Transcripts
1. Course Introduction: Hello and welcome to this course in which I will teach you the fundamentals of business finance. My name is Claudiu Ivan and I am an entrepreneur, investor, author and trainer. In the past, I've talked to many entrepreneurs or people who wanted to start a business, and I was surprised to find out that they didn't know how to answer basic questions about their business finances. Their responses were evasive and even aggressive, a sign that it was an uncomfortable subject for them. Most entrepreneurs and people in general believe that the accountant needs to know everything about the finances of their business. There is a grain of truth here, but beware, it is our duty to know the basic information about the finances of our business. We don't have to be experts, but we have to understand the basics, the basic information. For example, what are the profitability indicators that need to be tracked monthly in the business, or what are the efficiency, liquidity and solvency indicators to be followed? All indicators are very important and show us the general picture of the business. It shows us the health of the business. It is also important to know what analysis we need to do before investing money in a new business. In the course I have prepared very interesting analyzes that must be taken into account before any investment. What I said here is the basic information you should know. But don't worry, that's why I have created this course. To help you with the basics of business finance. Now, who is this course for? Startups, small business owners, entrepreneurs, college students, working professionals, business managers, and anyone who wants to learn more about a business's finances. The course is created as explicit and simple as possible to better understand everything. I will explain and show you how to build and complete each financial analysis to better understand. If you are in one of these lines, this course is right for you! Things you will learn in this course: business finance terminology and fundamentals. We will have a lesson for each indicator and analysis in which I explain each term used, and I will give many examples to understand what each one means. Find out the different types of financial and investment analysis. We have two types of investment analysis, namely sensitivity analysis and cost-benefit analysis, and three indicators for financial analysis: efficiency, profitability, liquidity and solvency indicators. We have a complete section for each financial analysis. Learn how to use profitability, efficiency, liquidity and solvency indicators. These indicators give us a general picture of the financial health of the business. They tell us how we are in terms of profitability. They tell us if we have money to pay short-term debts if we are solvent or not. In this course, we will discuss these issues with examples to better understand. You learn how to read financial analysis. At the end of the course, you will know how to read any financial analysis of any company. You learn what analysis needs to be done before investing in a business. Always, before investing in a business and putting our money at stake, we should do a minimum set of analyzes to know if the investment will be profitable or not and what expectations to have in the future. We will discuss in detail two analyzes that create and outline a detailed image of a possible business before investing money. You understand the life cycle of a business and how you can finance your business today. I focus on understanding the life cycle of the business just to know that any business reaches maturity and then follows its decline or relaunch. It is crucial to know these details because they will save us from bankruptcy. And if we know that the business is mature, we must take certain actions to relaunch it. We also have a separate lesson on possible sources of financing a business. This course will help you identify problems in your company, improve business performance, have a more complete picture of your company and its competitors. Now let's move on to the course structure. The course is divided into three sections. The first section is financial analysis. We will discuss profitability indicators, efficiency indicators, liquidity and solvency indicators with example, of course. And finally, we will have a practical part for each indicator to understand as well as possible. At the end of each section, you will need to complete a test. It will be a short recap. In the second section, we will discuss investment analysis. We will start with the cost benefit and sensitivity analysis. And finally, we will address the future value. The central idea is that a sum of money today is much more valuable than the same amount of money tomorrow. It is a lesson that you must see. Also, together with the future value, we discuss the compound interest and how it can enrich you in time. And in the last section, we discuss the cycles of business, the sources of financing and the financial leverage. Financial leverage can help you increase both your company's profitability and revenue. How? Well, we have a lesson dedicated to this subject and with a well-understood example. Once you know each indicator and analysis and used them, I am sure you will be a different person and you will change the way you see your business. What things you need to get started: basic skills in Microsoft Excel. We will use Microsoft Excel for financial reporting and analysis. So you need to master it at a basic level. You will receive everything ready, you just have to enter the numbers in the table. Desire to learn accounting and finance. No experience or understanding of reports and financial analysis is required. This course start with the basics and no materials required. I will give you many materials to get started. And what you will receive: lifetime access to the course. Access the course from any online device. Even if you have a phone, a tablet, a computer, you will be able to access the course from all devices. Thank you so much for watching. Stop thinking and build your financial fundamentals. My full support for every question or issue. I will answer your questions as quickly as I can. Let's get started, guys!
2. Profitability Indicators - Theory: Hello and welcome to this new lesson!
In this lesson, I want to talk to you about profitability indicators. Profitability indicators are: gross margin, EBIT margin (which is operating profit) and the net profit margin. These profitability indicators are obtained from the percentage presentation of the P&L. We will have two profitability indicators from the balance sheet, but we will have a practical part to understand much better how to apply and what to follow in them. It is important to mention that these indicators of profitability, efficiency, solvency are called key performance indicators or KPIs. In some books or articles that will be their name. Now let's move on to the first profitability indicator, namely the gross margin rate. It has a very simple calculation formula, namely GM divided by revenue. This gross margin rate is the first indicator that tells us something about the profitability of a business. The higher the gross margin, the more it can support other operating expenses. It represents the part of the sales that includes any company expense and profit, but not the purchase price. It is closely followed by managers as well as by each department involved in detailed. We refer to the departments in a company (sales, production, etc..) Now, I want to make a clear distinction between gross margin and commercial addition. I've always heard entrepreneurs confused these terms. The gross margin is equal to the commercial addition in absolute value. In the example in the tables, the 6000 USD are also the margin and the commercial addition. Both indicators have information on how profitable the sale is, but each looks at things differently. The gross margin looks from top to bottom, from the selling price to COGS (cost of goods sold). While the commercial audition looks from bottom to top, from cost of goods sold to the price. The tables show the calculation difference of the two terms and respectively the final result in percentages. You can use whatever term you want, but the most used of the two is the gross margin and the gross margin rate. It is used by investors, financiers and top management. They can better understand the business from the top down, from the sales to margin and then to operating profit and net profit. And so I introduce the following indicator, namely the operating profit rate or EBIT margin. The formula is operating profit or EBIT divided by sales income or revenue. This indicator measures the performance of the operational management of a business. The rate of operating profit or EBIT margin does not take into account the financial result and tax expenses because these elements of P&L cannot be controlled by an operational manager. The next indicator is the net profit margin. The formula is net profit divided by sales income. It measures the performance of the entire business and therefore both managers and shareholders and investors follow this indicator and its evolution. In addition to the profitability indicators that come from P&L, there is another set of profitability indicators that link data from P&L with those from the balance sheet. A first indicator is return on assets or ROA. The formula is net profit divided by total assets. It is an indicator that measures how well a company's assets are used and therefore the performance of those who make investment decisions. The second indicator is return on equity or ROE. The formula is net profit divided by equity. Report the net profit to equity and show how well the shareholders' money is used. Now that we know the profitability indicators, it is time to put them into practice. Let's see how they are calculated on a concrete example. So let's move on to the practical part. See you there.
3. Profitability Indicators - Practice: Hello and welcome to this new lesson!
In this lesson I want to put into practice the formulas of profitability indicators!
