Mikael La Ferla

This week’s reading covers why Warren Buffet closely examines cash flow, the main differences between cash flow and future metrics such as net profit, and the importance of knowing where cash flow comes from.

Legendary investor Warren Buffett follows three fundamental principles when buying shares: long-term growth over short-term growth, investing in brands he understands, and focusing on cash flow, or “owner earnings.” Owner earnings are a measure of the company’s ability to generate cash over a period of time. It’s available cash that can be used instantly, whether for rent, utilities, payroll, etc. The more cash on hand a company has, the better. For example, if a company has invested too much in property, land, or equipment and suddenly must pay a vendor, it will be much harder to meet the vendor’s request. Therefore, it is optimal for a company to have cash for a vendor when they unexpectedly request payment. Buffett prefers looking at this metric because it is much harder for companies to “manipulate” their cash flow. In contrast, it’s much easier for companies to give favorable estimates based on net profit. 

The three essential reasons cash and profit aren’t the same is because (1) revenue is booked at sale, (2) expenses are matched to revenue, and (3) capital expenditures don’t count against profit. Net profit is based on the promise of payment, so cash hasn’t changed hands yet. It normally takes businesses 1-2 months to pay an invoice. That means even though the sale can be recorded on an income statement; the company has to wait to receive the cash. Also, capital expenditures don’t count against profit. For example, a company can purchase a ton of machinery, and only a fraction of the cost will appear on each quarterly or yearly statement. Cash flow statements reflect all of these purchases as paid way before they’ve been fully depreciated.

It’s important to understand where cash flow comes from, whether from operations, investing, or financing. If cash flow comes from operations, that’s a good sign that the company generates cash from its products or services. If the cash flow comes from investing, it could mean one of two things: the company is growing, which results in increased revenues in the long term, or the company’s low level of liquidity makes it difficult to pay its expenses. If the cash flow is from investment, it may be an optimistic sign for the future, or it may also mean the company is selling stock to avoid going into debt/bankruptcy.

Works Cited

Berman, Karen. “Financial Intelligence, Revised Edition: A Manager’s Guide to Knowing What the Numbers Really Mean.” Google Play, Google, Jan. 2013, https://books.google.com/books/about/Financial_Intelligence_Revised_Edition.html?id=7TfCiz1LkMMC

Written by Mikael La Ferla

**I round to the nearest tenth for all of my answers**

1a. What does “above the line” vs. “below the line mean”? Why is it an important distinction (and for whom)?  Minimum of 100 words.

“Above the line” consists of the costs incurred by a business to make the product or service it provides to customers. This term is also known as “Costs of Goods Sold.” These costs are seen “above” the gross profit line. “Above the line” is important to investors and analysts, as it shows the company’s income and expenses. This metric determines how profitable a company is and whether or not to invest in them.

“Below the line” consists of the costs incurred by operating expenses, also known as “overhead.” These costs are not directly related to making the product or delivering a service. These costs are seen “below” the gross profit line. “Below the line” is important to managers and company leaders, knowing which “overhead” costs can be managed more efficiently. A big example is preparing for tax season, as companies want lower tax liability and high cash flow.

1b. Using the MSFT financial statements: What are the components of “above the line” and “below the line” (hint: it is not just accounts but also totals and/or subtotals) for 2018 and 2017?   

“Above the line” for 2017 = Revenue + Cost of Revenue = Gross Margin

• Revenue = Product ($63,811) + Service/other ($32,760) = $96,571 
• Cost of Revenue = Product ($15,175) + Service/other ($19,086) = $34,261
  • Gross Margin = $96,571-$34,261 = $62,310 (in millions) = $62.3 billion

“Above the line” for 2018 = Revenue + Cost of Revenue = Gross Margin

• Revenue = Product ($64,497) + Service/other ($45,863) = $110,360
• Cost of Revenue = Product ($15,420) + Service/other ($22,933) = $38,353
  • Gross Margin = $110,360-$38,353 = $72,007 (in millions) = $72 billion

“Below the line” for 2017 = Gross Margin – (R&D + Sales and Marketing + General and Administrative + Impairment and restructuring) + Other Income (expense)  = Income before income taxes → Income before Income taxes – Provision for income taxes = Net income

