 Well, hello everyone and welcome back to Sailor Academy's NBA 601 financial management. This is going to be The assessment review. This will be part one. Obviously We've gone through every episode of the every episode every week We've gone through every unit of the course and and done these videos So if you haven't watched those yet, you should definitely go back and of course these videos are supplemental to the course themselves So you should definitely check out the course all of that is linked in the description below if you're watching later Feel free to leave a comment down there as well If you're watching right now, you can leave us a question in a chat and we'll get to it But I'm just gonna hand it over to dr. Lou pierce. I'll to get us going and I'll get out of the way Thanks Michael and again, welcome back everyone This is a review we've we've actually gone through and Done a review of each of the units that were contained in our course There are seven units and we've talked at length about each one and and and discussed and if you've been watching, you know that our courses are designed around some stated learning objectives and Each week in the presentation. I've referenced the particular objective that applied to a unit Here's four. I'm not going to go through During the during the reviews But there were eight learning objectives and I believe you'll find that over the Throughout the course. We have in fact identified addressed and related to each of these objectives The the basis of this course is really a recognition and an understanding of the Valid the validity and the need to do financial analysis in your business All right and and simply put When we're looking at at financial performance, we're going to look at three things We want to see how did you do? And so we review the past we take a history lesson and in past performance We're keenly interested in how you're doing today And so as a former executive of a company I was I wanted to know how we were we were progressing Right now at this point in time against the plan that we went into the year with And and last you're going to be thinking about where you want this business to go Well, no surprise that a good part of these discussions A good part of these reviews Are going to go back to the numbers We say that at the end of the day Businesses about numbers the language of businesses numbers and hopefully we've conveyed that during these past presentations I'm going to take us back for a minute to unit two in the course where we focused a lot on financial ratios And I'm sure you had you saw a number of ratios probably too many ratios And what I can tell you is that with all the ratios that we covered in this course There are more And so why what what's the value there there are bits of information that help management focus And where there might be a need to take corrective action Where there might be a need to do more of Where we might have to make some decisions. So there's there's lots of Analysis going around ratios And we're going to talk a little bit about that in the first part of the assessment We also mentioned that when you're doing financial analysis, we're we're doing a number of things We're doing a comparative financial analysis. What are we comparing? We're comparing yesterday with today Or we're looking at what we're doing today and comparing it with where we want to go for next year So we're evaluating this is a moving plan. There's it's dynamic finances dynamic in business today We're going to consider trends and the trend says On a simple basis is our trend for sales going up If we flattened or our sales declining So we want to look at trends trends have a value And helping us determine where we want to focus some of our time and efforts And we're going to do some benchmarking Which means that it's not enough to sit here and exist in my own little world with my own business To really determine How well we're doing Or if there are opportunities to do better, we want to compare What we're doing want to benchmark against other people in our industry How do we compare in And in sales or in inventory issues compared to some of our major competitors in the industry Now we started all of this going back by taking a look at the basic financial statement of a business This is a simple income statement And uh, note that the income statement which basically shows how much came in how much went out and is there anything left In this case, it's categorized We're breaking those things down so that we can get a better idea of where we might want to focus intention So yes, we have product sales But we're going to make sure that we focus on what the cost of goods sold And remember the cost of goods is labor and materials and that results in a gross margin So Given the sales after we take out what we spent for labor materials. What was left? What's left is now going to be applied to a bunch of other categories because that's not the only expense category of the business So then we'll look at sgna selling general administrative expenses all the other expenses and operating our company Which will give us our earnings or we're going to look at earnings now before we pay out any interest Any taxes any depreciation any amortization or in other words EBITDA Then we're going to take out depreciation and remember depreciation is we're using up assets We bought a piece of equipment two years ago. It's not worth the same now. Why because it's two years older We've depreciated part of that part of that expense. So let's take that depreciation out now. We have earnings before income taxes So make sure that we pay our taxes. Absolutely. We'll take out our taxes and what's left is our net earnings Or the bottom line or profit That's what you've made out of your sales when everything else has been accounted for We also want to make sure that we look at the balance sheet certainly of interest to investors And the balance sheet if you recall The has current assets on one side of the balance sheet, which are all the things that we own Now current assets are those assets that can be turned into cash in a year or less We also have long-term assets typically property plant and equipment And on the right hand side, we have liabilities or things that we owe And again, like assets, we have current liabilities Things that have