Video Transcript: Financial Statements

Hi, welcome back. We're going to be discussing financial statements. First, we'll  be discussing the balance sheet. The balance sheet describes a business's  financial situation at a moment in time, or known as a snapshot. So I want to  know where does our company sit right now? Assets, liabilities, equity at this  moment in time. So balance sheet will give you a snapshot of how healthy a  company is, comparing assets to liabilities. The left side details the assets of a  business, right? So assets are anything tangible, resource oriented, cash, plant,  property, equipment, raw materials, inventory. The right side details how those  assets were acquired. So on the right side of the balance sheet, you're going to  have liabilities, your short term, long term debt, notes payable, accounts  payable, etc, and below liabilities, you'll see shareholders equity. So essentially,  assets minus liability gives you shareholder equity. So if I have positive assets, I  have more assets than I do liabilities, then I'm going to have a positive  shareholders equity both sides of the balance sheet always have to equal, so  assets should be equal to liabilities plus owner's equity. How loans affect a  balance sheet? You need a loan to help fund your business. A lot of times when  you're starting new projects. Let's say a construction project. For example,  you're going to need a bank loan more than likely to build whatever it is that  you're building. So a lot of times this this project will be funded 70% by debt, 65  maybe 75 maybe 80, depending on the bank. So you'll need loans to help build  your business. The bank lends you $100 and expects an interest payment of  10% right? So a long term loan includes interest known as notes payable. So  you'll see on the right hand side that we had our original investment of $100  which is going to be owners equity, and now we took a bank loan of $100 and  now we have that in liabilities. But notice we have cash $200 so $100 in cash  from the notes payable that we borrowed from the bank, $100 in cash of our  original investment. And notice how they both equal 100 plus plus 100 plus. 100  is 200 and obviously we have $200 of cash on the asset side, two types of  owners, people the business owes money to. So if you have a construction  project and the bank has a lien on that project, technically, the bank owns that  project, not you. The part of the business the owner owns is the owner's equity.  You can see, again, the original investment, $100 goes into owners equity. The  notes payable is in the liability spot above the owners equity. And again, $200  cash assets. Notice, assets equals liabilities plus owners equity inventory in the  balance sheet. How does inventory affect the balance sheet? Inventory consists  of products that you sell, right? So when you buy inventory, what do you do?  You decrease your value of cash, because you've got to go in buy raw materials  to produce the products that you make. So 50% of inventory buys you $35 for  50 sheets of paper and $15 in markers and colored pencils. So now let's look at  the balance sheet again. Cash has decreased from 200 to 150 but what did we  replace the $50 of cash with we bought inventory $50 our assets are still at 200  now we have notes payable again. We've we've not financed anymore for our 

operation, and we still have our original investment of $100 in owner's equity.  And the balance sheet still balances out $200 in assets, $200 in liabilities and  equity. So let's say in our first day of business, we can draw 40 characters for $2 a piece, right? So that's $80 in total sales. 40 times two is 80 unit costs equal.  Full price of inventory to create one finished good, right? So we $50 in inventory  produces 50 caricatures. So now we have to compute cost of goods sold. So  units sold is 40 times $1 for the unit cost. The $1 in unit cost is how much did it  cost us to produce this unit right? So we sold 40 our unit cost was $1 so now we look at gross profit, right? We can see that the sales of 40 characters at $2 a  piece, gave us $80 in revenue, and our cost of goods sold. That means, what  was our input cost? What did we have in raw materials? And production was  $40 so our gross profit 40 bucks. So sales is two times 40 caricatures, minus  cost of goods sold. Cost of goods sold, 40 units sold. The unit costs $1.80 minus 40 gives us $40 in gross profit. So let's look at our first day on the balance  sheet. Right? Our first day in business. So let's notice, how did assets change?  Right? We added $40 into our asset pool. So now we have, we didn't quite sell  all of our inventory, right? We still have a little bit inventory left, right, $10 worth  of inventory, but our cash did increase by by $30 so so we're looking good there, but we still have $10 of inventory on our books. So you notice that our gross  profit, we put it straight to the asset side, right, 240 bucks, or $40 in gross profit  went to the asset side. Our notes, payables didn't change in our liabilities  section, still $100 on that bank loan Owners Equity still original investment, still  the same, that didn't change earnings for the week ending 40 bucks. So we  made $40 we bank that into owner's equity. Now you can see that assets equals liabilities, and owner equity always make sure when you're reconciling a balance sheet that both sides assets equals liabilities and owner equity. Time to expand.  You increase your price to $5 per caricature, then you rent a space at the mall  for $80 per day. Buy a sign and easel for 50 bucks. So now we're expanding our operation. Right now we're trying to reinvest into our company and grow our  revenues. So next, we buy $50 in raw material as inventory. Then we sell 60  caricatures for $300 in sales. Now let's go back to the balance sheet. Let's see  how that affects us. Right now, we've increased our cash to $350 right? With  zero inventory, we sold out. We've sold out, right? So now let's look at notes  payable didn't change liabilities. Notes, notes payable didn't change owner's  equity, the original investment, $100 right? Retained earnings, still $40 from the  week before. Now we have new earnings week ending this week for $110 so we  sold 60 caricatures for $300 right? But we bought $50 in raw material. We  bought a $50 sign in easel, and then we had to rent space. So all of those costs  eroded away our profits. So you have to subtract out those costs from your  revenue of $300 and now you see your earnings for the weekend at $110 so you grew your operation, you expanded out into the mall. You're able to raise your  price because there was still a demand for it, and you knew that you were going 

