And here comes the point where we can see that in this process of forecasting,
this roundabout earnings approach may produce better results.
Well, some ideas. First of all,
you remember that in valuation,
we have the terminal value or tail,
and that is earnings based.
Well, because people must make some forecast on what will happen.
They do not observe any cash flows,
the cash flows for the period of super noble growth.
This is a term that is widely used in our final course of Monday.
That has nothing to do with anything super.
It just the period when we have direct forecasts.
But then, we'll have to make some assumption,
and this assumption is much more solid on earnings bases.
Another thing is here,
we can see that accounting,
earnings, they sometimes have
a better forecasting accuracy and power.
I'll put just power.
Well, why is that so?
I'll give you just one example. We deal with accruals.
Let's say you sold something on credit.
So you hear sort of,
locked in your future cash flow because your cash for sale will arrive later.
So somehow, by the use of accrual accounting,
you can better approximate your ability to generate cash flow in the future.
And if we go back to our corporate finance course,
when we talked about these boxes that produce streams of cash flows,
we used some numbers like for example,
this return on equity that was sort of an accounting or book value number.
And we said that this is the ability of this black box to generate cash,
namely for each and every dollar of book value,
it produces a few sense in perpetuity.
So here, we can see that we use that for the forecast of cash flows
specifically in cases in which we cannot make this forecast explicitly.
So when we have to deal with infinity,
and infinity as all of you know is a vague thing,
so we have to come up with a certain forecast
that will be nicely accepted by all the members of the investment community.
And here, we have to clearly produce all the assumptions
behind that and that is how we can support the use of the accounting approach.
So we can say that accrual here
works better than historical cash.
I'll put just cash.
That's easy to do.
And then finally is that strictly speaking,
when we deal with expected cash flows,
we also have this a random dimension because these cash flows fluctuate over time,
and in order to be able to better
approximate our expected cash flows with the use of of accrual accounting numbers,
we have to do something else,
and this something else is pretty clear.
We have to remove
all non-recurring,
I would put numbers quoted.
So let me give you some examples.
Example 1 would be
capital gains or losses realized.
Then, effects of disasters,
earthquakes, floods, fires.
Then, we have things like strikes,
and that is sort of more general, all discontinued operations.
So basically, if a company did this or that but then stopped doing this,
then this something that was discontinued,
that will not go further.
It cannot go into a forecast of something that'll keep happening.
So here, we can see that there are
quite a few special matters that do support our idea that in our studies of accounting,
we haven't wasted time.
And in the final part of this week,
that sort of wraps up our discussion of financial accounting.
We will also pay some attention to the following thing that in financial accounting,
people produce financial statements,
the income statements, the balance sheets,
and the statement of cash flows.
And we see that in order to properly
use the information for these statements in our valuation approaches,
we have to make adjustments and we have to keep thinking.
We have to take into account all that.
And the question arises,
"Is there anything in these statements that sends us
signals of what is likely to happen with these companies not now, but in the future?"
because we need these future cash flows.
And we can see that general financial statements.
They provide these signals, and analyzing them,
you can see some trends that show
what is likely to happen with this company or with this project.
So we will devote the last piece of this week to the analysis of financial statements.