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How The BALANCE SHEET Works (Statement of Financial Position / SOFP) - YouTube
Channel: Accounting Stuff
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this video is going to give you a solid
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introduction to the balance sheet in
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accounting I'm going to explain what it
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is how it's all laid out and then we're
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going to build ourselves a balance sheet
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from scratch using Google sheets and six
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example transactions hello there welcome
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back to the channel I'm James this is
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accounting stuff and in this tutorial
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we're going to cover the balance sheet
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in accounting the balance sheet or
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statement of financial position is one
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of the three major financial statements
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along with the income statement and cash
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flow statement so this is a big big
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topic if you run a startup then you
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absolutely must be able to prepare one
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of these in order to have a hope of
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getting funding and on the flip side if
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you're ever planning on learning money
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too or investing in a business then it's
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critical that you know how to read and
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understand the balance sheet because the
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balance sheet will give you an
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impression of the business's financial
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health and that will determine how risky
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the opportunity is for you and finally
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if you're an accountant then chances are
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you'll be hoping prepare one of these at
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the end of every accounting period over
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the past few months I've been posting
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weekly videos teaching accounting basics
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for beginners that you can find up here
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this video is going to link a bunch of
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these ideas together so if you find any
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parts of this explanation confusing then
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I recommend you check those out to
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cement your understanding and come back
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to this one if you need to there will be
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links in the description below to all of
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the relevant ones so feel free to check
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those out as I mentioned I'll be
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releasing new videos each week and I
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ain't cover all of the major parts of
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the balance sheet so hit the subscribe
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button and click on the Bell to be
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notified when those come out don't know
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about you but I'm itching to get
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cracking I mean what is the balance
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sheet let's find out the balance sheet
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looks like this
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the way it's presented can vary but
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there are some key elements at the core
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of the balance sheet that the rest of
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its built around here we have a balance
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sheet for a business called Craig's
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design and landscaping services that's
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because I tore this one from the sample
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company in QuickBooks Online quit books
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online is the biggest cloud accounting
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platform in the world and they
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specialize in small to medium size
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businesses so I thought this one would
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make a good example if you're thinking
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this all looks a bit crazy there no
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worries I'm only showing you the
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product will piece together a simpler
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one of these for ourselves in a moment
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right I think it's time for a definition
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a balance sheet is a snapshot of a
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business's assets liabilities and equity
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at a single point in time and that's
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exactly what we're looking at we have
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assets over here on the left and on the
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right hand side we have liabilities and
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equity beneath both of the headers we
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have all of the detail all of the
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individual groups of accounts summarized
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with their closing balances and the
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bottom of the balance sheet we have our
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total assets and total liabilities plus
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equity you'll notice that both of these
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numbers are exactly the same that's what
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we want to see is the aim of the game
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here because the balance sheet as
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suggested by its name always has to
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balance so your total assets must be
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equal to your total liabilities plus
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equity if they don't match each other
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exactly then we've got a problem in the
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past people used to make their balance
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sheets manually and this was a pain in
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the
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you could easily waste hours or even
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days trying to figure out where the
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errors were in your workings but
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thankfully nowadays the counting
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platforms like quickbooks online exist
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they ensure that your balance sheet
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always stays balanced if you run a small
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business and you'd like to give
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QuickBooks Online a try then you'd be
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doing me a massive favor if you follow
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my link down in the description it's an
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affiliate link so you'll get access to a
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free 30-day trial and the chance to
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support me making more accounting videos
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just like this one check out the video I
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made up here if you're interested but if
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cloud accounting isn't whew that's ok
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you can also support the channel by
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giving this video a like and sharing it
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with someone if you think they'd find it
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useful but anyway I promise you that
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we'd build ourselves a barn cheat from
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scratch and I meant it so here we are we
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have a clean slate we're going to build
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this balance sheet from the ground up
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using one key principle double-entry
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accounting in double-entry accounting
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every accounting entry has an opposite
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corresponding entry in a different count
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or put simply stuff the business owns is
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equal to the stuff the business owes we
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accountants course stuff there the
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business owns assets but the stuff that
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the business owes is a little bit more
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complicated we use two different words
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to describe it depending on who the biz
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yes Oh stuff too when a business Oh
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stuff to third parties like lenders
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suppliers and employees we call them
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liabilities however when a business Oh
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stuff to its owners we call it equity so
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we have assets are equal to liabilities
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plus equity
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this is the basic accounting equation
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and it always balances total assets must
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be equal to total liabilities plus
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equity now every financial transaction
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that a business is involved in affects
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this accounting equation so the values
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of our assets liabilities and equity are
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constantly changing but it's possible
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for us to take a snapshot and freeze
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their values at a single point in time
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when we do that we're looking at a
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balance sheet the thing is though that
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these three buckets are far too broad
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there are many types of assets
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liabilities and equity and it would be
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helpful if we could distinguish between
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them it's time for us to hop into Google
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sheets and flesh out this balance sheet
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we'll begin with assets and FY I'm going
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to move through this next section fairly
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quickly because I've made a video
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covering assets and a lot more detail
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that you can find linked up here and
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down below in the description the same
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goes for liabilities and equity so check
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those out if you'd like some fuller
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explanations assets are broken down
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broadly into two main categories current
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assets and non current assets current
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assets are short-term assets that can be
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converted into cash within one year some
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of the most common types of current
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assets are cash accounts receivable
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supplies inventory and prepaid expenses
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on the other hand non current assets are
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long-term assets that are used in
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operations to generate profit they can't
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easily be converted into cash so we
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expect to hold on to them for more than
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one year two common types of non current
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asset are long-term investments and
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property plant and equipment it's a
