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3.1 Cash Flows: Basics

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Decision Criteria & Applications

Мичиганский университет

4.7 (оценок: 23) | Зарегистрировано учащихся: 533

Курс 2 из 4 — Foundational Finance for Strategic Decision Making Специализация

This course is an introduction to decision-making criteria widely used in the real world and will help you understand the foundational principles of how most organizations make decisions. This course is part of a specialization titled “Foundational Finance for Strategic Decision-Making” and is helpful if you are interested in applying to an MBA degree program or learning the foundations of finance to be more effective in your career. This course is applied and problem-based with assignments that are intentionally introductory and simpler than real-world applications you will confront when making day-to-day financial decisions and in more advanced courses.

Просмотреть программу курса

Получаемые навыки

Calculating the Internal Rate of Return of a Project, Calculating Net Present Value of a Project

Рецензии

4.7 (оценок: 23)

5 stars
19 ratings
4 stars
3 ratings
2 stars
1 ratings

AS

Apr 23, 2019

An excellent course for decision making criteria and an intuitive as well as practical course for such concepts as IRR bench marking, cost of capital etc.

SH

May 08, 2019

The discussion and examples regarding NPV and IRR was very clear. It was also a good overview of project and business cash flows.

Из урока

week 3: Cash Flows

This week we will introduce the basics of cash flows, one of two critical inputs to any value-creating decision. Some exposure to Accounting will be helpful and Ross School of Business also offers a MOOC on the basics of Accounting.

3.1 Cash Flows: Basics15:27

3.2 Cash Flows: A Template16:56

3.3 Cash Flows: Capital Items14:37

Преподаватели

Gautam Kaul
Professor of Finance & Fred M. Taylor Professor of Business Administration

Текст видео

Hi. Today's class is all about

decision criteria in a deeper way.

And we talked about NPV last time, payback, and IRR.

I spent a lot of time on IRR but

I hope you realize that in the process I'm trying to show you why NPV makes sense.

One last comment about IRR.

And that is that the thing that concerns me

is that companies' value creation is happening

very differently these days than used to happen a long time ago.

In other words capital is coming from all over the world.

Globalization is happening which is great.

But at the same time the people running companies like

us are not the same as the people who own companies.

So our horizons are shorter than what companies' horizons are.

And what that may create is a little bit of bias in favor of using

short term myopic measures.

And that's why I'm so concerned about percentages.

I hope you think about it and

move forward, this I was very deliberately slow.

Because it's a very complicated issue and a very important one.

I think it's deep inside of us and so I just wanted to raise some issues about it.

Now I'm going to move onto the one ingredient common to everything we do.

Regardless of it's measure we use for picking projects or valuing things.

Cash flows are the basics to all.

I want to warn you about one thing as we move forward which I'll do

repeatedly again.

I told you promised you that we'll stretch whatever we need

during this class, we'll stretch ourselves to learn it as we go along, but

this is one topic on which I was actually talking to Ryan during the break.

Is that this is one topic where we could go on forever or

we could just give you the fundamentals.

And I'm going to just give you the fundamentals because you need

to take class on accounting or learn it on your own.

Because a lot of the issues we talk about are in tutor but

many of the issues here require a knowledge of accounting.

How do we keep our books.

So let's get started.

We are going to use NPV as the basic value creating paradigm or

procedure and it has two ingredients, right?

So the first ingredient,

sorry, is the cash flows on the top and the discount rate on the bottom.

But remember, we need cash flows to even do our IRR payback.

Before we go onto that, let me just emphasize something

about a snapshot of a project firm or you.

You could have a balance sheet, a firm could have a balance sheet, and

a project could have a balance sheet.

And I don't mean it in the accounting sense really.

I mean it about how to think about an idea, how to think about value.

I think of it in the following way as do

most people who understand finance really deeply.

Is on the balance sheet on the asset side, are real assets.

You could have a financial firm which has financial assets on both sides.

But we are largely talking about real assets here.

And what are real assets?

Things that generate your value for you.

I.e., cash flows is the first step.

So think of your idea as being a real asset.

Think of machines being needed to execute your idea, right?

So those are all sitting on the assets side of the balance sheet.

I want you to remember that on the assets side of the balance sheet

is where the action of value creation is happening.

So, your real assets are doing two things, generating cash flows and

then you're to go figure out what your r is to evaluate them.

For the time being, we're going to focus on these.

I want you to be very careful in understanding one simple thing.

And this is a profound result we'll talk about later as well.

Value creation is happening on your assets side.

On your liabilities side, you finance your idea.

So once you have an idea you go say do I use my own equity, my money.

Or do I borrow from the bank or even in equity,

you don't have to just use your own.

After you become big and successful, you may need more money.

And we'll talk about equity and debt in detail.

But the point right now I'm trying to emphasize is this,

don't worry about this aspect right now.

Keep this out of your mind.

And the reason is, to judge an idea and

to value an idea you shouldn't have to worry about how you finance it.

You should have to worry about what's the value of your idea and

the first ingredient important to judging value for idea is the cash flow.

This picture, I'll bring up over and

over again because it emphasizes where your focus has to be.

Okay, so let's get started.

Timeline, important as always, and I know I'm going to be very painful

about this because the one thing if you can put on your timeline,

your word problem, your firm, your idea, whatever.

You're in business.

So, let's draw a timeline.

So, first thing you have to decide is when you're doing your analysis,

you're doing your cash flows, you're to decide what is the length

that you're comfortable with for your project analysis?

And for the sake of convenience I'm just picking 10 years, 1, 2, and so on.

The first thing to remember is which point are you standing at?

Here, and your job is to do what?

Figure out cash flows C1, C2, C10.

And maybe they aren't.

And also what?

C naught.

Negative.

