How to Become a Financial Analyst from Scratch!

In this lecture we are going to see:

• Learning is a process. Most of the time you have to ask yourself: "What is the 10/20% that will give me 80/90% of results?" by leveraging on this powerful principle (Pareto Law) this course has been produced
• You will be given an overview of all the topics we are going to cover throughout this course
• We are going to define financial accounting. Indeed, financial accounting is the language of business.
• We are going to see what are the possible paths to undertake to achieve success as finance professional. How to get from accountant to investment banker? I will answer to this question throughout this lecture

You will be introduced to the Accounting Basics. We will cover several topics: 

• Journal-Entry, Accounts
• Chart of Accounts
• General Ledger

The objective of this lecture is to learn:

• How each transaction in Accounting has two sides: Debit and Credit.
• How Accounts are recorded and what are the main Accounts.
• How to use the Chart of Accounts and why is it so useful.

The main topics of this lecture are:

• Double-Entry System
• Accounts

The objective of this lecture is to learn:

• How to use the double-entry system from a practical perspective.
• How to use the main accounts from a practical standpoint.

The objective of this lecture is to understand "The Accounting Equation."  Don't be fooled by the fact that it is called "equation." In fact, event though it sounds as a strict mathematical concept, it is extremely simple to understand. 

What does the accounting equation tell you? 

Indeed the Accounting Equation tells you that Assets always equal Liability plus Equity (thus, A = L + E). 

In other words, the business has two ways to acquire the asset: 

• Through liability
• Through equity

In this lecture you are going to learn how this equation work. 

The objective of the lecture is to understand the basic functioning of the Accounting Equation. 

In this lecture we are going to see:

• How the accounting department is structured
• How the accounting department processes work. In short, how we go from a singe transaction to the generation of reports for managers and investors

The whole point of Building an Income Statement is to show the profitability of the business. The Income Statement (IS) is a summary of all the transactions happened in a certain period of time. Imagine you take 100 pictures in one year and then you arrange them in one big picture that is how the income statement works. 

In this lecture you are going to learn how is the income statement is structured.

The objective of this lecture is to show you how to build an income statement from scratch (Although you will be given the tools to perform this exercise at lecture 15). 

Total Revenues can be subdivided in two big categories:

1. Revenues coming from the operations of the business 2. Other revenues.

1. Revenues from operations are broken down in: Price/Unit (Price x Unit) * Units Sold (Volume).
2. Other Revenues can be una tantum (once in a while) revenues, such as interest income

Total Expenses can be subdivided in two main categories: 1. Expenses coming from normal business operations 2. Other Non-Operating Expenses.

1. Expenses from business operations can be subdivided in: Variable and Fixed. Usually COGS are considered Variable expenses and some other operating expenses can be both fixed and variable.
2. Other Non-Operating Expenses can be una tantum (once in a while) expenses, such as interest expenses.

In this lecture we are going to do a reverse engineering of the income statement. In other words, instead of starting from the revenues to get to the net profit/loss. We are going to start from the bottom line and work our way up to the income statement. This method is a lot used in consulting and it will give you an edge, since it will allow you to think strategically. Thanks to this method you can quickly and easily assess where the problem related to profitability lies.

The Balance Sheet is comprised of two main sections:

1. Assets, comprised of:

• CURRENT ASSETS, comprised of:

- Cash

- Temporary Investments

-  Accounts Receivable

-  Inventory

• NON - CURRENT ASSETS comprised of:

- Plant, Furniture, Equipment… and so on.

2. Liability, comprised of:

• CURRENT LIABILITIES

- Accounts Payable

- Accrued Expenses

- Short-term loans

• NON CURRENT LIABILITIES

- Long-term loan

3. Equity, comprised of:
- Owner's Equity
- Retained Earnings

Together with Income Statement and Cash Flow statement, the balance sheet is one of the three financial statements.

Assets are usually things that produce future benefits. They can be divided in two main categories: Current and Non Current or Long Term Assets. Long term Assets can be classified in Tangible and Intangible. Tangible assets are depreciated while intangible assets are amortized. Two main methods of depreciation and amortization are straight line and double declining balance.

Liabilities produce future expenses. They can be divided in Current and Non-Current Liabilities. In the bottom part of the BS we can find the Owner's Equity as well.

Complete the game that will make you proficient in accounting. What can you expect once completed it?

• Understood how the double-entry system works in practice
• Comprehended how the Balance Sheet and Income Statement are intertwined
• Matured the ability to build your own financial statements from scratch

Step 1. Open up The Accounting Game spreadsheet first.

Step 2. Watch the video and follow the instructions.

Step 3. Compare your results with the solutions provided.

