Company Performance and Accounting - PDF

LESSON 1 A company: is a group of people who carry out activities together with a commercial nature. Companies are commercial organizations because an organization is a group of people, but there can be commercial organizations, non-profit organizations like the Red Cross. Commercial organizations that are for-profit, that is, those that are established to sell services or products on the market and obtain benefits from them. Be aware of the meaning of business performance. The meaning of some metrics. Marketing consists of create, communicate and deliver value to customers to make a profit (Marketing is also connected to profitability) And you have to provide a metric to measure the outcome of that activity. And usually, the metrics are also financial in nature. Therefore, profitability is a key element in any company, regardless of size or sector. The same goes for operations and logistics. Whatever they do, they must ultimately contribute, directly or indirectly, to the performance of companies. That is why, among the many objectives that companies have, profitability is certainly on the list. Of course, it is not the only objective. ProfitabilityIt is not the only goal. You can have another goal: Becoming the market leader. Becoming the most innovative entrepreneur in that business. Or leaving a legacy to your nephew. Being profitable. Surviving over time. Meeting your personal goals. Etc. Suppliers are those who provide the company with a resource. It can be raw materials, the Internet, the heating system, the telephone line, money or knowledge. They give you some parts that you need to produce or bundle your service or product and put it on the market. That is why we all need suppliers, as a company, no matter the business or the size. Because we need a lot of resources. Some resources can be produced internally, others must be bought on the market. Distributors, All of them are necessary to put your product on the market. You cannot do everything on your own. As a company. No matter the business, no matter the size. Because we need a lot of resources. Some resources can be produced internally, others must be bought on the market. We can classify resources into many categories. We generally distinguish between primary resources and other resources. Primary resources are the fundamental resources that are needed first. And these two resources are manpower, labor, and money. You need manpower because a company is a group of people working together. That's manpower. You need labor because a company is a group of people working together, and with money you buy everything else. We can classify activities into three groups. The first group of activities is Management activities, i.e. running the business. Operations. Production. So, buying raw materials, producing the product, distributing it and selling it. This is operations. It is part of management activities, running the business. And then there are accounting activities which are not about managing or organizing the business, but about recording the business, taking notes and measuring the activities. What happens if the outcome of the activities is not measured? So, information and measurement are important for making decisions and evaluating past decisions, which is what we do in our daily lives. The algorithm decides when the lights can be turned off because there is no one in that area of the airport and the same goes for the heating system etc. This means greater efficiency, which means that money and time can be saved and it also means faster decision-making processes because people are no longer focused on these kinds of choices. It could also mean greater sustainability, as a lot of money can be saved and less pollution can be produced by adopting these kinds of tools. LESSON 2 The company is a group of people who work together for a common goal or a set of common goals. And that it is a commercial organization, that is, it has profit motives. And that profitability is one of the central processes that any company has. This outcome framework that looks at the firm as a set of activities that involves resources and generates an outcome, and any firm requires resources because firms are embedded in an environment where no one is self-sufficient, no matter what they do. This set of resources could even be quite long. And it includes, of course, manpower and money and then many other additional resources that are purchased with the money provided at the beginning by investors, okay, shareholders. The activities carried out by the company could be grouped into these three categories, The three categories of activities are: Management activities which have to do with the operation of the company (buying services and raw materials, physically producing the product, and then marketing and distributing the product, interacting with customers to generate sales. And then managing the activities as well by making other types of decisions and actions) Operational managementIt's about making things work on a daily basis. So testing inputs, turning them into operational results, and selling them. Strategic managementIt is something different. It is about looking outward, looking inward, making plans and implementing actions accordingly. This would be the focus of this course, strategic management. The second type of activities that any company must carry out are organizational activities. These are managing people, deciding who does what, how many people I need, what kind of skills I need those people to have or develop for my company to be successful. Richard Branson said that you have to put employees before customers, because many times, happy employees make happy customers. Employees are important. That's the main message. Steve Jobs says that organizing people is important. And as companies have grown on average over the last century, managing people has become a problem. That is why organizing activities is very important and should be considered as one of the fundamental activities that any company should carry out. A larger company needs specialization of work and, therefore, coordination. It is difficult. Organizing a company : It means identifying activities and assigning people to those activities. And that means deciding who does what. And then you also have to decide who is responsible for what. And then you have to delegate power. Nowadays, almost every company has a set of values. They are explicitly stated on their website, for example, or in company documents. These are their values: innovation, integrity, excellence, talent, entrepreneurship and management. And, of course, these values must influence the company's activities, that is, there must be coherence between values, actions and the result of the company's activity. And sometimes this coherence is not so easy to achieve. When you fail in terms of coherence, your reputation collapses. Managers and business owners care about their people, not just because they are human and good people, but they care about people because the successful productivity and reputation of the company is also related to its employees. Almost everything in the company is connected. And every time you move something, there is a change in the company, there are consequences. So it is a system of interconnected activities. Every time you touch something, you touch other parts as well. And then there are accounting activities. What does that mean? Companies measure almost everything they can. Data is becoming more and more important. Any kind of data. Well, data is fundamental and recording data, measuring things is fundamental for any business. Why? Because without information, nobody could make informed decisions. We don't look at that. In particular, if we focus on accounting, we focus on specific types of data. First of all, accounting means explaining. Accounting It is about giving information and explanations. And companies use this kind of information to make new decisions and judge previous ones. So what is accounting about? It is about – there are three different definitions – identifying, measuring and communicating information to enable the user of that information to make informed judgements and decisions. What kind of information? Financial information, but not only financial. At least partly financial. The financial part of the information is crucial, because through financial information we evaluate the financial performance of companies, which is what ultimately determines the success of the company. A company is successful when its performance is successful. And profitability is a fundamental part of its performance. If you are not profitable, you cannot survive over time. Of course, profitability is not, as I told you before, the only objective of the company, but without profitability you cannot achieve any other long-term objective because you cannot survive. Within the company, managers and investors need accounting data. directivos e inversores Managers are evaluated precisely on the performance they generate and they need that data to make decisions. Investors need accounting information because if companies are not performing well, they will take their money back and put it somewhere else, If a company is not profitable and the problem is that sales are declining, then salespeople are responsible for turning things around. Data is critical, and likewise, accounting information is important outside the company. Potential investors: They are interested in the characteristics of the company. Before investing their money in a company, they analyze its past performance, because this is mandatory. Governments: They get taxes and profits from companies, so they are genuinely interested in their numbers. Local governments, national governments and trade unions are interested in companies' numbers, because they represent the workers, so they want to understand how the company is performing, whether it is doing well or not, and what to expect from the people who work in that organisation. Suppliers: They are interested in the performance of companies. proveedores So this general interest in accounting data is the reason why companies often disclose this kind of information. Especially in their external communication, through press releases, annual reports, presentations to shareholders or stakeholders or local communities, etc. And if this information is false, there are consequences. Those are two scandals where companies disclose unfair information. sharehold: accionista/stakeholder: parte interesada Every company must have its annual reports certified by an external body. How can we measure a company's performance if it is so relevant?: First of all, a company's performance is complex and includes different KPIs to measure different dimensions of the company's performance. There is a financial dimension that answers the question of whether the company is profitable. Therefore, one must analyze the profits, if any, and other KPIs that we will see later. Being profitable, as we have already said, is important to ensure survival over time. You also have to generate positive competitive performance. And it's not about making money, it's about having satisfied customers. Both are important and they are different things. You can have, for a time, a profitable company with dissatisfied customers. And you can have, for a time, satisfied customers and a company that is not profitable. There is a third dimension, which is institutional performance or social performance. It involves achieving consensus with stakeholders. What is the difference between stakeholders and shareholders? Stakeholders: