Monday, February 7, 2011

Early Days

WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK.  FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON

When we left off last post, Best Blogs Ever, Inc. ("BBE") had been organized and the business was started.  It has shareholders, a board of directors, officers and employees.  Now it is time for me to start churning out those blogs which would attract subscribers willing to pay for the privilege of reading my posts.  Either I was right and my blogs will bring in paying subscribers or my blogs will be lost on the Internet, never to be read.

If, after the first year of operation, BBE has not made enough to show a profit after expenses, the shareholders may decide to "throw the bums out" at the next annual meeting and elect a new board of directors to run the company.  In all likelihood, I won't be the blogger-in-chief anymore.  If no money has been made and the $5,000 capital has been used up paying expenses,  the shareholders face a different issue.  They could decide to keep the business going, which means putting more money into the company, or they could vote to dissolve the corporation, sell the assets, pay those proceeds to the corporation's creditors and move on.  Such a vote would be for the liquidation of BBE.  If there is any money left after the assets are sold and all liabilities paid, the shareholders get some money back.  If nothing is left, their investment is lost, worth zero, and that's the end of the story.

On the other hand, let's assume that my blogs have been well received on the Web, and BBE made some money over and above the expenses of the business, a profit.  Gross revenue is the term for all of the money paid by the subscribers to read the blogs.  The goal is for gross revenue to be greater than the rent, payroll, utilities, advertising, computer maintenance and the like.  Once those expenses are deducted from the revenue, the remaining funds are the company's income or earnings.

The shareholders will want to know what the board of directors proposes to do with the earnings for the year.  For purposes of our story and to keep the math simple, let's assume BBE had earnings of $1,000 after the first year.  Remember that the shareholders put in a total of $5,000 of equity or capitalization in the company.  If however, the shareholders had said no to my requests for their money, they might have put that cash into a savings account at a bank and earned some interest on it.  Unless they can get a return on investment, some money back on their stock investment, the bank account might look like the better decision.  To reward the shareholders for buying stock in BBE, the directors could decide to pay some or all of the earnings out to the shareholders.  Since BBE might need some of that money in the future, the directors decide to pay the shareholders a dividend of $1 per share. Since each share was purchased for $10 and a $1 dividend is paid per share, the rate of return on the investment of the shareholders is 10%, which far exceeds the interest rates paid on bank savings accounts these days.  A 10% return should make the shareholders very happy.  For my $1,000 investment, I receive $100 after only one year.  The other shareholders receive the same return, $1 for each share of stock they own.

The rest of the money is kept for future equipment purchases or to pay increased wages or provide a "rainy day" fund for unexpected expenses.  The $500 which is not paid out in dividends is called the company's retained earnings.  Those retained earnings, which are one of the assets of BBE, have increased the value of BBE because the company has additional cash, the $500, in its bank account.  If you add that money to the value of the $5,000 of initial capital, there is now $5,500 of equity shared by the 500 shares.  Technically, each share should now be "worth" $11.
I say technically because a share of stock is only "worth" what someone will pay for it.  It may have an accounting value of $11 but unless someone is willing to buy my shares at a price of $11,  I can not realize the shares "worth".  Another term for that "worth" is book value.  A company's book value is the difference between the assets of the company and its liabilities, what the company owes to third parties, usually loans or obligations to anyone who has extended credit to the company.  So, the first year of operations has been a success.  BBE made money and increased its assets.  From an accounting standpoint, the shareholders' investment has also increased in book value.

We will continue to follow BBE in the next post, picking up some more business terms along the way.

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