The FaceBook Future Revenues-Profits Analysis

Summary
The financial data analyzed here was obtained from the Registration Statement filed by Facebook, Inc., with the United States Securities and Exchange Commission (Form S-1), on February 1, 2012, see brief extract on page 3 here. The analysis developed here reveals a remarkably simple linear relationship between revenues and profits when we consider either the quarterly data (for the eight quarters beginning with the quarter ending March 31, 2010) or the annualized data (beginning with 2007, with negative profits for 2 of these 5 years).

The linear relationship can be expressed as y = hx + c where x is revenues and y is profits and h and c are constants which can be deduced using the well-known classical linear regression analysis (also known as least squares regression or the best-fit line prediction). The results can be expressed as follows. Quarterly data: y = hx + c = 0.329x 5.94 Annual data: y = hx + c = 0.315x 109.03
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The noteworthy feature is the nearly same value of the constant h obtained by considering both the quarterly and annualized revenues-profits data. This means that, for Facebook, Inc., a fixed increase in revenues always produces the same fixed increase in the profits. If revenues increase by $100 million, Facebook Inc. will report an increase in profits of about $32 million. This is NOT likely to change significantly in the near future. Hence, the future profitability of Facebook, Inc. will be closely tied to its revenue-enhancement efforts. (Revenues are primarily due to advertisements at this point.) The constant h is similar to the marginal tax rate encountered in tax law. If the marginal tax rate is 35%, an increase in the taxable income of $1000 will always increase the taxes owed by $350. Thus, h may be thought of as the Marginal Rate of Profit (MRP) and differs from the familiar profit margin (PM) which is simply the ratio of profits to revenues, often expressed as a percentage. PM = Profits/Revenues = y/x, which is converted to a percentage. MRP = h = y/x c/x = PM (c/x) The familiar profit margin will equal the MRP only if the constant c = 0. However, this is IMPOSSIBLE since the constant c, as shown in appendix 1, is related to the fixed costs associated with the operation of a company. This is never zero. It is suggested that the MRP might be a more useful predictive tool for profitability analysis than the profit margin (PM).

http://col.stb.s-msn.com/i/22/5636932139164D78E9188FE7B75E7.jpg

After IPO, what's next for Facebook?

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http://www.sec.gov/Archives/edgar/data/1326801/000119312512034517/d287954ds1.htm
As filed with the Securities and Exchange Commission on February 1, 2012 Registration No. 333-

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form S-1 REGISTRATION STATEMENT

Under The Securities Act of 1933

Facebook, Inc.
(Exact name of Registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)

7370 (Primary Standard Industrial Classification Code Number)

20-1665019 (IRS Employer Identification No.)

Facebook, Inc. 1601 Willow Road Menlo Park, California 94025 (650) 308-7300 (Address, including zip code, and telephone number, including area code, of Registrants principal executive offices)

David A. Ebersman Chief Financial Officer Facebook, Inc. 1601 Willow Road Menlo Park, California 94025 (650) 308-7300 (Name, address, including zip code, and telephone number, including area code, of agent for service)

http://www.sec.gov/Archives/edgar/data/1326801/000119312512034517/d287954 ds1.htm#fin287954_3 Also, see last two pages of this document for the actual financial data.

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Table 1: Quarterly Revenues-Profits Data From Financial Statements filed with SEC for the IPO
Quarter Ending 31-Mar-10 30-Jun-10 30-Sep-10 31-Dec-10 31-Mar-11 30-Jun-11 30-Sep-11 31-Dec-11 31-Mar-12 Future ?? Revenue $ million 340 424 450 655 637 776 798 943 1060 1400 Profit $ million 95 129 131 251 233 240 226 302 205 Best-fit line Prediction 106.05 133.72 142.28 209.81 203.88 249.67 256.91 304.67 343.21 455.21

Table 2: Annual Revenues-Profits Data From Financial Statements filed with SEC for the IPO
Qtr/Year 2007 2008 2009 2010 2011 1Q2012 Future ?? Revenue $, millions 153 272 777 1974 3711 1060 4800 Profits $, millions -138 -56 229 606 1000 205 Best-fit line Prediction -60.89 -23.46 135.42 512.00 1058.47 224.45 1401.08

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Profits (Net Income), y, $ millions