Stakeholders are all people who have a stake in the company. Stake means interest. Any kind of interest. So, almost everyone is a stakeholder. So, let's make a short list of stakeholders. The employees, their personal economy depends on the company, the company pays them Investors or shareholders, also because they put their money into the company and become part of it. The government, He is a very interested actor in the company, because, I repeat, companies are part of society, they manage it. Suppliers, They are stakeholders, since they have business relationships with the company, so they have commercial interests. The banks, They are a particular type of suppliers. They supply money to the company and are also stakeholders. The local community, The company that works in is a stakeholder and the company is very interested in it, because it generates work for the local community, it can generate new services, new infrastructure, but also pollution and it can damage the beauty of the environment. Stakeholders are all those people who have an interest in the company, whether they are part of the company, internal or external, and also customers. Customers are a specific type of stakeholder. The European approach is broader, because they believe that they have to increase the number of stakeholders that need to be pleased. Including, for example, employees as well.This is part of what senior management must decide: the priority regarding stakeholder management. It is also mandatory to achieve consensus among stakeholders. That is why companies periodically measure employee satisfaction, supplier satisfaction and employee turnover, because it is a signal, an indicator of employee satisfaction. When employees are satisfied, they do not leave the company, they stay. They leave the company when the deal is not so convenient, The company is inserted in a network of interactionss -àwith stakeholders on the one hand, and with customers on the other. To be successful and maintain it, they have to manage their stakeholders as well as the products and services they put on the market, because they have to ensure that there is a good fit between their products and the needs of their customers. Of course, there are differences depending on the company's business and what it produces. For example, products are different from services. So this has implications in terms of activities and processes. If you are selling a product, you have something tangible that, for example, you have to store. So logistics can be an issue. On the other hand, if you are selling a service, then you don't have anything tangible to store. governance Manage: Running a business is different from running a business. They cannot be confused because the protagonists of these two activities can be totally different. Managing a business: It means to direct activities. I direct production, I direct logistics, I direct marketing activities… This is managing, directing activities, processes. Governance: It consists of setting the rules under which managers can conduct their activities, that is, making clear the guidelines, the architecture of the bodies responsible for setting the rules. The CEO participates partially in governance, but is the big boss in terms of management. Who is really in charge of governing the company? The owners, the investors, because the company belongs to them. So governance is not management. It is not. That is, overseeing the entire company on behalf of the owners. Exactly. That is governance. consejo de administracion The board of directors It is the protagonist of governance along with other companies. It is in an intermediate position between shareholders, investors and managers. It makes decisions that impact the management of the company on behalf of the owners, the shareholders. -Within the board, the CEO is very important. The CEO is the person with the highest responsibility, the boss of the directors, the person with the highest responsibility for the management of the company. The board of directors has a small number of people who must make important decisions. All of them, all the members of the board of directors, represent the shareholders. They define the company's ultimate goals, approve strategic plans, approve extraordinary operations, such as the acquisition of a new company... They monitor the company's performance by setting goals. Managers then have to decide what to do to achieve the goals. Here's how it works. The board of directors sets the ultimate goal and then the managers are responsible for steering the company in that direction. That is why there is so much attention paid to board meetings and there is a press release every time the board makes an interesting decision or a sensitive decision. The market needs to be made aware of that decision, especially if the company is listed on the financial market. That means that the company is public. Being public does not mean that it is controlled by the government. Being public means that the company is listed on a financial market. The non-executive partners are investors. The executive members are also managers, so they sit on the board of directors. They have to act on behalf of the investors, but they are also executives because they execute the decisions, as they are managers. So there is a mix of executive and non-executive members. And then there are the independent members. Independent members are people chosen for their skills and knowledge, as they can be a long-term guarantee for the company. Because they know what the business is about, because they know how this company should be managed, they are on the board of directors to ensure good governance and therefore the setting of good objectives and to properly supervise management activities. Financial performance: It works like this: companies make transactions many times a day, every day of their lives. A transaction is an exchange. So what happens in companies is that they take note of each of these external transactions. Every time one of them happens, tons of records are generated with this information. You take this data and you have to put it into a software, because if you don't use a software, you don't know what to do with this information. You put this information into a software and from time to time you decide on an analysis framework and you ask the software to process all the data regarding that analysis framework and produce a second readable document for a manager or an investor so that they can understand the performance of the companies. This is the process. The result of this process is a set of tables, well, financial statements, which is the set of documents where managers, investors, everyone can read and really analyze the performance of companies. The names of these financial statements, these tables, are: -balance, -income statement, -statement of cash flows, -statement of shareholders' equity, plus a document, which is not a statement, but a set of footnotes that report details and explanations of the figures in the statements. All of those statements combined give the reader the opportunity to understand and evaluate the company's performance. They don't refer to the entire life of the company, but to a period of the company's life. Usually, the period of analysis is the fiscal year. (That means a 12-month period.) That's why it's the annual report, okay, because it's about 12 months. It could be January to December, but it could also be different from the solar year or whenever. Anyway, it's a fiscal year, it's the annual report because it reports data related to a fiscal year, a 12-month period, and within the annual report, we have - a balance sheet - an income statement - a statement of cash flows - a state of so-called heritage - a set of footnotes, plus pages and pages, that report qualitative information, as important as the numbers. The time period could also be shorter than a year. It could be six months, or even three months. The structure of the financial statements is always the same. The content is always the same. What changes is only the length of the analysis period. This is very important because it makes the financial statements comparable with other financial statements. The technical system for recording information, for measuring, for recording every transaction. The system is the double-entry system, the exchange can be divided into two parts. It's not just one item, it's two items. Something you give and something you get in return. So, it says, every time I give, what I get in return is money, this is the transaction. So, I have two values to record. So, every transaction has to do with at least two values, always. Following this logic, companies take notes of transactions. It is not just about taking notes in this way about the transaction. It is also about following some accounting principles in order to be able to compare the figures of one company with those of another. That is why a list of international accounting systems was established, principles that companies apply, which are also known as international accounting standards (IAS). The first is that the company is an independent entity, as we said in the first lesson. Therefore, the company is an entity in itself. Second, all elements of financial statements are measured in terms of their monetary value. However, since all financial statements relate to a period of time, whatever that may be, they have to report values relating only to that period of time, nothing more and nothing less. Thirdly, we need to declare the period of analysis. As we said, it could be one year, six months, three months. It doesn't matter, but all declarations must refer to an explicit period of time. Therefore, everything has to be accounted for in terms of monetary value. This is another adjustment. This is the principle of matching. Just to tell you how much attention you should pay to the numbers. Otherwise, your data will not be fair. It will not be useful to understand whether you are doing well or not. The balance sheet is called the statement of ﬁnancial posi`on. Exactly the same. Whereas the income statement is called the consolidated income statement. Then there is the cash ﬂow statement and also the shareholders' statement. And then the footnotes. estado de resultados The income statement could also be called profit and loss statement. And it is a kind of film of all the transactions that occur during the year, in terms of revenues and costs for expenses. Everything that occurs in terms of activities, external transactions during the year, is reported in terms of revenues or expenses generated. Always according to the matching principle that we mentioned before. Nothing more, nothing less than what concerns that period of analysis. If we make a complete list of income and expenses, we can easily measure profitability, the common name is net income. Income because it is something that we earn. Net because it is the final profitability. It means that we start with the income and we have already deducted all the expenses that we had. When the net income is greater than zero, then it can be called profit. If it is less than zero, then it can be called loss. Net income > 0 ganancias < 0 perdidas It is a vertical document with a vertical structure. We start from sales or income, and then little by little we put in expenses and, if there are any, other income until we reach the final line. The final line is always the net income. In case whenever you see a number in parentheses, it is negative. It is an international standard. This says that if the number is in parentheses, it is a loss. Operating income is sales minus all