Economics

An overview

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Overview

1. What is produced?
2. How is it produced?
3. Who gets what is produced?

Production Possibility frontier = The alternative combinations of final goods and services that could be produced in a given time period with all available and limited resources and technology.

Opportunity Cost = Obtaining more production of one good, amounts reduction in the production (lost opportunity) of one or more other goods.

Law of Increasing Opportunity Cost = Obtaining more of a good in equal amounts requires giving up ever larger amounts of alternative goods.

Inside Frontier = Unemployed resources used inefficiently Expanding frontier occurs when resources are increased and/or technological advancements.

Utility = is the satisfaction obtained by the consumer from consuming a good.

Marginal Utility (MU) = is the extra utility from additional unit of consumption.

Principle of Diminishing Marginal Utility = Additional consumer satisfaction from the last unit of consumption falls as more of the good is consumed.

Utility and the Law of Demand = As the price of a good increases, the utility of the marginal dollar spent on the good decreases, since the marginal dollar buys less of the good. The consumer reallocates the marginal dollar away from the good, causing quantity demanded to fall in line with the Law of Demand.

Law of Demand = Increase in price causes decrease in quantity demanded.

Law of Supply = Increase in price causes increase in quantity supplied.

Four Key Elements of Finance:

1. reallocates economic value through time
2. reallocates risk
3. reallocates capital
4. expands the access to, and the complexity of, these reallocations

Financial contracts are typically between someone who wants to shift value to the present and someone who wants to shift value to the future. Two reasons to shift value to the present: consumption and production. Consumption covers: current expenses, buy food, pay medical bills, deal with unforeseen cost. Consumption loans mitigate risks. Governments also take loans from citizens (bond) and pay back with future tax revenues.

Consumption and production use current capital; investment provides that capital. It is the basic technology for saving for the future. That is why pension funds hold stocks and bonds and other financial assets.

Productive loans are different from consumption loans. They are used for economic growth. Finance can bring capital together to create an enterprise that will generate higher future value. Additionally, finance removes the perquisite of wealth from entrepreneurship.

Macroeconomics

Opportunity Cost = Give up one choice for another better choice and a better way to spend one

Macroeconomics = Bigger picture, GDP, Unemployment rate, interest rates, deficit

Microeconomics = How firms work. How much labor they hire to make a profit.

Incentives = External motivations that explain people

Scarcity = Humans working with finite resources and unlimited wants

Benefits and Costs = Costs outweigh benefits. Example, banning ALL cars because a tiny fraction of deadly accidents will lead to people walking, trains. Benefits are not

Industrial Revolution = raises standard of living, increased population.

1. First Industrial Revolution used water and steam power to mechanize production.
2. Second used electric power to create mass production.
3. Third used electronics and information technology to automate production.

Now a Fourth Industrial Revolution building on digital technologies. A fusion of technologies that is blurring the lines between the physical, digital, and biological spheres.

Adam Smith division of labor = A pizza man should make pizza and trade it for a guy who can make t-shirts, instead of trying to do everything.

Most nations have a mixed economy like the United States, but North Korea has a controlled economy, where the government controls the economy. Moreover, New Zealand is laissez a faire (less government).

Four market behaviors

1. Supply can go ⬇️
2. Supply can go ⬆️
3. Demand can go ⬇️
4. Demand can go ⬆️

Supply and Demand = Consumers and producers agree on price and production.

Law of Demand = Prices go up, consumers buy less. Conversely, Prices go down, people buy more.

Law of Supply = Prices go up, producers make a profit, will produce more goods (or services). Conversely, price goes down, producers profits go down, which leads to a curtail in production.

If the price goes up, producers produce lots of strawberries, but consumers wouldn't want to buy them. This is a surplus.

Equilibrium Price =The price at which quantity of a product offered is equal.

Equilibrium Quantity =The quantity demanded or supplied at equilibrium price. In 2014 gas prices went down dramatically due to a decrease in European and Chinese economies. In addition, fracking technology created more supply. The combination of decreased prices and increased supply drove the gasoline price down 40%. Creating a new equilibrium

Market = Any place where buyers and sellers voluntarily meet to exchange goods and services.Consumers give up money for strawberries.Farmers give up strawberries for money. Market transparency leads to less corruption.

2 successive quarters (six months) of negative GDP.

Depression = prolonged recession.

