 Good day, fellow investors. I continue with reading Charlie Munger's Almanac and I will do the videos that I will summarize the book in putting things into videos that are most relevant for investing. I've come to a few pages that discuss accounting. I've been a finance professor at the University of Amsterdam for three years and I really want to talk a little bit to give you a sense of what accounting is. Investing is yes about mindset and therefore this is a great book but also about skills and without accounting you really miss something when it comes to investing and I want to show you a few examples that will really really help you when it comes to analyzing companies to see okay whether you are going into something risky or not. The five topics that Charlie Munger discusses as misuse of accountings are EBITDA, pension fund estimations, accounting and ethics, aggressive accounting and derivatives. So we'll give you some examples. In short I'll try to keep it as simple as possible to really give you the most important point when it comes to accounting as I know that many investors haven't had a real in-depth accounting education or experience to really know all the details but a good overview will show you what is important and what you can apply in your future investing and your future investing endeavors. Let's start. I always argue with CFA's and other academics about EBITDA. So EBITDA is, Munger calls them bullshit earnings but the definition is earnings before interest, taxes, depreciation and amortization. So it's before interest like interest that you are paying and the debt the business is having doesn't matter, taxes it doesn't matter where the company operates, depreciation and amortization it doesn't matter what the business invested in the past you're investing in the future and that number EBITDA usually also adjusted EBITDA is what 90% of the managers show 90% of the academic analysts use to make calculations about what's the value of the business. I'm going to show you how that's very very dangerous and you might omit many risks that are there simply by omitting common sense because you are saying taxes are not important depreciation is not important it's not a cost it's not a cash cost and interest is not important because we all can borrow unlimited amounts because this is how they call it an efficient market. Let me give you an explanation of EBITDA misuse that might turn very well but might also end badly let's start. So clubbing is a brazilian paper and pulp company they produce or tissue etc and in their investor presentation they show a beautiful chart of constantly growing EBITDA. So adjusted EBITDA it was below one billion brazilian reels in 2011 and now it's more than four billion you would say okay this is really a great business a terrific performance great management so all is well but then let's go beyond EBITDA and that's what I always do I go beyond the numbers that are always shown and declared and yelled and you go to look okay what's beyond is that EBITDA really the return investors can expect or we should focus on something else I prefer to look at cash flows and in the first half of 2019 they have managed to have 500 million of negative cash flow on two billion of positive adjusted EBITDA so the picture is much much different okay you can then adjust for 470 million of dividends 288 million in a growth project that they are investing for the future and special projects and growth and then you get to adjusted free cash flow of 357 million but still the 357 million is just 80% of the declared EBITDA 18% so it's really up to you whether you want to use the top line where CAPEX is not important as you can see the second line interest paid received is not important income tax not important changes in working capital not important dividends paid out not important even if they take that to pay dividends so that's up to you whether you want to include those that for me are common sense accounts that you have to take into account when investing when it comes to analyzing businesses that simply is not taken into account because it's easier to take EBITDA because everything looks better why it looks better well look at clubbins net debt and leverage presentation you see okay net debt 14 billion and net debt to EBITDA is just free so okay you have say in three years they can pay down the debt no problems there well net debt to EBITDA is free but net debt to cash flow let's say let's even take not take into account growth and dividends net debt to cash flow free cash flow adjusted free cash flow is about 22 so that's really really a big difference when compared to the net debt to leverage of free times EBITDA managers will always present things in the best way possible in the best way possible that is allowed from accounting principles the big risk here again common sense not shown in EBITDA is currency they are producing in Brazil so their costs are in brazilian reals and the revenues in dollars over the last nine years eight years since the beautiful EBITDA chart is calculated the brazilian real lost what 50% of its value even more against the dollar which is a big big tailwind for clubbin so that's the common sense that is not shown in EBITDA cash flow common sense situation tailwinds in the business those are the things you have to look at not EBITDA when things turn and in a recession those usually turn you see how EBITDA is actually futile now another thing that Charlie Munger discusses is pension fund accounting I recently received an email from my pension provider in the Netherlands where I paid money into when I was a professor there and they said that it's very likely that my pension and current pensions will have to be lowered because there simply isn't enough money let's dig deep into this if we look at the pension organization and the latest investment return assumption for most pension funds those are between seven and eight percent now who can tell me how are these funds going to achieve returns of seven percent when the price earnings ratio of the SAP 500 is 20 20 something giving an earnings yield of four percent and 30 year treasuries are giving two percent only high yield bonds are giving six percent but that's still below the seven percent expected when you put these things into a balance sheet based on future expected payouts for pension funds then things change pretty significantly because balance sheets are overly optimistically shown there have been some changes in some accounting companies some do it differently so there is an improvement but still be very careful about what your pension funds is promising you another thing that Munger discusses is aggressive accounting that's the price practice of adjusting the numbers in order to make them look better then what those actually are for example a british company carillion went bust in 2018 after it used supply chain finance to cover up for businesses not going for business not going that well just look at the table so net cash and cash equivalents as reported 600 million 460 million pounds but then when somebody said look the finances that you are financing your suppliers with aren't really an asset or should be on the balance sheet as that and then net cash and cash equivalents suddenly were adjusted to 292 million negative and the company of course went bust so aggressive accounting is the practice of trying to hit hide something not really show how things really are and that's something that will always happen because the management is always incentivized by shorter management options to create the situation as good as possible until things work and until things can be shown that way until you get caught you're doing things really really well and that's also a problem with ethics that also Munger discusses but i want to give you one thing that's usually the big equalizer when it comes to investing and accounting that's cash cash is difficult to hide if you have it and it's difficult to produce if you don't have it so when investing it always boils down to cash you have to really be careful if the investments if the special accounts turn into cash if those don't turn into cash quickly then you know okay there might be something behind this again on ethics Charlie Munger says how accountants used to be normal people not rich people now they are rich people and they are incentivized wrongly even the best bigger companies audit firms put their signature because they get money to do that Kraft Heinz also needed to restate nearly three years of financial reports after an investigation Charlie summarizes this by saying the reason why accounts that stay silent is whose bread I eat his song I sing on derivatives a topic we will not go into Charlie says that account comparing accounting for derivatives with sewage is an insult to sewage Berkshire sold all of the general derivatives when they acquired it at a big loss so they had to mark them down and I'm going to show you how those derivatives end up by showing you Deutsche Bank chart and there is a nice video you can watch on my channel about Deutsche Bank so conclusion look for those investments that keep things simple that do not use aggressive accounting that are not trying to present themselves in a different light so be careful to watch what's the real benefit for investors thank you for watching please don't forget to subscribe click that notification bell so that you don't miss on the videos that really add value to your investment journey check my website for articles stock analysis my book my research platform and I'm sure you'll find something nice that can add value to your investments and also subscribe to my newsletter while I give a weekly bi-weekly overview of my work thank you and I'll see you in the next video