We will start with the first indicator, namely the gross margin rate. As I said before, gross margin or GM has a very simple calculation formula, namely gross margin rate equal gross margin divided by revenue. This gross margin rate is the first indicator that tells us something about the profitability of a business. The higher the gross margin, the more it can support other operating expenses. We will use a P&L to be able to calculate profitability indicators. If the term P&L and this table are new to you, then you should also see course number 1 on business accounting, where we discussed at length and in detail about P&L, balance sheet and cash flow. Now, let's go to the gross margin rate. The formula is here, so let's apply it. Equal, we select the value of the gross margin above and divide it by revenue or income. And we will multiply by 100 to see in percentage what the rate is. Multiplied by 100 and will have 70 percent gross margin rate. Which is very, very good, is a healthy business. The next indicator is the operating profit rate or EBIT margin. The formula is operating profit divided by revenue or EBIT divided by revenue. This indicator measures the performance of the operational management of a business. So let's calculate it. We will have equal, the operating or EBIT, the value of EBIT, divided by revenue. And again, multiply by 100. And we will have 25% EBIT. The next indicator is net profit margin. The formula is net profit divided by revenue. It measures the performance of the entire business and therefore, both managers and shareholders and investors follow this indicator and its evolution. We will have equal. Net profit divided by. Income. And multiply by 100. We get 20% net profit. These indicators are simple to calculate, aren't they? In addition to the profitability indicators that come from P&L, there is another set of profitability indicators that link data from P&L with those from the balance sheet. As you can see, a balance sheet. A first indicator is return on assets or ROA. The formula is net profit divided by total assets. It is an indicator that measures how well a company's assets are used and therefore the top performance of those who make investment decisions. ROA is equal, the value of net profit we select from here, divided by total assets. And multiply by 100. So we will obtain a return on assets of 36%, approximately 36%. A relatively OK yield. But beware, this profitability tells us if the company's assets are used optimally to make a profit. It is important to keep it in mind!! The second indicator is return on equity or ROE. The formula is net profit divided by equity. Report the net profit to equity and show how well the shareholders' money is used. ROE is equal, we select the net, the value of net profit. Divided by equity, total equity. And multiply by 100. We have an ROE of 74%, which is great. It means that the shareholders money is used optimally and brings result. A return of almost 100 means a great return. It means that for every dollar invested, another dollar is obtained in one year, that is, the capital is doubled. In order to have an image about the good or bad use of the assets in a company or its capital, the external benchmarking is very helpful. Benchmarking involves comparison with other players of similar size in the industry. And that being said, these are the profitability indicators in P&L and balance sheet, and that's how they are calculated. These are very simple terms, right? You need a little bit of practice and you will know them easily. See you in the next lesson where we discuss efficiency indicators.
4. Efficiency Indicators - Theory: Hello and welcome to this new lesson!
In this lesson, I want to talk to you about efficiency indicators. Efficiency financial indicators measure the operational performance of the business and therefore are constantly monitoring by top management, but also by operational managers such as heads of sales, production, etc. Usually, they have bonuses conditioned by reaching certain values of the operational indicators. Days receivables outstanding (DSO) and Days inventory outstanding are the two efficiency indicators that we will encounter most often. Let's start with the first efficiency indicator. The calculation formula for days receivables outstanding with the acronym DSO is (receivables at the end of the year divided by annual sale) multiplied by 365 days, if we calculate the average at year level. It shows how many days on average, the money is collected from the moment the invoice is issued to the customer. The company's financial analysts and accountants calculate the indicator on a monthly basis and inform managers and executive about its evolution. The monthly DSO is calculated according to the formula: (receivables at the end of the month divided by sale in the month) multiplied by number of days in the month. This monthly DSO tells us how fast, how many days a company's sales are collected. The faster it is collected, the better, because if we collect the receivables late, it is very possible that we will have to borrow money until the receivable is collected. We can borrow from the bank and guarantee with our debt (with our receivable) that the bank will take care of its collection. There are all kinds of methods. However, for these loans we will pay interest, financing costs will appear on the one hand, and on the other hand, the older a debt, the lower its chances of collection. However, What can we do to improve this indicator and collect receivables faster? We can improve the indicator when we do concrete collection actions. In order to collect the money, we must always know what amounts and from whom we have to collect them and to ask for them when they become due. The DSO is improved by rules and actions such as notifying the client when issuing the invoice, notifying the expiration of the due date after a number of days, contacting the client in case of longer delays, contacting professional collectors in more difficult cases, court actions, etc.. However, the optimal lending period depends a lot on the industry we are talking about. On the Internet, there are such tables with the average collection of receivables from each industry. The second efficiency indicator we will discuss is this days inventory outstanding. It measures the efficiency with which stocks are managed and tells us how many days from the moment of purchase the stocks will remain in the company without being sold (in the case of finished goods and products) or without being transformed (in the case of raw materials). The formula to calculate the days inventory outstanding at the year level is: (stock at the end of the year divided by annual sale cost), multiplied by 365 days. And this indicator is monitored monthly by managers, especially by managers in the logistic and production departments. The calculation formula for a month is: (stock at the end of the month divided by cost of sales per month) multiplied by the number of days in that month. Stocks, whether they are stocks of raw materials, semi-finished products, finished products or goods, are an important asset in which money is blocked. The shorter the storage period, the better. It means that stocks quickly turn into money, that people in the supply department do their job well and that there is communication between departments. As in the case of the receivables indicator, what an optimal storage period means depends a lot on the industry. For a pastry shop, the storage time is very short, averaging a few days. And for some products even a few hours, while for pastry equipment manufacturer the average storage period can be several months. And for this business to survive, it has to make loans. And for stocks, as for receivables, we will establish clear policies, minimum and maximum stock limits, we will review these limits periodically and we will introduce stock efficiency practices. There are all kinds of software that easily calculate the average storage period at the product level. And these details are useful because we can see which are the assortments that have long storage times, we can quickly see which products are difficult to sell or expired. Long storage periods mean not only significant amounts of money stuck in products, but also a large adjacent expenses. Such expenses are those with storage, handling, insurance and financing of these products. Losses often occur as a result of product damage or expiration. Thus, we can significantly improve the profit by reducing these expenses caused by large stocks. Now that you understand the terms, it's time to move on to the practical part where we will apply the newly learned formulas. See you there!
5. Efficiency Indicators - Practice: Hello and welcome to this new lesson!
In this lesson, I want to put into practice the efficiency indicators. Efficiency financial indicators measure the operational performance of the business and therefore are constantly monitored by top management, but also by operational managers such as heads of sales, production, etc.. As you already know, days receivables outstanding (DSO) and days inventory outstanding are the two efficiency indicators. We also have here, the formulas for the two indicators. The first indicator we will start with is Days receivables outstanding. The formula is (receivables at the end of the year divided by annual sale) multiplied by three hundred and sixty five days. The formula is to see the annual value. For the monthly DSO, we have the formula: (receivables at the end of the month divided by sale in that month) multiplied by the number of days in the month. This indicator shows us how many days on average the money is collected from the moment the invoice is issued to the customer. The faster it is collected, the better, because if we collect the receivables late, it is very possible that we will have to borrow money until the receivable is collected. For these loans we will pay interest, financing costs will appear on the one hand, and on the other hand, the older a receivable, the lower its chances of collection. Now, let's calculate both the annual and monthly DSO. We will need both P&L and balance sheet. We will take data from both tables. So we have receivables at the end of the year that we take from the balance sheet. From here. The balance sheet and P&L are from a donut shop and there are no receivables. Therefore, I set some values as an example. You should have receivables from current assets, in this section. And the first time we calculate the annual value, so we take the annual value of the receivables. In my case, I have 200.000 dollars. We go back and put Two hundred thousand divided by the annual sale, which is 1.000.000 in my case, and multiply by 365 days. The annual sale is the annual income or revenue, the income for the whole year. And we have the value of 73 days. What this means? It means that we usually collect receivables within 73 days. Is it good or bad? We don't know until we check the industry average where we operate. If the industry average is 50 days, then it is bad. We have to do something. If it is 100 days, then we are much better than the industry average and it means we are doing a very good job. Let's calculate the monthly indicator. Equal, receivables at the end of the month 20.000 in our example. You can calculate for any month you want, it is important to choose the value of the receivables for that month. We calculate for January. Then we divide the sale in that month. In my case, 100.000. And multiply by 31 because January has 31 days. If I did it in February, I had to put 28 or 29 days. For April we have 30 days and so on. And the final result is 6.2 days. We collect receivables monthly in 6.2 days. Again, we have to compare the result with the industry average to know where we stand. I said some solutions in the last lesson to improve this indicator. Now, let's move on to the second indicator. Days inventory outstanding measures the efficiency with which the stocks are managed and tells us how many days from the moment of purchase the stocks remain in the company without being sold (in the case of finished goods and products) or without being transformed (in case of raw materials). The formula to calculate days inventory outstanding at the level of the year is here: (Stock at the end of the year divided by annual sales cost) multiplied by 365 days. And the calculation formula for a month is (stock at the end of the month divided by cost of sales per month) multiplied by the number of days in that month. We took the stock at the end of the year from the balance sheet, more precisely from here (inventories or stocks). And for the first time, we will take the value for the whole year. 35.000 in our case. So let's apply. Equal. Thirty five thousand, Divided by annual cost (that being the annual cost of goods sold and we get from P&L, here) And multiply by Three hundred and sixty five days. The result would be about 43 days. The annual value for days inventory outstanding is 43 days. The result must be compared to the industry standard. Now let's calculate the monthly one. Stock at the end of the month is here. In my case, 5.000 dollars. So we will have 5.000, we divide at the monthly COGS that is 30.000 And multiplied by 31. And we have 5 days average monthly storage period. A very important observation to make is that the less stock left at the end of the year or month, the shorter the storage period, it means that stocks quickly turn into money. Let's take an example. If we make 3.500 out of 35.000 Let's see, we'll get 4.2 days. And we have significantly reduced the average annual storage period. The same is true for the monthly indicator. If we reduce the stock from 5.000 to 500, we get 0.5 days, which means we get rid of the stock in half a day. The observation is also valid for annual and monthly receivables. The fewer receivables, the shorter the average receivables collection period (so you will collect the money faster). To improve this indicator, I gave some examples in the previous lesson. As a brief recap, you take the receivables from the end of the month and the year from the balance sheet. From Current Assets Section. Annual and monthly sales refer to the annual and monthly revenue or income, and you get them from P&L. You also take the stock from the balance sheet, from current assets, and you take the COGS (cost of goods sold) from P&L. It's so simple to calculate these two efficiency indicators. See you in the next lesson where we discuss liquidity and solvency indicators.
