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PostPosted: Fri Sep 26, 2008 9:31 am 

Joined: Jun 27, 2008
Posts: 313
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Managing Your Business, Lesson 3:
Which Business is Best?

Today I'm going to change format a bit. I didn't plan to, it's just that no famous people called with convenient problems that happen to be on topic. (Off-topic questions aplenty, but I digress enough as it is.)

Allow me to introduce a very important term: ROI

ROI = Return On Investment

We are going to use a little math, but this is easy for anyone to learn. And to help by asking relevant questions, allow me to introduce my assistant, Faquey the Questioner. Say "hi," Faquey.

(°¿°) Faquey: Why would I do that?

That's helpful, thanks. :doh: OK let's get to it.

(°¿°) Faquey: Wait, before we start, what should I know first?

Good question! ROI is about comparing choices to find the best one. Before you can learn that though, you should be familiar with these lessons:

Mind Your Business 1: Should Bill Gates cut his own lawn?
If you think it's always best to do everything yourself, you need to read this!

Mind Your Business 2: The Apple Forest or the Apple Tree?
How to analyze part of your business, not just the whole company.

If you haven't read those, you should at least give them a quick glance because what we cover here is based on knowing those subjects. They are very quick and easy reads, I promise!

(°¿°) Faquey: Do you get paid when you shill for your own posts?

Of course not, I'm just pointing it out.

(°¿°) Faquey: Yeah, right. Kaching!

Quiet, you.

OK let's start by talking about interest rates.

(°¿°) Faquey: Like at a bank?

Exactly. Suppose you walk into the bank and they have two basic accounts for you. They are the same except for the interest they pay.

Plan A) You give us β1000 and we give you β50 every day.
Plan B) You give us β1000 and we give you β75 every day.

Which do you take?

(°¿°) Faquey: What am I, an idiot? Kind of a stupid question Knolls.

Alright, alright. We'd all take B I presume, it give you more money back without needing more from you.

What if it gets more complicated? What if the choices are like this:

Plan C) You give us β3000 and we give you β180 every day.
Plan D) You give us β1000 and we give you β75 every day.

Which do you take?

(°¿°) Faquey: They're both good offers!

Hey, I thought you only spoke in questions?

(°¿°) Faquey: Who told you that?

Nevermind. OK both of those might be good offers. But the goal here is to pick which is better. One gives more, but it also requires more. So we just divide to figure out the percentage.

Plan C) 180 / 3000 = 6%
Plan D) 75 / 1000 = 7.5%

Now it's easy. Plan D gives the higher rate.

To look at that another way, what if I just bought three of Plan D?

Plan C) β3000 in, β180 out.
Plan D) β1000 + β1000 + β1000 in, β75 + β75 + β75 out. (Which equals β225 out.)

When the numbers get weird it's easier to use percentages, which is what we'll do from here out. But remember that if a smaller deal gives a better rate, you can just buy more to get the better reward.

OK, so I know what question you're all thinking.

(°¿°) Faquey: Are you drunk?

No the other question you're all thinking.

(°¿°) Faquey: What does this have to do with Simunomics?

The important thing is that we are going for the best payment, the best Return we can get for the money that we Invest. It's obvious that you want to get 7.5% from a bank instead of 6%, right? Well when you are choosing between two products lines here, one of them is going to be more profitable than the other. All we need to do is figure out which one.

Let's start with Corn, and figure out what the Return On Investment is.
Corn:
Market Value of Inputs: β 1.00
Production Cost: β 0.20
Market Value of Finished Corn: β 3.00

Well clearly the profit is β 1.80 on that corn. And then we also know that a basic (Standard land, 100 ft) property will produce 4744.5 Corn per day. Therefore, that building can provide a total of β 8540.10 profit a day.

Notice that I used the market value of the inputs, because it doesn't matter if I made them myself or not.

(°¿°) Faquey: Another link? I knew it. Kaching!

You know I could replace you with a different figment of my imagination. . .

(°¿°) Faquey: Sorry! Ok, here's a real question. You said we need two numbers for each offer. There's only one there. What gives?

Now you're talking. That number - β 8540.10 profit- is what we get. But we also have to know what we give - in other words, Building Cost.

That basic farm costs β 102,000. So to find the rate of return:

8540.1 / 102,000 = 8.37%

And that's it! Just like at the bank, this is the rate you get for the money you put in. You get a β 8540.10 return on a β 102,000 investment. So 8.37% is the "Return on Investment" or ROI. And just like at the bank, a higher number is better.

(°¿°) Faquey: What if I don't like percents?