to be paid in the next 12 months and some non-current liabilities long-term debt a 20-year mortgage And the difference between assets and liabilities is of course shareholders equity That's what the owners have when all is said and done if the assets were liquidated and the liabilities were paid off Is there anything left for you the owner of the firm and that shareholders equity? Now having said that what we're going to do today and next week Is i'm going to take the opportunity to review a little bit about an assessment As in all courses once you've taken the course and read the material and completed the assignments We want to be able to assess Uh, what have you what have you learned as a result of this course? Call it a final exam a test a practice exam or an assessment It's assessing the fact that we hope that you you've got the information that we tried to present to you And you're able to apply that information Now i'm going to break the assessment down into two parts This week we're going to talk about part one And we're going to go back to one of your favorite topics, which is financial ratios Uh because it is so important in the analysis of our financial condition We we need to be aware of what they are Um how they're calculated And what they mean to the business So that's going to be part one So we're going to go through and i'll review the way these questions might appear Mostly multiple choice and we'll we'll chat a little bit about each one Next week, uh, we'll go to part two And part two of the assessment will probably spend a bit more time on talking about Understanding an application of financial principles Okay, so Let's get started and uh just to know what i've done here is there's a Um a simple income statement and balance sheet that will appear on the slide That's basically when we're doing financial analysis is what we refer to Um and there's going to be a question and so our first question is going to be Recognition of the gross margin it measures the impact of a firm's cost of good soul So what is the gross margin? And so in this case what we are going to do is we are going to take a look at two things We're going to take a look at what were the sales And what was the margin after accounting for a cost of good sold? And so you'll see down in the left hand corner that the Formula for calculating gross margin is simply taking the gross margin and dividing it by sales And the result here is that the gross margin is 35.2 percent So what does that mean? It means that out of sales of 3.4 million dollars 35 was left for gross margin That was the impact of cost of good soul Now a lot of things that you can tell from this and i'm not going to go back and repeat all the things we covered in our course But just remember there's only two numbers here sales and and cost of good sold that have an impact on this ratio So if you want this number to be higher Which i expect you do you can do a couple things You can keep costs of good sold. It's the same And generate more sales That will increase the gross margin ratio Or you can keep sales the same And you can reduce the cost of good sold negotiate better Agreements with your with your suppliers and vendors That will increase the gross margin percent Or you can follow one of pure sales rules, which is do both Increase sales reduce costs of good sold and make even more money Okay, so this is this is a typical Question in the first part of the assessment. And so let's just go through a few more Let's talk about the current ratio And if I can bring you back into the course, what is the current ratio? Well, the current ratio is going to ask us to look at assets and liabilities But we're going to look at the current assets Not all assets and we're going to look at the current liabilities in other words This is this is a measure of liquidity Right because current assets are the ones that can be uh turned to cash within 12 months Current liabilities are due within that same 12 month period So what is the current ratio of assets to liabilities? In this case, we're going to take a look at those current assets We're going to divide it by the current liabilities and we get a current ratio of 2.9 Great. What does that mean? Well, it does tell us something It says that for every dollar That we have in liabilities or money that you own you have almost three times that in assets in other words, you have Almost three times the assets available to cover the liabilities now. Is that good or bad? I don't know This is just a snapshot in a moment in time We might want to see what it has been over the past number of months Or what's been forecast or what's what's expected as a current ratio in your industry? It may be something that's higher. This may be fine. So as in all things These give you a number which is but the beginning of your task because your real task is to understand the story behind the numbers What does this mean for your business? What does it mean for your shareholders? Let's take a look at return on assets one of my favorites One of the things that the business does is you take in money from owners and shareholders You know, what do you do with that? Well, you invest it you invest in assets Assets that will generate sales for your products and services And that will create a business that's generating a return On investments So we might want to know what is the return on the assets that you've invested in and that's return on Assets and for that we're going to look at net earnings again What were the earnings that they were generated and the total assets? Remember total assets all the things that the firm owns because you spent money from owners and shareholders to buy this And so our return on assets in this case is 33.1 Again good bad. It depends What we know is that we have total assets of a million four Based on the use of those assets we were able to generate almost half a million dollars in earnings So we received a 33.1 return What I might be looking for as an investor is one Is that a reasonable return given this business in this industry at this time and two When we go back and we look historically or we look at the trend Are we showing a trend that maybe this is increasing year over year? That would be a good sign that management is is doing a reasonably good job of getting the right assets And using it to