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Alan Cring Productions in association with Emergent Light Studio presents the

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Illinois State Collegiate Compendium, academic lectures in business and economics.

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This is business finance, FIL 341 for Autumn Semester 2024.

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Okay, first we'll have a look at the numbers today and then we will take another look at

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cash flow, free cash flow projections.

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But before we do that, just a quick look across the numbers for just a little bit here.

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You can see that we have, there is not a lot of movement right now.

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The markets are in sort of an unexcited territory.

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That wait and see attitude that I was telling you about previously is that we are still

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sitting there just waiting to see what happens next.

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There is a general consensus that the Fed right now is in a difficult position for a

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couple of reasons.

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One of them is purely pure economics and one of them is political.

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The president who is coming into office in his first term, he threatened to fire the

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board of governors of the Federal Reserve, which of course he couldn't do, but it was

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still something kind of earth shaking.

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And the Fed, fortunately they are professional so they are not going to be too scared by

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that, but they are going to take it into consideration that the president wields not so much power

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over them as a president does over public opinion.

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And that could be a problem if they run afoul of what he wants to do.

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He could blame them for what is going to happen.

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He could say this was all the Fed and his followers would say yeah, I agree, yeah, what

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is the Fed?

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But that is something that we have got to be, they are a little concerned about.

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However, the other part of it is that the Federal Reserve was going to cut the discount

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rate one last time before the year is over and now they are taking a little bit, being

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a little coy about that because we did have a little bit of an uptick in some of the metrics

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of inflation and so we have to take that into account.

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The Fed might hold off on another interest rate cut long enough to get that inflation,

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those little embers still glowing to go away.

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So there you are.

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But if the Fed doesn't cut interest rates, well the White House will probably condemn

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the Fed and all of that kind of stuff because they want the economy juiced up.

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So there is this kind of, well let's see what happens next.

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As you can see the Dow started out down but it came back up.

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There is really nothing to write home about.

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The NASDAQ is, well the S&P 500 and the NASDAQ are doing pretty well today.

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Crude is just in a trading zone.

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It is comfortable.

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We are near a stable equilibrium.

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We have got good supply, not just at the refineries and in the gas stations.

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We have got a good supply on the high seas and in the reserve tanks at the well heads

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across the world.

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So there is this sense of calm right now.

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And you have noticed that there is not nearly as much news about the Middle East and attacks

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on countries attacking each other and bombing each other and all that right now.

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That helps the stability of oil prices.

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So we are in a very good position right now.

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Gold had a pop but it was up a little more than half a percent so that is nothing to

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worry about.

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Now if we look around here, prowl around just a little bit and I am trying to find something

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that is, I hate this, really don't like this presentation style.

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But the Nikkei was up today.

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Now as far as other markets are concerned, now the Hansang is actually something that

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you might want to keep an eye on over the next months because if we do go into a trade

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war with China, that is going to be terribly damaging both to our economy and to the Chinese

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economy.

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And you will see the Hansang begin to slide if there is more than just a little concern

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about a tariff war.

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If that concern gets more deeply embedded in the Chinese investment community's thinking,

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you will see the Hansang just begin to take a spiral downward.

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But that is not happening yet.

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Now they seem to have changed the way that they are doing the bonds a little bit.

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The 10 year is, on this one, this is a quote on the 100.

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On this one, that is the yield implied by the quote.

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So you are looking at, I think, the same debt instrument from both sides, but I have got

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to investigate a little further.

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Again, price and yield are inversely related.

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So you can see green, red, this is the price and you can do the calculation from my spreadsheet

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that I gave you to find the yield to maturity given the price and all that kind of stuff.

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So we do not really worry too much about it for the time being.

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Try to think here.

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What else?

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Oh yeah, and you will see other, they are showing other bonds now, but you know, and

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then they are showing the commodities again.

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Another one that you do kind of keep an eye on is natural gas because it is a major trading

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commodity across the world.

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Much of Western Europe heats through natural gas.

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We do, but not nearly to the extent that Western Europe does.

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Russia has a very powerful stranglehold on Europe because Europe gets a lot of its natural

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gas from Russia.

