Gennaro Cuofano's Blog, page 274

Book Launch | Financial Accounting Simplified Manual

At the beginning of the 20th century in the U.S., the mob phenomenon exploded. One of the most powerful exponents was Al Capone. He ranked among the most despicable gangsters of all time. He killed dozens of people. The climax came in 1929, when he ordered the assassinations of seven rivals. This became the greatest massacre in mob history.

How did the story of Al Capone story end?

Although he committed thousands of crimes he was only convicted with one. In 1931, he was finally convicted for Tax Evasion. A pool of Forensic Accountants directed the investigation. He served in prison for almost seven years. After that Al Capone was debilitated and mentally ill, he had to renounce to his mob career.

Accountants were the ones that brought down Al Capone. While you may never bring criminals to justice through your accounting, you can realize the power that accounting does have.

Although becoming a good accountant is a path that might take years of experience, forming the Accountant mindset is instead something that anyone can start at any time. Understanding and becoming aware of the fact that Accounting is the foundation of business is a crucial step to take.

This manual will give you the tools to start this path and it will allow you to analyze the world with the Accountant eye. Eventually the world won’t look the same again!

You can buy the E-book here.

Or the Paperback here.

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Why Reading the Market News Makes You a Sucker!

Mr. Informato woke up at the sound of his super-technological alarm. It is around 5 a.m.  the market news pour into his sleep-deprived mind. After snatching barely four hours of sleep, he is ready to take off. Mr. Informato wears his new smart-watch on the wrist, bluetooth earphones and tech-glasses that keep him constantly updated.

He knows every single move of the market. He feels he knows Wall Street better than his wife. In fact, he is thinking of divorcing to dedicate all his time to that. He is a successful portfolio manager. Ever since he joined Fortunata Inc. the company’s profits have skyrocketed.

That morning though something seems not to work as usual. Most of the investments he had made turned out to be too risky. The accumulated profits of the last years have been burned in less than one hour! What is going on? What happened? Did someone organized a conspiracy against Mr. Informato? Not at all.

99.5% of the News Is Noise

As the author of Antifragile puts it:

The more frequently you look at data, the more noise you are disproportionally likely to get (rather than the valuable part called the signal); hence the higher the noise to signal ratio.

and he goes on:

Assume further that for what you are observing, at the yearly frequency the ratio of signal to noise is about one to one (say half noise, half signal) —it means that about half of changes are real improvements or degradations, the other half comes from randomness.

This ratio is what you get from yearly observations. But if you look at the very same data on a daily basis, the composition would change to 95% noise, 5% signal. And if you observe data on an hourly basis, as people immersed in the news and markets price variations do, the split becomes 99.5% noise to .5% signal.

That is two hundred times more noise than signal —which is why anyone who listens to news (except when very, very significant events take place) is one step below sucker.

In other words, the false sense of knowledge and understanding that comes from the news is just an illusion. Therefore, if you spend most of your time reading the daily/hourly market news, you may not only be wasting your time but also limiting your understanding of financial markets!

To read the full post from Taleb, click here.

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The Art of Swimming in a Blue Ocean | How to Use the Blue Ocean Strategy to Start a Business Venture

From Steve Jobs to Elon Musk, it has been proved time and time again that esthetic is as important as the innovative aspects of the product that you are trying to launch. It is true that Apple makes among the most innovative portable devices out there, but it is undeniable that what gives Apple an edge over its competitors is the beauty of its products and the pride of being part of the “Apple’s tribe.”

Also, it is true that Tesla makes among the fastest and most efficient electric cars in the world, but what makes a Tesla car special is the beauty and simplicity of its design, which makes its buyers proud to be part of the “Tesla’s tribe.”

Yet if innovation and its esthetic side, elegance, had proved time and time again the success of a product, and the whole company that carried it; could this formula work for the oldest of the inventions, like footwear?

As Kiri Picone points out in “The Fascinating History of Footwear,” there is evidence of the invention of shoes, already 40,000 years ago, in the Middle Paleolithic. The first shoes resembled either sandals or moccasins.

Why Old Is Better Than New in the Tech World

Although among the oldest invention, shoes will be with us for millennia to come. How do we know? As Nicholas Nassim Taleb points out in his book, Antifragile, the longer a technology has been around, the longer its “life expectancy” will be. In short, Taleb wrote on Wired Magazine:

Technologies, ideas, and theories – anything informational or cultural, as opposed to physical –age in reverse.

 In fact, Taleb asserts that due to the so-called Lindy-Effect, a non-perishable thing, such as technology, will increase in life expectancy with the passing of time. Therefore, an old technology, like shoes, can be expected to live way longer than a more recent invention, like the Internet!

This point challenges the most common of the assumptions, that new is always better and it is usually destined to kick out old stuff. Yet from the mathematical standpoint this assumption doesn’t hold to be true.

Yet if old stuff is destined to be with us for longer time, how can we innovate?

Swimming in a Blue Ocean Is Safer

If anyone would ask you to swim in a pool plenty of sharks, would you do that? I guess you would not. Yet, when it comes to the business world, crowded places seem to be the rule. You see streets, where restaurants, shops and stores compete against each other, for a meager increased profit. The consequence is that, what seems a short-term relief, eventually becomes a sure long-term failure. How to avoid that?

The best way is to swim in blue, safer water. The Blue Ocean strategy is now very popular in the business world. On the other hand, this is often misunderstood. In fact, the blue ocean strategy simply states that “it is better to swim in a blue ocean, where competition is almost absent, rather than in a red ocean, where a great numbers of sharks compete against each other for the smallest piece of meat.” This all makes sense, but how to do that?

One way is to create new industries. For instance, when Apple Inc. came out with the I-pad this created the “Tablet Market” that did not exist before. Even though many companies dream of this scenario, this is too risky and costly. There is a second hypothesis.        `

Another alternative is “to expand the boundaries of pre-existing red ocean markets, therefore find a “piece of ocean” where competition is still absent. What does this mean practically?

Build on Preexisting Technologies

As Chan Kim, author of the Blue Ocean Strategy, pointed out in an interview for Forbes,

Our study shows that blue ocean strategy is particularly needed when supply exceeds demand in a market. This situation is applying to more and more industries today and will be even more prevalent in the future.

In other words, this is the only guiding principle of the Blue Ocean Strategy. Therefore, markets that are usually seen as unattractive are potentially profitable, according to this strategy. In fact, Chan Kim goes on and states:

By looking at the attributes of markets, one assumes that there are attractive and unattractive industries. While competitive strategy would advise companies to enter attractive industries and avoid unattractive ones, blue oceans can be created in any industries, be they attractive or unattractive, stagnant or fast growing, high tech or low tech.

He goes on by pointing out how an Australian wine-maker [yellow tail] entered a super-crowded market, which existed since thousands of years, by creating a product that reshaped the boundaries of that existing market. In other words, when thinking in terms of strategic framework, the entrepreneur or manager has to expand the reaching power of the company with a simple but effective tweak of the product.

