0:13

Learning outcomes.

Â After watching this video, you will be able to calculate the value of accruals.

Â [MUSIC]

Â >> All right, guys.

Â So, we are so far seeing the whole concept of accrual and

Â why theoretically this is supposed to work.

Â Now let's get into the actual formula.

Â So this is it.

Â This is the formula that Sloan uses to identify accruals.

Â It looks complicated on the face of it, but it's very,

Â very simple and straightforward.

Â If you really understand what's going on here, so accruals,

Â let's start from the first part of the formula.

Â So how do you calculate accrual?

Â So first for you to do is Delta C, what is this Delta C?

Â 1:18

Just pause for a while and think, what are current assets?

Â Do you get it?

Â Yeah, so current assets are those which

Â are easily convertible into cash within a quick time.

Â Usually people say within a year.

Â But the spirit of the human is there.

Â They are convertible into cash quickly.

Â So that's the idea.

Â So delta current assets, so change in current assets.

Â Now, remember, what are we up to?

Â We are trying to calculate this accrual company.

Â How much is the accrual earnings of a farm in a year, right?

Â So why should we take this delta current assets?

Â If you think properly,

Â 2:12

Now what happens?

Â How is such a transaction recorded?

Â Such a transaction is recorded as a receivable from that buyer, right?

Â So if you record something as a receivable from a buyer, so

Â what happens your current assets go up.

Â Remember, current asset consist of what?

Â Cash, receivables, stock, and so on, and so forth.

Â So any increase in current assets is an increase in accruals, right?

Â 2:39

So the sale, which is not a cash transaction, increases your income.

Â But at the same time it doesn't contribute to your cash.

Â So that is why Delta CA,

Â an increase in current assets is considered as increasing accrual.

Â It is not considered, it is an increasing accrual.

Â So first calculate that.

Â So how do you calculate?

Â Take this year's balance sheet, take the previous year's balance sheet,

Â and just take the difference, calculate the difference.

Â So, the first component is Delta C.

Â So this is basically the difference between all current assets of this

Â year and last year.

Â However, you have to subtract change in cash from them, okay?

Â Change in cash from change in current assets, why?

Â Because increase in cash is not accruals.

Â Increase in cash is cash.

Â So when you calculated increasing current assets you would have also taken cash

Â into account, right?

Â So if that same sale is because of cash or

Â within three months if the buyer pays cash, then that should not be considered.

Â So, basically, this part is increasing current assets net of increasing cash.

Â 4:06

There are some terms which you may not be familiar, but

Â you would understand the spirit of this formula.

Â Basically all that we are trying to understand is,

Â what is the change in operating income caused by accruals?

Â That's all. Now, ignore the negative sign for a while,

Â what are we trying to calculate here?

Â 5:21

But then, the actual payment may be delayed.

Â It may be a practice in your industry to pay off, let's say, three months or

Â six months.

Â Now, in such a situation, how do you record this transaction?

Â You will record this transaction as a purchase, which is an expense, but

Â at the same time in your balance sheet, what you do is show it as?

Â Yes.

Â Sundry creditors, bills payable, in different names, in different countries.

Â That doesn't matter, the spirit is that whenever you buy something on credit,

Â 6:22

Let me give you a concrete example.

Â I think then it'll be clear.

Â Suppose, let's take a guess,

Â there is a purchase of 300.

Â And you sold this for, let's say, 150, right?

Â 6:46

Now, imagine that this entire 150 comes in cash.

Â Okay?

Â Now, just for the sake of simplicity,

Â assume that there are no other expenses and you make a profit of 50.

Â I'm just making it too simple just for the sake of understanding.

Â Of course, you will have other expenses, closing stock, and so on, and so forth,

Â but let's take this example.

Â Now, in this case, what is the cash you will have?

Â So you started with, let's say, cash of,

Â 7:44

Yes, the cash earning is going to be You know, I gave that pause for you to think.

Â You know whenever I ask a question, I'll pause for a few seconds so

Â that you can think.

Â Otherwise, you can also mute this video and, sorry not mute,

Â pause this video and see this.

Â Think yourself.

Â So what happens?

Â The accounting profit is 50.

Â But the cash you'll have, imagine you started with 0, forget about 100,

Â how much cash you will have?

Â You will have a cash of 150, right?

Â So what did this credit transaction do?

Â It increased your cash earnings.

Â In other words, it reduced your accruals.

Â So cash earnings is 150, right?

Â 8:32

Because you had 150 in cash, you paid nothing.

Â You have cash earnings of 150, your accrual earnings is 50.

Â Right?

Â So if you're to calculate this number from this number, what you have to do?

Â You have to subtract 100 from this number.

Â That is what we are trying to do here.

Â 8:52

Right?

Â So, when you subtract 100, so you will actually arrive at the accrual number.

Â So we are trying to calculate what is the part of the earnings,

Â which is driven by accruals, right?

Â So that is why current liability is subtracted.

Â Very, very straightforward, where there is no rocket science going on here.

Â So subtract increase in current liabilities, now what's this animal doing,

Â Delta STD?

Â Now, this is not usual, you will not have it in every company,

Â suppose there has been an increase in short-term debt,

Â which is not used for our operational purpose.

Â A lot of times you, for financing activities, you raise money for some kind

Â of investment which is not related to your normal operating activities,

Â that should not be considered as a part of current liabilities, that's all.

Â I know you are subtracting this, and then this is Delta TP,

Â Delta TP is Delta tax payable.

Â So, in this short-term liabilities on the count of tax payable also should be

Â excluded, right?

Â Because it's not a part of your normal operations.

Â So, first calculate this part and calculate this part.

Â So, once both of them are done, and the final part is this depreciation.

Â Now, I'm sure you're going through depreciation in your accounting

Â module, right?

Â So pause for a while and think about it.

Â So what does depreciation do?

Â Is there any outflow of cash involved in depreciation?

Â No, so there is no outflow of cash.

Â All that we are doing is we have an asset, we have its use for life.

Â We are writing off the desert or its useful life?

Â That's all that is going on in depreciation.

Â So, but then in your income statement, let's go back to this example,

Â suppose there is depreciation here, so that depreciation saved 30 here, so

Â that is considered as an expense.

Â So in this case, if there is 30 depreciation,

Â now your profit will be how much?

Â Your accrual profit falls to 20, why?

Â 11:00

Because of this depreciation, if we take 30 rupees as depreciation in this case.

Â Instead of 50 accrual profit it becomes 20, because this 30 is considered as

Â expensive, which is not actually cash expense.

Â There is no cash overflow.

Â Therefore, that also has to be subtracted.

Â So, then you will actually get what is the actual accrual component of values,

Â so what do you do?

Â First step, calculate increase in current assets, net of cash.

Â That's the first step.

Â So that will give you what is the increase in accruals.

Â Subtract increase in current liabilities, net of increase in

Â 11:43

debt, which is used for financing activities.

Â They're also increasing tax payable.

Â So that will give you that component of cash earnings

Â that needs to be subtracted from here.

Â And finally, deduct depreciation, because there is no cash outflow there,

Â it's purely an accounting entry.

Â So the balance that you get is the accrual component.

Â So this is the first step in arriving at this formula for trading on this strategy.

Â