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So we are going to have to see what is going to happen if Russia decides to play that game

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again and cut off supply of natural gas to Western Europe.

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That is going to make it very miserable in Western Europe and it is also going to, oh,

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forgive me, I forgot to turn off my phone.

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Bear with me here.

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I apologize for this.

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Okay.

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Now again, Brent, now apparently crude, this quote right here is not including Brent.

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This is more, apparently, this has been, and I was mistaken about this, this is more of

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a composite.

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Brent, the light sweet stuff, the super light sweet stuff is a little bit higher, but it

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is part of the crude oil and it is better to look at this one if it is a composite of

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oil prices than to look only at the Brent sweet because that is not the only one that

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is in the refineries.

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I do not know what to say about these.

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I am just not used to this whole thing at all.

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Of course, if you are into Bitcoin or cryptocurrencies, there you go.

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There is your stuff.

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But let me take you over here just for a minute to Tesla, TSLA.

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Now Tesla, as you can see, very high beta, price earnings ratio is pointing to great

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overvaluation of the stock, possibly as much as three times what it should be.

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More likely, I would grant it is probably about double its actual intrinsic value right

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now.

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That does not mean it is going to crash any time soon.

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These are long haul years, months, years, decades to find intrinsic.

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For the time being, it is going to be on the north side of intrinsic by a good amount.

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Now we take that and look at it one year just to have a quick look and you will see that

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it has had a substantial spike.

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Interestingly before the election, but since the election, it has spiked dramatically on

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investors' assumptions that Elon Musk will use the levers of power he has in the White

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House as an official to benefit Tesla.

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That is just how it is.

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They see that he is going to be able to make Tesla a fortune by being in the White House.

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The ethics of that notwithstanding.

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Now let me take you on a journey here just for a few minutes.

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We are going to go over here and I am going to go to the SEC, sec.gov and pull in search

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of filings and we are going to look at Tesla, TSLA.

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And while I am thinking about it, I have opened a quiz for you.

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It is due Thursday night.

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That is quiz seven.

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Just get it done.

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Don't forget to.

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And you notice that if you do this long enough, it just gets to be second nature how you get

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to the financial statements.

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Now this is Tesla.

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And I am going to find the balance sheet.

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You are going to see the same routine every time.

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And I am going to prowl around for the statement of operations.

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Nope, that is not it.

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I don't want that.

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Statement of operations.

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Oh, there it is.

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So there is the statement of operations and I am going to drag that over to the balance

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sheet.

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Consolidated balance sheets.

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Put those together and I will need one more for what I am going to do here.

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Consolidated statement of comprehensive, statement of cash flows.

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There we go.

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I am going to drag that one over to here and put that with the statement of operations.

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So we have these three statements that we are going to work with.

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And I am going to expand those so that I can see them.

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You may be able to see them, but I can't.

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So well, no that will be okay.

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And then we are going to come back over here.

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I will let you catch up if you want to for just a minute.

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Come on.

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I want to get rid of these.

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So now, a couple of highlights that you will want.

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Make sure that you have your operating income.

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Operating income.

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They call it income from operations.

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And again, there used to be hard standards for what you named each line and that is just

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gone now.

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That is just gone.

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To Tesla's credit, at least they report gross profit, which a lot of companies just breeze

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right by.

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Now, the research and development.

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This is a difficult one for dealing with free cash flow analysis.

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Because R&D is to some extent a capitalized expense.

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It's capitalized over a period of years.

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But that might not be the case with the company that you have under consideration.

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They may have some way by accounting rules to expense the whole thing in the year in

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which it occurs.

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Now you will notice one thing though that there is no depreciation expense here.

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So we have to go over here to the statement of cash flows and make sure that we've got

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it right here.

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In some companies you have it both on the income statement and in the statement of cash

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flows.

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It will always be in the statement of cash flows.

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Now one thing that you have to watch out for though is that the statement of, the income

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statement, the depreciation expense might be different from what it is on the statement

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of cash flows.

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That can happen.

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And if you are going to make a choice of which one that you use, you use the statement of

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cash flows, not the one on the income statement.

