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Current time:0:00Total duration:10:14

Video transcript

in the last video we learned a little bit about what an income statement would look like for a very kind of vanilla company that sent that sells widgets and in this video what I wanted to do is kind of close the loop and see how this relates to what we talked about in the first video in terms of price per share and we'll talk about earnings per share in this case and also how the income statement relates to the balance sheet I said I would do it in the last video but then I realized I was running out of time and this is a bit of a quick review and you probably just watched that video but just in case you didn't revenue was literally the widgets that I sold I sold let's say this was for 2008 I sold three million dollars worth of widgets cost of goods sold well that's just the cost of the goods sold so I sold a milli the the three million dollar the three million let's say I sold three million widgets for $1 to produce those three million widgets for $1 it cost me maybe thirty cents a widget or thirty three cents of widget and so I had a total expense or total cost of goods sold of a million dollars and so the profit from just selling those let's say in that case that I just made up three million widgets or three million dollars worth of widgets was two million dollars but I have other expenses I can't just put that in my pocket had marketing sales general and administrative and then I was left with a million dollars and that's how much operating profit the my my little widget my widget company has produced but I'm not done yet in the last video I I didn't own the company outright I had some debt in this case five million dollars worth of debt so I had to pay some interest there was 10% interest so you take the interest out you're left with $500,000 of pre-tax income and of course you have to pay the government and you know we can debate on whether we're paying them too much or too little but you know they're providing me a defense so that you know other foreign countries can't come and bomb my factories and they're providing and hopefully an educated workforce for me and nice roads and infrastructure and electricity so who know so that's what I'm paying for or arguably and so I'm left with net income of $350,000 and when people talk about earnings of a company this is what they're talking about this net income is also earnings earnings so when someone says Google made four billion dollars this past quarter and quarter just means a quarter of a year or three month period and they normally are literally you know March June September and December so every fourth of the year they're literally saying Google made three billion dollars in net income now what if you know we talked in the first video when we started the series about different companies have different number of shares so let's write let's just make up a number of shares for this company so let's say this company has let's say shares let me do it in move so this company shares let's say it has 1 million shares 1 million shares so you've probably heard not only the term earnings you've probably also heard the term earnings per share so what they do is they just take your earnings number and you divide by the number of shares and you have earnings per share or EPS sometimes people just say EPS for this company and 2008 was and in this case you take $350,000 just your total earnings divided by the total number of shares you have and that's what that's 35 cents 35 cents per share of EPS now you've probably heard actually before I go into into something you know I before I go into price to earnings and all of that I want to connect the dots between the income statement and the balance sheet so in this period I made three hundred and fifty thousand dollars so what the way you can think about what an income statement is is it tells you what happens between balance sheet snapshots so let's say at the beginning of let's say on 12 31 12 31 2007 the balance sheet for the company would have looked like this let me just draw it I won't use the square tool so it had 10 million dollars of assets 10 million dollars of assets it had 5 million dollars of debt 5 million dollars you can kind of this is the liabilities of which debt is one of them let's just it's all of it so five million dollars of liabilities so the shareholders equity or you could almost be the Book value of the company the book value of the equity of the company is $5,000,000 $5,000,000 equity five million dollar equity and just to make the kind of tied a little bit with what we did at the at the in the first video if we have a million shares we have a million shares the book value of the equity is five million so if we say the book value book value per share is just going to be this number divided by the million shares I have so five million divided by 1 million is five dollars this is the book value per share remember there's a difference between Book value and market value this the the the stock of this company at 12:31 2007 it could have been trading at $10 at $7 at $1 thousand the market value per share this is the book value and the book value is essentially saying okay if you take the the book value of the assets and I talked about this a little bit in the last video but if you say oh well you know we paid ten million dollars and you know this is how much value there and I'll go into more detail into how you value these type of things and you take out the liabilities this is what the assets are worth according to the accountants the market value could be very different but fair enough I don't want to delve too much into that but now over this period of time over 2008 2008 happens so the rest of 2008 happens and we're left at the end of let's say it 1 1 2009 or we could say 12 31 2008 doesn't matter you know give or take a day it's a holiday anyway we have a new balance sheet right we have a new balance sheet but what happened here over the course of the year we earned some money and I won't go too complicated into you know cash and and accrual accounting and all of that right now we will get into that eventually but I just want to get you the gist of what's happening is that we made three hundred and fifty thousand dollars in this year so our assets will have increased by three hundred fifty thousand dollars if this was it have increased by $350,000 of cash it might have been increased by just other people saying they owe us $350,000 those are accounts receivables I'll make a whole video probably a whole series of videos on accounts receivables it just says that it's an asset that says someone owes me that money but anyway you think about it our assets will have increased by this amount of money over the course of the year so now our new balance sheet at the end of 2008 so 2008 happened let me draw 2008 2008 happens at the end of which our assets would have grown a little bit our assets are now at ten million three hundred and fifty thousand dollars so I'll put this in thousands right this is ten thousand three hundred fifty thousand so that's the same thing as ten point three five million right and let's see we haven't all we did is we paid the interest on the debt in this example we just paid interest and just so you know most corporate debt actually works that way we'll talk later about amortization schedules and how can you pay down the debt but unlike mortgages a lot of corporate debt they just pay the interest so we still have the same amount of debt we didn't pay down any of the principle of the debt so we still have five million dollars of debt and what's left over for the equity well all of our earnings since our debt stayed the same all of our earnings actually falls down straight to equity so we have five million three hundred fifty thousand dollars of equity so the way I think about it and probably the way you think about you should think about is the earnings of a company the earnings of a company in this case we have three hundred and fifty thousand dollars for the year or thirty five cents per share they essentially tell you what happened from one balance sheet to another so this tells you that this number the amount that this number grows by the amount that our equity grows by is earnings so this is three hundred and fifty thousand dollars earnings $350,000 of earnings and there's something I might want to touch on because in the last video I talked a little bit about return on asset where we just took the operating profit and we divide that by the assets we had a 10% return on assets you might say oh well why shouldn't the assets grow by that amount and the reason they didn't grow by that amount is because we actually ended up having to pay taxes on some of that even if we had no debt we would still have to pay taxes just this line would have disappeared so sometimes when people talk about return on asset which I did in that last video it might be interesting to say is that the pre-tax or the post tax return on asset in this example that I did in the previous video it was the pre-tax return on asset but fair enough I think that's an in this connection that income that balance sheets are just snapshots in time they're kind of like your bank account how much are you worth at any one moment and income statements tell you how do you get from one balance sheet to the next balance sheet and we'll learn later that the the cash flow statement essentially reconciles the income statement with what happens with your actual cash accounts or how things actually move within the balance sheet and we'll do that later on but anyway we started off in this video talking about oh you know what's cheap what's expensive and so the question is how do you determine that if you can't just go by the actual dollar price of the my my baby is crying I should probably run to that let me do that right now I realize I'm already at ten minutes I'll see you in the next video