500

y = 0.329x 5.94
400

300

200

Q1 2012 (1060, 205)

100

-100 0 200 400 600 800 1000 1200 1400 1600

Quarterly Revenues, x, $ millions

Figure 1: Graphical representation of the quarterly Revenues and Profits (Net Income) data for Facebook Inc. for the eight consecutive quarters starting with the quarter ended March 31, 2010. The data plotted here may be found in the Registration Statement filed by the company with the United States SEC on February 1, 2012. The data for first quarter of 2012 was obtained from recent publicly available news reports. One expects profits to increase as revenues increase. This is obvious from Table 1. However, this graphical representation reveals a remarkably simple and linear relationship between revenues and profits, which can be expressed mathematically as y = hx + c where x is revenues and y is profits. The constants h and c can be deduced from classical linear regression analysis. Thus, y = hx + c = 0.329x 5.94 = 0.329 (x 18.04). The finite value of the intercept c only implies that revenues must exceed a minimum value (similar to the fixed costs) before the company can report a profit.

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Profits (Net Income), y, $ millions

1600 1400 1200 1000 800 600 400 200 0 -200 -400 0 1000 2000 3000 4000 5000

y = 0.315x - 109.03

Annual Revenues, x, $ millions

Figure 2: Graphical representation of the annual revenues and profits data for Facebook Inc. starting with 2007, the first year for which data is available. The data plotted here was again obtained from the SEC filing on February 1, 2012. The simple linear relation between revenues and profits, revealed by the quarterly data, is again confirmed here. The slope h of the best-fit line is also very close to the value obtained from the quarterly data analysis.

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Discussion
Consider the six month period between March 31, 2010 and Sep 30, 2010. Revenues went up from $340 million to $450 million, an increase in revenue of x = 110. Correspondingly, the profits (net income) went up from $95 million to $131 million, an increase in profits of y = 36. Hence, the rate at which profits increase with revenues is given by the slope h = y/x = 36/110 = 0.327. Or, consider the nine-month period between Sep 30, 2010 and June 30, 2011. For this period, x = 326 and y = 109 and h = y/x = 109/326 = 0.334. These values of the slopes between individual (x, y) pairs are very close to the slope of the best-fit line obtained after linear regression analysis which considers ALL the data (except the Q1 2012 data, which is clearly an outlier here). The slope of the best-fit line actually represents an average value of many such slopes and is thus the statistically significant value. It can be readily shown that the linear relation between revenues and profits revealed here is a consequence of the classical breakeven analysis for the profitability of a company. This point is discussed separately in the appendix attached to the end of this analysis. It is also remarkable that the linear relation is maintained when we include data for the years 2007 and 2008 when Facebook reported a loss rather than a profit. It is readily shown that exactly similar relation between revenues and profits is revealed when we consider data for many other companies. Over the last several years, the present author has analyzed large volumes of such quarterly and annual profits and revenues data for companies operating in many different sectors of the economy and in many different countries, in a variety of political, economic, social and, of course, tax environments . For example, an exactly similar analysis for the profits and revenues data for the New General Motors (GM), after it emerged from its recent bankruptcy, and Ford Motor Company has been presented by the author, see the links given below. The linear law y = hx + c may therefore be taken as a universal law applicable to all companies and is actually a consequence of the familiar breakeven analysis for profitability of a company, see appendix 1.
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Finally, the constant h is similar to the marginal tax rate encountered in tax law and may be thought of as the Marginal Rate of Profit (MRP). It differs from the familiar profit margin (PM) which is simply the ratio of profits to revenues, often expressed as a percentage. Profit Margin = Profits/Revenues = y/x, converted to a percentage. MRP = h = y/x (c/x) = PM (c/x) The familiar profit margin equals MRP only if the constant c = 0. However, this is IMPOSSIBLE since, as shown in appendix 1, the constant c is related to the fixed costs associated with the operation of a company. The MRP is a might indeed be a more useful predictive tool than the PM for profitability analysis. http://www.scribd.com/doc/54996915/GMRPAnalysis-2R The New GM: Analysis of Revenues and Profits for five consecutive quarters ending Q1 2011. http://www.scribd.com/doc/55141133/FordGMRPAnalysis The New GM versus Ford. http://www.scribd.com/doc/55219473/FordGMRPAnalysis-1R The New GM versus Ford: Introducing a new measure of profitability.