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So that takes us up here.

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Operating income.

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What is going to be your revenues minus your operating expenses minus your depreciation?

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That's a problem here because we don't see depreciation expense being listed in the income

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statement.

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Is it hidden in there someplace?

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That is a practical consideration.

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And since you're going to, this is where you'll probably, you hit the wall with how to actually

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do this in practice here in this class.

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We have to make a decision.

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Another one.

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Restructuring and other.

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What in the hell does that mean?

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Again, you're running into questions, more questions than you have answers for in this

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income statement.

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That's not some deviance or anything like that.

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They're trying to hide something.

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It's just how this company reports.

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And if the SEC says it's fine, if their outside auditors say it's fine, then we have to live

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with it.

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The question is that restructuring and other, is that an operating expense?

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Research and development, that is definitely not an operating expense.

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So we have two of the three that probably are suspect as being included.

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So we probably are going to want to take operating expenses and then add back restructuring,

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which is fortunately, thank God, zero.

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But we're also going to probably have to recover that research and development before we go

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any further.

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But we will have to subtract the depreciation expense.

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And the only place we see that is on the statement of cash flows.

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So we've got a more complicated situation than just a simple textbook here.

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We'll get through it though.

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The first thing that I'm going to do, and I've told you this before, is we are going

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to want to make a sheet right here.

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Insert a worksheet.

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And we're going to call that thing free cash flow.

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This is where we'll do the heavy lifting for we're pulling numbers from other places to

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get them into alignment here.

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And remember, the entire goal is to get to a place where we can run that equation right

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there.

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So we're going to put the numbers in here, especially because that means we don't have

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to clutter up the financial statements very much.

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We will in one place.

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But from there, we have a place where we can just do these calculations.

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And if something doesn't look right, well, we're going to work on that.

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So I'm going to put here operating income.

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And of course, I have kicked, unplugged it.

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Operating income.

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And then we will do some magic with that.

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We're going to report equals, oh, I should put in, I apologize, insert a line here, 2023,

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and 2022.

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Apologies for that.

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Now the operating income, we're going to get statement of operations.

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So free cash flow equals for this purposes, we're going to go over here to operating income

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and we're going income from operations.

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But we're not finished here.

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Plus research and development plus or minus, I'm sorry, less depreciation expense.

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Because it's not listed in that income statement, we need to get it in there.

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Because it does serve as a tax shield.

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So first thing we'll do is we'll put in equals consolidated statement of operations.

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We'll put in that research and development.

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And then we will subtract out depreciation expense if we can find it.

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There it is.

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I put that in as a negative.

240
00:20:27,700 --> 00:20:32,500
I might want to change that to absolute value.

241
00:20:32,500 --> 00:20:39,180
So I can do.

242
00:20:39,180 --> 00:20:47,260
So then we finally have net operating income.

243
00:20:47,260 --> 00:21:00,020
Which would be equal to this plus this minus this.

244
00:21:00,020 --> 00:21:09,500
And so there is their real operating income.

245
00:21:09,500 --> 00:21:23,020
Less taxes at 21%.

246
00:21:23,020 --> 00:21:40,540
So we take this line equals that times taxes.

247
00:21:40,540 --> 00:21:41,540
Try that again.

248
00:21:41,540 --> 00:21:45,860
Boy, that was a mess.

249
00:21:45,860 --> 00:21:58,220
Equals net operating income times 21%.

250
00:21:58,220 --> 00:22:00,940
We'll fix all these.

251
00:22:00,940 --> 00:22:04,820
And that is notepad.

252
00:22:04,820 --> 00:22:09,660
Net operating profit after taxes.

253
00:22:09,660 --> 00:22:17,380
When we take equals that minus the taxes they paid.

254
00:22:17,380 --> 00:22:21,060
And we get that.

255
00:22:21,060 --> 00:22:24,900
So their notepad is $6.472 billion.

256
00:22:24,900 --> 00:22:29,740
Let me do something here.

257
00:22:29,740 --> 00:22:33,860
Format these.

258
00:22:33,860 --> 00:22:37,580
Currency zero decimals.