6. Liquidity and Solvency Indicators - Theory: Hello and welcome to this new lesson!
In this lesson, I want to talk to you about liquidity and solvency indicators. These indicators provide information about the company's ability to pay its debts. They are followed by managers, shareholders, investors, suppliers, all of whom are interested in not losing the money they have invested or financed a business with. We will discuss liquidity indicators for the first time. Liquidity indicators refer to a company's ability to meet its short-term payments. The main liquidity indicators and the most used are current ratio and immediate liquidity. Let's start with the first liquidity, namely the current ratio. It is calculated as current assets divided by current liabilities. A safety value of current ratio should be greater than 1. This means that current assets are higher than current liabilities. A value of over 1 shows that, in case of emergency, the company can liquidate all current assets to pay its short-term debts according to the due date, which creates creditors' trust. Suppose that the flow of income is affected or diminishes considerably, well, creditors' money is not lost, but can be recovered in a short time from the sale of these current assets. So it is important to have this current liquidity or current ratio in our sights. As I said at the other indicators in the previous lessons, the value of the indicator has different values depending on the industry in which the company is. For example, a current ratio of 1 is sufficient in an industry with small or nonexistent stocks or inventories, such as consulting firm, and in an industry with large stocks, a current ratio rising to 2 is more comfortable because stocks generally they represent less liquidity assets than receivables or cash, and therefore cannot be quickly converted into money. Because inventories confuse us when calculating current ratio, we will have another indicator called immediate liquidity that eliminates the impact of inventories. Immediate liquidity or acid test (a famous name of the indicator) has the calculation formula (current assets minus inventories) divided by current liabilities. Current assets from which we eliminate inventories can also be found as quick assets. To be safe, this indicator should have a value greater than 1, but here too, the values are different depending on the industry in which you operate. This indicator draws our attention to the fact that, in case of a sudden cessation of revenues or their drastic decrease, the company's products (that means inventories) could become unsaleable or hard to sell, that means we will not be able to use them. This is why we eliminated them from the calculation of assets that can be quickly converted into money and from the calculation of immediate liquidity. The conclusion would be that, good immediate liquidity gives even more comfort to creditors than good current ratio. Important observation. A company ends up having liquidity problems when it cannot honor its current debts. The terms used for such a situation is insolvency. A company becomes insolvent if it cannot pay its debts, if it doesn't have enough cash, even if it has enough assets with the help of which if it would sell them and collected them, it could honor its due debts. A business can be profitable, it can have valuable assets, and yet it can end up with no money to pay its current debts, current liabilities. Remember, creditors do not wait for the payment of debts until the company could sell and collect their assets. The workers do not wait too long for the payment of salaries and therefore maintaining good liquidity is vital. But in order to keep it good, we must know that it exists and calculate it monthly. A business can continue to operate for quite some time with problems of profitability and efficiency, but if it has liquidity and solvency problems, it risks going bankrupt in a short time. Let's talk about solvency indicators. These indicators measure the long term financial balance. The most popular of these is the debt to equity ratio. The solvency indicator is calculated according to the liabilities divided by equity formula. Creditors, banks and other financial institutions monitor this indicator to ensure that the company is not over-indebted and can repay its loans. Often, lenders impose conditions related to maintaining certain values of solvency indicators in the terms of credit agreements. These conditions are intended to prevent over indebtedness, which reduces the chances of repaying loans. It is clear that all financiers and investors want to ensure that the business will not go bankrupt during the period in which they credit the company and that they will recover their money, plus the related interest. The specifics of the industry determine what good solvency means. A solvency of 2 can be very good in some industries (those that require large investments) while a solvency of 0.5 can be excellent in others. It's time to implement the new formulas learned. See you in the next lesson!
7. Liquidity and Solvency Indicators - Practice: Hello and welcome to this new lesson!
In this lesson I want to put into practice the formulas of liquidity and solvency indicators. As I said in the last lesson, these indicators give information about the company's ability to pay its debts. They are followed by managers, shareholders, investors, all stakeholders interested in not losing the money they have invested or financed a business. Liquidity indicators refer to a company's ability to meet its short-term payments. The main liquidity indicators are current ratio and immediate liquidity. The formulas for the indicators are here. Let's start with the first liquidity, namely the current ratio. It is calculated as current assets divided by current liabilities or short term liabilities. So let's calculate it. Equal, the total value of current assets that we will take from the balance sheet. Current assets here. Divided by the total current liabilities, here. And we get the value 2.08. A safety value of current ratio should be greater than 1. This means that current assets are higher than current liabilities. A value of over 1 shows that, in case of emergency, the company can liquidate all current assets to pay off its short-term debts according to the due date, which creates creditors' trust. As I said at the other indicators, the value of the indicator has different values depending on the industry in which the company is. Now, let's calculate the immediate liquidity or acid test that eliminates the impact of inventories. Immediate liquidity has the calculation formula: (current assets minus inventories) divided by current or short term (debts) liabilities. So we will have equal, current assets, the value of current assets here, minus inventories and divided by current liabilities, total current liabilities. And we will get 1.66. To be safe, this indicator should have a value greater than 1, but here too the values are different depending on the industry in which you operate. This indicator draws our attention to the fact that, in case of a sudden cessation of revenues or their drastic decrease, the company's products (which are inventories) could become unsaleable or hard to sell. That means we will not be able to use them. That's why we eliminated them from the calculation of assets that can be quickly transformed into money and from the calculation of immediate liquidity. Let's move on to the solvency indicator. This indicator measures long term financial balance. It is calculated according to the formula of total liabilities divided by equity. So let's calculate it. Equal Total liabilities Divided by Equity. And we will get the value of 1.03. Creditors, banks and other financial institutions monitor this indicator to ensure that the company is not over-indebted and can repay its loans. The specifics of the industry determine what good solvency means. A solvency of 2 can be very good in some industries (those that require large investments) while a solvency of 0.5 can be excellent in others. If you want to calculate the indicators per year, you should take the annual values. For example, the value of current assets per year, here. The current total liabilities per year. From here and so on, with each indicator. Remember, a business can be profitable, it can have variable assets, and yet it can end up with no money to pay off current liabilities. A business can continue to operate for quite some time with problems of profitability and efficiency. But if it has liquidity and solvency problems, it risks going bankrupt in a short time. That's why it's important to learn to calculate these indicators and to prevent the bankruptcy of our business! See you in the next lesson!
