7. Expenses 1

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From the course by Indian School of Business

Trading Basics

313 ratings

Indian School of Business

Trading Basics

313 ratings

Course 1 of 5 in the Specialization Trading Strategies in Emerging Markets

The purpose of this course is to equip you with the knowledge required to comprehend the financial statements of a company and understand the various transactions that take place in the stock market so that you can replicate the strategies discovered by the extant academic literature. The first part of the course provides a brief introduction to financial statements and various common filings of firms. You will learn how to obtain information regarding a company's performance from them and use the information to build trading strategies. Next, you are taught basic asset pricing theories so that you will be able to calculate the expected returns of a stock or a portfolio. Finally, you will be introduced to the actual functioning of asset markets, type of players in the market, different types of orders and the efficient ways and opportune time to execute them, trading costs and ways of minimizing them, the concept of liquidity .etc. This knowledge is required to develop efficient algorithm to execute various trading strategies.

From the lesson

Basics of Financial Statements

This module provides a brief introduction to financial statements and various common filings. These are the most important sources for obtaining information regarding a company's performance. Most strategies are indeed based on financial statements. After completing this module you will be able to get the important details from the balance sheets.

1. Introduction to accounting5:28

2. The balance sheet3:37

4. Liabilities5:04

5. Shareholders’ Equity4:56

6. Income Statement4:46

7. Expenses 17:31

8. Expenses 26:42

9. Statement of Cash Flows4:31

10. Cash Flows from Operations9:51

11. Cash Flows from Investments and Financing6:35

Meet the Instructors

Ramabhadran Thirumalai
Assistant Professor
Indian School of Business

[MUSIC]

In this video, we will look at some of the common expenses a company incurs

while generating revenues.

Specifically, we will look at what cost of goods sold is, and

the different types of operating expenses.

We will also present some of the intermediate profit measures

calculated under income statement.

The first expense is cost of goods sold, referred to as COGS, C-O-G-S.

This refers to the direct costs a company incurs,

in generating a warehouse full of goods or products ready to be sold.

This includes raw material costs and direct labor costs,

that go into the production of the final product.

It does not include any distribution costs or sales force costs.

Amazon reports COGS as Cost of Sales.

It had $17.65 billion in cost of sales in 2015.

The annual report notes that this includes the purchase price of consumer products,

digital media content, packaging supplies, sortation and delivery centers.

And related equipments costs, and inbound and outbound shipping costs.

In summary,

it includes all costs Amazon incurs in delivering its products to its customers.

The first profit measure is the gross profit.

This is the difference between the company's revenues and it's COGS.

It tells us how much a company makes in profits after deducting the costs,

directly associated with producing and selling it's product.

Or the cost directly associated with providing services.

Amazon's net sales in 2015 were $107.01 billion,

and it's COGS were $71.65 billion.

Deducting COGS from it's net sales, Amazon's gross profits or

gross income for 2015, were $35.36 billion.

Next, the income statement contains various operating expenses,

which are deducted from the company's gross profits.

The major component of operating expenses is selling, general, and

administrative expenses, referred to as SG&A.

This is a non-production cost, and

typically includes all selling expenses related to selling the company's products.

Like advertising expenses, rent, and salaries of the sales force.

All executive salaries and costs of general support are also part of SG&A.

Finally, any general operating expenses are also included in SG&A.

Under the key component of SG&A, is depreciation and amortization expense.

Remember, we talked about expensing and capitalization last time.

Depreciation and

amortization expense, occurs when the cost of acquiring an asset is

capitalized because the benefits from this asset are realised over a number of years.

Rather than only in one year it was acquired.

The number of years over which the cost of the asset is spread over,

is referred to as it's useful life.

However, one thing to note here

is that unlike other expenses on the income statement.

Depreciation and amortization expense is not an amount that is paid out to someone.

Hence the depreciation and amortization expense is a non cash expense.

Depreciation is the expense related to P, P and D and other fixed assets.

Whereas amortization is the expense related to intangible assets

like goodwill, trademarks, brand names, etc.

On Amazon's income statement, SG&A consists of fulfilment, marketing, and

general and administrative expenses.

Its annual report states that fulfilment primarily includes costs Amazon

incurs in operating and staffing its fulfilment and customer service centers.

As well as its payment processing centers.

For 2015, this was $13.41 billion for Amazon.

Marketing expenses are cost incurred by a company in marketing and

selling it's products and services.

Amazon incurred marketing expenses of $5.25 billion in 2015.

The last part of SG&A is general and administrative expenses.

This includes payroll expenses, professional and

litigation expenses, other corporate costs, as well as depreciation expenses.

Amazon's general and administrative expenses for 2015 were $1.75 billion.

This gives Amazon's total SG&A for 2015 to be $20.41 billion.

However, one thing to note is that Amazon's income statement

does not state its depreciation and amortization expense separately.

It is implicitly captured under the different components of SG&A.

Amazon's statement of cash flows, reports it's depreciation and

amortization expenses to be $6.28 billion for 2015.

Companies incur costs on research and

development in developing new products and services.

This appears as technology expenses on Amazon's income statement for 2015.

Amazon's annual report, states that technology costs include payroll and

related costs for employees.

Involved in application, production, maintenance, operation and

platform development, as well as technology infrastructure expenses.

Amazon also incurred content costs, which include payroll and

related expenses for employees involved in category expansion,

editorial content, buying, and merchandising selection.

These technology and content costs totaled $12.54 billion for Amazon in 2015.

Once we add in the technology and contents costs and other operation

expenses of $0.17 billion to SG&A of $20.41 billion.

Amazon's total operating expenses for 2015 were $33.12 billion.

Subtracting these operating expenses from Amazon's gross profit of $35.6 billion,

gives us Amazon's operating profit in 2015 to be $2.24 billion.

Operating profit is also referred to earnings before interest and taxes.

These are the company's profits before any interest and taxes are paid.

Under the commonly mentioned profit measure is EBITDA, which stands for

earnings before interest, taxes, depreciation, and amortization.

To get this, we will simply add depreciation and

amortization expenses to EBIT.

For Amazon, EBITDA in 2015 was $2.24 billion plus

$6.24 billion, which gives us $8.48 billion.

This is a relevant number, as depreciation and

amortization expenses is a non cash expense.

Hence, this is a more relevant number in terms of profits made by the company.

Next time we will look at the remaining part of the income statement, and

a few other profit measures.

[MUSIC]

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