operating expenses listed below sales. Good net profitability has to come from a positive and high operating income. That's why they always put operating income in the numbers. Sometimes they call it EBIT, earnings before interest and taxes. It's a commonly used symbol for operating income. So if you can read these three key pieces of data, you can do a basic analysis of the profitability of any company. (value of production - operating costs) LESSON 3 The income statement is a kind of film of what happened in terms of expenses and income in the company in that period of analysis, and it has a vertical structure, all the operating titles are at the top of the document, while what is not operating, such as financial titles or taxes, are at the bottom. Net profitability At the bottom, is the final result, exactly, it is called net income. If it is positive, it is also called Positive net profit. If it is negative, it is also called Loss. What happens in income statements is that since the operating section at the top is really important, since successful companies are profitable with respect to operating activity, their own core activity, they want to get the message across in the right way. Sometimes they want to give additional details to better get their numbers across, to make sure that the reader gets the point the way the company wants them to get it. So what can happen is that instead of reporting all the operating expenses listed by accident, what could happen is that they split the list of operating expenses into two subcategories. They put the variable expenses first (changes by production) and then they put all the other expenses that are not variable (does not change by production), so they are fixed. dividen la lista en subcategorias: gastos variables que cambian segun la porduccion y los gastos fijos que no cambian If production increases, the amount of raw materials also increases. If production decreases, the amount of raw materials required also decreases. Therefore, there is a direct relationship between production and the amount of variable cost. On the other hand, we have fixed costs, such as the cost of personnel. They can change over time due to inflation, due to labour market conditions, but they do not change based on production. When a company makes the decision to separate the variable from the fixed, it means that something in between is needed. And what emerges is the contribution margin. This means that the income statement starts with revenue, as always. Then there are all the variable costs with the contribution margin, which is revenue or sales, minus variable expenses. It's a margin. It is necessary to separate both. Then all the fixed costs are added up and if the fixed costs are deducted from the contribution margin, the operating result or EBIT is obtained, which is the same. Therefore, there is only a change in the way the costs are listed. Why is it necessary or advisable to do so? It may be advisable if you want to show specific information. Some`mes they might be interested, maybe not in the contribu`on margin for some reason, but they might want to separate opera`ng expenses by another criterion, which is to separate the actual costs, the real expenses called cash costs from what are the non-cash costs. Well, that's how it works. It doesn't maber what type of input you're buying, you get the input, and in exchange you give money. Deprecia`on and amor`za`on. They are not the result of a transac`on that occurred that year, but the result of an accoun`ng technique applied to make the income statement correct according to the matching principle. This is the matching principle. I must put in the statements only what refers to the period of analysis. If you really want to check my opera`ng proﬁtability, instead of looking at EBIT, opera`ng income, look at my proﬁtability before you consider these fake costs. Well, in par`cular, look at EBITDA, which is EBIT plus DA. My actual proﬁtability is some`mes higher than opera`ng income because you have to consider that there is a lot of deprecia`on and amor`za`on. Which is not something you have to actually pay. Well, then, my ability to generate proﬁtability can be much higher than opera`ng income or EBIT. That is why, in the press releases of companies, they highlight not only net income, but also many `mes EBIT or also EBITDA. EBITDA is a financial indicator that shows a company's earnings, before subtracting payments and costs such as taxes, interest, depreciation and amortization. EBITDA = EBIT + Depreciation + Amortization If we go back to our company and move to the top of the document in the highlights, instead of repor`ng the en`re income statement, there's just revenue, EBITDA, EBIT, net income. Because with three KPIs, you've disclosed the messages that you want the reader to immediately receive at a glance. In addi`on to EBITDA, you could also report an EBITDAR. EBIT (Earnings Before Interest and Taxes) is a financial measure that indicates an organization's earnings before considering financing costs and taxes. It is useful for comparing profitability between companies of different sizes and capital structures. EBIT = Total Revenue - Operating Costs, LESSON 4 The annual report contains a set of financial statements, a set of documents, quantitative documents, which serve to fully reveal the performance of a company during a period of analysis. Among this set of documents. The balance sheet: A balance sheet is a picture, so it does not refer to the entire period of analysis. It refers to a specific point in time. And that specific point in time is usually the last point in the period of analysis. So, if we are considering a fiscal year, the last day of that fiscal year is the point in time that is taken into account in the balance sheet. The balance sheet is a list, a complete list of the economic resources that the company has. So, it changes every day. Because daily. It tells us about a specific point in time, because maybe the next day, the list of resources is different. So, it is impossible to report those changes. So, it is a snapshot of the situation in terms of resources that the company has at a specific point in time. So, we have a list of the financial resources that a company has and in the same document, the source of financing for those resources. So we know the resources and we also know how those resources have been financed. The list of resources: It is located on the left or at the top because it can be viewed in two ways. It can be reported in two different ways. While the list of the funding source is located on the right or at the bottom. activos The list of resources is called assets. The assets section of the balance sheet. And this could be a very long list of things because a company typically employs many different resources. Resources can be many different types. And all of them are listed in the assets section of the balance sheet. Then, depending on the business that the company is in, there could be specific resources, business-specific resources. Therefore, depending on the business and business model, very different elements may appear in the assets section. Therefore, the structure and composition of the assets section must be analyzed. The source of funding: It could be two. Not so many. The options are very few. The first option is to finance your own assets. Fixed financing. That is, your shareholders and the company itself finance their financial resources. That is equity. The second option, if it's not the company itself, it's another person. Someone who is not part of the company. That is, liabilities or debts. Liabilities means that the money is given by another person. This other person can be a bank or a financial institution, generally speaking. Or they can be suppliers. Because every time you have a debt with a supplier, it means that the supplier agreed to give you the down payment and give you some time before paying. That means you have more money in your pocket to do whatever you want. For a certain amount of time. 30 days, 60 days, 90 days. Which is a source of financing. You have time to pay. It's a different source of financing than what a bank offers. Because every time you have a debt with a bank, a financial debt, then things are different. Because you ask for money. They give you the money. And then you have a certain number of years to pay the money back. And what else? Interest. Which is the cost of that liability. When you have days before you have to pay a supplier, you don’t have any cost associated with that liability. —> So there are many different types of liabilities. But what they have in common is that they are liabilities. That is, it is money given by a third party outside the company that has to be paid (LIABILITY). Paid in a certain time established at the beginning of that type of transaction. Which is a totally different source of financing from capital. Shareholders put their money into the company to be part of it. They don't want their money back. So it's not a debt. It's the contribution of an investor. A contribution from someone who is part of the company. Because he gave the money. In the right section or lower section, there are two major components. And this is the balance equation. The balance sheet is the complete list of economic resources that the company has at a given time. And how have those resources been financed? We are saying that the total amount of resources, of assets, is exactly equal to the source of financing of the debt resources. Therefore, we are talking about equal overall values. That is why the balance sheet equation exists. That is why assets are always, at any time, equal to liabilities plus equity. If they are not equal, there is an error somewhere. What is credit? Credit is a promise to pay that you received from someone else. It's common in B2B (business-to-business) companies. That is, if the company sells a product to a retail customer, payment is made immediately. You can't just walk out of the store if you don't pay, right? That's the general rule. But when the company sells its product to a business customer, then the transactions can be paid in a completely different way, because business customers can agree on a deferred payment. So, trade receivables means that there are some accounts related to negotiated trade transactions where the money, the payment, is yet to be received. It is a synonym for trade credits. Another element that is often present in the figures is inventory. Inventory is defined as raw materials purchased but not yet used plus any progress in processing, if any, i.e. something that is in the middle that is no longer a raw material but is not yet a finished product, plus finished products that have to be sold, which are there, ready, but not yet on the market. These are inventories. There is one excep`on. Some businesses can't show signiﬁcant inventory. Those you can't store at all. Services. Service businesses typically show lible or no inventory at all. Because you can't store a service. The company is moving forward with its processes, transactions, and activities. So there is always something that starts in one fiscal year and ends in the next. That is why inventories are there, because maybe in December, at the end of December, the last day of December, you just bought new raw materials. You receive the new raw materials. But they will be converted into a product two days after the next fiscal year. So, the raw materials are part of the inventories in that fiscal year. Then we go on with our short list of items that are part of the assets section, and they could include equipment of any kind, from ERCT devices