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Balance Sheet - PowerPoint Presentation

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Balance Sheet - PPT Presentation

This module provides an introduction to the balance sheet one of the essential financial statements in accounting and includes an introduction to debits and credits and double entry accounting We suggest doing the Balance Sheet module prior to the Income Statement ID: 142623

credits debits balance assets debits credits assets balance liabilities sheet mbtn 000 management cash numbers equity shareholder change 500 transactions accounts current

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Slide1

Balance Sheet

This module provides an introduction to the balance sheet, one of the essential financial statements in accounting and includes an introduction to debits and credits, and double entry accounting. We suggest doing the Balance Sheet module prior to the Income Statement.

Author: Stu James© 2014 Stu James and Management by the Numbers, Inc.Slide2

The balance sheet is one of the essential financial statements (reports) for a company and is a required filing for all public companies.

Understanding how to read and interpret a balance sheet is an important skill for a business person or investor.The balance sheet provides important information about the financial health of a company at a particular point in time – a “snapshot”. This information includes:

Assets (what the company owns)Liabilities (what the company owes)Shareholder’s Equity (what is left for shareholders)Introduction to the Balance Sheet2Introduction to the Balance Sheet

MBTN | Management by the NumbersSlide3

Sample Balance Sheet

3Sample Balance Sheet

MBTN | Management by the NumbersFacebook, Inc.As of Sept 30, 2013$MillionsAssets14,933Liabilities1,885Shareholder Equity13,048

Here is a (very) simplified balance sheet for

Facebook

, Inc. as of Sept 30, 2013.

Facebook’s

balance sheet consists of three major categories.

What else can we say?

First, note that

Assets = Liabilities + Shareholder Equity

($14,933 = $1,885 + $13,048)

This must always be true!

Second, note that the figures are as of Sept 30, 2013, a particular moment in time.

We can also say that

Facebook’s

assets (what it owns) far outweighs its liabilities (what it owes).

Now let’s look at these three parts of the balance sheet in more detail.Slide4

Legal Rights4

Legal Rights

MBTN | Management by the NumbersFacebook, Inc.$MillionsAssetsProperty14,933LiabilitiesPrimary Rights1,885

Shareholder Equity

Secondary

Rights

13,048

Another way to look at this is a more formal legal definition where we have property (assets) and two general classes of property rights (liabilities and shareholder equity).

So we can also say that

Facebook

has $14,933 of property, of which $1,885 is claimed through liabilities, and $13,048 is left for shareholders. Legally, this is generally how it works.Slide5

Assets5

Assets

MBTN | Management by the NumbersFacebook, Inc. Assets$Millions Cash and Cash Equivalents3,100 Short-Term Investments6,228 Receivables879

Inventory

0

Other Current Assets

342

Total Current Assets

10,549

Plant,

Property and Equipment

2,685

Intangible Assets

1,609

Other Assets

90

Total Assets

14,933

Let’s look at

Facebook’s

assets in more detail:

First, note that assets are divided into current assets and non-current assets. Examples of current assets include cash, CDs, marketable securities (stocks and bonds), accounts receivable (payments owed to a company by customers), inventory, and pre-paid expenses (when a company pays a bill in advance).

Definition: Current Assets

are those assets which can reasonably be expected to be converted into cash within one year.Slide6

Assets6

Assets

MBTN | Management by the NumbersFacebook, Inc. Assets$Millions Cash and Cash Equivalents3,100 Short-Term Investments

6,228

Receivables

879

Inventory

0

Other Current Assets

342

Total Current Assets

10,549

Plant,

Property and Equipment

2,685

Intangible Assets

1,609

Other

Assets

90

Total Assets

14,933

Now let’s consider non-current assets:

Examples of non-current assets include buildings, vehicles, operating plants, equipment, office furniture, and intangible assets. Intangible assets would include intellectual property and goodwill. Most long-term assets are depreciated or amortized over time. Depreciation and amortization represent how a long-term asset gets used up over time.

Definition: Non-Current Assets

are longer-term assets that are not expected to be liquidated. These are depreciated or amortized over time.Slide7

Liabilities7

Liabilities

MBTN | Management by the NumbersFacebook, Inc. Liabilities$Millions Accounts Payable489 Short-Term Debt459 Other Current Liabilities

36

Total Current Liabilities

984

Long Term Debt

287

Other Liabilities

614

Total Liabilities

1,885

Let’s look at

Facebook’s

liabilities in more detail:

Just like current assets, current liabilities are those debts that are expected to be paid during the coming year. Examples of current liabilities include accounts payable (what a company owes vendors for products or services purchased), taxes payable, debt of less than one year or debt coming due within a year (bonds that mature in the coming year).

