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Hi, everyone.
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I hope all of you
are doing well.
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I know it is very
hard to motivate
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yourself when you're
doing this online thing,
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but you've got to do it.
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Let's look at Chapter
2, financial statement,
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taxes and cash flows.
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Do you all know what
financial statements are?
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What is included in
financial statements
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or what are three statements.
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Number 1 is called
as income statement.
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Number 2 is called
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as balance sheet or the
statement of financial position.
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They mean the same thing.
Number 3, cash flow statement.
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The key concepts and
skills there for you to
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go through. Chapter outline.
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Again, we are looking at
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the balance sheet,
the income statement.
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We'll talk briefly
about taxes and briefly
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about cash flow. Let's move on.
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The balance sheet.
What is balance sheet?
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Balance sheet is a snapshot of
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the firm's assets and
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liabilities at a
given point of time.
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That point of time
is very important.
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Balance sheet is usually
as of, let's say,
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December 31, even though
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it does not have to
be end of the year.
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It can be anytime,
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any period like
companies can choose
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when they want to end
their fiscal year.
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It is like a still
picture of the firms,
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what a firm owns and
what a firm owes.
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What it owns and what it owes.
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What a firm owns
is simply assets.
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It is either the left hand side
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if it is a horizontal
balance sheet,
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or it can be upper person,
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if it is a vertical
formatted balance sheet.
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Balance sheet can be
formatted either vertically,
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assets and liabilities
or horizontally
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assets and liabilities,
either is okay.
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The items in the assets,
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they are in the order of
decreasing liquidity.
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Let's define the word liquidity.
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Liquidity means how
quickly or the ease
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at which assets can be
converted into cash.
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How quickly can an asset
be converted into cash?
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That is what liquidity means,
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the quickly you can convert
an asset into cash,
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we say it's more liquid.
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Less liquid is, whatever
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cannot be converted
into cash quickly.
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For example,
accounts receivable.
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Accounts receivable
is whatever is
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receivable from the customers.
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Companies want to collect money
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from customers as
soon as possible,
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within a few weeks, maybe
a couple months, top.
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You could say account
receivable is
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more liquid than
some other asset
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like land, building,
plant, equipment.
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Those assets
obviously, business,
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they do not want to
convert those into cash,
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but they want to continue to
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use those assets
like land building.
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Account receivable
is more liquid,
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land building, less liquid.
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Then we have liabilities.
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Liabilities are what
a firm owes to other.
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This could come in the
form of like bank loan,
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accounts payable or bond.
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If you recall, bonds are loan
borrowed from the public.
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It is either on the
right hand side if it is
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a horizontal balance sheet or
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the lower portion if it is
a vertical balance sheet.
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Balance sheet identity.
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You just got yourself
a best friend here.
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That equation assets equals
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liabilities and plus
stockholder security.
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We'll be using that a lot.
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That equation will keep coming
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in problems that we will
do throughout this term.
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Make that your best friend.
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Let's move on to the next.
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Networking capital.
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Networking capital is
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current assets minus
current liabilities.
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Let's define those two first,
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current assets and
current liabilities.
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Current assets are those
assets that we expect
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to convert into cash within a
year, within the next year.
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Current liabilities are
those liabilities that
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we expect to pay
within one year.
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Current assets expect
to convert into cash or
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collect cash within a year.
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Current liabilities that you
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expect to pay within one year.
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Some examples of
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current assets, we'll
look at that later.
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But just to give you an idea,
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because some examples of current
assets would be accounts
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receivable, cash, inventory.
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Because again, inventory
also are expected to be
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converted into cash
within a year.
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Then we have current
liabilities.
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Current liabilities are
those liabilities that are
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expected to be paid
within a year.
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Expected to be received within
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a year or converting
to cash within a year.
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Expected to be paid
within one year.
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The relationship
networking capital is
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current assets minus
current liabilities.
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Why are we looking at
this relationship?
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Why look at something
like this, this equation?
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Because companies will convert
their current assets into
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cash so that they can pay for
their current liabilities.
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Current liabilities
is paid out of
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the cash collected from
the current assets.
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As you can say, tell that
it's a really important idea.
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Can you tell me for
a healthy firm,
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you want this number
to be at least what?
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Negative, positive, zero.
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You want this number
to be positive.
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You want current assets to be
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definitely larger than
current liabilities.
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Liquidity, we already
defined liquidity.
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Liquidity is how
quickly can you convert
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an asset into cash without
losing significant value.
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That is important because again,
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if I want to sell a property
worth $300,000 for let's say
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$100,000 I will be able to
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sell it quickly. But
that's not liquid.