259
00:22:37,580 --> 00:22:40,020
Okay.

260
00:22:40,020 --> 00:22:44,260
Now it gets a little bit better from here.

261
00:22:44,260 --> 00:23:00,340
Plus depreciation expense minus capital expenditures.

262
00:23:00,340 --> 00:23:12,260
Less, well, sorry, less capital expenditures.

263
00:23:12,260 --> 00:23:20,300
Less change in net operating working capital.

264
00:23:20,300 --> 00:23:24,940
And if we get through all that, we get free cash flow.

265
00:23:24,940 --> 00:23:29,100
But we have to go back here.

266
00:23:29,100 --> 00:23:33,140
First thing we're going to have to do is get change in net operating working capital.

267
00:23:33,140 --> 00:23:40,980
Now you're going to go here to your balance sheet.

268
00:23:40,980 --> 00:23:45,820
Now we have to calculate net operating working capital.

269
00:23:45,820 --> 00:23:50,540
So the first thing we are going to do is look at the current assets.

270
00:23:50,540 --> 00:23:56,380
Remember working capital is current assets minus current liabilities.

271
00:23:56,380 --> 00:24:00,980
Well we have to peel out anything that is non-operating.

272
00:24:00,980 --> 00:24:06,740
In this case, we have two items.

273
00:24:06,740 --> 00:24:23,060
Equals the total current assets minus the prepaid expenses and minus short term investments.

274
00:24:23,060 --> 00:24:31,900
And we do that for both years.

275
00:24:31,900 --> 00:24:34,020
Now the current liabilities.

276
00:24:34,020 --> 00:24:41,580
We're going to go down here to the current liabilities.

277
00:24:41,580 --> 00:24:45,660
Start with them and now we're going to peel out the non-operating.

278
00:24:45,660 --> 00:24:49,060
So we'll start with total current liabilities.

279
00:24:49,060 --> 00:24:57,540
Now we're going to subtract out current portion of debt and leases because they're not operating

280
00:24:57,540 --> 00:24:59,420
expenses.

281
00:24:59,420 --> 00:25:03,940
And then we're going to subtract out deferred revenue because that's not operating, it's

282
00:25:03,940 --> 00:25:05,740
deferred.

283
00:25:05,740 --> 00:25:08,380
And we're going to subtract out accruals.

284
00:25:08,380 --> 00:25:14,940
So basically we're going to subtract everything except your accounts payable.

285
00:25:14,940 --> 00:25:19,960
Because free cash flow is going to pay for the others.

286
00:25:19,960 --> 00:25:27,920
Those are non-operating, those are bills that are paid out of your free cash flow.

287
00:25:27,920 --> 00:25:29,820
So keep that in mind always.

288
00:25:29,820 --> 00:25:35,260
Free cash flow is telling you what you have to cover all that mess that's on the balance

289
00:25:35,260 --> 00:25:36,260
sheet.

290
00:25:36,260 --> 00:25:37,780
Most of it anyway.

291
00:25:37,780 --> 00:25:47,420
So then we will get, and we mark this one over, and we get the net operating capital

292
00:25:47,420 --> 00:25:49,420
for each year.

293
00:25:49,420 --> 00:25:56,300
Equals that minus that.

294
00:25:56,300 --> 00:26:02,460
And then we're going to move that over to this.

295
00:26:02,460 --> 00:26:13,660
So you can see that their net operating working capital changed by less than $800 million.

296
00:26:13,660 --> 00:26:16,460
That's still a lot, but it's not a very big change.

297
00:26:16,460 --> 00:26:22,780
So now we can go over here to this calculation of free cash flow and we can say equals the

298
00:26:22,780 --> 00:26:32,820
change which is going to be that minus that.

299
00:26:32,820 --> 00:26:35,660
Really?

300
00:26:35,660 --> 00:26:39,820
Let me try that again.

301
00:26:39,820 --> 00:26:41,540
Oh, I'm sorry.

302
00:26:41,540 --> 00:26:44,900
I thought those were in the same 19 and 16.

