[ Music ] >> Heitor Almeida: So let's start talking about short-term financial planning, okay. The general theme of these examples that we're going to talk about is that working capital management, which as we just learned is an investment of the, in the business, is going to determine cash generation and liquidity management needs for a company, okay. So this is going to become clear as we go through these three examples. The first one is going to be an example of inventory management in a high growth environment, okay. Then we're going to talk about seasonality. And the third example is going to be about managing liquidity risk arising from accounts payable, okay. So let's start with inventory management. The specifics, so we are going to have some numbers now to give a specific example. So the situation we have is a company that on average has to purchase inventory 90 days ahead of the time when the goods are actually sold, okay. The sales are going to be 300 million a year and they're going to grow at ten percent per quarter, okay. All sales are cash for simplicity. We're not going to have any receivables, okay, and we're going to have a profit margin of eight percent. And if you're wondering where did I get those numbers from, we can actually show that these figures closely match the current situation at Power Solutions International, okay. The distributor that we just talked about when we discussed the working capital ratios, what they have is a situation where they have a very high, you know, huge growth -- ten percent a quarter is a huge growth rate, okay -- combined with a very long cash conversion cycle, okay. So just to show you this, these are the basic financial numbers for PSI, okay. You can see in this table that the company is growing at a very high growth rate, right. So the growth rate of revenues here is 33% expected growth rate for 2014. Was 46% at that time, right. The company has about an eight percent profit margin, okay. So in terms of, and the revenue, even the amounts match, right, because it's about $300 million in annual revenue, 350 expected in 2014, okay. These are the numbers, right. It's a simplification of PSI's problem, but it is, it's going to give a very similar answer to what I, what's actually happening in that company, okay. So here we have a snapshot of a year in a company like PSI, okay. We have the sales, we have the costs, and we have inventory. So let's look at this example here. We have, right, annual sales is 300 million, right, so you start the quarter with $75 million in sales, okay, and then your sales are going to be growing at ten percent per quarter, right. So that's why sales are going to 82.5, then they go to 90.8, then they go to 99.8, okay. So those are your sales. You have an eight percent profit margin, right, so you profit is eight percent of sales. And your inventory has to be in place 90 days beforehand, right. What this means essentially, it's one-fourth of the year, okay. So what this means is that your inventory has to be in place at the beginning of the quarter, right. So to be able to sell the goods at the end of the quarter, a company like PSI has to have the goods already in place at the beginning of the quarter, okay. So that's what is in this model here -- in the beginning of quarter one, the company has to buy 69 million, which then you sell, right. This number goes here. That becomes your cost when you actually sell the good, okay. So you can check that PSI's profitable, right. You're making a profit, which is eight percent of sales by assumption, okay. And then at the end of quarter one, right, what PSI needs to do is to buy the inventory for the next quarter, right. The beginning, they are going to begin the second quarter with $75.9 million in inventory. Where is that number coming from? That number is the cost of the goods that they are going to sell at the end of the second quarter, right. So that's the situation in this company. Every quarter, if you look at this model here, right, every quarter, at the beginning of the quarter, they have to have the amount of goods in inventory ready to sell for the end of the quarter, okay. So that's the situation, right. So think about this. That is a very interesting example, right, when you start thinking about cash flows, okay. So here's the model. I hope, you know, and I hope everything is clear now where the numbers come from. So now let's think about the following question. What is the cash flow, right? At the end of each quarter, if we had to figure out how much cash is coming into a company like PSI, what would be the answer? What is the, how much cash are the, are they generating? And the answer, it might seem very surprising, but the answer is that PSI's generating negative cash flow, okay. Remember, you know, the assumption, this company has a very high growth rate, right. This company has a very high growth rate. Sales are growing. It's a profitable company, okay, but cash flow is negative. If you want to see why, you know, you just have to think about what's happening here, right. So at the end of quarter one, you're selling 75, but you have to buy the goods that you're going to sell next quarter, right. Because your growth rate is so high, right, the amount of inventory that PSI has to buy every, you know, every quarter end is actually larger than the amount that you're selling in that period, right. So your cash flow, for example, in quarter one, would be 75 minus 75.9, which is minus 0.9, okay. And this happens every quarter. Quarter one, quarter two, quarter three, quarter four, right. It's a negative cash flow plus you can see that the cash flow is growing. It's increasingly negative, right. That's very interesting I think, okay. So think about this. PSI is a profitable company that's growing very fast, you know. If I, if you had heard that before you took this course, you might have thought, "Yeah, this is a great company, right," and yes, it may well turn out to be a great company, but right now it's generating negative cash flow, okay, because your investment in inventory is always larger than the amount that you're selling, okay. So your cash flow is always negative. And if you look at the cash flow statement for the company, that's exactly what you see. So the company's profitable, you're generating a positive profit, okay, but the amount of, your investment in inventory, which is highlighted here, you know, for example, for the year of 2014 was minus $29 million, which is significantly higher than the profit that you're generating, okay. When we get to the bottom of the cash flow statement, of course, there are other items here. It's not just inventory. When we get to bottom of the cash flow statement, what you see is that PSI is generating a negative cash flow, okay. So you're profitable, but you're generating a negative cash flow, right. This is a situation where a company seems to be generating negative cash flow forever, right, and ask yourself, if a company generates negative cash flow forever, what should be the stock price, right? Let's go back to model one and think about what determines a stock price. The stock price is a discounted sum of future cash flows, right. If all future cash flows are negative, the company is worthless. Zero, okay. The company should be liquidated. It's not generating any profit, right. In economic, in cash flow, okay. So this is an extreme situation where you have a company with a very high growth rate, but, you know, working capital needs that are actually making the company cash negative. The company is not generating any cash flow, right. And of course, PSI is not bankrupt, right. PSI is a valuable company. Why is this the case? It has to be that PSI is going to become cash positive going forward, right. The company has to become cash positive going forward one way or the other, right. One possibility is that there's going to be a natural slow down in sales growth, okay. The 40% growth rate that we had in our model is not reasonable. I mean, it's what's happening right now. It's unlikely to go, to keep, the company isn't likely to keep growing at that rate, so if sales growth is low, then this problem is going to change. It's actually one of the examples that we have in our assignment for you guys to go and try to show that, okay. So there's going to be an exercise where you show that, okay. In addition, the company might actually consider changing working capital management, right. Perhaps what PSI needs is improved inventory management, right. Maybe you're keeping too much inventory. You have to move towards the situation where you have more adjusting time inventory and try to generate cash quicker, okay. Another possible solution is try to increase your profit margin, right. We can also show in the example that if a company has a higher profit margin, you're going to be generating positive cash flow, okay. So the bottom line is that for, you know, PSI is definitely expected to become cash positive going forward for some of these reasons. Possibly the most important one is that sales growth is not going to keep as high as it is right now.