ShmoopTube

00:00

principles of finance. a la shmoop. simplified Lemonade Stand. alright people

00:07

time to simplify simplify and yet Thoreau still has nothing on us. all [old man in the woods]

00:11

right well let's go back to our little lemonade stand and drill into some of

00:14

the more difficult elements of the income statement. the income statement

00:19

right here this thing read through it and you're skimming reading are you

00:22

paying attention good. okay so let's think about when our big question here

00:26

is easy. when are revenues revenues? all right. that's also from Jeopardy. well

00:31

when a customer stands at your stand and pays you the dollar for their lemonade

00:35

and they drink it they say boy howdy that was good. and they walk away well

00:39

that constitutes a clean sale. we're gonna assume that thirty minutes later [kid sells lemonade]

00:43

they aren't throwing up from food poisoning and then coming back to sue

00:47

you. and even if they did while the cost of defending yourself wouldn't be a

00:50

revenue item on the income statement, it would be in a new category you just

00:55

realized you need legal and insurance or something like that.

00:58

so clean sale makes for clean revenues. well when are they dirty?

01:01

well revenues are dirty when a sale may or may not happen. that is there isn't

01:06

certainty of revenues, but when is there really certainty? well you could posit

01:11

that when cash goes into your Bank of America coffers, that's a sale. but what

01:15

if there's a three-month money-back guarantee attached to it? don't you have

01:18

to reserve some amount of money for the number of people who will exercise their

01:23

right to that money-back guarantee? how do you do that ?well in the beginning

01:27

you really have no history so you essentially make all revenues deferred.

01:32

and yep that's a new category. and as soon as the 90 days are up then you can [deferred revenue defined]

01:36

call them revenues. but over time if you have one percent of your revenues pretty

01:39

steadily being redeemed for the money-back guarantee, well then you can

01:42

start to reserve way less than the hundred percent you started with. and

01:46

it's rational that in a given month if you took in a million dollars that you

01:50

reserve and at ten thousand dollars for that kind of guarantee. well why would

01:54

you have started with a hundred percent reserves? one word yeah GAAP we whispered.

01:58

it art we'll say it loud. loud GAAP. and not the Levi's store people. the religion

02:02

of GAAP tells you that you must do the most rationally conservative thing that

02:07

you can do when accounting for money. and since you were just starting a business

02:11

you had no idea if the product was going end up being a defective clunker or [cash counted on many screens]

02:16

something really good, where 1% or less was ever redeemed. okay so that's

02:20

deferred revenues. and what about the credit card issue here? well we noted

02:24

earlier that credit card companies take a fair chunk out of your purchases. in

02:29

this made-up example of nothingness, let's say the credit card companies take

02:33

3 percent of sales. well on a million dollars, you pay them 30 grand. and you

02:37

keep $970,000. would you book revenues as a million dollars or is

02:43

970,000? answer 1 million. why ?well this isn't the most conservative so why

02:49

wouldn't you claim revenues at just 970,000 instead of goosing them up to be

02:55

a million. because credit cards are a very common way of doing business. in

02:59

theory everyone in your industry uses them and it's fair to assume that a very

03:04

large part of say a bicycle shops revenues will be paid via credit card. [graphic showing many pay with credit card]

03:08

when standard practice dictates a certain set of costs that are common to

03:12

an industry you adopt the most common methods of accounting in that industry.

03:17

all right now here's another twist. what if revenues are suspect or iffy or

03:21

uncertain of being paid. imagine your rep providing lemonade to the Super bowl. well

03:26

if there's a risk that you won't in fact be paid for your million cups of

03:31

lemonade you know from those deadbeats at the NFL. should you still book the

03:35

million dollars promised you as revenues? no of course not. you do still suffer the

03:40

expenses of having had to produce and deliver the lemonade however and you are

03:44

still liable if people get sick from it even if you never get paid by the NFL [lemonade in a glass]

03:50

people. well maybe think about that when you negotiate your contract, ie that they

03:54

pay you X percent up front so that if they renege on the deal you've at least

03:59

collected enough cash upfront to cover your cups and a little bit more. well the

04:03

hard part here is figuring out what to deduct for risk of non-payment. is the

04:08

NFL going bankrupt anytime soon? well not bloody likely. do they have a history of

04:13

not paying their vendor bills? no will they claim non performance on your part

04:18

ie that you didn't actually deliver the million cups of lemonade? also not likely.

04:23

it had a lot of that on Camera now. well do they have a history of

04:25

sub charging you, that is claiming that the cups you brought left a mess on the

04:31

floor and now they had to clean up the sticky mess and deal with the ants, so [trash on the ground]

04:35

instead of paying you the million bucks you thought they would now they're gonna

04:39

deduct 50 grand for cleanup and just pay you 950 K .all right well all these

04:43

factors play into how you calculate revenues. no hard and fast numbers are

04:48

embedded here you just need to demonstrate that you thought about this

04:51

rationally. why would someone want to state revenues as being really low and

04:56

the regulator is not be okay with that? because you're being super conservative

04:59

here right? well revenues being stated as overly conservatively low have a big

05:04

effect on one particular line item on the income statement all else being held

05:08

equal. want to guess which one rhymes with sh max's. yeah if you had

05:12

expenses of 400 grand in revenues a million dollars long you'd have pre-tax

05:16

profits of 600 grand and pay your 30 percent tax or whatever the number is in [equation]

05:20

your state, and country and so on of $180,000 thirty percent on a 600 yeah

05:24

that's how we got there, to net 420 grand in earnings. but if you somehow came up

05:29

with a rental guarantee on the lemonade with the notion being that then well

05:34

nobody really buys lemonade they rent it, right? and then you were somehow able to

05:39

defer those revenues to be recognized some years later well then maybe you can

05:44

show only 500 grand of revenues instead of that million this year. you still have

05:48

the four hundred thousand bucks in expenses, nothing else changed here ,not

05:52

even sales commissions to your reps, so you'd show just a hundred grand in

05:55

profits, pay your 30 percent tax and you'll have paid 30 grand in taxes

05:59

instead of a hundred 80 grand you paid before .key idea here you still collected [equation]

06:04

the full million dollars in revenues it's just sitting in your bank account.

06:07

you're just not recognizing it yet as clean revenues .yes it's accounting

06:13

chicanery book cooking and other falsities when

06:16

you go to these fake extents to be conservative. and if you do find yourself

06:20

being encouraged by your CEO or whoever to do your accounting like this either

06:25

consult glassdoor.com fast or think about whether or not your body looks

06:30

good doing stripes. yeah they're slimming. [boy behind bars in black and white stripes]

Full Transcript