Lecture 06: Understanding profit and loss from a cost perspective

Cost is the greatest price given up. The more things you give up, the higher the price; the fewer things you give up, the lower the price. If there is no abandonment, there is no cost.

For example, if we go to the post office with a dollar to buy a stamp, buy it, assuming that we can take it to the post office at any time to change back to money, and then assume that we run to the post office to change the toss of money is not considered a toss, ignored. In that case, what is the cost of buying a stamp for one dollar? The cost is zero. Because you have not given up anything, you can always change the money back.

To change the example, we go to a fast food restaurant and buy a hamburger, then take the first bite. So how much did it cost you to take that first bite, and can the hamburger still be sold? It won't sell, probably not even a penny. At this point, the cost of your first bite is almost equal to the cost of the entire hamburger. If you eat this bite, you will hamburger for money back the opportunity to completely wipe out.

Another example, is if I buy a new car back, a new car on the road, driving for six months, the cost of using this six months, you say high or low?

The cost of using this half year is equivalent to the price of a new car, minus the selling price of the used car after six months of use. The price difference is very high, so when the new car starts, its cost of use is particularly high. When the car is almost used, quite old, more than half a year less than half a year are about the same time, the car's cost of use but down.

Another example, I bought a bowl in the street, and spent 10 yuan, ready to use for dinner. After I bought it, I found out that this bowl was once used by Emperor Qianlong, and now the market value is 100,000 yuan. So, will it cost me $10 or $100,000 to continue eating with this bowl? The answer, of course, is 100,000. Because the biggest price I give up is the income that this bowl can earn back by being sent to the museum and attracting tourists.

In other words, the moment we learned that this bowl was not an ordinary bowl, but a precious antique, we gained profit. Any profit is an accident, called windfall profit in English, which can be translated as "cross-wealth". Windfall profit happens the moment you realize that the value of the product is different from what you expected.

From this moment on, the value of the product has changed. The cost of your continued use of this product has to be estimated at the new value. Earning a profit is just a momentary thing. Once you earn a profit, this bowl becomes a different resource, a different kind of resource, and it brings a different kind of service in the future.

If you then use this bowl for other purposes, then the biggest price you give up is to use its future higher income as a benchmark. That is, you continue to take this bowl to eat, to use the level of income it earns in the museum as a calculation now. So, profit raises the cost of future use of the resource.

2. Losing money lowers the cost of using the resource

Let's reverse this example. I go to an antique store and pay $100,000 for a bowl that I believe was used by the Qianlong emperor. When I get home, I realize it's a fake, an ordinary bowl, worth only $10. So, I take this bowl to eat, does it cost 10 dollars or 100,000 dollars? The answer is $10.

Of course, I lost money and was cheated. I suffered a loss, but only for a moment. I readjusted my expectations for the bowl. At this moment, in this moment of suffering a loss, the loss is unexpected, is not imagined, expected, the English called windfall loss, and the Chinese can be translated as "horizontal disaster".

Once the loss is suffered, we will revalue the resource, and the maximum cost of continuing to use the resource will be estimated at the current valuation level of the resource. So I take this bowl to eat, the cost is not 100,000, but 10 dollars. That is, a loss reduces the cost of future use of the resource.

Both profits and losses, in the concept of economics, happen by accident. Economics cannot accommodate the concepts of profit and loss; we treat them both as accidents.

Whenever an accident occurs, we readjust the future valuation of the resource, and once the future valuation of the resource is readjusted, then the cost of using the resource is calculated according to this new valuation. So, once there is a profit, the cost of using the resource will increase; once there is a loss, the cost of using the resource will decrease.   

3. revaluation is not difficult, the difficult part is to find out the reasons for profit or loss

In real life, the difficult part is that you have to find the resources that bring losses or bring profits. Because in real life, all the resources it is combined into one piece of use.

Let's say a cafe makes money, then it makes money the moment there is a profit, this profit is of course unexpected. With this profit, we have to re-adjust the valuation of the whole cafe, it is valued higher.

This is not difficult to understand, but what is difficult about it? The difficulty is that the cafe is composed of a set of resources, we can not figure out, in this set of resources, at the end by which resources to bring "windfall", that is, profit, we have to find it out.

The reverse is also true. If a cafe is losing money, then we have to revalue the cafe, no problem. The hard part is to find out what resources are causing the loss of the cafe.

In general, in real life, it's not hard to revalue resources, but you have to find them. Whether to "attribute" or "blame", these two processes are difficult.

Let's say a cafe is making money, what exactly makes it profitable?

If the attitude of the waiter is particularly good, the service quality of the waiter will be appreciated, and therefore the cost will increase. Why? Because if we do not pay higher wages to these good waiters, we can not keep them.

It is also possible that the coffee shop is making money because the quality of the coffee beans is particularly good. This is when we have to reevaluate the value of the coffee beans and we have to compete for these better quality beans in the market.

It is also possible that the location was chosen correctly, at this point, we have to revalue the talent of those managers who are responsible for the location, and pay a higher price for their location talent.

It could also be due to a chain reaction, due to economies of scale. Your cafe is all over town and people recognize it, which increases your brand effect. If this is the factor that causes you to make a profit, then you may have to increase your investment and give your investors a higher return, thus raising more money to open more stores.

Of course, the reverse is also true. If the cafes are suffering losses, you have to find out what is causing the losses, lower the valuation of them and pay less for them. As for how to make reasonable attribution and blame in a team, company, or business with a set of resources, we'll stop there today and we'll go into more detail later in the course.