🏪 The Lemonade Stand That Wanted to Grow Up
A story about measuring success, finding balance, and using smart borrowing
The Big Picture: What is Business Performance?
Imagine you have a lemonade stand. Every day, you sell cups of lemonade. But how do you know if your stand is really doing well?
Just counting money isn’t enough. You need special tools to measure if:
- You’re actually creating value (not just moving money around)
- You’re selling enough to cover your costs
- You’re using your resources wisely
- You’re borrowing money smartly
Let’s learn these four superpowers! 🦸
🎯 1. Economic Value Added (EVA)
“Are you REALLY making money, or just pretending?”
The Story
Little Maya runs a lemonade stand. She made $100 profit this summer!
But wait… Maya’s dad gave her $500 to start the business. That money could have been in a savings account earning 10% interest ($50).
The big question: Did Maya really create value, or did she just do worse than a savings account?
The Magic Formula
EVA = Profit After Tax − (Capital × Cost of Capital)
Think of it like this:
EVA = What You Earned − What You COULD Have Earned Elsewhere
Maya’s Calculation
| What | Amount |
|---|---|
| Maya’s Profit | $100 |
| Dad’s Investment | $500 |
| What savings account would pay (10%) | $50 |
| EVA | $100 − $50 = $50 |
Maya created $50 of REAL value! 🎉
If her profit was only $40, her EVA would be negative ($40 − $50 = −$10). That means she destroyed value—dad’s money was better off in the bank!
Why EVA Matters
graph TD A["Profit looks good!"] --> B{Calculate EVA} B --> C["EVA Positive ✅"] B --> D["EVA Negative ❌"] C --> E[You're creating<br>REAL value!] D --> F["Money was better<br>off elsewhere"]
Simple Example
A toy company makes $1 million profit. They used $8 million of investors’ money. Investors expect 15% return.
- Cost of Capital: $8M × 15% = $1.2 million
- EVA: $1M − $1.2M = −$200,000
Even with a million dollars profit, they’re destroying value! 😱
⚖️ 2. Break-Even Analysis
“How much do I need to sell just to NOT lose money?”
The Story
Tommy opens a cookie shop. He pays:
- $300/month for the shop (rent) — he pays this no matter what
- $1 for ingredients per cookie — only when he makes cookies
- He sells each cookie for $4
The big question: How many cookies does Tommy need to sell to break even (not make money, not lose money)?
Two Types of Costs
| Fixed Costs 🏠 | Variable Costs 🍪 |
|---|---|
| Stay the same no matter what | Change with each sale |
| Rent, salaries, insurance | Ingredients, packaging |
| Tommy: $300/month | Tommy: $1 per cookie |
The Magic Formula
Break-Even Point = Fixed Costs ÷ (Price − Variable Cost)
The (Price − Variable Cost) part is called Contribution Margin — how much each sale contributes to paying off fixed costs.
Tommy’s Calculation
| What | Amount |
|---|---|
| Fixed Costs | $300 |
| Price per cookie | $4 |
| Variable cost per cookie | $1 |
| Contribution Margin | $4 − $1 = $3 |
| Break-Even | $300 ÷ $3 = 100 cookies |
Tommy must sell 100 cookies to break even!
graph TD A["Sell 99 cookies"] --> B["😢 LOSS"] C["Sell 100 cookies"] --> D["😐 Break Even"] E["Sell 101+ cookies"] --> F["🎉 PROFIT!"]
Why Break-Even Matters
- Below break-even: You’re losing money every day
- At break-even: You’re surviving (but not thriving)
- Above break-even: Every extra sale is pure profit!
Simple Example
A phone case seller:
- Fixed costs: $1,000/month (website, ads)
- Variable cost: $5 per case
- Selling price: $25 per case
- Contribution margin: $25 − $5 = $20
- Break-even: $1,000 ÷ $20 = 50 cases
Sell 50 cases = survive. Sell 100 cases = make $1,000 profit!
🎢 3. Operating Leverage
“How risky is your business structure?”
The Story
Two friends start pizza businesses:
🤖 Robot Rita buys expensive pizza-making robots ($10,000/month). Making each pizza costs only $2.
👨🍳 Manual Mike hires workers to make pizzas by hand (only $2,000/month fixed). But each pizza costs $8 in labor.
Both sell pizza for $12.
Who Has Higher Operating Leverage?
