Financials Demystified: Long Term Liabilities Explained

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3:58They actually got me into reading stats for anything. You're tuned in to the Investing for Beginners podcast. Led by Andrew Sather and Dave Ahern. Step-by-step premium investing guidance for beginners. Your path to financial freedom starts now. Starts now. All right, folks. Welcome to Investing for Beginners podcast. Today, we're going to continue our journey through financials demystified. and we are going to continue our fun little conversation about the balance sheet. Today, we're going to talk about long-term liabilities. Yes, turn up the radio. It's going to be a lot of fun. It's counting, but it's going to be done well.

4:40But before we dive in today, we'd love to hear from you. So we're running a listener survey and everyone who participates will get entered into a raffle for a$500 Amazon gift card. Hello, Christmas presents. plus the first 100 people to respond will receive a free investing for beginners coffee cup and coaster set super cool head over to investingforbeginners.com slash pod survey that's also in the show notes your feedback will help us make the show better so we'd appreciate you taking a few minutes to share your thought again that's investingforbeginners.com slash pod survey must be 18 or older to apply and other conditions will apply as well So with that, let's go ahead and dive into long-term liabilities.

5:26So take it away, Sir Andrew. Okay. So not too many to cover, which is, I think, a relief for most of us out there. Should I start on debt or should I start on lease liabilities? Which one do we prefer? Let's do lease liabilities first because debt has lots of layers of the onion we can peel. Yes, it certainly does. Okay, so I pulled up a company called Texas Roadhouse, one that both Dave and I own, just to pull up their balance sheet and to look at some of their long-term liabilities. So for Texas Roadhouse, they have operating lease liabilities. And first off, hold on. Let me just slow it down for two seconds.

6:09Beginner's show. I got too into our whole series here. but a balance sheet is a measure of a company's assets and their liabilities. What do they own and what do they owe? And so on the balance sheet, they split it into four pieces. You have current assets at the top, long-term assets in the middle, current liabilities at the top, and long-term liabilities at the bottom. And all that is is just long-term liabilities is anything longer than one year. So these line items are going to be from the long-term liabilities portion. So for Texas Roadhouse, operating lease liabilities, they have restricted stock in our deposits, deferred tax liabilities, which will be your lane that we're going to drive down, and then other liabilities.

6:56So the thing with accounting and with businesses, there's just a wide range of types of businesses, right? There's so many different ways to make money, so many different ways that companies need to spend money to make money and spend to have their operations and keep the lights on and all of those things. So we don't want to get too bogged down in the minutia of, oh man, there's just, I don't know what this means or I don't know what that means. There will be a few common line items you will see across many companies. So those will be the only ones we'll focus on today. the one for Texas Roadhouse, I kind of hinted on last series of this, but operating lease liabilities.

7:41So companies, when they open a restaurant or open a store, they have the option whether do you want to own the building or do you want to lease the building? So operating lease liabilities is going to add up all of the various leases they have on their restaurants, and it's going to add it up and there'll be a total number. And so we know if I want to invest in Texas Roadhouse, for example, I can pull up the balance sheet and I see, okay, about 800 million in operating lease liabilities. Is that a lot? Is that a little? I don't know. So you always want context, right? Well, what kind of profit are they at?

8:16Okay, 450 million, give or take. All right. So now I know we're not talking about a trillion dollars versus a million dollars. We're talking about numbers that kind of make sense. So that can be the first step to making sense of the numbers is if you put it in context with other numbers on the income statement, the cash flow statement. It's not going to give you a perfect answer, but it at least gets you started on starting to understand and be fluent in this language. Yeah. Yeah. And it's important to understand, especially when you're talking about a company like Texas Roadhouse, because it is a cost of them doing business.

