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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. And just as a first pointer, I've uploaded some files for you.

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And what I'm going to do today will be mostly Excel. I'll try to go slowly.

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If I go too fast, you can shoot me with a tranquilizer dart or something like that.

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But I will also upload the product of what I've done to Canvas for you,

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as well as another, there's another document there for you to consider,

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a couple more for you to keep in mind. But I'll probably spill, this lecture will spill

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a little bit into Monday, not a whole lot of it, but some of it will.

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So I'll make sure that you have some extra time for the homework that will be coming up due for this one.

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But other than that, we are going to have a look, as we always do, at the numbers

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before we dive into Excel and do a tedious lecture today on that.

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But as you can see, the markets have, oh, we're still open, got a little less than an hour.

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So we can go through this. And first things first, who haven't I bothered?

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Sir, is this a bull day or a bear day on the market? Bull, it's a bull day.

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Not a big bull day, but it's a bull day. I mean, we take our happiness where we can get it.

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As you can see, the Dow is up about a half a percent.

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And the somewhat riskier S&P 500 is up more, normal pattern, 0.88 percent.

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And the riskiest of those that you see up there, the NASDAQ is up 1.07 percent.

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It's following a typical pattern of risk return for today, which it almost always does.

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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?

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Which is good news. So investors were putting money into stocks.

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They were pulling it off the sidelines, buying stocks, hence why the prices are going up.

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But let's see what was going on with the bonds. Ten-year bond.

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The yield is up, so the price would be down.

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So as you can see, the yield was up about, what, 2.3 basis points, not much.

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But that would mean the prices were down.

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So investors were drawing a little bit on net out of the bond market

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and probably using those proceeds to buy into the stock market.

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This is a good sign. Investor confidence.

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They're willing to take the higher risk of equities because they see more potential gain.

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And shed some of their more defensive position, which was in the bonds.

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And so we have sort of a nice little, nothing spectacular, but it was nice good news today.

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Looking at more physical things, crude oil is in that trading range.

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I've mentioned it on a number of occasions, from about 72 to 79.

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And it seems to like that range, and right now it's on the lower end of it, bouncing around.

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And so that's giving us some indication that the traders are not concerned about supply disruptions of oil,

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resulting from the conflicts around the Middle East and Southwest Asia.

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So good news, gas prices, they're not going to go skyrocketing.

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They may even shed a little bit of where they are, go down a little bit, but it won't be much.

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Oil is just staying in a nice place. Now gold, pretty much flat.

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There's no rush to buy gold because the world is coming to an end.

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So we see some good numbers today. Equities are up. Investor confidence is up.

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Bonds are down, so they're willing to take more risk, investors are.

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And no one is buying gold waiting for the apocalypse to happen. All good news for the day.

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And of course, I can always change on a dime if something scary happens,

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but it looks like there's generally positive sentiment in the markets.

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Now over in Japan, the Nikkei 225 finished about flat. It was down all day, just a little grouchy.

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But it was down 0.11%, which is pretty much not even anything to notice.

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It's just a little grumpy Tokyo was, and they went finally closed, went to bed,

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and then the sun rose over in Western Europe and in Great Britain.

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And we see that that grumpiness had more steam in London.

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It slid downward, not hard, but it slid.

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And then it stayed stable, and then there was another selling wave that brought it down even more.

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It wasn't a horrible down day, but it was definitely a down day for the London Exchange and the FTSE,

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which is the index of 100 big companies on it.

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But interestingly enough, that didn't come over here when the sun set over in London and rose over here.

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Our investors were in a pretty good mood. It was up through the day, had a good spike there, most of the markets did,

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and then it just sort of drifted along waiting for some more good news.

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But the optimism seemed to have let it lift up a little bit more towards the end of the day.

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Looking at a couple here, just out of curiosity.

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Of course, my favorite whipping boy, Tesla, it had a good day, I think.

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Yeah, it was up pretty nicely for the day.

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Now, looking at a couple of other markets, what I want to look at here?

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MRO, no, no, no, no, MRO, Marathon Oil, just look at the oil market, up a little bit, good day for oil.

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And you say, well, doesn't the price of oil have to jump for those stocks?

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Not necessarily. It has a lot to do with demand for what Marathon sells.

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It sells gasoline if demand is going up as we get into warmer weather in this part of the country,

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and transportation is getting stabilized, delivery of goods and all that.

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Yeah, it's going to show some signs.

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Looking at a couple more, Procter & Gamble, basics.

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Look at that beta. Procter & Gamble, you probably know it, sells just basic consumer products, a lot of its businesses.

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And they were up a little bit for the day, nothing big there.

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Notice the beta, companies that sell basic products generally tend to be low-risk companies.

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It is a profitable company as well.

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Now getting over here to our meat of the day, US Steel.

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This is the one that we're going to break down with a hardcore financial analysis,

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one of those tedious lectures where almost everything is done in Excel.

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But before we get to that fun, we do see that, just as a reminder, it's a high-risk stock.

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It seems to be undervalued though, and it is a profitable stock.

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Now you keep that in mind, US Steel is a profitable company.

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It has positive net earnings per share, which means it has positive net earnings.

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And it pays a nice little dividend. Not a huge one, but it pays a nice dividend.

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So we've got everything set up for us to be able to do our financial analysis.

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Now let me take you over here for a little bit.

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Now again, I will upload what I do here.

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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.

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But if you come over here, files. First things first.

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In your files, you will have financial analysis formulas.

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These are the ratios for ratio analysis, all of them, that I would care about.

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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.

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But just to make it clear to you, you can have this sheet with you for quizzes and for exams.

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Don't write anything else on it because you get a note card for exams.

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But these ratios. Now truthfully, I don't care if you memorize them or not.

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You've got your sheet. If you use them enough in my business, you remember them.

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But I mean, even sometimes I'll go to one of these sheets like this to look.

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And there are literally dozens and dozens of ratios.

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And these are kind of like the top, most important of them.

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And we will do these in Excel.

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The key here is that it is not your calculation. If you can put it into Excel, you'll get the right number.

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If you put it into Excel correctly.

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The action for in finance is not on the what. It's on the why.

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Why did this ratio go up or go down? Is this a good number or is this a bad number?

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Now in that regard, there are a few ratios.

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You don't want them to be less than a certain number or more than a certain number.

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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.

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Okay, this ratio is this. Well, what's the industry average?

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Is it above the average, below the average, or at about the average?

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The second thing that you have to ask yourself is what are the changes that are happening in these ratios?

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That's important. That's where the key is.

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To see, okay, this is a little bit worse than this ratio, but it has been trending in the right direction over the past couple of years.

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Okay, so that means that the management knows there's an issue and you can see the issue being addressed.

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Those kinds of things are kind of important.

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You also want to ask yourself some deeper questions, which I would only touch on the surface with the deeper questions.

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Let me give you an example. See this inventory turnover ratio?

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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.

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Inventory turnover ratio, at least in a theoretical kind of way.

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So the whole emphasis over the past 20 years or more is get that inventory turnover ratio higher and higher.

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Get the inventory in, get it out. Bring more in, get it out.

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That means smaller warehouses and all that good stuff. You don't have to hold as much inventory.

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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.

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Hell, the limit is infinite inventory turnover ratio like the Japanese do with their just-in-time system.

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No inventory, therefore the denominator is zero.

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They bring in parts for a car as the car that they're building needs it.

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They don't keep it inventory, so therefore the bottom denominator is zero, so sales over zero is infinity.

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That's the dream. Get that inventory ratio up there as far as possible until the lockdown.

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You're selling your inventory out, getting rid of it, and then you bring more in.

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Well, what happens is the supply chain breaks.

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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.

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That's why we didn't have some other basic products on the shelves of stores.

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It was because they were keeping so little in inventory, relying on getting more the next day,

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that they stocked out and they couldn't get more, and so the shelves were emptied.

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That was what it was all about.

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Never mind the talking heads talking about these deep issues and complexities.