8. Cost-Benefit Analysis - Theory: Hello and welcome to this new lesson!
In this lesson, I want to talk to you about cost-benefit analysis. Why do we need to learn these analyses and more? Well, these analyses must be done when we want to make an investment. If we want to open a business, we want to invest in a building and so on, it would be ideal to do some analyses before throwing our heads forward. A first analysis in the series is the cost-benefit analysis. Cost-benefit analysis means evaluating the benefits of an investment and the costs associated with it over a period of time, in order to find out if an investment makes economic sense. That is, if the investment is profitable. This analysis has 5 steps. You need to identify and estimate the expenses required for the investment. To identify and estimate the income that the investment will generate. Identify and estimate possible cost reductions. Estimate the duration of income and costs associated with the investment. And finally, you have to take into account the possible benefits and costs that cannot be quantified. They are not difficult at all and they have even a logic. Let's start with the first one. Identify and estimate the necessary expenses for the investment. Why do we need to start with an estimate of expenses? Well, before throwing the money out the window, we need to know how much the investment itself would cost. We need to know how much money we will give on each item. Knowing the expenses, we will know how much money we will need. Let's say we want to open a donut shop. Now, we will discuss the theoretical part and in the next lesson we will work with numbers. What expenses will we have if we want to open a donut shop? The first time we have to document ourselves and analyze the market. We need to make a list of the materials and equipment we will need. We need to know if we will have employees and what salaries to offer. We need to consider marketing and promoting the business in order to have exposure to the public. Basically, at this stage will identify and estimate the expenses necessary to open our donut shop. After we have the list of possible expenses, we move on to the second stage. We estimate the income that the business will generate. By far, this is the most difficult to estimate. If we can estimate the cost with enough accuracy, the income in the absence of a business history is difficult to approximate. We have to think, will the donut shop have chairs inside and out? If so, how many will there be? How many customers would come daily and buy? And of what value?
Exactly how many donuts per customer would be daily? At this stage, it would be good to go in recognition of the competition and see how many customers enter per hour and how many donuts they buy on average. You have to do this on different days and times because, of course, on Sunday night there would be more people on donuts because it's the weekend and there are family outings compared to Monday night after a day of work. So it is important to analyze the competition and make your own estimates based on your own prices and assortments of donuts. In the next lesson, we will have one example of estimation. The third step of the cost-benefit analysis is not a very difficult one. What do cost reductions mean? We have to ask ourselves: what expenses are reduced as a result of the investment made? If you want to start a new business, there are no cost reductions because we have no expenses with the newly established business. Here is an example to better understand. Let's say we have a 5 year old donut shop. The donut dough was made by 5 pastry chefs. We will make an investment that involves buying a daugh machine. Following the investment, we will lay off 4 of the 5 employees because now the machine does a much better job and works nonstop. In this case, the cost reductions are the salaries of 4 people. If the machine uses even less dough, we also have a cost reduction here because we will use less raw material. I hope you understand how it is with these cost reductions. In the next stage, you have to estimate the duration of the income and costs associated with the investment. In order to estimate this, we need to ask ourselves: what is the period for which we calculate the income and costs associated with the investment? When we make an investment, that is, we want to open a business, we want to open it for at least 5 years, Right? So it would be ideal to calculate these costs and revenues for a period of 5 years. It is not complicated at all. In the next lesson, we will have an example. And finally, we must consider the possible benefits and costs that cannot be quantified. The benefits that cannot be quantified are not difficult to estimate. In the case of our donut shop, it can be about selling other products than donuts. For example, we can sell juices, snacks and other small items that can produce long-term benefits. An investment project can have different consequences on other activities, benefits but also costs that must not be forgotten or taken incorrectly in the analysis. Let's analyze these costs a bit. Cannibalization is one such effect, which occurs when an investment reduces the profitability of other activities. In other words, snacks will bring more income than the main activity of selling donuts. Synergy occurs when a new project leads to the improvement of existing activities. Snacks could have a synergetic positive effect. Why? People would know that at our donut shop they find not only donuts but also snacks. The great difficulty with cannibalization and synergy is that they are not easy to quantify. But we estimate as we see fit. Another discussion that arises when it comes to investment projects is that of allocated costs. When we analyze an investment, the already existing expenses are not taken into account. In other words, they are not allocated to the investment. If we want to invest in an automatic dough machine, we should not include rent or electricity in the calculation of the machine because we used electricity anyway and we paid the rent until the machine appeared. We will make these expenses, whether we start the investment or not. Instead, the current used only by the machine, the cost of the machine itself will be taken into account. You have to remember that, the existing costs will not be taken into account, they will not be allocated. And finally, we have the opportunity cost and please be careful because this term applies in all areas of life. Opportunity costs are other costs that we sometimes lose sight of when analyzing an investment. They refer to what is sacrificed to achieve a certain result. An example: the time you spend listening to this course is an opportunity cost because you could have used it in other ways, but you found it useful to use it in that way. Another example. We want to invest 10.000 dollars to start a business. The opportunity cost is this 10.000 because we can do something else with this money, we can invest it other than in a business, but we have chosen to do it. In the next lesson we will put into practice each step to better understand. See you there!