Definition: Current Liabilities

are

those debts

which are expected to

be paid within the coming year.Slide8

Liabilities8

Liabilities

MBTN | Management by the NumbersFacebook, Inc. Liabilities$Millions Accounts Payable489 Short-Term Debt459 Other Current Liabilities

36

Total Current Liabilities

984

Long Term Debt

287

Other Liabilities

614

Total Liabilities

1,885

Now let’s consider

Facebook’s

long-term liabilities:

Long-term liabilities include items such as long-term bonds with a maturity date over a year, real estate loans, and other long-term bank loans.

Definition: Long-Term Liabilities

are those debts which are expected to be repaid more than a year in the future.Slide9

Shareholder Equity9

Shareholder Equity

MBTN | Management by the NumbersFacebook Shareholder Equity$Millions Retained Earnings2,636 Capital Surplus10,399 Other Shareholder Equity13

Total Shareholder Equity

13,048

Now let’s look at

Facebook’s

Shareholder Equity:

Shareholder equity includes retained earnings (from the Income Statement), Capital Surplus (any initial or subsequent investment in the company by shareholders beyond the par value of the stock). In addition, the par value of any preferred or common stock would be listed here separately.

Definition: Shareholder Equity

accounts are the residual accounts – what would be left for the shareholders after all liabilities are paid.

Insight

Equity accounts represent the (residual) value of the company (or, assets minus liabilities)Slide10

Transactions10

Transactions

MBTN | Management by the NumbersAn accounting transaction is an event that must be recorded in a company’s accounting system that impacts the balance sheet and/or income statement. These are also call journal entries. Let’s look at a few simple transactions that impact the balance sheet so you can better understand how the balance sheet works in practice.Consider the following transaction events:Receiving a 30 day loan as a $1,000 cash deposit from a bankObtaining $5,000 from an investorBuying $3,000 of inventory with cash

Paying a $3,000 bill owed to vendor

Receiving a $500 wire payment from an international customer

How do these transactions impact the balance sheet?Slide11

Transactions11

Transactions

MBTN | Management by the NumbersReceiving a $1,000 loan will impact two areas as shown below. It will increase your cash balance by $1,000 and increase your short-term liabilities by $1,000 (maintains assets = liabilities + shareholder eq.). AssetsLiabilitiesShareholder EquityCashS-T Liabilities

+$1000 =

+$1000

+ $0

Obtaining $5000 from an investor will also increase your cash balance. But instead of a liability, the offsetting entry is capital surplus under equity (maintains assets = liabilities + shareholder equity).

Assets

Liabilities

Shareholder Equity

Cash

Capital Surplus

+$5000 =

+$0

+ $5000Slide12

Transactions12

Transactions

MBTN | Management by the NumbersBuying $3,000 of inventory with cash only impacts the asset side of the balance sheet as shown, but the net effect maintains the equation.AssetsLiabilitiesShareholder EquityInventory+$3000 =

+$0

+$0

Cash

-$3000 =

+$0

+$0

$3000 -$3000 =

+$0

+$0

What if the inventory is purchased on credit with the vendor, instead?

Assets

Liabilities

Shareholder Equity

Inventory

Accounts Payable

$3000 =

+$3000

+$0Slide13

Transactions13

Transactions

MBTN | Management by the NumbersWhen the vendor sends an invoice for the inventory and it is paid with cash, cash will decrease and so will accounts payable.AssetsLiabilitiesShareholder EquityCashAccounts Payable

-$3000 =

-$3000

+$0

Note that the net on the accounts payable account is zero for the last two transactions. Paying on credit, instead of using cash, basically creates a temporary condition of a short-term liability, called accounts payable (A/P).