Let’s see few practical cases that The Four-Week MBA team has found to show how some young entrepreneurs are trying to redefine the boundaries of red ocean markets:

The Italian shoe-market, Rodolfo Shoes is trying to reshape the boundaries of the extremely crowded and what seems at first sight unattractive market of shoes, by adding a small magnet device that allows the tongue of the shoes to be changed time and time again. This open up endless possibilities.
The pillow-maker FaceCradle Travel Pillow came up with a new pillow to make the traveling experience more pleasurable. By doing so it is redefining the boundaries of the “travel and sleep industry.” this particular case shows how innovation is possible anywhere.
The cooking-device maker, Sansaire Delta, is reshaping the boundaries of the mass-cooking industry. By bringing smart devices into the kitchen of everyday chefs, this company is reshaping the way we think about amateurish kitchen.

The above-mentioned are only some of the examples out there of new companies, built on the premise of the Blue Ocean Strategy. On the other hand, the opportunities are endless.

Suggested reading:

Blue Ocean strategy
Chan Kim Forbes Interview 
Wired Interview to Taleb

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A Quick Overview into Behavioral Finance | The No-Nonsense Fast Guide to Investing

The objective of this article is to give you an overview of the relatively new field of behavioral finance in respect to standard finance and how you can use this knowledge to make better financial decisions. The ideas contained in this article are developed from the research paper, drew by Victor Ricciardi and Helen K. Simon, “what is behavioral finance?”

The Flaws of Standard Finance and the Rise of The “Behavioral Crew”

In the first half of the twenty centuries, a group of economists believed that markets overall worked efficiently. In other words, we could assume by looking at the price of the assets exchanged through the stock exchanges that those prices were fairly valued.

This leads to the development of investment strategies, mainly based on the Modern Portfolio Theory (MPT), of which Harry Markowitz, of the University of Chicago, was the prophet. In short, the MPT developed a financial toolbox that presumingly would give the investor the maximum return, based on the assumed risk the investor undertook.

This led to the overconfident use of standard deviation and Beta, to assess the expected return of a certain stock. Although this method is flawed, it is still used from many financial institutions and professionals.

Economists slowly understood that in order to create a valid framework for investing a new approach was needed. Indeed, the understanding of the “psychology of the masses” was already known at the beginning of the twenty centuries (see Selden’s 1912 book “Psychology Of The Stock Market“).

On the other hand, this understanding was not packaged into the financial decision framework, because the “Chicago crew” was still too powerful. But the severe crises, happened in the last decades convinced economists and practitioners that the “new science” (behavioral finance) could not be ignored.

The “Behavioral Investor”

The rise of the efficient market theory survived throughout the twenty-century. On the other hand, recent studies have confirmed the importance of understanding the “psychological and sociological framework” before picking up stocks.

Therefore, the modern investor has to have foundation in psychology and sociology as well. Why? For two main reasons:

First, as Shefrin stated: “One investor’s mistakes can become another investor’s profits.” in other words, by creating a financial model that incorporates the new discoveries of behavioral finance would more credibly fit reality.
Second, one of the major causes of troubles in finance is due to overconfidence. The most striking aspect is that overconfidence affects academics and practitioners, more than the average guy.

Make Inaction Your Ally – the Overconfidence Paradox

Finance is one of those fields, in which experience and knowledge may create more harm than good. And the paradox is that hundreds of millions of individuals rely on the ability of fund managers to safeguard their savings.

What are the main behaviors we have to safeguard ourselves from?

As the say goes, “who dares wins.” No doubt that this say may work in some fields, such as entrepreneurship. On the other hand, when it comes to finance and investing it is important to take two variables into accounts: the opportunity cost and the transactional costs.

In other words, before buying and selling any stock, it is important to understand that when our money is tied to a financial instrument, we cannot invest it in an alternative one. In economics, this is called opportunity cost.

In addition, modern technologies allow us to buy and sell with a high frequency. This creates the illusion of low if not irrelevant transactional costs. But this is only an illusion. Why? For instance, in a study between how men and women invested, men resulted more overconfident. Therefore, they traded with more frequency. The sudden increase in transactional costs, due to the impulse of men to act, slowly eroded the returns of those investors.

Surprisingly enough, transactional costs reduced men’s investments return of about 2.5%, compared to the 1.72% for women. This may seem a small percentage but it is actually a 45% increase in transactional costs, which compounded for few years, makes a huge difference. One way to avoid this is to set-up a long-term plan and make sure to stick with it.

Switch off Your Narrative Machine

Mr. Average has bought Popular Inc. stocks, based on the article he recently read on the Wall Street Journal. The article argued how the company that now produced the coolest socks in the world, was an amazing investment, due to their new acquisition. It all made sense in Mr. Average’s mind.

On the other hand, after few days the stock declined considerably. Did Mr. Average sell? Of course he didn’t. In fact, he felt relieved when the news confirmed this only was a temporary adjustment. Unfortunately, it was not.

Yet even after losing more than half of the invested capital, Mr. Average still believed his investment was sound, and eventually he would have profited. Why? He forgot to switch off his narrative machine.

In fact, modern psychologists argue that our conscious brain often intervenes after the fact. In short, if we are swept by our emotions, the unconscious mind decides for us. The conscious mind only intrudes to generate an ex-post narrative, which gives us the illusion that everything is under control. But this is only an illusion! Behavioral finance calls this phenomenon, “cognitive financial dissonance.”

Probability Neglect – Careful to the Sure Gain

Probably due to our biological heritage, we love sure things. Mr. Hominidus, while hunting in the Savannah, when given the chance to have a sure prey he could not resist the temptation. Why resist?

It was crucial for him to survival. Unfortunately, what worked in the Savannah, does not work nowadays. In a complex world, which rhythm is imposed by the probabilistic laws, Mr. Hominidus (which is us) makes a lot of bad decisions. In behavioral finance, this is called Prospect Theory.

Its assumptions are diametrically opposed to that of efficient market theory. In fact, prospect theory holds that, “under condition of uncertainty individuals act irrationally.” In other words, they neglect probabilistic laws altogether, which makes them very bad decision-makers.

How to Get out from the Savannah

As we saw many of our human features, evolved when we still lived in the Savannah. Now cultures and societies evolve at such a fast pace, that we are not able to keep up with them. How can we become better investors? Victor Ricciardi and Helen K. Simon give us some advice:

“The best way for investors to control their “mental mistakes” is to focus On a specific investment strategy over the long-term. Investors should keep detailed records outlining such matters as why a specific stock was purchased for their portfolio. Also, investors should decide upon specific criteria for making an investment decision to buy, sell or hold.”

To read the entire article click here.