1. Frictional Unemployment = The time period between jobs when a worker is searching for a job, or transitioning from a job. Example, the new employees entering the workforce from college
2. Structural Employment = Unemployment caused by a lack of demand for workers specific type of labor. Example, VCR repairman. Moreover, the example of employees being replaced by robots.
3. Cyclical unemployment = people stop buying goods leads to businesses layoff workers and in turn those laid off workers stop buying goods and more people lose their jobs.

Real GDP and Unemployment are inversely related. Look up circular flow of income.

Look up Zimbabwe.

Business Cycle = Changes in four components:

1. Consumer spending
2. Business spending
3. Net exports
4. Changes in speed of economy

Productivity = is the ability to produce more output, per worker, per hour. An increase in productivity is better for the country. Look up Singapore.

Factors of Production = Land, labor, capital. Human capital = education, skills, knowledge.

Capital has a cost, but finding new ways to organize production is virtually free technology.

Purchasing power = Amount of goods and services that can be bought by a given amount of money.

Inflation = Increase in a currency supply. Number of people using the currency increases, resulting in rising prices of goods and services overtime. Look up Venezuela

Bubbles = Surges in asset prices to the levels significantly above the value of the asset. Housing bubble. Look up NINJA loans.

CPI = Consumer Price Index, shows how prices have changed in different years.

Real = price from past adjusted for inflation. Nominal is not adjusted.

Demand pull inflation = Too much money chasing too few goods.

Supply Shock = Decrease in oil production, leads to increase in gasoline price, which leads to increase in delivery costs and the pizza prices. Thus, people will not buy pizza.

Fiscal Policy = Government intervention by government spending or taxes.

Recessionary Gap = situation wherein the real GDP is lower than the potential GDP at the full employment level.

Inflationary Gap = When unemployment is low, factories work overtime, but this is not sustainable. Producers will bid up costs leading to more inflation.

Expansionary Fiscal Policy = Stimulate the economy during or in anticipation of a business-cycle contraction (Obama 2009).

Concretionary Fiscal Policy = Reduce the money supply and ultimately the spending in a country. This is rarely implemented (Bush 1993).

Budget Deficit = Amount of which a governments spending exceeds its income over a particular period of time.

Economists are focused on federal deficit as to percentage of GDP rather than federal debt (adjusted for inflation)

Debt = Accumulation of budget deficits.

Central Bank has two roles:

1. Regulate and oversee that the nation's commercial banks have enough money in reserve to avoid bank runs.
2. Conduct monetary policy by increasing or decreasing the money supply to speed up or slow down the economy.

Interest rate = price of borrowing money. When banks lend money, they expect to be repaid the amount leaded.

Financial System = A network of institutions, markets, and contracts that bring lenders and borrowers together. Banks, Bond Markets, Stock Market.

Fluctuations in the stock market are not reliable indicators of how the economy is doing.

HyperInflation = Confusion on what prices to charge for products. Moreover, forces consumers to spend as quickly as possible rather than save money. Therefore, there is no money to be invested in businesses.

Velocity of money = number of times a dollar is spent per year.When people spend their money as quickly as they get it, that increases velocity, which pushes inflation up an even faster vicious cycle.

Liquidity Trap = Continuing falling prices leads to layoffs and economic depression.

Stagflation = Output slows down or stops at the same time price rises. America's largest trading partner is Canada.

Net Exports = is the difference between imports and exports.

International trade shuffles jobs.

Balance of Payment =

• Current Account = Records the sale , purchase of goods, services, investment income
• Financial Account =Records the purchase and sale of financial assets like stocks and bonds

There is a reason why the flow of goods and flow of money are symmetric. If consumers, businesses, and the government want to buy more stuff than their country is producing domestically, they have to import more products from abroad.

Microeconomics

Governments decide if building an additional park will add any utility, if the benefits outweigh the costs. Law of diminishing returns.

Elasticity of Demand = Sensitivity to quantity when there is a change in price.

Productive Efficiency = Idea that products are being made at the lowest possible cost. No wasted resources of workers, raw materials, capital. This leads to profits.

Allocation of Efficiency = State of the economy which production represents consumer preferences. Scarce resources allocated to products consumers want. Unlike Laser discs.

Price gouging = When sellers raise prices for essential items to a much higher level than is considered reasonable. Toilet tissue.

Price Ceiling = Government sets a max price.

Floor = Minimum price in a specific market. Price is artificially high and above the equilibrium. Corn producers will have incentive to produce more corn, but consumers will look for alternatives, like wheat.

Subsidies = Government payment given to farms designed to offset costs. However, farms can handle price shocks. Subsidies can discourage farmers from innovating.

Accounting profit = Revenue - explicit costs.