to machines of any kind, and then we could also have intangible items like patents (BREVETTO). Patents are quite important, they are close to copyrights and other items that protect your intellectual capital from any kind of manipulation, okay, so patents, copyrights are important for some companies, they are crucial, and then there could be other tangible items like plants or property of any kind, real estate, land, whatever, sometimes you read just one item instead of those that are PPE, property, plants and equipment, so sometimes you read just PPE with the total amount and within that item there are many different things combined. On the other hand we have how those assets are financed, some of them are financed by liabilities, through liabilities, what kind of liabilities - First of all, commercial accounts payable, the company is the one that has to pay, those are commercial debts, the most common item within this category are debts to suppliers - then we have other kind of debts too, long term loans, this is something different, long term means more than 12 months, they are there to stay, in long term loans, within this category, you can have different items, severance fund, = Severance fund is a kind of debt that all companies have with their employees, it is a kind of debt that increases every month, little by little, because every month, corporations retain part of the money that is owed to their employees, and they will return this money to the employees, only when they retire, that is severance fund, why is it not a debt - but then in the same category of long term loans, there could also be other types of liabilities, for example, long term financial debts, bank loans, mortgages, vouchers, 5 year, 10 year, 15 year loans, and every time you pay an installment of the loan, the total amount of money that you have to pay to the bank goes down, and then there are the deferred taxes from the bank, because again, this is something that is there quite frequently. If it is not a liability, then what is on the right side is part of the equity, equity means the capital that the owner invests in the company, but also the profit that the company generates year after year, okay, if there is a profit, if there is a loss, the loss goes here too, but it is not a contribution to an increase in equity, it is a decrease in equity. the dividend= is a percentage of equity given to investors as a reward for the money they put into the company, So every year this is a decision that the company has to make. As you can see, the total amount of assets is exactly equal to the total amount of liabilities and equity. What happens in the annual reports that are published, OK, and are available online, for example, is that within the assets section and within the liabilities section, the items are not listed by chance, they are listed following a specific logic, they are ordered according to a criterion. In the assets section, the criterion is usually liquidity. They list assets from the most liquid to the least liquid, or vice versa, but liquidity is always the logical one in any case, On the contrary, in the section on responsibility, the criterion is a temporal element. => We put first the liabilities that mature in the short term and then all the long-term liabilities, that is, all the liabilities that mature in the long term, in more than 12 months, that is, we divide the liabilities into two subgroups, the short-term liabilities and then the long-term liabilities. Why do companies do that? Because when classifying assets and liabilities according to a criterion, Asset Classification: Quick Assets: Highly liquid (cash, cash equivalents, accounts receivable). Inventories: Less liquid, but will be converted into cash or short-term credits. Current assets: They include quick assets and inventories; they are short-term and liquid. Fixed assets: They remain for more than one fiscal year and may be tangible (equipment, property) or intangible (patents, financial investments). Liabilities and equity: Current liabilities: Short-term debts (less than 12 months), such as payments to suppliers. Non-current liabilities : Long-term debts (more than 12 months). Equity: It is ideal that it be the main source of financing, as it reflects financial autonomy. Common financial risks: Imbalance between current assets and current liabilities: May force the company to take on more debt or sell assets, compromising future operations. Excessive dependence on liabilities: Reduces financial autonomy and can limit decision-making capacity. The raVosThey are common in ﬁnancial communica`on, as well as in many other parts of a company's strategic communica`on. They are sta`c by nature, they say nothing about the company's evolu`on over `me, and they say nothing about the future. They only represent a situa`on related to a speciﬁc moment. And, as they are so easily comparable. ROI, return on investment of company communicaVon, which is an abempt to capture and synthesize the return on communica`on ac`vity, which is very diﬃcult to measure, because the return on communica`on ac`vity could be direct or indirect, and it is very diﬃcult to understand even to what extent performance KPIs can be considered the direct result of a communica`on ac`vity. We can group them into four families. - The ﬁrst family are the liquidity ra`os that measure the ability to pay debts. - The second family is the solvency ra`os, which are about mee`ng long-term obliga`ons, long-term liabili`es. - The third family is the proﬁtability ra`os, and they measure a company's ability to be proﬁtable. - The fourth category deals with growth ra`os or expansion ra`os and they measure the company's ability to grow over `me because growth is mandatory, if a company cannot grow in the long term, it fails. When the current ra`o is equal to one or even higher, liquidity is good, because assets are greater than short-term liabili`es. Conversely, when current assets are less than current liabili`es, the ra`o is less than one. That means we have a problem. And the lower it is, the bigger the problem. LESSON 5 1. Objective of financial analysis: o Understanding business performance by interpreting financial ratios. o Ratios are KPIs that summarize key data, are easy to compare, and are commonly used to evaluate business performance. 2. Types of financial ratios: o Liquidity Ratios: They assess the company's ability to meet its short-term obligations. o Solvency Ratios: They analyze the company's stability and ability to meet its long-term obligations. Liquidity Ratios 1. Current liquidity ratio: o Formula: Current assets / Current liabilities. o Reference value: ≥1 indicates good liquidity (current assets cover or exceed current liabilities). o Example: Campari has current assets of €1,711.6M and current liabilities of €1,152.5M, ratio = 1.48 (good liquidity). 2. Quick Liquidity Ratio: o Formula: (Current assets - Inventories) / Current liabilities. o Used when inventories represent a significant portion of current assets. o Example: If Campari's inventories are €617M, the quick liquidity ratio = 0.95 (moderate, but acceptable). 3. Liquidity Considerations: o Liquidity assesses whether the company can pay its short-term debts, regardless of profitability. o Good liquidity requires a ratio ≥1, while lower values indicate possible financial problems. Solvency Ratios 1. Debt to Assets Ratio: o Formula: Total liabilities / Total assets. o Evaluates what proportion of assets are financed with debt. o Low values (close to 0) indicate good solvency; high values (close to 1) indicate debt dependence. 2. Capital to assets ratio: o Formula: Net worth / Total assets. o It complements the debt-to-assets ratio. o Higher values indicate greater financial independence. 3. Debt/equity ratio: o Formula: Total liabilities / Net worth. o Measures how many times liabilities exceed equity. o Lower values indicate greater financial strength. § Example: A ratio of 1 indicates a 50-50 ratio of debt to equity; a ratio of 2 means debt is twice as much as equity. Practical keys: Use specific ratios according to the company's context (example: consider inventories only if they are significant). Do not measure complementary ratios at the same time, since they provide the same information. Liquidity and solvency ratios are calculated using data from the balance sheet, not the income statement. 1. Financial ratios and qualitative analysis: o Quantitative ratios must be complemented by qualitative analysis to fully understand the financial situation. o Evaluating what type of liabilities and assets predominate in the balance sheet (commercial, financial, short/long term) enriches the conclusions. Solvency is about measuring the company's ability to survive over time, to meet long-term obligations. So we move from a short- term horizon to a long-term one, which implies a different perspective. We are interested in understanding how independent and autonomous the company is today, this involves looking at the balance sheet. 2. Financial solvency: o Key ratios: Debt-to-equity ratio, equity-to-assets ratio, and debt/equity ratio. o Key thresholds: § Ratio around 1: Reasonable solidity (example: 50-50 between debt and equity). § Ratios greater than 2: Indicate excessive dependence on debt, which can be worrying. o Case study: A company with assets of €4.8 billion and a debt/equity ratio of 1.02 indicates a 50-50 structure, reasonably balanced. 3. Key questions for solvency: o What assets can be covered with equity? o Are assets essential to operations (such as plants, fleets or machinery) covered? Profitability. Profitability is measuring the ability of the company to be profitable. So let’s go back to profitability now. —> And to measure profitability, we cannot use the balance sheet or just the balance sheet. We need, of course, also the income statement. There are many ways to measure the profitability of a company. Let’s look at three ways, three fairly common KPIs, really common. The first one. The first one is return on sales. 1. Return on sales (ROS): o Formula: EBIT / Sales. o Measures the company's effectiveness in generating profits from sales. o General threshold: § Negative: Critical situation. § Positive and low (e.g. 0.5%): Low profitability. § Positive and high: Solid profitability. o Comparisons: § Historical: Compare with previous years to evaluate trends. § Competition: Analyze against direct competitors. § Industry average: Contextualize within the sector. 2. Return on assets (ROA): o Formula: EBIT / Total assets. o Evaluates the company's efficiency in using its assets and generating EBIT. o Rules similar to ROS: § Negative:Unfavorable situation. § Positive and high:Indicator of good operational management. 3. Return on equity (ROE): o Formula: Net profit / Net worth. o Measures profitability from the investors' perspective. o Thresholds: § Negative: Losses, serious situation for shareholders. § Positive and growing: Better use of investments. o Example: If the ROE is 5%, for every €100 invested by shareholders, €5 of net profits are generated. Negative Heritage Definition and causes: o Shareholders' equity can become negative when accumulated net losses exceed contributed capital and reserves. o Example: If shareholders' equity is 85, reserves are 5, but net income is a loss of 100, total equity will be -10. o This is a sign of serious financial problems, usually in companies on the verge of bankruptcy. 