Before making any investing decision, take the following steps:

Set-up a long-term strategy
Run a quick what if analysis on your head. What if your strategy does not work?
Place automatic stop loss and strategies
Set the time-frame of your investment. How long will you hold it?

Our suggestion is also to become more comfortable with probabilistic laws. We suggest you take a look at the resources available at http://www.fooledbyrandomness.com

To learn more about finance consult our Portable Guide for Non-Finance Professionals.

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How Marcus Aurelius Can Change the Way You Think About Entrepreneurship

Rome wasn’t anymore the unchallenged empire, which under the Pax Augusta (Augustan Peace), had enjoyed a relative quiet period that lasted for almost two hundreds years. The fortified frontiers of the Roman Empire, the so-called Limes, were slowly collapsing under the pressure of the bordering barbarian populations.

In the second century BC the Pannonian Limes, also known as Danubian Limes, although protected by the Danube River, where under threats from some Germanic populations. The most feared were the Quadi and Marcomanni.

Those same Germanic tribes had been defeated almost two centuries before, by the Roman troops led by the general Nero Claudius Drusus. In some way the same populations had managed to survive and become stronger throughout the centuries. We are in the year 162 AD, Marcus Aurelius, together with his brother Lucius Verus had to defend Rome from the barbarian attacks; at the same time, if Rome wanted to safeguard its empire, it had to show its strength.

It wasn’t an easy time, both inside and outside the borders of the Empire. The initial military campaigns were successful and kept the German populations away from the borders of the empire. Yet, the attacks by Marcomanni didn’t stop there. Additionally, few years later, in 169 AD the co-emperor Verus died, living Marcus Aurelious as the only emperor to lead the Roman Empire; in the most extreme situation Rome had faced in the last centuries.

In those years of wars, Marcus Aurelius didn’t give up and made it through the hard times. The only thing that kept him motivated throughout those years, were the meditations; a set of diaries, that helped him reconcile the stoic soul, with that of a man who had to carry the weight of millions of people on his shoulders.

Marcus Aurelius was a philosopher, but most of all a man of action. Why is Marcus Aurelius a great example for modern entrepreneurs?

Entrepreneurs Are the New Emperors

Ever since the launch of the atomic bomb on Hiroshima and Nagasaki in 1945, wars have become a taboo. In fact, humanity has learned through a hard lesson that due to those new weapons, wars cannot be fought anymore, at global level. But humans are biologically the same that they were less than a century before.

It is our tendency to fight against each other; it is a biological need to show that we are right; explorations, conquest and many individual sacrifices have been driven by this desire of conflict. Yet wars are not fought anymore on the military field but on the economic playground.

The lives of billions of individuals nowadays depend upon new empires: Corporations. Each day, billions of workers wake up, recruited by huge conglomerates to fight the “profit war.” Corporations organize fierce fights against each other to keep their employees motivated.

Apple’s employees’, under the command of their former general, Steve Jobs, were incited to fight against the rival, Microsoft, by the motto, “let’s kill the tasteless giant!” in this fierce fight, new kingdoms, like “Google Empire” form and dominate the world.

In this scenario of bloody economic struggle and conflicts the new Emperors, the so-called Entrepreneurs have to keep their main goal in mind, “Bringing humanity forward.” In fact, while decades ago, “The Art of War,” by Sun Tzu was the main manual for shrewd manager and entrepreneur; the world is now taking a new turn.

The new “Emperors,” seem to have grasped the necessity to create real value, beside sheer profits. In this state, modern tycoons resemble more enlightened emperors, like Marcus Aurelius, rather than Hitlerian tyrants.

Therefore, Marcus Aurelius’ “meditations” has become the new source of inspiration for wannabe entrepreneurs. The “Aurelian Mindset” is based on few basic but powerful principles. I am going to cite the three foundational ones.

Learn from Others

“Of my grandfather Verus I have learned to be gentle and meek, and to refrain from all anger and passion…” Verse I, Book I, Meditations.

In his first book, Marcus Aurelius goes on to list all the things he learned from all the people he encountered throughout his life. Not only he does not carry anger against anyone, but also he recollects all the lessons learned from others. Entrepreneurs, often learn this lesson the hard way, through many failures.

In fact any great entrepreneur will tell you how important is to learn as quickly as possible from the people around you. Entrepreneurs, like scientists, have learned the “principle of ignorance,” for which, “the more you think you now about a subject the less you really know.” In other words, the great entrepreneur has to push his understanding of a subject to the point of reaching “ignorance.”

In fact, only at that point innovations happen. People like, Tesla, Musk and Bezos pushed their understanding of a certain fields to the limit. Progress, therefore isn’t based anymore on the past.

It Is Not About Fame

 “…Our life is a warfare, and a mere pilgrimage. Fame after life is no better than oblivion…” Verse XV, Book II, Meditations.

 For a successful entrepreneur, fame comes as a side effect. The “Aurelian Entrepreneur” knows that fame itself is worth nothing. On the other hand, this is a tool that the successful entrepreneur can use to deliver the message of his/her mission.

Entrepreneurs, like Leila Janah and Blake Mycoskie know that and use their popularity to deliver the message about the mission of their organizations. Creating a valuable enterprise is not about fame, vanity or personal enrichment. Instead, it is about social impact.

Internal Antenna 

“Our life is what our thoughts make it,” Marcus Aurelius’ Meditations.

Modern society has become increasingly noisy. News and rumors are generated at each blink of an eye. With one finger-tap we can reach the other side of world; we can listen to a podcaster in California, while driving our car in a small town of South Africa; we can monitor the trend of our stocks, while sipping a nice Martini, on Red Beach, in the beautiful Santorini.

While, this may seem an advantage at first, entrepreneurs have to know how to manage the chaotically modern world at their advantage. Entrepreneurs usually have a long-term vision that often sees decades forward, compared to the nearsighted masses.

Therefore, the “Aurelian Entrepreneur” has to know when and how to listen to other people’s opinions. In other words, they are internally oriented. In fact, their antennae are focused inwardly. Only seldom they turn outward, when the moment is right to listen and see what happens in the external environment.

Conclusions 

In conclusions, Marcus Aurelius’ “Meditations” has become a powerful tool for the modern entrepreneur that has to manage adversity, in an increasingly complex environment. The economic playground has become a continuous struggle for the conquest of the world; the progress of humanity depends upon enlightened entrepreneurs, now more than ever!

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The Good and the Bad of the Self-Help Industry – (The Don’t Be Fooled Guide)

 Today more than ever, the self-help industry exploded. Only in US this market was worth $10 billions in 2014 and it is growing at an exponential rate. We can expect this trend to continue in the future.

Self-taught pseudo-gurus teach us how to go from zero “to millionaire in one year.” Real estate magicians tell us how to make “sure money” by flipping properties. Renowned authors tell us the habits to develop to have “sure success.”

In this world of gurus and how-to-get-rich-in-ten-days schemes, determinism, planning and goal setting seem to be a must-do to be successful. How much of it is true? The objective of this article is to make you aware of what to avoid, but eventually we’ll also make some recommendations.