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Appendix 1 Linear Profits-Revenue Law and the Classical Breakeven Analysis for Profitability
The statement Profits = Revenues Costs may be thought of as a fundamental law that describes the behavior of all financial and economic systems. As revenues increase, we expect the profits to increase. Is there a simple, universally valid, relationship between profits and revenues? It appears that there is. Let N denote the number of units of a product sold by a company to generate revenues. The total cost C associated with this operation can be written as C = Fixed Cost + Variable Cost = a + bN. This is the simplest mathematical relation between C and N. If k is the unit price, the total revenues R generated by the sale of these N units is R = kN. Here a, b, and k are constants that depend on the type of units being sold and/or manufactured. The profits P = Revenues R Total Cost C and is therefore given by: P = R C = kN (a + bN) = (k b)N a (A1)

But, the units N = R/k. Hence, eliminating N from equation A1 yields the relation between profits P and revenues R, which can be written as: P = [ (k b)/k ] R - a (A2)

Equation A2 implies a linear relationship between Profits and Revenues and can be rewritten as y = hx + c where x is revenues and y is profits. The constants h and c are therefore related to the constants a, b, and k from the breakeven analysis. h = (k b)/k = 1 (b/k) c=-a (A3) (A4)

It is clear that the non-zero intercept in the profits-revenues graph is related to the fixed costs associated with the companys operations. Facebook represents a new
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genre of companies, with its unique costs and revenues structure, compared to traditional companies like GM and Ford Motor Company which are involved in manufacturing operations. Nonetheless, it is remarkable that the simple linear law relating profits and revenues applies to all companies and this is clearly related to the classical breakeven analysis for profitability of any companys operations. The breakeven number of units N = N0 and the breakeven revenue R = R0 can be deduced by setting profits P = 0 in equation A1. Hence, The breakeven quantity The breakeven revenue N0 = a/(k b) R0 = kN0 = ak/(k b) = a/h

The universal law relating profits and revenues for any company can be written as P = hR - Cf = hR a = h(R R0) where Cf = a = Fixed Cost

With the impetus provided by its recent IPO (stock trading began on Friday May 18, 2012), Facebook can make significant strides in improving its profitability in the coming quarters and years by paying attention to the fundamentals as revealed by the classical breakeven model and the simple analysis developed here. An accurate determination of the constants a, b, k, which are then related to the macrolevel values of h and c, appears to be the first step to improving long term profitability of Facebook, Inc.

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Appendix 2 Marginal Rate of Profit (MRP) and the Profit Margin (PM)
As discussed in appendix 1, the linear law relating revenues, x, and profits, y, is a consequence of the classical breakeven analysis to determine the profitability of a company. The familiar profit margin (PM) is the ratio of the profits y to the revenues x, which is then often converted into a percentage. Hence, the linear law implies that: y = hx + c and PM = y/x = h + (c/x) = MRP + (c/x) (B1) (B2)

Also, as shown already, the nonzero intercept c in this linear law is related to the fixed costs of the operation and is never zero. Hence, the familiar PM will be equal to the MRP only if the fixed cost goes to zero, which is IMPOSSIBLE. More Detailed Analysis of Quarterly Profits-Revenues data for 2010 Quarter Revenue, Profit, Profit Delta x Delta y MRP y x Margin, y/x x or dx y or dy h = dy/dx 340 95 0.279 Q1 2010 424 129 0.304 Q2 2010 450 131 0.291 Q3 2010 655 251 0.383 Q4 2010 84 34 0.405 Q2-Q1 26 2 0.077 Q3-Q2 205 120 0.585 Q4-Q3 315 156 0.495 Q4-Q1 764 224 0.293 Q1+Q2 1214 355 0.292 Q1toQ3 1869 606 0.324 Q1toQ4 Note: All the quarterly data analysis here is based only on the advertising revenues instead of total revenues. This was an oversight. The advertising revenue, however, is the dominant source of revenue for Facebook, Inc.
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The MRP is a measure of the rate at which profits will increase as revenues increase and is thus a dynamic measure of how profits increase, for example, during a fiscal or calendar year. Consider the data in Table 1 as an example. The quarterly revenues and profits vary from one quarter to the other. The sum of the revenues and profits for all four quarters equals the annual revenue and profits reported in Table 2. The smallest increase in profits and revenues was between Q2 and Q3 of 2010. Revenues increased by $26 million, from $424 million to $450 million. The profits only increased by $2 million. This means that although Facebooks revenues increased it did not result in an increase in the profits due to its fixed costs. All the additional revenue was absorbed as a cost of operation. Now consider the situation for Q1 and Q2 of 2010. The revenues increased by $84 million and the profits increased by $34 million. In other words, nearly 40% of the additional increase in revenues reflected itself as profits. The biggest increase in revenues was between Q3 and Q4, an increase of $205 million. The profits now increased by $120 million. In other words, 58.5% of the additional revenues was turned into profits. The quarterly profit margins (PM) on the other hand, calculated from the y/x ratios varied between 28% for Q1 2010 to 38% for Q4 2010. Clearly, the MRP values, rather than the PM values, are more revealing about the nature of the cost structure of Facebook, Inc. Similar conclusions can be drawn by analyzing the profits-revenues data for all other companies.