• R&D = $13,037
• Sales and Marketing = $15,461
• General and Administrative = $4,481
• Impairment and restructuring = $306
  • Income before income taxes = $62,310 – ($13,037 + $15,461 + $4,481 + $306) + $876 = $29,901
  • Net income = $29,901 – $4,412 = $25,489 (in millions) = $25.489 billion

“Below the line” for 2018 = Gross Margin – (R&D + Sales and Marketing + General and Administrative + Impairment and restructuring) + Other Income (expense)  = Income before income taxes → Income before Income taxes – Provision for income taxes = Net income

• R&D = $14,726
• Sales and Marketing = $17,469
• General and Administrative = $4,754
• Impairment and restructuring = $0
  • Income before income taxes = $72,007 – ($14,726 + $17,469 + $4,754 + $0) + $1,416 = $36,474
  • Net income = $36,474 – $19,903 = $16,571 (in millions) = $16.57 billion

1c. Interpret the results of 2018 “above the line” compared to 2017 “above the line” and then 2017 “below the line” and 2017 “below the line”.  Use totals where you can so this is high level.  I don’t want a comparison of account by account, line by line.  150 words MAX.  

“Above the line” = Microsoft experienced an increase in gross margin of $9.7 billion (15.6%) between 2017 and 2018. This increase is primarily due to Microsoft’s revenue (products and services) exceeding its cost of revenue in this period, which means Microsoft’s gross margin will go up.

“Below the line” = Microsoft experienced a decrease in net income of $8.92 billion (-35%) between 2017 and 2018. This decrease is primarily due to Microsoft’s income tax spike, as paying taxes diminishes a company’s net income. Microsoft paid over 3x the amount in taxes, as they paid $4.4 billion in 2017 and $19.9 billion in 2018.

2a. Summarize the revenue and cost streams of MSFT using the 10K.  Specifically note how costs are allocated between the product and service streams.   150 words minimum.

In the “Revenue: Product Revenue and Service and Other Revenue” section, Microsoft’s revenue streams mainly consist of product revenues (primarily includes sales from operating systems; software development tools; and video games and consoles) and service/other revenues (primarily includes Microsoft Office 365, Xbox Live, sales from online advertising and Linkedin). Product costs, consisting of manufacturing and distribution costs, operating costs related to product support, and costs incurred to include software on PCs sold by original equipment manufacturers (“OEM”), are all recorded as COGS. Service costs, consisting of datacenter costs and royalties; warranty costs; inventory valuation adjustments; costs associated with the delivery of consulting services; and the amortization of capitalized software development costs, are recorded as costs of services. Capitalized software development costs are amortized over the estimated lives of the products. As a result of this revenue breakdown, product revenue demands upfront costs for developing software and games, while service revenue demands recurring costs for maintenance.

2b.  Summarize the revenue recognition policy of MSFT.  SUMMARIZE IN YOUR OWN WORDS.  DO NOT COPY FROM THE REPORT. 100 words MAX.

Microsoft’s revenue recognition policy means that revenue is only recognized when Microsoft has carried out the services the consumer pays. Microsoft’s agreements to fulfill its services may consist of products and services considered separate tasks. Any taxes received in customer payments are then given to the government. 

2c.  Give examples of the revenue recognition for each area as mentioned in the report.  This will require using some imagination and your general or learned knowledge about MSFT.  The purpose is to see if you really understand the principle and application of revenue recognition.  Mention words like transfer of title or ownership and compare to payment. Give it your best shot.   200 words minimum

Product Revenue

• Operating Systems and Applications
  • When it is transferred to the consumer, Microsoft recognizes revenue relating to its operating systems and apps (i.e., Microsoft Excel, Microsoft Word). When a product is licensed or downloaded, that is the transfer of control. An example of this is Microsoft’s OS, which at the time was Windows 10. When the consumer thoroughly updates his OS to the most recent version, Windows 11, this now means the consumer can use and benefit from his purchase. 
• Hardware and Video Games
  • Microsoft recognizes revenue relating to its hardware and video games (i.e., computers, Xbox) when the product has been delivered to the consumer. An example of this is when John orders an Xbox to his house. Microsoft only records the revenue once John receives it.