The Science of Success Scheme

 The Four-Week MBA in the book “The Art of Mentorship” has treated the theme of the “science of success.” On the other hand, we made it clear that the so-called habits to develop to be successful will not bring you success. Rather those are habits that allow you to go through tough times and persevere. On the other hand, there is no habit that can guarantee you success. Why? Because success – meant as wealth, and professional achievement – is something external. In other words, this is something, which is not in our control. Therefore, we recommend staying away from the sure success schemes, which are now extremely popular in the self-help industry. Another aspect of the self-help industry that is worrisome is the wrong belief that “success is a linear path.” Almost like a ball that is launched from point A to point B, the self-help schemer makes you believe that once you develop the right habit, you will become successful. The self-help schemer makes you believe that the only thing you have to do to become successful is to have a clear plan. Why is this reasoning flawed?

The Know Thyself Bias

 It is an unusual chilly day in Wall Street, in the middle of August. The adage “sell in May and go away” does not seem to apply. In fact, Mr. Splendido just closed the most important deal in the history of the financial district. Mr. Splendido felt like the British colonels that in the 17th century dismantled the wall, which at the time defended the city of New Amsterdam. Once the wall was conquered, the British founded what it would then become “New York’s Wall Street.” Mr. Splendido had created the greatest financial conglomerate of the world. Journalists hurried to the building where his new office was located to ask him the secret of his success. Mr. Splendido not surprised at all by that question, immediately shouts out, “Planning is the key to success.” He says how since he was a kid he had planned in minor details the takeover of Wall Street. He also adds how all the people he had known throughout his life also agreed with that statement. There is not doubt that Mr. Splendido truly believed in that. But why is this belief flawed?

The Autobiography Scheme, Also Known as Self-Selection Bias

The autobiographical industry has never been as successful as today. Everyone from Oprah to the President’s dog felt the need to let the world know about their lives; and what made them successful. A bunch of prophets and pundits tell you with Madoff’s presumption, about the secret of their lives’ success and how you too should be like them. There is one problem; those advices are worthless! Why?

Statistically speaking they carry no real meaning. In fact, in statistics, what makes an analysis thick is the selection of a sample, which has to be random. In other words, unlike Mr. Splendido, which believed to have understood the secret of success, by looking at the people in his circle, the statistical sample has to include a set of people that have to represent the “whole population.”

In addition, the only fact that Mr. Splendido has been so successful in his life; it doesn’t make him wiser than a common man. Why? We will never know how much of Mr. Splendido success is due to skills and how much is due to luck. In short, we have to be careful to the “survivorship bias.” Therefore, all autobiographical accounts should be read, just like you would read Homer’s Iliad or Odyssey.

Summary – Biases to Beware of

 So far we saw how the self-help industry has grown exponentially and what biases it carries. The most common ones, are the flawed belief that success is linear, which we will call “deterministic bias;” the false belief that someone successful can tell you better than anyone else how to be successful, which is called “survivorship bias;” the fact that we know better than anyone else what made us successful, which we will call the “know thyself bias;” and the wrong belief that our personal experience has any statistical validity, which it isn’t necessarily true, due to the “self-selection bias.”

How to Navigate the Self-Help Industry

Most of the times self-help books are a great panacea, when facing life’s adversities. The main reason, I believe, is due to the fact that most self-help books reinforce our built-in biases. Therefore, they delude us, but also comfort us.

There is nothing bad in looking for comfort in a book, as soon as we don’t allow that book to make us delusional, which in the long-term may affect our understanding of the world. In conclusion, this article gave you the tools to understand the most common biases, on which the self-help industry leverages to grow its revenues.

On the other hand, it is also important to preserve a skeptical approach. Do not believe in anything you are told, naïvely.

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How to Think Like an Entrepreneur

Every great entrepreneur, from Musk to Bezos, from Zuckerberg to Jobs, has a thinking framework that allowed them to formulate decisions differently from the masses. You may wonder, why to use a thinking framework in the first place?

On Human Fallibility

Humans share their origins with other living beings, in particular with chimpanzees. Although it may be hard to admit, we are still very related to our cousins, more than we think we are. In fact, before the 1980s many evolutionary biologists were convinced of the fact that chimpanzees were closer to gorillas than humans.

But the new technologies and the ability to compare the DNA of different species, proved that belief to be flawed. Indeed, as it turned out humans and chimpanzees are more related to each other than chimpanzees to gorillas. In other words, 98% of our DNA is shared with our cousins, the chimpanzees. What does this imply? As much as we loved to believe, humans are not that different from other living creatures. In other words, our biological constraints make us fallible beings.

How to hack our biology? Successful entrepreneurs largely understood this principle, and that is why they developed the thinking framework that allows them to be shrewd decision-makers. In fact, while the majority of us tend to make important life decisions, based on the mood of the moment; successful entrepreneurs, use a thinking framework that keeps them on track. How does this work?

Signal to Noise Ratio

This is a sort of model that allows entrepreneurs to make wise decisions. In fact, the only way to be consistent and avoid bad decisions it to have a simple and clear framework that makes you immune to noise. In other words, while most humans minds are like candle swayed by the wind; entrepreneurs’ minds are more like magnets.

They work with a very simple mechanism of positive and negative charges. In short, like a positive magnet repels another positive magnet; entrepreneurs are able more than others to detect noise and let it go; while keeping the signal strength constant in time. In conclusion, the main difference between entrepreneurs and the rest is not about their genes, intelligence or wealth. Instead, it is all about mindset, which is the result of the thinking framework we are going to see next.

How to Think Like an Entrepreneur

 Since thousands of years ago, the “Homo Entrepreneurus” has been the innovator, the game changer and the risk-taker. He built tools to hunt; he tamed the fire to cook; and he eventually brought us to the moon. What makes the “homo Enrepreneurus” think like he does? Could a bigger and larger brain be the answer? Not at all.

Entrepreneurs have learned to use a thinking habit that keeps their emotions in check and allow them to think differently from the rest of humanity. In modern times, we see more of these “super-humans,” leading our species forward and getting where none has been able to do so before. Entrepreneurs like Musk want to lead us to Mars. Others like Bezos want to deliver happiness around the world.

Others yet, like Zuckerberg want to create a community that anyone can bring in his/her pocket. All those entrepreneurs share the same thinking framework, which we baptized “the M.T.P. framework.” Although it may sound like a sandwich name, it is a powerful framework to make any kind of entrepreneurial decision. But how does it work?

The M.T.P. Works Like a Building Project

Like a construction, where you build the foundation first, this framework needs to be built one layer over the other. In short, if you miss the “M block” the whole edifice will fall. On the other hand, if you have the M block in place, but miss the T and P blocks you won’t go far. Let’s see this framework more in detail.