Stock Price, $

FB stock trading pattern on day one of IPO

Time of day
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Appendix 3
A More Detailed Analysis of Annual Profits-Revenues data Quarter Revenue, Profit, y x 2007 2008 2009 2010 2011 08-07 09-08 10-09 11-10 153 272 777 1974 3711 -138 -56 229 606 1000 Profit Margin, y/x -0.902 -0.206 0.295 0.307 0.269 119 505 1197 1737 82 285 377 394 0.689 0.564 0.315 0.227 Delta x Delta y x or dx y or dy MRP h = dy/dx

The significance of the MRP, emphasized here, as opposed to the PM, may be illustrated further, as follows. As revenues increased between 2007 and 2008, the loss reported by Facebook Inc. decreased. In other words, an increase in revenues increases the profits, even if it is a negative value (or a loss). The year-to-year changes in revenues x and profits y are also given in the above table. The rate of increase in profits, as measured by the MRP, h = y/x = dy/dx [mathematically speaking, dy/dx is the derivative of a function y = f(x) and gives the rate of change], was the highest between 07 and 08. Profits increased by $89 million with an increase in revenues of only $119 million. Subsequently, when Facebook started reporting a profit, we see the MRP decreasing with increasing revenues. Hence, strictly speaking, the mathematical law relating profits and revenues is a non-linear law. The simplest type of non-linear law that can be used to describe this situation is the power-law: y = hxn + c y = hxn if c = 0 (C1) (C2)

The exponent n is called the power-law index. For n = 1 this more general law reduces to the linear law. Now, we have three different cases. The rate of increase
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of profits, with increasing revenues, dy/dx, depends on the exact value of n. dy/dx = h (nxn-1) = n (hxn/x) = n(y c)/x dy/dx = n(y/x) if c = 0 (C3) ...(C4)

For n < 1 profits increase with increasing revenues but at a decreasing rate (deceleration of profits). For n > 1, profits increase with increasing revenues but at an increasing rate (acceleration of profits). For n = 1, profits increase with increasing revenues at a fixed rate (linear law).

Profits (Net Income), y, $ millions

1200 1000 800 600 400 200 0 -200 0 500 1000 1500 2000 2500 3000 3500 4000

Annual Revenues, x, $ millions

Figure 3: The annual revenues and profits data for Facebook Inc. is replotted here to emphasize the non-linear relation between revenues and profits (which was approximated earlier in Figure 2 by the linear law). The slope of the individual line segments is equal to the values of h given in the table here.
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The values of the constants h and n (and c) can again be deduced using statistical analysis. Financial analysis thus far has been based on determining various ratios, such as the profit margin, y/x. This is called ratio analysis but its predictive value is actually severely limited. The difference between the ratio y/x and dy/dx is well-known in the physical and engineering sciences and is used to make predictions. It is the rate of change dy/dx or y/x which determines future values, not some average value of the ratio y/x. The laws of motion, as deduced by Galileo in the 17th century, from his empirical observations on bodies rolling down an inclined plane, could be formulated only by considering the rate of change of distance with time, ds/dt, not the overall value of the ratio s/t, where s is distance traveled (or space covered) and t is the time taken to cover the distance. A generation later, Newton developed calculus to take Galileos laws to the next level and develop his theory of gravitation to explain both the terrestrial motions (such as motion of falling bodies) and heavenly, or planetary, motions. Non-linear laws must be invoked only after careful analysis of the data since predictions based on non-linear laws can lead to gross underestimates (if n < 1) or overestimates (if n > 1). Thus, Galileo used the simplest law, a quadratic law (n = 2) to describe the motion that he observed, s = at2 where a is the constant acceleration of the falling body, instead of advocating more complex higher order polynomial regression laws, see W. H. Jeffery and J. O. Berger in the American Scientist (1992), vol. 80, pp. 64-82. http://exploringdata.net/ws_galil.htm D. A. Dickey and T. Arnold in http://www.amstat.org/publications/jse/v3n1/datasets.dickey.html Blind statistical analysis, unfortunately very popular (especially in financial, social, and even medical sciences), does not lead to any fundamental insights.

