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


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

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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

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