M Stands for Mission

 If you ask to Mark Zuckerberg what is the most important aspect any entrepreneurs has to consider before starting a venture, he will swiftly say, “Mission.” But what does it mean? Do you really need a mission statement to start your own business? Yes and not. In short, there is no need of a written mission statement. On the other hand, you have to keep in mind the kind of change you want to bring to humanity. For instance, Ford, with his Model T, wanted to change the way transportation worked. Nowadays Elon Musk is doing the same, with his Model S. Therefore, the mission translates in the level of change and impact that as entrepreneur you want to bring to the world. Although it sounds ambitious, this doesn’t have to be necessarily a change that involves the whole humanity. For instance, your aim may be to change the way people sleep on an airplane. Therefore, you will come out with a product like “Woollip Travel Pillow,” which will change the way people around the world travel. This is the foundation.

T Stands for Team: Debunking the Founder Myth

One of the greatest myths of modern times is the fact that entrepreneurs did it all on their own. In other words, most people tend to identify the company with its founder. Therefore, Facebook = Zuckerberg, Amazon = Bezos, SpaceX (or Tesla) = Musk.

Even though founders played a great role in setting up the initial organization; the truth is that most of the work is done by teams of very talented and smart people. If you asked Ford about anything he didn’t know, he would have picked up the phone and asked one of his most talented people.

This tendency to identify companies with its founders is due to our biological need to anthropomorphize companies. We want companies to personify someone, so that we can better relate to them. For instance, people who don’t like Zuckerberg may think of Facebook like an unpleasant company.

Therefore extending the personal features of the founder with that of the company. This happens because we often forget that companies are only imaginary construct that exist in our shared imagination. But what really a company is? It is a set of assets and people, working together for a common objective.

Today more than ever, especially for Hi-Tech companies, the real assets are people’s minds and how they intertwine to create a huge collective intelligence. Therefore, even if we love to think of entrepreneurs as geniuses, they often are people that had the ability to choose the right team.

P Stands for Persistence

Starting an enterprise is not an easy job. You have the odds stacked against you. Many believe that entrepreneurs are only “lucky dudes” that made it through thanks to the kiss of “Lady Fortuna.” No doubt, “Lady Fortuna” plays a crucial role in the success of any enterprise. Yet, how much of this is true?

It is undeniable that some entrepreneurs take huge risks without being aware of them. But can we really define those people, entrepreneurs? For instance, when Richard Branson adventures in one of his crazy explorations, he knows the risks he is going thru. In his mind, he knows that he is putting his life on stake. This is called calculated risk.

In other words, he is not facing adversity; thinking that he is an invincible being. Rather, he is taking the risk knowing how fallible he is. Therefore, shrewd and resilient entrepreneurs are aware of the risk they are taking. In this scenario where odds are stacked against you, the only way to improve your chances of success is to persevere. Like a man flipping a coin and getting tail ten times in a row, the entrepreneur is aware of the “law of the big numbers.”

In short, you know that by flipping the coin time and time again, you will eventually get “head.” To become a successful entrepreneur you only need one “head” against the multiple “tails” you encounter throughout your path. Therefore perseverance is the key.

M.T.P. Framework. The Questions to Answer

In conclusion, the M.T.P. Framework is the real driver of success for any entrepreneur. You can start using this framework right now by answering the following three questions:

Mission: what change/impact am I going to create?

Team: which competences I lack that need to be filled with a team of smart and cooperative people?

Perseverance: how can I minimize my financial risk, so that I will be able to start multiple ventures, in case the next won’t work?

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Useful Tips To Get Momentum With Financial Analysis And Ace The Interview Process

In this article we are going to provide some useful tips for those of you that are going to be interviewed as financial analysts and want to get familiar with the topic as quickly as possible

What Is Financial Analysis?

Financial analysis is a very wide field that requires a preparation in several subjects of economics, accounting, finance and math. Don’t get me wrong financial analysis is not rocket science. But there are three things, which are very important:

Understanding financial markets (macroeconomic and microeconomic)
Understanding the main financial statements (balance sheet, income statement and cash flow statement) together with the ability to analyze them (fundamental analysis, ratio analysis)
Be up to date with the most important financial news (read financial publications, watch financial broadcasts and documentaries)

These three aspects imply not only an academic understanding of business in general, but also a true interest that absorbs part of your personal time. In short, a successful financial analyst is the one that uses part of his spare time to stay up to date with financial news, read publications, and research new topics

I usually do not advocate for an excess of information when it comes to investing. In fact, I actually believe that investing is one of those fields where “noise” gets in between the investor and his potential returns. This principle is particularly true for long-term investors.

On the other hand, I do believe that the financial analyst has to be up to date with financial news out there. Indeed, as analyst you are part of the short-term game. In other words, you are selling information to your clients.

Therefore, the more new and appealing news you have at your disposal to include in your analysis the more your recommendation will look appealing to your clients. Therefore, I find legitimate for the financial analyst to spend part of his spare time to gather and play along with financial data. In short, you want to pick this field only if you are very passionate about it.

Some Useful Statistics

By looking at the US bureau of labor statistics, in 2014 the median pay for a financial analyst was $78,620 ($37.80 per hour). Usually a bachelor degree is the minimum requirement to get into the door. In addition, this profession grew 12% faster than average. No wonder financial analysis is increasingly competitive.

But what are the main tasks a financial analyst is required to perform?

An Overview on the Main Tasks

The financial analyst may be required to perform a large number of tasks within his duties. Some of them are:

Make recommendations on the portfolio composition
Research and evaluate financial data
Understand economic and business trends
Financial statements analysis
Valuation analyses in excel
Written reports for investors or upper management
Meetings with clients

Usually financial analysts can be divided in two main categories:

Buy-side. Usually the analyst manages a portfolio for the company he works for (hedge, pension, mutual funds and so on) and he is supposed to recognize investment opportunities to grow the portfolio he/she manages.
Sell-side. It requires the analyst to make recommendations on certain stocks. Many times you work for third clients. For instance, think of a company that sells reports to third investors. The analyst produced these reports for the company he works for, and then this company sells these reports to third parties. This kind of job requires a lot of analysis and research.

Required Skills

No doubt the financial analyst must have analytical skills. But what does that mean? Let’s see the definition given by the business dictionary:

“An examination of data and facts to uncover and understand cause-effect relationship, thus providing basis for problem solving and decision making.”

In other words, the analyst has to be able to deconstruct the data and facts available and eventually provide recommendations (decision making) to buy, hold or sell certain stocks. In doing so, the analyst has to research extensively into the topic he is covering (detail oriented).

Once those facts and data have been gathered and examined, the analyst will build a model, usually in excel. At the end of the analysis the analyst will create and present a report that must clearly communicate the result of his investigation.

In short, the financial analyst has to be detail oriented, problem solver and communicative.

From the technical standpoint the use of the Microsoft Package (Excel Macros and VBA in particular) is crucial for the job.