BS and P&L are usually produced on accrual basis. CFS is a statement that shows all cash inflows and outflows within a certain period of time. The CFS is produced on a cash incremental basis. Sometimes looking at just the P&L can be misleading, since the Net Profit does not mean the organization has enough cash to support its operations. To not be fooled by the Net Income a Financial Analyst has to look at the CFS.

The CFS is divided in three main sections: Cash from Operations, Investments and Financing activities.

Building a CFS means starting from NI (Net Income) on P&L and add all the items from BS that helps to determine cash inflows and outflows for a certain period. You know that on the BS, we have two main categories of accounts: Assets, Liabilities. When Assets increase you will register a cash outflow while when they decrease you will register a cash inflow. When Liabilities increase you will register a cash inflow while when they derease you will register a cash outflow. Let me give you an example. When your accounts receivable increase (Assets), even though you had more sales the customers did not pay yet for them. Furthermore, even though you have higher income you didn't receive any cash inflow for that additional income, at least not yet. On the other side, if your accounts payable increase (Liabilities even though your expenses increased on the income statement, you did not pay for them yet. Furthermore, you did not register any cash outflow.

"Delta" is the fourth letter of the greek alphabet. In cash flow analysis "Delta" cash flow is the incremental cash generated in the current period from the previous. For example, when you compare the current year over the previous year you can determine if you had an increase/decrease in cash. This change in cash is defined Delta.

The CF from operations is one of the main sections of the CFS. It allows you to adjust the Net Income from all the non-cash items included in it. In addition, it allows to reflect the change in working capital happened within a time frame. The CF from operations is crucial for upper management to assess whether the business is run efficiently.

The Accrual principle states that income is recognized as soon as the transaction between two parties happened, independently from cash payment. The Cash principle, instead, states that, in a transaction, income is recognized when cash payment is given from one party to the other.

The working capital is defined as the resources at the company's disposal to run its operations in the short term. The formula is: Current Assets - Current Liabilities. The working capital is crucial to assess the liquidity of an organization. Many companies go bankrupt since they lack the resources to deal with short term needs.

Financial Analysts have to know CF from operations from the inside out. As Financial Analyst you will be dealing with cash most of the time. Remember: "Cash is King" in Business.

The Cash flow from investments takes into account the changed in CAPEX or Capital Expenditure. CAPEX is defined as expenses incurred by an organization to acquire or improve an asset. In general, CAPEX are expenses over $2,500 that last for over one accounting cycle and that will generate benefits for the overall organization.

Producing a great CFS is one of the main task of the Financial Analyst. Your CFO will ask you many times to produce these statements. Make sure you go thru this section again if something was not clear to you the first time.

Ratio Analysis is a quick way to analyze company's financials. This is a step forward, that will get you closer to corporate finance, since this implies more analysis and reasoning.

The Objective of this lecture is to understand:

• How to assess profitability
• What are the main profitability ratios

The profitability ratios are very useful if used in conjunction with other metrics as well.

The Solvency Ratios help us to assess what is the proportion between Debt/Equity in an organization or how the leverage affects the optimal capital structure of the company. Even though Debt is very important for the future growth of any business (you can buy long-term assets and finance the growth of the company). On the other hand, there is a certain threshold over which Debt can be harmful for the organization. The Solvency Ratios help us to strike the right balance between debt and equity. Think of your organism. You need fat to survive. Too much of it can be lethal though. The same applies to debt,

The Efficiency ratios help us in assessing how the management is using the company's resources. In other words, the objective of any manager should be that of maximizing the resources. Eventually decreased costs will lead to increased margins, and therefore profits.

The ROE (Return on Equity) is one of the most used ratios in finance. It can be very misleading though.

Indeed, ROE is given by: Net Income/Shareholders' Equity. The ROE is a relationship between two variable and as such we have a Numerator and a Denominator. Furthermore, when the Denominator decreases, the ROE increase, since the Numerator gets bigger in comparison to the Denominator. In this case, Shareholders' Equity can be manipulated in several ways. Few examples include: Buybacks, Dividends and Debt.

Another way to look at the ROE is thru the Dupont Analysis. Formulated in 1920 by Dupont Corporation, it states the ROE as composed by: Net income/Sales * Sales/Average Assets * Average Assets/Average Equity. In few words, according to this formula the ROE can be deconstructed as a combination of Net Profit Margin * Assets Turnover * Equity multiplier. This formula is not a magic formula but it works much better compared to ROE. Even though I showed you the Dupont Analysis, you don't have to feel obliged to use it. Indeed, in Finance is crucial to be Creative. Don't be scared to select your own Ratios bucket and build an original analysis for the CFO.