2. Growth rate formula Calculation: Application: o It allows you to measure the percentage change in any financial or non-financial item (income, number of employees, fleet, etc.) between two periods. o Practical example: § If revenue in 2020 was 100 and revenue in 2021 was 19, the growth rate would be:19−100100=−81%10019−100=−81% Which indicates a drop of 81%. External context VS internal performance Importance of the environment: o If poor performance is caused by external factors, such as COVID-19, it is perceived as less critical than if it were the result of poor management. Difference between contingent and permanent conditions: o Contingent conditions (such as a pandemic) are temporary and allow for recovery. o Permanent conditions require strategic adaptations to ensure long-term viability. Financial performance analysis should consider both the numbers and the underlying causes. Using metrics such as growth rate is essential to assess changes over time. Reading and analyzing annual reports provides valuable context for understanding financial and operational results. Investors want to know how good the investment has been, which is different. You can be efficient at managing assets and generating EBIT, but let's say you have so much debt that interest reduces EBIT to zero. From an investor's point of view, that's not good. The idea here is to compare net income to equity. The higher the income is compared to equity, the beber the situa`on. Return on equity is a general measure of the company's proﬁtability that also takes into account the gross value and the ROA value. A growth ra`o is the same for any item, also for ﬁnancial items. The formula is the most recent value minus the least recent value in parentheses. The result of this deduc`on should be divided by the least recent value. LESSON 6 So, evalua`ng performance is a very key ac`vity for any company. Because we measure success by the performance of the nutrients. So, if it's not because an external factor is causing your performance to be bad during the COVID pandemic, no maber what the strategy, every company was doing badly. But not because the strategy was bad, but because the exercise was crazy. So, during these unusual business periods, no maber what you do, your performance is bad. Strategy: It is a long-term plan with clear objec`ves, a unique approach and the ac`ons required to achieve them. It involves a thorough analysis of the environment, the alloca`on of resources and a clear vision of what you want to achieve. TacVc: These are speciﬁc, one-oﬀ ac`ons to achieve short-term goals. They are immediate moves or solu`ons that may be eﬀec`ve in the short term, but are not suﬃcient to guarantee long-term success. So they are not completely diﬀerent, but they are diﬀerent in nature. But they are complementary. They are easily combined. You have a strategy and then the tac`cs are useful in achieving your long-term goals. Compe``ve advantage is a company's ability to oﬀer something unique or beber than the compe``on, giving it a privileged posi`on in the market. This advantage can be the result of many strategic decisions, including resource alloca`on, marke`ng ac`vi`es, pricing, and other key factors. Example of compeVVve advantage: If a company has an advantage in innova`on or a unique business model that its compe`tors cannot easily replicate, this allows it to stay relevant and compe``ve in the long term. The temporary compeVVve advantage, Which means you have to review and adapt your strategy on a regular basis, almost daily, because the environment changes very oyen. So the new keywords now are ﬂexibility, responsiveness, innova`on, in addi`on to other keywords like sustainability or CSR or ESG, which is the same from an investor perspec`ve. In terms of strategy formula`on and monitoring, there have been many models over the years. Andrews model:Andrews proposed a model of strategy formula`on based on ra`onality and sequencing. According to this model: Strategic intent: It begins with the deﬁni`on of long-term objec`ves. Strategy formulaVon: A plan is drawn up to achieve these objec`ves. ImplementaVon: The ac`ons necessary to carry out the plan are executed. EvaluaVon of results: The results are evaluated to see if the objec`ves were achieved. Feedback loop: Based on the assessment, a decision is made whether to maintain the objec`ves or adjust them, which leads back to the formula`on phase. This model is very structured and logical, but reality oyen does not follow such a sequen`al path. Mintzberg's review: Harry Mintzberg, in the 1990s, argued that Andrews' idea was oversimpliﬁed. According to Mintzberg, strategies do not always follow a linear and ra`onal path. Some`mes strategic decisions emerge from informal discussions or from prac`cal experience during implementa`on. For example: Emerging strategies: They can arise during the strategy implementa`on process, and managers adjust ac`ons based on what happens in prac`ce, not just what was planned at the beginning. This makes the ﬁnal strategy a combina`on of what was planned and what was adapted to real circumstances. Key elements of the strategy: Where and how to compete?: Companies must make strategic decisions about which sectors or industries they want to operate in and how to compete within those sectors. o Where: ¿In which industries or sectors will you operate? o As: ¿How will you compete within that sector? For example, in the airline sector, you can compete as a low-cost airline (Ryanair) or with a focus on luxury and premium services (Emirates) Corporate strategy: Refers to the decisions made by companies opera`ng in various sectors. These decisions include: o How many businesses do we want to manage? o Should we sell some of our business units? o How do we allocate resources between diﬀerent businesses? Business Strategy: Each business within the corpora`on needs a speciﬁc strategy, as each has diﬀerent products, customers, prices and compe`tors. You cannot manage, for example, a broadcas`ng company like you manage an airline. In companies like Virgin, which operates across mul`ple sectors, both a corporate strategy (to manage the en`re business por{olio) and speciﬁc strategies for each business are required. EﬀecVve strategies are the source of superior proﬁtability. If a company is successful over the long term and consistently outperforms its compe`tors, the reason behind this is a good strategy. Strategy is not only a ra`onal and sequen`al process, but must also be ﬂexible and able to adapt to the reali`es of the business environment. Companies must make key strategic decisions about where to operate and how to compete in those sectors, considering both their corporate strategy and speciﬁc business strategies. Sources of proﬁtability can be unconven`onal and must be deeply understood to achieve long-term success. Strategy is not only ar`culated at the corporate level, but there are also strategies at compe``ve and func`onal levels: Corporate level: It involves decisions about the en`re company, such as the sectors in which to operate, diversiﬁca`on, among others. CompeVVve level: Focused on how to compete in each sector or industry. FuncVonal level: It covers speciﬁc areas within the organiza`on, such as marke`ng, human resources, or produc`on. Each of these areas has its own strategies, such as the marke`ng strategy or the human resources strategy. The need for coordina`on between these levels is crucial, as you cannot have a marke`ng strategy focused on high spending while the commercial strategy is based on cost reduc`on. Strategy can be viewed from a current perspec`ve (what the company does today) or a future perspec`ve (what it plans to do in the future). Strategic decisions must take both perspec`ves into account to be eﬀec`ve. The loca`on of the company, both in terms of sectors or industries and its geographic presence, is one of the most fundamental decisions in strategy formula`on. The key to success in a compe``ve market is ﬁnding a way to diﬀeren`ate yourself. A company needs to oﬀer something unique or diﬀerent from its compe`tors, which translates into a unique value proposi`on. Once a company has a clear strategy, it serves to: Make beber decisions Crea`ng coherence and unity Commitment and produc`vity The rela`onship between proﬁtability and strategy is key to a company's success and sustainability, but it goes beyond being a simple KPI (key performance indicator) to evaluate strategy. Here are the key points on how proﬁtability connects to strategy: Proﬁtability as a Necessary, but Not Suﬃcient, Requirement: Proﬁtability is essen`al for a company's survival. However, proﬁtability is not the ul`mate goal. It is a necessary condi`on for the company to con`nue opera`ng, but it is not the reason for its existence. Strategy must go beyond proﬁtability, since companies do not exist only to generate proﬁts. Proﬁtability facilitates the fulﬁllment of other long-term strategic objec`ves, but it is not its only purpose. Proﬁtability Within the Long-Term Strategy: Although proﬁtability is a key aspect of strategy, it should not be seen as an end in itself, but rather as a tool to achieve other broader objec`ves, such as growth or customer reten`on. Strategy is designed to achieve a long-term vision, and proﬁtability is only one of the indicators that reﬂect the success of that vision. Thus, strategies must balance growth, eﬃciency, and other objec`ves with proﬁtability. Vision and Mission in Strategy: A company's vision and mission are key elements in deﬁning its purpose and how it plans to achieve it. Strategy is the set of decisions and ac`ons that help achieve this vision, while concrete objec`ves are the measurable steps to achieve it. Companies must be clear about how they are going to achieve their goals and how proﬁtability contributes to these broader objec`ves. Measurable Goals and ObjecVves: A strategy must be measurableThis means that goals should be clear and quan`ﬁable, such as a 10% increase in sales or acquiring 5 new customers per month. Without measurable goals, it's hard to know if the strategy is working properly. Speciﬁc, measurable goals help monitor progress toward proﬁtability and other long-term strategic objec`ves, ensuring that the company is moving in the right direc`on. Proﬁtability through Growth and Eﬃciency: Growth is one of the main strategic objec`ves of companies. This does not only involve increasing proﬁts, but also expanding market share, acquiring new customers and increasing brand awareness. Eﬃciency is also a key factor in achieving higher proﬁtability. Being eﬃcient means maximizing results with available resources. This may involve reducing costs or beber u`lizing inputs. Proﬁtability through Cost ReducVon: Increasing revenue is one way to improve proﬁtability, but so is reducing costs. Managing overhead costs (ﬁxed opera`ng costs) is a strategic objec`ve that can increase a company's proﬁtability. The strategy can focus on doing more with less (insourcing produc`on) or buying from external suppliers (outsourcing), depending on what is more eﬃcient and proﬁtable in the long term. Strategic Decisions: Make vs. Buy: One of the key strategic decisions is whether to make (insource) or buy (outsource) products or services. Both op`ons have advantages and disadvantages: o Doing so involves greater control over the process, quality and costs, but also entails greater investments and the need to train staﬀ. o Purchasing from suppliers is more ﬂexible, as no investments in infrastructure or personnel are required, but it has the cost of paying the supplier and being dependent on them. 8. Proﬁtability as an Indicator of Strategy Progress: Throughout the strategic process, proﬁtability is used not only to measure current performance, but also as an indicator of progress toward long-term goals. If a company is proﬁtable, it is likely making progress toward fulﬁlling its vision. Strategy