Education

The minimum academic credential required to become a financial analyst is a bachelor degree in business administration or any related field.

After completion of the bachelor degree if you want to get to the next level it is advisable to enroll in an MBA or a master degree in finance. This isn’t the only path to be successful.

In fact, given the high cost of enrolling in an MBA or master I would suggest you undertake the path of the self-taught financial analyst. Let’s see how to achieve that.

CFA Certification

One of the most recognized certifications in financial analysis is “CFA” or “Chartered Financial Analyst.”

Taking that certification would be the best path. On the other hand, it also requires a lot of time to get there and we want to become familiar with the subject as quicly as possible. Therefore, you may want to consider to follow their “course of study” just to understand what are the most important topics in the financial industry.

For instance, the first CFA level requires the understanding of the following ten topics:

Ethical and Professional Standards
Quantitative Methods
Economics
Financial Reporting and Analysis
Corporate Finance
Equity Investments
Fixed Income
Derivatives
Alternative Investments
Portfolio Management and Wealth Planning

You can find the detailed program here.

As you can see the first level requires a great deal of knowledge, but how to start? Let me suggest you three books that can really give you a jump-start.

 Three Books to Get You Jump-Started with Financial Analysis

The books contained in this article although connected to Amazon are not affiliate links. In other words, I do not make any money by suggesting them. Those are the books I personally used and that is why I am suggesting them to you:

Applied Corporate Finance 3rd Edition by Aswath Damodaran. Corporate finance can be a very intricate subject for the newbies. There are many books out there about the topic, but very few are practical as Damodaran’s applied corporate finance.In fact, the author uses a language that can be understood also by people that are just starting out. In addition, he points out all the most important tools that the financial analyst has to know to get the job done.
Investment Banking: Valuation, Leveraged Buyouts, and Mergers and Acquisitions by Joshua Rosenbaum, Joshua Pearl. Don’t be scared by the name. Although investment banking seems to be an esoteric subject that can be understood just by a small circle of people that rules the world, you’ll be surprised. In fact, investment banking is not rocket science and most of the time relies on the understanding of simple ratios and metrics that will be used over and over again. In this respect the authors of the book made a great job at explaining the subject with the maximum simplicity.
The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel by Benjamin Graham, Jason Zweig. Even though this book has been first published in 1949, it still remains the best book on value investing. In addition, the author has done a great job in readapting the book, by leaving its original chapters and adding additional chapters to contextualize it to modern times. If you listen to many of Warren Buffet advice you will see that this is the book that most influenced his life, together with Security Analysis.

The above books are useful to get you started with the technical and theoretical skills needed to be a good analyst. But if you are like me and want to also have an overall understanding of how the financial world works we have to dig deeper.

Three Books That Can Boost Your Understanding of the Financial World

Here I want to suggest you three books that can give you a deeper understanding on how we got to live in today’s financial world. In fact, these books will give you an historical excursus and also a wider outlook on how the financial world works:

The Ascent of Money: A Financial History of the World, by Niall Ferguson. This book is by far one of my favorites when it comes to financial history. You will discover how our modern banking system was created, how the bond market started, when the first bubble took place, until the development of what the author calls “Chimerica.”
Antifragile: Things That Gain from Disorder (Incerto), Nassim Nicholas Taleb. In this original book, the author introduced you to a new form of thinking. This book is part of a trilogy, called “Incerto” of which are also part “The Black Swan” and “Fooled by Randomness.” Although, the other two books are extremely interesting and they also prepare you for a better understanding of “Antifragile” you can still read it alone and still have a great understanding. Taleb introduced you to new concepts and to think in a more critical way. For instance, he tells us how the modern systems although they are gaining in complexity, they are also gaining in fragility. Meaning that an unpredictable event will swipe them out. To never take for granted what other say you have to read this book
When Genius Failed: The Rise and Fall of Long-Term Capital Management, by Roger Lowenstein. There are times in which large financial institution based on wrong beliefs can almost make the system collapse. LTCM (Long-Term Capital Management) was one of these cases. In fact, LTCM was a speculative fund and one of its partners was Nobel laureate, Myron Scholes. I really suggest you read the detailed account of this great failure of financial history, which can teach you much more than any other success.

Three Short Manuals – From Scratch to Professional Level

Most of the times what makes finance hard to learn and understand is the useless jargon used in manuals, which are too technical. The Four-Week MBA produced three short manuals with the aim to get you started with financial analysis. With an extremely low investment of money and time you will be introduced to the most important topics related to financial analysis:

Financial Accounting Simplified Manual
Corporate Finance – The Toolbox for The Financial Manager
Fundamental Analysis – Simplified Manual: Simplified Manual to Understanding Fundamental Analysis

Three Documentaries to Watch

If you have more time to invest, you may want to consider to watch these documentaries:

The Ascent of Money. This follows the same story from the book and Niall Ferguson directly hosts it. It lasts over four hours but it is worth the investment.
Inside Job. To have a detailed account of the financial crisis of 2008.
Chasing Madoff. The Madoff fraud was by far the greatest of all times. He was able to create a $50 Billion Ponzi scheme. The documentary shows how he was able to do so and how he was eventually caught.

There Is Not Better Way to Learn Than to Practice

Theory is a huge part of the training for a financial analyst, then of course practice kicks in. if you want to dirt your hands you can open a demo account at this link Oanda Demo Account to get you started with trading.

Some other tools useful to make some nice analyses and research:

Google Stock Screener. This tool allows searching for any listed stock in several markets. In addition, you can also customize your search very easily. For instance, you can decide to look for all company that have a certain market cap, ROI, and so on. Start playing along with it to become familiar with some stocks you may find more interesting.
Gurufocus. This platform is very interesting, since it allows you to see how the gurus invest their money.
Economagic. Great platform also, it allows you to get macroeconomic data of any kind (very suited if you operate in US). Further in the excel section you will find data already available in excel, ready for download.

Summary and Conclusions

As we saw in this article, getting started with financial analysis is a very committing task. On the other hand, financial analysis can be very fun and rewarding job. Further, if you are someone already passionate about financial markets and business in general you may be lucky enough to make of this job your profession. I apologize for the length of the article, but I really tried to suggest the best resources available to give momentum to your training.

In addition, this website also provides free resources to get you started with financial statement analysis and finance in general. Don’t lose the chance to also download our free resources here.

Any comment on the topic would be highly appreciated. If you found that other topics also deserve to be covered, let me know in the comments below. Please understand that I really would love to give you the best information you can find on the web. On the other hand, I cannot afford to invest time and effort in producing resources that you may not find useful. Therefore, if there is any particular topic that concerns you, don’t hesitate to let us know at fourweekmba@gmail.com

Good luck with your job search!

