General accounting
II. 5. Toy manufacturer (part 2)
Video
A first recap: the "assets" of the firm
If we list what the firm has at the end of month 3 we get this:
- 7000 € at the bank
- 1000 toys ready for sale
- no more raw materials (suppose the initial purchase covered precisely the 3000 toys produced)
- a used van
- a mechanical saw
- some office equipement
- and a piece of paper from Carrefour promising a payment of 20 000€ in a month and a half.
If we want to be complete, we also have three months of rent paid in advance.
Other assets?
We could also say that we have other things in this firm:
- we have a know-how
- we have operations which run (we can produce objects and generate sales and profit)
- we begin to have a reputation, a good name
- etc
None of this however will be taken into account in general accounting.
There is an exception to this last point: if we sell our firm A to another firm B, and B pays for A more than "A's value as shown in its books", the difference will correspond to the points listed above (as well as to a possible synergy between the activities of B and of A, see next section, third paragraph), and will be accounted for in B's accounts as "goodwill".
Value of a firm
A firm is more than the collection of its elements. By this we mean that it is a "machine" which works and, when it's well tuned, which creates value.
Somebody else may buy this firm for way more than the sum of the values listed in the asset recap above, even if it has no relationship with his or her other activities, that is even if it is a "standalone" acquisition.
When the acquired firm has synergies with the other activities of the buyer, it is yet another story. When A is somehow a key to a treasure chest which B has, B may pay an apparently preposterous sum compared to the economic and financial figures of A. Remember eBay, in the Fall of 2005, which purchased Skype (then 3 years old, a few million dollars of revenues, only losses), for $2.6 billions.
This price was in fact reasonable. It is not the place here to explain the financial calculations, which eBay made, leading to this price. Let's just notice, once again, that when you own a treasury locked in a trunk, and somebody else owns the key, you are ready to pay for the key much more than the cost of metal and labor that were necessary to make the key.
Valuation of stocks
Notice that we did not compute any value for the stock of finished goods. It is less, hopefully, for us than the 10 € per toy at which we sell them.
When we buy raw materials or intermediate goods going into our own final goods or even sold as is, there is a problem of stock valuation (if we purchase several times the same things at different prices). We shall study the famous LIFO, FIFO, and other methods to assign a value (for us) to this stock of goods.
Last steps
17) At the end of month 3, say after the above recap, we purchase raw materials: 1000 €. At the end of month 4 we pay various expenditures 1500 €. And we have to pay the salaries 6000 €. But we only have 4500 € at the bank, so we pay the two employees, and the boss will wait. At the bank we are down to 500 €. We shall wait until Carrefour's check to purchase more raw materials, and to pay with a delay the boss salary.
18) We receive the payment from Carrefour: 20 000 €, in cash or put one way or another in our bank account.
And life goes on, because the firm is a "going concern".
Unlike a project, like building a bridge, with a beginning date and an ending date, a "going concern" has no end date.