9. Cost-Benefit Analysis - Practice: Hello and welcome to this new lesson!
In this lesson, I want to practice the 5 stages of cost-benefit analysis. Do not be afraid of these tables because we will take them, in turn, to understand as well as possible. Cost-benefit analysis means evaluating the benefits of an investment and the costs associated with it over a period of time, in order to find out if an investment makes economic sense. Let's start with the first stage of the analysis. We need to identify and estimate the necessary expenses for the investment. As I said in the last lesson, before throwing money into a business idea, we need to know how much the investment itself would cost. Thus, the first table is with the investment estimate. Let's say we want to open our donut shop called Gogo, from scratch. We will need furniture, architect, craftsmen and experts. We must rearrange the space as appropriate as possible for a donut shop and we must have certain facilities on the inside. All these investments would reach 100.000 USD. Numbers are invented for this example. The idea is to understand their order and what you need to go through in each table. After we obtain the value of the investment, we calculate the annual amortization, i.e. we divide the value of the investment by 5 years and we will obtain 20.000 USD. Why we do this? Because if we want to open a business, we expect to get our money back in a period of a few years and not a few months. We want to build a healthy long term business, don't we? The second table is for the annual costs of the business. In other words, we wwill note the OPEX of the business. This includes the monthly rent, the cost of employees, promotion, utilities, consumables and amortization. Let's say that in this example, we have 2 employees, utilities and others worth 95.000. At the first stage, you have to think about the investments required by the business you want to open. Do you want a coffee shop? OK, in the first table, you have furniture, remodeling and other materials. Table 2 lists the usual monthly expenses you will have with the business. And I say again, the USUAL monthly expenses. Very important. The next step involves estimating the annual revenue that our donut shop will generate. Suppose the rented space has enough space for 30 seats. An occupancy rate of 50% would mean about 15 seats occupied. In these 15 places there would be 3 clients per day per occupied place, and the average consumption per client would be 10 USD. Being a donut shop, we also have passing customers who will not take a seat but will buy and leave. Suppose there are 20 passing customers a day and the average consumption is 10 USD. All these figures translate into an income of 600 (approximately) USD per day, 19.000 (approximately) per month and 200.000 dollars per year. A good year for the Gogo donut shop. It is quite difficult to estimate the income correctly. You need to ask yourself: how much space you will have for your customers? How many customers would come daily and buy, and of what value? Will you only have seats inside or outside? Ideally, you should go and see what your competition does and how it handles. Be as artistic as possible when estimating income, otherwise, you will have profitability problems in the future. The third step in the cost-benefit analysis is to estimate cost reductions. We have to ask ourselves: what expenses are reduced as a result of the investment made? If you want to open a new business, there are no cost reductions because you have no existing expenses with the newly established business. You just set it up and you have no expenses. On the other hand, if the donut shop is 5 years old, we could invest in high-performance machines to replace some employees and increase the profitability of the business. That cost of dismissed employees must be entered in the table as a reduction of expenses. In our case with the Gogo donut shop, we do not have these cost reductions because it is a newly established business and we have nothing to reduce. Everything is new. In the next stage, we must estimate the duration of the income and costs associated with the investment. In order to estimate this, we need to ask ourselves: what is the period for which we calculate the income and costs associated with the investment? Ideally, we should choose the 5 year period. During this period, the business can generate income and profits large enough to recover our money. Now, let's consider the last step about the benefits and costs that cannot be quantified before doing the P&L for the next 5 years. A benefit in the case of our donut shop, it can be about selling other products than donuts. For example, we can sell juices, snacks and other small items that can produce long-term benefits. At the beginning of the business, we will focus only on the sale of donuts, and along the way we will take into account other income lines. Related to costs, we have cannibalization, synergy, allocated costs and opportunity cost. If our donut shop already had other income lines and we want to invest in another income line, then cannibalization would have occurred because it is possible that this new income line will eat from the main income line that involves the sale of donuts. Also, this new income line can have a synergy effect. We would position ourselves on the market as having various assortments of other products, not only donuts. So it can be a beneficial effect. We do not have allocation costs because the business is new. When we analyze an investment, the already existing expenses are not taken into account. In other words, they are not allocated to the investment. As we gave the example in the last lesson, if we want to invest in an automatic dough machine, we should not include rent or electricity in the calculation of the machine because we used electricity anyway and paid the rent until the machine appeared. We will make these expenses whether we start the investment or not. And we don't take the opportunity cost into account now because we decided to invest the money in a new business instead of investing it in something else. If we were to take it into account, we would be wondering what else we could do with the money? What could we invest them in? Do we make a modern or a classic donut shop? Questions like these to see if we can put them in other placements. Let's get back to the table, here. We start from the year 2021. We noted the annual income from table 3. We consider that we will have a COGS of 30% of income and a gross margin of 70%. I took the operating expenses from table 2 and calculated the total OPEX and EBITDA. We also took the amortization from table 2 and obtained an operational profit of 66.000. We will pay an income tax of 16% and we will obtain a net profit of 56.000 USD. Not bad at all for the first year of operation. For the next 4 years, we deduced that, we will have an annual income increase, annual growth of 5%. The growth is also valid for COGS (why? just to be able to sustain that higher income, we will need more raw materials), promotions, utilities and consumables have also increased. And finally, the net profit. We can see that the profit increases from year to year and the cumulated profit for 5 years is almost 350.000 dollars. Basically, this table is filled with the data from previous tables. From there we will take all the numbers. Now, Let's calculate the ROI. That means the return on investment for our investment, of course. The formula is: profit divided by investment. The profit for 5 years is here, and we divide it by our initial investment. And we will get almost 350 ROI. Honestly, the figure is very good. In 5 years, we will get three and a half times the money invested. Now, it is your turn to make estimates of income and expenses. Start with the first stage and take it gradually. It's very easy. Watch this video again to fix your steps in your mind. See you in the next lesson!
10. Sensitivity Analysis - Theory: Welcome back! In this lesson I want to talk to you about sensitivity analysis. You need to understand from the start that we are working with estimates in these analyzes. And that is a downside in investment analysis. We rely on estimates, estimated revenues and expenses, estimated receipts and payments, and we have no certainty that all of this will be as we calculated it. Some elements can be estimated more accurately, for example the value of the initial investment or certain costs. However, other estimates start from assumptions that may turn out to be wrong during the project, for example revenues. In general, estimates in investment projects are based on working assumptions. For example, we count on certain prices for materials, on a certain demand for the products we sell on a certain level of taxes, etc. During a project, the conditions can change significantly and the assumptions from which we started may no longer be valid. To assess the risk of an investment, the risk of changing assumptions, sensitivity analyses are used. Sensitivity analyses show the effect of changes in prices, costs, other variables in a project. These analyzes are done by comparing several possible scenarios. Usually, in such analysis, we will encounter at least 3 scenarios: best-case scenario (it is the one in which the revenues are maximum and the costs are minimal). Worst case scenario (the one in which the revenues are minimum and the costs are maximum). The third scenario, the most likely of them or most probable scenario, is the one that we estimate has the best chances of realization. Often, analysts prefer to calculate an average model in which the result (that mean net profit) is the best case scenario is added to the worst-case scenario, and their sum is four times the most probable scenario and finally is divided by 6. Thus, an estimate more sensitive to the influence of extreme cases is obtained than simply considering the most probable scenario. You do not have to memorize this formula. It is rarely used. We usually work with the scenarios described above because they are more comfortable and offer more options. Let's move on to the next lesson where we will create 3 scenarios for the Gogo donut shop. See you there!
11. Sensitivity Analysis - Practice: Welcome back! In this lesson I want to show you how to work with the probability scenarios of sensitivity analysis. As I said, we rely heavily on estimates, estimated revenues and expenditures, estimated receipts and payments, and we have no certainty that all of this will be as we calculated it. Therefore, we cannot count 100% on the income put there. Expenses may be taken into account because we can estimate them from research, but income is not guaranteed. Sensitivity analysis is an interesting and mandatory analysis when we want to open a business or make certain investments, because it shows us not only the beautiful side of things, but also the bad. It makes us aware that bad things can happen and if they do, what the results would be and what we can do. It is very important. We have 3 scenarios. Worst case scenario, most probable case and best-case scenario. For best case scenario, we decided to have a seat occupancy rate of 70%. Of the total number of 30 seats, 21 will be occupied by customers. And we have changed the number of transient customers (passing customers) to 34, which means more customers pass per day than usual. The rest of the data remained the same in terms of average consumption per customer, i.e. 10 dollars. So the only variables in these scenarios were the number of seats occupied and the number of passing customers per day. We obtained a daily income of almost 1000 USD, per month of 29000 and per year of almost three hundred and fifty thousand. Let's see how P&L is influenced in this scenario. We have 5-year income here with a 5% annual increase. COGS has also grown because being a higher income, we will need more raw materials to create those donuts. Expenditures also increased relative to revenues. In this case. What interests us is the cumulative profit for 5 years, namely these 720.000 USD. If the value of the investment is 100.000 we will obtain a ROI (that is a return on investment) of 700%. What this means? It means that for every dollar invested in the business, we receive 7 back. Sounds great, but let's remember that, this is the best-case scenario. Let's move on to the most probable case. The most probable scenario is the one calculated in the last lesson. Same occupancy rate of 50%, 15 seats occupied with 20 passing customers daily. And the income is almost 200.000 USD. Let's see. How the P&L would look like. We have a cumulative net profit for 5 years of 346.000 USD and the ROI of almost 350%. It is very, very good. For every dollar invested, we receive 3.5 USD. Now let's see what the worst case scenario looks like. We have an occupancy rate of 30%, that is 9 occupied places and 6 passing clients per day. It would translate into an annual income of almost 120.000 dollars. Almost half of the probable scenario. Let's take a look at P&L for this situation. The situation is not rosy at all. We already see minuses which translates into losses. We see that in the first 4 years, we have a negative net profit and only in year 5 we are in plus. The average of the 5 years is -28.000 and the ROI is -28%. It's not that bad because it can grow. Ideally, we should increase our income through various online or offline marketing strategies, and move on to expenses that can be reduced (possibly to turn some fixed expenses into variable expenses). How can you do that? You can talk to the landlord and instead of offering him a fixed rent of 1.000 USD per month, you can give him 1% of the monthly net profit. And no matter how much the profit will be, he will receive 1%. There are other well-understood solutions. For example, if we reduce the cost of goods sold from thirty five thousand to 30.000, let's see look what will happen. This situation will not turn pink but there are signs of hope. A ROI of -2% and the last 2 years of P&L on positive profit. These scenarios are also valid in the case of the cannibalization and synergy effect. Do you want a second line of business income and do you think the cannibalization effect will apply? Well you're running scenarios. One scenario would be that the secondary income line will eat 30% of the main income line and make a table with this 30% cut revenue. Another scenario: you can decrease by 50% the sales from the main line and you run a table with something like that. Write in the table the incomes from the second line of income or more simply, enter in the table both the incomes cut from the sale of donuts and the sales from the second line, that is the snacks. And see if the profit is OK. You can also apply the scenarios to the synergy. That is, snacks will increase donut sales by 15% and you run a table. There are many alternatives. I want to say in the end that, it is very important to take the sensitivity analysis into account because it makes us aware and that bad things can happen, and if they do, what the result would be and what can we do. At the beginning, when we want to open a new business, we are very excited and forget that unwanted things can happen. Therefore, it is mandatory to take into account the scenarios in the sensitivity analysis. See you in the next lesson!
