[MUSIC] So as said in the previous clip, the company is growing too much, right? Company grows too much. And what is not too much? Well it's what is the sustainable growth of a company. This is what we're going to see in this clip. We're going to do a little bit of algebra. So, don't get too afraid about that. But, we will go slowly about that. Now, sustainable growth. A company that is growing the NFO like this, and the Working Capital like this, is not sustainable, because it needs more, and more, and more credit. So the bank is actually taking all the risk of the growth of this company. If something goes wrong, the one liable is the bank and all the owners of the company. That's why the bank is not really willing to give money to companies that are in an exploding need of growth, right? So what is sustainable growth? Well, sustainable growth would be the growth, the maximum growth, for which these two lines, instead of being open are the mouth of the crocodile is parallel or getting closed, right? Like this. If this is parallel, the credit is not exploding. So that will be a sustainable growth and what does that mean in terms of growth of Working Capital. Well basically the growth of NFO has to be smaller or equal than the growth of Working Capital. So If Working Capital grows faster or at least as the same pace as the NFO then the company is sustainable. Let's put it in formula, right. Don't freak out. Let's go little by little here. Now, the change in.NFO has to be smaller than the change in Working Capital. Now can we develop a little bit this idea of change in NFO? Let me show you. So NFO can be put as a percentage of sales. So NFO in year t would be equal to NFO as a percentage of sales times sales. NFO over sales times sales is NFO. This is just equality, right? And the change in NFO would be NFO as a percentage of sales times the change in sales in t. All clear, do you agree with me with that? If this is clear, we move on to the other part. What is the change in Working Capital? Now let's make an important assumption here. If you remember, Working Capital is equal to equity plus long term debt minus fixed assets. Imagine that fixed assets that do not change. Imagine that long term debt do not change. And imagine that you don't increase capital, in issue of new equity. So the Working Capital would only increase in the part of equity that comes from the net income, right? So the increasing Working Capital would beat the net income of that year, agreed? Now if we want to introduce the concept of Return on Sales, we can put another equality, like the other one before. Net income over sales times sales is equal to net income. But net income over sales, we call it return on sales. So we could say that the change in working capital is equal to return on sales times sales in t. Now let me move one step forward. With the sales in t, in year t, if you agree with me, it's going to be the same as sales in year t minus one plus the change in sales in year t. You will see why we're doing this. I'm not trying to confuse you. But I'm trying to get to a formula that is very simple and very usable. So as I said, ROS times Sales is the same as ROS times sales in year t-1 plus the change in sales. Now we have developed an expression for the change in NFO. And develop an expression for the change in working capital. If we put those expressions equal to one another, this is what we get, right. NFO is a percentage of sale tax times changing sales qqual to ROS times sales t minus 1 plus change in sales in t. Now if in both sides of the equation, I divide everything by sales in t minus 1 and you'll see why we do this. We will basically have the same expression, right? Now if you see, the change is sales in t over sales in t minus 1 is exactly growth. How do you measure growth? Well growth is sales in t minus sales in t minus 1 over sales in t minus 1. This is the growth and we call growth g, then change in sales in t over sales in t minus 1 is g. So this will be equal to NFO as a percentage of sales times g. And then, on the right hand side, sales in t minus 1 with sales in t minus 1 cancel each other. So, we will get that. Now, if we rearrange that term to leave G apart then we get the G is ROS over NFO minus ROS. Now I know this was a little complicated, but it helps us a lot to see that the sustainable growth depends basically on two things. One, ROS and the other one NFO as a percentage of sales. In other words, so the bigger the ROS, the bigger your profitability, the bigger your sustainable growth, the more you can grow without exploding credit. And the bigger the NFO, the bigger the Need of Funds for Operations, the lower your sustainable growth. If in order to operate, you need a lot of financing then you cannot grow that much wide. [MUSIC]
