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Speaker: Marie-Lys Leschiera

How does a company generate wealth? You may have plenty of thoughts here.

I need a very good product. I need to have hired top-notch engineers. I need excellent marketers.
Plenty of things.

But there is only one crucial thing to keep in mind, if a company wants to generate wealth, that is to
be able to sell, sell-sell-sell products and all services.

But if you don't manage to sell, never ever, will you be able to generate wealth. So, wealth comes
when we have a good enough sales revenue that is largely enough to cover our costs.

What do we mean by wealth? Actually, we mean profits. A company generating wealth is a company
that generates profits and profits arise simply when the sales revenue is more than the costs
incurred to realise those sales during the period we're talking about.

So that's what the profit is. Of course, if the costs are more than the sales revenue and the
company's at a loss, but that's not what we want.

And naturally we need a statement and accounting statement to monitor whether we've been able
to generate wealth or not during a given period, that statement is the income statements, often
called the Profit and Loss statement or the PNL.

So, that's the first statement we need.

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Speaker: Marie-Lys Leschiera

But is it enough to look at the profits generated from sales? Not really.

You see the income statement is a little bit narrow minded, sales are important, but many other
things happen in a company. You may have purchased or sold machines.

You may have acquired a company. You may have raised capital and that doesn't show up in an
income statement.

So, actually we need other statements to describe the rest of the company to get a broader view of
the company's situation.

The second question that is important to raise is what activities generate cash movement? Cash
inflows, you may think about you know, being able to sell goods that generates a cash inflow.

Well actually it generates a cash inflow, the day you are able to collect cash from customers. You
may get cash inflows because you've borrowed money from a bank because shareholders just
injected more capital in the company.

You may also think about plenty of cash outflows like purchasing raw material from a supplier,
paying your workforce, you know paying an advertising campaign, distributing dividends,
purchasing machines.

So, there are plenty of different cash outflows. So, we'll have an accounting statement to describe
all the cash movements.

That statement will be the cash flow statement. And in the cash flow statement, we can sort out the
cash movements into different categories.

If the business is relatively small, the easiest way is probably have a column with the cash inflows
and another column with the cash outflows.

But if the company gets larger and if you wanted to do some analysis of what happened in the
business, you may need a bit more structure in your cash flow statement.

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So, usually when you open the cash flow statement of the company, you find that the items are
sorted out into three categories. And these three categories systematically come back when we are
working in finance.

So, what are these three categories? Actually we have the operations, the investments and the
financing activities. The operations include everything that relates to the day-to-day core business
of the company.

So, this talks about selling goods, purchasing raw material, paying the workforce, paying for this
advertising campaign, taking care of HR, legal you know, after sales services, all these things you
can think about that happen inside the day-to-day business.

The investment activities relate to the purchase or sale of assets that you plan to use over the long
run. So, purchase new machines or sale of new, old machines, acquisition of other companies.

These are all investing activities. And how about the financing activities? While the financing
activities are all the activities that relate to your relationships with bankers and shareholders.

So, when you borrow money from a bank or you repay an existing loan, when you distributed
dividends, when you raise share capital from shareholders, all these are the financing activities, and
it's fairly natural at the end of the day, because why do we make these financial statements public?

Well, because we wanted to give a view to outsiders on what happened inside the company during
a given period of time.

So, the financing parties, the ones that are sitting in the financing activities want to know what is
done inside the company with their money, you know, how was it invested to buy machines, make
acquisitions, and did that help generate cash from the day-to-day business the operations? 

So in a nutshell, when we look at the cash flow statement, we have two possible types of structure.
You don't sort out the items by cash inflows and cash outflows, or sort them out into three
categories, operations, investments, and financing activities.

So, we can bridge the gap between how much cash the company was holding at the beginning of
the period on its bank account and how much it holds at the end of the period, thanks to all the
different categories of cash.

So, the total cash flow generated by the company during the period will be the difference between
the cash left on the bank account at the end of the year. And the cash that we had on the bank
account at the beginning of the periods.

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And it will also be the sum of all the cash inflows minus all the cash outflows, or it can be the sum of
the cash generated by the operations minus the cash spent in investments plus the cash that came
in or out, it depends from the financing activities.

Speaker: Marie-Lys Leschiera

We've seen two important questions so far, and that gave us an opportunity to look at the profits
generated by a company during a period of time and more broadly speaking, all the cash
movements that can happen in a company during a period of time, again.

But from time to time, it is important in a company to take a snapshot of the situation.

For example, at the end of the year, well, sometimes at the end of the month or at the end of the
quarter, or just before the company is sold to another party.

There is now a third question I would like to raise, who are the main company fund holders? You
may have thought about the shareholders of course, you may have thought about the bankers and
maybe some of you spoke about the suppliers.

Those three parties, are yes, granting funds to the company so that it can run its business over time.

I would make a slight distinction between shareholders and bankers on the one hand side and
suppliers on the other hand side.

Suppliers belong to the world of operations. Why do we take advantage of supplier credit?

Because our procurement people have negotiated good payment terms with suppliers, and that's
typically part of the operations, the day-to-day core business of the company.

The shareholders, the bankers somehow they sit outside the company and their preoccupation is
whether they will get the expected return on their investment or not.

They're not involved at all in the day-to-day core of business. So that's why shareholders bankers
on the one hand side, suppliers are on another hand side. But however, all of them are helping fund
the business.

And the key question of course is what does the company do with this good money?
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So from time to time, it's good to take a snapshot of the situation of a company and show where the
money comes from?

And that statement that shows what the company owes versus what it owns is what we call the
balance sheets.

So, the balance sheet is really these snapshot that we take at the end of a year to understand
where the money comes from and how it has been used, who the company owes money to and
what it owns now, thanks to the funds it was rented by shareholders, bankers and suppliers
typically.

So, who invested funds in the company and how were these funds invested in the operations?

That's what you can see in a balance sheets. So, typically what the company owns is what we call
the assets.

And the money that the company owes is called liabilities and equity. Equity is owed to
shareholders.

Liabilities is owed to all other parties, mainly the bankers and the suppliers. And there is one
important thing to remember in accounting.

It is that your assets will always be equal to your liabilities and equity. Both sides of a balance sheet
must always match.

Besides the accounting rule, I mean, this say something really important about the company.

It says that whatever company owns, it owes it to external parties. So, a company is never rich or
poor because whatever it owns, it owes it to external parties.

And therefore in the exercises, we'll have to ask ourselves what happens when a company makes
money generates a profit, who does it belong to?

I just said the company is never rich or poor. So, when a company creates wealth, who does it
belong to? More to come in our next exercise.

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Speaker: Marie-Lys Leschiera

Through the three previous questions we addressed, actually, we were able to introduce the three
basic financial statements we are systematically working with in accounting.

We said we need an income statement to emphasise how a company managed to generate wealth
during a period of time.

We also said that, besides the income statement, it is important to have a look at the cash flow
statement that will give us a broader picture of what happened in the company during that same
period of time, because it will describe all the cash movements that occurred during the period.

And thirdly, in order to bridge the gap between the beginning and the end of the period, it's
important to be able to look at a balance sheet.

A balance sheet will be a snapshot of what the company owns, its assets and what the company
owes, its liabilities and equity at a precise point in time.

Now we're going to put this into practice, because I know no better learning than practicing through
exercises.

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