12. Future Value + Compound Interest - Theory + Practice: Hello and welcome to this new lesson!
In this lesson I want to talk to you about future value and compound interest. An essential concept in finance and investment analysis is the concept known as the time value of money. The central idea is that the sum of money today is much more valuable than the same amount of money tomorrow. Important to remember. You know that the world that what is in the hand is not a lie. Beyond the certainty, it is about the fact that the money brings other money. Let's calculate an example to better understand what this concept is like. Suppose we have 1000 USD. We will do the calculation for the simple interest for the first time. We put those 1.000 in a bank account and take an interest rate of 7% for a period of 20 years. Every year we get an interest of 70 USD and for a period of 20 years, the interest would be one point four thousand USD. This is the situation in which we annually withdraw the interest earned and spend it. So every year we start over. Let's see what the compound interest looks like in this case. For the compound interest, if we do not withdraw the interest and keep it in the savings account, that is, we have an account with interest capitalization (or simply let the interest accumulate year after year to those 1000 initial dollars), the 70 USD annual interest also brings us another interest. Sounds great, doesn't it? This is the compound interest and at the end of the 20 years, the value of the gain from simply keeping the money and capitalizing the interest, in other words the value of the accumulated interest, would be almost 3000 USD. Which translates into a gain of more than 2 times higher compared to the simple interest. Let's take a look at this table where we have the 2 interests. We have here the simple interest and respectively the capital from each year, that is 1.000 USD. Annual interest of 70 USD. As I said, we always withdraw the interest earned in a year and we always start over. We see that the accumulated interest for 20 years is 1400 USD in the capital and interest are two point four thousand USD. On the right side, we have the initial capital of 1.000 USD and the interest of 70 USD We noticed that from year 2 we have more capital, here. Why? Because the interest from the first year we left it there to bring us even more money. And so we did every year. We have practically not touched the interest earned for 20 years at all. And we see that the interest in 20 years is almost 3000 USD, which is double the simple interest. It is the power of the concept of "the value of money over time", meaning that money brings other money. That's what you have to keep in mind from here, just keeping the interest in the deposit, the gain has significantly increased a lot in these 20 years. Of course, for very long periods of time we will not make such tables, but we will apply a formula. This formula. Therefore, we will apply the formula for the future value of money, namely FV is equal to PV, that is present value multiplied by 1 + i, that is interest rate to the power of the number of years of the period "n". The formula is here, as I said. Let's take an example to see how it applies. So, we have the example with 1000 USD that represents the present value of the money, we deposit it in a deposit with a rate of 7% for a period of 20 years, and we expect a future value. So let's calculate. Equal, 1.000 multiplied the POWER function and we have 1+0.07 comma (0.07 because we divided 7 by 100), comma, and we put 20 because that's the period. And we get almost 4000 exactly as we got in the table here, but with less effort. Let's take another example. We have 100.000 USD present value of money. We deposit them in a deposit with an interest rate of 7% for a period of 10 years, and we expect a future value. So. Equal. We select the present value. Multiplied, The POWER function. And we have 1 + 0.07 comma, and we put 10 because that is the period. And we will get almost 200.000 USD. If for 10 years we do not touch the money, we will have almost doubled them at a fixed interest rate of 7%. You will receive this table so that you can return to it whenever you need to review the formulas and how to apply them. You should know that 1.000 USD today are better than 1000 USD tomorrow, next year or in 10 years. Knowing the FV formula, the future value formula, we can get the present value, the present value of the money we will receive in the future. Let's say we have to receive 100.000 USD in 10 years with an interest rate of seven percent. Therefore PV is equal to FV. Let's apply the formula, 100.000 Divided. By, the function POWER. 1+0.07 Comma, and 10 (that is the period). And we obtain almost 51.000 USD present value. If I put you to choose between 55.000 today or 100.000 in 10 years, it would be better to accept those 55.000 today, because the present value of 100.000 in the future is only fifty one thousand currently, and receiving those 55.000 you are earning. If you had to choose between 40.000 USD today and 100.000 in 10 years, you better choose those 100.000. OK, now we haven't considered the short term plans and what you can do with them now even if they are fewer, we are just discussing financially what would be the right decision. If I offered you a million dollar today or the same amount in a year, obviously, you will prefer the million today because time brings with it interest. The present value therefore calculates the value that today has an amount that we will collect in the future, taking into account a certain interest rate or a certain cost of capital. The reasoning is the opposite of the calculation of the future value of an amount that we have today and that we can invest with a certain interest rate. When we talk about a certain cost of capital, we actually refer to a few aspects. Interest is the amount of money that someone who invests his money in a deposit expects to receive. And dividends are the amount of money that someone who invests in a business and takes risks expects to receive. These amounts expressed as a percentage at the year level represents the interest rate, respectively the rate of return on equity or ROE. From the company's perspective, the interest or dividends that the company pays for the attracted funds represent the cost of capital. And these being said, we see each other in the next lesson where we will discuss new interesting and useful terms. See you there!
