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Current time:0:00Total duration:11:13

Video transcript

all the talk today is about are we going to see inflation or deflation and before we do that I think it's really important to get up a microeconomic level understanding of why do prices increase or decrease and so where we'll do a little example of me starting a business and and when the prices increase or decrease in that market so let's say I wanted to start a a cupcake factory cupcakes cupcake factory and then actually in the process of this video even though this isn't the intent of this playlist the intent of this playlist is eventually for you to be able to go to your econ professor and say no we you know we won't or we will have inflation or deflation for reasons x y&z but in the process you might learn a little bit about accounting and starting a cupcake factory so let's say I want to start a cupcake factory it costs a million dollars to build so 1 million dollars to build and just the economics of the factory is it costs five hundred thousand dollars five hundred thousand dollars a year to operate so that's literally to pay the electric bills to have people sitting there ready to make cupcakes and I have accountants and you know all the rest have to pay people to clean the place let's say the economics of the cupcakes themselves the cost per cupcake so is one dollar cost probably do that in red because actually I'll do all of these in red because these are I'll do that later so the cost per cupcake is $1 one dollar cost per cupcake and where does that cost well that's you know some of it is the incremental let's just assume that I had a completely automated robotic Factory so there's actually you know let's say there's very little labor at my factory and this is just the cost of ingredients you know cream and sugar and butter and you know those little wax paper things that the cupcake is held in and the electricity to run my robots and then you know over time to kind of maintain the robots that make pie that make my factory and so what what would be the X say I think that the general you know I can charge two dollars per cupcake two dollars per cupcake so just as an exercise let's think about oh and one other thing my 1 million dollar factory can produce can produce 1 million cupcakes 1 million cupcakes per year so this is a couple of exercises because I'm a businessman I'm not just going to plunk down a million dollars before I before I figure out how much money I can make let's think about how much money we can make in different scenarios so let's say let's call this scenario one which is kind of the best scenario so called it's the optimistic optimist is that I sell a million cupcakes so my factory can produce a million cupcakes and I sell a million cupcakes if I sell 1 million cupcakes and I'll take a side here because this is an issue that I want to bring up a lot I am fully utilized my factory can produce 1 million cupcakes and I in this scenario I'm producing a million cupcakes so we would say we're 100% utilized how much are you producing relative to what you can produce 100% so if I sell a million cupcakes what what would be my revenue and I will go into the details of accounting let me make revenue in green because that's a good thing so what is my revenue if my background weren't already black I would make that in black and that's why people saying being in the black or being in the red because being in the black means you're positive and being in the red means you're negative but my background is black so I'll use green so we'll say being in the green so what would be my revenue well I'm selling 1 million cupcakes and this is my optimistic scenario let's say I actually am able to charge two dollars per cupcake and we'll have a obviously the whole discussion is what happens to this price over a bunch of different scenarios so I am able to charge two dollars per cupcake so my revenue is equal to two million dollars per year right I produce a million this is a million cupcakes per year what are my cost of goods cost of goods and I'll write the common acronym they're cogs and you know that this is what you'll see if you actually look at income statements for for companies public companies you will see something like cost of goods or or you know variable cost but it usually actually cost of goods or cost of services is what you'll see most often and so if I have a million cupcake so let me do this in red I said I'm doing red so I have a million cupcakes times what's my cost per cupcake times one dollar cost per cupcake so it's a one dollar one million dollars per year and so what is my profit just from selling the cupcakes before I think about how much does it cost for me to you know all of the overhead expenses just kind of though the money I'm just getting from selling the cupcakes and that term is called gross profit gross profit and that's essentially how much am i bringing in from the cupcakes and then how much are just those cupcakes costing me so I'll do a line here I'll subtract that from that so gross profit I'm making 1 million dollars two minus one you might say oh that's great I'm making a million you're making a million dollars on your cupcake factory in this scenario is like oh no we're not done yet this is just the gross profit this is just the money directly from the cupcakes but I had all I have all of this overhead expense and oftentimes on a regular income