[MUSIC] Hi, my name is Marla Noel OC growth advisors. Welcome to the fundamentals of finance. In this module, I'm going to talk about how we can understand our financial statements. What does that mean? It includes identifying the components of the financial statements, the balance sheet, the income statement, the statement of cash flow. Also, how are we going to use the balance sheet and the income statement in our business and how we're going to affect change and improvement in our business with our financial statements. Welcome to the fundamentals of finance module 1. In this module, you will learn how to understand your financial statements. Real quickly about me, Marla Noel. I ran a local midsize business for a little over 15 years. And then sold the business for 15 times EBITDA, which is a very good number. I participate in three for profit boards and have served on several nonprofit boards. I am an Chapman professor at Chapman in the business school. I'm a licensed CPA and I received my MBA actually from Chapman. I work with clients to help them understand the importance of focusing on the vital field so that they can grow their business and manage their business in the right way. I also facilitate strategy meetings and help the business owners to manage their accountability. Why is it important that you know your financials? I've got many horror stories but one that really sticks in my mind from a very early age. A long time ago I had a client of a CPA firm that I worked in. And this client was about seemed old to me because I was 20 something and the client was about 60 something, and he had the same bookkeeper for over 14 years. Really trusted this book keeper of course. Because he knew the bookkeeper so well. So he didn't review his financials, he didn't check on his bank balances and the bookkeeper stole all of his cash. So this poor man he was an optometrist, probably could never retire or sell his business. And I think of this guy even to today how desperately horrible that would have been to him and his whole life. I also want to emphasize that there are people that will apply for the CFO job or the controller job for the accounting manager job when they really don't know accounting. So once upon a time I helped a client to hire a CFO and we interviewed about 12 people. And only four of those people new accounting actually and passed my accounting test. Which is a pretty basic bookkeeping test. So there are eight people that came to apply for that position. And this was through a company that only provided CFOs and theoretically tested people to see if they knew accounting. But quite a few people will say they know accounting when they actually do not. So I want you as a business owner or manager to understand your financial statements and the importance of the financial statements. So what is included, I'm going to talk about the balance sheet and the income statement and the statement of cash flow. And I'm going to explain what is in each one of those financial statements and how you can use them. Your balance sheet contains all of the assets liabilities and equity of the organization or company as of a given point in time. So the assets and liabilities and equity of the business as of a point in time. So assets are what your business owns less liabilities, what your business owes an equity, who owns the business and add the accumulative income or loss of the business. When I own a business, I have assets as part of my balance sheet. So the assets are meant to grow the business again, they are included on the balance sheet. If I'm going to increase my assets, I'm going to debit the assets to increase my assets, I'm going to debit the assets. The assets are broken into current assets and long term assets. Current assets are consumed in one year or less. And long term assets are used for longer than one year. And I'm going to give you some examples of that in the next slide. To record an asset again, I'm going to debit the asset and an example of current assets would be cash, accounts, receivable, inventory, prepaid expenses and an example of long term assets. So these are assets that are going to be in the business for longer than one year. So that would be something like building equipment, land. So those are examples of long term assets. Liabilities are what the business owes as a matter of doing business. And my liabilities are on the balance sheet. I increase my liabilities by crediting the liabilities. So as I'm recording my journal entries, if I am recording something like accounts payable, I'm going to credit accounts payable to increase it. I have both current liabilities and long term liabilities. This is similar to what I refer to in my assets section of my balance sheet. My current liabilities should be paid in 30 days or anywhere anyway under one year. But most vendors won't let you hold their liabilities out there their accounts payable out there for typically more than 60 days. So most of the time you want to pay your vendors in 30 days. A long term liabilities. Those are debts that we owe over a period of longer than one year. So longer term liabilities are things like mortgages or notes payable. Again, I'm going to increase my liabilities by crediting the liabilities. So I talked about current and long term liabilities. Again, these are part of my balance sheet. My current liabilities are going to be things like accounts payable salaries, payable accrued expenses. And my long term liabilities would be notes payable or mortgages payable anything that is due for longer than one year. Equity reflects the ownership of the business. So if I'm the owner of a business, whether it's a sole proprietor partnership corporation, if I'm going to put money into the business, then it's going to be reflected as a credit to equity. If I put money in, it's a debit to cash, credit to equity. If somebody buys part of my business