Okay, whether you took a break or not, we are at a point where we want to dig deep into cash flows with the caveat. I'm not going to spend too much time on all aspects of it. Two reasons, that's a class on its own. Second, it's not clear that at this stage you need all that information. What I want you to understand, is what are the main elements of a cash flow statement? So let's start off right at the top. Cash flows are from your project and operations. If you can see it clearly, why do I have projects and operations in italics? I usually don't try to emphasize things in writing, because I will start very early on, that I was doing it for every [LAUGH] third word, and not everything in the word is that important. So when I do it now, it's for a reason. Remember, who are you looking at, how you financed your project, or what the value of your project is to begin with? Remember, forget about financing for now, your job is not to worry about whether you have the money or how will you raise the money for your project? Believe me, if you can't tell the value or the cash flows of your project, nobody, including you, should give you the resources to do it. So projects. The first item, and you'll see this kind of a layout. This layout is trying to remind me of some things, and later it'll make a lot of sense. These lines will make sense, but I'm going to go one item at a time. And I'm going to now start writing. I know some of you will say, he's writing, I can't understand his [LAUGH] handwriting. You will, don't worry, it's simple stuff. So what is revenues? That's top of the line, if you're not making money inflow from your idea, then there's a problem. So we will assume this is for years 1 through 10. Why am I writing years 1 through 10? Because this kind of analysis or set up, will help you for years 1 through 10. It will also help you from year 0 and at the end, but in a very different way. So let's assume you're doing this for year 1 through 10, and you're choosing the specific year. So you'll have to do it for year 1, year 2, year 10, and so on. So the first item that you always worry about is revenues, okay, what is revenues? Remember, price times quantity, so, very straightforward. Why is it straightforward? Because usually you have something to sell, and the quantity of it determines what the number of units are. And what is the price? The price is the market price determined by the marketplace for your commodity or your service, right? It could be anything, it's the willingness of people to pay, as the price and your quantity is determined by again, the demand, okay? So this is easy, and I'm going for the time being assumed that's $5 million, I'm going to use some numbers. Now, quick question, how difficult is it to do? The difficulty is not very high, but it's not easy either. What do you do, you do a market analysis, you understand what your whole market looks like, right? And then you understand where you are in the market, or if it's a brand-new idea, where are you going to fit in the market, and that's called market share. So you go from the big market to your market and which year? Year one, which is not that difficult to predict, but it's still in the future. Year two, it's a little bit more and so on. So you're predicting things in the future, price and quantity in which year? Year one, for convenience, I'll assume that you have done it and it's $5 million. In the real world, who does this? In the real world, your accounting office does this, or your finance office does this. But good companies make the people who are selling a commodity do this analysis. There's a whole field called market research and analysis. So, companies like Toyota are famous because of the management practices. And management on one hand is very difficult, because it's people issues, right? But on the other hand, it's easy, it can be made easier if you give the right people to make the right decisions. I want to emphasize this, because your numbers are as good as where they come from. Sitting in an office, isolated from the market, you cannot predict revenue reliably. And people are not going to be happy, because you're imposing your numbers on top of people who are actually selling, okay? So revenues, remember the prediction, who are the right people to do that, you have to always think about it. Next is cost of good sold. And what I'm going to emphasize here is, what is cost of goods sold? So cost of goods sold can be thought of as the flip side of revenue. And remember, it's also price times quantity. In fact, the big difference typically between revenues and costs of goods sold is, cost of goods sold has many prices and quantities, why? Because it takes people to produce stuff, it takes different raw materials to produce it, and so on and so forth. Does that make sense, yeah? So cost of goods sold is also price and quantity, but of your inputs, and several inputs are needed to produce even one output. I'm not saying you're producing only one output in your project, it could be several. But it's almost always true, that you need many inputs to produce one output, so cost of goods. Where are these numbers coming from? Remember, and this was 5 million, right, let's assume this is negative 2 million. And I'm putting negative numbers in parenthesis. And so, the important point about both of these is, this is coming from your income statement, this is coming from your income statement. So this is the accounting part that you need to remember or need to think about, right? Income is a flow statement, these are both flows, these are typically both variable. So, let's try to stay on this chart and see, what is the next item? Selling, general administration costs. Let me give you a little bit of flavor of what this is all about. Once you have produced your thing, all the costs of production on there, or most of them, are included in costs of goods sold. And these are things that are measurable or variable. Selling and general administration costs, why did I put it separately? I put it separately for one simple reason, selling and general administration costs may not be easily identifiable with the specific project. What do I mean by that? They may not be incremental to the project at hand, so, for example, what are these? You have a sales force already, and you are already selling some products from before, right, because most existing companies evaluate new ideas. It's much more rare to come up with the company for this first time with a new idea. So you are incurring some costs on selling and sales force, accounting department, headquarters, administration, you already have spent money on it, right? So the key here is to try to figure out, how much more are you spending because of this specific project? That's called incremental. And this is a little bit of a