8:56And so you do need to understand how much they have to pay in rent, for example, to occupy the space that they're using. and if I remember right companies like they and chipotle will tell you how many stores they have so you should be able to get a rough estimate of how much they're paying per store for that as well as you could also compare that to the revenue as well if you really want to get in the nitty-gritty you could take the total number of stores and divide that the revenue by that to get a number per store and then do the same thing with the operating lease liabilities to get an idea of how much they're paying in rent.

9:36And then that could give you a pretty good idea of what kind of profit they're playing with to pay for things like employees and food and other utilities and things of that nature. So it can give you a really good idea of how profitable the business could be because this is something they have to pay for. So it isn't a wish list or a want, it's a have to. And so if you're trying to figure out the business economics of each store, that's a good place to start is looking at something like that. And it could be very helpful to give you a sense of, okay, how much does it cost to run the store? How much revenue does each store make?

10:17And so when they tell you, we're going to put up two new stores, you can kind of sort of get an idea of the economics of each store as they put it up. Not every store is going to be the same, depending on the size of the store and the location of the store. Those will have bearings on what kind of revenues they do as well. But this can put you in the ballpark to get a general sense of what kind of revenue and what kind of profit the company should generate from each new store. So if they open 10 new stores and they are averaging$2.5 billion from each store, then 10 stores should translate to$25 billion.

10:55So I'm just using rough numbers here. So don't hold my feet to the fire on that. But that's how I would approach looking at that. When I look at those numbers, depending on the business, it can be very helpful. I love that, especially if, let's say we were to do it for Texas Roadhouse. You could compare that to like a Longhorn Steakhouse, or you could compare that to like a Bloomin' Brands. and just try to get a sense for what's the difference between this concept and that concept. And if you want extra credit, you can dive into the financial statements of REITs and you can actually see on a per, sometimes depending on how small the companies are, on a per unit basis.

11:38One other thing I want to throw out there, if you are just dying to find use cases for blind items in the financial statements, and I'm probably the one person in this entire planet who would do something like that, I would say you can look at the footnotes. So Control-F has always been our friend. That allows you to search within an annual report, financial statement. And you can search for lease liabilities, for example, and read through the footnotes. So for Roadhouse, they mentioned that... I kind of found this interesting, But they mentioned the breakdown because they say that the lease liabilities are split between the real estate and the equipment.

12:24So you can kind of look. And for Row House, it's vast majority is real estate and only a tiny bit is equipment. But I would imagine for a company that's maybe more equipment heavy, like a trucking company or something like that, it would be flipped. So that can give you a sense to, okay,$123 million versus$3 million. And even though it might be fun to go up to a former restaurant manager and say, hey, what kind of restaurant equipment do you guys buy? And how does that help you run your business? You can look at the numbers and say, well, maybe I don't focus my time on the equipment. Maybe I look on the actual land value and try to get a determination based on that.

13:05So getting as much context as you can, I think, helps you narrow your research process. Sure. For sure. And each business that you look at is going to have different aspects of it that you're going to need to focus on more than others. And restaurants are certainly their own kind of beast, if you will. And so understanding the different line items and how they impact the financials and the capital decisions that not only the company makes, but on a store level, the decisions that they'll make. Because equipment is important. and if your ice machine breaks or your dishwasher breaks on a Saturday night, because they only break on Fridays and Saturdays.

13:45If you didn't know that, that is the rule. They only break on Fridays and Saturdays and on busy holiday days or weekends. That's the only time that those break. And so the poor people that work for companies like Centos that you buy that equipment from, they will come out and fix that for you so you feel for those people because they have to come enjoy the holidays or the weekends with you fixing a dishwasher on a saturday night that is lots and lots of fun can you while we're on this can you throw a few metrics line items that you would focus on if somebody's interested in like a texas roadhouse or chipotle or mcdonald's what is the first step for somebody wading into that industry I think probably the first two things I would look at, well, three things, would be revenue, obviously.