13. The Life Cycle of a Business: Welcome back! In this lesson I want to talk to you about the life cycle of a business. Where to get the money we need is an almost inevitable question in business. Let's see what would be the financing needs of a business, how and when they appear in a company? If we were to structure things as in the manual, we will see that there are two types of financing sources: internal financing or self-financing, that is the cash flow generated by the company and external financing. The forms of external financing depend on the development stage in which the business is. Depending on the business moment, we are dealing with different objectives, and external financing sources are also different. The development stages of a business are as natural as possible. Here is a diagram that summarizes everything. Any business that is just starting out looks like a newborn. The founders of the business must be constantly vigilant because at any time the baby can wake up in dangerous situations. The second phase is that of growth, a kind of adolescence of the business, a period not without turbulence and emotions, but in any case, less risky than the previous period. After this growth phase follows a phase of consolidation of the business, of the obtained position and at the same time a preparation for a new moment of growth, namely the expansion. We would compare the expansion with the youth of the business. The company is full of energy, with all the engines at maximum power, it manages to reach new markets, to develop new products, to reach high business volumes and to have a maximum performance. This stage is followed by a mature phase of the business, a stage in which the numbers are high, even if the increases are small. At this stage all the processes are well regulated, the business is safe on it. And after the maturity phase, there may be a reorganization of the business, a reinvention (or revival) of it or the decline may begin, followed by the liquidation of the business. That is why some companies with long experience on the market and which have reached maturity, choose to reinvent themselves with new designs (that is a rebranding or with new products on the market). Everything is at the discretion of each company. All sorts of events and all kinds of financing needs can occur along the way. Business at the beginning of the road is very risky. The failure rate of startups is impressive, over 80% in the first year and a half since its establishment. Of the companies that go beyond the startup phase, most remain small businesses. They do not aim to grow, but only to maintain a level of performance and profitability convenient for shareholders. The truth is that not all owners dream of making a successful exit, that is, to grow the business and sell it for many millions of dollars. Most small and profitable businesses remain small and profitable, providing owners with income for a certain standard of living. It provides them with a comfortable income. These companies have low financing needs. The owners of a small and efficient business can choose to use the profit obtained by the business exclusively for their own needs withdrawing it from the business through the distribution of dividends. On the other hand, they can choose to develop the business, to maintain the profit or a part of it in the company, thus self-financing the development needs. Once the business starts to grow, self-financing may not be enough. The company will then turn to external sources of funding to grow. However, if the company has a good management, will demonstrate business performance, will succeed in consolidating the business and will have good financial indicators, then the company will be able to access financing sources that will allow it to expand. Let's move on to the next lesson where we discuss external funding sources. See you there!
14. How to Fund your Business: Welcome back! In this lesson I want to talk to you about how you can finance your business. Exactly what funding sources exist in the world and which we can access. There are many ways you can finance your business. Here, we have several examples including own funds, family and friends, business, angel, crowdfunding, microcredit, factoring, non-reimbursable financing, financial leasing and etc. There are a few in number, but let's take them one by one and discuss them so that you understand as well as possible. The first source of funding is very simple. Own savings or money from friends or help from family. Start-ups have relatively few opportunities to finance themselves. This is because a new business is a risky business and few amateurs risk their money in such ventures. A company that has not yet proven anything, has not shown that it can produce profit and it can pay its debts, has limited access to money. But it is natural. Banks do not trust such companies because the risk of not recovering their money as credit is high. In addition to saving money and borrowing from friends or family, a startup can try to get the money differently. It can get money from a business angel. Business angels are business people who have capital and are looking for investment opportunities. An entrepreneur must meet with such an investor, present him with a well-thought-out and well-developed business plan, demonstrate experience in the chosen business field, showed that he understands the industry, that he knows what problems he is going to solve in the market. In short, the entrepreneur must convince the potential investor to join the board. A business angel will bring money into the business in the form of share capital or in the form of loans that can then be transformed into share capital. A business angel brings into the business not only the money it needs but also ideas and business experience, helping the business to take advantage. According to several studies, startups funded by business angels have higher chances of survival and better performance than the average startup in general. In addition to the sources mentioned so far, a new business can be financed by crowdfunding. Crowdfunding is another way of financing businesses that are at the start. It uses the online environment to attract funds from the general public through dedicated platform or through social networks. However, obtaining relatively small amounts from a lot of investors has been practiced in the past, using other methods such as written requests or organizing events. Maybe an entrepreneur at the beginning of the road doesn't have enough arguments to convince a business angel and not too bright chances for crowdfunding. The entrepreneur may try to access other sources of financing. Microcredit is one such example. These are low value loans of 10-20.000 USD. They are also offered by commercial banks, but most often they can be accessed to various non-bank financial institutions or nonprofit organizations that seek to promote entrepreneurship and support small businesses in certain sectors. Examples of microcredit would be microcredit dedicated to women or young entrepreneurs. In addition to microcredit, commercial credit is another form of financing. This includes the credit granted by a supplier or a customer. Let's say we get a 60-day commercial loan from a supplier for raw materials for donuts. Therefore, we will pay the raw material only after 60 days. Advances from customers are another form of commercial credit. For example, a customer offers us a sum of money in advance to deliver a quantity of donuts to an event, and thus we benefit from a commercial credit. Our donut shop has the money from the customer, we buy the donuts with this money and there would not be need for other money to be able to honor the order. An advantage of commercial credit is that, it is not interest-bearing, has no costs and obtaining it is very, relatively easy. Usually no documents, business plans or guarantees are needed. The respective raw material deposit will receive the money from us after 60 days from the moment the raw material is sold to us, without asking us for the interest for the two months of financing. This commercial credit is like the supplier is offering us products for free for 30, 60 or 90 days. We take the products, we sell them and after the established period we will pay for the respective products. If the commercial credit is not interest-bearing, factoring instead is interest-bearing. It is a rather expensive way of financing because it involves not only financing but also taking risks. Factoring can occur when a company has sales on credit. For example, if the Gogo donut shop would sell large quantities of donuts to a store and through a contract we would establish that the store will pay for the donuts after six months, we could go with this invoice to a bank or a factoring company. It will take over the right to collect the invoice at maturity and will pay to the Gogo donut shop the invoice amount immediately, not later than six months when the store will do it. The factoring company will pay the invoices, but will not pay them in full, will retain the interest for the six months of financing, a risk commission for the eventual non-collection of the invoices and other administration fees. This factoring company has the right to refuse certain invoices or certain bad paying customers. In addition to all these types of reimbursable financing (that is the money received must be repaid at some point), businesses at the beginning of the activity may have access to non-reimbursable financing such as governmental or non-governmental grants or subsidies dedicated to start-ups. This type of financing involves meeting certain criteria that may be related to the industry in which the startup is, depends on the existence of a contribution of business owners and usually requires a slightly larger volume of documents and analysis than in other forms of financing. To access such financing, you need a business plan, a feasibility plan, marketing studies, cost benefit analysis, all kinds of standardized forms. Companies that innovate or develop new products are more likely to attract capital. This is a venture capital or private equity. Venture capital is provided either by individuals or by institutions (such as investment banks, pension funds, insurance companies, or foundations) that have funds available and invest some of them in risky but high potential enterprises. Investors in the private equity area aim to have a significant percentage of shares in order to control the business. Investments are for limited periods, usually 3 to 7 years. Expectations regarding the return on invested capital are high. The value of the invested capital is expected to be much higher at the end of the period 8 to 12 times higher. When financing a business, venture capital companies take into account the business potential, experience and quality of the company's shareholders and managers, but also the ease with which the investment can be liquidated after a period, namely the possibility of successful exit. Financial leasing is another form of external financing to which a growing company has access. Leasing can finance long-term assets, so that the financed good can be a guarantee for the leasing contract. If we were to buy a new donut making machine for the Gogo donut shop, we would first have to identify the seller with whom we will set the purchase price. Let's say we don't have enough money to pay for the good, we will go to the leasing company, which, after signing a contract with the Gogo Donut Shop, will pay the full price of the machine to the seller of the donut machine. Our dounut shop, that is, the user of the asset, will initially contribute with an advance of 15 to 30% of the asset value, and then will pay to the leasing company tranches or periodic installments, usually monthly for a period of 3 to 5 years. These rates cover the financed value, interest and commissions. Another special form of financing is the sale and leaseback through which a company that already owns an asset, sells it to a leasing company that pays the set price. The company receives the money in the account, it remains the user of the goods it sold, and in order to use it, it concludes with the leasing company a leasing contract, paying the monthly installments. The main advantage of leasing is related to its flexibility because you can give up a lease at any time, while the main disadvantage is related to costs, leasing being more expensive than bank credit. When a business has reached a certain size, it has access to all the sources of financing discussed, but also to others that a small business cannot afford. Companies that have a history of performance and end up having credibility with financiers and investors can get much higher amounts by listing on the stock exchange. The capital thus obtained by the company will never be reimbursed to investors who buy shares (that is, property rights over the company). The shareholders are the owners of a company and depending on the percentage of shares held, they may or may not control the business. Being owners, in case of liquidation of the company, they are entitled to a share of the liquidation value. Usually, stock market investors do not buy shares either to control the business or to recover the money, in case of a possible liquidation. They hope that they will receive a dividend, and the shares once acquired can be easily sold on the stock exchange (that is, they can be turned into cash when needed). Bonds are other financing instruments that the large companies have access to. The bond loan is a long-term loan. A company can attract funds by offering bonds to the general public or only to private institutions. A bond is a certificate that looks like an institution, or a company, owes a sum of money to a creditor, due at a certain time (for example over 10 years). The company undertakes, under a contract, to pay a certain interest at regular intervals and at the time of maturity to reimburse to the bondholders the credit obtained. The interest for the bonds is called the coupon. Bonds are transferable securities, but while shareholders own a part of the business, those who hold the bonds are creditors. These would be the main sources of financing both for a business at the beginning of the road and for a large and promising business. Of course there are others, but these are the most important. Choose what you think is right for your business. See you in the next lesson where we talk about financial leverage!
