Welcome to understanding your finances part two. In part one we talk about the six basic things you need to know. Now we talk about how to organize this information so we can easily see what’s happened in your business at any given time. If you have the watch part one, I do recommend you go back and see it. To understand how to organize the six things you need to know, let us meet our two friends; the income statement and the balance sheet.
The income statement is our first friend. The income statement answers what I earn, what I spend and what I have left over in the business this year. Now George’s tenant paid him $15,000 in rent the first year (these are just assumptions). So, his total revenue will be the $15,000. However, to keep this income, he had to have some expenses. He had to have repair expenses. He had to pay property taxes. He had to market for a period to bring in the tenants. So, all this expensive required to keep producing income from his assets. And then in addition, he also had an interest expense. Interest expense however is not really required to keep producing income from the asset. But it’s only required because he did not have enough capital to buy his property outright, so he had to take a loan. So, interest expense is something paid on the debt on the asset. So, it’s only necessary when there is debt.
George gets to keep $13,375 for his business the first year. So, that’s pretty good. So, in other words that interest expense is justified because without that expense he would not have had the income. So, you really have to weigh the cost benefit analysis when it comes to interest. If the interest expense is not bringing you more income or it’s not helping you invest an asset that can bring you more income that it might not be worth your while to invest in that asset.
So, now let’s look at two which is brand number two, is a balance sheet statement. It answers what I have, what I used to get what I have or what I’ve kept in the business over time. So, we can see the balance sheet statement on the right. We can see cash is $13,375 which is the amount George netted because the property was a $100,000. Those are the only two assets George had. For education purposes I am not taking into account depreciation. And then, we can see property loan was $70,000 which was the loan he received. I did not include any principal payments just keep it simplified. We’re just make an assumption he made only interest only payments. The interest was on the income statement. Capital contributions were $30,000 and retained earnings which is his income was $13,375. So, we can see liabilities plus equity equals $113,375. Assets must always equal Liabilities plus equity. So, that means assets has financed with either debt or equity. That’s the only two ways which is what the balance sheet tells you is, what you have, your assets and how did you get it? Did you use capital contributions, or did you use debt to get it? Or did you get it from your retained earnings?
Now I want you take the time and look at your financials and leave any questions you want me to address and feature videos below. Thank you.
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