- Course: Finance for Absolute Beginners
- Module: Day 1
- Lesson Type: Video
- Lesson Duration: 7:21
To buy initial supplies, we need money. Let’s imagine that we take $30 from our piggy bank and invest it in to our Lemonade Stand business. How does this impact our business? The two sides of this transaction are, cash is up and investment is up. Let’s see how it maps on the financial statements.
What does the market research say? On an average day, we can sell between 10 and 35 cups of lemonade. Before we buy supplies, let’s check the weather forecast.
It is a sunny day. Let’s get ready to buy supplies.
To simplify the illustration, let’s make the following assumptions for Day 1, Day 2 and Day 3.
- All supplies are purchased with cash.
- Cash is paid at the time of purchase.
- All sales are made for cash. Cash is received at the time of sale.
- There’s no inventory of supplies or lemonade. All of the supplies purchased for that day are used up to make the lemonade. Any lemonade left over at the end of the day is discarded.
We are at the grocery store. The total cost of all supplies to make one cup of lemonade is $.40. Based on the market research and the weather forecast, you buy supplies to make 30 cups of lemonade. With the cost of $.40 per cup, you pay $12 in cash. How does this impact your business?
When we buy supplies and pay cash at the time of purchase and with our assumption of no inventory, one side of the transaction is, cash is down. The other side of the transaction is, expenses are up.
This is your income statement and the balance sheet. On the balance sheet, we see $30 under cash and $30 under owner’s investment, reflecting your investment in this business. Let’s see how the two sides of the transaction to purchase supplies map on these financial statements.
Minus $12 under cash and positive $12 under expenses. Negative $12 under cash indicate reduction in cash. Positive $12 under expenses indicate increase in expenses.
Let’s see how many cups of lemonade you sold? In other words, what the demand for your lemonade was on Day 1. The demand on Day 1 was 25 cups.
Your price was $1.00 per cup. You sold 25 cups of lemonade for a total of $25 in cash. How does this impact your business?
When we sell lemonade for cash, one side of the transaction is cash is increased. The other side of the transaction is sales are increased. Remember our assumption of no inventory of supplies or lemonade. We will look at how inventory works later in this lesson.
This is your income statement and the balance sheet with the numbers from prior transactions. Let’s see how selling $25 worth of lemonade maps on the financial statements. Just a reminder, we assumed no inventory of supplies or lemonade. When you sell $25 worth of lemonade, we reflect $25 increase in cash and $25 increase in sales.
Let’s recall how the demand for your lemonade was determined. A wild card. It’s like rolling a dice!
Would you like to roll the dice in your business every day? Probably not. Demand is one of the most difficult areas to project. Why? There are many factors and drivers that are in your control and outside of your control such as what your competition is going to do. Factors that are in your control include, quality, features, functionality of your product or service, marketing and advertising initiatives and how much money your organization allocates to marketing and advertising. Price of your product and service. Even though you do decide on the price, it may depend on various factors too such as your competitor’s prices, quality, features and functionality of your product relative to your competitor’s.
What is not in your control or in your direct control, is your competitor’s decisions about their product and service, quality features and functionality of their product and service, their marketing and advertising initiatives and introduction of new products.
Macro-economic conditions and various domestic and global market conditions and changes can also impact your demand.
At the same time, demand is one of the most important areas for any organization to project. Let’s think why.
Demand drives everything else in the business. Production capacity. People resources needed. Processes required. Estimation of production capacity includes projecting needs in raw material, labor, equipment and facilities. Estimation of production needs also includes how many units of product we need to produce. If we do not produce enough, we will miss out on opportunity and will lose potential sales.
As a result, customer perception of our brand and organization may worsen. Customers may change their mind in waiting for the product to become available or they may decide to buy from our competitors.
If we produce too many units of our product, we will have excessive inventory. Our cash will be tied up in that inventory. Inventory carrying costs will increase. If our production capacity that includes raw material, labor, equipment and facilities are not aligned with the demand, we run the risk of either losing potential demand or incurring excessive costs, both of which will negatively impact our profitability.
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Module 1 0/5
Setting The Foundation
Module 2 0/2
Module 3 0/1
Module 4 0/1
Module 5 0/4
Accounts Receivable, Accounts Payable and Inventory
Module 6 0/1
Interpreting Financial Statements
Module 7 0/5