statement it'll be called selling general and administrative or overhead costs or operating costs or or something like that I'll just call it overhead I'll make it red because it's an expense so this should be red - cogs and so I'll call it overhead once again that's kind of the offices and the accountants and the bookkeepers so that's going to be $500,000 a year and then how much am I making from the business now from the business and this is called operating profit operating profit how much am i making from operating the business and I won't go into all of the details of an income statement but any income statement you look at will have this operating profit line and everything below the operating profit line just as an aside will kind of cover things not related to the actual operations of the business it'll you know it'll be expenses related to financing the business if I took a loan for that million dollars or it'll be expenses related to taxes and all of that but where assuming a world an ideal world that doesn't have taxes and let's say assume you know I inherited this million dollar so I didn't finance it so my operating profit is really my profit because I'm not I don't have to pay taxes on it so let's see I got gross profit just from selling the cupcakes a million overhead the the accountants and the people cleaning the factory and etc etc that's five hundred thousand a year so my operating profit is five hundred thousand dollars and that's pretty good I mean I had a 1 million dollar investment one time investment and I'm assuming that this five hundred thousand two year to operate it also maintains my building so this kind of 1 million dollar investment will exist forever right and I'm making five hundred thousand dollars a year in this scenario so that's a 50% return right which is great if I told you I had an investment where I could make 50% a year on your money you'd say we have here's here's my money here's a check but this this is of course an optimistic scenario let's let's let's think of other centers and there's actually a ton of scenarios because you can keep adjusting how much you sell and the price you sell it for and come up with different numbers here and it's actually a fun exercise to do in Excel and you can do probability distributions and all that but I won't worry about that right now let's do a pessimistic well actually let's let's let's do this scenario what do I have to do just to make sure that I don't lose money right so to make sure I don't lose money let's let's do it let's kind of do it backwards so we're going to do a break-even analysis and trust me this will eventually lead to whether we are seeing we are going to see inflation or deflation in this economy and I think in them in the in the meantime you might learn a little interesting things about about starting a business but so let's say I want to I just want to know I just want to know what what has to happen for my operating profit to be zero right to not be negative what's the minimum number of cupcakes I need to make or what price have to charge so if my operating profit is zero we know my overhead the overhead this is fixed this is a fixed expense there's nothing I can do about it just if you want to have a cupcake factory it will cost you five hundred thousand and already is a negative number because we're going to subtract it from the gross profit so what does the gross profit have to be so the gross profit the gross profit in order for this to come out to be zero the gross profit has to be $500,000 and so now we can say we can think of a bunch of scenarios where we end up with 500,000 gross profit we could if we sold what did we say if we sold a so how can we get to 500,000 let's say we're selling I don't know instead of selling a million cupcakes we're only selling 500,000 cupcakes 500,000 cupcakes right this should work out so then our revenue will be 500k and let's say I'm still selling it for $2 a cupcake times $2 and so that would be 1 million dollars of revenue coming into the door per year and then my cost of cupcakes or my cost of goods sold is what I should be doing this in red I'm not being consistent my cost of goods sold is what we said it was a dollar per cupcake right so it's 500,000 times $1 and really just you know I mean it would be silly to ever sell a cupcake for less than $1 right then I mean you're just you're just kind of handing checks out to your cupcake eaters but anyway in this case my consequence sold would be minus 500,000 and everything would work out so this is a break-even scenario where I sell 500,000 cupcakes at $2 per cupcake with this being the cost of goods and then I'll make 500,000 gross profit and then take out the overhead and at least I won't make a loss but this is interesting because this tells me if I'm charging two dollars per cupcake I have to sell at least I have to sell at least 500,000 cupcakes to make money so you might say well yeah so it would never be rational it would never be rational to sell anything less than 500,000 cupcakes otherwise you shouldn't operate the business and what we'll do in future videos is we'll actually explore situations in which that does happen and in which people will start to kind of cut prices to actually compete and in the process they'll be doing very rash things but anyway I realize I'm run off - I've run out of time in this video I'll see you in the next one and we'll actually see what happens once I start my cupcake Factory