generate earnings for shareholders and owners What about return on equity? now remember that equity is The amount of money that the owners and the shareholders have in the business If that business were to be liquidated today, what did the owners walk away with that's equity? Well the return on equity again is going to look at what are the net earnings that the businesses has earned And what is that total shareholders equity note by the way that we're using both the income statement and the balance sheet And as we get further into this or as you get further into analyzing your business Remember that there are other parts of the financial statements that you're going to be using Making it simple. We're focusing simply on income statement and balance sheet today So in this case the We're going to take the net earnings from the that the business earned We're going to divide that by shareholders equity and we're going to get what's the return on equity In this case, the return is almost 80 percent I mean net earnings are almost half a million and shareholders equity is 600 000 So it shows what how much Return are you making based on the equity that is in the business? It's a it's another measurement of use of equity or net using equity And again, whether or not you're you're happy and pleased with 79 percent depends on a number of additional factors Including what else is going on in the industry and how does this fair for for businesses and competition in the marketplace? Let's take a look at inventory turns This has always been one of my favorites If you are a business that has to maintain an inventory of your product for sale if you're in retail If you're a Walmart if you're target if you're any major retail operation you have inventory The inventory is a is a balancing act Inventory cost money All right, if you're a manufacturer like I was back in my time with carrier air conditioning company We manufactured air conditioning and heating units We had manufacturing facilities around the world building product question is Yes, I have to have inventory so that they're available for sale, but how much inventory? Remember every unit that we produced and I put on a shelf Cost money it costs money to buy the parts and materials Costs money for labor Costs money to operate the manufacturing facility. It's costing money for the distribution center The overhead the rent the insurance Inventory is an expense It's controllable And how do you control inventory? What do we want to look at? We want to try to get and have no more inventory that is necessary to really support the requirements of our customers In an ideal world I would have one unit on the shelf I would put it on the shelf today and somebody would buy it this afternoon I would be maintaining no inventory and would have met what amazing impact on cost that will be But that's not reasonable But what we do want to do is we want to make sure that our inventory is at as an appropriate level And one way to do that is by looking at inventory turns So in this case, we're going to look at the cost of goods sold Remember the cost of goods sold is that materials and labor to build the products And we're going to look at the inventory that's sitting in the shelf Now inventory is an asset It's something we own But the real value of inventory, of course is when it's sold and it generates revenue So if we look at the cost of goods sold and we divide it by the inventory, we come up with inventory turns In this case, it's 2.83. Now, what does that mean? That means over the course of a year We are going to fill up the warehouse Sell the material and we're going to do that 2.8 times So we are turning the inventory almost three times a year Now again What's the right inventory turn number? Depends on the on your business depends on the product depends on the production cycle I will tell you this Back at my time as a director of materials for a manufacturing firm Folks planning inventory part of their compensation and incentive package was in Increasing the number of inventory turns year over year In other words find ways To reduce the amount of inventory you're carrying so you're turning it faster And we're not consuming and spending all of that money prior to a sale By the way, this is one of the things that by analyzing this and looking at this Company started working with close and critical suppliers And came up with programs like just in time I mean, what is just in time inventory? It's inventory that arrives at the at the at the door to your manufacturing facility The day it's needed to go into production So you've eliminated storage And carrying that inventory So there's a there's a real benefit to digging into the numbers And understanding what they're doing we make decisions based on this And in some cases we we started involving Suppliers and even customers and trying to find out ways to make ourselves better more effective than and more proficient Now at this point i'm going to take a quick break and see if anybody has any questions Well, we uh, of course, I got my eye on the chat right now if anyone has any questions They can put them in the chat and of course if you're watching later Feel free to put them down in the comment section below and and we'll get to them if we can Um, I'm not uh, not seeing any questions right now Though if someone in the chat would like to come up with uh, Some sort of game around pierce all's rules. I would enjoy that. I think that uh, I think I think I think people watching could come up with With a with a pierce all rules, uh drinking games or something like that. They're all good rules Well, number one, I bet they would and number two, I always thought they were good Is that number one and number two pierce ours numbers the second pierce all's rule is pierce all thinks his rules Seriously, they're serious. This is a finances serious stuff, but it's also fun. Yeah, okay. So seeing no questions or comments. Um, Let me go on here And let's talk about the debt to equity ratio Um, now remember when we were talking about uh, debt and equity talking about the capital plan One of the things that the company does is we recognize that the capital plan has two major components one is debt Money that we borrow from from outside lenders any other is equity using that equity that owners equity that's in the business