Operating Leverage = How much of your costs are FIXED
| Robot Rita | Manual Mike | |
|---|---|---|
| Fixed Costs | $10,000 HIGH | $2,000 LOW |
| Variable Cost/pizza | $2 LOW | $8 HIGH |
| Operating Leverage | HIGH | LOW |
The Magic Formula
Degree of Operating Leverage (DOL) =
Contribution Margin ÷ Operating Income
Or think of it as:
DOL = % Change in Profit ÷ % Change in Sales
When Sales Go UP 📈
Let’s say both sell 2,000 pizzas:
Robot Rita:
- Revenue: 2,000 × $12 = $24,000
- Variable: 2,000 × $2 = $4,000
- Fixed: $10,000
- Profit: $10,000
Manual Mike:
- Revenue: 2,000 × $12 = $24,000
- Variable: 2,000 × $8 = $16,000
- Fixed: $2,000
- Profit: $6,000
Now sales INCREASE by 50% to 3,000 pizzas:
| Rita | Mike | |
|---|---|---|
| New Profit | $20,000 | $10,000 |
| Profit Increase | 100%! | 67% |
Rita’s profit doubled while Mike’s only went up 67%!
When Sales Go DOWN 📉
Sales DROP by 50% to 1,000 pizzas:
| Rita | Mike | |
|---|---|---|
| New Profit | $0 😰 | $2,000 |
| Profit Change | −100%! | −67% |
Rita is at break-even, Mike still makes money!
graph TD A["High Operating Leverage"] --> B["🚀 Big wins when sales UP"] A --> C["💥 Big losses when sales DOWN"] D["Low Operating Leverage"] --> E["📊 Steady, smaller changes"]
The Lesson
High Operating Leverage = High risk, high reward (like a roller coaster 🎢)
Low Operating Leverage = Steady and safe (like a merry-go-round 🎠)
💰 4. Financial Leverage
“Borrowing money to make MORE money (but be careful!)”
The Story
Two ice cream shops want to expand. Each needs $100,000.
🏦 Borrowing Betty takes a $80,000 loan (pays 10% interest = $8,000/year). Uses only $20,000 of her own money.
💵 Cash Charlie uses $100,000 of his own savings. No loans, no interest.
Both shops make $20,000 profit before interest.
Who Gets a Better Return on THEIR Money?
Borrowing Betty:
- Profit: $20,000
- Minus interest: $8,000
- Net profit: $12,000
- Her investment: $20,000
- Return: 60%! 🚀
Cash Charlie:
- Profit: $20,000
- No interest
- Net profit: $20,000
- His investment: $100,000
- Return: 20%
Betty made 3x the return on her money by borrowing!
The Magic Formula
Degree of Financial Leverage (DFL) =
EBIT ÷ (EBIT − Interest)
Where EBIT = Earnings Before Interest and Taxes
The Dark Side of Borrowing 🌑
What if the shop only makes $5,000?
Borrowing Betty:
- Profit: $5,000
- Minus interest: $8,000
- Net loss: −$3,000 😱
- She STILL owes interest!
Cash Charlie:
- Profit: $5,000
- Still positive! ✅
graph TD A["Financial Leverage<br>Using Debt"] --> B{Business does WELL?} B --> C["YES 📈"] B --> D["NO 📉"] C --> E["Returns MULTIPLY!<br>Shareholders happy"] D --> F["Losses MULTIPLY!<br>Still owe interest"]
The Debt-Equity Balance
| Low Debt | High Debt |
|---|---|
| Safer | Riskier |
| Lower returns | Higher potential returns |
| Survive bad times | Struggle in bad times |
| Own more of your profits | Pay a lot in interest |
Simple Example
Two companies, same $500,000 in assets:
| Safe Sally | Risky Ryan | |
|---|---|---|
| Debt | $100,000 | $400,000 |
| Equity (own money) | $400,000 | $100,000 |
| Interest (10%) | $10,000 | $40,000 |
If both make $60,000 profit (before interest):
Safe Sally: ($60,000 − $10,000) ÷ $400,000 = 12.5% return
Risky Ryan: ($60,000 − $40,000) ÷ $100,000 = 20% return
Ryan gets higher returns… but if profits drop to $30,000, Sally still makes money while Ryan loses money!
🎁 Putting It All Together
| Tool | Question It Answers | Key Insight |
|---|---|---|
| EVA | Am I creating REAL value? | Profit minus opportunity cost |
| Break-Even | How much must I sell to survive? | Fixed costs ÷ contribution margin |
| Operating Leverage | How risky is my cost structure? | More fixed costs = more risk/reward |
| Financial Leverage | Am I borrowing wisely? | Debt amplifies gains AND losses |
The Golden Rules
- EVA Positive = You’re truly creating wealth
- Know Your Break-Even = Understand your survival point
- Balance Operating Leverage = Match risk to your stability
- Use Financial Leverage Carefully = Debt is a powerful but dangerous tool
🌟 You Did It!
You now understand the four superpowers of business performance:
✅ EVA tells you if you’re really making value ✅ Break-Even shows your survival number ✅ Operating Leverage reveals your risk from fixed costs ✅ Financial Leverage shows your risk from debt
These aren’t just formulas—they’re the secret language that successful business owners speak. Now you speak it too! 🎓
Remember: A smart business owner looks at ALL FOUR measures to make great decisions.