15. Financial Leverage: Hello and welcome to this new lesson!
In this lesson I want to talk to you about financial leverage and how you can use it to increase your income and profit. So let's get started! In finance, there is a golden rule that you must know. She says that the financing of short-term assets is made from short-term financing sources and that of long-term assets through long-term financing sources. Short term means up to one year and long term over 1 year. In the last lesson, I said that if you want to expand and develop, you have to turn to external sources of funding. These can be in the form of interest-bearing financial debts with different repayment terms, or they can be in the form of non-repayable capital and do not require a fixed payment such as dividends. Financial leverage is the ratio between financial debt and equity. The more financial debts there are (that is bank loans, leases, other interest-bearing debts), the higher the level of financial leverage. Although a high level of financial leverage is immediately seen in profitability because interest rates reduce net profit, you must understand that using these loans, a company can develop activities that generate a significant profit relatively easy, enhancing business capabilities. Let's look at an example to better understand financial leverage. Let's say that the Gogo donut shop sells 20.000 dollars a year for 3 USD per donut, meaning annual income of 60.000 USD. Let's say we buy a donut with 1 USD from a deposit and we will have a cost of goods sold of 20.000 dollars and we will make a profit of forty thousand per year. The profit rate is 66%. We will assume that we have no other expenses to simplify the table. There is gross profit or brut profit because I have not noted the annual tax to be paid. Let's say we could sell 40.000 donuts, but we do not have the funds to buy that many. Therefore, we will borrow from the bank for the other 20.000 donuts, namely, we will take a loan of 50.000 dollars with an interest rate of 7%. On the right side, there will be a new expense compared to the first column, namely the cost of interest, because now we have credit. 7% per year out of 50.000 USD would come three point five thousand dollars. But be careful. We also obtained additional sales reaching a figure of 120.000 dollars. The realized profit was 76.000 meaning a profit rate of 64%. What you need to remember. Using the financial leverage, the profit of the donut shop increased to seventy six thousand instead of 40.000 as we had in the previous year without credit, even if the profit rate has decreased from 66% to 64%. However, in numbers there is a difference to be taken into account. A high level of financial leverage increases the company's financial risk, (that is the risk of not paying its interest on time, of not repaying its loans on time), increases the total level of risk that shareholders assume. Companies must maintain an optimal financial structure that generates higher profits for shareholders but does not create financial pressures. Although it can have negative effects in adverse conditions (for example, if there is a decrease in sales, if there are delays in receivables), this financial leverage offers opportunities for growth. Many of us think that our debt will bury us and we will not be able to pay them. We have the impression that the absence of loans gives us comfort and we do not lose much. But from the previous example, we saw that if we take a loan and use it properly, we will have enormous benefits in turnover and profitability. Let's discuss another example of how you can use financial leverage. In this example, our donut shop buys ingredients to make donuts from warehouses. And as we already know, warehouses are a business that has their addition. Therefore, the first column represents the raw materials or ingredients purchased from the warehouse. And the second column is the raw material purchased directly from the manufacturer. I mean, I cut the commission from the middleman. In order to able to work with the manufacturers, it is clear that we have to give slightly higher orders in order to receive a generous discount. What is the plan? We take a bank loan of 50.000 USD from the bank with an annual interest rate of 10%. Thus, we can negotiate with the manufacturer and provide us with the necessary raw material, 2 times cheaper than what is on the market. We see that the number of donuts is the same in both columns and implicitly the total sales. The difference is made at cost of goods sold because we have reduced the cost by half. In the end, we will have an extra expense with interest of 5.000 USD. But in total we doubled our gross profit. It increased from 50.000 to 95.000. And the gain using the credit is 45.000. This is another simple example of how you can use financial leverage in your favor. However, when you want to use financial leverage, take into account the sensitivity analysis with the scenarios. Why? In case you will not have the estimated income, you can still survive with your business and pay interest and other expenses. Every move in the business must be thought out and analyzed. That would be ideal. And that being said, see you in the next lesson!
16. Thank You!: Hello there! We have reached the last lesson of this course. I want to congratulate you for the ambition and seriousness you have shown so far. I know that it wasn't easy for you to understand all the indicators, but I'm sure that you will watch and watch again the lessons that you did not understand or you understood only a little. I am sure in the short time you will learn business analysis. Anyway, you did a very good job. Now, I want to briefly recap everything I discussed in this course to make your notions much clearer. Profitability indicators are gross margin rate, operating profit rate or EBIT margin, and the net profit margin. These profitability indicators are obtained from the percentage presentation of the P&L. We also have 2 indicators of profitability from the balance sheet, namely, return on equity and return on assets. Profitability Indicators show us what the financial condition of the company is and how profitable the business is. The following are efficiency indicators. Efficiency financial indicators measure the operational performance of the business and therefore are constantly monitoring by top management, but also by operational managers such as heads of sales, production, etc.. Days receivables outstanding (DSO) and days inventory outstanding are the two efficiency indicators that we will encounter most often. Next, we have the liquidity and solvency indicators. These indicators provide information about the company's ability to pay its debts. Liquidity indicators refer to a company's ability to meet its short term payments. The main and most used liquidity indicators are current ratio and immediate liquidity. Solvency indicators measure long term financial balance. The most popular of these is the debt to equity ratio. The chapter on investment analysis is important if you want to invest in a business or a good project. Cost-benefit analysis means evaluating the benefits of an investment and its associated expenses over a period of time, in order to find out if an investment makes economic sense. However, to assess the risk of an investment, the risk of changing assumptions, sensitivity analyzes are used. Sensitivity analyzes show the effect of changes in prices, costs, other variables in a project. These analyzes are done by comparing several possible scenarios. And the last concept discussed was that of future value. The central idea is that a sum of money today is much more valuable than the same amount of money tomorrow. And in the last chapter, we discussed the life cycle of the business, the sources of financing the business and the financial leverage. The life cycle of the business makes you aware of the fact that at some point, any company reaches maturity and follows a period of decline if we do not relaunch the business through a rebranding, new products, new services, etc.. Do not hesitate to use the financial leverage in your favor and to grow your business, why not. Let's see, what do you have to do now? You need to learn all the terms used in all the lessons, starting with the profitability indicators, because they are the easiest indicators. Then gradually learn the terms from the other lessons. You don't have to know them by heart, but you have to understand them and know if the value of the results is a good sign in the business or not. Download the resources because they will help you a lot! Once you have learned the terms, you can create your own financial and investment analysis. You will see that it is not so difficult. And finally, one last tip, practice, practice and repeat the process! Following this course does not make you an expert in financial analysis. You have to practice a lot. This is the secret of understanding financial analysis. Practice. That was all for this course. Thank you for following me, and I congratulate you again for the seriousness and perseverance you have shown. You are the best! I really hope you found this course valuable, but in any case, please leave a review and share your experience with others. I'm sure it will help many others. I only wish you well with your financial analysis. Have a great day!