And we have a pool of debt and equity To come up with the amount of capital we need to make critical investments new plants new equipment new facility Um one way to see how well we're doing with debt to equity is to look at the debt to equity ratio And for that we're simply going to take a look at total liabilities And we're going to look at what that shareholders equity is So when I look at total liabilities and shareholders equity, I see that the debt to equity ratio is 1.3 Now what's that mean? It means that for every dollar in equity. I have 1.3 dollars in debt Now remember that we talk Or I hope that you remember we discussed a bit that using debt Is is a good thing in business. We call it leverage. We're leveraging other people's money to generate a return And as you increase the amount of debt You increase the return on equity To owners. Why because the return is is going up or the return is same, but you're using less of their money As in all things the downside to having too much Liability is risk and it's the risk of the fall The risk that the firm won't be able to meet their obligations to repay the debt and of course that can lead to Really adverse activities like bankruptcy So debt to equity one of the major ratios ratios we want to use When we're looking at how is the firm making decisions on capital? Let's consider the fixed asset turnover ratio now big word But before I go further, let me just stop and mention fixed assets What are they? Well fixed assets are those things like plant Property and equipment they're fixed because you buy a facility you build a manufacturing plant That asset isn't going to go anywhere. You're going to be using that. It's a fixed asset However, also recognize that on these assets assets are recorded at acquisition firms So for example, if you bought a piece of equipment at a hundred thousand dollars You record that as a hundred thousand dollars in assets But five years later, is that still worth a hundred thousand dollars? No It's five years older. You've been using it or you've been consuming that asset And we call that depreciation And so we count the depreciation we keep track of how the equipment Is in fact appreciating so for our Fixed asset turnover ratio We're going to look at sales because how much sales were generated as a result of the investment in fixed assets Note that we're looking at net fixed assets or net property plant equipment Why is that important? Because that's the value of those assets today All right after we've taken out the depreciation Now just to note one thing that a An investor or a potential investor can look at when looking at the balance sheet is What the net property plant equipment is For example, if you know that a firm bought a piece of equipment for a hundred thousand dollars They purchased that piece of equipment five years ago And after depreciation the value of that piece of equipment is now ten thousand dollars That tells you something It tells us one that the company's been using that asset to create revenue But it also tells you that There's probably not too long before it's going to be necessary for the firm to make another capital investment Right that equipment may need to be replaced So again, we look at the numbers are the numbers. What's the story behind the numbers? What is it telling us? Now in this case, we take net sales We divide it by the the net fixed assets and we have a fixed asset turnover of 10.4 In other words for every dollar that was invested in those fixed assets You've got 10.4 dollars in net sales All right attack. Is it a good ratio? Depends as in all things additional analysis and research is required Let's take a look at the total asset turnover now Because now we're going to we're going to expand the scope. Let's look at all the assets not just the fixed assets And so what are we going to do? We're going to take net sales and this time we're going to take the total assets available And the total asset turnover is 2.3 Now obviously this is lower than the fixed asset turnover because the asset number is bigger But you are still generating 3.4 million dollars in sales With 1.4 million dollars that you invested in assets. So there's a 2.3 turnover rate One thing that That I would look at as a shareholder Or I would be looking at as the president and co of a business is Can't what are we doing to make sure that the assets we're acquiring Are exactly the ones we need to generate an appropriate amount of sales for the business I mean, is it possible to invest too much in assets? Sure Suppose you and your planning you determine that you could dramatically improve sales You bought a second facility and the sales plan didn't work You're going to have a substantial amount of assets. Excuse me on the balance sheet With not a big improvement Excuse me in the sales number to show for those assets Remember going back to the responsibility of management To make decisions that are in the best interest of shareholders and owners And this is one of the things that we'll be looking at to determine that Basic earning power is an interesting ratio And the basic earning power wants to know Given the assets of the firm How how is that having an impact on revenue? But we don't want to consider The extraordinary expenses of like interest payments and taxes So what we're going to do for this ratio is we're going to look at EBIT Back on the income statement EBIT the earnings before We have paid out any interest in any taxes. Remember interest in taxes are a function of financing and decisions that the business has made That's not the revenue being generated just by operating the business that would be EBIT So let's take EBIT and divide it by total assets And in this case our basic earning power is 59.2% That EBIT after taking out costs of goods sold in SG&A Of $800,000 based on total assets of a million four has a basic earning power of 59.2% Again, one more method one more grade to give to the executives of this business And evaluating how well they're doing in making decisions They made decisions in acquiring assets Are we seeing the result in the revenue that's being generated? through using those assets Another thing that we would be interested in and looking especially in days like today where there are issues with Inflation and the economy and it's a global issue Is accounts