[MUSIC] Now, we want to understand now a very brief example of sustainable growth. So for you to be very familiar with the concept of sustainable growth, if I were to tell you how does the short balance sheet of a company looks like? For a company in the first year, there has to following elements, pay attention, Sales at 100, ROS 10%, NFO, a percentage of sales, is 20%, Dividends are 50% and WC is 5. Now, if you want to just click pause to this video one second if you want and think for a second and see how would you draw in this box, that we did before, a short balance sheet. Take your time, just click pause to the video if you want and then think about it. And after you have thought about it, you would agree with me that the very short version of the balance sheet is basically NFO at the left-hand side and working capital and credit in the right-hand side. Now, if NFO is 20% of sales, 20% of 100 would be 20, you're going with me? So left-hand side 20, now if working capital in the bottom line is 5, then we will have 5 of working capital, so as a consequence, what is the credit that we need this year? 15, very clear and lets move 1 of the step. Which is I tell you that there is one year, what happens next year if the situation is exactly the same, the company does not grow, keep selling 100 and the policies is exactly the same. Now it comes a bit tricky, what is the NFO now? You agree with me that it's still 20% of sales. Sales are still 100 so NFO would be 20 again. Now, the tricky thing here is now, what is working capital now? Click pause for a second to the video and think about it if you want. And after you have thought about it, you would agree with me that working capital grows with the equity, with the net income that is re-invested in the company. In this case what is the net income? Well, return on sales is 10% so 10% of 100 is 10. Now, it turns out that we are not reinvesting everything because we are giving out some dividends 50%. So 50% of 10 would be 5. So we are reinvesting five so if we reinvest five, then the new working capita would be five from before plus the five reinvested now. Would you agree with that? It's pretty simple, so not enough to finance the whole NFO so we still have to ask for credit but you see that now credit is 10 instead of 15. Now, even trickier, if I tell you what happens not in year two, but in year three. What happens in year three? Again, no growth, sales are still 100, NFO 20% of sales, everything the same. Now, you would agree with me, if it doesn't change, NFO still would be 20, but then working capital grows 5 every year. So in year 2, we would have gone from working capital of 10 to 15, and in year 3, we would be with a working capital of 20. Agree? So no more credit needed. And from now on, what happens, what in year four if we still are in the same situation and we do not grow, what happens is that NFO is still the same as before, but working capital increases five again because you are reinvesting the profit. So working capital now is going to be 25. So what happens then? Then, what happens is that you don't need credit when you start having this extra cash now. Pretty simple. This is the extreme in which you do not grow at all. What is the extreme which just start growing a lot? Well, this situation will be, if in year 1 you grow 100%. So for example, sales are 200 instead of 100, then NFO that is 20% of sales, 20% of 200 is going to be 40. So now NFO doubles because our sales double. But working capital goes from five to what? Well, the ROS is 10%. Agree with me, 10% of 200 is 20, but you're giving out 10 as dividends. So you would increase working capital at 10. So working capital of 5 plus 10 is going to be working capital of 15, so now credit is going to be 25. So you see that if we grow a 100%, our credit starts exploding, and we said so, with 0 we reduce credit, with 100% of growth we increase credit, then what is the sustainable growth? Well, we know that the formula was ROS over NFO minus ROS. I now include a new term of 1- d which is the dividend policy that the company has. Because when we are interested in the ROS that is reinvested in the company. So in this case, the co-sustainable growth would be 33%. Now, I gave you a super simple example of sustainable growth. It's super simple example but at least you understand and you have the idea of how companies, by operating, accumulates profit and then that profit goes into to the equity and that's feeding up. If that profitability is not enough because we are growing too much then the growth of credit explodes. So let's now move into the following part in which we will explain some other aspects of the NFO on working capital. [MUSIC]