Take a moment to recognize that the net impact of a cash purchase of inventory is the same as a purchase on credit after paying the vendor. The accounting system just records the fact that the company owes the vendor a payment for the inventory, which is reflected in liabilities.Slide14

Transactions14

Transactions

MBTN | Management by the NumbersReceiving a $500 wire payment from a customer is kind of the flip side of paying a vendor for inventory already received. Here, a customer owes you money (recorded in accounts receivable), and pays it, removing the expected, but not yet received, payment owed by the customer.AssetsLiabilitiesShareholder EquityCash

+$500 =

+$0

+$0

Accounts Receivable

-$500 =

+$0

+$0

+$500 - $500 =

+$0

+$0

Just like the purchase of inventory earlier, this transaction only impacts the balances on the asset side of the balance sheet.Slide15

Debits and Credits15

Debits and Credits

MBTN | Management by the NumbersThis module provides basic understanding of how balances change with transactions. We’d be remiss if we didn’t mention one additional dimension to transactions – credits and debits.Every accounting transaction consists of one or more credits and offsetting debits such that the balance sheet equation is maintained (assets = liabilities + shareholder equity). You can have debits and credits in each major category of the balance sheet. What matters is that credits = debits and that change in assets = change in liabilities + shareholder equity!Definition: For every transaction,

Credits = Debits

Assets = Liabilities + Shareholder Equity - and -

Net Change in Assets = Net Change in (Liabilities + Shareholder Equity)Slide16

Debits and Credits16

Debits and Credits

MBTN | Management by the NumbersAccount CategoryDebit / CreditIncrease / DecreaseAssetDebitIncreaseAssetCredit

Decrease

Liability

Debit

Decrease

Liability

CreditIncrease

Equity

Debit

Decrease

Equity

Credit

Increase

The table below is a summary that you can use to determine if a transaction is a debit or a credit, or whether it will increase or decrease the balance of the account category.

So, rather than putting in a negative number to decrease an asset account, we credit it. Rather than putting in a negative number to decrease a liability account, we debit it.Slide17

Debits and Credits17

Debits and Credits

MBTN | Management by the NumbersThe system of using debits and credits, or double entry bookkeeping, originated in Venice over 500 years ago. The system is still in use today, though obviously modernized through the use of computers. Computers have vastly improved on the manual approach of “T” tables, but the approach is still the backbone of the system.InsightWhile the computer ensures that values balance, the data entered must be accurate and the right accounts must be chosen or the balance sheet will not be an accurate portrayal of the company’s position.

Assets

Liabilities

Shareholder Equity

Cash

S-T

Liabilities

Debits

Credits

Debits

Credits

Debits

Credits

$1000

$1000

“T” TableSlide18

Debits and Credits18

Debits and Credits

MBTN | Management by the NumbersNow let’s try our examples again, but using the full system of debits and credits, as well as showing the impact on the account.Receiving a 30 day loan as a $1000 cash deposit from a bankObtaining $5000 from an investorBuying $3000 of inventory with cashPaying a $3000 bill owed to vendor

Receiving a $500 wire from an international customer

Here is the entry for the first transaction. Now try the others:

Assets

Liabilities

Shareholder Equity

Cash

S-T

Liabilities

Debits

Credits

Debits

Credits

Debits

Credits

$1000

$1000

Increase

Increase

No changeSlide19

Debits and Credits19

Debits and Credits

MBTN | Management by the NumbersObtaining $5,000 from an investorAssetsLiabilitiesShareholder EquityCash

Capital Surplus

Debits

Credits

Debits

Credits

Debits

Credits

$5000

$5000

Increase

No change

Increase

The cash account is debited (increases) by $5,000 and the capital surplus account is credited (also increases) by $5,000. Debits and credits are equal ($5,000 = $5,000). Change in assets = Change in liabilities + shareholder equity ($5,000 = $5,000)Slide20

Debits and Credits20

Debits and Credits

MBTN | Management by the NumbersBuying $3,000 of inventory with cashAssetsLiabilitiesShareholder EquityCash

Debits

Credits

Debits

Credits

Debits

Credits

$3000

Inventory

Debits

Credits

Debits

Credits

Debits

Credits

$3000

Cash decreases (credit) and Inventory

increases (debit), but no net change in assets.

No change

No changeSlide21

Debits and Credits21

Debits and Credits

MBTN | Management by the NumbersIf instead, the inventory had been purchased on credit (terms)…AssetsLiabilitiesShareholder EquityInventory

Accounts Payable

Debits

Credits

Debits

Credits

Debits

Credits

$3000

$3000

Increase

Increase

No Change

Later, paying the $3,000 bill owed to that same vendor

Assets

Liabilities

Shareholder Equity

Cash

Accounts Payable

Debits

Credits

Debits

Credits

Debits

Credits

$3000

$3000

Decrease

Decrease

No ChangeSlide22

Debits and Credits22

Debits and Credits

MBTN | Management by the NumbersReceiving a $500 wire payment from an international customerAssetsLiabilitiesShareholder EquityCash

Debits

Credits

Debits

Credits

Debits

Credits

$500

Accounts Receivable

Debits

Credits

Debits

Credits

Debits

Credits

$500

Cash increases (debit) and Accounts

Payable decreases (credit), but no net change in assets.