receivable days In other words, we're selling goods and in most cases we're not selling them for cash But customers are buying on credit. You buy a product. You're going to get an invoice and the invoice should be paid in 30 days Well a critical question for the management team is How well are those invoices being paid? You can imagine that as um, the economy gets tougher That it may take people longer to Perhaps pay those invoices that are due That extends out the number of days that you are sitting there with accounts receivable Now before we get to the ratio, let me just step back and remind you that Accounts receivables is an asset. It's right there on the balance sheet under assets It's something that the firm Owns we that's money that is due us if we have Accounts receivable of a million dollars. We're considering that an asset However, recognize that that's an asset if it gets paid If it doesn't get paid it becomes a write-off it becomes a liability and it has a negative impact on the business so Companies will pay attention to the accounts receivable and how well it's being turned Remember it has a direct impact on cash flow If I have a substantial amount of money out there that's that's due to the firm through accounts receivable And i'm not collecting it. I may have to use equity or Take out a short term note to cover day-to-day operating expenses So one of the things that we'll look at is the accounts receivable day Which says let's take a look at what those accounts receivable are And what were the overall sales? We're going to multiply that by 365 days a year In this case our accounts receivable days is 31.6 Now if the sales terms are Invoices are paid in net 30 And we're not doing too bad If our invoices or our terms were payable in 10 days, then we're running over And in my experience from my business one of the things that I got and a monthly basis was a statement of accounts receivable days broken down By what was current What was 30 to 60 days? What was 60 to 90 days? What was over 90 days? At some point You're going to have to make a determination and the likelihood of you actually collecting a receivable that's way overdue Two things have to happen one You're going to have to exercise additional time and resources and money to try and collect the debt Or worst case you'll have to write the debt off And again, that's the negative impact. So paying attention to accounts receivable days Is one of the keys to being aware and managing what's taking place in your business This has been a Short overview with some of these ratios. I mean, you know from the course There's a lot more and there are many more that we didn't cover We will use ratios and we'll identify ratios that we want to capture Based on our analysis of what's taking place in the business where we might need to focus some attention What are some things that we might have to address or spend some time and resources on? Now having said that There's a couple keys to success here. If I were looking to Coach you on addressing an assessment At this stage on these things like financial ratios What would you do? Well, I think first of all make sure that you familiarize yourself with the financial package And it goes back to something we've said throughout the these lectures Which is that the ink of the financial package is Essential information for management and for investors and potential investors You need to understand what the numbers are where they go we get Uh financials can come on a weekly a monthly a quarterly an annual basis So this this information is coming in but they're only useful If you're able to pick up that package and go through each of these statements And you know what you're looking for you know what it represents And one thing that I mentioned early on in our course was that Although like for today's review we looked at the income statement and the balance sheet Which one of these statements is more important the most important? All of them The reason why we have a financial package consisting of these statements is that they all tell us something different They all give us a unique perspective about what's going on in the business Review the various financial ratios. There is tons of material both of going back and looking at at some of our previous videos Online lots has been said about financial ratios calculating them and more importantly for me Is understanding what they mean what do you get out of it? So take the opportunity to practice Uh calculating some of these financial ratios go back and look at the question before you turn to the answer page in this lecture Can you calculate those ratios? Next week, um, I'll do an assessment A review of the assessment part two, which I said, uh, no calculations Which may be good or bad But more discussion on application of basic financial principles And what they mean to the management of a company and to the shareholders and with that, uh, turn it back to michael All right. Well, um, as always, thank you so much dr. Pierce all, um We do not uh, I've not seen any questions in the chat right now But if you have them feel free feel free to leave them I know sometimes when we do exam reviews, uh, you know You understand it right when it was explained and then you might have a question later You know like what won't you go back? So, you know, of course go back and and and watch But if you have a question want to you can leave it later in the comment section and we can get to it next week If in fact you're thinking about it over the week, you know something comes to you But I want to thank um everyone for joining us again Thank you, dr. Pierce all for taking us through this and so at the same time Next week we'll go through the um the final exam and again if you've just been watching this and maybe it was confusing Do you maybe go back and check out the course and check out the previous videos we did because again These are all overviews of the courses of the course that is on uh, sailor academy and linked below but again um I'm just give I think that was a pretty good closing vamp and I'm not uh seeing any questions in the chat So everybody um again, thank you so much for joining us again. Thank you dr. Pierce all for going through this And we will see you all uh these uh same time next week Thanks, Michael. Thanks everybody for watching