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No, it was because there was this management fantasy, this goal of getting inventory turnover as high as possible,

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which meant that you kept very little in inventory.

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Your inventory numbers were low, and that was the consequence of it.

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There are other ones, too, that the questions are not, well, what are they? Is this good or bad?

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But sometimes it's a question of is it too good to be true?

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If it's bad, what are they doing to get this problem fixed?

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In a lot of ways, the ratio analysis would go well beyond a course at this level,

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but you do have to appreciate that you look at these numbers.

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Look at the numerators and look at the denominators.

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So I could say, okay, suppose, for example, that total assets of a company fell and net income was rising.

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Well, if you look over here at ROA, return on assets, you've got net income over total assets.

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So if net income is going up, but you're driving the total assets down, ROA goes up.

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Yay, return on assets is getting bigger and bigger. Isn't that wonderful?

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Not always.

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I'll give you an example of this one.

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When I was in consulting, I got into, actually personally, professionally, into the oil and gas industry

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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

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and then dust ourselves off and go to the next one.

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Okay, that's interesting business.

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Down in that area, everyone knew everything about oil.

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And one thing that I was learning was that there were the refineries that had been built,

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many of them in the 60s and 70s.

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There were not a lot of new refineries being built after that period.

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And the refineries that existed were depreciating, both in accounting and economically.

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Well, what that would mean is that oil companies, which were making bigger and bigger profits, net income was going up,

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but the total assets were going down because there was all this depreciation on the old refineries,

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but there were no new assets being added for depreciation to replace them.

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You follow?

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So total assets were falling against rising income, so ROA was going up.

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Great thing.

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Wow, these oil companies are awesome.

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Well, there was a problem with that.

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They weren't replacing refineries.

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They weren't even upgrading and fixing the old refineries.

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So by the time we get to around the beginning of the 21st century, boom, oil refineries,

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these old ancient beasts were exploding, killing workers, poisoning the communities around the refineries

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where the workers' families lived.

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It was a nightmare, all because they didn't replace refineries with new refineries,

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replace old equipment with new equipment, and so what you had were ROAs going through the roof,

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and ultimately it was a catastrophe of human proportions and not just economic proportions.

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So always be cautious when a good thing looks too good.

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You start asking questions.

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Why is this happening?

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Now, again, this is beyond the wheelhouse in this course,

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but those are the issues that you begin to think about,

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and so when people throw numbers at you, don't be impressed until you know how those numbers came to be.

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Good lesson for everyone.

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Okay, now close that.

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Now, the next thing I'm going to show you here, if you go under files,

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I've put up a new folder in files called links,

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and that will have links that I mention in class.

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So remember when we went to the Edgar system to get the U.S. Steel?

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Look, here it is.

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Here's a link to that right here.

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You get the link right here.

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Just click on it, and there you are, right at it.

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So it's there for you 24-7.

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Instead of you having to remember what I did in book markets, you can just pull it up.

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Okay, so there is the Edgar company filings,

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and I'm going to go back through what I did on Monday,

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and I try to do this as much as I can just to reinforce, repeat something, just to reinforce it for you,

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especially if it's something important,

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and especially if it's something important beyond just this class,

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and knowing where to go for these primary sources is big for the rest of your career here

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at this great university.

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Okay, so here we go.

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Now remember, you're here at the Edgar company filings.

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Click on the company and person lookup, and you type in the trade symbol.

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I said you type in the trade symbol.

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I hate, hate, hate the internet here.

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Seriously, let's refresh this page.

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Try it again.

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There we go.

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You'll get a drop-down, and the first one is the one we want, United States Steel Corp.

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And you'll be, the landing page will be the one on the right, it says Selected Filings.

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Now I'm saying this as I'm going along so that it's in the podcast, too,

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so that if you don't get it here, you'll hear it in the podcast, too.

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But now we want 10Ks.

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This is where your Qs and Ks are.

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00:20:35,000 --> 00:20:39,000
And we'll want the most recent 10K.

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00:20:39,000 --> 00:20:43,000
And as I said last time, don't click on the text hyperlink.

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Click on the little box that says Filing.

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Okay, the first thing you'll do is you'll go to a screen with,

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that mostly is dominated by those document and image files.

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Ignore those.

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Up here just above center on the left is a blue button that says Interactive Data.

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You click on it.

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00:21:10,000 --> 00:21:14,000
Your landing page will have something special.

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Up here just above the black bordered box, you'll see View Excel Document.

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00:21:23,000 --> 00:21:25,000
And this is the truth, no matter what the company is,

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they all are laid out exactly the same way, the same steps,

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00:21:29,000 --> 00:21:32,000
no matter which company you want to get to.

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View Excel Document, just click, and it will download.

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And there is the document right there.

230
00:21:46,000 --> 00:21:48,000
Now again, this is a repeat of what I did on Monday.

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I'm just getting a running start, create continuity for the lecture.

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Okay, first things first.

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We're going to scoot documents around to set up our workspace the way we can use it more efficiently.

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We're going to need the income statement.

235
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There it is, right there.

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00:22:10,000 --> 00:22:13,000
We're also going to need the balance sheet.

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00:22:13,000 --> 00:22:15,000
Well, that's not it.

238
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The next one over is the balance sheet.

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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.

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So those two are together.

241
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Now you'll see why this is important here in a minute.

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Now the other one we'll need is the statement of cash flows.

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00:22:37,000 --> 00:22:39,000
There it is, right there.

244
00:22:39,000 --> 00:22:41,000
Nope, there it is.

245
00:22:41,000 --> 00:22:50,000
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.

246
00:22:50,000 --> 00:22:57,000
Now I've got my three primary documents, three primary worksheets together.

247
00:22:57,000 --> 00:23:05,000
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,

248
00:23:05,000 --> 00:23:12,000
just a little to the right of where the income statement gives way to the balance sheet.

249
00:23:12,000 --> 00:23:21,000
I'm going to right click and I'm going to say insert a worksheet.

250
00:23:21,000 --> 00:23:32,000
And I will call that the calculations sheet.

251
00:23:32,000 --> 00:23:38,000
That will be where I do my actual calculations, my back of the envelope, my scratch work.

252
00:23:38,000 --> 00:23:40,000
That's where I'll do it.

253
00:23:40,000 --> 00:23:43,000
Now I'm going to do something here that you don't need to worry about.

254
00:23:43,000 --> 00:23:45,000
I'm going to make all of these bigger at once.

255
00:23:45,000 --> 00:23:53,000
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.

256
00:23:53,000 --> 00:24:04,000
Those four, the income statements, the balance works of the calculations, the balance sheet, and the statement of cash flows.

257
00:24:04,000 --> 00:24:12,000
And then if you highlight all of them together, what you do to one will happen to all of them that are highlighted.

258
00:24:12,000 --> 00:24:20,000
That includes actually if you highlight all of them, what you type in one will happen in the same place in the other.

259
00:24:20,000 --> 00:24:30,000
So we want to not let that happen, but I am going to make these bigger so you can see it better.

260
00:24:30,000 --> 00:24:37,000
Okay, so now then to get out of it, you click on a sheet that's not part of what you did.

261
00:24:37,000 --> 00:24:42,000
Okay, there you go. See all of them are now bigger. You can see them all.

262
00:24:42,000 --> 00:24:53,000
Okay, now down to the grinder. On Monday we did our recon, just looked at them. This time we're going to do calculations.

263
00:24:53,000 --> 00:25:13,000
Now the first thing we're going to calculate is the Holy Grail, the free cash flow.

264
00:25:13,000 --> 00:25:25,000
We've got a darker marker here, the free cash flow.

265
00:25:25,000 --> 00:25:30,000
And believe me, the way we do it in Excel makes it a lot really straightforward.

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00:25:30,000 --> 00:25:36,000
You're going to just collect the pieces of information from the different sheets, you'll put them in the calculation sheet,

267
00:25:36,000 --> 00:25:51,000
and then you'll just run the calculation. It starts with this. Revenue minus costs.

268
00:25:51,000 --> 00:25:57,000
Now I'm assuming that the depreciation expense is there in the cost somewhere. It's in there.

