Session 1: First Steps in Finance #Finance

this is the first session of the foundations of Finance to me none;">Finance is at the heart of almost everything that you do in a business among the old saying it’s about the money sounds crass but in business that is always true because no matter what aspect of business you’re talking about strategy marketing human relations public

relations it’s still always about the money that is how I think about Finance when I teach my corporate

style="font-weight: bold; color: #1a73e8; text-decoration: none;">Finance class and when I teach my Valuation class in fact I’m often asked what’s the difference between the two classes and there’s actually a very simple way of describing what the

difference is between corporate Finance and Valuation in corporate text-decoration: none;">Finance you look at a business from the inside out you’re looking at financial decision making within a business how do you run a business well and how do you create value in the business in Valuation you’re looking at the same

business from the outside in so with the driving notion that it’s always about money what I’d like to talk about in this session are six melding blocks that you need no matter what none;">Finance class you take now this is my subjective judgement there might be others who believe there are other building blocks but these are the six building blocks that to me make up text-decoration: none;">Finance the first is Finances are very simple and at the same time very complex way of looking at businesses so I’m going to start

off with the concept and structure of a business at least as we see it in Finance and in the process we’re going to lay out the philosophical foundation for

href="https://cashnews.co/finance" style="font-weight: bold; color: #1a73e8; text-decoration: none;">Finance which is it’s always forward-looking it’s not about what you’ve done in the past but what I expect you to do in the future that drives the way we think about

decision making the second big concept we’re going to talk about is Cash Flows Finance is all about Cash Flows as a bust as opposed to

what as opposed to Accounting earning some book value of Assets it’s always about Cash Flows understanding what drives Cash Flows why they’re different from earnings the different types of Cash Flows is

central to understanding Finance the third is the notion the driving force of risk everything in color: #1a73e8; text-decoration: none;">Finance it’s better on measuring risk and making sure you are all ready to return that is sufficient given the risk you’ve taken on so in the process we’ve got to define risk we’ve got to come up with measures of risk and

we’ve got to come up with perspectives andris sound strange but I’ll talk about that in a moment the fourth big idea on which Finance is based is the time value

of money you all heard the saying right a dollar today is worth more than a dollar you’re from now but why understanding the intuition of time values centered also understanding why currencies matter and why the time value of money itself might shift across time the fifth big building block

for Finance is understanding the basics of value how do you value a cash a set of Cash Flows what are those Cash Flows are contractually set

what if their residual Cash Flows what did they contingent Cash Flows understanding the basics of Valuation and finally while financial none;">Markets might not be necessary to run businesses near the lubricants that allow businesses to run well understanding trading is central to Finance in fact every

trade and likes to make money without taking any risk and in fact you’d like to invest no money take no risk and make money that’s called arbitrage understanding what makes arbitrage so difficult in text-decoration: none;">Markets is again central to thinking about Finance so let’s take a step in each in in the right direction on each of these six concepts

let’s start with the concept of a business you’ve seen Finance an Accounting Balance Sheet right you’ve got

Assets you got libraries a financial Balance Sheet lays out the core of how we think about businesses in a financial Balance Sheet you want to see Assets and Liabilities just like you do in an

Accounting Balance Sheet but unlike an Accounting Balance Sheet in a financial Balance Sheet when we think about Assets we think about not what you’ve already put into these

Assets what are you invested in them but what we expect you to make from these Assets in the future it’s always about the future and that’s going to change your perspective and what you see on the asset side of the Balance Sheet on the

library of side of the Balance Sheet I like to believe that in Finance we keep it simple simple in what sense they’re only two ways you could raise

money for a business one is you can borrow the money that’s dead the other is you can use their own money that’s Equity as you expand as a business the layers of Debt inEquity might change but they still remain there still remain only

two ways you can fund a business Debt inEquity the second big idea in Finance is Cash Flows we make a big deal about

Cash Flows in Finance and it’s it’s useful it’s a critical that you understand why Cash Flows can be different from

earnings because often the raw information we have on companies takes a form of Accounting information Accounting earnings understanding white Cash Flows and earnings are different it’s important to understanding why some businesses that look

good in an Accounting basis might not be worth very much and others that don’t look good on an Accounting basis could be worth a lot the second big idea in Cash Flows that I’d like to get through is that Cash Flows can

take one of three forms they can be contractually said at the time you’re entering agreement that’s what you get with the corporate bond the bank Loan they can be residual Cash Flows which is what you get when you’re the owner of a business or an