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Appendix 4 Linear law with a misleading positive intercept (Negative Fixed Costs)
The annual profits-revenue data for Facebook, Inc. compiled in Table 2 permits a clarification of the apparently misleading positive intercept in the linear law relating profits and revenues. As seen in Table 2, Facebook reported a loss for 2007 and 2008. Nonetheless, as already discussed (see appendices 2 and 3), the negative profits also follow the law of increasing profits with increasing revenues. The Facebook data is best described by the simple best-fit line analysis (Figure 2). However, depending on ones viewpoint, one could also make a case that Facebook demonstrates the classic power-law behavior (Figure 3) with profits increasing at a decreasing rate with increasing revenues. The latter conclusion, however, seems a bit premature (lacking long term data) and the simple linear law is the better model for Facebook profits-revenues trends for the near future. Nonetheless, the profits-revenues data for a young and emerging company like Facebook provides the perfect opportunity to clarify the reason for the apparently misleading positive intercept in the linear law that is often observed when we analyze the data for more mature companies (such as Walmart, Microsoft, or GM or Ford Motor Company). The linear law can be rewritten as follows. y = hx + c = h[ x + (c/h)] = h (x x0) where, x0 = - c/h (D1) (D2)

Here x = x0 is the cut-off, or breakeven, revenue at which profits y = 0. Since the slope h is positive, the numerical value of the constant c determines the value of x0. If c has a negative value, the intercept x0 is positive and the graph will cut the x-axis at a positive value of x, see Figure 4. The steeper dashed line, which describes the data for low revenues, has a negative intercept and hence a positive x0. When a company is operating far away from the breakeven point, the slope h (the MRP) decreases and the intercept c becomes positive.

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However, this DOES NOT mean negative fixed costs. It only means that we are lacking data at low revenue levels where the positive fixed cost will be revealed. More importantly, it means that the company is now operating with a lower MRP and that the rate of increase of profits with increasing revenues, revealed by the constant h, has actually decreased. The Facebook data is thus quite revealing and historically significant for such data analysis.

Profits (Net Income), y, $ millions

1200 1000 800 600

400
200 0 -200 -400 0 500 1000 1500 2000 2500

y = 0.263x + 24.82 = 0.263 (x + 94.45) x0 = - 94.45

y = 0.588x 228 = 0.588 (x 388) x0 = 388

3000 3500 4000 4500

Annual Revenues, x, $ millions

Figure 4: The annual revenues and profits data for Facebook Inc. is replotted here to illustrate the fundamental reason for the apparently misleading positive intercept in the linear law observed when we analyze the profits-revenues data for mature companies. As shown here, the Facebook data can be described using two linear segments with two different values of the slope h. As revenues increase, the slope decreases and the intercept changes from a negative value (due to the fixed costs) to a positive value. This does NOT mean the company has a negative fixed cost. Rather it means that the company has matured and is now currently operating with a lower MRP (lower slope h).
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Appendix 5
From the Linear Law to Power law to the Power-Exponential Laws If careful experimental observations suggest a deviation from the power law, one can use the power-exponential law to modify the power-law. A good example is the performance data (speed versus time, or the acceleration data) for a modern automobile. Carefully controlled acceleration tests indicate (we will NOT discuss this here; this will be presented separately) that the acceleration is not a constant. The behavior similar to that we see in Figure 3 here is usually observed with the speed versus time data. The power-law is a more satisfactory description for the performance data for most cars. However, when we consider high performance vehicles (Corvette, BMW, Lamborghini, Ferrari, etc.) which are tested to speeds in excess of 100 mph, we see deviations from the power law. The power-exponential law now becomes the more appropriate model to describe vehicle performance. This law may be written as: y = mxne-ax (C5)