269
00:25:57,000 --> 00:26:03,000
If it's not, we don't worry too much about that.

270
00:26:03,000 --> 00:26:09,000
And now we're going to take one minus the tax rate.

271
00:26:09,000 --> 00:26:19,000
Now first of all, this right here should, if the financial statements are well prepared,

272
00:26:19,000 --> 00:26:32,000
this is what we call EBIT or operating income. It could have either name.

273
00:26:32,000 --> 00:26:38,000
So all we do is we just pick that off the income statement and put it in our calculation sheet.

274
00:26:38,000 --> 00:26:44,000
We don't have to do the revenue. No, it's all there in the operating income,

275
00:26:44,000 --> 00:26:49,000
or as some companies call it, the EBIT, earnings before interest and taxes.

276
00:26:49,000 --> 00:27:03,000
Now a little note about this. When income taxes were first initiated over a century ago,

277
00:27:03,000 --> 00:27:11,000
and for a long time, the T, that would be the highest tax bracket that a company could have.

278
00:27:11,000 --> 00:27:22,000
That T would have been 90% of their earnings.

279
00:27:22,000 --> 00:27:29,000
Over the years, it fell to 70% during the Kennedy administration.

280
00:27:29,000 --> 00:27:35,000
Now by today's standards, that would have been just unconscionable, the horror of all times.

281
00:27:35,000 --> 00:27:41,000
But the reality is that our country was, the economy was growing robustly.

282
00:27:41,000 --> 00:27:49,000
We came from basically just one of the nations of the earth to the dominant power of the earth

283
00:27:49,000 --> 00:27:53,000
during that time when we had a tax rate 70%.

284
00:27:53,000 --> 00:28:00,000
So don't ever let anyone tell you that this high taxes are what destroys an economy, bullshit.

285
00:28:00,000 --> 00:28:05,000
We did pretty darn well under 70%. Then in the early 1980s,

286
00:28:05,000 --> 00:28:15,000
the Reagan administration had got Congress to lower the top marginal tax bracket to 39%.

287
00:28:15,000 --> 00:28:23,000
Okay, whatever. However, it was kind of odd about that tax rate.

288
00:28:23,000 --> 00:28:32,000
39% was not what the very largest corporations paid. They paid 35%.

289
00:28:32,000 --> 00:28:41,000
It was the large but somewhat smaller corporations that were hit with that 39%.

290
00:28:41,000 --> 00:28:57,000
Okay, well then we got to 2017 and the Congress lowered the tax rate to a flat, not a tiered progressive,

291
00:28:57,000 --> 00:29:08,000
just to a flat 21%. In other words, almost they cut the tax bracket, the top tax rate,

292
00:29:08,000 --> 00:29:21,000
all tax rates down to half, almost half of what they had been from 1981 I think it was to 2016.

293
00:29:21,000 --> 00:29:26,000
That 39% was gone and it's 21% now.

294
00:29:26,000 --> 00:29:34,000
And this is why we are running the most insane budget deficits in history.

295
00:29:34,000 --> 00:29:40,000
And our national debt is accumulating at the fastest rate in history.

296
00:29:40,000 --> 00:29:46,000
Fortunately, that's not my problem, it's your problem. You'll have to figure out how to pay that mess.

297
00:29:46,000 --> 00:29:52,000
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,

298
00:29:52,000 --> 00:29:56,000
but it's your problem, not mine. Just a little side note there.

299
00:29:56,000 --> 00:30:03,000
But for our purposes, that T will be 21% for any kind of calculations.

300
00:30:03,000 --> 00:30:12,000
Now one more thing, interestingly enough, here's where we begin our journey away from the accountants.

301
00:30:12,000 --> 00:30:23,000
Now if you look here, we are, you get to EBIT, we don't, the accountants don't calculate tax there,

302
00:30:23,000 --> 00:30:34,000
they subtract out interest expense. We don't. Why? Because we are in the business of operations.

303
00:30:34,000 --> 00:30:41,000
What makes the company sell products and get revenues from them?

304
00:30:41,000 --> 00:30:50,000
Interest expense and dividends and all those things, that's after we see if we've got enough money to do it.

305
00:30:50,000 --> 00:30:59,000
In other words, we would worry about those after we see what operations have done for the company.

306
00:30:59,000 --> 00:31:08,000
So that's the first thing is that we stop here and calculate our taxes and we jump over interest expense

307
00:31:08,000 --> 00:31:13,000
because interest expense doesn't cause operations.

308
00:31:13,000 --> 00:31:21,000
Do you have any bills to pay like credit cards, madam? No? Oh, fine.

309
00:31:21,000 --> 00:31:26,000
Someday you will. I want to see you in debt up to your ears.

310
00:31:26,000 --> 00:31:32,000
This pisses me off. No, I've never heard of debt. Good God.

311
00:31:32,000 --> 00:31:40,000
Okay, realistically though, a company, it's got to pay interest expense every time it's due or it's out of business.

312
00:31:40,000 --> 00:31:45,000
So why are we ignoring it here? Well, think about it this way.

313
00:31:45,000 --> 00:31:50,000
All right, guys, on the assembly line, we paid our interest expense. Everyone crank up now.

314
00:31:50,000 --> 00:31:54,000
No, they don't. What the hell are you talking about?

315
00:31:54,000 --> 00:32:01,000
It has nothing to do with the operating of the company, making the products, getting them on the shelves, selling the product.

316
00:32:01,000 --> 00:32:14,000
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.

317
00:32:14,000 --> 00:32:25,000
So that's why we get there. Now, we have a name for this.

318
00:32:25,000 --> 00:32:39,000
NoPACT, Net Operating Profit After Taxes. NoPACT.

319
00:32:39,000 --> 00:32:51,000
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.

320
00:32:51,000 --> 00:32:57,000
It is in here somewhere. If it's not, then you all have to subtract it out independently.

321
00:32:57,000 --> 00:33:03,000
But usually companies put it in their overall costs, operating costs.

322
00:33:03,000 --> 00:33:09,000
And the reason we leave it there is because it does create a tax shield.

323
00:33:09,000 --> 00:33:17,000
See, I told you about the lens that I have $4,500 actually went out. But every year I subtract $900.

324
00:33:17,000 --> 00:33:22,000
There was no $900 anywhere in my purchase or use of the equipment.

325
00:33:22,000 --> 00:33:32,000
However, it does protect some of that revenue from getting taxed. It drops the net a little bit.

326
00:33:32,000 --> 00:33:38,000
So that's why we have to leave it in there so that we can have it do its tax shield there.

327
00:33:38,000 --> 00:33:46,000
But once that's happened, then we have to add it back in. The whole thing, depreciation expense.

328
00:33:46,000 --> 00:33:55,000
We add it back because it wasn't a real cash flow.

329
00:33:55,000 --> 00:33:59,000
And then we have to subtract a few things.

330
00:33:59,000 --> 00:34:07,000
And minus, traditionally we put these two in parentheses together and add them.

331
00:34:07,000 --> 00:34:17,000
The first one is capital expenditures, what you actually did spend. Capital expenditures.

332
00:34:17,000 --> 00:34:20,000
What you actually spent.

333
00:34:20,000 --> 00:34:34,000
And then this little bugger right here, the change in net operating working capital, Now.

334
00:34:34,000 --> 00:34:49,000
Here's the side calculation. Net operating working capital is your current operating assets minus your current operating liabilities.

335
00:34:49,000 --> 00:34:55,000
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?

336
00:34:55,000 --> 00:35:05,000
It's this. Most of your current assets are operating. Most of your current liabilities are operating.

337
00:35:05,000 --> 00:35:14,000
It's just that we kind of, current assets, we just take current assets. It's easier to do it. We're lazy.

338
00:35:14,000 --> 00:35:23,000
Current liabilities are the same way. Technically I could take out the non-operating current assets

339
00:35:23,000 --> 00:35:31,000
and the non-operating current liabilities, but life is short. We're not going to do that.