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Liquidity is if it
is $300,000 worth,
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can I sell that for
$300,000 quickly,
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if yes, then that's
a liquid asset.
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If no, then that's
not a liquid asset
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and that is very valuable
in avoiding distress.
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By distress, we mean
financial distress.
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Financial distress means you
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don't have money to
pay for your dues.
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That's a financial
distress or to do
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things that are necessary
for the business to survive,
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then that's a
financial distress.
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For example, right now JCPenney
is in financial distress.
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Then there is this equation,
debt versus equity.
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This is a very important
equation actually.
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The equation is from assets.
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If you recall earlier,
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we say that assets equals
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liabilities plus owner's equity.
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From this equation, you
can also say that OE =
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A - L. Why are we looking
at this equation?
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Oftentimes people say,
I'm a millionaire.
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You have, let's say, a
house worth $1 million then
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you probably would be tempted
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to say you are a millionaire.
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But yes, that's your assets,
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but let's say your liabilities,
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what you owe to the bank on
that house is let's say,
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$600,000 then you are honestly,
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really not a millionaire.
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You only have $400,000
of net worth.
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That net worth is owners equity.
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How much a firm owns,
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after paying off
their liabilities
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or after subtracting what
is owed to everybody else,
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that is owners equity.
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That is the true value of
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your wealth or the
wealth of the business.
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This is a very important idea.
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Your best friend is still.
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Here is an example of
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a balance sheet of
a US corporation,
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and as you notice here
is current assets.
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Current assets include cash,
a conceivable inventory,
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and all of those
are expected to be
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converted into cash
within a year,
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and then the firm also
has fixed assets.
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These are assets that
are expected to be used,
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not converted into cash.
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This is an example of
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horizontal balance
sheet not a vertical.
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We have assets on
the left and then we
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have liabilities
on the right side
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and then we have
current liabilities.
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These are the liabilities
that are expected to be
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paid within a year
long term date.
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These are expected to be
paid in more than a year,
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maybe five year,
ten year, 20 years.
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It can be anything, whatever
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it is the maturity
of those obligation.
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Then there is owner's equity.
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Owners equity is not something
that needs to be paid,
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it is owners stake in
the company so they
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will keep it for as
long as they want to.
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For example, if I've invested on
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Google I expect to keep
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it for a long time I do
not want to sell it,
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it's my choice so this
is not an obligation.
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If you do not want to have
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your equity in the
business anymore,
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you just transfer or sell
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your ownership stake
in the company.
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If I don't like Google
anymore, Google stock anymore,
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I can just sell it so this is
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not an obligation, but again,
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this is owner's equity
or call it net worth,
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assets and one very
important idea,
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so the total of asset
they must equal.
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Asset equal liabilities plus
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let me use the
pointer option here.
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Notice here, this is assets,
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this is liabilities
and this is equity.
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Assets, this is the
total of assets,
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must equal the total
of liabilities,
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428, which is short
term liability,
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long term liabilities,
428 + 408 + 1920.
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That's equity so the total,
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this total and that total
equals for 2013 same idea.
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The total for 2014
and total for 2014,
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they must equal because again,
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the idea is assets equals
liabilities plus equity.
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Let me show you the
balance sheet format here.
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On this Word document,
this is a Word file.
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Let me draw a table here.
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By looking at this, you
can tell that this is
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a horizontal format
balance sheet
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because I have asset of
course on the left side,
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and then liabilities and
equity on the right side.
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Let's make it bold.
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In fact, you could
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also make it more colorful
if you wanted to.
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That's not what I wanted.
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Anyway, so under Assets,
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the first category of assets we
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have would be current assets.
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This is a category of an asset
so let me italicize that.
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Under current assets, we
have many different assets.
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If you recall, we have to put
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everything in the
order of liquidity.
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I will start with the most
liquid of all the assets.
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What do you think
that would be cash.
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Cash is the most
liquid because again,
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the definition of liquidity is
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whatever can be converted
into cash quickly.
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The next is accounts receivable.
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The next one under
current assets would be,
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you guessed it right
if you did inventory.
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That's all of our current
assets that we talk about.
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There could be some more,
but let's stop there.
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Then we have fixed assets.
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That's the second category.
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Two categories so let
me italicize that.
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Then under fixed assets,
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think about what could be
the assets that we are using
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but not converting into
cash within the next year.
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You could say land
and buildings.
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You could also say
planting equipment,
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and I want to add some
more rows on the table.
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If you're wondering
how I did that,
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you just hit "Tab," it goes to
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the next cell and then
if you hit "Tab" again,
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it will just add more and more
column that should be QU,
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planting equipment, land,
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building, you could
say furnitures.
