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in this video i want to introduce you to
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the topic of financial statement
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analysis
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so financial statement analysis is very
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important when making several key
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business decisions
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for example if you are thinking of
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lending money to a company
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and you're trying to decide whether that
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company is a good credit risk or not
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you want to know am i going to get my
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interest payments and am i going to get
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the principal repaid to me
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or maybe you are a supplier to a company
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and you want to know
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hey should i ship them inventory on
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credit
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why would you be worried well what if
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they never pay you what if you never get
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the cash okay so suppliers are concerned
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about this different
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lenders maybe you're thinking of
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investing in a company you're thinking
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of buying stock in a company like
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walmart
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or google so you want to look at the
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past performance of that company
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which is given in their financial
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statements to try and make predictions
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about the future going forward what will
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be the company's future sales what will
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be their future profits okay
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now why is financial statement analysis
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so critical
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in making these decisions because let's
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take me for example
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so i'm an investor i don't work at
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walmart however
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i don't know what's going on at walmart
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i can't just talk to the ceo and be like
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hey let's have a sit down
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i'd like to know about the financial
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performance because i'm thinking of
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buying some more stock in walmart
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i don't know what's going on i'm not an
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insider at that company
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so walmart being a publicly traded
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company in the united states
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they are required to put out financial
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statements if they have to be audited by
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an external auditor
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and then investors like me can look at
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those financials and
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have an idea of how the company has
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performed in the past
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now that's no guarantee about how it's
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going to perform in the future
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but i can make judgments based on oh
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sales have been increasing or sales have
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been declining and i think this trend
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will continue or reverse and so forth
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okay
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i don't work at google so if i'm
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thinking of lending money to google
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if i'm thinking of investing in google i
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don't know
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about google's actual perform i can't
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sit down with the ceo and be like let's
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talk about what's going to happen next
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quarter
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i don't know what's going on because i'm
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not an insider at google
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so these financial statements are like a
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window
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into a company and they give me a
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picture of what is going on at this
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company and what can i expect to happen
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with respect to profits sales cash flows
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in the future and so what financial
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statement analysis when we talk about
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that when you hear that term
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we're really thinking about the three
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main financial statements and we're
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going to focus a lot on these in the
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videos to come
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think about the income statement which
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is sometimes called the statement of
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operations or just the p l statement
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stands for
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profit and loss okay so the income
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statement
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we've got the balance sheet which has
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the company's assets liabilities and
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equity accounts
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okay per ifrs so international financial
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reporting standards
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that is called the statement of
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financial position so the statement of
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financial position
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the balance sheet are the same thing
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okay and then we've got the company's
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statement of cash flows which is going
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to tell us where is this
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company getting its cash from is it from
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their operations from business
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operations or maybe it's financing maybe
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they're borrowing cash that's where
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a company needs cash otherwise they
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can't be in business how would they pay
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their employees how would they pay their
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utilities and so forth
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so we're going to focus a lot of time on
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these financial statements and really
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understanding them
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so we can make predictions about the
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future so i want to just give you an
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idea about financial stem analysis kind
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of where we're going the types of things
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we can do
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at the most basic level okay at the most
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basic level of financial statement
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analysis
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you could just look at a company's
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financials and here i've got financials
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for walmart
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i had the most recent uh you know annual
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financials at the time i made this video
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so you can look and just say okay our
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sales growing
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okay and so walmart actually has two
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types of
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operating revenue here we've got net
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sales which is just selling inventory
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then you see this membership and other
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income that's because walmart also owns
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sam's club and sam's club sells
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memberships
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but let's not focus too much on the
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details right now let's just look at the
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total revenue
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and these amounts are in millions so we
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see that
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2019 teen 2020 2021 for the year fiscal
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year ended january 31st each year
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we see that the top line revenue for
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walmart
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okay so that increase went from 514
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billion to 523 billion to 559 billion so
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we see
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an upward trend okay so revenues are
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increasing so we can see that
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from looking at their income statement
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this is a basic love just looking at
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just top line revenue what's going on we
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can see whether they're profitable
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yes they are okay we can now we look and
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we can also see that profit decline and
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we can ask why now that's a more
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advanced level trying to figure out well
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why exactly did the profit go down and
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we'll get into that
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now we can also get do they have any
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debt now we're not going to see that on
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the income statement we're going to see
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that on
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the balance sheet aka the statement of
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financial position
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and then we can use the statement of
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cash flows to say well where are they
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getting the cash from
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is it their operations are they
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borrowing money are they selling fixed
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assets what's happening how are they
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getting the cash now
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that's when i say basic level i mean all
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you do is look at the income statement
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you look at the balance sheet you want
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to know how much debt they have it'll
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say current
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debt long-term debt and so forth so
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that's a basic level of analysis
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but we go a little more intermediate a
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little more deeper
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we could start to compute some ratios
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and we're going to talk a lot about
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ratio analysis
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with respect to financial statement
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analysis very important tool
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uh for analyzing financial statements
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for example
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how long does it take walmart to sell
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their inventory
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how many days okay so we can calculate
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something called inventory turnover
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and then we can convert that to