340
00:35:31,000 --> 00:35:38,000
Don't do it yourself. That's why you'll hear me sometimes say, I'm doing a dirty free cash flow.

341
00:35:38,000 --> 00:35:44,000
Because little minor things that I really should do, I don't.

342
00:35:44,000 --> 00:35:51,000
But the numbers come out very close to what they would be if I got in every tiny little detail.

343
00:35:51,000 --> 00:35:57,000
Okay, so in order to get net operating working capital for a year, I take the current assets of the year

344
00:35:57,000 --> 00:36:10,000
minus the current liabilities. Now the change would be delta, N-O-W-C, would be the net operating working capital

345
00:36:10,000 --> 00:36:19,000
for the current year, sub-zero, minus the net operating working capital for the previous year, sub-negative one.

346
00:36:19,000 --> 00:36:29,000
And that will tell me on net, has your net operating working capital gone up or gone down

347
00:36:29,000 --> 00:36:42,000
from the previous year to the current year? That would tell us how much cash has been freed up or depleted.

348
00:36:42,000 --> 00:37:00,000
If delta, N-O-W-C goes up, free cash flow is hurt, goes down.

349
00:37:00,000 --> 00:37:08,000
If net operating working capital goes down, then free cash flow is helped.

350
00:37:08,000 --> 00:37:25,000
See, because my net operating working capital goes up, that tells me that cash has been absorbed into your current affairs.

351
00:37:25,000 --> 00:37:33,000
If net operating working capital went down, that would mean that you have freed up some capital.

352
00:37:33,000 --> 00:37:40,000
Like, suppose my inventories go down. Well, that means that I didn't spend as much money as I did last year,

353
00:37:40,000 --> 00:37:53,000
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.

354
00:37:53,000 --> 00:37:59,000
That would mean that I'm keeping some money in my pocket that I should have paid in wages.

355
00:37:59,000 --> 00:38:04,000
So that's the logic of that. Just put it as a sidebar calculation.

356
00:38:04,000 --> 00:38:10,000
It's one of those, if you've got it somewhere where you can get to it in notes or on a note card,

357
00:38:10,000 --> 00:38:18,000
it's an easy question that I almost always ask somewhere on a quiz or an exam.

358
00:38:18,000 --> 00:38:28,000
Sometimes I do it more than once. And at first it seems counterintuitive, but the more you do it, the more it kind of makes sense.

359
00:38:28,000 --> 00:38:38,000
But anyway, here it is, the free cash flow calculation in a nutshell.

360
00:38:38,000 --> 00:38:46,000
So we'll do that first so that you can see how we use Excel.

361
00:38:46,000 --> 00:38:50,000
Now, a couple of things, and I think I said this in the last class.

362
00:38:50,000 --> 00:38:57,000
You are in your professional work, you should use the keyboard and not the mouse.

363
00:38:57,000 --> 00:39:03,000
I do the mouse in this class because you wouldn't be able to see what I'm doing on the keyboard.

364
00:39:03,000 --> 00:39:12,000
And anyway, I still use the mouse sometimes. I can't remember every keyboard command to get something.

365
00:39:12,000 --> 00:39:19,000
Now, the second thing is, this is what you would be expected to do.

366
00:39:19,000 --> 00:39:29,000
This is what I'm going to do here. This would be basic stuff that you would be expected to just do in a corporate job,

367
00:39:29,000 --> 00:39:35,000
to work out models, to do some financial model.

368
00:39:35,000 --> 00:39:43,000
So kind of follow along and keep yourself informed about, well, can I do this on my own?

369
00:39:43,000 --> 00:39:52,000
Can I be able to do this? If the answer is yes, you should be able to say, I know Excel.

370
00:39:52,000 --> 00:39:55,000
Well, at least that gives you a little more justification.

371
00:39:55,000 --> 00:40:01,000
If this is fogging you, then I'll work with you for the rest of the course, getting you up to speed,

372
00:40:01,000 --> 00:40:05,000
and that's why I require the certifications. This isn't just finance.

373
00:40:05,000 --> 00:40:12,000
This is any kind of corporate job where you'll be expected to use Excel from time to time.

374
00:40:12,000 --> 00:40:27,000
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.

375
00:40:27,000 --> 00:40:30,000
I'm going to jump down a line here to start this.

376
00:40:30,000 --> 00:40:37,000
Now, what are the pieces we're going to need? Okay, I'm going to need operating income.

377
00:40:37,000 --> 00:40:42,000
I can pick that up off the income statement. I don't have to do revenue and costs.

378
00:40:42,000 --> 00:40:46,000
It'll be there for me. It has to be. That's required.

379
00:40:46,000 --> 00:41:02,000
Free operating income or EBIT.

380
00:41:02,000 --> 00:41:12,000
Now, the next thing I'm going to need is the tax rate, and that is always going to be 21%.

381
00:41:12,000 --> 00:41:19,000
Now, you can put.21 or you can type T, 21%.

382
00:41:19,000 --> 00:41:28,000
I usually do it as a percentage because it's visually more elegant to show what we would say in language.

383
00:41:28,000 --> 00:41:33,000
Well, the top tax rate is.21. No, the top tax rate is 21%.

384
00:41:33,000 --> 00:41:36,000
That's why I do it in more common language there.

385
00:41:36,000 --> 00:41:38,000
Okay, what else are we going to need?

386
00:41:38,000 --> 00:41:47,000
Well, that means that with those two, I can get no pat.

387
00:41:47,000 --> 00:41:58,000
Then the next thing is I'll need the depreciation expense.

388
00:41:58,000 --> 00:42:12,000
Below that, I'll need the capital expenditures.

389
00:42:12,000 --> 00:42:18,000
And then I'm going to have to do a little bit of quick side calculation.

390
00:42:18,000 --> 00:42:22,000
First, I'll need the current assets.

391
00:42:22,000 --> 00:42:27,000
Well, let's do it this way.

392
00:42:27,000 --> 00:42:38,000
And I'll need the current liabilities.

393
00:42:38,000 --> 00:42:49,000
And from those two, I can get the net operating working capital.

394
00:42:49,000 --> 00:42:56,000
And I don't abbreviate too much in here because that just makes me go faster and leaves you further behind,

395
00:42:56,000 --> 00:43:00,000
especially when you go back to look.

396
00:43:00,000 --> 00:43:15,000
And then from those two, I can get the change in net operating working capital.

397
00:43:15,000 --> 00:43:29,000
And those all will leave us with nothing but the calculation of free cash flow.

398
00:43:29,000 --> 00:43:50,000
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.

399
00:43:50,000 --> 00:44:03,000
And I'll let you catch up here for a minute.

400
00:44:03,000 --> 00:44:06,000
Okay.

401
00:44:06,000 --> 00:44:12,000
Lock and load.

402
00:44:12,000 --> 00:44:14,000
Operating income.

403
00:44:14,000 --> 00:44:18,000
If you don't know how to do this, watch.

404
00:44:18,000 --> 00:44:20,000
I'm going to say equals.

405
00:44:20,000 --> 00:44:25,000
Now, operating income is going to come on the income statement.

406
00:44:25,000 --> 00:44:31,000
So I say equals, then I click on the worksheet called consolidated statement of operations.

407
00:44:31,000 --> 00:44:34,000
And I prowl around here.

408
00:44:34,000 --> 00:44:36,000
There it is.

409
00:44:36,000 --> 00:44:38,000
EBIT, they call it.

410
00:44:38,000 --> 00:44:44,000
And I click on that 799 at cell B17.

411
00:44:44,000 --> 00:44:54,000
And just hit enter. And there it is.

412
00:44:54,000 --> 00:45:04,000
And then I can just grab that little, whoops, grab that little, what the heck?

413
00:45:04,000 --> 00:45:05,000
Why is it doing that?

414
00:45:05,000 --> 00:45:20,000
Why did I change that?

415
00:45:20,000 --> 00:45:24,000
What in the world is going wrong here?

