UGBA 10 Lecture Notes - Lecture 2: Operating Leverage, Spacex, Accounting Equation
23 May 2018
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Cost Structure and Breaking-Even January 25
I. Cost structure for a business (think about at THAT moment; can a firm operate without it?)
• Costs are made up of variable and fixed costs
o Variable costs: dependent on units sold; these costs go up with sales (ie: people
working at minimum wage, ingredients, supplies, products).
o Fixed costs: does not depend on units sold; these are the same not matter how
much you sell before you make a profit (ie: rent, manager salaries).
o Profit = sales – costs; contribution margin = prices – variable costs
• Good operating leverage: Google has low variable costs (not free, because they have to
pay for the tech people that fix the system).
II. Business financing to leverage the equity
• Copaies fiae thei assets y issuig stokholdes’ euity o though det.
o “tokholdes’ euity: issuae of oo stok.
o Stockholders: owners of the company.
III. Accounting equation: all assets must be financed by eithe stokholdes’ euity o liailities
(debts).
• Assets: economic resources that can be useful to the company (ie: buildings).
• Assets = liailities + stokholdes’ euity
• Debt and equity are claims on the companies assets
• Claim that gets back first are the liabilities.
IV. Concept of financial seniority
• Fiaial seioity: ode i hih lais o the opay’s assets ae paid if the
company is liquidated.
o Clais ae opised of liailities ad stokholdes’ euity
o Claim that gets back first during liquidation are the liabilities
o Liquidation: sale of all assets for cash and payment of the cash to the investors
ho hold lais; oly happes he the opay is i ad shape.
• Rules of financial seniority:
o Liabilities (debt) are paid first
o If there is cash remaining after the debt is paid, that residual amount is paid to
stokholdes usually thee is little left fo stokholdes sie detholdes ae’t
always paid in full).
• What is good about being residual?
o Means that the company is worth a lot. It is an upside potential that makes
equity attractive as a long-term investment.
o Debt: fixed claim
o Equity gets the remaining value
o It is this upside potential that makes equity attractive as a long-term investment.
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