ShmoopTube

Where Monty Python meets your 10th grade teacher.

Search Thousands of Shmoop Videos

Principles of Finance: Unit 3, Expenses - Variable v Fixed 17 Views


Share It!


Description:

Fixed expenses are fixed, while variable expenses... vary. Did we blow your mind with that one?

Language:
English Language

Transcript

00:00

Principles of finance ah la shmoop expenses variable versus fixed

00:06

We'll once again let's go back to our little anemic

00:08

income statement for our lemonade stands are us thing with

00:12

a few adjustments made aren't sawn in twentynine bucky age

00:16

nineteen Credit card Sixteen thousand there All right Well this

00:21

statement is seriously anemic It omits a ton of things

00:24

that in real life you have to pay for When

00:26

you run a really business like lawyer fees state unemployment

00:30

fees insurance legal things and on why'd we omit them

00:34

Kiss not the rock man Keep it simple Shmoop Ear's

00:37

All right So for now precision is our enemy Just

00:40

good wins All of that noted expenses break down into

00:43

two key categories as you run a business fixed things

00:47

like rent and insurance and that drinking cooler thing with

00:50

the huge plastic bubbles of water and variable like lemons

00:54

Hot month tons of traffic to the stores Well lots

00:56

of lemons snow months and on so many lemons It'll

00:59

very right Well when you build the sign ege for

01:02

your lemonade stand or the stand itself the counter behind

01:05

it the stools people sit on while they sip that's

01:07

All fixed or fixed in place In this case it's

01:10

a capital expense You'll pay for it once and then

01:14

use it for years Hopefully so here's a tricky one

01:17

for you If you spend a hundred bucks on a

01:19

stool how much did it cost Good one Well for

01:22

accounting nerds Uh here we go Answer a hundred books

01:26

Answer be before or after tax extra points for that

01:30

one Well can you expense the full hundred dollars Assumes

01:33

you've committed to pay for it Should you Well if

01:36

the stool will last five years and then be worth

01:39

zero at the end of those five years wealth and

01:41

isn't it really a twenty dollars a year kind of

01:44

expense Even though you had to pay one hundred dollars

01:46

in cash for it up front Well what if the

01:48

stool is worth twenty dollars after five years when you

01:52

sell it used on ebay That is it's Residual value

01:56

is twenty bucks It will have lost eighty dollars in

01:59

value during those five years not one hundred So what

02:02

do you do Well you don't appreciate the whole hundred

02:04

dollars in value of the stool as if it was

02:07

Kindle ing at the end you just appreciate eighty dollars

02:10

of it or sixteen dollars a year for five years

02:13

while lots of other ways to think about expensing this

02:16

expense and its relative value to the firm meaning that

02:19

one way to look at assessing the cost of that

02:22

stool sorry different stool Like what if a stool could

02:26

last forty years or two years but that its duration

02:30

was entirely dependent on the number of butts that sat

02:34

on it All right In that case we turn to

02:36

answer See prue would per glass per week per customer

02:39

per But well there we go That's the winner let's

02:42

say you pay one hundred dollars for that stool And

02:44

in its lifetime it only sat butts from one hundred

02:47

paying customers in that entire five years before then wore

02:50

out Well then the cost of that seat per but

02:53

was a buck that's a dollar but a buck a

02:55

butt and each but or its owner paid a dollar

02:58

for eliminates So that hundred dollars was a lot to

03:01

pay for that stool based on the butts it served

03:04

Why was the stool too fancy No it was expensive

03:08

On a relative basis because you had so few customers

03:12

using it if you'd had like ten thousand customer but

03:15

sit on that stool over the course of five years

03:17

well and per customer but it cost one hundred dollars

03:20

divided by ten thousand or a penny a customer but

03:23

and if on average each customer bought who drinks well

03:26

it be half a penny a cup and that's ah

03:29

point five percent in stool costs per cup cheap The

03:32

big takeaway here however is that the stool cost is

03:36

fixed it a ton of people use it assuming no

03:38

breakage or only a few people use it well that

03:41

hundred dollars you spent toe by it was fixed or

03:44

set no very ability So all the stuff we were

03:47

talking about above was fixed and remember fixed things are

03:51

things like capital expenses like the stool which has kind

03:53

of a set depreciation schedule and things like rent and

03:56

insurance which generally don't change from month to month question

04:00

is insurance variable or fix has an expense Well it's

04:05

fixed Usually you don't change it every month you buy

04:07

insurance based on a number of factors but once you

04:10

buy it You kind of have a set premium and

04:12

that's it You pay it month after month as the

04:14

insurance company smiles and winks at you but it rikers

04:18

as a charge month after month It is fixed but

04:21

recurring you know like the costs of leasing a building

04:25

All right so moving on next category variable costs cups

04:29

and lemons the lemonade itself there variable amounts mostly but

04:33

you don't buy Cops wanted a time Here's another curveball

04:36

for you You buy them in boxes of a thousand

04:38

saved money via volume discounts You get it You're a

04:40

friendly people at costco Yeah we love costco So cups

04:44

expenses air variable but at a unit rate of a

04:46

thousand cups at a time So if the cups cost

04:49

us dime than the unit variable is one hundred dollars

04:53

box of a thousand cups Generally speaking the product you

04:56

serve because it's volumes generally very is almost always a

05:01

variable cost Okay here's curveball question our employees of variable

05:05

or a fixed cost Well the answer both or at

05:09

least some employees operate that way Think about a sales

05:12

rep selling gigabit secure routers to banks with a friendly

05:16

smile and a tie She gets a modest base salary

05:19

maybe two grand a month and then she gets ten

05:22

percent of whatever she sells If she has a big

05:24

year and sells three million dollars worth of routers well

05:27

then wow three hundred grand in commission for that year's

05:30

work is her variable cost that twenty four grand a

05:34

year of base salary was fixed All right what about

05:36

taxes Are they variable Yeah it's very variable They change

05:40

every year based on how profitable or not you are

05:44

in that year Alright well at the end of this

05:45

story you have profits hopefully and it's the job of

05:48

companies to produce profits That's Why shareholders invested a dollar

05:53

in order to get mohr than a dollar back when

05:55

the company was started Of all the income statement line

05:58

items profits or the squishy ist or most squishy is

06:01

that what you think Well they can be cajoled manipulated

06:04

faked stretch shrunk adam braided in uh tweaked in nineteen

06:08

thousand ways So whenever you hear profits number be skeptical 00:06:13.087 --> [endTime] and a half

Up Next

GED Social Studies 1.1 Civics and Government
39790 Views

GED Social Studies 1.1 Civics and Government

Related Videos

Fake News
11936 Views

How do you tell fake news from real news?

Finance: What is Bankruptcy?
260 Views

What is bankruptcy? Deadbeats who can't pay their bills declare bankruptcy. Either they borrowed too much money, or the business fell apart. They t...

Finance: What is a Dividend?
1774 Views

What's a dividend? At will, the board of directors can pay a dividend on common stock. Usually, that payout is some percentage less than 100 of ear...

Finance: How Are Risks and Rewards Related?
589 Views

How are risk and reward related? Take more risk, expect more reward. A lottery ticket might be worth a billion dollars, but if the odds are one in...