Here we assume, for convenience that when x = 0, y = 0, i.e., the graph passes through the origin (0, 0) with no intercept on the y-axis. This was the law being used to describe the experimental data on blackbody radiation, towards the end of the 20th century, before Planck developed quantum physics by essentially modifying this law slightly. Plancks mathematical law can be written as: y = mxn [e-ax /(1 + be-ax) ] + c .(C6)

Equation C6 is actually a generalization of Plancks blackbody radiation equation. In Plancks law b = - 1 and c = 0. It can be shown that the graphs of both equations C5 and C6 will reveal a maximum point. The position of the maximum point can be readily calculated using rules of calculus. The graphs will deviate for large x. In blackbody radiation theory, the Rayleigh-Jeans law, which was deduced theoretically using pre-quantum physics ideas, is a power-law (equation C2). This description of radiation lead to serious fundamental problems (it was called the ultraviolet catastrophe) indicating a lack of theoretical understanding about the nature of blackbody radiation. Wien deduced the power-exponential law (equation C5) from his experimental studies but was not able to offer any theoretical
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explanation to justify the introduction of the exponential term. It was essentially what we would call a curve-fitting procedure. (Wien received the Nobel Prize in 1911 for his discoveries regarding the laws governing the radiation of heat, see http://www.nobelprize.org/nobel_prizes/physics/laureates/1911/ ) Planck modified Wiens law to equation C6 (with b = - 1 and c = 0) and introduced what is now called the quantization hypothesis there is an indivisible unit of energy called the energy quantum. Planck was then able to derive equation C6 using statistical arguments (originally due to Boltzmann) that he had despised all his life. The term within the square brackets in equation C6, [e-ax /(1 + be-ax) ], is the correction factor needed to fix the theoretical problems with the Rayleigh-Jeans law which is a pure power law (equation C3). Planck received the Nobel Prize in 1918. Years later, Planck would call this (the introduction of statistical arguments into the physics of heat radiation) his desperate attempt to explain blackbody radiation, at any cost. It eventually led to the birth of quantum physics in 1900. Now, one can think of money in economics as being similar to energy E in physics. In physics, we also encounter what is known as entropy, which is taken to be the measure of the extent of chaos in a system. The higher the chaos or disorder the higher the entropy S. Energy E and entropy S are related to the temperature T via the first and second laws of thermodynamics, viz. T = dE/dS. This is the definition of temperature used by Planck to derive the radiation law, equation C6. Well, even financial and economic systems (and social and political systems) exhibit this property called chaos. Using these mathematical analogies (and pretending that we understand the meaning of entropy S and temperature T as applied to systems outside physics), one can actually go through the exact arguments that Planck uses in his 1900 paper and rederive a generalized version of Plancks law and apply it study the behavior of financial, economic, and even social and political systems. This generalization will not be pursued here. At first, even Planck was not sure about what he had accomplished. In 1900, quantum physics just seemed like a convenient mathematical manipulation to justify Wiens law and the experimental observations. Quantum physics took off only after Einstein applied Plancks idea of an elementary quantum of energy, in
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1905, to explain the photoelectric effect. Einstein used the power-exponential law (equation C5) to develop the theory and ultimately proposed the simple linear law y = hx + c with the non-zero intercept c. Einstein called c the work function. When a particle of light, which we now call a photon, impinges on the surface of a metal it gives up some of its energy and ejects electrons from within the surface of the metal. The electrons have a kinetic energy K which is less than the energy of the incoming photon. The difference is the energy that must be given up in this process. Thus, Einsteins law becomes K = E W = hf W (C7)

Here E = hf is the elementary quantum of energy conceived by Planck, h is a constant, now called the Planck constant, and f is the frequency of light. (Light has both a particle and wave like characteristic. The frequency f is due to its wavelike nature. The fixed quantum of energy hf is due to its particle nature.) The work function W, the energy that must be given up, is similar to the fixed costs of operation of a company. We can also think of an elementary quantum of money (the elementary unit of revenue generated). Each fixed elementary unit of revenue (like one advertisement for Facebook) produces a fixed amount of profit. But not all of the revenue will appear as profits. The difference is the fixed cost, much like the work function W in Einsteins law. Thus, Profits = Revenues Costs (C8)