416
00:45:24,000 --> 00:45:38,000
Okay. Now, see that 799? I'm just going to put the cell I'm on and then just drag it over.

417
00:45:38,000 --> 00:45:49,000
And it copies the previous years.

418
00:45:49,000 --> 00:45:54,000
Now, NOPAT.

419
00:45:54,000 --> 00:45:59,000
NOPAT will be equal to, whoa, let me do something here real quick.

420
00:45:59,000 --> 00:46:04,000
In cell E, I'm going to, for you, I'm going to upload this later this evening.

421
00:46:04,000 --> 00:46:12,000
In cell E3, I'm going to type where I got it.

422
00:46:12,000 --> 00:46:16,000
Income statement.

423
00:46:16,000 --> 00:46:27,000
And the tax rate in cell E4, given.

424
00:46:27,000 --> 00:46:30,000
Okay, so now NOPAT.

425
00:46:30,000 --> 00:46:39,000
NOPAT is nothing but equal to operating income times, open parenthesis,

426
00:46:39,000 --> 00:46:46,000
one minus the tax rate at B4.

427
00:46:46,000 --> 00:46:47,000
But I've got to be careful here.

428
00:46:47,000 --> 00:46:52,000
I'm going to hit F4 right now to make that an absolute reference

429
00:46:52,000 --> 00:46:58,000
so that when I drag it across, it leaves that 21% in place.

430
00:46:58,000 --> 00:47:03,000
Close the parenthesis, there.

431
00:47:03,000 --> 00:47:05,000
Why does it keep doing that?

432
00:47:05,000 --> 00:47:12,000
Now I'm going to take this and drag it across from 2023 through 2021.

433
00:47:12,000 --> 00:47:19,000
And over here in the E column, I'll write calculated.

434
00:47:19,000 --> 00:47:26,000
If I try to not look at the keyboard and talk.

435
00:47:26,000 --> 00:47:33,000
Okay, so there we go.

436
00:47:33,000 --> 00:47:39,000
Let you catch up to me.

437
00:47:39,000 --> 00:47:43,000
Now you're pretty proficient in Excel as far as getting things done,

438
00:47:43,000 --> 00:47:46,000
but I do want to not run over you on this.

439
00:47:46,000 --> 00:47:50,000
Now the depreciation expense, B6.

440
00:47:50,000 --> 00:47:54,000
Now the best place to get this is off the statement of cash flows,

441
00:47:54,000 --> 00:47:56,000
because I know it will be there.

442
00:47:56,000 --> 00:47:58,000
It could be in the income statement too,

443
00:47:58,000 --> 00:48:01,000
but I know it will be in the statement of cash flows.

444
00:48:01,000 --> 00:48:09,000
So I'll say equals, and then I'm going to shuttle over here to the statement of cash flows.

445
00:48:09,000 --> 00:48:22,000
And there it is in the statement of cash flows on cell B6, 916.

446
00:48:22,000 --> 00:48:27,000
Now I'll scoot that one all the way over.

447
00:48:27,000 --> 00:48:41,000
And now I'm going to type in the E column for that one, statement of cash flows.

448
00:48:41,000 --> 00:48:48,000
This will help guide you back if you wonder where I got things.

449
00:48:48,000 --> 00:48:54,000
Now the next one is a little bit of a, you're going to have to remember something.

450
00:48:54,000 --> 00:48:59,000
The capital expenditures are going to be in the statement of cash flows.

451
00:48:59,000 --> 00:49:04,000
However, they are reported there as a negative.

452
00:49:04,000 --> 00:49:08,000
You don't want that because you're going to subtract them right there.

453
00:49:08,000 --> 00:49:12,000
So here's how we do that.

454
00:49:12,000 --> 00:49:16,000
In cell B7, capital expenditures, I'm going to say equals,

455
00:49:16,000 --> 00:49:20,000
and before I run over there and grab that in the statement of cash flows,

456
00:49:20,000 --> 00:49:24,000
I'm going to type ABS, open parenthesis.

457
00:49:24,000 --> 00:49:29,000
In other words, take the absolute value of this.

458
00:49:29,000 --> 00:49:35,000
And now I can go over to the statement of cash flows.

459
00:49:35,000 --> 00:49:38,000
Now, down here, let's go to the statement of cash flows.

460
00:49:38,000 --> 00:49:41,000
You go to investment, investing activities.

461
00:49:41,000 --> 00:49:43,000
You see, it's a negative.

462
00:49:43,000 --> 00:49:46,000
You don't want it to be a negative because you're going to subtract it.

463
00:49:46,000 --> 00:49:48,000
You follow?

464
00:49:48,000 --> 00:49:55,000
Now, you notice that there are other items below that.

465
00:49:55,000 --> 00:50:03,000
You don't want those because those are probably non-operating expenditures.

466
00:50:03,000 --> 00:50:05,000
You want that top one.

467
00:50:05,000 --> 00:50:10,000
In this sheet, it would be B25.

468
00:50:10,000 --> 00:50:16,000
Now, some people say, well, just take the net one at the bottom of the investing activities.

469
00:50:16,000 --> 00:50:18,000
I say you probably don't want to do that.

470
00:50:18,000 --> 00:50:21,000
Even if you did it, they're trivial.

471
00:50:21,000 --> 00:50:26,000
They're usually, in this case, there's only one that has a positive entry.

472
00:50:26,000 --> 00:50:34,000
But overall, these numbers after the big dog in B25, they're trivial.

473
00:50:34,000 --> 00:50:37,000
They're not operating anyway.

474
00:50:37,000 --> 00:50:44,000
So I'm just going to leave it, close my parenthesis, boom.

475
00:50:44,000 --> 00:50:52,000
Now, I'm going to take that B7 and I'm going to drag it across.

476
00:50:52,000 --> 00:50:57,000
And I'm going to type that also.

477
00:50:57,000 --> 00:51:07,000
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.

478
00:51:07,000 --> 00:51:15,000
And then you go to the cell where you want to paste it and hit control V if you want to do it fast.

479
00:51:15,000 --> 00:51:19,000
Now, we've done that.

480
00:51:19,000 --> 00:51:25,000
Now, current assets, well, those will be on the balance sheet.

481
00:51:25,000 --> 00:51:34,000
Equals, where the hell are current assets?

482
00:51:34,000 --> 00:51:40,000
Total current, come on, for heaven's sake, there they are.

483
00:51:40,000 --> 00:51:43,000
6943, cell B7.

484
00:51:43,000 --> 00:51:47,000
Okay, that one's done.

485
00:51:47,000 --> 00:51:53,000
Current liabilities, just go over and find those.

486
00:51:53,000 --> 00:52:03,000
Equals, go to the balance sheet, find your total current liabilities, which here are cell B22.

487
00:52:03,000 --> 00:52:18,000
Net operating working capital is just equal to cell B8 minus cell B9.

488
00:52:18,000 --> 00:52:31,000
Now, I can take those three cells, B8, B9, and B10, and I'm going to slide them over.

489
00:52:31,000 --> 00:52:35,000
But I'm going to take only one over.

490
00:52:35,000 --> 00:52:39,000
Why?

491
00:52:39,000 --> 00:52:41,000
Well, here it is.

492
00:52:41,000 --> 00:52:43,000
The balance sheet is only two years.

493
00:52:43,000 --> 00:52:45,000
I've got only two years.

494
00:52:45,000 --> 00:52:52,000
So if I slid it over another year, I'd get the error, pound symbol, and all that.

495
00:52:52,000 --> 00:52:54,000
Okay.

496
00:52:54,000 --> 00:53:03,000
Now, if I wanted, I could find the December 2021 entries for the balance sheet

497
00:53:03,000 --> 00:53:07,000
and put those in there, but life is short.

498
00:53:07,000 --> 00:53:16,000
So the change in net operating working capital for 2023, you just take cell B10

499
00:53:16,000 --> 00:53:26,000
minus cell C10, and there it is, negative 912.

500
00:53:26,000 --> 00:53:35,000
So your change in net operating working capital was $912 million.