14:40I would also look at the two main costs. So these are not balance sheet related, so I'm going to go off topic here for a moment. But the first two you're going to want to look at is you're going to want to look at the labor costs. How much does it cost the company to generate that revenue from the labor? and some restaurants, some companies will break it out such that you can see the difference between the front of the house and the back of the house. And that will have a certain bearing on it as well. And then the other line item is how much does the food cost? What is the food cost compared to the revenue?

15:18And generally the lower, the better, the more profit you can make from those companies. And that is where you'll start to see where the rubber meets the road. and generally you want to see it depends a little bit on the industry. So fast food might have a little bit higher labor costs than maybe a company like Texas Roadhouse because they have higher ticket items. And so they'll have things that are higher profit on their menu that will help drive that number down. So when you're looking at those numbers, it's all fine and dandy to look at them in absentia. Just like Solo, it would be much better to look at them in contacts with other companies.

16:04So for example, if you're looking at Texas Roadhouse, it's fine to look at them on their own and compare them over a long period of time. That'd be great. But you also want to compare them to companies that are similar to them, like Intervention, Longhorn, Steakhouse. you'd want to see what their food cost is and what their labor cost is compared to Texas Roadhouse because that'll give you a comparison on whether Texas Roadhouse is doing a good job of managing those. Those are the two biggest costs that all restaurants face, whether it's McDonald's, Chipotle, or Texas Roadhouse, or Capitol Grill.

16:36Those are the biggest two costs that they're going to face and how well the company or the management handles those will go a long ways towards how profitable the business is. Because if they can't price the food correctly, then they're not going to make enough profit. I'm looking at you, Sweet Green. So that is one of their big problems. So those are the three things you would look at first. Is your wardrobe well-stocked for the upcoming season change? I'm recording and it's the first warm day we've had in a while. And I'm realizing my wardrobe isn't as robust as it should be. So I went to Quince and got myself a three-pack of 100 % Pima cotton tees.

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19:40Check it out at einvestingforbeginners.com slash 60. Well, I'm glad you moved the conversation from steak to salad because I was getting really hungry and then you kind of fixed that for me. So appreciate you. You're welcome. I'm here. I'm here to help. I'm here to help. What do we got next? Let's look at everybody's favorite topic and let's talk about taxes. so everybody loves to pay taxes everybody loves to talk about taxes uh i'm of course saying that a hundred percent in jest but when we're looking at companies we they have to pay taxes too and so we need to understand how their tax situation works and what kind of taxes they owe So under long-term liabilities, you will see one of two or both, sometimes not.

20:32Every company will be a little bit different on how they report this, whether it's in the actual balance sheet or whether you have to look in the notes of the business to get more details. But for the company I was looking at, which was Microsoft, I like to use Microsoft as an example because they generally have fairly clean financials and they're easier to understand. So they have two light items on their balance sheet that focus on taxes. One is deferred taxes and the other is long-term taxes. And you're probably asking yourself, well, isn't deferred? Doesn't that mean long-term? And yeah, it is confusing.

21:11And the main difference is the easiest way is deferred taxes really refer to the timing of when the taxes are going to be paid. And long-term taxes are actual obligations, whether they're real or not, that extend beyond one year. So I'll go a little bit deeper on that. So deferred taxes, for example, is a line item that Microsoft reports. And basically what happens is they recognize revenue or expenses differently depending on the time of the year. A balance sheet, when we look at it as a snapshot in one day of where the business is in that particular day. And because of that, accounting-wise, they may or may not have recognized revenue or tax liabilities at that particular time, and they will owe them.

22:04And so what they'll do is they'll put those differences, if you will, in deferred taxes as a means of resolving at some point in the next year or so, depending on the timing of when those liabilities are due. Long-term taxes on the balance sheet typically refer to uncertain tax positions or unrecognized tax benefits. So basically what that means is they may have ongoing tax disputes with the IRS. So us individuals are not the only people that don't always get along with the IRS. Corporations will have competitions with them as well. Sometimes Microsoft may take tax positions that may or may not be challenged.