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Furnitures, let's say computers,
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let's say vehicles.
All of those.
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Then this is what
a company owns,
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and then we have
what a company owes.
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You could just write A
here just to make sure
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that these are distinct
from all the other items.
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This is a category,
not an item by itself.
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Similarly, we have
current liabilities.
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Current liabilities would be
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accounts payable.
That's too many.
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Then we have notes payable.
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If you're wondering what
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is the difference
between these two?
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Accounts payable is payable to
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supplier and notes payable
is payable to the bank.
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If your money you owe
to your suppliers
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because you have purchased
goods on credit,
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that goes under
accounts payable.
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If it is payable to the
bank within the next year,
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that goes under notes payable,
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so that's category A.
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Usually, we have only those.
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Just to be consistent,
category B,
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we have long-term debt.
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Call it long-term liabilities.
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Liabilities or debt
mean the same thing.
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Debt and liabilities
they are synonym.
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Under long-term debt, we have
bank loan, call it payable.
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You might say, this is
also payable to the bank.
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This is payable to the
bank within a year,
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this is payable to the
bank in more than a year.
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Maybe this loan
matches in five years
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or 10 years or whatever
else that may be.
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Then we have bonds.
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If it is a public
corporation mostly,
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even private companies
may issue bonds,
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but most of the time
it is issued by
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public companies and also
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by the government and
some other entity.
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But here we are talking
about balance sheet
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for a company,
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so that's public debt or
you could just write that.
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Then the last category
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of item in the balance sheet
and the last category within
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liabilities and equity could
be shareholders equity.
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Under shareholder equity,
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just to be consistent,
-
let's format it
exactly the same way.
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It is saying to put
the apostrophe,
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I think here. That's
what it is saying.
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Under shareholders equity,
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I'll just write a couple items.
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The one is common stock.
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That's the equity that
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the company has
issued to the public.
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The other one would
be something we call
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is paid in surplus.
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Paid in surplus is
whatever the public have
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paid in excess of the
value of common stock,
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the par value of common stock.
-
For example, when Facebook
went public, the common stock,
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whatever value they assigned
to the company's stock,
-
but the public actually
paid, let's say $39.
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Their expected
value, let's say was
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$30 but they sold for $39,
-
that would be paid in surplus,
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would be that $9 in
excess of common,
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in excess of par whatever
the company received when
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they sued the equity
to the public.
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That's paid in surplus.
-
Again, par is the
arbitrary number.
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Companies assign some value
-
to their stock when
they go public,
-
but the public might
actually pay something else
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more than their expected
par value of the stock.
-
In that case, there
is paid in surplus.
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The last, but not the least,
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is accumulated
retained earnings.
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If you recall from
or we'll talk about
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this in the income statement,
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what this accumulated
retained earnings is.
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Hold your breath.
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That's the format
of balance sheet.
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Let's look at an example.
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It is asking you to
prepare the balance sheet.
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I will show you here on
-
this table how to
work on that problem.
-
Before we do that,
let's do one thing.
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Let's look at this table,
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and then let's figure out
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where each of these
items should go.
-
For example,
accounts receivable,
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I know is a current asset item,
-
so just to make
sure to color that,
-
I just so I can see it clearly.
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Similarly, this
bank loan would be,
-
what do you think?
What category?
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We have current assets,
we have fixed assets,
-
we have current liabilities,
-
we have long-term liabilities,
and then we have equity.
-
We have those five categories.
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That is what I'm trying to do.
-
Bank loan would be
long-term debt.
-
Inventory would be
current assets.
-
Accounts payable is. What
is accounts payable?
-
Current liabilities.
-
Accounts payable is
payable to the supplier.
-
Land would be fixed assets.
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Equipment, fixed assets.
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Notes payable to the bank?
-
What do you think that
is? Current liabilities.
-
Here bank loan is long term,
-
but when we say notes payable,
-
that is still payable to the
bank like this bank loan,
-
but it is current liability
-
because it has to be
paid within a year.
-
Then we have checking account
which is current assets.
-
Checking account is like cash,
-
savings account,
checking account.
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Oftentimes you may hear
-
this terminology,
certificate of deposits.
-
They are all equivalent to
-
cash and hence current account.
-
What do you think?
Taxes payable?
-
Taxes payable is the tax
payable to the government?
-
Very likely you will pay this
within the next few months.
-
That makes it a
current liability.
-
Bonds, they are
again, if you recall,
-
when companies borrow
loan from the public,
-
that's bond, so that
makes it long-term debt.
-
Savings account, current
assets, equivalent to cash.
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Buildings, fixed assets.
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Let me give all of them
colors just to make sure that
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we see that properly
what we just wrote.