Well you can get an equally valuable answer just by flipping it over. Like this:

β 102,000 spent
β 8540.1 a day earned

102,000 / 8540.1 = 11.9 days

This is called the Payback Period. It tells you the same thing, in a way. You could say that you earn 8.37% back a day. Or you could say that you get paid back all the money you spent in 11.9 days. Both mean the same thing, as long as you are clear. With the ROI percentage, a higher number is better (more money every day). With the Payback period, a lower number is better (fewer days to get your money back). But either way is just as useful.

(°¿°) Faquey: Sounds easy enough. Isn't it time for a big dramatic question, or are you not doing that this lesson?

Why yes it is! Here are two products and some figures to use for them:

Blankets
Market Value of Inputs: β 100.00
Production Cost: β 6.00
Market Value of Finished Blankets: β 406.00
Produced per day: β 83.07
Cost of Blanket Facyory: β 158,000

Car
Market Value of Inputs: β 10,000
Production Cost: β 3500
Market Value of Finished Car: β 25,000
Produced per day: β 1.04
Cost of Car Factory: β 185,000

The Question

Which of these two products is better? And how do they compare to Corn? Answer for yourself, then scroll down to part 2 for the answer.

(°¿°) Faquey: dun dun DUN!!!!

_________________
The Guide to Managing your Simunomics Business:
Lesson 1: Should Bill Gates cut his own lawn?
Lesson 2: The Apple Forest or the Apple Tree?
Lesson 3: Which Business is Best?
Lesson 7: All is Well - Advantage Mine or Raw Deal?
Lesson 8: The Art of the Business of War


Last edited by Knolls on Thu Oct 09, 2008 1:17 am, edited 1 time in total.

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PostPosted: Fri Sep 26, 2008 9:32 am 

Joined: Jun 27, 2008
Posts: 313
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(°¿°) Faquey: Was that little gap really necessary?

Well some people like to answer the question for themselves. As they should, it's not much effort to make sure you understand the concept. And putting some space between sections lets me hid the answer a bit lower. That's actually why I'm still talking, to push it down just a little further on the page.

(°¿°) Faquey: So what's the answer?

The Answer

Blankets:
406 - 6 - 100 = 300 profit each.
300 * 83.07 = β 24,921 profit a day
24,921 / 158,000 = 15.7% return each day
OR
158,000 / 24,921 = 6.34 days to get paid back

Car:
25,000 - 3500 - 10,000 = β 11,500 profit each
11,500 * 1.04 = 11,960 profit a day
11,960 / 185,000 = 6.46% return each day
OR
185,000 / 11,960 = 15.5 days to get paid back

So the correct answer is:
Best: Blankets
Middle: Corn
Worst: Car

(°¿°) Faquey: So why didn't you just say "make Blankets"?

Well first of all, that's not the point. And second, the market prices can always move and when they do, the "best product" answer changes. But with this method you can always figure that out for yourself. And a lot more besides.

(°¿°) Faquey: What else should we know?

Well I cheated a little bit.

(°¿°) Faquey: Typical.

To make it easier. Back where we listed costs? Those are only the cash costs. Building also requires pipes, glass, bricks, and wood. So you should really include the price of those items as well. Add the cost of those to the building cost. (I think it's roughly β 50,000 for all but that too will vary.)

Some people might even want to include the cost of one day's production materials and costs. This is because you need to spend those up front too before you make any profit. The more of this information you include, the more accurate your conclusion will be. But what we did is enough to clue you in if something is really good or bad.

(°¿°) Faquey: OK, so what do I do with this? Do you expect us to do this for every product in Simunomics? And once for each city? And repeat it every few weeks in case the market changes?

No.

I mean you could. The information is readily available, and market prices are pretty easy to get. But I don't think that's necessary. Simunomics has a feature called the Product Advisor, and it will automatically create a recommendation for what products to pick in each city. I have looked at it a bit and it seems to make pretty good recommendations. So if you want to pick a new product, I would look there and see if any of the suggestions caught my eye.

But there may be times when you think to yourself "I wonder which of these products is more profitable?" Maybe you have two business lines and have decided to focus on one. Or maybe you picked a business a while ago and feel like it's slowing down, so you want to check. ROI is the method to use anytime you want to check profits.

(°¿°) Faquey: Is that ...

But wait, that's not all!

(°¿°) Faquey: You couldn't let me ask that?

Sorry. But it's true, ROI is useful for comparing the profitablity of anything! Not just factories with different products. Anything at all.

(°¿°) Faquey: Stores?

Absolutely. We'll cover that in a future lesson - because first we need to learn about pricing. But you can definitely use ROI or Payback Period to compare stores with each other, or with the factories or farms that supply them.

But you could also compare a product with itself.

(°¿°) Faquey: What you talkin' 'bout Knolls?

A Gary Coleman reference?

(°¿°) Faquey: Sure, why not?