Service Revenue

• Cloud-Based Solutions
  • Microsoft recognizes revenue related to its cloud-based solutions (i.e., Microsoft Office 365) when the services are received on a recurring basis. An example is paying monthly ($9.99/month) or an upfront payment for the whole year ($99.99).
• Solution Support and Consulting Services
  • Microsoft recognizes this revenue on an ongoing basis. An example is technical support, as the agent will assist a Microsoft user when experiencing a problem with his product or service. 
• Online Advertising and LinkedIn
  • Microsoft recognizes this revenue when these services are provided. For example, Microsoft gets paid when they host other company’s advertisements on their products. 

3.  Calculate EBIT and EBITDA for MSFT for 2018 and 2017  Detail the calculation don’t just give me a total answer.

EBIT = Earnings before interest and Taxes

• How it’s calculated:
  • Gross Margin – Total operating expenses = Operating income

EBITDA = Earnings before interest, taxes, depreciation, and amortization 

• How it’s calculated:
  • EBIT + Depreciation and Amortization Expenses

“EBIT” for 2017

• $62,310 – ($13,037 + $15,461 + $4,481 + $306) =
  • $29,025 (in millions) = $29 billion

“EBIT” for 2018 = 

• $72,007 – ($14,726 + $17,469 + $4,754) =
  • $35,058 (in millions) = $35.1 billion

“EBITDA” for 2017

• Depreciation, amortization, and other = $8,778 (in millions) = $8.8 billion
  • $29 billion + $8.8 billion = $37.8 billion

“EBITDA” for 2018 = 

• Depreciation, amortization, and other = $10,261 (in millions) = $10.3 billion
  • $35.1 billion + $10.3 billion = $45.4 billion

4.  Using the MSFT financial statements, calculate the variance for the balances listed below (some are clearly stated and some you might have to calculate).  The answer must include:     

     % change from 2017 to 2018
    $ change  from 2017 to 2018
     you must state whether it is a favorable or unfavorable variance from 2017 to 2018

Cost of services

• 2017 = $19,086 (in millions) = $19.1 billion
• 2018 = $22,933 (in millions) = $22.9 billion
  • Percentage change = ($22.9-$19.1)/$19.1 = .19895 =

19.90% = unfavorable

• Dollar change = $22.9-$19.1 = $3.8 billion = unfavorable

Selling, general, administration and other

• 2017 = $33,285 (in millions) = $33.3 billion
• 2018 = $36,949 (in millions) = $36.9 billion
  • Percentage change = ($36.9-$33.3)/$33.3 = .108 = 

10.8% = unfavorable

• Dollar change = $36.9-$33.3 = $3.6 billion = unfavorable

Gross Profit of services

• 2017 = $13,674 (in millions) = $13.7 billion
• 2018 = $22,930 (in millions) = $22.9 billion
  • Percentage change = ($22.9-$13.7)/13.7 = .6715 = 

67.15% = favorable

• Dollar change = $22.9-$13.7 = $9.2 billion = favorable

Gross Profit of products

• 2017 = $48,636 (in millions) = $48.6 billion
• 2018 = $49,077 (in millions) = $49.1 billion
  • Percentage change = ($49.1-$48.6)/$48.6 = .01028 = 

1.03% = favorable

• Dollar change = $49.1-$48.6 = $500 million = favorable

5.  Here is the 10K for Microsoft Corporation

Go to the financial statements and provide for me the balance of total deferred revenue for Microsoft at 2018 and 2017 (Hint:  Do not be thrown by the use of alternative terms.  As the book states, there are various terms used for different line items and accounts and sub totals.  Emphasizing the important point, you must understand the terms, not just memorize them).  Explain in your own words, what is in the balance of deferred revenue (hint: refer to the footnotes of the financial statements in the Microsoft 10K.

The balance of total deferred (or unearned revenue) is:

• 2017 = $26,656 (in millions) = $26.7 billion
• 2018 = $32,720 (in millions) = $32.7 billion

 Microsoft’s deferred or unearned revenue is income received, but services have not been delivered. Deferred revenue is generally recognized at the beginning of each year’s contract agreement. These payments consist of software assurance (“SA”), cloud services, and consulting services such as annual subscriptions (i.e., LinkedIn, Office 365, Xbox Live, and Skype).

Created by Mikael La Ferla

Created by Mikael Laferla

This week’s reading covers how different audiences interpret the income statement and balance sheet, how Goodwill was used to bolster expanding companies’ net worth, and how mark-to-market accounting contributed to the Financial Crisis of 2008.