challenge, because, that's why these two things are separated out typically. It's because it's much easier to figure out cost of goods sold, if it is one to one with the revenue you're generating, it's a variable. Here it's more a lump, and your problem will be, and this is the whole field, that how much of this is actually variable? So I'm going to make it half a million. So what is half a million? Half a million is costs that I incur on a general basis, but only because of this new project. So one way to think about is this. You start a new product, and your company already has ten people selling the existing projects. And you have to add another person to be able to sell this project, that additional person should shop in these. If you don't need an additional person, then you shouldn't take the past administrative costs and impose it on top of it by dividing or something like that, by allocating. Okay, does that make sense? So you have to be a little bit careful, and I think there's a whole area in business that tries to sort this issue out. Is how do I allocate, how do I take fixed costs and try to allocate them to a specific new project? And talking about allocations, here is the king of allocations, depreciation. And I'm going to spend a little bit of time, but let's first see how much it is. I'm going to make it negative 1 million. What is depreciation? We'll spend a little bit of time later on it, but depreciation is the use of your machinery, of building, that can be allocated to this project. So, because it's going to be a little bit dicey, I'm going to talk about it later, a lot. But depreciation to me, is something that you rarely need to worry about, and the reason is the following, it is not real. It's a number largely imaginary. So imagine if you bought your machine at some point to produce your goods. What is depreciation? Depreciation is that part of the machine that you've used in the year, very tough to calculate, right? But that's what somebody in an office sitting somewhere decides that you used 10% of this type of machine a year, regardless of what you actually have done, and you subtract that. So suppose that number is 1 million, and we'll come back to that in a second, okay? You subtract it, and now you know, just recap, you have 5 million as revenues, you have 2 million as cost of goods sold. You have half a million as selling and administration costs. And then you have this what I would call an artificial number, for the use of your buildings and your machines and all, that you are allowed to deduct, based on a specific schedule. That is on year one, you can deduct so much and so forth, decided by the tax authorities and so on, okay? So what's the next step? This is called operating profits. So what do you do? You take your revenues, 5 million, you subtract out how much? 2 million as costs of goods sold. How much are you left with? 3 million, you subtract out selling and general administration costs. How much are you left with, 0.5 million. Now, these numbers, if done right, are basically to do with creating your commodity or service. Then you have to kind of bring up depreciation, that is, the value of all fixed machines and so on, that you've used for this specific year. Remember, this is year one, and you'll do a similar analysis for year two and so on. So what's left is operating profit, so what are my operating profits? 5 minus 2 is 3, minus 0.5 is what, 2.5, minus 0.1 is what, +1.5 million. Now, if you were in my class in front of you, I would say, is that 1.5 baloney? Now, I know you're from all over the world, and probably baloney doesn't make much sense to you. But let me explain what baloney is. Baloney is like a sausage, which is made out off leftover parts of, you don't even know which animal. And then it's really smashed together, and it actually tastes pretty good. But it has good parts and not so good parts of meat of all kinds of animals that we eat, right? So operating profits is like baloney. It is something really in it, but it also has something artificial and not so good in it. And the not so good part is depreciation. And the reason it's not so good is, because it's not real. It's a number created based on some estimation of how much of your machine you used. So let me ask you the [LAUGH] following question. If you drive a car, or you take a train, or you ride a bike, what is depreciation? Depreciation is saying, how much of your car did you use in a particular year? Or how much of your bike got worn down in a particular year? And how is it calculated? Well, somebody tells you that this type of a machine should be depreciated at 10% every year, right? So if this is a ten year project, and you spent, you'll see, $10 million at the beginning of the project to buy a machine. And it's straight line depreciation, which means straight 10% a year, that's where the 1 million is coming from. So if it's a ten year project and it's straight line depreciation over ten years. And the government allows you to depreciate at a straight line way and you bought 10 million, what is the position every year? 1 million, but please recognize that 1 million is not real. You're not spending 1 million during year one or two or three, you spent 10 million at the beginning, right? But why are you subtracting it? And the reason is very straightforward, you are allowed to subtract it before you pay taxes. So you would be rather silly not to. So, now what's the next item? Taxes, and remember, what am I emphasizing in taxes? Cash, so I'm going to assume for convenience that your tax rate, Is 1/3 third, or about 33%. Why am I choosing this, because it makes my life simple. But you have to recognize that's another reason why you need to dig down and figure out your accounting systems. It's because tax rates may or may not be the same, okay? So now look, if the tax is 1/3, how much taxes do I pay? >> [CROSSTALK] >> Divide 1.5 by 1/3, that'll be tax of 0.5 million, and it's a negative number, okay? Let's now do the next item, it's called net operating profits after taxes. So how much is my profit? Very simple, plus 1 million, look at the word I'm using here. I'm using the word profits, which should remind you that they cannot be for ten years at a time, they have to be per year. So the analysis that I'm doing for you, is I'm doing say in year one, you have to then do year two, three, four, following the same criteria. Now, if you have 500 products for revenues, what happens? You have 500 things to add up, similarly you have 500 cost of goods sold. But you have to all add them up to come up with the final thing for your project. I'm going to make it simple, I'm going to assume that you know how to add and subtract, and you have combined all those numbers. And your total turns out to be 1.5 million for the specific year, say year one.