No change

No changeSlide23

Building a Balance Sheet

23Building a Balance Sheet

MBTN | Management by the NumbersThe last example we’ll use is to create a balance sheet from scratch for a start-up coffee shop. While this is obviously a very simplified exercise, it will help you understand how the transactions build together to create the balance sheet.On the next page, there are 7 transactions that you can use to test your comprehension. Try to build it yourself before checking the answer key. We’ve also provided the detail on all the individual transactions so you can follow how the accounts were updated.Slide24

Building a Balance Sheet

24Building a Balance Sheet

MBTN | Management by the NumbersCreate a balance sheet from the following transactions:An investor starts the company with $25,000 of cash.The manager obtains a $15,000 long-term loan from a local bank. The manager purchases an espresso maker for $1,500 on credit.The manager purchases a computer for $1,000 for cash.

The manager purchases $2,500 of goods to resell (inventory) using cash.

The manager signs a 3 year contract to rent a building space that requires a $1,000 deposit and first month’s pre-paid rent of $1,000.

The manager writes the check for the deposit and rent.

Ready, set, go

– don’t advance until you’ve tried it!Slide25

Building a Balance Sheet

25Building a Balance Sheet

MBTN | Management by the NumbersAssets$ Cash$34,500 Inventory$2,500 Pre-Paid Rent$1,000

Current Assets

$38,000

Equipment

$2,500

Deposit

$1,000

Total Assets

$41,500

Liabilities

$

Accounts Payable

$1,500

Current Liabilities

$1,500

L-T Liabilities

$15,000

Total Liabilities

$16,500

Shareholder Equity

$

Capital Surplus

$25,000

Total SH Equity

$25,000

Total

Liab

. + Equity

$41,500

Though very simple (and only including transactions that impact the balance sheet alone), this exercise provides a good sense of how the balance sheet changes over time. The detail of the transactions and T accounts are shown on the following pages for reference.Slide26

Building a Balance Sheet

26Building a Balance Sheet

MBTN | Management by the NumbersAssetsLiabilitiesShareholder EquityCash

Capital Surplus

Debits

Credits

Debits

Credits

Debits

Credits

$25,000

$25,000

Increase

No change

Increase

Assets

Liabilities

Shareholder Equity

Cash

Long-Term

Liab

.

Debits

Credits

Debits

Credits

Debits

Credits

$15,000

$15,000

Increase

Increase

No Change

Assets

Liabilities

Shareholder Equity

Equipment (or PPE)

Accounts Payable

Debits

Credits

Debits

Credits

Debits

Credits

$1,500

$1,500

Increase

Increase

No ChangeSlide27

Building a Balance Sheet

27Building a Balance Sheet

MBTN | Management by the NumbersAssetsLiabilitiesShareholder EquityCash

Debits

Credits

Debits

Credits

Debits

Credits

$1,000

Equipment

Debits

Credits

Debits

Credits

Debits

Credits

$1,000

No net change

in Assets

No change

No change

Assets

Liabilities

Shareholder Equity

Cash

Debits

Credits

Debits

Credits

Debits

Credits

$2,500

Inventory

Debits

Credits

Debits

Credits

Debits

Credits

$2,500

No net change

in Assets

No change

No changeSlide28

Building a Balance Sheet

28Building a Balance Sheet

MBTN | Management by the NumbersAssetsLiabilitiesShareholder EquityCash

Debits

Credits

Debits

Credits

Debits

Credits

$2,000

Prepaid Rent

Debits

Credits

Debits

Credits

Debits

Credits

$1,000

Deposits

Debits

Credits

Debits

Credits

Debits

Credits

$1,000

No net change

in Assets

No change

No change

Signing the contract generally does not create an accounting transaction, only when the deposit and pre-paid rent is actually paid.Slide29

MBTN Income

Statement Module. This MBTN module provides a similar introduction to the income statement. Financial Statements– Further Reference

29Financial Statements - Further ReferenceMBTN | Management by the Numbers