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principles of finance a la shmoop. balance sheet. okay so we're gonna add on

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a bit of complexity to our proverbial lemonade stand image here. first we're [man sits in front of white board]

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gonna think about our cash. how was the company started? well it got a loan five

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grand from Grandma.com. she didn't want to charge us interest but our parents

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made her. their real life matters kind of parents. so she charged us ten percent

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interest or five hundred bucks a year. for as long as we were renting that five

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grand. well at the end of our first year we have a financial decision to make. do

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we want to pay off the loan fully? or spend our six grand in after-tax cash

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profits on building a second lemonade stand? [equation]

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well our gut will tell us which way is most profitable risk-adjusted and that's

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what we'll do. well let's go back and restate our income statement to include

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the interest we owe on the five grand we borrowed. and there we go so a couple of

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interesting things to notice here. we added five hundred bucks in expenses via

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actually accounting for our loan to start the company. well before we had

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added that in we had six grand in net profits so it would be rational to think

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that we've just added five hundred bucks in expenses and now our new net profits

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number should be fifty five hundred but it's not. it's better than that. why ? taxes.

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yeah that 500 bucks came before the government took its 25% bite out of us.

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well essentially the government paid for a quarter of our interest expense. hmm

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how's that work? and you can imagine that in very high tax situations the [cost spreadsheet shown]

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incentive to borrow more money is much higher because the government

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essentially covers a lot of those expenses in the form of your being able

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to deduct the interest expense on the money the money you borrow against the

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taxes you'd be paying on your profits. all right another interesting thing to

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note here was that we generated five thousand six hundred twenty-five dollars

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in cash during the year. our interest expense was five hundred dollars. we

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generated way more cash than we had in interest expense meaning that our

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bankruptcy risk here is very low. which is good. we wonder to ourselves so

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how much money could I borrow if we wanted to go big with lemonade stands

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R US. lemonade stand on every corner in the country .okay and so doing a little [boy celebrates in front of lemonade stand]

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bit amusing on the math here like if our interest rate was 10 percent we're

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generating with one stand over five grand in cash well couldn't we borrow

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ten times that number of fifty grand? if we did a 50 grand borrow that'd be about

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five thousand dollars in interest we'd still have more profits than interest.

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how much would it cost to launch a new additional stand would that stand

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cannibalize revenues from our first stand. mmm could we buy supplies cheaper

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if we had more scale or size? how many licks does it really take to get the

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center of line? oh never mind. okay so we wonder about

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the ratios here that go behind debt. largely revolving around how much debt

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could we borrow if we wanted to max out. well we know that banks focus on an

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arcane term called EBITDA when they loan money. side note if we ever get a

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large dog at shmoop we're gonna name him gonna EBITDA. well what is EBITDA anyway?

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well it stands for earnings before interest taxes depreciation and

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amortization and in our case here we'd calculate our EBITDA is our earnings of

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five thousand six hundred twenty-five dollars but then we'd add back interest

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of five hundred bucks and taxes of 1875. we don't have any assets. [EBITDA explained]

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we're depreciating or amortized so that totals 8 grand and EBITDA. and we use

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EBITDA to get rid of non apples-to-apples things like taxes and

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interest which can change a lot over time with interest rates moving in taxes

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being different different states different countries and so on. we do this

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so that we have a clearer picture of the basic operating health of the company.

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and it's often quoted as a multiple by banks when they think about appropriate

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levels for loaning money in the form of a debt to EBITDA ratio. and a ratio of four

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is often about as high as low risk seeking bank will ever want to. go four

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times debt to EBITDA and that would mean that without paying enormous

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interest costs lemonade stands our us could get a loan of about 32 grand give [man explains in front of a lemonade stand]

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or take. that's four times that $8,000 they

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or EBITDA. so for a moment let's think about maxing out our loans. if we

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found a bank stupid enough or visionary enough to trust us with a loan for 32

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grand and they charged us 10% interest amazingly well we can still make the

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interest payment. the bigger question is could we then use the 32 grand to open

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up say six more lemonade stands at a cost of five grand each ? and still have

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two grand left over for whatever. all right well at first blush our

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projections say yes . and if each of those six stands could themselves generate

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something like five grand a profit at the end of their first year like the

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first one did well then wow we could pay back all of the loans in just one year. [equation]

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and hmm that feels a lot like how Starbucks got started.

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