to be taking on additional costs through more inventory, more raw materials, the  sign and easel. And now I've got rental space at the mall, so I had to create, I  had to increase my price in order to compensate and offset the increase in  costs. And we did well, as we increase our owners equity, $510. Again, we just  went through these changes, but you can see them graphically. Now, the $350  equals the previous cash of 230 minus the expenses, minus the inventory plus  the sales. That gives us $350 in cash. So the earnings for the week with $110  which equals the $130 of expenses. Remember the the rent at the mall, the  easel and the stand and the raw materials? So now you have the notes payable, the bank loan didn't change again, the $110 well, we have the $100 in original  investment, the $40 of the retained earnings from week before and now our  increase in week ending earnings of $110 which gives us liabilities and owner  equity at 350 Notice again, total assets, liabilities and owner equity equal. So  explain the earnings for the week ending, right? So most errors in accounting  are because of a lack of understanding on how to calculate earnings week to  date. This is an income statement, normally updated weekly. So an income an  income statement is going to tell you how profitable your company is, right? So  we're going to look at this income statement real quick. Beginning Inventory,  right? We have $10 and beginning inventory purchases. We bought the paper  and markers and other supplies to make the signs, right? That was 50 bucks. So total available for sale, $60 minus ending inventory. We sold out all of our goods. So the cost of goods sold was 60 bucks. So our gross profit on the $300 in sales was 240 right. Now we have to go back and we have to subtract out our  expenses, right? So we're going to get the rent for 80, the sign for 20, the easel  for 30, for $130 and total expenses. Now you've got gross profit here 240 after  you've subtracted out the cost of goods sold from revenue, and you have $130  and total expenses, which gives us our net profit of 110 and now you can see  what we put the 110 and the balance sheet, which allowed us to match assets to liabilities and equity. Second week in business. Week two, you decide to rent the mall booth for three days. That cost you $240 you spend 150 on raw materials.  You use $25 of raw materials to create your picture books. Right? You sell 125  characters, but no picture books. So now we're trying to diversify our product  line by introducing picture books at our mall stand right? But we didn't sell any.  We only, but we sold 125 characters. So if you notice that our characters are  really starting to increase in demand, so we're increasing the supply, right? And  our $5 price is a good price because we continue to create demand. So let's  check it out, right? Remember, subtract, invent ending inventory, and then move  net profit to earnings week to date, right? So our beginning inventory $0 we had  nothing to carry over, right? Our purchases, $105 in paper, $45 and markers,  right? So now we have total available for sale, 150 ending inventory, 25 so we  sold a lot, right? We sold a lot. 125 ending inventory, 25 so now our cost of  goods sold $125 for our gross profit being $500 notice, we had 625 in sales. So 