303
00:26:44,900 --> 00:26:53,820
So before we go any further, you see that positive change that is a drain on free cash

304
00:26:53,820 --> 00:26:55,620
flow.

305
00:26:55,620 --> 00:27:02,460
When the net operating working capital goes up, that means that your current structure,

306
00:27:02,460 --> 00:27:08,380
part of that capital structure, is absorbing cash.

307
00:27:08,380 --> 00:27:14,940
It went from 16 to 19, 16.7 to 19, something like that.

308
00:27:14,940 --> 00:27:19,100
So that is a drain on free cash flow.

309
00:27:19,100 --> 00:27:26,220
And that is a pretty substantial, that's $2.3 billion got sucked up into inventory and all

310
00:27:26,220 --> 00:27:27,740
that kind of stuff.

311
00:27:27,740 --> 00:27:30,380
Net of other things.

312
00:27:30,380 --> 00:27:33,500
So that one, so now we can go back up here.

313
00:27:33,500 --> 00:27:40,100
We're going to say equals and we're going to go over here to the statement of cash flows

314
00:27:40,100 --> 00:27:45,220
and pick off that depreciation.

315
00:27:45,220 --> 00:27:48,780
Now we're going to pick off the capital expenditures.

316
00:27:48,780 --> 00:27:53,700
Now the only, you've got to watch it here.

317
00:27:53,700 --> 00:27:56,300
This is reported as a negative number.

318
00:27:56,300 --> 00:28:04,620
So you put absolute value before you go over here and grab it, go to investments.

319
00:28:04,620 --> 00:28:06,500
Where the hell?

320
00:28:06,500 --> 00:28:07,500
From investment activity.

321
00:28:07,500 --> 00:28:10,060
Oh, where the hell?

322
00:28:10,060 --> 00:28:11,060
There it is.

323
00:28:11,060 --> 00:28:12,700
See, it's a negative number.

324
00:28:12,700 --> 00:28:16,860
You want to make it a positive number so you can subtract it by the formula.

325
00:28:16,860 --> 00:28:26,340
And that is a whopping $8.9 billion in capital expenditures.

326
00:28:26,340 --> 00:28:29,500
So now we can finish and get free cash flow.

327
00:28:29,500 --> 00:28:41,700
Equals, no pat, plus depreciation expense, minus capital expenditures, minus the change

328
00:28:41,700 --> 00:28:50,300
in net operating working capital, Tesla has a negative free cash flow.

329
00:28:50,300 --> 00:28:55,860
It does not have enough from internally generated operations to pay.

330
00:28:55,860 --> 00:29:01,900
Let me show you what can't pay from what its operations have delivered.

331
00:29:01,900 --> 00:29:04,420
It cannot pay.

332
00:29:04,420 --> 00:29:10,340
Where the heck?

333
00:29:10,340 --> 00:29:11,940
Interest expense.

334
00:29:11,940 --> 00:29:16,340
Where you say, well, it got interest income.

335
00:29:16,340 --> 00:29:18,340
Glory be.

336
00:29:18,340 --> 00:29:19,620
Fine.

337
00:29:19,620 --> 00:29:24,540
But let's look at its capital expenditures.

338
00:29:24,540 --> 00:29:33,300
Free cash flow capital, capital expenditures, $8.9 billion and free cash flow was negative

339
00:29:33,300 --> 00:29:37,420
71 million.

340
00:29:37,420 --> 00:29:46,500
Those capital expenditures could not have been paid by the operations of the company.

341
00:29:46,500 --> 00:29:51,540
So what we look over here, and let's have a look to see where in the hell they got the

342
00:29:51,540 --> 00:29:53,820
money to do this.

343
00:29:53,820 --> 00:30:02,220
So if we look down here, the first place we're going to look is for debt.

344
00:30:02,220 --> 00:30:10,860
Debt went up by $1.3 billion.

345
00:30:10,860 --> 00:30:16,580
That's not enough.

346
00:30:16,580 --> 00:30:23,540
So let's look to see if they sold more stock.

347
00:30:23,540 --> 00:30:28,260
Come on.

348
00:30:28,260 --> 00:30:38,480
They did sell $2.7, $2.8 billion in new common stock.