Yeah. Um... Anyway, one obvious way would be to compare between two cities. You could check if blankets were more profitable in Abalesk or Bellerive, and focus your next expansion there. But there's something even less obvious. Perhaps a question you've wondered when starting a new construction?

(°¿°) Faquey: Why is it called a "building" after it's finished? Shouldn't it be called a "built"?

You are no help whatsoever.

I meant the special lands - Industrial Centers, Soil Belt, etc. In the examples above we only used Standard land. But the costs and profits are different for each type. So we could pick any product, and then compare two potential builds to see which gives the better ROI. That would let us know if a special land was worth the extra cost or not.

(°¿°) Faquey: Let me guess - future lesson?

Yup. :grin:


Last edited by Knolls on Fri Oct 17, 2008 1:42 am, edited 4 times in total.

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PostPosted: Fri Sep 26, 2008 9:33 am 

Joined: Jun 27, 2008
Posts: 313
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The Lesson to Take Away

(°¿°) Faquey: This is where you introduce some new cool buzzwords for us right? You say we should reenvision our paradigm outside the box or something.

Something like that. Only this time we don't have to, because we've been using it all along. ROI is a very real, very important term that gets used wherever financing is discussed.

Whenever money is spent on a new project, you can be sure the Return on Investment will be discussed. If it's an expanded product line, a new store, or an ad campaign, there will be a direct connection: "We will spend X and make Y." But you can also use it regarding savings: "If we replace all our current windows with energy-efficient ones, it will cost $20,000 now. But we'll save $6000 a year in energy bills. So it will pay back in 3.3 years."

(°¿°) Faquey: What about something where the income isn't steady? Like you spend β10k now and make β2k the first year, β6k the second year, and β8k every year after that?

That definitely happens. In this case you could probably guess for yourself one way to handle that. Your payback period is the first two years, and a quarter of the third, or 2.25 years. That's not a perfect answer but sometimes it's good enough.

However, you bring up a very good subject.

The Time Value of Money

Let's consider this $100 dollar bill that I'm going to borrow.

(°¿°) Faquey: That looks like ... hey, that's my wallet!

Right. Now would you like to get this $100 back tomorrow, or next year?

(°¿°) Faquey: I want it back right now. Seriously, hand it over.

Of course you want it now. Because you have so many more options, because you can invest it in something else, because prices might go up on things you want to buy ...

(°¿°) Faquey: Because you're a deadbeat and I don't trust you...

Right! The borrower might "default" and not be able to pay you back. All of those things mean that a dollar is worth more today than the same dollar will be a year from now.

So when you consider an investment, you have to think about not just the total amount of money coming out, but when. This is especially true for an investment that will pay off for a while and then stop.

ROI then leads us to one...

(°¿°) Faquey: Hey, example over. Pay up.

Fine. As I was saying, ROI then leads us to one other term:

Discount Rate

Discount rate is very important when talking about the time value of money, which often comes in with major investments. But for now, let's just say it means "The lowest ROI you will accept."

Suppose a Simunomics bank pops up, and tells you that you can earn 2% a day by depositing money. Any day, as much as you want. That will become your "discount rate" because you now know that you can always do that. And any investment you can make will get compared to that. If it's worse, then you simply pass.

I hope this was helpful to people. If any questions arise Faquey and I will be here to answer them.

(°¿°) Faquey: Nobody's listening anymore.

As I was saying, I'll be here by myself to answer them.

_________________
The Guide to Managing your Simunomics Business:
Lesson 1: Should Bill Gates cut his own lawn?
Lesson 2: The Apple Forest or the Apple Tree?
Lesson 3: Which Business is Best?
Lesson 7: All is Well - Advantage Mine or Raw Deal?
Lesson 8: The Art of the Business of War


Last edited by Knolls on Fri Oct 17, 2008 2:24 am, edited 3 times in total.

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PostPosted: Fri Sep 26, 2008 11:02 pm 

Joined: Jun 26, 2008
Posts: 1090
Location: Sydney, Nova Scotia (Canada)
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Stupid Faquey :eyeroll:


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PostPosted: Fri Oct 17, 2008 5:47 am 

Joined: Oct 17, 2008
Posts: 705
Location: Ottawa Ontario, Canada
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User avatarCanadian Productions
Simunomics Sponsor
lmao great information in a humourous way Knolls, Awsome work :)


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PostPosted: Thu Dec 24, 2009 1:17 am 

Joined: Dec 15, 2009
Posts: 90
Location: Right here...or is it over there?
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I really enjoy reading your lessons. Please keep them up.

_________________
If at first you don't succeed, you're running about average. —
If at first you do succeed, try to hide your astonishment. —

Quote:
I have to complement the Devs on what they have accomplished, not what they haven't. Nice job creating Simunomics!


:panic: Weeeeeeeeeeeeeeeeeeeeeeeeeeeeeee!


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