馃攳
How the Balance Sheet Works | with a FUN Demo - YouTube
Channel: Leila Gharani
[0]
In this video, we're
going to cover the basics
[2]
of the balance sheet.
[3]
It's also called the statement
of financial position.
[7]
This is where many people get confused.
[10]
I'm going to be honest with you.
[12]
It confused me for many years.
[14]
I'm going to explain it with a fun demo.
[17]
You're going to see what I mean,
[19]
but before we get to the fun part,
[21]
let's just cover the theory first.
[24]
The balance sheet is one of the three
[25]
main financial statements.
[27]
The other two are: income
statement and cash flow.
[31]
It's critical to know how
to read a balance sheet.
[34]
If you want to understand the
financial health of a business,
[38]
that's the place to start.
[40]
So, let's get into it.
[41]
(relaxed instrumental pop music)
[46]
The balance sheet looks like this.
[48]
(laser swoosh)
[49]
Its purpose is to provide an idea
[51]
about the company's financial position
[54]
at a certain point in time.
[56]
It doesn't show the flows
[59]
into and out of the
accounts during that period.
[64]
That's important to remember.
[65]
A balance sheet always
only shows you information
[69]
at a particular point in time.
[72]
That's usually the end
of the financial year,
[75]
or for listed companies,
[77]
it's also the end of a
quarter or half year.
[81]
Now, in the case of
Microsoft in our example,
[84]
it's as of June 30th, 2018.
[87]
It shows you which
assets the company owns,
[90]
the liabilities it owes to others,
[93]
and the equity that belongs to the owners.
[96]
In the first Accounting
(laser swoosh) Basics video
[98]
in the series, I'm going
to add the link to it
[100]
in the description of this video.
[102]
We showed the balance
sheet at a T-account.
[104]
It looked like this.
[106]
Now, Microsoft's balance sheet
[108]
isn't structured like a T-account
[110]
but in a list type of form.
[113]
It could also be shown like a T,
[116]
and you can see that both
sides are in balance.
[119]
In this form, it's just easier to read.
[123]
Now that we cleared that up,
let's use a very simple example
[127]
to see how these components work together.
[130]
I learned this from a fellow
teacher and colleague of mine
[134]
from the controller institute,
[136]
and I really like the explanation.
[139]
So, let's start with the
fun part. (finger snap)
[141]
(laser swoosh) Let's say
we create a new company.
[144]
What do we need for that?
[146]
Cash, right?
[148]
Where do we get it from?
[149]
Well, one way is that as
the owners of the company,
[153]
we're going to put in our own
private money into this company.
[157]
That's called the equity.
[159]
We're going to show this
with a glass of water.
[162]
I marked the current level of
equity with a green line here,
[166]
but here's the thing.
[167]
For most startups, its
own equity is not enough.
[171]
We need additional funds and
we're going to get a bank loan.
[175]
In our example, this glass of orange juice
[177]
represents our bank loan.
[180]
I marked the current
level with a red line.
[183]
Now currently, we only have
balances on the credit side
[186]
of the balance sheet.
[187]
The balance sheet doesn't
balance, so what's missing?
[191]
Credits represent the source,
[193]
meaning where the money's coming from.
[195]
We are missing the debits.
[198]
Debits represent a destination,
[200]
meaning where does the money go to?
[203]
Or, what is it spent on?
[205]
In our case, we didn't
spend it on anything yet.
[208]
All the money went to the cash account.
[211]
(relaxed instrumental jazz music)
[213]
(liquid pouring)
[217]
The cash account consists
of the money we got
[220]
from the owners and from the bank.
[223]
So, by just looking at the cash account,
[225]
we can't distinguish what came from where.
[228]
So, how much is our own funds
[231]
and how much is externally financed?
[233]
It's just cash, (tapping
glass) orange juice with water.
[237]
What does the company do with its cash?
[240]
It's probably going to invest.
[242]
Maybe it's going to buy machinery.
[244]
Now, how does that
affect the balance sheet?
[247]
We take money out from the cash account
[251]
and we put it into equipment.
[253]
(relaxed instrumental jazz music)
[254]
(liquid pouring)
[258]
The total amount of assets
doesn't change by that.
[261]
We have less money in
the bank but in exchange,
[264]
we have the value of the equipment.
[267]
Now, if you start using the machine,
[270]
it's going to lose its value
because we're using it.
[273]
In accounting, this is
reflected by depreciation.
[281]
Also, the company incurs expenses like
[284]
personnel costs for its employees,
[286]
because we have to pay salaries and wages,
[289]
and these are taken out
of the cash account.
[295]
In both cases, the financial
value of the company decreases.
[301]
At the same time, our customers are happy
[304]
and they pay for the products
and services they got from us.
[308]
So we get money from them
[310]
(liquid pouring) in our cash account.
[314]
Now, we want to know if
in total we increased
[317]
the financial value of the
company since we started.
[321]
What do we need to do?
[323]
We need to add up the value of the assets
[325]
available at this point.
[327]
So which assets do we have?
[330]
We have the current
value of the machinery,
[332]
which is what we initially paid
for, minus the depreciation,
[336]
so which is the decrease in
value because of wear and tear,
[340]
plus what we currently have in the bank.
[344]
(relaxed instrumental jazz music)
[345]
(liquid pouring)
[349]
That's the total assets of the company.
[353]
Now, from this total,
[354]
we need to deduct the debt of the company.
[357]
We can see this with the
red marker on the glass.
[363]
(liquid pouring)
[367]
Now, if the value of the remaining assets
[370]
is higher than the original
equity the owners paid in,
[374]
the company made a profit and
increased its financial value.
[379]
(liquid pouring) Let's check.
[384]
If it's less, we made a loss.
[386]
Now in our case, it's
higher than the green line,
[388]
so we made a profit and increased
the value of the company.
[392]
The important part of this
exercise is that (laser swoosh)
[395]
the glass with the
equity was always empty.
[398]
It stood right there.
[400]
That's because equity on its
own doesn't really exist.
[404]
What exists are the assets
of the company and its debt.
[408]
Equity is just a calculation
of total assets minus debt.
[412]
It exists only on paper.
[414]
The more assets a company
has and the smaller its debt,
[418]
the bigger equity will be.
[420]
So let that sink in.
[422]
(laser swoosh) It all comes back
[423]
to the main accounting equation:
[425]
assets equal liabilities plus equity.
[429]
If we rearrange this,
[431]
equity equals assets minus liabilities.
[435]
The higher value for assets and
lower value for liabilities,
[440]
equals higher equity.
[442]
I hope this fun demo was
helpful to understand
[445]
the mechanics of the balance sheet.
[447]
And I also hope you're
enjoying our finance series.
[450]
Let me know in the comments below
[452]
if you want me to cover a specific topic.
[455]
If you enjoyed this video,
give it a thumbs up, (pop)
[458]
and if you want to improve your skills,
[461]
consider subscribing, (clicking)
[462]
and don't forget to hit
(bell ding) that bell
[464]
so you don't miss any new videos.
[466]
Thank you for watching.
[468]
See you in the next video.
[469]
(relaxed instrumental jazz music)
Most Recent Videos:
You can go back to the homepage right here: Homepage