22:52Because the company is international, they have foreign earnings. and so maybe they haven't repatriated those earnings from France. And so because they haven't done that, they owe taxes on that money. And so that has to be resolved. Or they may have a multi-year tax plan. Maybe they had a tax liability that took a few years to resolve with the IRS. And so they have a payment plan to settle that. And all those different things will get lumped into what's called long-term taxes. Now, one of the things that makes it a little more interesting for Microsoft is because they are a multinational company.

23:31So they do business all over the world and different countries around the world have different tax structures and the timing of when those taxes have to be calculated and paid. And so Microsoft may carry from time to time bigger long-term tax liabilities depending on those situations. And so it is a number you want to be aware of and understand what goes into it. And again, Control-F is going to be your friend. You can go to Control-F and you can find more specifics on what exactly these different tax liabilities may be on their balance sheet and how the company is planning on dealing with those.

24:09Yes, it is not the most exciting part of the balance sheet by any stretch of the imagination, but depending on the number, it could be something worth looking into. If it's a smaller number compared to the overall assets and liabilities of the company, you could give it a cursory glance. But if it's a third of their liabilities or half of their liabilities, you probably want to get to the bottom of that and figure out how that could impact the business. Because that could translate into the income statement, which will impact the earnings, which will impact the valuation of the company. And Wall Street does not like those kinds of things.

24:43So that's where kind of doing your due diligence and at least understanding what goes into it can be helpful. That was good. So just to recap, and hopefully let me know if I'm incorrect here, but basically if in the first instance we're talking about lease liabilities, you can use that as a comparison ratio. You're talking about deferred taxes more like a red flag checker, like either things look kosher or they don't. Cool. Perfect. Yeah, I think that's a great way to look at it for sure. similar that's how i always did it as well all right let's start to peel the onion now on debt we we teased on that this is the air quote sexy part of long-term liability so let's maybe start to peel the onion on long-term debt yeah um all right pulling up a company called danaher also a company we own we own all three it's interesting to look at companies where they use debt strategically there's all sorts of reasons why people and companies can use debt some of the less ideal things I mean I don't have to call out names we all see it when we see it and the problem with when a company does a huge acquisition and they might borrow Let's say their balance sheet's like$400 billion and they borrow$100 billion just to do one acquisition.

26:22That can absolutely tank their balance sheet for years. And there was a company that did something similar to that, and it was not pretty. So we try to look for businesses where that long-term debt is not a big portion of the balance sheet. That's really, I mean, you could kind of just sum it all up there, but that would be no fun. And let's continue dragging this along. So what's interesting, another thing to look at long-term debt. So obviously you want to look at the numbers and we'll share some metrics too, but not only can you look at the total aggregate number, but you can also look at how it's staggered.

27:01I think the correct term is technically lathered. Does that sound? Yeah, cool. I'm straightening my tie as I say it. you want the debt to be lathered. So what that means is rather than having the debt all due in one year, which can cause you the default, which companies have defaulted from balloon principle due, you can stagger it. So if you pull up Danaher and you look at the footnotes, they have two sets of notes in 2024. one for 2025, two for 2026, two for 2027. So it's like, even though the number is big, 15 billion, if it's only a billion or two per year, then that's really, really small for a company of their size, a$60 billion balance sheet.

27:55So already the numbers were pretty decently small. And one of the reasons we bring this up is they do use debt sometimes to finance acquisitions. Acquisitions are a huge piece of their business. and it's a fascinating business to look into. If you're interested in Berkshire Hathaway, you should check out Danaher because there's just really great capital allocators at that company. But I thought this was interesting, so we're going to play a little Jeopardy here for you. Okay, so Danaher had these 1.3 billion that they borrowed in a special euro note. so first off like what if if uh if a company was borrowing out to 2028 let's say they did like a 10-year thing what kind of an interest rate would you feel like would be a good one um probably i mean in this day and age i i would say anything less than five percent maybe four percent less than four percent yeah so what i find interesting so so guess this one it's 1.3 billion.