501
00:53:35,000 --> 00:53:37,000
Look there.

502
00:53:37,000 --> 00:53:46,000
In other words, they freed up almost $1 billion in free cash flow.

503
00:53:46,000 --> 00:53:52,000
They cut some things down that were current assets, increased some things that were

504
00:53:52,000 --> 00:54:02,000
current liabilities, and the net effect was to free up cash flow for the current year.

505
00:54:02,000 --> 00:54:05,000
For the year just ended, I should say.

506
00:54:05,000 --> 00:54:11,000
Okay, here's the holy grail, the free cash flow.

507
00:54:11,000 --> 00:54:15,000
And I'll be able to do this for only one year because I have only one year of change

508
00:54:15,000 --> 00:54:17,000
in net operating working capital.

509
00:54:17,000 --> 00:54:21,000
Equals, okay, go here, notepad.

510
00:54:21,000 --> 00:54:22,000
Where the hell is it?

511
00:54:22,000 --> 00:54:26,000
Up here, it's cell B5.

512
00:54:26,000 --> 00:54:36,000
Well, I've already done that, so plus depreciation expense, cell B6,

513
00:54:36,000 --> 00:54:45,000
minus open parenthesis, capital expenditures, plus change in net operating working capital,

514
00:54:45,000 --> 00:54:53,000
close the parentheses.

515
00:54:53,000 --> 00:54:59,000
And what will come out of there is what really happened, the real story.

516
00:54:59,000 --> 00:55:05,000
And it is, survey says, negative $117 million.

517
00:55:05,000 --> 00:55:13,000
In other words, they were in the hole in actual cash that they had to use to pay all

518
00:55:13,000 --> 00:55:16,000
of those other accounting entries.

519
00:55:16,000 --> 00:55:22,000
They were in the hole $117 million.

520
00:55:22,000 --> 00:55:24,000
That's not money, that's not just an abstraction.

521
00:55:24,000 --> 00:55:27,000
They had to have that money.

522
00:55:27,000 --> 00:55:32,000
In order to have paid those items that you saw in the rest of those financial statements,

523
00:55:32,000 --> 00:55:34,000
they had to have that money.

524
00:55:34,000 --> 00:55:36,000
So how did that happen?

525
00:55:36,000 --> 00:55:38,000
Where did it come from?

526
00:55:38,000 --> 00:55:41,000
Well, there are a couple of places.

527
00:55:41,000 --> 00:55:48,000
The first thing is they could dig into their retained earnings.

528
00:55:48,000 --> 00:55:53,000
Now, retained earnings are one type of equity.

529
00:55:53,000 --> 00:56:01,000
This is what the company has put into the bank, as it were, over the years previous.

530
00:56:01,000 --> 00:56:05,000
The buildup of profits of the company are there.

531
00:56:05,000 --> 00:56:08,000
That would be the first place they would reach.

532
00:56:08,000 --> 00:56:12,000
That retained earnings belongs to the shareholders.

533
00:56:12,000 --> 00:56:15,000
We, in fact, have a name for it.

534
00:56:15,000 --> 00:56:25,000
The first place, well, they would dig retained earnings.

535
00:56:25,000 --> 00:56:28,000
We call that internally generated equity.

536
00:56:28,000 --> 00:56:39,000
This is the shareholders' money that was generated by its operations in the past.

537
00:56:39,000 --> 00:56:45,000
So that would be the first place you would go to get the money.

538
00:56:45,000 --> 00:56:51,000
Another kind of equity would be new stock.

539
00:56:51,000 --> 00:56:55,000
They could sell new stock.

540
00:56:55,000 --> 00:57:02,000
That would be called externally generated equity, new owners.

541
00:57:02,000 --> 00:57:12,000
Sell some stock and get the money to pay off, pay your bills.

542
00:57:12,000 --> 00:57:17,000
Or they could use debt, borrow.

543
00:57:17,000 --> 00:57:23,000
They could borrow to do it.

544
00:57:23,000 --> 00:57:29,000
Now, a couple of interesting things.

545
00:57:29,000 --> 00:57:33,000
Right away, they're in the hole $117 million.

546
00:57:33,000 --> 00:57:39,000
They have got to get that because that's how they're going to pay their bills

547
00:57:39,000 --> 00:57:45,000
that they weren't able to pay through their operations.

548
00:57:45,000 --> 00:57:50,000
That would be how they would pay other things.

549
00:57:50,000 --> 00:57:52,000
Let's look over here real quick.

550
00:57:52,000 --> 00:57:58,000
Let me pull up US Steel again.

551
00:57:58,000 --> 00:58:02,000
They paid a dividend.

552
00:58:02,000 --> 00:58:05,000
They gave their shareholders money.

553
00:58:05,000 --> 00:58:12,000
In other words, that's $117 million if you look back through where the numbers came from.

554
00:58:12,000 --> 00:58:17,000
Some of that is what they paid their shareholders in dividends.

555
00:58:17,000 --> 00:58:18,000
Now, understand this.

556
00:58:18,000 --> 00:58:22,000
If you don't pay your debt holders, they'll turn you off.

557
00:58:22,000 --> 00:58:26,000
They'll take you right into bankruptcy, and you have to run to a bankruptcy court

558
00:58:26,000 --> 00:58:30,000
to protect you from them liquidating your company.

559
00:58:30,000 --> 00:58:35,000
But what can the shareholders do if you don't pay them a dividend?

560
00:58:35,000 --> 00:58:37,000
All they can do is cry.

561
00:58:37,000 --> 00:58:49,000
So why in the heck is US Steel paying its shareholders a dividend?

562
00:58:49,000 --> 00:58:50,000
Yeah?

563
00:58:50,000 --> 00:58:55,000
No, that wouldn't be it.

564
00:58:55,000 --> 00:58:57,000
Let's take you.

565
00:58:57,000 --> 00:58:59,000
Turns out you're my son.

566
00:58:59,000 --> 00:59:01,000
I know, easy.

567
00:59:01,000 --> 00:59:04,000
We're still in a story here.

568
00:59:04,000 --> 00:59:09,000
Now, every year on your birthday, I give you $10,000.

569
00:59:09,000 --> 00:59:13,000
That's why you like me.

570
00:59:13,000 --> 00:59:17,000
Now, this last year, I've been having problems.

571
00:59:17,000 --> 00:59:21,000
I lost my job, and I'm getting back on my feet.

572
00:59:21,000 --> 00:59:25,000
But I'm still going to give you that $10,000.

573
00:59:25,000 --> 00:59:30,000
Why?

574
00:59:30,000 --> 00:59:33,000
Any idea?

575
00:59:33,000 --> 00:59:35,000
So you'll still like me.

576
00:59:35,000 --> 00:59:40,000
Dividends are given to shareholders as a signal.

577
00:59:40,000 --> 00:59:43,000
They signal, we're doing okay.

578
00:59:43,000 --> 00:59:46,000
Everything is fine with our company.

579
00:59:46,000 --> 00:59:50,000
In fact, the Wall Street boys, if I don't pay a dividend,

580
00:59:50,000 --> 00:59:55,000
those Wall Street firms that have massive amounts of my stock in their portfolios,

581
00:59:55,000 --> 00:59:57,000
they're going to kick my ass.

582
00:59:57,000 --> 00:59:59,000
They're going to sell my stock.

583
00:59:59,000 --> 01:00:02,000
They're going to have a conference call with us

584
01:00:02,000 --> 01:00:07,000
and put the squeeze to our board of directors to get rid of upper management

585
01:00:07,000 --> 01:00:09,000
and to get rid of the board itself.

586
01:00:09,000 --> 01:00:15,000
Yeah, I'm going to give that dividend just to keep them from getting upset.

587
01:00:15,000 --> 01:00:20,000
We didn't understand it for a long, long time

588
01:00:20,000 --> 01:00:25,000
why companies would give dividends even if they were in great trouble.

589
01:00:25,000 --> 01:00:32,000
Then came along 20 years ago signaling theory, which had been around forever.

590
01:00:32,000 --> 01:00:34,000
And it answers the question.