Equity investor or they can be contingent Cash Flows what a contingent Cash Flows the Cash Flow will happen if something else happens if an event occurs understanding those different Cash Flows is useful in valuing

those Cash Flows then comes the concept of risk we are as human beings risk of us say that all the time but what does that mean understanding how we came to that conclusion or that we are risk averse is central to starting to think about risk and to convert that risk aversion into

our decision-making we need to do two things one is we need to understand that risk is not a bad thing risk is not something to avoid because to become a great business you often have to seek up dress but you have to seek out the right kind of risk risk is a two-sided beast it’s got good a

good side and a bad side and you want to make sure the trade-off works in your favor the second big idea we’re going to promote is that when you think about risk in an A in an investment you got to look you could ask the question risk through whose eyes think about a publicly traded company

you’ve got thousands of shareholders you got managers each of them might have a very different perspective on the risk in a decision whose risk should dominate and thirdly we’ve got to convert that risk perspective into a risk number something we can bring in explicitly into

decision-making you could actually argue that the history of the development risk measures closely parallels that development of Finance as a discipline the fourth big idea

is the time value of money if you’ve taken a Finance class you undoubtedly have a financial calculator take a look at that calculator take a look at all those buttons

and take a look at that PB button and look at how worn out it is it’s amazing how much of Finance it’s a present value problem in fact every

href="https://cashnews.co/finance" style="font-weight: bold; color: #1a73e8; text-decoration: none;">Finance class starts with that Nostrum and dollar today is worth more than $1 year from now but why understanding the intuition behind why a dollar today is worth more than a dollar

year from now is central to Finance and converting that intuition into mechanics in other words if I get to give you a series of Cash Flows can you bring

them back to today or can you move them forward to a different point in time that’s a skill that anybody who claims me in Finance has to have which brings us to

Valuation we’ll have an entire class on Valuation but I’m going to start off by saying something that I truly believe Valuation is simple if you keep it simple we choose to make it complex in fact I’m gonna argue that to

understand Valuation you got to go back and think about those three kinds of Cash Flows I’d talked about because the way we approach Valuation is actually different depending on the type of Cash Flow for contracts reset

Cash Flows the way we do Valuation is we use the promised Cash Flows and we discount them back at a default risk adjusted this country that’s how we value bond the promised Cash Flows are the coupons in the face value the

default risk adjusted cost of Debt is what we used to discover them for residual Cash Flows we estimate the residual Cash Flows those expected Cash Flows we discovered them back at a risk that reflects a risk we as investors see

when we invest in those residual Cash Flows that’s how we value Equity for contingent Cash Flows we need a different token we use option pricing we’ll talk about the basics of option pricing but if we can get those three concepts down

we can value just about anything and finally there’s trading as I said financial Markets of the lubricant that allow businesses to operate so understanding the notion of buying and

selling the notion of training is critical to understanding Finance so let’s start off with every traders dream every traders dream is to find something to risk free

and make more than the risk free reign or put differently to be able to invest no money take no risk and walk away with Profits that’s a pure money machine that’s called arbitrage in practice it’s almost impossible to find our Batoche if it exists it it’s

there it’s transient it’s there then it’s gone so we’re going to talk about the frictions in the market place that caused it to disappear why is it so difficult for Chouard things to exist in text-decoration: none;">Markets and we’re going to talk about two big frictions so first is trading costs nice thing that’s easy it says the $4.95 I have to pay when I trade not so fast trading costs are much deeper they include other items that we don’t even think about when

we trade so understanding those trading costs are central to understanding why free lunches are so difficult in trading the other is Taxes you’ve all heard the old saying right there only two things in life that I guaranteed death and Taxes and I’m not

even sure about death Taxes are an issue in investing they have to be an issue because as investors when we invest in companies we get to spend off to tax Cash Flows so bringing in Taxes into decision making into trading into investing is central

so let’s lay the foundations for how Taxes enter into the process those are the foundations on which we’re going to build these corporate Finance

and Valuation buildings so let’s make sure we get these foundations right