16 Business Terms Any Finance Professional Should Be Aware Of

10K Report

It’s a statement to be submitted each year according to U.S. SEC regulations. It needs to be submitted within 90 days of the end of the fiscal year. This statement/form is a detailed account of all the information related to the company, which submitted it. The 10K report usually contains information related to business and financial profile of the organization. In addition, you will find also corporate governance information and managers’ compensations. This is the main report, which the analyst will consult to extract financial information to perform an analysis. (learn how to read a 10k reports from Fundamental Analysis – Simplified Manual: Simplified Manual to Understanding Fundamental Analysis)

Accrual Method

Accounting method for which sales and expenses must be recorded when occurred. This means that each time a customer buys an item, even though on credit, the sale must be recorded. Therefore, independently from cash disbursement the transaction will be recorded on the accounting books. This method is mandatory for company, following the SEC regulations. On the other hand, some companies are allowed to use the cash method as well. (learn more about financial accounting through Financial Accounting Simplified Manual)

Assets

Any organization has resources at its disposal that can be used for operational purposes. Those resources are called assets. In finance lingo, assets are displayed on the balance sheet. They can be classified in current and non current. The former are the ones, which will be converted into cash within one year. The latter are the ones, which will be on the balance sheet for few years. In addition, current asset are usually listed on the balance sheet according to their degree of liquidity. Therefore, we will find on the balance sheet the following items: cash, cash equivalents, short-term marketable securities, account receivable, inventory and prepaid expenses. The non-current assets (also called fixed assets) can be tangible or intangible. The former are physical things, such as plant and equipment. The latter are intangible things, like licenses or patents, which will have a life of few years as well. While, tangible assets are depreciated, non-tangible assets are amortized.(learn more about financial accounting through Financial Accounting Simplified Manual)

Backward Integration

In the business world the supply chain is the set of processes a product has to go through before and after it is sold. For instance, a tomato sauce before it gets sold in the supermarket needs to be packaged. Before packaging comes production. Before production comes growing and farming the product. All these steps are crucial to make the product available to customers. When a company controls all the processes (like in our example), from farming to end customers, this is called vertical integration. When a company decides to move backward in the supply chain, this is called backward integration. For instance, Starbucks, which is a coffee chain, sells its products directly to its end customers. On the other hand, Starbucks also bought some farms were the coffee is produced; therefore Starbucks used backward integration to reduce its costs related to purchasing; but also to guarantee an higher quality of the final product.

Bear Market

Financial markets are in an eternal fight to reach the point of equilibrium. In short, each time demand and offer agree on the value to be given to a certain asset or stock, that is when a price forms. Therefore, in the market there are buyers and sellers. The former have an optimistic outlook, and the latter a negative or pessimistic outlook. When sellers dominate, a bear market forms.

Beta

In corporate finance, understanding risk is crucial. But how can we define risk? This can be defined as the amount of reward to expect for each level of risk undertaken. In other words, if I take on more risk I also expect a higher return and vice-versa. The objective of corporate finance is to quantify the risk and also the expected return. How to measure it? Thru CAPM (Capital Asset Pricing Model) the main measure of risk is Beta. Beta tells you the specific risk of a company stock in comparison to the market portfolio. In short, the Beta tells you of how many units will a particular stock move in comparison to the market portfolio. For instance, a Beta of 2 means that the stock is more volatile compared to the market portfolio. In other words, a swing of the market portfolio would result in a much greater swing of the stock with a high Beta. The Beta is the main component of the CAPM, which helps us in assessing the cost of equity (expected return for a certain investment). This means that a higher Beta will also result in a higher cost of equity. Of course this works in theory. Although Beta is one of the most used measures of risk this is based on historical value of the stocks. We learned in the last years that future cannot be predicted based on the assumptions of the past. Therefore, this measure may work in “normal times” but be useless during “abnormal times.” (Learn more about corporate finance through Corporate Finance – The Toolbox for The Financial Manager)

Black Swan Event

Before the first black swan was discovered, in Australia, it was believed that black swans did not exist. This means that a single event (a black swan) can swipe out all the empirical evidences found until a certain point in time. This leads up to the thanksgiving turkey problem. The turkey, which was fed for 1000 days, made a reliable assumption based on a fair number of observations that it would have always worked in that way. Until, Thanksgiving Day comes and the turkey is slaughtered and eaten. Nicolas Nassim Taleb brings up these two examples, which in his book “The Black Swan” opened up the road to better understand randomness and the limits of empiricism.

Blue Ocean Strategy

How does a blue ocean look like? Imagine first a red ocean; plenty of sharks, which try to compete for each single fish in that water; blindly fighting against each other for a small piece of food. In such a scenario, many sharks will die, and few will survive. Imagine, instead an open blue ocean unexplored by other sharks. The shark, which has the courage and ability to find that new ocean, will enjoy unlimited resources. What is the most successful example of Blue Ocean Strategy? Only few years ago, I-Phone and I-Pad did not exist in the mind of consumers. Apple came out with these products. Therefore, Apple was successful in convincing consumers that those new products would have filled a real need they had. Although that need didn’t exist few months before. This is one of the most sublime examples of Blue Ocean Strategy.

Bull Market

Financial markets are in an eternal fight to reach the point of equilibrium. In short, each time demand and offer agree on the value to be given to a certain asset or stock, that is when a price forms. Therefore, in the market there are buyers and sellers. The former have an optimistic outlook, and the latter a negative or pessimistic outlook. When buyers dominate on sellers that is when a bull market forms.

Call Option

An option is a financial instrument that gives the right to its holder to buy or sell a stock or asset at a determined price. The option’s holder has the right and not obligation to buy or sell that stock. When the option’s holder bought the right to buy the stock after a certain date, then he bought a call option. For instance, you can buy 10 call options at $1 each for a stock worth $10. Therefore you spent $10 total. In one month this stock rises at $12. You exercise your right to buy 10 stocks, worth $12 but you will pay just $10. This means that you will own now 10 stocks worth $120, but you paid $100 $10 = $110. In conclusion you made $10 profit ($120 – $110). (Learn more about financial options through Option Basics: Simplified Manual for Understanding Financial Options)

CAM in Real Estate

In commercial real estate, CAM or common area maintenance are expenses incurred by the landlord on common areas (such as landscaping, parking lot, utilities and so on). Those will eventually be reimbursed by the tenant based on its pro-rata share of square meters in comparison to the overall commercial building. For instance, a tenant, who occupies 1,000SF on a commercial area of 10,000SF, will pay 10% of the total common area maintenance; if stated in its lease, otherwise the tenant will be not responsible for that. Why is this so important? CAM is crucial for both tenant and landlord. For the former it is important to understand the hidden expenses resulting from a lease. For the landlord, it is important to quantify common area expenses, to determine the amount to ask as reimbursement to the tenant. For instance, there are two main categories or leases: Gross and Net. According to the lease stipulated the CAM expenses could change a great deal for the tenant. In turn, the CAM reimbursement will grow substantially for the landlord if contracted one lease or the other. (Learn more about commercial real estate through Fast Tenant’s Guide to Understanding Commercial Lease Agreements)