Managers focus on the company’s income statement because for managers to budget effectively, they need to be aware of the revenue and expenses of the company. In addition, balance sheet data rarely considers an operating manager’s budgeting process. On the other hand, investors and analysts prefer looking at a company’s balance sheet, as it displays the assets, liabilities, and shareholders’ equity at a specific point in time. This snapshot allows investors and analysts to assess how liquid and solvent a company is, which helps them determine whether or not to invest in it. 

Goodwill is an intangible asset on a company’s balance sheet when it acquires another business for a price greater than its net asset value. When Goodwill could be amortized, companies were incentivized to acquire companies to undervalue the physical assets that came with the company. However, since Goodwill can no longer be amortized, companies want to purchase companies with little to no inventory. Tyco was a prime example of doing this, as they bought more than six hundred companies in two years. As a result, investors and analysts started looking at tangible net worth, which is total assets minus intangible assets minus liabilities.

Congress commissioned Fannie Mae and Freddie Mac. These two enterprises were designed to buy mortgages from the banks, package them into securities, and sell the securities to investors. These are also called mortgage-backed securities. Many banks, including Lehman Brothers and Bear Stearns, suffered the consequences of buying these securities mixed with prime and subprime loans due to mark-to-market accounting. This accounting method means banks must mark these mortgages down to their current value. So if a bank held $10 billion worth of mortgages and the market dropped 10%, it would have to record a loss of $1 billion. Although these banks profited handsomely from the interest and principal payments from these securities, they were careless in determining who was worthy of paying their mortgages. As a result, too many people defaulted on their mortgages, which resulted in crashing home values and ultimately forced many creditors and lenders into bankruptcy. 

Works Cited

Berman, Karen. “Financial Intelligence, Revised Edition: A Manager’s Guide to Knowing What the Numbers Really Mean.” Google Play, Google, Jan. 2013, play.google.com/store/books/details/Karen_Berman_Financial_Intelligence_Revised_Editio?id=7TfCiz1LkMMC

Written by Mikael La Ferla

1. Market Cap Calculation = Current market price per share multiplied by total number of outstanding shares
   1. The “weighted average number of common and common equivalent shares outstanding: basic” for 2020 is 1,808 (in millions)
   2. *Since October 3, 2020 was a Saturday, I’m using the adjusted close share price for October 2, 2020 (Friday). The share price was 122.55. Please understand this in case the answer you have is a little different.*
      1. 122.55 multiplied by 1,808 (in millions) = $221.57 billion
   3. *Here’s the source I used to find the market price per share for Disney*

2. “Above the line” consists of “Costs of Goods Sold.” These costs are seen “above” the gross profit line. “Below the line” consists of “overhead” costs. These costs are not directly related to making the product or delivering a service. These costs are seen “below” the gross profit line. 
   1. “Above the line” in 2020 was 3,794 (in millions), so $3.79 billion. “Above the line” in 2019 was 11,830 (in millions), so $11.83 billion. Gross profit has decreased from 2019 to 2020 primarily because of the drop in product revenue and the rise in cost of services.
   2. “Below the line” in 2020 was -2,864 (in millions), so -$2.86 billion. “Below the line” in 2019 was 11,054 (in millions), so $11.05 billion. Disney experienced a net loss from 2019 to 2020 primarily because of the increase in restructuring and impairment charges and interest expense.

3. At the beginning of fiscal 2019, Walt Disney began following a five-step model for revenue recognition set forth by the FASB. Disney now intends to recognize revenue when its products and services are transferred to customers. As a result, Disney’s new guidelines recorded a $116 million net reduction to opening fiscal 2019 retained earnings. There are four important changes to Disney’s revenue recognition policies. 1) Disney recognizes a smaller portion of immediate revenue and spreads out the remaining revenue in the future. 2) Any excess over actual earnings for character images, brands, and trademarks with minimum guaranteed license fees is recognized gradually when there’s a shortfall. 3) TV and Film title license fees are recognized when they exceed its set limit. 4) Instead of revenue being recognized when a licensing agreement is renewed or extended, it is now recognized when Disney content is available under the renewal or extension.

4. The major segments of Walt Disney Company are: Media Networks, Parks, Experiences and Products, Studio Entertainment, and Direct-to-Consumer & International. 

The total revenue for all segments in 2020 was $65,338 (in millions).