1. Companies in competitive markets don't usually make very much profit. Maybe no profit.

1. They must make accounting profit

Costs of production = Variable + Fixed costs.

Fixed Costs can be spread over large units.

Economies of Scale = Companies that produce more can utilize mass production techniques and spread out their fixed costs over many units.

Goal of a business is to make right amount of products that maximize profits.

Marginal revenue = additional revenue earned from selling another unit.

Marginal cost = additional cost of producing another unit.

Sunk cost = a cost that as already been paid and cannot be recovered.

SBA: Steps of Buying a Business

• Guide to Buying a Biz
• Business Definition
• Source

1. Pick a familiar industry.
2. Consider your skills, talents to eliminate unrealistic business ventures.
3. List your conditions of purchase: Location, size, time-commitment, multi-location
4. Look for business in your preferred area
5. Hire a business broker
6. Business with low overhead
7. Business start post Covid
8. Business with best cash flow
9. Business necessary metrics

1. You require a sales agreement to:
2. Buy a business legally.
3. Finalize the purchase of the business.
4. Define everything that you intend to purchase

Questions to Ask When Buying a Business

Source

Get a solid business broker and select a business that you have some experience with.

1. What is the state of the industry in which the business operates? Is the industry in growth mode, or is it mature or in decline?
2. What is the state of the business’s target market? Is its target market growing or shrinking? Are its target customers undergoing demographic changes, such as aging, loss of disposable income, or other transitions that could put the business at risk?
3. Is the business’s customer base growing? Is the business adequately diversified, or is it overly dependent on one or two big customers?
4. How does this business compare to competitors in its industry? How many competitors are there? What are their strengths and weaknesses?
5. What is the state of the region where the business is located? Are people moving into the area or are they moving out? What about businesses? Is the local economy growing or shrinking?
6. What kind of staff does the business have? Do employees have skills that are difficult to find elsewhere? Are their wages average, above average, or below average for the industry? What benefits does the company offer?
7. Is there a lot of turnover at the company? How long have key employees been with the company? Are key personnel likely to stay with the company after a change in ownership?
8. What is the company’s reputation in the industry and the community? Businesses are often up for sale because of problems the owner may try to hide. Go online and ask around in the community to learn as much as you can about the reputation the company has among customers, vendors, and prospects.

5 key metrics

Source

1. Product or Process

You have to be interested in the the service or product (or the combo of both).

2. Business Plan

Look at their business plan. See how their goals align with yours. Their plan should show how the product/process is marketed. In addition, check out how similar companies stack up in sales. If they don't have a business plan but their is potential, then create your own plan.

3. Financial

If the business does not have solid financial documents, walk away. Financial documents are the health of the business.

4. Customers

Know the current customers as well as web-mapping the area with Google map and Trulia. Key metrics: demographics, adjacencies. Then determine: market saturation, or potential growth.

5. Performance and Progress

The efficiency of the business. Workers adequately working? This would reflect in the expense and income columns. Is the owner active, or is there a manager, sub-managers?

5 Key Performance Indicators (KPI)

Source

1. Customer acquisition cost

2. Customer retention rate

Customer retention rate = customers who come back regularly for goods and services High retention rates include: High quality product at a competitive price, customer support, and customer satisfaction.

3. Profit margin

Profit margin = "markup" how much a product or service's revenue exceeds its cost to the business. Business with low margins are vulnerable to drops in sales or poor market share. This will raise concern about long-term sustainability.

4. Overhead

5. Employee turnover

High employee turnover could be a red flag that current management isn’t engaging staff or rewarding strong individual or company performance. If you’re considering a business with high turnover, revamp employee policies.

Property Management 10 (KPI)

1. Properties Won vs Property lost: Property managers need to track how many properties successfully acquired within a year.
2. Occupancy rates: should be 95 to 96% at any given time
3. Average Arrears (debt, money owed to you) can impact a company's cash flow. Always try to minimize arrears
4. Tenant turnover: Unless, you are managing rent controlled properties, it is common for tenants to turn over every year or two.
5. Rent-Ready costs: when a unit turns over, do you know how much it will cost to get the unit in rent-ready condition?
6. Average Days-to-Lease: Each day passes without a resident occupying a unit is money being lost
7. Net-Income: Besides tracking rent, track other revenue streams like washer and dryer costs
8. Repair and maintenance cost: Property maintenance should line up reputable service companies, know specific cost of repair (example: bathroom remodeling)
9. Property management fees usually 8 to 12%
10. Revenue growth

Financial Accounting (Libby, Libby, and Short)

Most companies list assets in order of liquidity or how soon an asset is expected by management to be turned into cash or used. Liabilities are usually listed on the balance sheet in order of maturity (how soon an obligation is to be paid). Managers business decisions often result in transactions that affect the financial statement. Decisions to expand the number of stores, advertise a new product, change and employee benefit package and invest excess cash would affect the financial statement. The decision to purchase additional inventory for cash in anticipation of a major sales will increase inventory and decrease cash. But if there is no demand for additional inventory, the lower cash balance will also reduce the company’s ability to pay its other obligations.

