Accounting Measurement

  

Metrics. Like...how much did the coffee mugs with the swear words painted on them cost us? What if we'd sold a million instead of a hundred? There was a union strike last month, and production slowed 10%...how much did that cost us? If we replaced those workers with robots, how much would that change our numbers?

That's the metrical part of Accounting: you measure everything. For more intimate measurements, we suggest doing them privately. Wars have been fought over less.

Related or Semi-related Video

Finance: How do you assess the cost of e...11 Views

00:00

finance a la shmoop how do you assess the cost of equity

00:07

all right so people remember that's equity that's your stock that's the [Man driving a car]

00:11

ownership of the company trying to figure out how you assess the cost of it

00:15

when you do stuff with it okay so your specific motors your like [Specific motors store]

00:19

General Motors but your products way less vague with your stock at $20 a

00:25

share and fifty million shares outstanding Wall Street is telling you

00:29

when they're paying 20 bucks a share for your stock that specific motors is worth

00:32

a cool billion dollars got it 20 times 50 there you want to buy your dreaded

00:38

hated competitor Alfalfa Romeo for two hundred million dollars yep [Plane carrying Alfalfa Romeo banner]

00:43

the one started by the little rascal that one so you've gotten your board to

00:47

agree to let you make this transaction and you've gotten Alfalfa Romeo to agree [Specific Motors and Alfalfa Romeo board in a meeting]

00:53

to it as well the only question now is how you pay for this transaction that is

00:58

how you pay the two hundred million dollars is it in cash or is it in stock

01:03

all right well you could borrow the money and if you do the rate of interest

01:06

you'll pay is seven percent with terms already set so that you have to pay back

01:10

one tenth of the loan each year for ten years until it's all paid off got it so

01:16

two hundred million dollars that is 20 million a year and you can handle the

01:19

interest it would be 14 million bucks interest in year one but you would also

01:23

owe 20 million in principle pay downs at 34 million in year one and well frankly [Interest payments for year 1]

01:28

that's where you get nervous that's a lot of cash out of your pocket here...

01:32

If things don't go perfectly smoothly in your profit margins of the combined

01:36

company specific romeo' are less than you'd plan well then you could risk

01:41

putting the company in financial peril even bankruptcy because you know that if [Car driving by and stock value stamped with bankruptcy]

01:46

you don't pay back debt according to the deals terms, well then at least in theory

01:50

the debt holders could knock on your door one day and take ownership of your [Chains engulf Specific Motors]

01:54

company yeah company suicide, career suicide, the

01:58

financial end of the world as you know it so you look at paying the 200 mil in

02:02

equity instead of debt and you're wondering how to assess that cost got it

02:08

so you have a billion dollars you're going to give a fifth of that or 200

02:11

million dollars to the shareholders of Alfalfa Romeo in return for their excellent

02:16

cars all right well on your own this year you'll have three hundred million [Revenues for Specific Motors]

02:19

dollars in revenues to specific motors to deliver 40 million dollars in

02:23

earnings you trade at 25 times that 40 million of earnings billion dollars

02:29

remember you have 50 million shares outstanding trading at 20 bucks a share

02:33

do the math on both sides and you'll get a billion dollars either way see we do

02:37

it here for you at no extra charge at shmoop you can see it right there on the [Man points to Shmoop calculations]

02:40

screen....

02:42

well your business doesn't have a lot of research and development not big capital

02:46

expenditures so most if not all of your earnings is cash earnings that is of the

02:52

40 million dollars in earnings this year well close to a hundred percent of it is

02:56

cash we'll just call it that for this problem all right well if all you were

03:00

was a dividend producing machine well then this year you would be showing a [Machine producing dividends]

03:05

"free cash flow yield" of four percent or 40 million dollars in

03:12

cash generated by the billion-dollar market cap company that you have going

03:17

on there got it that's 40 million over the billion dollar valuation it's like a

03:21

4% cash yield for investors meaning if you paid $20 for a share of [20 dollars transfers to a share of stock]

03:25

stock you got about 80 cents in cash production from it so that's 80 cents

03:29

over 20 bucks the combo gets you a 4% cash yield so yeah that's how you assess

03:35

the cost of equity, you're paying for things in all stock with about 4% kind

03:41

of yield money so if you're paying a fifth of the company to buy Alfalfa

03:46

Romeo well you're gonna dilute that cash yield down and then you just have to do [Maths book opens]

03:50

the math whether Alfalfa Romeo generates enough cash to make the difference to

03:55

you does that make sense Otay! [Man waves]

Up Next

Finance: What are Market Metrics?
187 Views

What are market metrics? Market metrics are all of the figures used to determine how well a company is performing and whether an investment should...

Finance: What is GAAP?
21 Views

GAAP is an acronym for Generally Accepted Accounting Practices. In order to remove as much subjectivity as possible, accounting policy bodies, such...

Finance: What Happens When your Stock Splits?
62 Views

If you go to an arcade and want to play coin-operated games, you will often exchange $1 bills for (4) quarters at a time. This is the equivalent of...

Finance: What is Hurdle Rate?
62 Views

One of the toughest jobs any head coach for the NFL or NBA has is: who makes the final team roster? Is there a level of production that warrants th...

Find other enlightening terms in Shmoop Finance Genius Bar(f)