01:11:40,000
I thank you.