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That's that.
-
I have all of that.
-
I will keep it here a
little bit outside.
-
You may not be able to see that.
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You will not see that, but you
can see that on the video.
-
The first current assets that
-
we noted was
accounts receivable.
-
But if you recall, it has to be
-
in the order of liquidity.
-
I will start with the most
liquid of current assets.
-
The most liquid current acid
here is checking account.
-
I'll just write that here.
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Checking account.
-
Checking account is how much?
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$2,000. Then we have
savings account.
-
Then for savings account,
we have $50,000.
-
What else do we have?
-
The other current
assets we have would
-
be accounts receivable
and inventory.
-
I guess that's it.
Let's do that.
-
Accounts receivable is 40,000.
-
Then what do we have next?
-
We have inventory.
-
Inventory is $35,000.
-
I think we're done
with current assets,
-
so let's move on
to fixed assets.
-
Then for the fixed assets,
-
we have land and buildings.
-
Land is $50,000,
buildings is $200,000.
-
That's it, so total assets
-
the sum of that we'll
look at that and then
-
we have current liabilities.
-
The first current
liabilities we have would
-
be accounts payable in the
order of when it is due,
-
so we usually put accounts
payable, so let's do that.
-
Accounts payable
which is payable to
-
the supplier and that comes
-
out to be $16,500.
-
The next current liability we
-
have is notes
payable to the bank.
-
Notes payable to the bank
is $5,000 and then we
-
have taxes payable which
-
comes out to be $3,000.
-
Let's not make that Italy size.
-
I will make it normal,
-
so that's all of our
current liabilities.
-
Now we have a long-term
debt, so long-term debt.
-
The long-term debt
that we have is
-
bank loan and then bonds,
-
so bank loan is $30,000
and then we have bonds.
-
If you recall bond is the loan
taken by corporations from
-
the public and that comes
out to be $180,000,
-
so let's see if we included
every single item,
-
so we looked at accounts
receivable bank loan inventory
-
that all done,
-
so let's find the total
of each of these.
-
Looks like I missed
one item here.
-
There should have
been equipments.
-
I missed equipment, so
equipment should be 44,000,
-
so that's an item I forgot.
-
Our total assets if
-
you do the calculations
should come out to be
-
$421,000 and if you
-
find the total of this it
will come out to be how much?
-
It should come out to be,
-
so this will come out to
be if you add all of them.
-
It should come out
to be 234,500,
-
but if you know that
cannot be right.
-
If you know our total assets and
-
total liabilities and equity
it has to be the same,
-
so if they do not balance that
means the balance must go
-
under equity or you
-
could call it shareholders
equity to be more precise,
-
so shareholders equity should
-
be the difference
-
between this, so 421,000-234,500
-
that equals 186,500.
-
That is what it should be.
-
At this part and this guy
this should be the sky,
-
so now if you take the
total liabilities and oops,
-
and equity amount
should be 421,000.
-
Now they balance,
-
so again just to
repeat what I just did
-
was they would have to balance,
-
but here with the items that
we had it did not balance.
-
The balance sheet did
not balance simply
-
because we were missing
shareholders equity of
-
a part and if you
recall the formula for
-
shareholders equity
is total assets
-
minus total liabilities.
-
That is what I did
here. Total assets.
-
I took that total assets
and then I subtracted
-
total liabilities which is
the sum of all of that.
-
If any questions
should mean email,
-
so finding working capital or
-
networking capital
is pretty easy if
-
you know the formula
-
and the formula is
pretty straightforward.
-
Let me show you here current
or networking capital,
-
working capital
equals current assets
-
minus current liabilities and we
-
know current assets here equals
-
shaking plus savings account
plus accounts receivable.
-
I'll just write AR for
accounts receivable.
-
That's a usual notation for
accounts receivable plus
-
inventory and that
comes out to be if you
-
do the calculation that's
2+50, 52+40, 92+35.
-
I think that comes out to
be 127,000. Same idea.
-
Current liabilities
equal accounts payable.
-
I'll write AP. Again
that's normal.
-
That's understood for
accounts payable AP.
-
Notes payable is the
usual denotation
-
for NP or NP is the usual
denotation for notes
-
payable plus taxes payable
-
and that comes out
to be how much?
-
16+5, 21+3, 24,500. I'm just
-
taking all the numbers from
-
the previous table that we
-
worked on for the balance sheet,
-
therefore networking
capital again
-
that's a usual denotation
-
for networking capital NWC equal
-
the current assets which is
-
127,000 minus current
liabilities which is
-
24,000 and that comes
out to be 103,000,
-
127-24 and that's our answer.