Equations C7 and C8 allow us to make the transition from the world of quantum physics to the financial world. Chaos prevails in both these worlds, but one has been understood (to a fair degree) while the other beckons our understanding. 19MAY12

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Examples of well-known mathematical laws

No. 1 2 2 3 4 Name Equation Comments Force F and acceleration a, slope = m the mass of the body Shear stress and shear rate (d/dt) of a fluid, slope = , the viscosity of fluid Voltage V and Current I, slope = R the resistance of the electrical circuit Velocity V and Distance D, slope = H0 the Hubble constant Stress and strain , slope = E the elastic modulus also called Youngs modulus. Pressure P and depth h below free surface, slope = g, Finite positive intercept on y-axis (pressure-axis) Volume V and temperature T of gas; Absolute Zero temperature T0 = - a/b Maximum kinetic energy K of electron and frequency f. Slope = h, Plancks constant. Intercept = - W, the work function of the metal Usually depicted as linear laws. Either price, or quantity, is taken as independent variable!

Newtons force law F = ma Newtons viscosity = (d/dt) law for a fluid Ohms law V=RI Hubbles law Hookes law V = H0D = E P = P0 + (g)h

Hydrostatic law Pascal

6 7

Charles law for an V = a + bT = ideal gas b[ T + (a/b)] Photoelectric law K = hf - W due to Einstein

Price P versus quantity Q supplied or demanded Galileos law for falling bodies: s = at2 relates space (s) covered, or distance traveled and time t. The constant is the acceleration and power-law index n = 2. 8

Supply and Demand laws in economics

Keplers third law: T2 = ka3, or T = K a3/2. Period T of the orbit related to the semi-major axis of the elliptical orbit. The constant is called Keplers constant. The power-law index n = 3/2. Rayleigh-Jeans law from blackbody radiation: Relates intensity of radiation (or energy density, energy per unit volume) to the frequency of the radiation.
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About the author

The author obtained his Masters (S. M.) and Doctoral (Sc. D.) degrees in Materials Engineering from the Massachusetts Institute of Technology, Cambridge, MA, USA. He then spent his entire professional career at leading US research institutions (MIT, Allied Chemical Corporate R & D, now part of Honeywell, NASA, Case Western Reserve University (CWRU), and General Motors Research and Development Center in Warren, MI). He holds four patents in materials processing, has co-authored two books and published several scientific papers in leading peer-reviewed international journals. His expertise includes developing simple mathematical models to explain the behavior of complex systems. While at NASA and CWRU, he was responsible for developing material processing experiments to be performed aboard the space shuttle and developed a simple mathematical model to explain the growth Christmas-tree, or snowflake, like structures (called dendrites) widely observed in many types of liquid-to-solid phase transformations (e.g., freezing of all commercial metals and alloys, freezing of water, and, yes, production of snowflakes!). This led to a simple model to explain the growth of dendritic structures in both the ground-based experiments and in the space shuttle experiments. More recently, he has been interested in the analysis of the large volumes of data from financial and economic systems and has developed what may be called the Quantum Business Model (QBM). This extends (to financial and economic systems) the mathematical arguments used by Max Planck to develop quantum physics using the analogy Energy = Money, i.e., energy in physics is like money in economics. Einstein applied Plancks ideas to describe the photoelectric effect (by treating light as being composed of particles called photons, each with the fixed quantum of energy conceived by Planck). Einsteins photoelectric law is a simple linear law, as we see here, and was deduced from Plancks non-linear law for describing blackbody radiation. It appears that financial and economic systems can be modeled using a similar approach. Finance, business, economics and management sciences now essentially seem to operate like astronomy and physics before the advent of Kepler and Newton.