we're subtracting out the 125 giving us a gross profit of $500 our rent was 240  bucks. We subtract that out of our $500 gross profit, giving us a net profit of  $260 so now let's move over from the income statement back to the balance  sheet. So cash 585 Why is cash 585 Well, we had previous cash of 350 we  subtract out the $150 revenue. We subtract out the $240 rent cost, plus the new  sales of $625 from the 125 characters being sold. So now our cash is increased  to 585 but we do have inventory on hand of $25 worth of finished goods, right  for a total assets of $610 now ending week balance, right, $260 as you see in  owners equity, underneath retained earnings sales, 625, it's the weekly sales  minus our cost of goods sold, minus our expenses, so finished goods and  retained earnings, right? So we've got finished goods at 25 over on the asset  over on the asset side. Now we've taken our $240 our $260 and added it to  earnings week end. So we had $100 and original investment, our retained  earnings from a few weeks ago have increased from $50 to $150 or $100 to  $150 now we can cycle back, and we can put this earnings weekending from  this week's worth of sales right at 260 so you notice, as we're expanding our  operation, our revenues and our profitability continue to go up. And total assets,  610 liabilities, Owners Equity also 610 and they equal one last development,  right? In our example here, my friend offers to buy picture books for 50 bucks on credit. So now we're going to add a new twist on there. We're going to offer  somebody, one of our customers, an opportunity to purchase on credit. And how does that affect our balance sheet and income statement? The mall operator  wants half up front, $120 in a prepaid expense, right? So not only now we  putting something on credit, we're giving purchase to somebody on credit. Now  we're pre paying for a good or a service that we intend to use in the future. Now  check into accounts payable, right? So now we have an accounts payable,  right? So, so the accounts payable is zero, okay, let's start at the top, right. So  now we've got a receivable here. So now that goes the receivable goes to the  asset side, because the receivable is a cash flow is going to be received  sometime, and the future. And it depends on terms. Most companies offer 15,  30, 45, days, 60 day terms, right? So we'll give you payment terms, and then  you have to pay us a full amount, net 60 days, or whatever it is, right? So some  so somebody is buying something on credit, it's now a receivable on the asset  side, because that's future cash flow that's going to be guaranteed sometime in  the future, right? Our inventory didn't change. We had zero inventory, right? But  our prepaid expenses did increase, and that goes on the asset side, because  we prepaid for a good or service that we'll use in the future. So that's going to be an asset for us, because we own that good or service. Now, notes payable,  right? It stayed the same. $100 on the liability side, accounts payable, right? $0  we have nothing out there on credit. We did buy prepaid service, but it's not on  credit, it's prepaid. So we have no payable still. So our total liabilities is still the  $100 bank loan, original investment, 100 bucks, still in owners equity. We've 

retained that cash, retained earnings from the previous weeks of operations.  150 this week's ending 285, right? So we're continuing to increase our cash and  our owner's equity. So total owner's equity $535 so right now, this company is  positioned very well a strong owner's equity component versus a very weak  liabilities component, which is good. So our equity to debt is about five times.  We're in good shape here. What happens if debt isn't paid? All right? So now we remove accounts and accounts receivable, right? Because they aren't going to  pay the debt. So now we now that's a liability to us, because we're not going to  receive that cash flow, right? So delete the same amount from earnings week to  date. So we're going to subtract that out of the earnings week to date, right?  Don't touch retained earnings. So now that $50 in the receivable is now zero,  and now, because it was the same week ending, we took it out of week ending  cash on the owners equity side, right? So we just. Lost that cash. We shouldn't  have put it out there on credit, but that's a risk that you take when you issue  credit terms. Let's review what assets are right? Cash is cash. Cash is cash. It's  just cash, right? We can spend it. It's liquid, it's movable, transferable, right?  Now, inventory is made up of raw materials and finished goods, right? So raw  materials are inputs into our product to develop what our finished good is, and  those are all assets. I either own the raw materials to create the products, or I  own the inventory of finished goods that are ready to go to market for sale.  Accounts receivable are payments made on credit. As we saw, we put $50 out  there on credit. We didn't get paid back, so We deducted that from owner's  equity. So prepaid expenses are payments made in advance of receiving  benefits. So we prepaid for the service. In the future, we'll get the service. So  that's an asset to us. Cost of inventory and prepaid expenses are subtracted  from cash, so we have to make sure that we prepay the $120 in prepaid service, right? The $120 in prepaid service. Now we have to make sure that we make the exact same subtraction. Because we made the addition, we have to make the  exact same subtraction from the cash. We got to take it out of cash because  now as a prepaid expense, and we are ready to consume that service, the  review of liability accounts payable are short term loans due in a month's time.  Normally do not require interest payments. So a lot of times, we'll put payment  terms out for somebody you know, another company buy something from us on  credit raw materials, and we put them on a 30 day payment terms, and we  expect to be paid back in 30 days. Interest Free. Notes payable are long term  loans that normally require interest payments. Let's review the equity. Original  investment is the owner's investment in the company, right? So we're going to  put a little bit of our own capital down as skin in the game that's going to be  retained as owners equity, right? We have an initial investment. Retained  earnings are earnings that have been reinvested in the company. So so we we  have our gross profit, we subtract out expenses. We have our net profit. After  our net profit, we decide on how we're going to distribute that profit. Are we 

going to distribute it out to shareholders and form of dividends, or are we going  to retain that earnings and reinvest it into our company so that we can continue,  continue to expand operations? Earnings week to date, is found by subtracting  cost of goods sold and expenses from sales on the income statement. Bad debt  is subtracted from earnings, as we saw when we didn't get paid back on the  credit.