isn't just about making calcula`ons; it's about evalua`ng ac`ons, objec`ves, and their implementa`on. Strategy evalua`ons are oyen qualita`ve, meaning that diﬀerent groups may oﬀer varying responses about a company's strategy. CommunicaVng the strategy: Companies oyen promote certain values or commitments, such as sustainability, but these claims need to be cri`cally assessed. You should not rely solely on what companies say; you need to verify and check whether internal ac`ons support those values. This involves comparing policies and behaviours with public statements. CSR(Corporate Social Responsibility): refers to the eﬀorts of companies to act in a socially responsible manner, that is, to contribute to the well-being of society and the environment, in addi`on to genera`ng economic beneﬁts. ESG criteria are an approach to sustainability from an investor perspec`ve. Companies that meet these criteria are seen as more sustainable and proﬁtable, which abracts investors. AND(Environmental): E Environmental impact of the company. S(Social): Commitment to social welfare, equity and labor rights. G(Governance): Corporate governance prac`ces, transparency and ethics. Investor moVvaVon: Investors care about sustainability, not only for philanthropic reasons, but also because sustainable companies are oyen more proﬁtable and resilient in the long term. Furthermore, sustainability is becoming a legal requirement in some regions, such as with the European Union's CSRD (Corporate Sustainability Repor`ng Direc`ve), which requires companies to disclose their sustainability impact. Stakeholders' Interests: The American approach highlights shareholders as the most important party, while the European approach sees companies as responsible for a wider range of stakeholders, such as employees and local communi`es. Stakeholder iden`ﬁca`on should take into account their power and interest, which can be mapped onto a power and interest matrix. Strategy and Environment: Business strategy is situated between the company's internal objec`ves and capabili`es and the opportuni`es or threats of the environment. Proﬁtability depends not only on the company's internal decisions, but also on external condi`ons and the compe``ve environment. Analysis of the Environment: The concept is introduced that the proﬁtability of companies also depends on the condi`ons of the sector or industry in which they operate, not only on their internal management. It is pointed out that threats and opportuni`es in the environment must be carefully evaluated. The PEST Model: Environmental analysis is divided into four categories: poli`cal, economic, social and technological (PEST). Examples of how these factors impact businesses are examined: o PoliVcal: Such as regulatory changes or government decisions, such as airline deregula`on. o Economic: Factors such as unemployment rates, inﬂa`on or exchange rates, which aﬀect the demand for products and services. o Social: Demographic trends, changes in consumer preferences, such as veganism or interest in sustainability. o Technological: Technological innova`ons, such as ar`ﬁcial intelligence, can be both opportuni`es and threats. The passage highlights that entrepreneurs must be aware of these factors, even if they cannot control them, in order to minimize risks and take advantage of opportuni`es. The strategy must be aligned with both the company's internal capabili`es and the forces of the environment. Impact of various compe``ve forces in a business environment using Portery's Five Forces model and PESTLE analysis. Here are the key points you need to consider in assessing these elements and their impact: 1. High CompeVVve Rivalry: If compe``on in your industry is strong, you need to consider how this aﬀects proﬁtability. Price cuts due to high rivalry are common, and this can reduce proﬁts. It is vital to monitor how compe``on is inﬂuenced by product diﬀeren`a`on and barriers to exit. If rivalry is high, proﬁt margins are likely to be squeezed. 2. Bargaining Power of SuppliersIn industries with few key suppliers, such as the airline industry with Boeing and Airbus, suppliers can command higher prices and unfavorable terms. If you have few suppliers for crucial products, such as technology or key components, their bargaining power can impact your costs and proﬁt margins. 3. Customer Power: When customers have many op`ons and can easily compare, as is the case with airlines, their bargaining power is high. This translates into pressure to reduce prices and improve service. Customer preferences and subs`tu`on op`ons need to be constantly monitored. 4. Threat of New Entrants: The ease or diﬃculty for new compe`tors to enter the market inﬂuences the structure of compe``on. Low barriers to entry can be a threat, as they make it easier for new players to enter and increase compe``on. It is important to assess barriers such as regula`ons, investment required or market access. 5. Threat of SubsVtutes: The impact of subs`tutes depends on how easy it is for customers to choose alterna`ves. For airlines, high-speed trains and video conferencing op`ons (such as Zoom) become subs`tutes. In your industry, it is vital to be aware of technological innova`ons or changes in customer preferences that may oﬀer cheaper or more convenient alterna`ves. Business Impact If compe``ve forces are high, proﬁt margins may decline, aﬀec`ng proﬁtability. If barriers to entry are low, future compe``on may increase, which also reduces market control. The inﬂuence of suppliers and customers directly impacts costs and pricing ability. Strategic alliances and mergers can be a way to mi`gate compe``ve pressure by sharing resources and reducing costs. Determining Factors: Product DiﬀerenVaVon: If your products or services are diﬀeren`ated from those of your compe`tors, rivalry will be less. Diﬀeren`a`on can also reduce customers' price sensi`vity. Barriers to Entry and ExitHigh barriers to entry protect exis`ng ﬁrms, but barriers to exit (such as infrastructure investments) can make it diﬃcult to adapt in declining markets. Switching Costs: If customers or suppliers have high switching costs, they may be less likely to switch, giving you greater control over your business. What to Monitor: Industry and CompeVVon: Constantly monitor compe``ve forces and changes in barriers to entry. Suppliers and Customers: Evaluate the power of your suppliers and the loyalty or power of your customers, especially in highly informed markets. SubsVtutes and InnovaVons: Stay alert to new technologies or business models that may replace your products or services. LESSON 7 Porter's Five Forces Model, which explores the competitiveness of an industry, is based on five key players that can affect market dynamics and profitability: competitors, suppliers, buyers, the threat of new entrants, and the threat of substitutes. These players are influenced by specific determinants, such as product differentiation, intensity of competition, and other factors, which can increase or decrease the profitability of an industry. The model has several practical applications: At the business level, it helps to understand the reasons behind different profitability in various industries, as the configuration of the five forces varies by sector. It is also useful for identifying future opportunities, such as technological or regulatory changes, that could alter these forces and improve profitability if responded to appropriately. However, the model is not without limitations. Its static nature does not reflect rapid changes in the external environment, making it necessary to update it regularly. Furthermore, the original model does not consider complementary products, which has been a recent criticism. Questions are also raised about the clarity of boundaries between industries, such as in the case of events, where technological advances have altered the borders between traditional competitors and new entrants. Complements are products or services that are used in conjunction with another main product or service to increase its value or functionality. Often, although these complementary products are necessary for the proper functioning of a main good, they are produced or sold by different actors. This creates an interdependence between the products, and their relationship affects the profitability of the companies involved. This implies that when analysing a market or industry, not only the direct players (competitors, suppliers, etc.) should be considered, but also the complementary players. Ignoring these complementary players could lead to an incomplete view of the competitive forces, as they have a significant impact on profitability and bargaining power in the industry. Market segmentation:Market segmentation is another key concept that helps focus competitive analysis. It involves dividing a market into smaller, homogeneous segments, where customers share similar needs, characteristics, or behaviors. Segmentation is essential to understanding and targeting specific customer groups with personalized offers. Segmentation is not only based on demographic variables (such as age), but also on more sophisticated aspects such as personality, lifestyle, and purchasing behaviors. Changes in the competitive environment:In the analysis of the five forces, it is crucial to distinguish between two types of changes that affect competitiveness: 1. Contingent change: It is temporary and does not permanently alter the structure of the industry. An example of this could be the COVID-19 pandemic, which temporarily altered the profitability of some industries, but its effects were not permanent. 2. Structural change: These are profound and permanent changes in the environment that alter long-term competitiveness. This includes disruptive technological innovations, new regulations, or changes in globalization, such as the opening of international markets. These changes must be closely monitored and analyzed, as they fundamentally alter competitive forces within an industry. Key success factors: Key success factors (KSFs) are the elements that enable a company to outperform its competitors and achieve superior profitability. These factors vary by industry, but are generally derived from a deep understanding of the customer and the industry. Identifying and managing these factors is essential to any company's strategy, as they are what enable it to excel in its sector. To do this, a company must understand both the needs of its customers and the dynamics of the market and competition. Rivalry among existing competitors: This force describes the level of competition between firms within an industry. High rivalry can reduce firms' profits as they must compete on price, quality, innovation, etc. Factors that influence rivalry include: Number of competitorsThe more competitors there are in the market, the greater the rivalry. Market growthIn markets that are not growing, competitors fight for a share of the same pie, intensifying competition. Excess capacity:If there is more supply than demand, competition increases even more, leading to low prices and a greater effort to acquire customers. Threat of substitutes: Substitutes are products or services that can replace current ones, affecting demand in an industry. The greater the availability of substitutes, the greater the threat to companies in that industry. Some factors to consider: Availability of alternatives:If consumers can find alternatives of equal or better quality at a lower price, the threat of substitutes will be high. Technological improvementTechnology can create new substitutes that did not exist before, as in the case of digital services replacing physical ones. Threat