then they would share in the equity. So it reflects the amount of ownership of the individuals, partners, corporation. And also the accumulative amount of income or loss from the business operations and activities. Which is reflected as retained earnings. As a quick quiz what are the three primary financial statements? Is it A the balance sheet? The statement of liabilities in the income statement. B the statement of assets. The statement of liabilities in the income statement. C the balance sheet. The income statement and statement of cash flow or D the asset sheet. The statement of liabilities and the statement of a cash flow. If you guessed C the balance sheet, the income statement and the statement of cash flow. Congratulations, you are correct. So when I say the balance sheet balances, what I mean is that assets equal liabilities and equity. Assets equal liability and equity. And so why is that? Because when I record a journal entry, I must record a journal entry that balances. My debits have to equal my credits. And my balances are always as of a certain point in time. So when I recorded activity or something that occurred in the business as far as the transaction, my debits always must equal my credits. And that's why the balance sheet always balances. It's funny I have a business owner that has had her business for at least 20 years. Very successful and said she just found out why her balance sheet balances or the fact that he does balance. So I don't want you to get to that point where it's 20 years down the road and you're just really realizing this. The balance sheet is supposed to balance your assets should always equal equal your liabilities and equity. The books of any business is called a general ledger. The books of your business is considered to be a general ledger. Whether it's in the computer are on paper. Whenever a transaction is recorded in your business, it is recorded in a general ledger. This is very old accounting practice. And when I recorded transaction in my general ledger, my debits must equal my credits. There are two sides to every entry. The debits have to equal the credits and this is recorded as a journal entry. So when I get my balance sheet, my income statement, my statement of cash flow the balance sheet and the income statement comes from the general ledger balances. Any entry I need to record, I use a journal entry and I do what is called posting that journal entry into a general ledger. And the general ledger includes my chart of accounts. What is in my chart of accounts? It's a listing of all the accounts that I would use for any activity in running my business. So all my asset accounts, cash accounts, receivable, inventory on my liability accounts accounts payable accrued salaries, all of my income accounts revenue, my expense accounts, all of these are in my chart of accounts. So I suppose you're wondering what this looks like. If I deposit $200 in cash from the sale of whatever I'm selling I'm going to debit cash and credit sales or revenue. And this is what the journal entry looks like. The owner of the business needs to put in $500 into the business. So we debit cash for 500 and we credit equity for 500. And notice the two examples that I have shown you both balanced debits equal credits. In this example, I sell something for $100 but I do not get cash for this. Instead I record this as an accounts receivable. So I debit accounts receivable and I credit sales or revenue. And so again it's clear that this the debits equal the credit and this is what the journal entry would look like when I record this transaction. In this next example, I have an expensive $50 for salaries which I pay for in cash. And the journal entry is a debit to salaries which is an expense. If I want to increase in expense account, I debit the expense and I'm decreasing my cash. So I'm crediting the cash. Again, debit to increase the expense credit to decrease the cash. I know you're getting excited about what this is doing to your general ledger. I'm recording all of these transactions and you're going to see with an unimaginable amount of excitement what is going to result from all of these transactions? So in this case I get an electric bill for $50 so I debit the utility's expense and I didn't pay it yet so I'm going to credit accounts payable. This tells me that I owe $50 for this bill. So I'm recording the expense but I haven't yet paid it. So the journal entry is still a debit will equal credit but there's no cash that's gone out of my system yet. No cash that's gone out of my bank account. But I am recording this transaction. This is considered a cruel accounting. In this example I get a bill for rent and I'm going to again debit the expense which is debiting rent expense. And I haven't paid it again so I'm going to credit accounts payable. So this journal entry affects both the income statement and the balance sheet. The income statement, rent expense is part of the income statement, right? In expense is part of my income statement and accounts payable is part of my balance sheet. So this is impacting my income statement and my balance sheet. So I double at the expense which is increasing the expense and I credit my liability which is increasing my liability. This is so exciting. You had a chance to see in action how journal entries are created and used. The journal entries that I showed you all of them balance debits equal credits. If I had more lines on any of the journal entries, it would still have to balance I could have three lines as the debits, three lines, those credits or five lines as credits. But they all the debits would need to equal the credits. Once the journal entries are posted are recorded in the general ledger for any time period, say we're talking about a month. Then I can take the totals for the month and create the balance sheet, the income statement and the statement of cash flow. [SOUND]
