ShmoopTube

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Accounting Allah shmoop above the line expenses All right So

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our favorite little sleepy time company has grown from an

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egg of an acquisition from the Farmer Joe into a

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fast growing almost scale company with forty five million bucks

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in total revenues up from just eight million a few

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years ago The revenues have gone well nuts But what

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about the expenses What's happening with them That is if

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they're going down on a per unit sold basis relative

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to revenues then you'd say that company is beginning to

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scale or exert scale economics or synergies with volume discounts

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improved vendor payment terms better distribution and warehousing and shipping

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deals and so on So let's take another look at

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that income statement and zero in on the expenses right

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here Well the expense part of the income statement is

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divided into two segments will start with the above the

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line expenses well the above the line expenses generally applied

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to the cost of items required to actually build the

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product Getting one unit of product out comprises in this

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case the application of chicken feathers pillow case material etcetera

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As noted let's view each of these inputs in context

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So what's the line Right above line bloodline What is

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that Essentially it's the gross margin line and from it

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comes the gross profits of the company A single pillow

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sells for thirty bucks and the feathers cloths sewing shrink

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wrap and shipping costs about ten bucks So the unit

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gross profit here at twenty bucks The gross margin then

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would be twenty over thirty or about sixty seven percent

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So line by line inspection hear and note that most

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or all of the products going into these pillows are

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pure commodities You can get them from dozens of different

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vendors all around the world who've essentially no leverage against

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you So you should be able to negotiate viciously for

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discounts And favorable terms is you get to be bigger

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and bigger Okay First consider chicken feathers Note that they

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comprise eight million bucks of expenses in a year where

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our company has forty five million dollars in total revenue

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and forty one million just from pillow sales And it's

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worth noting that in two thousand eighteen chicken feathers comprise

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about twenty percent of the revenues of the company So

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here's the math right We've got eight million bucks and

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expenses and forty one million in revenue about nineteen percent

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there It's just an interesting factoid to think about because

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if you're going to try to be a profitable company

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you want your revenues high and your expenses low And

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it's interesting that such a commodity product that you can

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probably get cheap anywhere is such a big percentage of

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your revenue So we're just kind of mumbling allowed here

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mumbling giving you a chance But note how dramatically that

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percentage declines is the business increases over three years Well

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how can that possibly be While chicken feathers are a

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total commodity that is a chicken feather grown in central

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Chicago is basically the same as one grown in central

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China Central Mexico North Vietnam You picket all places that

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grow chicken feathers which usually come attached you know two

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chickens And it's highly likely that in the financial model

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that management put together under pressure from shareholders to show

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improved profits there was a structured shift in supply of

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chicken feathers from a U S dominated highly unionized very

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expensive set of feather plucker sze to the kindly loving

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auspices of people in the developing world Prison plucking chicken

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feathers for ah a bowl of rice a day Note

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that we focus on the percentage expenses of chicken feathers

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as it relates to revenues from just pillow sales Why

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do we do this Well because the sale of APS

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and AP upgrades has almost nothing to do with the

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price of rice in China and or tea and or

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the price of chicken feathers in Mexico or Taiwan or

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wherever we're getting It's also worth noting that chicken feathers

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are budgeted at ten million and expense in twenty twenty

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under one hundred five point eight million on pillow sales

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in twenty twenty Well the expenses of chicken feathers have

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declined dramatically to be below ten percent of the total

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revenues here It should not be surprising that the pillowcase

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material follows the same type of trajectory While revenues are

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escalating dramatically costs are only going up around ten percent

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a year Why Well because pillowcase material is mostly cotton

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another commodity that's also available and essentially anywhere in the

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world If we go to the third expense line stitching

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and assembly well the expense structure changes or even more

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dramatic Here Labor is clearly being shifted out of the

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United States toe lower cost countries such that even on

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dramatically increased unit pillow production Three years out cost of

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labour has declined from three million two two million Well

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the above three items are absolute commodities with a globally

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competitive environment of vendors who wish to provide their services

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or supplies to the American buyer The moral It is

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good to be a buyer of commodities and a seller

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of Ah highly branded proprietary product Yes Warren Buffett said

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that can anyone think of the best company in the

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world that doing this show of hands It's the kindly

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loving people of Coca Cola They buy sugar from emerging

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market countries put it in a fizzy water or rather

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license it to other people to put it in fizzy

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water Mark up the price like 20 times spend money

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on TV ads in weird sponsorship and create arguably the

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best long term investment returns on Wall Street or least

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during the pantheon there in the Hall of Fame Next

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we've got the expenses related to act The form factor

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of any product refers to the physical plastic or whatever

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material that houses the guts of that product being sold

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here's a form factor Here's a form factory and here's

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another thing We got phone casing camera sunglasses And in

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this case the form factor also includes the storage device

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the power unit the speaker and all the other physical

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elements required to play the music or white noise or

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whatever boring readings help the customers to sleep Note that

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the expenses related to the AP form factor appreciate at

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only slightly slower speeds on a relative basis compared with

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revenue increases No plastic is a total commodity so our

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batteries so our speakers So why did the costs go

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up in a very different manner from which the cost

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of chicken feathers go up Not the answer is that

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physical form factors that require hardware devices are key today

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in great demand during this era that everyone's customizing things

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and batteries and stuff like that's a total commodity But

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it's a commodity in huge demand So while they are

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a total commodity demand is so high that suppliers can

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hold their relatively high profit margins as they remain vendors

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Tio hungry pillow assemblers and makers of other similar product

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Well the same structure holds true in a content licensing

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world where content copyright owners are able to exert power

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in the form of increased prices So if we step

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back the total expenses of the company under the forty

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five million dollars revenue scenario are twenty five point five

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million And under the one hundred thirteen point eight million

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revenue scenario well they grow to just thirty seven million

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The most interesting line here should be the vast increase

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in gross profit margin which goes from forty three point

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three percent to sixty seven point five percent Well this

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set of numbers covers less than half of the story

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however Recall that we label this structure is above the

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line expenses That means there's gotta be something below the

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line too And for you Hollywood movie fans note that

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above the line expenses refer to the major stars writers

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producers and directors many of whom earn profit participation points

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in the movies and television shows they produced Why is

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this important Well because Hollywood accounting can often obscure the

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true profitability of a movie When the profit definition is

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made fairly simple as it is to calculate the above

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gross margin numbers the talent is less likely to be

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tricked out of profit dollars they otherwise would have earned

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Well the big takeaway here is that the delineation between

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above the line and below the line is really important

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When companies think about allocation of precious resource is like

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their cash and you know their best brains in Hollywood

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above the line people are rare It's hard to find

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movie stars who are so exciting to the public that

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they actually put butts in seats in theaters after paying

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the fifteen dollars ambition dealing with parking lines traffic expensive

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popcorn and so on So those people make bank and

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are either worth it or they don't work again Well

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the same holds true for above the line expenses in

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Cos the best resource is get allocated to the product

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If company's product isn't at least pretty awesome well then

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everyone is out of a job So the best brains

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in companies generally get allocated to figuring out the best

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presentation of the product They sell far down the line

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or the various ancillary elements of the company like secretaries

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a soon to be all Elektronik Allah Google and Amazon

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shipping docks Soon to be all robotic Allah Google and

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others and lawyers soon to continue to be generally reviled

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And even you dear future accountant computer's gonna replace you

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someday If you want to live above the line then

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well be an accountant at an accounting firm where you

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are the product bringing in very high paying customers rather

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than serve the taskmaster of a seller of whoopee cushions

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Where you just served to count beans Sena fax Uh 00:08:46.42 --> [endTime] well you know

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