Carry Trade

Before we get to the meaning of this exotic term let me answer the following questions: what is a central bank? What does it do? And what are the tools available to it? First, the central bank is an institution, which objective is to “stabilize” the economy and therefore financial markets. How? Central banks have different tools to achieve this objective. The two most powerful instruments are interest rates and money printing. For the sake of understanding carry trade, we are going to focus on the former, “interest rates.” In fact, when the economy slows down, usually central banks tend to lower interest rates, to allow the economy to recover and stabilize. Instead, when there is too much “exuberance,” prices of assets and commodities tend to rush, by creating what economists call “inflation.” To avoid such scenario central bankers tend to increase interest rates. Not all central banks have the same approach and not all central banks face the same economical scenario. Therefore, you will have countries in which the interest rate is 5% and other countries where the interest rates are between 1-2%. Speculators take advantage of such arbitrage opportunities. How? Thru carry trade. In fact, they borrow money in countries where interest rates are lower and invest in countries where interest rates are higher. For instance, in Japan interest rates are close to zero. Therefore, you will borrow money in yen (Japanese currency) and invest in euro, where interest rates are higher.

Cash Flow Statement

Benjamin Franklin used to say, “Cash is king.” This holds true in business and finance. For such reason, while balance sheet and income statements give a certain profile of the business; the cash flow statement tells whether a business is making enough cash to survive and thrive. In fact, the cash flow statement can be obtained by adjusting the income statement to reflect all the non-cash items that are included into it. Therefore, this statement, which has three sections: operating, investing, and financing are going to tell us where the cash is coming from. Therefore, if you are a manager you will focus more on cash flow from operations. If you are an investor you will focus more on cash flow from investing. And if you are a banker you will focus more on cash flow from financing.(learn more about financial accounting through Financial Accounting Simplified Manual)

FED Bank

The Federal Reserve Bank is the U.S. central bank. The central bank main role is to stabilize the economy through three main tools: discount rate, open-market operations, and by controlling the reserve requirements of institutions. The FED uses discount rates to affect the economy. For instance, lower interest rates imply a less positive outlook for the economy, while higher interest rate will be used to slow down inflation, when the economy is in good health. In the open-market operations the FED indirectly controls interest rates. In fact, by buying U.S. bonds, the FED will influence the price and interest of these securities, and this de facto influences the economy. In the third case, the FED makes sure that banks and financial institutions hold reserves, or funds. For instance, although banks receive billion of dollars in deposits, if they could they would lend 100% of this money, to maximize their profits and also avoid costs associated with keeping money into their vaults. Therefore, the FED determines the % amount of deposited funds to keep as reserves, for emergency situations.(Learn more about corporate finance through Corporate Finance – The Toolbox for The Financial Manager)

Pareto Principle

Wilfred Pareto was an Italian economist (he actually was a polymath) that lived across the 19th and 20th century. At the end of the 19th century Pareto found out that most of the wealth of the population was in the hands of few. This observation became the 80/20 principle, which states that 80% of the effects is given by 20% of the causes. The 80/20 is just indicative and there are phenomena, which go beyond the 80/20. For instance, new observations show that 0.1% of U.S. population owns 22% of the household income. The Pareto principle can be extended to any other field, and why not, also personal life. What is that 20% of your daily activities that gives you the 80% of joy and happiness?

Pecking Order

The pecking order theory was first formulated outside finance and it related to the social hierarchy existing in the animal world. This theory was reformulated to fit the finance world. In short, the pecking order states that a company can finance itself through three main sources, internal funds, debt issuance and new equity issuance. Managers based on the necessity of the organization pick those three. In normal conditions, the firm will finance itself through internal funds or debt. As last resort the company would use equity. The reason stands in the fact that there is asymmetry of information. Managers know more about the company, that external investors do. Therefore, if managers “pick” new equity as finance option, it means that they believe the stock to be overpriced. Instead, when the management is positive about the value of the firm, they will issue debt or use internal funds.

Consult our professional manuals here.

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How to Avoid Hidden Expenses in a Commercial Lease Agreement

Common area maintenance is a set of expenses (landscaping, parking lot, lighting, electricity, insurance, property taxes and so on) that the Landlord anticipates to keep the common areas (the areas shared by all tenants) in good condition.

These expenses are usually incurred by the Landlord as a sort of service in favor of the tenants. In fact, if the property were vacant there would be no reason for the landlord to guarantee any service on it. That is why property owners usually ask Tenants to pay back for these expenses.

Usually the Landlord assesses CAM expenses on a monthly, quarterly, or yearly basis, it really depends by what the lease states, in the section related to CAM, also called Operating Expense section.

Let me clarify the difference between CAM actual and CAM estimates. In fact, those are not the same thing. CAM estimates are monthly estimates, billed to the tenant each month. CAM actual instead, are expenses incurred by the property owner each year.

At the end of the year, the Landlord will compare the actual expenses with the estimates. If the estimates paid by the tenant are higher than the CAM actual, then the Landlord will issue a refund to the tenant. In the opposite scenario, if the actual expenses are higher than the estimates, the Landlord will issue an invoice to the Tenant, which will pay within 30, 60, or usually 90 days, depending on what the lease states.

The amount to reimburse will be assessed according to the tenant’s pro-rata share (Sq. Footage of premise over total square footage of commercial area). Usually, this information is reported in the first page of the commercial lease and it is expressed as percentage.

Case Study

For instance, if you rent a premise of 100 sf. on a commercial area of 1,000 sf., your share will be 10% (100/1,000). Therefore, if the Landlord incurred total CAM or operating expenses (different words to mean the same thing) for $1,000 your chargeable amount should be $100.

Assuming that you paid $5 per month of CAM estimates, on a yearly basis it corresponds to $60 ($5*12 months).

In conclusion, you still owe $40 to the Landlord ($100 – $60). The Landlord will issue an invoice that must have the detail of all expenses incurred in that same year for CAM and how your share was computed.

In fact, even though you must pay within 30, 60 or 90 (according to the lease agreement) you still have the right to perform a due diligence of the CAM charged by the Landlord, which must keep the record of it…

The above case study was a simplification. In fact, the way the CAM expenses are computed depends by the kind of lease you signed (Gross or Net and so on) and what the lease states.

To know more about Commercial Lease Agreements check out the following articles:

Introduction To Commercial Lease Agreements | Real Estate Essentials

How to deal with Common Area Maintenance (CAM) – a fast guide for Landlord and Tenant

Or you can get the e-book: Fast Tenant’s Guide to Understanding Commercial Lease Agreements: Learn the most important aspects of a commercial lease (Simplified Real Estate Guide Book 1) (English Edition) eBook: Gennaro Cuofano: Amazon.it: Kindle Store