591
01:00:34,000 --> 01:00:35,000
It's a signal.

592
01:00:35,000 --> 01:00:36,000
We're doing okay.

593
01:00:36,000 --> 01:00:37,000
Don't worry.

594
01:00:37,000 --> 01:00:39,000
Everything is okay.

595
01:00:39,000 --> 01:00:42,000
And that's what's going on here.

596
01:00:42,000 --> 01:00:47,000
The U.S. deal is going to keep paying its dividend saying everything is good.

597
01:00:47,000 --> 01:00:48,000
We're fine.

598
01:00:48,000 --> 01:00:49,000
We're fine.

599
01:00:49,000 --> 01:00:52,000
Just to keep that from happening.

600
01:00:52,000 --> 01:00:55,000
Now, something much more important.

601
01:00:55,000 --> 01:00:57,000
Let me take you back to the spreadsheet.

602
01:00:57,000 --> 01:01:01,000
And let's have a quick look here.

603
01:01:01,000 --> 01:01:08,000
Free cash flow is negative $117 million.

604
01:01:08,000 --> 01:01:12,000
Now, it doesn't take a rocket scientist to figure that that's a bad thing.

605
01:01:12,000 --> 01:01:14,000
Oh, but wait a minute.

606
01:01:14,000 --> 01:01:19,000
Let's look at what the accountants say and what all the talking heads say.

607
01:01:19,000 --> 01:01:22,000
Oh, U.S. deal, well, look at this.

608
01:01:22,000 --> 01:01:27,000
Their net earnings are positive $895 million.

609
01:01:27,000 --> 01:01:29,000
Great company.

610
01:01:29,000 --> 01:01:30,000
By God, slap them on the ass.

611
01:01:30,000 --> 01:01:33,000
They're doing good.

612
01:01:33,000 --> 01:01:35,000
We know they're not.

613
01:01:35,000 --> 01:01:38,000
That's the whole problem with accounting.

614
01:01:38,000 --> 01:01:43,000
It isn't showing what really happened.

615
01:01:43,000 --> 01:01:46,000
You, madam, are my daughter.

616
01:01:46,000 --> 01:01:53,000
You come in wearing a nice suit, looking great, hair really good.

617
01:01:53,000 --> 01:02:01,000
You put some heavy makeup over the tattoo you got because you were dating a biker named Nick.

618
01:02:01,000 --> 01:02:06,000
So you had Nick on.

619
01:02:06,000 --> 01:02:18,000
But if I were to do a CT scan of you, you, I told you, my doctor said if the body is a temple,

620
01:02:18,000 --> 01:02:22,000
you, Professor Crane, are a Baptist revival tent.

621
01:02:22,000 --> 01:02:23,000
Yeah.

622
01:02:23,000 --> 01:02:27,000
Inside, we know you're not doing okay.

623
01:02:27,000 --> 01:02:29,000
That's what's going on here.

624
01:02:29,000 --> 01:02:34,000
It's the accounting financial statements are telling a surface story.

625
01:02:34,000 --> 01:02:41,000
And we have to dig in because we are responsible for advising on investments,

626
01:02:41,000 --> 01:02:48,000
for preparing a company to fix the problems instead of pretending they aren't there.

627
01:02:48,000 --> 01:02:50,000
That's what we do.

628
01:02:50,000 --> 01:02:57,000
And that's why you'll see this company is profitable, nearly a billion dollars profit, by golly.

629
01:02:57,000 --> 01:02:59,000
And we're looking at it.

630
01:02:59,000 --> 01:03:01,000
No, it's not.

631
01:03:01,000 --> 01:03:03,000
It's bleeding.

632
01:03:03,000 --> 01:03:08,000
Bleeding $117 million in real free cash flow.

633
01:03:08,000 --> 01:03:10,000
That's the whole thing.

634
01:03:10,000 --> 01:03:15,000
There are many, many companies and billionaires and millionaires.

635
01:03:15,000 --> 01:03:19,000
On paper, they're fantastic.

636
01:03:19,000 --> 01:03:24,000
But in reality, they are a disaster.

637
01:03:24,000 --> 01:03:31,000
And oftentimes, they and all of the media and all of their acolytes just keep telling them,

638
01:03:31,000 --> 01:03:35,000
damn good, you're great, you're awesome.

639
01:03:35,000 --> 01:03:39,000
And no one has the guts to say, you are a mess.

640
01:03:39,000 --> 01:03:41,000
And that's what we have to do.

641
01:03:41,000 --> 01:03:45,000
That's why we are different in our world.

642
01:03:45,000 --> 01:03:49,000
We have to tell the truth, not just to the investors but to the company.

643
01:03:49,000 --> 01:03:51,000
We have to speak the truth to the power.

644
01:03:51,000 --> 01:03:55,000
And that's what's going on here with U.S. Steel.

645
01:03:55,000 --> 01:04:00,000
So now digging in, and I'm not going to do a lot of this today.

646
01:04:00,000 --> 01:04:02,000
I'll save it for Monday.

647
01:04:02,000 --> 01:04:04,000
The ratio analysis.

648
01:04:04,000 --> 01:04:11,000
And if you look back, did I delete that Dagon sheet?

649
01:04:11,000 --> 01:04:12,000
Well, let me pull it back up.

650
01:04:12,000 --> 01:04:14,000
It should be in downloads.

651
01:04:14,000 --> 01:04:16,000
Yeah.

652
01:04:16,000 --> 01:04:25,000
Financial analysis sheet.

653
01:04:25,000 --> 01:04:28,000
Now, these ratios, oh, shut up.

654
01:04:28,000 --> 01:04:29,000
Quit it.

655
01:04:29,000 --> 01:04:30,000
Leave me alone.

656
01:04:30,000 --> 01:04:31,000
Get off me.

657
01:04:31,000 --> 01:04:32,000
Okay.

658
01:04:32,000 --> 01:04:38,000
Now, this sheet, these are the ones, almost all of these are in your textbook too.

659
01:04:38,000 --> 01:04:43,000
But here's a sheet with just these on it.

660
01:04:43,000 --> 01:04:49,000
You might want to even get this made into a poster and put it up in your living room.

661
01:04:49,000 --> 01:04:52,000
It's just, okay, maybe not.

662
01:04:52,000 --> 01:04:59,000
But there are a few in here, I can think of one, that isn't in your book.

663
01:04:59,000 --> 01:05:06,000
It was around for decades, but then somewhere along the way it just fell out of favor.

664
01:05:06,000 --> 01:05:15,000
Well, in the past couple of years, this ratio has begun to be really, really important.

665
01:05:15,000 --> 01:05:18,000
And companies are beginning to pay attention to it.

666
01:05:18,000 --> 01:05:21,000
Investment analysts are beginning to pay attention to it.

667
01:05:21,000 --> 01:05:29,000
In fact, here at Illinois State, a course that went away years ago was brought back.

668
01:05:29,000 --> 01:05:33,000
And they looked around and they saw me and they said, okay, you can teach us.

669
01:05:33,000 --> 01:05:35,000
Well, yeah, I can.

670
01:05:35,000 --> 01:05:38,000
It is about the most boring course you could ever want.

671
01:05:38,000 --> 01:05:40,000
It sucks the life out of you.

672
01:05:40,000 --> 01:05:42,000
It just turns you into beef jer-.

673
01:05:42,000 --> 01:05:45,000
No, anyway, but it's so important.

674
01:05:45,000 --> 01:05:47,000
It's the cash management course.

675
01:05:47,000 --> 01:05:51,000
And I've got a ratio we used to use, but we haven't used.

676
01:05:51,000 --> 01:05:55,000
It's in the liquidity ratios, this burn ratio.

677
01:05:55,000 --> 01:05:58,000
It's also sometimes called the cash ratio.

678
01:05:58,000 --> 01:06:03,000
Matter of fact, quick ratio, you'll oftentimes hear that called the acid test.

679
01:06:03,000 --> 01:06:10,000
But these two, and especially this cash ratio, suddenly, well, gee, cash is king.