of new entries: This force refers to how easy or difficult it is for new companies to enter a market and compete with existing ones. Barriers to entry are factors that make it difficult for new competitors to enter and affect this force. Some common barriers include: Capital Requirements: If a large initial investment is required to compete, it will be more difficult for new players to enter the market. Technological or knowledge barriers: Lack of experience, access to technology or specific knowledge can be a barrier. Economies of scale: Established companies can produce at lower costs due to their size, making it more difficult for new players to compete initially. Bargaining power of suppliers: Suppliers have power when they can influence the costs and quality of the products or services they provide to firms within the industry. High bargaining power of suppliers can reduce firms' profits because they must pay higher prices for inputs. Some factors that give suppliers power include: Concentration of suppliers: If there are few suppliers and many customers, suppliers have more power. Product differentiation: If a supplier offers unique or essential products for production, they will have more power. Switching costs:If changing suppliers involves high costs or quality problems, suppliers will have more influence. Supplier bargaining power refers to the ability of suppliers to influence the prices and terms of inputs that firms need. If there are many suppliers available, their bargaining power is low. The variety of options allows companies to choose from several suppliers, which reduces the ability of suppliers to impose high prices or unfavorable conditions. While some suppliers may be large and well-known in their sector, competition between them reduces their bargaining power. Companies therefore have greater flexibility in the terms on which they negotiate. Bargaining power of buyers: Buyers or customers have power when they can influence the prices or quality of the products or services they receive. High bargaining power of buyers can reduce companies' profits, as customers can push for lower prices or better terms. Factors that give buyers power include: Availability of alternatives: If buyers have many options to choose from, their power increases. Importance for business:If a customer represents a significant portion of a company's revenue, they have more power. Switching costs: If the cost of switching suppliers is low for the buyer, the buyer will have more power. Buyers' bargaining power is related to the ability of customers to influence the prices and conditions of the products or services they purchase. If there are many competitors in the market, buyers have greater bargaining power because they can easily switch suppliers without facing large additional costs. This is due to the abundance of options. Buyers' bargaining power can be high if companies fail to offer clear differentiation or if buyers can find alternatives that meet their needs in a similar way. Low switching costs are a key factor that strengthens this power. Internal Analysis: Resources and Capabilities: The internal analysis of a company focuses on evaluating the resources and capabilities it has to compete in the market. Resources: Resources are the inputs that the company uses for its operations. They can be of different types: o Physical resources: Equipment, technology, facilities. o Financial resources: Capital to invest in operations and expansion. o Human resources: The talent, skills and experience of the staff. o Intangible resources: Such as brand reputation or specialized knowledge. Capabilities: Capabilities are the skills or competencies that a company has to use its resources effectively and achieve its strategic objectives. These capabilities are usually the result of the management and organization of resources. Capabilities may include: o The ability to innovate in products or services. o The ability to operate efficiently. o The ability to manage relationships with customers, suppliers or employees. Resource-Based View: The Resource-Based View (RBV) suggests that a firm's competitive advantage comes from its unique resources and capabilities that are difficult for competitors to imitate. According to this theory, resources must meet certain criteria: o Be valuable: They must help the company create value. o Be rare: They should not be easily available to everyone. o Be inimitable: They must be difficult to copy by other competitors. o Be organizable: The company must be structured to take advantage of these resources effectively. Impact of Internal Analysis: The analysis of internal resources and capabilities allows companies to identify their strengths and weaknesses, which is key to forming competitive strategies. It helps the company understand whether it has the right resources and capabilities to meet market challenges or whether it needs to invest in new areas to improve its performance. Generally speaking, resources and capabilities are fundamental to any business, as they are the pillars that enable operations and long-term success. Businesses are defined as a set of resources and capabilities, and the reason why some are more successful than others is due to the quality and combination of these elements. In a changing environment, having the right resources is crucial to achieving a solid strategy and long-term profitability. Resources: These are the assets that a company has at a specific time, necessary to carry out the activities and processes within the organization. These resources can be classified as follows: 1. Tangible Resources: Tangible resources are mainly divided into financial and physical: o Financial Resources: These include money and the ability to generate funds, such as profits and the ability to borrow to finance the company's activities. These resources are key to the financial viability of the organization. o Physical Resources: These include tangible assets, such as facilities (factories, offices) and equipment, that are needed to produce goods or services. The need for these resources varies by industry (for example, an airline needs airplanes, and an automobile company needs factories). 2. Intangible Resources: Intangible resources are non-physical assets but essential for competitive advantage: o Technology: Includes patents, copyrights and internal know-how that can protect products or services from competition. Technology is a key resource that can be intangible or made visible through patents or intellectual property rights. o Reputation: Reputation is crucial for customer loyalty, attracting investors and positioning in the market. Although it is not tangibly visible, it has a great impact on the sustainability and profitability of the company. It is measured through indicators such as customer retention or supplier loyalty. 3. Human Resources: Human resources are the people who make up the company. Although companies do not own people, they do own their labor. These resources are vital to the functioning of the organization. o Human resources are measured through indicators such as employee qualifications, job turnover (which measures how many employees leave the company) and training. o Keeping employees within the organization is key, so the company must invest in professional development activities, rewards and benefits to retain talent. Classification of Resources: The classification of resources, although diverse, can be summarized in these three main types: tangible, intangible and human. Tangible resources are essential for the day-to-day operations of the company, while intangible resources provide a competitive advantage that can be more difficult to measure but equally important. Human resources, on the other hand, are the driving force of the company, as they allow tangible and intangible resources to be managed and used effectively. Importance of Resources in a Changing Environment: In a competitive and changing environment, companies must be well equipped with the right resources to adapt and excel. Without an adequate set of resources and capabilities, profitability and long-term sustainability will be compromised. The competitive advantageA company's performance is derived from its ability to effectively use available resources, managing not only tangible assets, but also intangible ones, such as technology and reputation, along with the human talent it possesses. This approach is based on the Resource-Based View (RBV), which emphasizes that firms with a unique set of valuable, rare, inimitable and organizable resources are more likely to gain sustainable competitive advantage. SECOND Hour Chapter 3 on resources and capabilities delves into how companies use these elements to create competitive advantage and long-term sustainability. In the case of Harley-Davidson, a variety of tangible and intangible resources are illustrated, and how these are directly related to its strategy. Harley-Davidson Tangible Resources: 1. Physical assets: o Headquarters and production plants: The company has several manufacturing plants in key locations such as New York and Kansas City. These physical assets are essential to the manufacturing of its motorcycles and to controlling product quality. The location and size of these plants directly affect its production capacity. o Distribution network: Harley-Davidson has a global network with 765 dealers in North America and 693 in the rest of the world. This network is vital for distribution and also for the customer's purchasing experience. The dealer network becomes a critical part of the brand experience, allowing customers to live the "Harley experience", an emotional and symbolic aspect that goes beyond the purchase of a product. Harley-Davidson Intangible Resources: 1. Brand and values: o The Brand: Harley-Davidson has a deep emotional value for owners, who often belong to a community of loyal fans. This community doesn't just buy a bike, it identifies with the values of freedom and rebellion that the brand represents. The brand creates a shared identity and customers often become ambassadors, persuading their friends and family to buy Harley products. o Reputation and values: Brand reputation is another crucial intangible asset. Harley-Davidson's brand loyalty is so strong that customers not only buy a bike, but also encourage the purchase within their close circles, amplifying the brand's value. 