0:12

Hello and very welcome to the last week of Operational Finance.

I wonder if you're prepared for the last session.

So, what we're going to do today is basically look what we did last week,

then we're going to move onto understanding several aspects that we

didn't mention last time, which is bits and

pieces that will complete the whole passing of operations of finance.

And how to understand the financial statements to make sound decisions and

build a robust business.

So, here's the outline.

In the outline, you will see that what we will do today first is do a quick

recap from week three, then we will move on to a sensitivity analysis.

Together with the sensitivity analysis,

I wanted to show you an example of sustainable growth to building up

on the idea of what is business sustainable growth.

Then fourth one,

you will see that we will understand some other elements in the NFO that we

didn't mention before, then we'll look at the specific case of seasonal companies.

Now we were looking to the building up the ROE, which is return on equity what

shareholders care about and how we can decompose that into several elements.

Then finally, we will do a little test and a game to see whether you are actually

familiar and whether you followed me throughout the course.

And finally, we will close up the course.

So, let's just start with the first one.

So we count from three week,

you'll remember that we basically did three things.

The first one was to understand the two concepts of NFO working capital.

The second one was diagnosis of the problem.

Look for what it is.

What is the problem?

And the third one is the action plan.

What do we do to solve that problem that we found in point two?

So with those two concepts, quickly brief recap.

We understood that you can summarize the balance sheet, basically,

in a super short version of the balance sheet.

The example was very simple, you had receivables, inventory and fixed assets.

Finance, we have equity, long-term debt, credit and payables.

2:13

And we said, there is this concept that we call NFO,

which is need of funds for operations, which are the needs that we have of

funds to operate in the company on a daily basis.

And that is defined, as the sum of receivables plus inventory minus payables.

We need to finance receivables.

We need to finance inventory, but

part of that need is already financed with the payables.

That is why we subtract it.

So if we introduce these concepts, then the short balance sheet looks like NFO and

fixed assets are the only things we have to finance in the asset side.

And those are financed with equity, long-term debt and credit.

Now there was the second concept which we introduced, which is working capital.

What is working capital?

Well, working capital is precisely when you look at the sources of

finance that are long-term.

It's basically equity, long-term debt.

Those two are financing the fixed assets.

Once the two have financed the fixed assets,

there is some money left that we call capital for working.

Then if we include that in the equation,

you see that is the finance equity plus long-term debt minus fixed assets.

Now if that amount is not enough

to finance the NFO as you can see here working capital is five and NFO is ten,

i'ts not enough to finance, then we have to go to the bank and ask for a credit.

In this case, the credit is five.

3:39

We mentioned that many of you might have seen textbooks that

actually working capital is defined a little differently,

that is current assets minus current liabilities.

And we concluded, look, both terms give you the same number.

Because we looked at current assets minus minus current liabilities,

it gives you five, which is exactly working capital.

So, the number is exactly the same.

Now we said, why then do we define it differently?

Well, there were too many reasons.

The first one is that when you define as assets minus liabilities,

you might tend to think that it is an asset.

And actually, working capital is not an asset.

It's a liability, it's a source of funding.

It's capital used to finance something, that's why it's called working capital.

It's a liability.

So we like to define it, as equity plus long-term debt minus fixed assets.

The second reason was that it's current.

So it's current means that when you define as current minus current,

you might tend to think that it's something current or

volatile that changes a lot overtime and it's not the case.

What changes a lot is the NFO that depends directly on sales, but

the working capital is pretty stable overtime.

Now once we've seen these, the second point we saw was the diagnosis.

What is the problem?

And if you remember, we had a problem.

The problem is that before looking at the problem,

we said that the diagnosis has to be something that is concise, brief.

We have to keep it simple, then it has to be to the point,

it has to be concrete like to the point.

Then we said that it has to be clear.

Understood by everyone. Don't use very specific concepts or

complex things, but

it has to be understood by everyone in management in the company.

And lastly, it has to be complete.

We don't need a partial explanation.

We need a complete explanation.

5:27

Now do you remember in the case of poly panel,

what happens is that we did a forecast with the most recent operational ratios.

You remember that of the last year, it was about 81, 80 and 94.

And we said, okay, let's keep those ratios for the future.

Now keeping those ratios for

the future gave us a need of credit over the years 2008,

9 and 10 of 469, 598 and 744 as you can see here.

Now we said, if this is the problem,

then we should check if with the good ratios we solve the problem.

We actually did check that.

If you remember, which is, okay let's take the good policies.

We check with the good policies and

it happened that the need of credit is again, exploding.

So is values not the diagnosis of the problem, then what is it?

6:18

And when we said that, okay, it's about working capital and NFO.

What we understood is that working capital grows much slower than NFO and

it turns out that the difference between the two lines is the credit that you need,

and it turns out that we said this is like the mouth of a crocodile.

And so, the diagnosis now is clear.

NFO is growing faster than working capital and

then the crocodile can keep growing and growing.

And if you don't do anything, the company might collapse, because they need more and

more credit.

And the bank,

probably doesn't want to take on all the risk of the growth of a company.