680
01:06:10,000 --> 01:06:14,000
If you can't survive in the short run, there ain't no long run.

681
01:06:14,000 --> 01:06:16,000
So that one's in there that you won't see in the book.

682
01:06:16,000 --> 01:06:24,000
And the rest of these, again, if you use them enough, you'll memorize them, as I have.

683
01:06:24,000 --> 01:06:27,000
Matter of fact, sometimes you'll even see me go back to this sheet.

684
01:06:27,000 --> 01:06:32,000
It's more important that you know what they're telling us, what they're saying,

685
01:06:32,000 --> 01:06:38,000
what the whispers are behind those raw numbers that you see on financial statements.

686
01:06:38,000 --> 01:06:47,000
So the liquidity ratios, they simply say how many times over can you pay your current assets with your current liabilities?

687
01:06:47,000 --> 01:06:51,000
So in other words, if I've got a liquidity ratio of 1.0,

688
01:06:51,000 --> 01:06:56,000
I've got just enough current assets to pay my current liabilities.

689
01:06:56,000 --> 01:06:58,000
If it's much above 1, well, that's one thing.

690
01:06:58,000 --> 01:07:01,000
If it's much below 1, that's another thing.

691
01:07:01,000 --> 01:07:03,000
Things like the asset activity ratios.

692
01:07:03,000 --> 01:07:06,000
There's that inventory turnover ratio I was telling you about.

693
01:07:06,000 --> 01:07:12,000
This tells you how hard your assets are working for you.

694
01:07:12,000 --> 01:07:18,000
The profitability ratio is similar.

695
01:07:18,000 --> 01:07:27,000
It's actually measuring in percentage what your profit margins are.

696
01:07:27,000 --> 01:07:31,000
Your gross margin, your operating margin, your net margin.

697
01:07:31,000 --> 01:07:34,000
Now that's important because when you're comparing two companies,

698
01:07:34,000 --> 01:07:40,000
their raw numbers could be vastly different, millions versus billions.

699
01:07:40,000 --> 01:07:46,000
But if we turn them into percentages, then we're comparing apples to apples.

700
01:07:46,000 --> 01:07:53,000
And then we can compare a billion-dollar company with a $10 million company.

701
01:07:53,000 --> 01:07:55,000
And that's the way it is with a lot of these.

702
01:07:55,000 --> 01:08:00,000
Now I'll just go through a couple of quick ones with you to finish the day.

703
01:08:00,000 --> 01:08:05,000
Okay, ratios.

704
01:08:05,000 --> 01:08:06,000
Come down here.

705
01:08:06,000 --> 01:08:10,000
First one, we'll do liquidity, and that's the only ones I'll do today.

706
01:08:10,000 --> 01:08:12,000
A couple of those.

707
01:08:12,000 --> 01:08:17,000
Now the current ratio.

708
01:08:17,000 --> 01:08:26,000
The quick ratio, which is sometimes called the acid test.

709
01:08:26,000 --> 01:08:36,000
And then the burn ratio, sometimes called the cash ratio.

710
01:08:36,000 --> 01:08:38,000
And these are just like I did before.

711
01:08:38,000 --> 01:08:40,000
All you do is go to the different sheets.

712
01:08:40,000 --> 01:08:46,000
The liquidity ratio, the current ratio, that's current assets over current liabilities.

713
01:08:46,000 --> 01:08:51,000
Equals, go over here to the balance sheet.

714
01:08:51,000 --> 01:08:53,000
Okay, where's current assets?

715
01:08:53,000 --> 01:09:00,000
Total current assets divided by total current liabilities.

716
01:09:00,000 --> 01:09:05,000
And that's about 1.76.

717
01:09:05,000 --> 01:09:13,000
That means that they can overall, if they liquidated all of their current assets today,

718
01:09:13,000 --> 01:09:19,000
they could pay all of their current liabilities 1.76 times over.

719
01:09:19,000 --> 01:09:26,000
Now the units on these are, for these ratios, are time symbol.

720
01:09:26,000 --> 01:09:35,000
Now the quick ratio is similar, but it says, yeah, but, I mean, really, you take your current assets.

721
01:09:35,000 --> 01:09:37,000
Fine.

722
01:09:37,000 --> 01:09:38,000
Total current assets.

723
01:09:38,000 --> 01:09:44,000
But inventory, you can't liquidate that at what the accountants say.

724
01:09:44,000 --> 01:09:50,000
If you had to get rid of your inventory today to generate cash, you might get 10 cents on the dollar.

725
01:09:50,000 --> 01:09:58,000
So the quick ratio subtracts out the inventory.

726
01:09:58,000 --> 01:10:06,000
And then takes the result and divides it by current liabilities.

727
01:10:06,000 --> 01:10:12,000
Well, they can still cover 1.2122 times over their current liabilities,

728
01:10:12,000 --> 01:10:17,000
with their current assets that actually can be liquidated pretty quickly.

729
01:10:17,000 --> 01:10:21,000
The burn ratio simply says this.

730
01:10:21,000 --> 01:10:26,000
The reality is that if you had to pay all of your current liabilities today,

731
01:10:26,000 --> 01:10:31,000
the only thing that you could really draw would be your cash.

732
01:10:31,000 --> 01:10:45,000
So the burn ratio, the cash ratio just says, just take your darn cash and divide it by your current liabilities.

733
01:10:45,000 --> 01:10:52,000
And that one is pretty low.

734
01:10:52,000 --> 01:10:55,000
It's not terrible.

735
01:10:55,000 --> 01:11:08,000
Now, liquidity ratios, if they are too low, the company doesn't have enough liquidity.

736
01:11:08,000 --> 01:11:18,000
However, if they're too high, that would tell me that they are not using their liquid investments

737
01:11:18,000 --> 01:11:23,000
to turn those into long-term higher yield investments.

738
01:11:23,000 --> 01:11:29,000
If I've got money in my pocket, $1,000, well, I'm highly liquid.

739
01:11:29,000 --> 01:11:37,000
But at least some of that money I could put into stocks or bonds or something like that and get a much higher return.

740
01:11:37,000 --> 01:11:44,000
So those liquidity ratios, you don't want them to be through the roof because that's saying you're wasting money.

741
01:11:44,000 --> 01:11:49,000
An example of this, very quickly, Netflix.

742
01:11:49,000 --> 01:12:00,000
Three or four years ago, they borrowed over a billion dollars and they borrowed it at a stupidly high interest rate.

743
01:12:00,000 --> 01:12:05,000
Everyone would say, okay, boy, I wonder what they're going to put that into.

744
01:12:05,000 --> 01:12:10,000
Well, they're at sat in their current assets as cash.

745
01:12:10,000 --> 01:12:13,000
And everyone would say, what the hell?

746
01:12:13,000 --> 01:12:23,000
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.

747
01:12:23,000 --> 01:12:26,000
It was just absolutely ridiculous from our perspective.

748
01:12:26,000 --> 01:12:30,000
As it turned out, they were explaining it like this.

749
01:12:30,000 --> 01:12:36,000
Look, we have to have highly liquid resources.

750
01:12:36,000 --> 01:12:46,000
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.

751
01:12:46,000 --> 01:12:58,000
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.

752
01:12:58,000 --> 01:13:02,000
So that was why they were explaining that transactions motive.

753
01:13:02,000 --> 01:13:08,000
They wanted all that still liquid so that they could use it quickly.

754
01:13:08,000 --> 01:13:11,000
We still thought, oh, God, this is ridiculous.

755
01:13:11,000 --> 01:13:17,000
Over the last few years, they've been peeling it down to more sane levels, but still.

756
01:13:17,000 --> 01:13:25,000
So in other words, you're seeing how these ratios, you have to think about them both ways, too high, too low.

757
01:13:25,000 --> 01:13:27,000
We'll pick it back up on Monday.

758
01:13:27,000 --> 01:13:29,000
But for today, that's all I have for you.

759
01:13:29,000 --> 01:13:32,000
I think.