10.- Building up the ROE (Part 3)

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En provenance du cours de IESE Business School

Operational Finance: Finance for Managers

286 notes

IESE Business School

Operational Finance: Finance for Managers

286 notes

Cours 2 sur 5 dans Specialization Foundations of Management

When it comes to numbers, there is always more than meets the eye. In operational finance, you will learn how to read the “story” that the balance sheet and income statement tells about the company’s operations. The insights you gain from this “financial story” will then become a tool for short-term decision-making at the top management level relating to current assets, current liabilities and the management of working capital. Finally, by the end of the course you will understand the financial consequences of managerial decisions on operations, marketing, etc.

À partir de la leçon

Week 4: Negative NFO and DuPont Analysis

In this final week, we will introduce the final pieces of the puzzle to give you a complete overview of operational finance. We’ll discuss tools like sensitivity analysis that will help you consider the potential outcome of a decision given different variables. In this session we will also look at other crucial concerns for the firm and its shareholders like sustainable growth and ROE (Return On Equity) plus revisit NFO (Need of Funds for Operations) and other topics. Objectives: By the end of this session, you should have a complete overview of the key aspects of operational finance. You will also understand what tools financial professionals use in order to make decisions to strengthen a company’s position.

Course Conclusion & Congratulations0:55

1.- Recap from Week 37:11

2.- Recap from Week 3 (Part 2)3:55

3.- Sensitivity Analysis7:33

4.- Sensitivity Analysis (Part 2)5:54

5.- An Example of Sustainable Growth6:03

6.- Minimum Cash and Other Elements in the NFO7:37

7.- Seasonal Companies6:54

8.- Building up the ROE (Part 1)3:57

9.- Building up the ROE (Part 2)5:20

10.- Building up the ROE (Part 3)4:57

11.- Blind Financial Statements5:02

12.- Blind Financial Statements (Part2)3:34

13.- Blind Financial Statements (Part 3)7:19

14.- Brief Recap2:42

15.- Course Conclusions6:46

Rencontrer les enseignants

Miguel Antón
Associate Professor
Financial Management

[MUSIC]

Now that you understood this concept, if I asked you,

if you were a private equity in which of these companies would you invest?

You might say wait, wait, wait, Miguel, I don't know what a private equity is.

Don't, don't. This is the foundations of managements, so

don't tell me weird names.

Okay, I agree.

I agree.

You are an individual that sometimes could invest in the stock market and

buy one stock.

If you buy one stock of Facebook, you keep that stock in your pocket or

in the bank account and you can do nothing with that.

You cannot change the company because one stock of Facebook,

it's almost nothing out of the millions of stocks of Facebook out there, right?

However if instead of buying 1% of Facebook you were to buy sorry 1%,

one stock, if you were to buy imagine 30 million stocks of Facebook.

Imagine that that amounts to 12% or 15% of all Facebook's stocks.

That means that you have a lot of ownership in Facebook

which means that you can actually change something in the company with your votes

in the general meeting in the annual meeting of the shareholders.

Now imagine that you are one of those private equity that buys most of

the equity of one company and you can change in the company wherever you want

and I show you these three companies with the different ratios.

So clearly, I give you some sales, some growth margin and ROS and

then the DuPont composition in the bottom.

This is for you to [INAUDIBLE].

Look at Walmart, Carrefour and Corte Ingles, a big retail chain in Spain.

It turns out that the ROE is 20, 22 and 10.

Now which one would you invest in, if you were a private equity?

Now, if you are an individual investor and you can do nothing to change the company,

then you would go for the highest ROE, which is 22%.

Carrefour gives you 22%, you invest in that one.

But if you have a lot of stake in the company and you can actually

change something, which are the things that you can change in a company?

Can you change the ROS, return on sales, in this big companies?

Well, not easy.

Right?

It's not easy to push prices of Walmart down even

more because their prices are already really, really low.

So Walmart is competing in prices aggressively.

So you can not go and

just say I just bought Walmart and I'm going to push prices down even more.

People in the management of Walmart are going to tell you we can not do that,

we have already prices as low as we can.

And that happens with many other places.

So ROS in general out of these three elements of the formula is

the most difficult one to change.

What about turnover?

Turnover perhaps is a little easier to change than ROS, but it's still difficult.

It is very difficult to put a Walmart in the middle of [FOREIGN] Barcelona or

Passeig de Gracia, rght?

Because Walmart normally is outside, in places that are cheap, so

you cannot change it into strategy.

If you start putting something in the 5th Avenue,

you are not going to put it at Walmart, because the price of

the rent would ruin your margins in a way, because you are selling cheap stuff.

So it turns out that the easiest thing to change in this formula is the leverage.

So in this case, as you can see, Walmart has a leverage of 2.3.

Carrefour is actually very levered, high leverage, 5.3, and

El Corte Ingles is the one lowest leverage.

Now do you agree with me that El Corte Ingles has the enough power and

the ability, with a strong balance sheet and a strong P&L,

to go to a bank and ask for more credit and more loans?

If actually Corte Ingles doubles the leverage or

even triples the leverage, they would go into an ROE of 30.

And El Corte Ingles could do that whereas Carrefour,

if Carrefour goes to the bank and asks for more loan,

the bank is going to say no I'm sorry, you' are too levered so far.

So you see these things that we have seen right now in terms of return on equity,

it's a very simple formula.

It's just ROS times turnover times leverage but it turns out that

it's very useful to understand the business of a company and to understand

where the return of equity is coming from from a strategic perspective.

So now we're going to do a small game.

[MUSIC]

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