Operating Cycle: The long term objective for any business is to turn cash into more cash. If a company is to stay in business, this excess must be generated from operations that is from activities for which the business was established, not from borrowing money or selling long-lived assets.

Business Operations

Financing, investing, and operating are the three major activities in business operations. Financing deals with the initial startup of the business as well as funding the business throughout its lifetime. When a business owner seeks a loan from a bank or SBA, issues stock to investors, or uses a combination of both, the owner becomes part of the capital market.

Investing has to do with buying tools for a business. Examples: a cash register, machinery, land.

Operating activity takes care of day-to-day operations of a business by selling/creating products, providing services, or both.

Business creates a enormous amount of data. Think of how many sales a single Walmart makes in a day!

Four fundamental financial documents represent this data

Four Statements

The Cash Flow Statement can be likened to the business's checkbook, providing a record over a specific period, unlike the instantaneous snapshot provided by the Balance Sheet. It encompasses transactions from operations, financing, and investing.

Cash, a liquid asset, is represented on the Balance Sheet where Assets = Liabilities + Equity. The term 'liquidity' is used to indicate whether a business is generating cash from its assets or can quickly convert its assets into cash.

It's important to note that cash is not the same as profit. A business can generate cash without making a profit, and a profitable business may not necessarily have a positive cash flow.

When assessing a business, most investors prioritize the Cash Flow Statement over the Income Statement. This allows them to verify if there is a healthy cycle of money entering and exiting the business.

High Profit, Low Cash Flow Businesses:

Software as a Service (SaaS) Companies: These businesses often have high profitability but may experience low cash flow due to the nature of their business model. They incur less expenditure on raw materials than other sectors, which contributes to their high profitability.

Food Trucks: While they can be highly profitable, the cash flow can be inconsistent due to factors like weather, location, and seasonal demand.

Low Profit, High Cash Flow Businesses:

Digital Course Creation: This business can generate a high cash flow as the cost of production is primarily time and expertise. However, the profit margins may be lower due to the competitive nature of the market.

Pressure Washing Business: This business can have high cash flow due to the constant demand for services, but the profit margins may be lower due to operational costs.

Consulting/Coaching: These businesses often have high cash flow due to the demand for services and low overhead costs. However, the profit can be lower due to time constraints and the cost of acquiring new clients.

Vending Machine Services: These businesses can generate high cash flow due to the constant demand for products. However, the profit margins may be lower due to the cost of goods sold, machine maintenance, and location rental fees.

Remember, the profitability and cash flow of a business can vary greatly depending on factors such as location, management, market demand, and more. It’s always a good idea to conduct thorough market research and financial planning before starting a business.

Balance Sheet

The Balance Sheet provides a snapshot of the financial condition of a business at a specific point in time. It measures the business's total assets and the claims or rights to those assets. Remember, the Balance Sheet remains constant over time.

The key equation here is: Assets = Liabilities + Owner Equity.

Balance sheet insolvency occurs when the value of assets is less than the sum of liabilities and owner equity. For instance, consider a house purchased for $200k, now worth $140k. Selling all your assets wouldn't cover the liabilities.

Balance sheet insolvency differs from cash flow insolvency, where a business may have assets but cannot convert them quickly enough to settle bills. This is also referred to as liquidity.

Income Statement

The Income Statement displays the income earned and the costs and expenses associated with earning that income. However, it does not show cash flow, which is detailed in a separate statement.

Earnings Statement

The Retained Earnings Statement reports the accumulated retained earnings at the start of the year, plus any net income added to those earnings. The formula is: Retained Earnings = Previous R.E. + Net Income - Dividends Paid.

It also reports dividends issued to investors, which are cash payments made to shareholders and represent a type of cash outflow.

The Earnings Statement can help determine three things:

1. Whether to distribute some or all money (dividends) to investors.
2. Whether to retain the money within the business.
3. A combination of the above two options.

However, the Retained Earnings Statement does not report what is done with the retained earnings or cash flow. It merely reports the earnings.

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