349
00:30:38,480 --> 00:30:42,020
So what else happened?

350
00:30:42,020 --> 00:30:52,020
Where in the hell did this retained earnings jump by $15 billion?

351
00:30:52,020 --> 00:30:55,860
The question is how?

352
00:30:55,860 --> 00:31:05,940
And that's the subject of a night with a good single malt whiskey and a good conversation

353
00:31:05,940 --> 00:31:09,900
around a fire.

354
00:31:09,900 --> 00:31:18,660
Where did the retained earnings leap by that $14 billion?

355
00:31:18,660 --> 00:31:21,220
That's how they paid.

356
00:31:21,220 --> 00:31:27,800
They did not have enough money from operations to cover their non-operating expenses.

357
00:31:27,800 --> 00:31:32,660
They certainly don't have anything for dividends.

358
00:31:32,660 --> 00:31:37,620
They paid their interest expense, but how?

359
00:31:37,620 --> 00:31:42,620
It's not clear on these financial statements how this magic is occurring.

360
00:31:42,620 --> 00:31:52,540
From a basic financial standpoint, their operations lost $71 million last year, and yet they were

361
00:31:52,540 --> 00:31:55,220
able to pay for research and development.

362
00:31:55,220 --> 00:31:58,540
They were able to pay their interest expenses.

363
00:31:58,540 --> 00:32:05,020
They were able to pay for a massive increase in their capital expenditures, $8, almost

364
00:32:05,020 --> 00:32:11,380
$9 billion worth of new factories and whatever.

365
00:32:11,380 --> 00:32:14,500
But we don't see how it happened.

366
00:32:14,500 --> 00:32:17,780
That's what we have to ask.

367
00:32:17,780 --> 00:32:19,900
And we dig in deeper.

368
00:32:19,900 --> 00:32:21,940
We start making phone calls.

369
00:32:21,940 --> 00:32:27,780
We start looking at any other possible way they could have done it.

370
00:32:27,780 --> 00:32:33,860
But it is clear that the financial statements are telling us how they did it, how they're

371
00:32:33,860 --> 00:32:36,820
still in business.

372
00:32:36,820 --> 00:32:38,100
That's what we do.

373
00:32:38,100 --> 00:32:41,700
We go in with an objective eye.

374
00:32:41,700 --> 00:32:45,020
If the numbers look good, well, we're happy.

375
00:32:45,020 --> 00:32:51,140
But if the numbers look like this, we've got a question mark that is the size of a continent

376
00:32:51,140 --> 00:32:54,300
about what's going on here.

377
00:32:54,300 --> 00:32:57,740
That's what we do in financial analysis.

378
00:32:57,740 --> 00:33:00,180
And I could break down the ratios of this.

379
00:33:00,180 --> 00:33:02,020
Ratio analysis is good.

380
00:33:02,020 --> 00:33:06,420
And just some qualitative, well, they have a great car and all that kind of stuff, and

381
00:33:06,420 --> 00:33:09,780
he's a super guy, and he sure does know how to run a business.

382
00:33:09,780 --> 00:33:12,340
But that's not explaining how this happened.

383
00:33:12,340 --> 00:33:15,420
And that's where we come in as professionals.

384
00:33:15,420 --> 00:33:17,420
Now as students, you can do this too.

385
00:33:17,420 --> 00:33:22,780
You'll get by with a lot less heat than I will as writing about this.

386
00:33:22,780 --> 00:33:26,220
But that's what we do.

387
00:33:26,220 --> 00:33:29,580
We break these numbers down, and we've got a number there.

388
00:33:29,580 --> 00:33:32,660
Now you could quit with some of the ways that I calculated it.

389
00:33:32,660 --> 00:33:37,300
But there sure is hell no way that I'm going to recover all those billions of dollars that

390
00:33:37,300 --> 00:33:42,100
seem to have come out of nowhere to keep that company rolling.

391
00:33:42,100 --> 00:33:44,580
Anyway, that's all I have for you today.

392
00:33:44,580 --> 00:34:04,980
And I thank you.