1. Media Networks = $28,393/$65,338 = .4342 = 43.42%
2. Parks, Experiences and Products = $16,502/$65,330 = .2526 = 25.26%
3. Studio Entertainment = $9,636/$65,338 = .1475 = 14.75%
4. Direct-to-Consumer & International = $16,967/$65,338 = .2597 = 25.97%
5. Eliminations = -$6,110/$65,338 = -.0935 = -9.35%

5. Percentage and money variance from 2019 to 2020 → (2020 value – 2019 value)/2019 value
   1. Cost of services = 2019 = -36,493, 2020 = -39,406
      1. Percentage = .0798 = 7.98%  = Unfavorable variance
      2. Money = $2,913 (in millions) = $2.9 billion  = Unfavorable variance
   2. SG&A = 2019 = 11,549, 2020 = 12,369  
      1. Percentage = .0710 = 7.1%  = Unfavorable variance
      2. Money = $820 (in millions) = $820 million  = Unfavorable variance
   3. Gross Profit of Services = 2019 = $60,579 – $36,493 = $24,086, 2020 = $59,265 – $39,406 = $19,859
      1. Percentage = -.2129 = –21.29% = Unfavorable variance
      2. Money = –$4,227 (in millions) = –$4.2 billion = Unfavorable variance
   4. Gross Profit of Products = 2019 = $9,028 – $5,568 = $3,460 , 2020 = $6,123 – $4,474 = $1,649
      1. Percentage = -.5234 = -52.34% = Unfavorable variance
      2. Money = -$1,811 (in millions) = -$1.8 billion = Unfavorable variance

Solved by Mikael La Ferla

1. Mikael La Ferla disagrees that “organizational” decision-making is pointless. Organizations are composed of individuals who adhere to principles and rules that have propelled them to where they are today. The main argument against organizational decision-making is when it’s “groupthink,” which is when a group of people’s goal for “unanimity overrides their motivation to realistically appraise alternative courses of action” (Griffin, P. 301). Organizations can still have diverse teams consisting of people from different socioeconomic and cultural backgrounds, which can enhance the organization’s decision-making.
2. A programmed decision “recurs often enough for decision rules to be developed,” and a nonprogrammed decision is unstructured and infrequent (Griffin, P. 284). Since Mikael’s alarm goes off every morning, his brain is programmed to respond to the alarm clock and wake up routinely. An example of an unprogrammed decision is when Mikael La Ferla is creating Shopden, as he isn’t used to these actions, and there aren’t set rules to follow. 
3. The role of a rational decision-making model is based on expecting people to follow a “systematic, step-by-step process” that makes effective decisions for a company (Griffin, P. 287). The role of a behavioral model of decision-making acknowledges that human behavior plays a significant part in this process. Mikael believe companies should implement more rational decision-making strategies because being data-driven provides accurate analysis of a situation. In contrast, someone’s feelings may put an individual’s needs over the entire company.
4. Discussing the different decision-making models makes sense because each model has pros and cons. For example, suppose a company is too analytical and not sympathetic to its employees. In that case, the company culture will suffer as no one trusts the company to assist them if they struggle. As a result, it is important to incorporate a hybrid of the two approaches.

Works Cited

Griffin, Ricky (2020). Organizational Behavior: Managing People and Organizations. Cengage.

Written by Mikael La Ferla

Hey Everyone!

Here’s a formal introduction to Shopden, the list app that allows users create and share shopping lists, track expenses, and receive location-based notifications.

Users can create and share lists when shopping for groceries, hygiene products, office supplies, pet supplies, and electronics.

Users also can track their expenses by setting budgets for each list and comparing their current spending to previous purchases.

Shopden launches in June 2024 on the App Store/Google Play Store

Check out our website!

Created by Mikael La Ferla

I am thrilled to announce that I have recently become certified in Bloomberg Marketing Concepts (BMC). This certification represents a significant milestone in my professional journey. I have gained a comprehensive understanding of essential marketing principles, analytics, and strategies. This knowledge equips me with the tools to make data-driven decisions and develop effective marketing campaigns. In an increasingly competitive and data-driven business world, this certification not only enhances my career prospects but also allows me to contribute meaningfully to the real world. I am excited to apply my newfound expertise to help organizations navigate the complexities of marketing and make a positive impact on their growth and success.

Completed by Mikael La Ferla

Created by Mikael La Ferla