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similar situation for liabilities we
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have current liabilities which are our
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businesses obligations that need to be
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settled within one year from now these
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include accounts payable salaries
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payable taxes payable and accrued
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expenses and we also have non current
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liabilities obligations that aren't
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expected to be settled within one year
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stuff like long term loans
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and that leaves us with equity the final
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piece of the puzzle
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this section works a bit differently to
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assets and liabilities we have two broad
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categories to consider owner's equity
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and retained earnings you can think of
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retained earnings as profits held for
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future use and this is key because as
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the profit in retained earnings that
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forms the link between the balance sheet
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and the income statement
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keep that in mind or demonstrate how it
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works in this next example but before we
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get stuck in let's do some housekeeping
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and tidy up this balance sheets by
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adding some totals on the Left we have
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total assets and on the right we have
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total liabilities and equity these have
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to match each other exactly because the
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balance sheet always has to balance to
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emphasize this I'm going to add a little
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balance checker that'll take the
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difference between these two cells this
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should always be equal to zero now that
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we've built a template for our balance
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sheet it's time for some numbers let's
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go back to the scenario of the window
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cleaning business that we covered in the
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videos on t accounts journal entries and
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the trial balance I'll drop links to all
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of these down in the description we're
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going to use these transactions again so
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that you can see how all of these
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concepts fit together in the interest of
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saving you time I'm going to move
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through these transactions fairly
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quickly so if you find yourself getting
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stuck and wanting some deeper
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explanations of the debits and credits
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then go back and watch those videos on T
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accounts and journal entries by the way
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in a side note the trial balance is not
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the same thing as the balance sheet if
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you'd like to see me make a video
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explaining the differences let me know
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in the comments there are six
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transactions that we're going to cover
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and we'll work through them one by one
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filling out our balance sheet templates
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as we go in transaction number one the
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owner of the window cleaning business
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makes capital contributions of $100
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we're double entry bookkeeping so this
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transaction is going to effect two
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accounts cash and owner's equity the
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business's cash is going to be debited
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to increase it by $100 an owner's equity
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will be credited to increase that by
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$100 as well are we in balance yes we
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are in transaction number two the
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business takes out a further $200 loan
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to fund this activity
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we need to debit cash again by $200 to
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increase it and credit long-term loans
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by $200 to increase them to transaction
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3 the business spends 30 dollars in cash
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on window cleaning equipment we credit
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cash by 30 dollars to decrease it and we
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debit our pond property and equipment by
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30 dollars to increase our equipment in
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transaction for the business spends a
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further $50 on cleaning supplies the
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payment is made on account paying for
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something on account means that you're
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agreeing to pay the supplier at a later
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date so we debit our supplies by $50 to
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increase them and this time we don't
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credit cash we credit accounts payable
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by $50 to increase them instead just a
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couple more transactions left to go
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you've got this these ones are going to
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affect our retained earnings account
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remember that means our profit held for
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future use and it links the balance
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sheet and the income statement together
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I'll show you how this works now
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transaction 5 the window cleaning
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business makes a hundred and fifty
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dollars cleaning windows and uses up
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half of its cleaning supplies in the
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process this transaction is a bit more
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tricky than the ones we've covered up to
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this point because there are two parts
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to it each with their own double entries
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the first thing that we need to do is
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recognize revenue earned to do that we
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debit cash to increase it by a hundred
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and fifty dollars and we also credit
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revenue to increase that by a hundred
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and fifty dollars behold up
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where does revenue go I can't see it
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anywhere in our balance sheet we're
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going to need to jot down an income
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statement for our window cleaning
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business an income statement is a
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summary of our revenue earned and
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expenses incurred over a period of time
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so here we have revenue of a hundred and
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fifty dollars almost there next we need
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to record the second part of the
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transaction half of our cleaning
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supplies were used up on this job so we
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can't recognize those as an asset
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anymore they now make up our cost of
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sales which is a kind of expense and
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belongs in our income statement as well
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in the fourth transaction we spend $50
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on cleaning supplies so if we've used up
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half of them that we need to credit
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supplies by $25 to decrease them and
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debit cost of sales in the income
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statement to increase our expenses by
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$25.00 but our balance sheet still isn't
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in balance how can that be
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we need to build a bridge between the
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profits in our income statement and the
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retained earnings or profits help future
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use in the equity section of our balance
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sheet so the hundred and twenty five
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dollars of profits in our income
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statement now flows through the retained
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earnings and bounces our balance sheet
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one important thing to note retained
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earnings and profit for the year don't
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normally match each other exactly like
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they're doing this example that just
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happens to be the case because we don't
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have any retained earnings from previous
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years and none of the profits had been
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drawn out of the business
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that being said the simplicity of this
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example is a great way to demonstrate
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this link between the income statement
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and the balance sheet we'll see how that
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works one more time in transaction 6
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where our window cleaning business
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incurs laundry costs of $20 the payment
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is made in cash so we need to credit
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cash by $20 to decrease it and debits
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laundry costs by $20 to increase them in
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the income statement our profit of a
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hundred and five dollars rolls up into
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the retained earnings section of our
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balance sheet giving us total assets of
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four hundred and fifty five dollars and
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total liabilities plus equity of four
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hundred and fifty five dollars as well
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and our balance sheet checker is showing
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zero good stuff how did you find that I
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didn't want to skip any steps in this
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balance sheet tutorial if you've got any
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questions let me know down below in the
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comments or send me a direct message on
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instagram at accounting stuff hit this
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circle to subscribe and keep up to date
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with all of the latest videos and check
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how the accounting basics playlist over
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here to explore some of the ideas that
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we just touched on in more detail and go
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like with those balance sheets
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