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Appendix 6
From the SEC Filing February 1, 2012, by Facebook, Inc.
SELECTED CONSOLIDATED FINANCIAL DATA The consolidated statements of income data for each of the years ended December 31, 2009, 2010, and 2011 and the consolidated balance sheets data as of December 31, 2010 and 2011 are derived from our audited consolidated financial statements that are included elsewhere in this prospectus. The consolidated statements of operations data for the years ended December 31, 2007 and 2008 and the consolidated balance sheets data as of December 31, 2007, 2008, and 2009 are derived from audited consolidated financial statements that are not included in this prospectus. You should read this information together with Managements Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and the related notes included elsewhere in this prospectus.
2007 Year Ended December 31, 2008 2009 2010 (in millions, except per share data) 2011

Consolidated Statements of Operations Data: Revenue Costs and expenses : Cost of revenue Marketing and sales Research and development General and administrative Total costs and expenses Income (loss) from operations Other expense, net Income (loss) before provision for income taxes Provision for income taxes Net income (loss) Net income (loss) attributable to Class A and Class B common stockholders Earnings (loss) per share attributable to Class A and Class B common stockholders(2): Basic Diluted Pro forma earnings per share attributable to Class A and Class B common stockholders(2): Basic Diluted
(1) Costs and expenses include share-based compensation expense as follows:
(1)

$ 153 41 32 81 123 277 (124) 11 (135) 3 $ (138) $ (138)

$ 272 124 76 47 80 327 (55) 1 (56) $ (56) $ (56)

$ 777 223 115 87 90 515 262 8 254 25 $ 229 $ 122

$1,974 493 184 144 121 942 1,032 24 1,008 402 $ 606 $ 372

$3,711 860 427 388 280 1,955 1,756 61 1695 695 $1,000 $ 668

$(0.16) $(0.16)

$(0.06) $(0.06)

$0.12 $0.10

$ 0.34 $ 0.28

$ 0.52 $ 0.46

$ 0.49 $ 0.43

2007 Cost of revenue Marketing and sales Research and development General and administrative Total share-based compensation expense $ 1 3 56 13 73

Year Ended December 31, 2008 2009 2010 (in millions) $ $ $ 4 2 2 7 6 9 19 19 9 $ 30 $ 27 $ 20

2011 $ 9 43 114 51 $ 217

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(2) See note 2 of the notes to our consolidated financial statements for a description of how we compute basic and diluted earnings (loss) per share attributable to Class A and Class B common stockholders and pro forma basic and diluted earnings per share attributable to Class A and Class B common stockholders.

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Quarterly Results of Operations Data (From the SEC filing)

The following tables set forth our quarterly consolidated statements of income data in dollars and as a percentage of total revenue for each of the eight quarters in the period ended December 31, 2011. We have prepared the quarterly consolidated statements of income data on a basis consistent with the audited consolidated financial statements included elsewhere in this prospectus. In the opinion of management, the financial information reflects all adjustments, consisting only of normal recurring adjustments, which we consider necessary for a fair presentation of this data. This information should be read in conjunction with the audited consolidated financial statements and related notes included elsewhere in this prospectus. The results of historical periods are not necessarily indicative of the results for any future period.
Mar 31, 2010 Jun 30, 2010 Sep 30, 2010 Three Months Ended Dec 31, Mar 31, 2010 2011 (in millions) Jun 30, 2011 Sep 30, 2011 Dec 31, 2011

Consolidated Statements of Income Data: Revenue: Advertising revenue $ Payments and other fees revenue Total revenue Costs and expenses(1): Cost of revenue Marketing and sales Research and development General and administrative Total costs and expenses Income from operations Net income $

340 5 345 100 36 25 22 183 162 95

$ 424 8 431 111 44 32 26 213 218 $ 129

$ 450 17 467 131 45 41 34 251 216 $ 131

$ 655 76 731 150 59 45 40 294 437 $ 251

$ 637 94 731 167 68 57 51 343 388 $ 233

$ 776 119 895 210 103 99 76 488 407 $ 240

$ 798 156 954 236 124 108 72 540 414 $ 227

$ 943 188 1,131 247 132 124 80 583 548 $ 302

(1) Costs and expenses include share-based compensation expense as follows: Three Months Ended Dec 31, Mar 31, 2010 2011 (in millions) $ $ 1 3 4 2 3 $ 6 $ 7

Mar 31, 2010 Cost of revenue Marketing and sales Research and development General and administrative Total share-based compensation $ 2 3 5

Jun 30, 2010 $ 1 2 2 5

Sep 30, 2010 $ 2 2 4

Jun 30, 2011 $ 3 11 35 15 64

Sep 30, 2011 $ 3 16 33 18 70

Dec 31, 2011 $ 3 16 42 15 76

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