Accounting: Above the Line Expenses

years ago The revenues have gone well nuts But what

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

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

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

scale or exert scale economics or synergies with volume discounts

improved vendor payment terms better distribution and warehousing and shipping

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

that income statement and zero in on the expenses right

here Well the expense part of the income statement is

divided into two segments will start with the above the

line expenses well the above the line expenses generally applied

to the cost of items required to actually build the

product Getting one unit of product out comprises in this

case the application of chicken feathers pillow case material etcetera

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

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

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

comes the gross profits of the company A single pillow

sells for thirty bucks and the feathers cloths sewing shrink

wrap and shipping costs about ten bucks So the unit

gross profit here at twenty bucks The gross margin then

would be twenty over thirty or about sixty seven percent

So line by line inspection hear and note that most

or all of the products going into these pillows are

pure commodities You can get them from dozens of different

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

you So you should be able to negotiate viciously for

discounts And favorable terms is you get to be bigger

and bigger Okay First consider chicken feathers Note that they

comprise eight million bucks of expenses in a year where

our company has forty five million dollars in total revenue

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

worth noting that in two thousand eighteen chicken feathers comprise

about twenty percent of the revenues of the company So

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

expenses and forty one million in revenue about nineteen percent

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

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

you want your revenues high and your expenses low And

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

probably get cheap anywhere is such a big percentage of

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

mumbling giving you a chance But note how dramatically that

percentage declines is the business increases over three years Well

how can that possibly be While chicken feathers are a

total commodity that is a chicken feather grown in central

Chicago is basically the same as one grown in central

China Central Mexico North Vietnam You picket all places that

grow chicken feathers which usually come attached you know two

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

that management put together under pressure from shareholders to show

improved profits there was a structured shift in supply of

chicken feathers from a U S dominated highly unionized very

expensive set of feather plucker sze to the kindly loving

auspices of people in the developing world Prison plucking chicken

feathers for ah a bowl of rice a day Note

that we focus on the percentage expenses of chicken feathers

as it relates to revenues from just pillow sales Why

do we do this Well because the sale of APS

and AP upgrades has almost nothing to do with the

price of rice in China and or tea and or

the price of chicken feathers in Mexico or Taiwan or

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

are budgeted at ten million and expense in twenty twenty

under one hundred five point eight million on pillow sales

in twenty twenty Well the expenses of chicken feathers have

declined dramatically to be below ten percent of the total

revenues here It should not be surprising that the pillowcase

material follows the same type of trajectory While revenues are

escalating dramatically costs are only going up around ten percent

a year Why Well because pillowcase material is mostly cotton

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

world If we go to the third expense line stitching

and assembly well the expense structure changes or even more

dramatic Here Labor is clearly being shifted out of the

United States toe lower cost countries such that even on

dramatically increased unit pillow production Three years out cost of

labour has declined from three million two two million Well

the above three items are absolute commodities with a globally

competitive environment of vendors who wish to provide their services

or supplies to the American buyer The moral It is

good to be a buyer of commodities and a seller

of Ah highly branded proprietary product Yes Warren Buffett said

that can anyone think of the best company in the

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

loving people of Coca Cola They buy sugar from emerging

market countries put it in a fizzy water or rather

license it to other people to put it in fizzy

water Mark up the price like 20 times spend money

on TV ads in weird sponsorship and create arguably the

best long term investment returns on Wall Street or least

during the pantheon there in the Hall of Fame Next

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

of any product refers to the physical plastic or whatever

material that houses the guts of that product being sold

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

another thing We got phone casing camera sunglasses And in

this case the form factor also includes the storage device

the power unit the speaker and all the other physical

elements required to play the music or white noise or

whatever boring readings help the customers to sleep Note that

the expenses related to the AP form factor appreciate at

only slightly slower speeds on a relative basis compared with

revenue increases No plastic is a total commodity so our

batteries so our speakers So why did the costs go

up in a very different manner from which the cost

of chicken feathers go up Not the answer is that

physical form factors that require hardware devices are key today

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

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

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

a total commodity demand is so high that suppliers can

hold their relatively high profit margins as they remain vendors

Tio hungry pillow assemblers and makers of other similar product

Well the same structure holds true in a content licensing

world where content copyright owners are able to exert power

in the form of increased prices So if we step

back the total expenses of the company under the forty

five million dollars revenue scenario are twenty five point five

million And under the one hundred thirteen point eight million

revenue scenario well they grow to just thirty seven million

The most interesting line here should be the vast increase

in gross profit margin which goes from forty three point

three percent to sixty seven point five percent Well this

set of numbers covers less than half of the story

however Recall that we label this structure is above the

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

line too And for you Hollywood movie fans note that

above the line expenses refer to the major stars writers

producers and directors many of whom earn profit participation points

in the movies and television shows they produced Why is

this important Well because Hollywood accounting can often obscure the

true profitability of a movie When the profit definition is

made fairly simple as it is to calculate the above

gross margin numbers the talent is less likely to be

tricked out of profit dollars they otherwise would have earned

Well the big takeaway here is that the delineation between

above the line and below the line is really important

When companies think about allocation of precious resource is like

their cash and you know their best brains in Hollywood

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

movie stars who are so exciting to the public that

they actually put butts in seats in theaters after paying

the fifteen dollars ambition dealing with parking lines traffic expensive

popcorn and so on So those people make bank and

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

the same holds true for above the line expenses in

Cos the best resource is get allocated to the product

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

everyone is out of a job So the best brains

in companies generally get allocated to figuring out the best

presentation of the product They sell far down the line

or the various ancillary elements of the company like secretaries

a soon to be all Elektronik Allah Google and Amazon

shipping docks Soon to be all robotic Allah Google and

others and lawyers soon to continue to be generally reviled

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

someday If you want to live above the line then

well be an accountant at an accounting firm where you

are the product bringing in very high paying customers rather

than serve the taskmaster of a seller of whoopee cushions

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