So remember unless you have an idea of how far

you can do valuation, or what the life of your project analysis is, you can't start.

So please remember we are going to come up with some notion of project life.

Which depends on your comfort level in how far you want to go.

So if ideas are brand new there's no point going for ten years.

In fact, when you're in a very early stage of investment if you go for

ten years you're kind of fooling yourself that you know what's going to happen.

So shorter horizons are used in your analysis.

But under steady state business you're going to start to compete with say,

Walmart, which I won't necessarily encourage you to do because it's tough.

But if you start dealing with things that are known,

you've known about them for a while, it's easier to have a longer interval.

But the point, I'm not, I'm not trying to say go ten of five.

I'm saying the nature of the beast,

the idea, determines how long you can do project analysis.

And we are going to assume that's the first thing you do, and

what is this in an Excel spreadsheet?

Just different columns.

So that's why I like Excel.

It's a natural time line.

And now Excel becomes very important for another reason, and

that is, how do I get all these numbers?

And you'll see it's not easy.

So Excel is extremely important in terms of laying out all the data.

But as I said very early in this class, I'm not into teaching Excel because it'll

take away from understanding what's going on.

Excel is just a machine, is just a number calculating and data gathering machine.

Let's just move on to valuing an idea or project.

All value is relative.

When you do cash flow estimation, and when you do valuation, remember what we love

in finance as the only thing we probably have to offer is the law of one price.

That's way throughout this class, what have I said?

Try to figure out your competition is.

Because value is always relative.

If I don't know what the price of a bottle of Coca Cola is, and

I want to produce something very similar, I'll have a tough time.

Right?

So that's why markets are so cool.

That's why I love markets.

Markets allow you to figure out value.

But value's always relative.

So what my value should be depends on the closest parable.

It's not perfect, but

in the real world a very simple rule to follow, one which we don't.

There are two basic ingredients.

Cash flows, who do they belong to?

The project.

The other is cost of capital.

Who does it belong to?

The marketplace, other opportunities.

This session will be very brief introduction to estimation of cash flows.

And to understand cash flows deeply,

I really encourage you, especially because you're right now all over the world.

Some of you are having breakfast, others are getting ready to go to bed.

And some of you are just bored in the middle of the night and

found this class so exciting.

And I hope that's true, actually.

Anyway, bless you.

Let's see one thing about this which I really want to emphasize.

Whenever I know I'll need your help in boning up or kind of

gaining knowledge in another area I'll warn you and this is one warning point.

Do not expect this class to equip you with al the accounting principles,

but at the same time, I'm pretty okay with it, because I teach you fundamentals for

which you go looking for accounting.

So you already know what you're looking for.

The second reason why I don't mind not doing accounting is for

a lot of the stuff we do in this class, it's personally oriented.

Should you invest in a stock, should you invest in a bond, should you take a loan?

Lot of those examples, you don't need to know accounting.

So, accounting is particularly useful if you're trying to evaluate your own idea,

which I hope you become an entrepreneur,

I hope you create value, or I hope when you're working for someone

you're constantly asking yourself what is value and cash flow is an important step.

Okay, all about future cash flows for the life of the project, this is not about

the past remember in finance the first principle always look forward.

Now the problem is the future is not known so this is not going to be easy.

Sources of cash flows come from what are called Pro forma Income and

Balance Sheet statements.

This is where accounting comes in.

And I'm not going to spend a lot of time on accounting, but

I'll talk about these two as we go along.

Fundamentally, what's an income statement?

Income statement shows you the flow of things during the year.

So you obviously going to ask yourself,

why the heck don't I use the income statement directly?

Why am I doing cash flows?

And the reason is, accounting is a language.

Even when it wants to express something, it's stuck by the language.

And the language is very specific to a country too, many times.

So like I speak English right now and you are probably thinking in Japanese.

Your accounting systems in the two countries are likely to be different too.

So yes,

income statement ideally should be exactly what I should go to, it's not the case.

The second reason is, I have to go to balance sheets.

And the simple thing about a balance sheet,

which I showed you conceptually a little while ago, assets and liabilities.

What a balance sheet is, a snapshot of how your

value looks like, all the assets that you have.

Right? So

know there are bunch of things that are ongoing.

What is the value of Google?

You look at the assets.

What is the value of Microsoft?

What is the value of a shop next to you?

You look at the balance sheet and assets.

But the difference between a balance sheet and income statement is one is a flow

similar to cash flow, the other is a snapshot at a point in time.

So the question is you ask yourself,

why the heck do I need the balance sheet to do cash flows?

And you'll see the balance sheet is needed for

a couple of reasons and we'll get to that in a second.

Okay so remember, you do need flows for the most part, but

sometimes you also need balance sheet items to calculate specific things.

Quick question.

Suppose I have a snapshot and I want a flow.

How do you get that?

I have a snapshot and I want to measure the change over a period of time.

So suppose you want to see, using Google,

how your city has changed over the last ten years.

What do you need to do?

You need to take a snapshot ten years ago and take another snapshot ten years later.

So, what do you need to do to be able to get a flow from balance sheets you need to

have two snapshots, beginning of the year, end of the year.

And how do you get a flow?

Just the change.

This is a very simple thing.

The reason I am emphasizing all of this is because

it is easy to understand without knowing a specific language, which is accounting.

Okay, but I re-emphasize over and over.

If there's one class you need to do, is the language class which is accounting.

Specific to your country and

then read about other countries too because business is all over.

So, now specifics.

Let's get started.

I would encourage you if at this point you want to just go run around the block,

do yoga, smile, talk to your relatives.

Have breakfast with your family or dinner whatever.

Nice time to take a break.

But because it's not heavy right now I would encourage you if you feel

inclined to just move on to the next part of the video.

And try to get an understanding okay?

I'll take a break here, but we will start in a second.

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