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something called days to sell inventory
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so
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i'm not going to speculate here on how
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many days i haven't calculated for
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walmart but let's just say that there
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was a retailer in general
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uh some retailer that it took them 73
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days to sell their inventory
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historically and then it went to one
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year with 79
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and then the next year was 88 you say
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wait wait a minute uh
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this is not a good trend why is it
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taking that company longer and longer to
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sell your inventory so then you would
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have questions about that company like
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what what is going on
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are customers maybe not as excited about
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this company's product anymore
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what's happening you could look at uh so
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again that would be the days of cell
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inventory which is calculated from
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inventory turnover which is a ratio
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another ratio you can calculate is
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profit margin okay so profit margin
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we'll talk about profit margin is
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for every hundred dollars or 100 euros
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in sales
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how much of that actually turns into
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profit okay because remember sales are
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very different from profit you might
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have
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100 or 100 euros in sales but only two
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dollars or two euros
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in profit and so then you would have a
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two percent profit margin okay
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so this if i say intermediate level
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analysis we're not just looking at the
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numbers on the financial statements
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we're now calculating these ratios to
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try and extract more meaning
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from the the financial statements
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thinking about uh we could express the
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company's r d
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research and development costs as a
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percentage of the company's sales
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and then we could look at well how does
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that compare to what the competitors are
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spending maybe they spend three percent
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okay they spend three percent of their
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of their sales on uh research and
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development maybe all the
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competitors are spending six or seven
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percent we say well why isn't this
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company spending as much
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or maybe they're spending more than
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their competitors and so forth and we
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can look at the trend over time
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there's lots of layers that we can deal
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with here now
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getting more advanced okay ratcheting up
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in terms of
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what can we do a financial statement
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analysis we can look so one of the
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ratios
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that i didn't mention we think about roa
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return on assets or roe you might have
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heard of these
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okay so roi uh excuse me roa let's focus
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on just the company's net income
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their bottom line profit divided by
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their average assets
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so if we take roa and we say okay maybe
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roa is increasing
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and we say well why is it increasing
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well we can actually decompose roa
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into two components we can decompose it
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into something called asset turnover
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and profit margin so asset turnover
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times profit margin
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is equal to roa and we could dig into
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that and say okay well did roa increase
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because profit margin increased or
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because asset turnover increased or
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maybe both of them increased maybe one
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went down one went up whatever
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we can also decompose roe okay we can
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disaggregate it into its component parts
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and see well what is really driving
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increases in return on equity or
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return on assets so that's dupont
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analysis and we will talk about that
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now in understanding why net income
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increase or decrease you might think wow
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if
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you know a company's net income went up
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it must be that they sold more product
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well maybe
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not not necessarily the case right maybe
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sales were flat
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okay maybe sales were flat but expenses
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went down
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so then it comes down to okay well what
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expense was it
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it was it an expense that the company
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had some control over like
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oh maybe it was cost of goods sold and
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the company got better at bargaining for
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like better prices from their suppliers
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and you say oh good job you know the
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company did a good job
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but what if it was something like tax
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expense and it was like oh well there
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was a new law
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uh you know think about like in the
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united states for example when the tax
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cut and jobs act come out it decreased
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the corporate tax rate
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so a lot of companies their tax expense
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declined
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so the profitability goes up and you say
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like oh well if the company's
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profitability goes up and i show you
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that well 90
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of that was due to just a decrease in
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tax expense which the company really
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didn't have any control over
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it doesn't seem as impressive because
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it's more external events
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affected the company's profit and not an
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improvement in the company's
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business operations that's why it's this
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advanced level we
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i will show you how to take apart bit by
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bit and what are all the various
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components
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that affected a company's net income why
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did the net income go up or down
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what were the you know seven eight nine
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different things that happened okay now
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we really want to dig deep when we talk
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about advanced level
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thinking about manipulation can't we
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trust the numbers in the financial
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statements remember that management has
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a lot of opportunity there's
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estimates that they make when we think
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about like depreciation what will be the
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useful life
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of property planning equipment there's
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accounting choice of which different
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methods they can use
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and then there's just you know companies
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doing things like aggressive revenue
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recognition where they're engaging in
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channel stuffing and things like that
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to artificially inflate the company's
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sales so remember that the company
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knows that you're going to be looking at
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these financial statements and making
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judgments about the company based on the
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information in those financial
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statements
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so they have an incentive to make the
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financial statements look better
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sometimes than what they're actually the
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business operations happen to be
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and so i'm going to show you some ways
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when we get into advanced level analysis
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talking about what kind of manipulation
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might you expect what are some warning
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signs what are some things you might
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look at
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to you know see what what is going on
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here wheels think about
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what is the quality of the earnings
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number that the company's putting out if
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they say oh well we had you know 10
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billion dollars
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of net income well to what extent can we
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trust that number
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so we're going to do a lot of things i'm
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going to show you how to make common
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size uh
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income statements we'll make trend
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statements i'll show you dupont analysis
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we'll calculate a ton of ratios and i'll
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show you cause of change why didn't net
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income go up
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why did it go down how do we break that
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down we're gonna do a ton of cool things
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with financial statement analysis in the
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videos to come