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principles of Finance a la shmoop. income statements, margin operating

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profits and more. all right so we're still following the sauce company. let's [projector screen]

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roll the clock forward so tree grows another ring. all right well the first

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year goes gangbusters for the sauce company. the company was able to lease a

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bottling facility which they came to call their own. Reed, through his contacts

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in the banking industry helped Artie and Bernie secure trade credit, meaning the [trade document]

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loans from suppliers. the various supplies oils onions garlic brown sugar

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and a secret greenish powder are all kept under tight lock and key. the

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packaging is approved by Bubbe, it's a 17 year old picture of her smiling ,but she

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said the buyers don't have to know it was taken at the boys bar mitzvah. at [mom smiles with her boys]

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year-end fifty store chains are carrying the sauce. the product has become kind of

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a kitschy fun thing that retailers love hanging on their shelves. and by the way

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getting into fifty store chains was no easy feat. Artie and Bernie only got [map of the US]

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there because Reed had those relationships and was respected enough

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by the chain owners to take a risk on the sauce, and well, that risk has paid

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off handsomely. the stores benefited in other ways because of the newness of the

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sauce ,they were able to take a relatively very large cut or percentage [line of bottles of sauce]

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of the sales of each bottle. a bottle of the sauce sells to Joe Sixpack for eight

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bucks. the store keeps four bucks. the stuff inside the bottle costs the sauce

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company corporation two bucks, leaving two bucks for overhead. that is the

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salaries of Artie and Bernie marketing shipping delivery legal costs insurance

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and so. on lest you think we don't heart chart well, here you go. well to the sauce [chart shown]

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company corporation they only care about four bucks they get per bottle from the

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stores .those four bucks are their revenues per unit. the fact that each

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unit costs two bucks implies that the sauce company corporation keeps two

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bucks a unit in profit or has a 2/4 or yes fifty percent gross margin. and no

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gross is not a pejorative word about a spilled bottle, rather it is one of the

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delineations of profits. so there's gross margin which is the [bottle of spilled bbq sauce]

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profits after the basic unit or product is sold and it doesn't count

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anything else. alright further on down you have operating profits which are

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profits after you've sold the bottle or paid for it, and then after all of the

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salaries of the employees are paid and after lawyer fees and other [definitions on screen]

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infrastructure costs. well operating profits are basically all the profits

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accept taxes and dividends hence they're operating. it's just profits from the

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actual operations of the company. and then there are net profits which are the

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famous bottom line. net profits are profits after everything that is you [definitions]

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know thereafter cost of goods cost of overhead costs of taxes dividends and so

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on. so check out the performance of the sauce company after the first year.

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here's the income statement for year one well that's one point two five million

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dollars in revenues. not bad for a first year startup. note that when Reed funded [man smiles from doorway]

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the company with his half million bucks the company had almost no revenues. Reed

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had valued the company at one point five million dollars post, meaning after he'd

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put in his five hundred grand, which was at the time almost infinity times

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revenues. now after year one the valuation there is just one times

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revenue roughly. not a very huge multiple in this kind of fast growth via product

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in industry. and revenue multiples in a vacuum mean almost nothing really low [vacuum sucks up paper]

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margin companies trade at low multiples of revenue. but there used to calculate

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things when you have nothing else - cuz the company has no earnings at this

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point only a promise of earnings in the future. however at first blush it looks

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like the sauce company corporation should be eventually a pretty high [chart]

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margin company. over time their gross margins should trend above 50% and with

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scale, overhead, like all the infrastructure costs as a percentage of

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revenues should come down a lot well. at the moment Reed is guessing that they

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are a 30% operating margin business at scale. meaning if they sold a zillion

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dollars worth or well let's just say a hundred million dollars worth of bottles

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well they'd have a twenty percent net margin business. meaning on a hundred

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million of sales the sauce company would have twenty million dollars of after-tax

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profits. how does he get there? he just made it up! he just looked at their gross [pie chart]

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margins of 50% and thought well maybe in the future

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these 60 or 65 and there's operating costs, which he'll subtract but like how many

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secretaries you need how many parking lots do you need how many office square

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feet do you need and then he kind of imputed what the tax rate might be at

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the time. well read notes that the average S&P 500 large public company

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trades today at fifteen times earnings, and that the sauce company is growing

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much faster than almost all of those companies, so it should trade at a much

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higher multiple. well what's an average S&P 500 company? you know like Bank of [bank of America logo]

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America and caterpillar Tractor and GE. but even at fifteen times

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the sauce company's projected twenty million dollars of profits well Reed

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things the company could be worth well over three hundred million dollars.

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that's a huge windfall return on his original 500 grand investment, you know

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if they execute and actually put up the numbers .all right we'll note some other

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important elements in their first year's income statement. one they made a bit [income statement]

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less than four bucks a unit. some of the larger stores were able to negotiate to

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keep five dollars on the $8 selling price, and this was a reasonable deal for

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the sauce company to do .being in a few Walmart stores while they keep less

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money, help the awareness of their product get out there. was almost like

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advertising they were just happy to be included in the Walmart shelving. Two, [sauce on a shelf]

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their expenses were a bit more than they had originally thought, a common problem

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in startups. so the gross margin was 42 percent instead of the 50% that they had

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been modeling. over time with size and scale and more negotiating leverage

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against the onion suppliers and frankly with better management, they'll be able

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to garner more favorable pricing. all right three they're losing money. just a [ men stand in front of farm]

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little. in year one they lost fifty five thousand dollars or four cents a share.

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assuming that the company gets sold for more than 1.5 million dollars, well, all

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of the shares would convert to being one class. so that's how we got that four

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cents a share there they're all converted. but this is just year one

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people. if all goes as planned while the years that follow will be awfully good [documents]

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to our sauce making heroes. so yeah not all heroes wear capes,

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some wear aprons. [woman in apron]

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