2. Technology and R&D: o Investment in R&D: Harley-Davidson spends $152 million annually on research and development (R&D). This investment is essential for developing new products and improving existing ones. Like technology companies, Harley spends large sums on R&D to ensure that its products remain competitive in a rapidly changing marketplace. Human Resources: 1. Training and loyalty: o The company invests in employee training, which not only increases their skills but also builds a sense of belonging and loyalty. Employee loyalty translates into increased efficiency, a positive work environment, and ultimately a better customer experience. Employee hiring and training not only aims to make workers competent but also make them feel part of a “big family,” which is an important factor in Harley-Davidson’s organizational culture. Strategy and Capabilities: 1. Organizational capabilities: o Organizational capabilities are a company's ability to use its resources effectively to achieve results. In this case, Harley-Davidson uses its distribution network, brand reputation, technological innovation capacity, and engaged employees to maintain a competitive advantage. o There are distinctive capabilities (things the company does particularly well) and core capabilities (skills that are necessary but not sufficient for competitive advantage). For example, Harley-Davidson has the distinctive ability to manage its brand and customer loyalty, which is critical to its strategy. Importance of Resources for Strategy: Resources alone are not enough; they must be combined with capabilities to transform those resources into something that creates value. A company's strategy depends on the right combination of resources (tangible and intangible) and capabilities. An example would be that Harley-Davidson not only has factories and dealerships (tangible resources), but also a strong brand reputation (intangible resource) that is effectively managed through its distribution network and organizational culture (capabilities). The Correlation between Capabilities and Strategy: A coherence between resources and capabilities ensures that a company can maintain a sustainable competitive advantage. Harley-Davidson achieves this by investing in tangible resources (plants and dealerships), intangible resources (brand, reputation, technology) and capabilities (brand management, employee and customer loyalty). Sustainable competitive advantage is based on a company's ability to manage and combine its resources and capabilities in ways that are difficult for competitors to imitate. This is what allows Harley-Davidson to maintain its position in the motorcycle market for years. Brand Management: Brand management becomes a crucial activity, as brand value has a significant economic impact. Although brand value is not always reflected in financial statements, it is a key asset that could influence a potential acquisition. Companies such as Amazon, Apple or Google demonstrate how a strong brand can generate billions in value. Basic and Strategic Capabilities: A company must have the necessary competencies to be successful. If it lacks them, it must "buy" them by hiring experts or consultants. Vulnerability arises when a company does not possess the key capabilities to function effectively. The Distinctive Competence: If a company's core capabilities are also its distinctive competencies, success is more likely. Companies must monitor their capabilities and adapt to new demands, such as those arising from artificial intelligence (AI), which may become a core competency. Competence Assessment: Assessing capabilities is essential both in specific functions and across the entire organization. The goal is to verify whether the company has the capabilities needed to function properly and adapt to changes. This is done through functional analysis or value chain analysis (proposed by Michael Porter). Organizational Capability Models: The skills required in areas such as finance, management (leadership, coordination, long- term vision), and marketing (brand management, reputation, business intelligence) are highlighted. Specific capabilities, such as negotiation and relationship management, are crucial in sales and distribution. The Value Chain Model: The company is broken down into a number of primary and support activities. Primary activities include logistics, production, marketing, sales, and service. In companies like Amazon, logistics is crucial, as managing millions of products around the world requires specialized capabilities. Importance of Training: Companies must continuously train their staff, both in technical and soft skills, to remain competitive. Skills must be aligned with market needs and organizational strategy. VRIO The DRAO model is a framework used to rank a company's capabilities and resources in relation to their contribution to a sustainable competitive advantage. This model is broken down into four key dimensions: Value (D), Rarity (R), Imitability (A), and Organizational Support (O). Each component is explained below: 1. Value (D): The capability must have value for the customer. This means that the company's capabilities must generate tangible value, such as high speed of delivery or quality of service, that the customer perceives as beneficial. 2. Rarity (R): For a capability to be a source of competitive advantage, it must be rare. This means that the company must have exclusive resources that only it can access, or unique capabilities that other companies cannot easily replicate. Patience, for example, is a capability that may be unique and difficult to find in other organizations. 3. Imitability (A): The capability must be difficult to imitate. Companies can protect their competitive advantage by making their capabilities difficult for others to copy. This may be due to factors such as: o Reputation: Very difficult to replicate, as it is built over time through consistent actions. o Causal ambiguity: The difficulty of understanding or identifying the causes of a capability, making it difficult to replicate. Companies can take advantage of this uncertainty to protect their advantage. o Complexity: Capabilities can arise from the complex interaction of different firm activities, which also makes them difficult to imitate. 4. Organizational Support (O): The organization must foster and protect capabilities through appropriate organizational support. This involves investing in training, ongoing assessment and development of capabilities within the company. Finally, the concept of dynamic capabilities is introduced: these are capabilities that develop and adapt over time in response to changes in the environment, such as competition, technology and market needs. Dynamic capabilities allow companies to innovate and evolve in the face of change. Examples of dynamic capabilities include: Detection and monitoringof the environment to identify opportunities. Exploration and innovationto design new products or processes. Organizational reconfigurationto adapt to new needs or emerging technologies. This dynamic capabilities approach underscores the importance of companies continuing to develop and adapt their capabilities to remain competitive in an ever-changing environment. LESSON 8 Competitive advantage is a company's ability to outperform its competitors and be more profitable than the industry average. This advantage can arise from both internal and external factors. For example, it can originate from a change in market demand or from a technological innovation, such as a unique feature of a product that only the company has on the market. It can also come from within the company, through unique capabilities in areas such as logistics, supply chain management, or product development that make it superior to its competitors. Key aspects of competitive advantage: 1. Long term: A true competitive advantage is not only profitable in the short term, but must be sustained over the long term. This implies that the company has achieved a clear difference in the market, either due to a single factor or a set of factors that make it different from others. 2. Positioning: According to Michael Porter, competitive advantage is achieved through clear strategic positioning in the market, which is achieved through key decisions about the scope (the area in which the company will compete) and the type of competitive advantage it wants to achieve. Key strategic decisions: 1. Scope of competition: o Wide scope: It refers to competing throughout the industry or market, as Coca-Cola does, which offers products for a wide variety of consumers. o Narrow scope: It refers to competing in a specific segment or in market niches, such as Ryanair, which focuses only on flights within Europe and the Mediterranean area, or Le Silinuse, a luxury hotel that targets a very exclusive and specific audience. 2. Type of competitive advantage: o Cost advantage: This involves producing products similar to those of competitors, but at a lower cost. This allows the company to offer more competitive prices and generate greater profitability without sacrificing quality. Examples of companies with this approach include those operating in mass sectors such as utilities. o Differentiation advantage: Rather than competing on price, companies seek to offer unique products that are distinct from their competitors through exceptional features, superior quality, or innovations that customers value. Companies like Apple and Tesla are examples of companies that seek to differentiate themselves through the quality and innovation of their products. Competitive strategy is based on the decision of how to position oneself against the competition, and two key dimensions can be identified in strategic decision-making: 1. Competitive scope: This can be: o Wide scope: It covers the entire industry or market. o Narrow scope: It focuses on a single market segment or niche. 2. Source of competitive advantage: Could be: o Cost advantage: Offer products similar to competitors but at a lower cost. o Advantage through differentiation: Offer unique products that consumers consider superior and are willing to pay more for. Combining these two dimensions, four possible competitive strategies are generated, as shown in the matrix: 1. Cost leadership(Broad reach, low cost advantage): The company seeks to be the most cost efficient and offer similar products at lower prices than competitors. 2. Differentiation(Broad reach, differentiation advantage): The company offers unique products, differentiated from those of the competition, and charges a higher price because of this uniqueness. 3. Cost approach(Narrow scope, low cost advantage): The company focuses on a specific segment and uses the cost advantage to be more profitable in that niche. 4. Differentiation approach(Narrow scope, differentiation advantage): Similar to the cost approach, but differentiation is sought in a specific segment. Importance of making a clear decision: Michael Porter emphasizes that a company must choose a clear strategy and not get caught in the "middle" - that is, not try to combine a cost leadership approach with a differentiation approach, as both strategies require opposite approaches and actions. If a company tries to do both at the same time, it runs the risk of having no coherence in its strategy and failing. It is important to be consistent with the chosen strategy and not try to combine different approaches. Once a strategy is chosen, its implementation must be consistent over time. Changing strategies, especially from a cost approach to a differentiation approach, or vice versa, is very difficult and risky, as it may require a total overhaul of operations, investments and the product. Cost Leadership Strategy: To achieve a cost advantage, companies must focus on reducing costs efficiently, which may include: Efficiency in scale: Take advantage of economies of scale to reduce costs per unit. Fixed cost control: Keep overhead costs, such as operating and administrative expenses, low. Outsourcingof activities: Outsource those activities that are not key to reducing costs. It is crucial not to compromise on the essential quality of the product. For example, if a camera company decides to cut costs by removing key features (such as the ability to take photos), its product would lose market appeal, resulting in ineffective cost savings. Cost advantage is a strategy that seeks to make a company the low-cost producer within its industry or segment. To achieve this, the company must control and reduce production costs efficiently, allowing it to offer products at lower prices than its competitors and still be more profitable. Theory behind cost advantage: 1. Cost leadership: Being the lowest cost producer within the industry allows the company to have a significant competitive advantage. By reducing production costs, the company can of

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